Waters Corporation (WAT) Q2 2020 Earnings Call Transcript

Waters Corporation (NYSE: WAT) Q2 2020 earnings call dated Jul. 28, 2020

Corporate Participants:

Bryan Brokmeier — Senior Director Investor Relations

Flemming Ornskov — Chairman of the Board, Waters Corporation and Chief Executive Officer, Galderma SA

Christopher J. O’Connell — President and Chief Executive Officer

Sherry L. Buck — Senior Vice President and Chief Financial Officer

Analysts:

Vijay Kumar — Evercore ISI — Analyst

Derik De Bruin — Bank of America Merrill Lynch — Analyst

Tycho Peterson — JPMorgan — Analyst

Douglas Schenkel — Cowen and Company — Analyst

Dan Leonard — Wells Fargo Securities — Analyst

Stephen Beuchaw — Wolfe Research — Analyst

Jack Meehan — Nephron Research — Analyst

Presentation:

Operator

Good morning. Welcome to the Waters Corporation Second Quarter 2020 Financial Results Conference Call. [Operator Instructions]. If anyone has any objections, please disconnect at this time.

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

Bryan Brokmeier — Senior Director Investor Relations

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation second 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 commentary on potential market and business conditions the Company expects for the third 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 may 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 31st, 2019, in Part 1 under the caption Risk Factors and in our most recent quarterly report on Form 10-Q for the quarter ended March 28th, 2020 in Part 1 under the caption, Risk Factors, both of which are on file with the SEC, as well as the cautionary language included in this morning’s press release, including with respects 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 October 27, 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 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, in comparison to the second 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 Dr. Flemming Ornskov, Waters’ Chairman of the Board to make a few brief comments. Flemming?

Flemming Ornskov — Chairman of the Board, Waters Corporation and Chief Executive Officer, Galderma SA

Thank you, Bryan, and good morning everyone. I wanted to join at the beginning of this call for two reasons. First, to thank Chris for his contribution to Waters; and second, to discuss our leadership transition process and the appointment of Udit Batra as Waters’ next CEO. I want to begin by thanking Chris for his leadership over the last five years and for his commitment to ensuring a seamless leadership transition through the end of this year.

Over the course of the last few months, which have been particularly challenging against the background of a global pandemic, Chris has kept the team focused on execution. Throughout his tenure, Chris has demonstrated a clear commitment to advancing a new product cycle that has in part helped us establish a strong foundation for growth.

As you know, on July 15th, we announced that Udit will be joining us on September 1st. Udit is a highly accomplished executive with more than two decades of leadership and operational expertise in our industry. He has demonstrated a proven track record of delivering tangible financial, and operational results as evidenced by his prior roles at Merck KGaA, headquartered in Darmstadt, Germany.

Importantly, he also has a strong appreciation for our purpose, culture and people. We are confident he will help Waters build on our foundation and usher in our next chapter of innovation, growth and shareholder value. I know Udit is eager to get going and we look forward to introducing him when he officially joins us in September.

With that, I’ll turn the call over to Chris and Sherry to conduct the earnings call and Q&A.

Christopher J. O’Connell — President and Chief Executive Officer

Thank you for the kind words Flemming, 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 that you and your loved ones are doing well as the world continues to manage through this truly extraordinary time of the global COVID-19 pandemic. It’s amazing how much is happening on a daily basis, and I wish you peace and fortitude as we all work hard to improve both health and economic conditions for everyone.

During today’s call, I will provide an overview of our second quarter operating results as well as some broader commentary on our business in the context of COVID-19 and describe the actions we are taking to emerge from this period stronger than ever. Sherry will then review our financial results in detail, and update you on our financial actions as it relates to the balance sheet and cost structure.

We will then open up the phone lines and Sherry and I will take your questions. To briefly review our operating results for the quarter, Q2 sales declined 12%, and adjusted earnings per share declined 2%. While Q2 was expectedly a bit softer than Q1 in terms of year-over-year growth, our revenue results reflected modestly better market conditions than we had anticipated, an increasing impact of new products as well as strong execution by our global sales, service and operational teams.

During the quarter, we also executed well on our plans to achieve meaningful near-term cost savings to ensure our financial strength and flexibility under a variety of recovery scenarios. This combination of higher-than-expected revenue and the timing of our near-term cost actions enabled us to exceed our margin and EPS expectations. As we enter the second half of the year, we are focused on our recovery trajectory and normalizing our operating spend and investment in the business. I am very proud of our team’s execution across the business in this dynamic environment.

Looking ahead, while risks and uncertainties in our operating environment remain as a result of the COVID-19 pandemic, we believe that our end markets and geographies will see modestly better conditions in the second half of 2020 than they did in the first half. I will provide some additional color on this later in my remarks.

As we navigate the COVID-19 global pandemic, we continue to execute against our five point value creation model which emphasizes our unique specialty positioning, organic innovation, operating excellence, disciplined capital deployment, and a sharp focus on people and culture. That said, I’d like to focus my comments today on our near-term operating priorities relating to the COVID-19 period that I outlined on our last earnings call. We are making great progress against each of them.

First, our top priority remains the health, safety and well-being of our employees and our customers. The deliberate actions and cautions we have taken during the pandemic have minimized the infection rate within our employee population, while still enabling the organization to operate efficiently and effectively. Our multi-phased safe return to workplace process is well underway with teams returning to our major facilities in several stages. Our second priority is to ensure business continuity. Our service engineers have consistent access to customer sites globally in order to maintain, service and install instruments, while our sales reps have less consistent access given the varied pace of recovery across our geographies.

