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Waters Corporation (NYSE: WAT)
Q2 2018 Earnings Call
Jul. 24, 2018, 12:00 pm ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, welcome to the Waters Corporation's second quarter 2018 financial results conference call. All participants will be in listen only mode until the question and answer session of the conference call begins. This conference call is being recorded. If you have any objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. Bryan Brokmeier, head of investor relations, please go ahead sir.
Bryan Brokmeier -- Head of Investor Relations
Thank you operator. Good morning everyone, and welcome to the Waters Corporation's 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'll provide guidance regarding possible future income statement results of the company for the third quarter and full-year 2018.
We caution you that all such statements are only predictions, and that actual events or results may differ materially. For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our annual report on form 10-K for the fiscal year ended Dec. 31, 2017. In part one under the caption risk factors, and the cautionary language included in this morning's press release and 8-K.
We further caution you that the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results except during our regularly scheduled quarterly earnings release conference calls and webcast. The next earnings release call and webcast is currently planned for Oct. 23, 2018.
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 the company's earnings release issued this morning. Our discussions of the results of operations, we may refer may pro forma results which exclude the impact of items such as those outlined in our schedule titled "Reconciliation of GAAP to adjusted non-GAAP Financials" included in this morning's press release.
Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the second quarter of fiscal year 2017. In addition, unless we say otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call are given on a comparable constant currency basis. Now, I'd like to turn the call over to Waters Chairman and Chief Executive Officer, Chris O'Connell. Chris.
Chris O'Connell -- Chairman and Chief Executive Officer
Thanks Bryan, and good morning everyone. Thank you for joining us today. Along with Bryan Brokmeier, joining me on this morning's call is Sherry Buck, Waters Chief Financial Officer. During today's call, I will provide an overview of our second quarter operating results, as well as some broader commentary on our business. Sherry will then review our financial results in detail and provide comments on our third quarter and full-year 2018 financial outlook. We will then open up the phone lines to take your questions.
Briefly reviewing our financial highlights for the second quarter, revenues grew 5%, and adjusted earnings per share grew eleven 11%. Overall, I am pleased with the progress we made in the quarter, demonstrating clear sequential improvement versus the first quarter and reinforcing the confidence we have in the ongoing growth trajectory of our business. Highlights in the quarter included: Mid-teams growth in China, double-digit growth from our TA product line, and high single-digit growth of recurring revenues.
Looking briefly at the P&L, we're pleased with the operating leverage we generated and the solid earnings results we realized in the quarter. While investing in growth to organic innovation, we demonstrated disciplined operating expense management that drove margin expansion, which enabled us to deliver double-digit earnings-per-share growth in the quarter.
Before I review our end-market, geographic and product line performance, I'd like to provide an update on two factors we cited in last quarter's call that adversely impacted our first-quarter, Mass Spectrometry and India. First, in Mass Spectrometry, we saw sequential improvement in the second quarter driven by solid growth from our core Tandem Quad portfolio. Our tandem quads, which represent the majority of our mass spec sales, have continued to sell strongly over the past year, offset by softer growth from our high-resolution mass spec product line.
For further context, mass spec technologies are a key part of our LC-MS and direct mass spec system offerings, yet represent a smaller part of our overall business, and within mass spec, high-resolution mass spec represents only about a quarter of the total mass spec revenue. Our sales force realignment which had a minor impact in our U.S. mass spec business during the first quarter is now complete and remains a key element of our ongoing market development strategy.
With respect to India, growth was flat in the second quarter with a return to growth in pharma partially offset by some weakness in industrial and governmental and academic. We remain confident in the improvement of our Indian business in the second half of the year as customers continued to regain purchasing momentum.
Now, taking a closer look at the business starting with a review of our market categories at the corporate level, sales to our broadly defined pharmaceutical category grew 4% in the quarter. Growth was driven by double-digit growth in China, partially offset by a slight decline in developed markets due to slower-than-expected budget releases by our largest pharma customers.