Salesforce access has been improving however, as customers continue to ramp up their laboratory operations. That said, our strategic technology investments over the last several years are paying off, and have enabled us to effectively serve the vast majority of sales, service and scientific activities with a hybrid in-person and digital effort. We have been successful getting our experts in front of customers through virtual events and we are restoring normal interactions with sales reps and regional specialists where possible.

Operationally, we have confidence in the continuing stability of our supply chain, manufacturing and distribution processes. Our third priority is maintaining our financial strength, flexibility and liquidity even in our most conservative forward looking scenarios. Exiting the second quarter, we are on track to achieve our $100 million cost savings plan for the year relative to our prior internal forecast.

We are nearly complete, returning those employees on temporary 90-day furlough to work, we have restored full hours and salaries and we have now reoriented our focus towards investment in the business in the second half to enable our return to growth. Sherry will provide more details on these measures during her remarks. Our fourth priority is to accelerate our recovery, by focusing on actions we can control.

In particular, we are taking direct action to a, maximize the impact of our strong new product cycle, b, target our R&D efforts on near-term product introductions, c, service our installed base either remotely or in person as customer labs allow, and d, focus our sales efforts on customer labs that are open to operation. In Q2, we saw an increased contribution from our recently launched mass spec products while launching an important new LC instrument. More on this in a few minutes.

Finally, we are continuing to contribute our expertise and capabilities in the global fight against COVID-19. Our customers have responded enthusiastically to our offers of deep scientific and technical expertise across a range of COVID-19 therapy and vaccine candidates under development. In particular, our unique system solutions have been very useful in critical workflows including peptide mapping, glycans analysis and oligonucleotide analysis. While the short-term revenue impact is minimal, these efforts have been deeply appreciated and have greatly advanced relationships across our customer base while also advancing the fight against COVID-19.

Now, I would like to make a few comments on our outlook. As we outlined last quarter, our planning scenarios are based on a categorization of each geography into one of three phases of the COVID-19 pandemic: Containment, Recovery, and Return to growth. We currently believe that all of our major geographies have now transitioned to the recovery phase. As a result, and as I mentioned before, we believe the second half will be modestly better than the first half.

However, we don’t anticipate that quarterly revenue growth will turn positive until 2021. From an end market perspective, our largest market, pharmaceutical is leading the recovery. Encouragingly, our top global pharma accounts grew in the second quarter and year-to-date. In addition, CXOs and large molecule pharma customers are recovering nicely, while generic and specialty pharmaceutical customers are still operating with more constrained capital budgets.

Looking ahead, though we expect most pharma customers to return to normalized operations this fall, risks and uncertainties certainly remain, particularly in Q4 around meaningful year-end budget releases that we typically see. Our industrial markets are recovering more slowly with customers generally operating under tighter capital budgeting restrictions than in pharma. Notably, because these customers provide less recurring revenue than our pharma customers returning to normal operations doesn’t immediately result in a corresponding return of spending in the form of capital equipment.

Within the industrial category material, science labs are operating at higher activity levels than food and environmental labs and we expect them to return to normal levels more quickly. Lastly, academic and governmental markets are lagging corporate customers, and are expected to be the slowest to recover. Many academic labs remain closed or only partially open, while governmental business has been significantly impacted by delayed tender activity.

Turning now to our geographies, all major regions have transitioned from containment to recovery phase with each seeing steadily increasing customer activity throughout the quarter. A number of countries including China, other countries in Asia and parts of Europe are moving through the recovery phase more rapidly. On the other hand, the United States, India and remaining parts of Europe are progressing more cautiously through these various stages of easing restriction.

In aggregate, as we look to the second half of the year, we are expecting improved demand across the business, in particular for instruments as we expect a gradual easing of capital spending with constraints in all of our end markets. Looking specifically at China, the pharma market is leading the recovery with solid growth in large molecule pharma and CXOs.

Generic pharma remains under pressure as customers remain cautious on capital spending in the context of both the GPO program implementation and the COVID-19 pandemic. That said, China’s pharma recurring revenues grew in the quarter across both large and small molecule which we expect to continue bolstering our confidence that we will see increasing instrument demand over time.

China’s food and environmental markets were down in the second quarter, reflecting the continued funding pressure that is impacting government labs, partially offset by growth within independent labs. Elsewhere in Asia, recovery is a mixed picture with strength in certain geographies such as Korea and slower recoveries in other regions such as Japan and India.

Turning to the US, we are seeing a dynamic and somewhat uncertain environment with various states experiencing increasing COVID-19 cases over the past several weeks. And therefore, are seeing rollbacks of previously implemented reopening plans. The pharma market is leading the recovery, driven by large molecule customers.

Capital spending is slowly, but steadily improving, and we are seeing strong customer support for our new products. Elsewhere in the Americas, Latin America remains very soft. Lastly in Europe, recoveries in the countries of Southern Europe and Northern Europe are lagging those in Eastern Europe and Central Europe. Pharmaceutical markets are recovering more quickly than other markets with QA/QC reporting growth in the second quarter.

Our recent European performance has been stronger compared to the Americas, because many European countries have been more effective managing COVID-19 containment efforts and European customers are adopting some of our new mass spec technology at a faster rate than other geographies as we typically see. Aside from these current market dynamics, we remain sharply focused on our primary growth strategy of organic innovation.

We believe we are well positioned to leverage our robust and growing new product pipeline as demand normalizes and we expect continuing increases in contribution from new products. Looking at the Waters product line, there is increasing evidence of traction of new products throughout the quarter particularly BioAccord and Cyclic IMS. In addition, we launched six new instruments year-to-date and have received very positive initial feedback. These new product launches were highlighted by the Arc HPLC, a rugged, reliable and modern HPLC system that is a significant advancement, and enhances our strong technology leadership position in the core, liquid chromatography market.

In our TA Instruments product line, the three new products launched last quarter at PittCon have received strong customer interest. Material science markets have been challenged, but these products are poised to support future growth and market share gains. In summary, the sales in our second quarter continued to be impacted by the COVID-19 pandemic. Our revenue results reflected modestly better market conditions than we had anticipated, and increasing impact from our new products as well as strong execution by our global sales, service and operations teams.

We also took decisive actions to manage our cost to ensure the largest portion of our 2020 savings plan in the second quarter, which as expected was a more challenging environment than the first quarter. This combination of better than expected top line performance with the benefits of our cost containment efforts enabled us to exceed our margin and EPS expectations. Although risks remain with the uncertain trajectory of the global COVID-19 pandemic, we expect market conditions to improve modestly in the second half versus the first half of the year, and therefore have accelerated our growth investments to take advantage of opportunities as demand recovers.

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

Sherry L. Buck — Senior Vice President and Chief Financial Officer

Thank you, Chris and good morning everyone. In the second quarter, we recorded net sales of $520 million, a decrease of approximately 12% in constant currency. Currency translation decreased sales growth by approximately 1% resulting in a sales decline of 13% as reported. In the quarter, sales into our pharmaceutical market declined 10%, sales into our industrial market declined 13% while academic and governmental markets declined 21%.

Looking at our product line growth, our recurring revenue, which represents the combination of precision chemistry products and service revenue declined 3% in the quarter while instrument sales declined 23%. As we noted last quarter, there was no year-over-year difference in the number of calendar days during the second or third quarters, but there are two additional calendar days in the fourth quarter of 2020 compared to 2019.

Chemistry revenues were down 4% in the quarter, driven mostly by weakness in academic and governmental. On the service side of our business, revenues were down 2% as mid single digit growth in service contract revenues were offset by a decline in on-demand service revenues and spare parts. Breaking second quarter product sales down further, sales related to Waters branded products and services declined 12%, while sales of TA-branded products and services declined 20%.

Combined, LC and LCMS instrument platform sales declined 24% and TA’s instrumentation system sales declined 20%. Looking at our growth rates in the second quarter geographically, and on a constant currency basis, sales in Asia declined 12% with China down 20%. Sales in Americas declined 15%, including a 14% decline in the US and European sales were down 9%. Before I comment on our second quarter non-GAAP financial performance versus the prior year, I would like to update you on the progress of our cost actions in response to the COVID-19 pandemic that we shared with you during our last quarterly earnings call.

We are on track to achieve cost savings of approximately $100 million for the year relative to our prior pre-COVID internal plan. We achieved about 60% of our planned annual savings in the first half of the year, which was better than expected, as we focused on aligning our operations and investments with our growth challenge in the second quarter.

This result flow through our P&L and is the primary driver for favorable performance in gross and operating margins versus the second quarter of 2019. Looking ahead, while we plan to maintain strong operating discipline through the end of the year, a significant portion of our cost actions were enacted for a 90-day period and are nearly complete. Employees are returning from temporary 90-day furloughs, and we have restored reduced work hours and salaries to normal levels.

As a result, the second half of the year will not reflect the same level of savings reported during the second quarter, as we re-orient our focus towards growth investment in the business in the second half. We anticipate the remaining 40% of our cost savings to be achieved in the second half of the year. This plan reflects our core assumption that the business moves to the recovery phase and business conditions improve in the second half. We’re monitoring our business conditions and we will adjust our plans as appropriate based on the pace of the recovery.

Returning to our second quarter’s non-GAAP financial performance, gross margin for the quarter was 59% compared to 58.4% in the second quarter of 2019, primarily as a result of our cost savings actions. Moving down the second quarter P&L, operating expenses decreased by approximately 13% 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 15.4% compared to 15.7% in the prior year. Net interest expense was $9 million, an increase of about $3 million as anticipated. Our average share count came in at 62.2 million shares, a share count reduction of approximately 11% or about 7 million shares lower than in the second quarter of last year as a result of shares repurchased through the end of the first quarter of 2020, subsequent to which we paused the share repurchase program.

Our non-GAAP earnings per fully diluted share for the second quarter decreased to $2.10 in comparison to $2.14 last year. On a GAAP basis, our earnings per fully diluted share decreased to $1.98 compared to $2.08 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 second quarter results and activities. We define free cash flow as cash from operations, less capital expenditures and excluding special items.

We made good progress in the quarter on our capital expenditure and working capital improvement plans shared during the last quarterly earnings call, and we also remain on track for the full year. In the second quarter of 2020, our free cash flow came in at $175 million after funding $46 million of capital expenditures. Excluded from free cash flow was $23 million related to the investment in our Taunton precision chemistry operation. In the second quarter, this resulted in $0.34 of each dollar of sales converted into free cash flow, and $0.30 year to date.

Our strong free cash flow was primarily a result of cost savings actions implemented in the second quarter. Turning to working capital, accounts receivable days sales outstanding came in at 87 days this quarter, up 8 days compared to the second quarter of last year and inventories decreased by $8 million in comparison to the prior year quarter, reflecting revised production schedules. Waters maintains a strong balance sheet, access to liquidity and a well structured debt maturity profile.

We ended the quarter with cash and short-term investments of $356 million and debt of $1.7 billion on our balance sheet at the end of the quarter. This resulted in a net debt position of $1.3 billion, and a net debt to EBITDA ratio of about 1.8 times at the end of the second quarter. We also have $1 billion available on our bank revolver for a total available liquidity of $1.4 billion at the end of the second quarter. In terms of returning capital to shareholders, while our future capital structure target of approximately 2.5 times net debt to EBITDA remains unchanged, our near-term focus is maintaining financial flexibility and preserving liquidity.