Importantly, we saw strong year-over-year growth in our large molecule business as we continue to leverage our refresh Xevo Tandem Quad portfolio in this high-growth market. We feel good about our pharma market position and, in particular, our ability to meet the needs of our Bio-molecule customers as their investment environment continues to be positive.
Sales to our worldwide industrial category, which includes the materials characterization, food, environmental and fine chemical markets were up 3% in the quarter. Sales within our TA brand continued a strong trend we have seen, giving us confidence in a positive outlook for our industrial category, as volume in our thermal and radiology product lines has been our best proxy for industrial and market demand.
We saw softer demand from food and environmental customers in the quarter, partially offset by strength in the chemical materials market. Despite these near-term puts and takes we continue to be excited about our product positions and pipeline as well as the breadth of opportunity across materials characterization, food safety, and environmental applications.
Looking at our governmental and academic category, sales grew by 13% in the second quarter, with broad-based growth across all major geographies. Weakness in biomedical research was more than offset by improvement in other research applications including pharmaceutical materials and clinical diagnostics. Next I will review our sales performance by geography at the corporate level. Asia, our largest region in terms of revenue was up 8% in the second quarter as strong mid-teens growth in China offset flat performance in India. Demand in China continues to be robust with strong growth in pharma, food and materials.
Turning to the Americas, overall sales grew 1% in the quarter with sales in the U.S. declining 2%. Although growth in Canada and Latin America was strong, including Brazil, Mexico, and Puerto Rico, it was offset by some softness in the U.S. particularly in biomedical research markets as well as slower-than-expected pharma growth. In Europe, sales were 5% in the quarter. Industrial as well as government and academic were particularly strong in the region, while European pharmaceutical growth was a bit softer driven mostly by tough comps in big pharma.
Finally, I will review product line dynamics within our Waters in TA brands. Waters-branded instrument sales were flat in the second quarter driven by the previously mentioned mass spec systems softness. On the other hand, we were pleased with our sales of stand-alone chromatography instruments. With NLC, the Acuity arc continues to see significant broad-based demand and the newly launched Acuity Plus is receiving strong market acceptance. Our core Tandem Quad mass spec portfolio has sold really well over the last year highlighted by the Xevo TQ-S micro and the Xevo TQ-XS.
In high resolution mass spec, growth was challenged within the biomedical research market. We recognize we are currently in the latter phases of a product cycle and high resolution mass spec and therefore, face more competitive pressure than the rest of our portfolio. That said, we continue to see significant growth opportunity in this space are investing assertively and are confident in the strength of our technology pipeline that we expect will begin to show in the coming year. Waters-branded recurring revenues, which reflect the combination of service and precision chemistries and represent approximately 50% of the total business grew 8% in the quarter. Recurring revenues were driven by global strength in our service, sample prep, application kits, and UPLC columns.
Turning to our TA product line, sales increased 12% in the quarter. Instrument sales for TA increased 12% and service sales increased 11%. There was broad-based growth across our key thermal analysis, micro calorimetry, and ElectroForce product lines. In particular, growth within our Discovery line of thermal analyzers continues to be very strong. We have now introduced nine new instruments over the past two years within the Discovery series including the DMA 850, which was introduced earlier this year. Our balanced growth of new customers and existing customer upgrades gives us confidence that the Discovery series continues to have a long runway ahead of it.
In summary, we are pleased that we saw sequential improvement in our second quarter results highlighted by strong growth in China, our TA product line, and our recurring revenues. In addition, we delivered meaningful operating leverage which enabled us to deliver double-digit earnings-per-share growth. As always, we remain steadfastly focused on executing to our five point value creation model. As we have previously communicated, we aim to create shareholder value by first, holding a focused and highly differentiated leadership position in structurally attractive markets, second, executing a clear growth strategy driven by organic innovation, third, seeking opportunity for continuous operational improvement, fourth, being a disciplined capital allocator, and fifth, operating with a performance-oriented culture and management team.