As a result, our share repurchase program remains on hold, and so we see a more stable and predictable business environment. We expect the actions we’ve taken will continue to provide us with adequate flexibility under a variety of potential recovery scenarios. Given the uncertainty surrounding the magnitude and duration of the COVID-19 pandemic, and its impacts on our customers, we’re not providing full year guidance. However, there are a few data points that will be helpful for modeling purposes.

Due to the timing of our cost actions, as discussed earlier, we expect full-year operating expense growth in the range of negative 1% to positive 1% year-over-year in constant currency. For the full year at current rates, currency translation is expected to decrease sales growth by about one percentage point and to negatively impact earnings per share by about 3 percentage points. For the full year, 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?

Christopher J. O’Connell — President and Chief Executive Officer

Thank you, Sherry. In summary, while the second quarter was challenging as we expected, we were very pleased with our results, which were driven by a modestly better market conditions than we anticipated, increasing impact from new products and the strong execution by our team. We are looking forward to the back half of the year, and we are optimistic that the Company is well positioned to return to growth in 2021.

Before we take questions, I would like to add a few brief comments on our upcoming CEO transition. It has been the honor and privilege of my career to serve as the CEO of Waters Corporation. I have loved every single day working with such inspiring customers and an incredibly talented and committed group of colleagues. Together, we have significantly advanced Waters over the course of the last five years, including, we have transformed our organic innovation engine and established an unprecedented new product pipeline and supplemented our technology portfolio through external investments and tuck-in acquisitions. We have implemented a new capital deployment framework with increasing emphasis on growth investments while also returning capital to shareholders.

And we have significantly advanced the Company’s talent organizational capability and technology infrastructure. I will pass the reins to Udit Batra on September 1st knowing that Waters is moving forward from a strong foundation. I extend my warm welcome and best wishes to Udit, and my gratitude to our Board of Directors for giving me the opportunity to serve as CEO of Waters.

Finally, I want to thank our investors and the equity research community. It has been a pleasure to work with all of you, and I wish you the very best. With that, Sherry and I will now begin the question-and-answer session. As we are not always able to get to everyone’s questions please limit yourself to one question and one follow up. And, if you have additional questions, please contact the Waters’ Investor Relations team after the call.

Operator?

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Vijay Kumar from Evercore ISI. Your line is open.

Vijay Kumar — Evercore ISI — Analyst

Hey, guys. Thanks for taking my questions. And Chris, wishing you all the best for your next phase of your career. I do feel like a part of the story that’s missed out here is some of the investments, the new product cycles that we’ve seen. Hopefully, it will bear fruit over the coming years. Just — on the topic of the new products, I think there was some comments on the call about how new products that came in better than expected in 2Q, I want to make sure I heard that right. And why wouldn’t this continue into the back half? Because, I think the second half sounded perhaps a little bit cautious maybe on third quarter capex commentary. Is that perhaps due to the feedback you’ve gotten from customers or any color I think would be helpful.

Christopher J. O’Connell — President and Chief Executive Officer

Sure. Well, thank you very much, Vijay for the comments and the question. And you’re right, the heart of our strategy is really the R&D investment that has grown consistently at twice the rate of sales growth over the past five years and is now producing this really great stream of new products. And I made comments on the call, not just on products that we have launched like BioAccord and Cyclic and some of the tandem quads last year. But also some new products that are coming into the market now, like the Arc HPLC and other systems and more that’s coming.

So we — we do have a lot of confidence in the new product pipeline. As it relates to the contribution, yes, you interpreted that correctly that in particular, BioAccord and Cyclic have — it really took a strong step forward in the second quarter with regard to orders and sales. I don’t want to quantify that. But we’re really I think coming into the power curve on those products and feel good about our pipeline for the remainder of the year. I tried to comment that we do expect the continuation of positive progress in terms of impact of new products in the second half of the year and increasing vitality index and an increasing overall contribution that we’ve seen in the second quarter and we expect to see in the second half.

That said, my comments on the — on the market conditions of the second half are important, because you know, while we are seeing recovery in all of our geographies and end markets, as you know there are a lot of puts and takes and there are likely to be setbacks and so our assumptions don’t assume everything just progresses on a straight line, we do assume different puts and takes and that everything doesn’t go perfectly, and there is also the question of year end budget flush. And to what extent pharma, in particular will release year end budget. So that’s really the reason for our overall tone on modestly better market conditions, but from a new product standpoint, we believe that, that story is very much intact and actually getting more exciting.

Vijay Kumar — Evercore ISI — Analyst

That’s helpful, Chris. And one more quick one for Sherry. I think you mentioned opex for the year at the midpoint is flattish, on a dollar basis, considering that second half perhaps revenues we’re still looking at that down in the second half. The implied opex growth in second half implies earnings still to be in the negative territory. I just want to make sure I have the math right on the earnings trajectory here for second half.

Sherry L. Buck — Senior Vice President and Chief Financial Officer

Yes, Vijay. Just to provide some clarity on that. So, as you know, we implemented a number of temporary cost actions earlier this year, many of them were 90 days in alignment but we have about 60% of that, that we achieved in the first half, and 40% in the second half. And so we’ll try to give you some data points around the operating expenses, and so we’re expecting on a full year range of negative 1% to positive 1% kind of year-over-year, full-year on a constant currency basis. So that’s kind of the commentary around the operating expenses.

Vijay Kumar — Evercore ISI — Analyst

Got you. Thanks guys.

Operator

Our next question comes from Derik De Bruin with Bank of America. Your line is open.

Derik De Bruin — Bank of America Merrill Lynch — Analyst

Hi, good morning everyone.

Christopher J. O’Connell — President and Chief Executive Officer

Good morning, Derik.

Derik De Bruin — Bank of America Merrill Lynch — Analyst

So — Hey, Chris, just remind me what are the capabilities of the Arc that you think it would drive a sort of replacement cycle? I’m just sort of comparing it to Alliance and just Waters — you know, basically it’s a question of like, do we expect at some point an upgrade cycle within your pharma customers for doing QA/QC, just a little bit more color on that. Thanks. I have a follow-up.

Christopher J. O’Connell — President and Chief Executive Officer

Sure. Sure, thanks Derik. You know, first part of your question there on Arc, you know, as you know, we have a very, very strong installed base and franchise with the Alliance HPLC as well as with the acuity UPLC of course on a higher end. And over the years, we’ve introduced intermediate technology and what you might call the UHPLC category and that’s the Arc — ACQUITY Arc platform. What we’ve done is built sort of ground up new sort of Arc range program, but targeted at the HPLC market, which allows method transfer from any direction, but really a modern chassis and interface really in the heart of where the core business is. And so we think that’s going to be a very important step forward in our core HPLC franchise and will allow the seamless transition of that large Alliance base over time, both mixed and matched as well as new installs.

So a lot of the — a lot of the follow-on innovation we’ve been doing in LC in recent years has been more in the UPLC category, and we’ve had a lot of good refresh of the ACQUITY line, and this is a very significant advancement more in the heart of the traditional HPLC franchise with the full method transfer in both directions.

Derik De Bruin — Bank of America Merrill Lynch — Analyst

I thought that was sort of what the H class was to begin with, it was basically allowing for method transfers.

Christopher J. O’Connell — President and Chief Executive Officer

Yeah. And it’s — I mean, again this is — that’s true. But this is a broader based product more for the core Alliance space. It’s also higher pricing alliance and has a number of key target applications in quality control laboratories such as batch release testing on small mall pharma. So this provides a much greater coverage and ease of transition in that environment.

Derik De Bruin — Bank of America Merrill Lynch — Analyst

Great. And so in — Sherry, can you help me think about the gross margin going forward? I mean, obviously there were a lot of cost savings come out with it, and it was much better than we thought. Kind of — how do we — we should think about that as some of the costs come in — come back in?

Sherry L. Buck — Senior Vice President and Chief Financial Officer

Yes. Hi, Derik. So, yeah, if you think about gross margins in the second half, and as you noted there, and in my prepared remarks, we did get a lot of benefit from the cost action. So while we still do have some remaining cost actions, they won’t be as significantly impacted on the second half and gross margin really becomes more of a factor of our volume mix, FX and fixed cost absorption. So just maybe to look at our first half performance, our gross margins in Q1 were about 55%, largely that was a pretty depressed gross margin from at the end of a small quarter. We had some fixed cost absorption and kind of a one-time FX translation. Our Q2 was at 59% and was probably higher, just driven by the benefit of our temporary cost actions. So if I were to look at our full-year gross margin, I would book it in between kind of that high and low of our Q1 and Q2.

Derik De Bruin — Bank of America Merrill Lynch — Analyst

Great, thank you. I’ll get back in the queue. Chris, good luck on your next endeavor. Thank you.

Christopher J. O’Connell — President and Chief Executive Officer

Thank you very much, Derik.

Operator

Thank you. Our next question comes from Tycho Peterson with JPMorgan. Your line is open.

Tycho Peterson — JPMorgan — Analyst

Hey, thanks. [Technical Issues].

Christopher J. O’Connell — President and Chief Executive Officer

Hey, Tycho. I think I heard the gist of the question about the pace of the pharma recovery and projects across different sectors. I’ll take a first crack at that and then maybe you can follow up, and maybe — get, maybe your line will be a little better or my line there as it may be. But yeah, pharma, as I mentioned, let me just comment on Pharma, because Pharma was one of our better categories, and we’ve seen from the beginning has clearly been leading the recovery. Encouragingly, the recurring revenue on a worldwide basis in pharma was positive in the quarter, and instruments were negative, but not as negative as the overall — the overall business.

And so in that way, we do see both the activity levels as well as the investment levels in pharma picking up. As I mentioned, we track our top global pharma accounts, which are generally the largest multinationals, and they actually grew in the quarter and year-to-date. We also saw investment from CXOs, and even in markets like the US that were a bit slower to recover in the quarter.

Large molecule Pharma was recovering more quickly, while we see some of that capital pause on the more on the small mall generic side. We’ve done a lot of research and serving if you will of our customer labs and generally labs or the pharma labs are operating across the world at about two-thirds of their pre-COVID levels, right now. But more than 3/4 of those labs expect to be more normal level sometime in the fall.

Like I said, one thing we were really encouraged by particularly as we move through the quarter is that the chemistry revenues remained more resilient than we expected and service revenues were more solid than we expected. So that to us indicates utilization of the base and pointing towards some investments later. We still think all the same things about underlying demand characteristics in small large mall pharma for different reasons going into the future and are just positioning all of our new technology to take advantage of the continued recovery in pharma.

I’d say, I’d point out, in particular, in China, we had strong recurring revenue growth in pharma. Even though instrument growth has been under some pressure, and Europe was also positive in terms of recurring revenue growth in pharma with US slightly negative, but overall worldwide positive. So that’s a pretty good indicator. And so, maybe if there is something I missed about your question, you can try another shot there.

Tycho Peterson — JPMorgan — Analyst

[Technical Issues].

Christopher J. O’Connell — President and Chief Executive Officer

Yeah. You’re right, about 70% of our business overall in pharma is small molecule and over 80% of all pharma businesses either late-stage development or QA/QC and we do see opportunity there. I mean, we’ve truly been in a tough environment for the last year or so in some of that downstream environment where pharma investment has been tilted more towards the research development and discovery side. Some of the areas that we have our biggest areas of strength have been on balance less invested in, and so we think in — that there is pent-up demand building, and that we’re especially encouraged by the nice step forward in recurring revenues relative to our internal expectations in the quarter and we expect some of that pattern to continue. So, you know, ultimately, we know that volumes of — sort of small molecule drugs are steadily marching forward around the world in the mid single-digits and that ultimately will create demand on the instrument side, and as our strategy has been all along, we want to meet that demand with a really refreshed new product line as it normalizes.