I would now like to add a few comments highlighting our strong focus on innovation at Waters. We are pleased with the progress of our product portfolio including our recent introductions of the Acuity Arc Biosystem, the Acuity UPLC Plus series, and the Xevo TQ-GC as well as numerous new products from our TA Instruments business such as the recently launched DMA 850. We continue to prioritize and invest proactively in organic innovation with second quarter R&D investment growing 9% year-over-year. I am personally excited about the rich pipeline we are building across instruments, informatics, and precision chemistries.
To augment these internal innovations, we are increasingly evaluating select external technologies to strengthen our overall product portfolio and enhance organically developed products. As an example, yesterday, we announced the acquisition of [inaudible] desorption electro spray ionization (DESI) technology for mass spec imaging. The acquisition of DESI technology bolsters Waters' market-leading portfolio of direct ionization mass spec which also includes [inaudible] and the dark QDA with Live ID. These technologies allow for simplified direct sample analysis under ambient conditions without any required sample preparation.
We're excited about our unique ability to provide advanced digital molecular imaging solutions and related analytical tools to researchers who should strive to answer complex biological questions. In fact, my recent visit to ASMS reinforced to me the excitement of the research community for mass spec imaging technologies, which saw 18 oral presentations and 105 poster presentations. When coupled with our Xevo G2-XS QTof and SYNAPT G2 Mass Spectrometer, DESI provides maximum flexibility by leveraging the power of time-of-flight mass spectrometry analysis, and for more demanding applications, additional orthogonal resolution using ion mobility mass spectrometry.
Importantly, DESI is highly complementary to other imaging modalities such as multi, making it a strategic addition to our evolving imaging portfolio and positioning Waters as the market leader in direct Ionization Mass Spec techniques. With that, I'd like to pass the call over to Sherry Buck for a deeper review of the second quarter financials. Sherry.
Sherry Buck -- Chief Financial Officer
Thank you Chris, and good morning everyone. In the second quarter, we recorded net sales of $596 million, an increase of approximately 5% in constant currency. Currency translation increased sales growth by approximately 2%, resulting in 7% sales growth as reported. In the quarter, sales into our pharmaceutical markets grew 4%, sales into our industrial markets increased 3%, and sales into our governmental and academic markets grew 13%. Looking at product line growth, our recurring revenue, which represents the combination of precision chemistry products and service revenue, grew 8% in the quarter and instrument sales grew 2%.
As we noted last quarter, there's no year-over-year difference in the number of calendar days during the second or third quarters, but there is one additional calendar day in the fourth quarter of 2018 compared to 2017. Breaking product sales down further, sales related to Waters' branded products and services grew 4%, while sales of TA branded products grew 12%. Combined LC and LCMS instrument platform sales were flat and TA's instrumentation system sales grew 12%. Our total recurring revenues, associated with both Waters and TA products, grew by 8%.
As Chris already shared, we're encouraged by the strong momentum that we've seen from TA in the first half of the year, which gives us confidence in the positive outlook for our industrial category. Looking at our growth rates in the second quarter geographically and on a constant currency basis, sales in the Americas were up 1%, but sales in the U.S. down 2%. European sales were up 5% and sales in Asia were up 8%, led by 14% growth in China. Now I'd like to comment on our second quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 59.2% versus 58.9% in the second quarter of 2017, positively impacted by mix in FX.
Moving down the second quarter P&L, operating expenses were up approximately 3% on a constant currency basis and foreign currency translation increased operating expense growth by approximately 3% on a reported basis. In the quarter, our effective operating tax rate was 14.7%, up 280 basis points year-over-year, which was in line with our expectation and reflects the net impact of U.S. tax reform that we discussed in our Q4 2017 earnings call. Net interest expense was $3 million, down $3 million from the prior year, benefiting from the reduced debt levels as part of our capital allocation framework, as well as higher rates of return on investments versus the prior year.