Tycho Peterson — JPMorgan — Analyst

And then lastly Chris on China, you had said 90% of pharma was back online, last quarter in regards to China, it was still about 20%, so was the pace of recovery there on your expectation or no?

Christopher J. O’Connell — President and Chief Executive Officer

Actually China exceeded our expectations Tycho in the quarter from overall revenue stand point. You’re right, about 90% of our pharma customers have reported being open for business at the end of last quarter. That doesn’t mean they’re operating at 90% capacity. But they’re — China customers continue to tick up. And so, if I look at our first quarter and our second quarter on any metric, whether it’s total revenue or instrument revenue or recurring, they were all net positive moving in the right direction by a meaningful amount.

And like I mentioned earlier on pharma recurring, China pharma recurring was up strong double digits and pharma overall recurring was up nearly double digits. So that recurring revenue service and chemistry piece was a helpful, we think leading indicator of ultimately what will turn out to be instrument demand, although admittedly instrument demand continues to lag, although not nearly as impacted in Q2, as it was in Q1.

Tycho Peterson — JPMorgan — Analyst

Thanks. [Technical Issues]

Christopher J. O’Connell — President and Chief Executive Officer

Thank you, Tycho.

Operator

Our next question comes from Douglas Schenkel with Cowen. Your line is open.

Douglas Schenkel — Cowen and Company — Analyst

Hey. Good morning, and first off, thanks Chris, and good luck on your future endeavors. Right, I want to start on your commentary regarding the second half outlook. If you take a look at Street consensus numbers, it looks like investors were expecting atleast a nominal return to revenue growth in the fourth quarter. I can see why you have two extra days, you’re up against a really favorable comparison, you described expectations for gradual improvement over the course of the year and you talked a lot about new product momentum over the course of this call. So what specifically are you seeing or hearing that would make you confident enough to say today that you think Q4 revenue will decline year-over-year given as we all know, it’s — there’s a lot moving around right now, and it’s only late July.

Christopher J. O’Connell — President and Chief Executive Officer

Yeah, I — Doug, I think that’s a very fair question, and obviously it’s hard to look out too far in the kind of environment we are in, because things change on a day-to-day, week-to-week basis, and we’re — I would say, a lot of our thinking on the back half of the year is just that, it’s thinking about trends and dynamics over the course of the half. And we do expect better conditions in the second half versus the first, which is why we expect continued positive progress forward. But obviously, we don’t we never want to put together a model that assumes everything goes right, and all the recoveries are on some kind of a straight line. There is also more uncertainty than usual on year end budget release. And so, even if you look at a quarter like fourth quarter of a year ago, there was — there was some more typical year end budget release type activity and we think that’s probably something that is more at risk this year than typical years. But we’ll just have to wait and see. Obviously we have more visibility on Q3 than we do on Q4 at this point, and we’ll just continue to try to provide clarity on how we think that’s going to shape up as we move through the year.

Douglas Schenkel — Cowen and Company — Analyst

Okay. That’s helpful, thank you for that. And then pivoting back to cost savings. On one hand it could be argued that the cost actions you took during the quarter made a lot of sense given the uncertainty of the current environment. On the other hand you cut pretty aggressively in a short period of time, you actually cut, you know, 50% of — you got 50% to your target versus one-third of the goal that you talked about last quarter.

The non-included R&D declining $4 million sequentially, SG&A declined at a rate that exceeded that of your sales decline. Recognizing you’re bringing back people now and seemingly starting to ramp some investment activity and your guidance actually seems to imply that you’re going to reinvest pretty quickly. I’m just wondering, you know, as you sit here today, should we have any concern that there could be at least a near-term hangover for Waters associated with, really just the trajectory of these changes, especially given how important investment, I mean, both R&D and SG&A, arguably are in the context of reinvigorating company growth to levels that approach those of peers?

Christopher J. O’Connell — President and Chief Executive Officer

You know, it’s interesting question, and we obviously thought a lot about how we wanted to shape the cost plan. I’ll have Sherry add some comments to this, but I’ll just provide a bit of an overview. But we knew, or we believe heading into the second quarter that, that would probably be our period of most significant topline challenge.

And so we did want to front end the savings. Keep in mind that the vast majority of our P&L investment is in people and so by really focusing on our — the savings that we wanted to achieve over the course of the whole year within a period, we were able to do quite a bit. And also, we’re able to ramp that up very quickly. I think we managed through that very, very well. Our employees as I mentioned are back, salaries, hours are restored.

And we also did a lot of work around our R&D, near-term R&D portfolio to orient those investments towards products that are going to have a bigger impact in the near term, and we’re excited about really an even better near term product pipeline now than we had contemplated coming into the year. I’d also say that given the social distancing requirements, and the remote work, we’ve been, I think remarkably and surprisingly efficient and productive working from home for those who are not required to be at a facility. Even our R&D teams have been amazingly productive not just on the software side, but even on the core design side.

So I think, we’re emerging from this really well. I think we feel good about the fact that we’ve actually front-loaded this because it does clear the play a little bit to be in more investment mode right from the start of the second half. And that was our plan all along. And I think we feel very good about how we’ve managed through that. So maybe I’ll ask Sherry to comment further.

Sherry L. Buck — Senior Vice President and Chief Financial Officer

No. Chris, the only thing I would add is that our employee base is excited to be back, and we kind of managed through this really crucial time in Q2. And while there’s still some flexible — volatility and unknowns in the second half, we’re resuming projects that we’ve put on hold and accelerating and the workforce is excited to get back to business.

Douglas Schenkel — Cowen and Company — Analyst

Okay, thank you very much, Chris and Sherry.

Operator

Thank you. Our next question comes from Dan Leonard with Wells Fargo. Your line is open.

Dan Leonard — Wells Fargo Securities — Analyst

Thank you. So could you elaborate on month-to-month business trends within the quarter and maybe what the exit rate looked like exiting June or even early July?

Christopher J. O’Connell — President and Chief Executive Officer

Hi, Dan. Sure. We generally don’t want to provide too much of that and obviously quarter-end activity always has an impact. But what I’d say is that the second quarter typical to first had a much lower effect of the typical year-end capital purchasing given the environment. And so there was a little more balance in that sense. But a lot of the interesting insights of that question are probably more on a geography basis, and maybe one I’d call out as an example is the US, which actually started quite slow because of the level of containment efforts we saw in April, and particularly in the recurring revenues of chemistry, but the US was very soft in April and then better in May and actually quite encouraging in June.

So we saw that type of progression in a market that obviously went through quite a bit of change in terms of the overall operating environment. I guess the other thing I’d say is that, we track service data really, really closely, and things like service — case rate customer access, and that data indicates that customer activity really in all major geographies, starting with China and then across Europe, India and the Americas improved as we move through the quarter, and in many geographies that service case rate data and customer access data is heading towards normalization.

So that’s probably the best indicator we have of overall activity and access is the ability of the service rep to get in there, and those were consistently better month to month in each major geography.

Dan Leonard — Wells Fargo Securities — Analyst

Okay. Thank you for that color. And my follow-up is a bit similar to Doug’s question. I’m hoping to get a bit more color or elaboration on the decline in the R&D spend, the 15% dollar decline year-on-year. In your comment that you’re reorienting some things in the R&D budget, is there anything maybe specifically we might have been looking for that was cut and possible to get an update on the progress of waters_connect? Thank you.

Christopher J. O’Connell — President and Chief Executive Officer

Yeah, no, I don’t — I don’t think there’s anything really to read into that. A lot of the cost savings in different functions reflect the labor savings component and R&D is obviously a very labor-intensive effort. And we actually feel like net-net, we improved our R&D pipeline, particularly in the near-term, and there was nothing major from something in terms of what will affect revenue and our outlook that sort of came off the books, if you will.

We were very efficient during this period, and it’s not a mode you want to operate in on an ongoing basis, but our team really rallied, and like Sherry said, people are really excited to be back. Waters_connect, you mentioned, is obviously a major software platform, and as I alluded to and even stated last quarter, the productivity of our software engineering has actually got up during COVID with remote work. And we continue to meet or exceed all milestones on the waters_connect platform and are really excited about what that means strategically for the Company in the future.

Dan Leonard — Wells Fargo Securities — Analyst

Great, thank you.

Christopher J. O’Connell — President and Chief Executive Officer

Thanks Dan.

Operator

Thank you. Our next question comes from Steve Beuchaw with Wolfe Research. Your line is open.

Stephen Beuchaw — Wolfe Research — Analyst

Hi. Good morning. Thanks for the time here. And Chris, I’d say thanks for all your help in our second time working together in this type of relationship.

Christopher J. O’Connell — President and Chief Executive Officer

Thank you.

Stephen Beuchaw — Wolfe Research — Analyst

I wanted to ask about a couple of things, just going into a little bit more detail on points that have been addressed on the call. One is China. Chris, I might direct it your way, and the other is on the cost-savings program, which I might direct to Sherry. Chris, as it relates to China, it’s a very different operating environment relative to the rest of the world, in part, because of the way they’re going about stimulus with a pretty unique approach in terms of the way they’re going about monetary stimulus, while at the same time there are some fiscal challenges.

Can you talk about to what extent that’s weighing in how you think about the back half? And then if you wouldn’t mind elaborating a little bit on the commentary around the GPO dynamics in China. I’ve certainly been hearing the same, but hadn’t heard that terminology used there all that much thus far. And then for Sherry, before I jump back in queue, pretty simple one, though the math might be a little complicated, as you think about the cost savings that you’ve implemented this year, if you look out beyond this year, think about 2021 and beyond, how much of that cost savings do you think you hold on to over time? Thanks so much.

Christopher J. O’Connell — President and Chief Executive Officer

Great. Thanks, Steve, and I’ll take the first one and then Sherry can take the second. So, China is a different environment, but is also one we obviously know very well. Historically, exactly what you described on the stimulus side, it’s been a boon to the markets there. And what I would say, that a lot of our assumptions for the back half of the year do not anticipate a meaningful change or direct impact of that type of fiscal stimulus, if you will, or monetary stimulus.

Obviously, the one factor that would be helpful, as we recover in China, would be for the government tendering to return to some normal activity, which certainly can be related to the stimulus. So that’s the piece that’s held us back in China. But a lot of the more tangible improvement in market conditions is related to the commercial sector, the business sector, if you will. And so, our assumptions in China just continue to call for that steady ramp back up of, not just customer openness, but customer activity level in the labs.

And let me also clarify and answer the second part of that, on the GPO, just to be really clear what that is. The GPO now is now the common name that we use to refer to the four plus seven program. So the four plus seven competitive bidding process for generic drugs which began as a pilot program at the beginning of last year was originally called four plus seven. Now it’s commonly known as GPO and it has gone through several rounds. As you know there was a first national round or what some people called second round late in ’19, which was the same 25 drugs that had been through the pilot in the 11, four plus seven cities. That extended to 27 provinces. And then, there was the third round, or what they call the second national GPO round, which happened earlier this year, actually in January, which extended to 25 new drugs in 32 provinces or all provinces and approximately double the value of total sales going through.