Our average share count came in at 78.4 million shares, approximately $2.3 million shares lower than in the second quarter of last year. This is a net effect of our ongoing share repurchase program. Our non-GAAP earnings per diluted share for the second quarter were up 11% to a $95 in comparison to earnings of a $76 last year. On a GAAP-basis, our earnings per share were a $98 versus a $63 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 allocation, 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.
In the second quarter of 2018, free cash flow came in at $144 million, after funding $21 million of capital expenditures. Excluded from free cash flow, were $47 million for U.S. tax reform payments, a $15 million payment for litigation settlement, and $2 million related to the investment in our tonne precision chemistry operation. Just as a reminder on U.S. tax reform, we incurred a $550 million GAAP tax expense charge in Q4 of 2017. Primarily associated with the transition tax on earnings and profits outside the U.S. This tax liability is expected to be paid over eight years with the first payment of $47 million remitted in this quarter. The lower free cash flow generation in the second quarter as compared to the prior year is impacted by a change in the timing of our current year U.S. estimated tax payments. We anticipate our free cash flow will normalize by the end of the year.
Year-to-date 2018, we have converted $0.27 of each dollars up sales into free cash flow. In terms of returns to shareholders in the quarter, we repurchased 1.4 million shares of our common stock for $271 million. These capital allocation activities along with our free cash flow resulted in cash and short-term investments of $2.2 billion and debt of $1.1 billion on our balance sheet at the end of the quarter, resulting in a net cash position of $1.1 billion. Accounts receivable, days sales outstanding stood at 75 days this quarter, which is the same as in the second quarter of last year. The quarter inventories increased by approximately $13 million in comparison to the prior year quarter, which is in line with typical seasonal patterns.
As we look forward to the balance of the year, I'd like to comment on our full-year 2018 guidance. Our outlook assumes continued global growth in demand from our pharmaceutical end markets, year-over-year growth in our industrial markets and consistent growth in our recurring revenue. These dynamics along with the sequential improvement that we saw in our second quarter performance, support full-year 2018 guidance for constant currency sales growth of 4% to 6%. At current rates, currency translation is assumed to increase 2018 sales growth by less than 1%, which is a change from our prior 2018 guidance that assumed a benefit of 2% to 3%.
First margin guidance for the year is unchanged at 58.5% to 59%. Our plan for the full year is to continue managing operating expense growth at a rate that is below our sales growth rate. Moving below the operating income line, net interest expense is expected to be approximately $14 million. This assumes that the debt repaid in the first half of 2018 is not reborrowed during the course of the year. Our full-year tax rate guidance is unchanged and an effective tax rate of 13% to 15%. Regarding capital allocation, our guidance assumes a continuance of our share repurchase program at a level that will result in an average diluted share count of about 78.5 million shares outstanding. Rolling all of these together and on a non-GAAP basis, full-year 2018 earnings per fully diluted share are projected in the range of $8.05 to $8.20, which is revision from our previous range of $8.10 to $8.30. At current rates, the foreign currency impact on the full-year earnings-per-share growth is expected to be neutral.
Which has a change from our prior 2018 guidance that assumed a benefit of about 1%. Looking at the third-quarter of 2018, we expect 4% to 6% constant sales growth. At today's rates, currency translation is expected to decrease third-quarter sales growth by about 1% to 2%. Combining these top-line factors with a moderate increase in expenses, we estimate third-quarter non-GAAP earnings per diluted share in the range a $1.85 to a $1.95, which assumes an approximate 3% negative impact from currency translation at current rates. Now, I'd like to turn the call back to Chris, Chris.