As I’ve said many times, before we think this is a real positive long term in the sense that China is trying to scale its generic drug supply and give many more people access. So volumes are going up. There’s been almost an inordinate profit pool there that is targeted. And even with GPO prices, the generic industry’s profitability in China is now probably on par with the rest of the world, not ahead of the world.

So we don’t think it’s devastating in any way. In fact, we think it’s very much in keeping with the economics of other health systems. And we’ve been on balance more successful with the winners of these tenders, since they’ve tended to be larger companies. And so, all of our beliefs about the GPO program, as it rolls forward and even reflects in provincial, kind of, systems remain. And we’ve seen that — the positivity in terms of our recurring revenue and believe that portends future rising demand for instruments.

So anyway, I’ll pause there on the GPO and hand it over to Sherry on the outlook for cost savings into the future.

Sherry L. Buck — Senior Vice President and Chief Financial Officer

Yeah. Hi, Steve. So if you look at the cost savings that we took against our original plan from the year, a lot of those had to do around actions around our salaries, hours and adjusting the workforce during this second quarter, where we were a little bit more challenged.

The other buckets of our cost savings had to do with non-discretionary travel, because the things were locked down. So I would say, in general, that we would expect these were temporary, and that we would see these come back next year and normalize. Obviously, during this time, we’ve learned how to be more efficient and effective using digital and video and that type of thing. But I’d say, largely we’d expect these to come back next year.

Stephen Beuchaw — Wolfe Research — Analyst

All right, thanks for all the color there. Have a great morning.

Christopher J. O’Connell — President and Chief Executive Officer

Thanks. We probably have one more — time for one more question we can squeeze in.

Operator

Thank you. Our last question comes from Jack Meehan with Nephron Research. Your line is open.

Jack Meehan — Nephron Research — Analyst

Yes. Thank you. Good morning. Chris and Sherry, I was hoping you could provide a little bit more color, just around the expectations for capital equipment in the second half of the year. I know it’s tricky, given the progress of lab closures. But maybe some color around how order trends were in the second quarter and just what you’re seeing across academic and industrial customers would be helpful.

Christopher J. O’Connell — President and Chief Executive Officer

Sure. Jack, happy to take that. So capital equipment as we look at the quarter, we’ve modeled certain demand for instruments. We actually came in a little bit better than our model in the second quarter. And so conditions were slightly more favorable in the quarter relative to capital purchasing than we expected and we expect that to continue.

And so, while we still see some year-over-year declines in capital spending in the back half of the year it’s on a — it should be on a much improved trajectory. And as I mentioned before here, the largest uncertainty on that as we look out into the rest of the year is really around what year-end kind of budget activity looks like that typically we see in this industry. That’s led by pharma. As I mentioned, pharma instruments were better than the rest. But if you look at the industrial and academic side, those have been held back in part because on the industrial labs, particularly in the food and environmental area there’s been less activity.

Some of that’s government activity which has been a little slower government and academic. And then generally the government and academic sector, while actually turning out better than we expected in the quarter is still curtailed by delays in university re-openings and restrictions to government funding particularly tender programs.

So I think we’re just stepping through this. We do expect modest improvement in that environment over the quarter with the caveat on the end of the year and we’ll see how it plays out.

Jack Meehan — Nephron Research — Analyst

Yeah, I think that’s all fair. And then, I kind of [Phonetic] appreciate still expect revenue to decline in the second half of the year. I was hoping to get just a little bit more color on chemistry sales within the quarter just the performance for pharma. And as demand starts to stabilize into the second half of the year, do you think chemistry could actually turn positive in the third quarter? Or do you expect that to be negative as well?

Christopher J. O’Connell — President and Chief Executive Officer

Yeah. Sure, that’s a good one to close on because the strength of our chemistry franchise and that is a leading indicator on business coming back overall. So we actually headed into the quarter with an assumption on chemistry that we pretty handily beat. Our chemistry performance was actually quite a bit better in the quarter than we expected and that actually improved through the quarter a little bit, as I mentioned in one of the previous questions on gating.

Our outlook for the remainder of the year assumes sort of the continuation of where we’ve been with a little bit of modest improvement. And certainly, as we see more laboratory operations moving towards normalization, some of the assumptions that we made on volumes and then purchasing activity around customers should continue to sort of brighten as we move over the course of the quarter and certainly could envision that particular type of category turning positive as we get towards the end of the year and in general with recurring revenue as well.

So we do see sort of the lead back if you will to positivity and growth probably first showing itself through the chemistry line and the service line and could be — could see that as we get towards the fourth quarter. So anyway we feel really good about that franchise and it is a bit of a leading indicator as to where the business is headed. So maybe I’ll pause there Jack. I know we’re a little bit over time, so [Speech Overlap] wrap up the call.

Jack Meehan — Nephron Research — Analyst

Yeah. Thanks, Chris.

Christopher J. O’Connell — President and Chief Executive Officer

You got it. Thanks.

So, thanks everybody for your great questions. In conclusion, for the second quarter those sales in the overall first half of the year were negatively impacted by COVID-19 pandemic. Our team continued to execute well. We have seen an increasing contribution from new products and global market conditions improved more than we originally anticipated during the second quarter.

So although the trajectory of the global COVID-19 pandemic remains uncertain, we do expect market conditions to improve modestly in the second half of the year and as always remain sharply focused on executing on our primary growth strategy of organic innovation and we believe we’re well positioned to leverage our significant new product pipeline as demand normalizes. 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 updating you on our progress during our Q3, 2020 call which we currently anticipate holding on October 27th, 2020. Thank you, and have a great day.

Operator

[Operator Closing Remarks]