Chris O'Connell -- Chairman and Chief Executive Officer
Great. Thank you, Sherry. To recap, after a slower than expected start to 2018, we were resolved to deliver a solid second-quarter, and I'm pleased that we delivered 5% revenue growth and 11% earnings-per-share growth. We made good progress in the parts of the business that held us back in the first-quarter, and we benefited from a number of key areas of strength that we will continue to leverage in the back half of the year.
As such, we expect our constant currency revenue growth for the back half of 2018 to be stronger than the first half of the year. With that said, we 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. Our first question today will be from Steve Beuchaw of Morgan Stanley. Your line is open.
Steve Beuchaw -- Morgan Stanley -- Analyst
Well, Chris, first of all, I'd say thanks for pre-empting my first question there at the end of your prepared remarks. I think what people really focus here is on the drivers of the confidence in the outlook for the back half. So, thanks for going there proactively. I wonder if you could maybe go into even a little bit more detail on just a couple of the components there. Number one is India, can you talk to us in a little bit more granularity on what you're seeing that gives you comfort from the ground level there about what the drivers are for the improved confidence in spending patterns for your customer base there in India? The second piece of the back-half, I love to hear just a little bit more on the sales force. You mentioned that the sales force, the key positions are filled people, are in their seats. How recently did that happened and how much of an impact did that have on 2Q?
Chris O'Connell -- Chairman and Chief Executive Officer
Sure. Thanks, Steve, for the questions. First of all, in India, I guess the way I would characterize it is that the caution that we saw in our first quarter which is as we talked last quarter was the final quarter of the year for Indian pharmaceutical companies. The caution that they expressed there as eased gradually over our second-quarter which is their first-quarter, and that caution is really around the overall financial year they had had before, plus what is continuing to be a robust regulatory environment, FDA compliance, et cetera, and we've seen this caution warm up gradually over the last quarter and we expect it to continue to warm up.
In particular, the pharma sector is firming up. Pharma was really what held us back in Indian Q1. And as I noted in my prepared comments, pharma turned positive in our second-quarter. So, we do see some pent-up demand building, and really are just continuing to press forward and stay very focused on what we do to serve our customers. And we do expect that as we get into the back half of the year, that improvement will become more pronounced. As it relates to the sales force, like I said, the expansion and reterritory activity and in some parts of the sales force were left some open positions during the course of Q1. Those were predominantly filled by the end of Q1, and those positions have on-boarded, and gained traction in terms of building their territories.
They're becoming more productive and we expect that to really pay off in the second half of the year. So, like I said before, I had the opportunity to be part of a lot of sales force changes over the course of my career and investments and this one in the broad scheme of the world was very modest in terms of the overall scope. I think the team executed well through it and I'm excited about what this team is going to contribute as we move forward.
Steve Beuchaw -- Morgan Stanley -- Analyst
Really appreciate that. And then just one quick follow up, given some of the commentary in your prepared remarks about maybe somewhat elevated focus on capital deployment to M & A. Can you remind us of what your parameters are, what your commitments are, how you think about required returns, accretion and then the most appropriate sizes of deal? I recall you saying in past years best quarters you think about M & A as a tactic and not a strategy. Can you just remind us what you're thinking like there?
Chris O'Connell -- Chairman and Chief Executive Officer
Sure, yes. Thanks Steve happy to comment on that. First of all I would completely reinforce my view on M & A, which is that, M & A is a tactic, it's not an overall strategy for the company for capital deployment. We will be opportunistic in acquiring everything from intellectual property to technologies to tuck-in type opportunities if they meet a high strategic bar and a high financial bar. Nothing's really changed in that regard. So, in terms of any additional guidance on financial hurdles, that's probably not needed because we retain all of the parameters that we've operated with.
That being said, one thing I've had the opportunity to do over the past couple of years is to build a corporate development department here at Waters. It's lean group but one that is trying to enhance our focus outside of the company to make sure that we remain oriented to thinking about growth and innovation from a 360-degree view. I think the team has been very productive. We've had the opportunity to make a few very high impact minority investments in very promising new technologies that fit right squarely in the center of our strategy.
Then the acquisition, the full acquisition of the DESI Technology from Prosolia, where we had a partially exclusive position before. Now we really have locked-up that technology which we think is one of the most interesting things going on in mass spec imaging. I think those are just examples of the way we're thinking about it and just trying to make sure that as we strive to deliver on our growth and innovation strategy that we're certainly prioritizing organic innovation but also taking advantage of some really interesting technologies that are out in the marketplace.
Steve Beuchaw -- Morgan Stanley -- Analyst
Thank you very much, Chris.
Operator
Thank you, our next question is from Dan Arias from Citigroup. Your line is open.
Dan Arias -- Citigroup -- Analyst
Good morning, thanks. Chris can you just help us with the overall mass spec growth number for the quarter? Then I guess should we expect some meaningful product news later this year at the high-end of the market. I know you don't like to pre-empt your announcements but you hinted at some things last quarter in terms of new higher-end systems. Was that a reference to the GCMS announcement ASMS? Should we think about some things in the second half of the year that we can look for and that will be meaningful when you think about the portfolio going forward?
Chris O'Connell -- Chairman and Chief Executive Officer
Sure, Dan. I'd rather not breakout specific growth numbers other than to reinforce what I said that we had quite a slow start to the year in mass spec, things definitely picked up in the second quarter. Not where we wanted to be yet but moving in the right direction. We're really excited frankly about what we're doing in terms of R&D investment.
Mass spec is a huge priority for the company particularly, as it relates to a true system orientation around LC. Mass spec as well as what I talked a little bit more about this morning, which is wide-open field of direct Mass spec. I think as we move into the future, there is going to be more interest in some of these direct ionization techniques, and there's a lot of white space out there for growth.
So, we've been assertively investing. We have increased the system orientation of our core Mass spec portfolio, which I think is a competitive advantage for Waters, and we've also created a greater focus around our high-resolution Mass spec. In terms of the product that's new and coming, yes, the GC Mass spec is interesting in new and current, but clearly, there's a lot more beyond that.
I've talked in the past about our BIOTOF system, which is working its way through development very, very well, and then we have a few what we believe to be groundbreaking technologies in high resolution mass spectrometry that we'll certainly give more visibility to as we roll into 2019. So, stay tuned for that, and the bottom line is that we remain very focused on pushing forward technology, pushing forward system orientation, and doing things that we can do uniquely well.
Dan Arias -- Citigroup -- Analyst
Okay. Then, maybe just on industrial, can you add a clarification there? I believe you said that food and industrial were soft, but that chemicals was strong, and I usually lumped chemical into industrial. So, I guess how are you thinking, how are you parsing things out there, and then what is the growth expectation for the year for the industrial in the way that you stated in the press release?
Chris O'Connell -- Chairman and Chief Executive Officer
Sure. So, industrial had a lot of puts and takes of course, led by TA, which gives me the most comfort in the overall tone of the market. Obviously, we're benefiting in TA from a really strong product, new product launch cadence right now, but we're also benefiting from what we believe are stable end market factors. Overall, on industrial, we did see a sequential improvement from Q1 to Q2.
While there were puts and takes like the ones you mentioned there, we do feel that the overall portfolio of industrial on the Water side is normalizing. There were some tough comps for example in China and India. In particular, in Q2 of last year was very strong in industrial. There was also a dynamic within the environmental business where the EPA had some pretty big purchasing activity last year.
Where that has not yet recurred in this year, and so that links that there's a lot of puts and takes, but overall, we feel good about the category and expect some of the puts and takes we've seen in the first part of the year to normalize in the back half of the year with continued strong TA performance.
Dan Arias -- Citigroup -- Analyst
Okay. Thanks a bunch.
Chris O'Connell -- Chairman and Chief Executive Officer
Thanks.
Operator
Thank you. Our next question will be from Jack Meehan, Barclays. Your line is open.
Jack Meehan -- Barclays -- Analyst
Thanks. Good morning guys. Chris, I was hoping you could just elaborate on the trends you're seeing here in the United States, and what was weaker versus what was better across the different end markets.
Chris O'Connell -- Chairman and Chief Executive Officer
Sure. Happy to, Jack. The U.S., as I mentioned before, was a bit slower in the first half and a little bit of a mixed bag, and I think that really reflects some of the unique customer mix that we have. I mentioned about medical research share sector has been slow out of the gates, but It's very much a lumpy business.
So, hard to quantify exactly what direction that goes. But pharma, particularly large pharma was a little softer coming out of the shoot, and certainly, offset to a certain degree by biotechnology and generics.
But we really remain confident in the overall end market around pharma and ongoing investments they're making. We're encouraged by quoting activity that we're seeing, and so the tone of a lot of our customers in the U.S. and particularly in pharma gives us some confidence in the stability of the market. We think it's a very reasonable expectation for a stronger second half assuming that we get the typical year-end purchasing activity and at this point we have no evidence to suggest that won't be the case.
So again, another point there that I think is important is the strong service and chemistry performance indicates to us some building in terms of some pent-up demand for instruments in terms of our unique customer mix. But overall, like I said, we are expecting a solid second half of the year.
Jack Meehan -- Barclays -- Analyst
Great. Thanks for all that. Then, just to follow up on the government and academic performance. I know this can be lumpy on a quarterly basis. But obviously, 2Q look pretty good. Were there any revenue that was in or out of the quarter from a timing perspective, and what's the outlook for the rest of the year there? Thanks.
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah. Good point, Jack. Yes, it's governmental, and academic is the smaller sector of our three. It is lumpy and it was even mixed a little bit within that, I mentioned, biomedical research was soft, but yet, other research applications were strong.
Research, particularly in the part of academics, in areas like pharmaceutical discovery, in areas like material sciences, in areas like clinical diagnostics that are more research oriented. So, there's a good quarter there, the patterns in that business tend to be a little more cyclical. So, we're just trying to focus on the things that are going well and try to make sure they're more enduring.
Jack Meehan -- Barclays -- Analyst
Thank you, Chris.
Operator
Thank you. Our next question will be from Tycho Peterson of JP Morgan. Your line is open.
Tycho Peterson -- JP Morgan -- Analyst
Hey thanks. Chris, I want to follow up on your comment a minute ago about the U.S. and you mentioned slower-than-expected budget release from pharma. Can you maybe just elaborate? Has some of that subsequently come through post the quarter and I guess what gives you confidence is the budget release issue and not something else.
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah it's a good question. I would just sort of reiterate what I said Tycho. We watch this very, very carefully. In many ways, it feels like last year, where we saw this same pattern, where we had a slower budget release from our largest pharma customers in the first half of the year and that firmed up in the second half of the year. At this point, like I said, we don't have any evidence that that's sort of not headed in that direction again.
Things that we focused on when understanding the tone of our largest pharma customers is certainly the servicing chemistry and the utilization of the technology which is solid. The quoting activity which we're encouraged by, so the tone that we're hearing we're obviously very close to these customers, gives us like I said, a reasonable expectation for a more solid second half. That's what I can see from where I sit right now.
Tycho Peterson -- JP Morgan -- Analyst
Okay, and then you guys are obviously putting up good numbers in China and that's kind of consistent with what we've heard from peers about the demand environment. Can you talk how you think about the back half of the year, the sustainability, you didn't proactively make any comments on tariff. So presumably, there's nothing we really need to be worried about there either?
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah, from a China standpoint, tariffs is really not a factor right now, that's obviously an evolving picture. But at the end of the day, we don't export out of China. We import very little directly into China from the U.S. the vast majority of our business into China comes from our global manufacturing and supply chain network. So, we don't necessarily foresee a large impact on that part of it. But just in general, China is performing well. It appears from everything we can see solid. Even in our forecast, we're not necessarily assuming everything goes perfectly right.
My impression just from spending a lot of time in China and around Asia, generally is just- well, it's not always in a straight line. The long-term outlook is promising, and we have a very diverse business in China. It's actually the most diverse portfolio we have of any major geographical end market. There's less farmer weight there, more food and materials weight, and there appears to be a really decent amount of balance in the business right now. So, our expectations of our China team continue to be high. We're investing to sustain that type of growth and investing to win.
Tycho Peterson -- JP Morgan -- Analyst
Right, and then just last one. I'm curious about the decision to enter the GC market. Obviously, partnering up with Agilent to OAM, the GC. So, what do you think your advantages in that market or is it just opportunistically pushing in between?
Chris O'Connell -- Chairman and Chief Executive Officer
It's interesting because the GC-MS market is an important market where we think there's unmet measurement need, if you will, in Med technology need on the mass spec side, and historically, I don't have the full history because I've only been here a few years, but historically we did have quite a bit of presence in that GC-MS field and I think our position faded overtime. The team has been really excited about reasserting that, particularly in applied workflows in food and material science.
Large food labs in China and Europe are demanding this technology, and we thought it was a very focused way to play it to really be able to hook onto some of the more broadly accepted core GC technology to provide a superior mass spec interface which we think the market needs. So, we definitely see an opportunity there. It won't be the largest product offering in our mass spec portfolio for sure, but we think it's a nice niche. Frankly, it will help us drive our overall portfolio, particularly on the food side.
Tycho Peterson -- JP Morgan -- Analyst
Thanks.
Chris O'Connell -- Chairman and Chief Executive Officer
Sure, thanks Tycho.
Operator
Thank you. Our next question will be from Puneet Souda of Leerink Partners, your line is open.
Puneet Souda -- Leerink Partners -- Analyst
Hi Chris. Thanks for taking my question. I have two broader questions maybe one around- first, let me say around Empower. How would you characterize the Empower's strength today and the position that it holds in the market versus a year or two back, is it as strong and sticky as in the accounts? I'm asking that in context of the U.S. decline here and somewhat pharma that looks back half-loaded. Could you maybe characterize what the strength you see in Empower, how is that versus before? Thanks.
Chris O'Connell -- Chairman and Chief Executive Officer
Sure. Yeah, and I'm happy to talk about Empower. Empower is a really major competitive advantage for the company particularly in pharma in the most rigorous regulatory compliance environments. The one trend that's unmistakable for sure is the rising regulatory requirements on our customers and the increased priority our customers have on rigorous data management and compliance. In that environment, the Empower position has only strengthened, particularly for global companies who are working on Empower enterprise type network system. If anything, we've seen major customers work to adopt this across their LC platforms and earn what I call incremental strategic wins. Now, the reason I say incremental is, because we already have a really strong and leading market share, we're really in all of the top 20 or 25 major pharma accounts in one way shape or form and those typically trend toward more enterprise type deployments.
Furthermore, we continue to push the technology down that curve where we started with workstations, we've been very oriented around enterprise solutions, and now, we're increasingly migrating toward the cloud. So, really, we're continuing to invest in our next-generation chromatography data systems. I personally had a chance to review a lot of that work. I'm excited about taking the strength further, and we obviously want to see many more companies besides the enterprise customers continue to behave in that way and we think for that reason, there's runway.
Puneet Souda -- Leerink Partners -- Analyst
Okay. Thanks for that. The second one I have is around the recent retirement and management changes. I wanted to get a higher view from your vision, your long-term strategy. So, we have seen 15 to 30 years, 10 years that senior leadership at Waters, but recently, Rohit Khanna, SVP, Applied Technology, he was there for 30 years, I believe he retired. Dave Terricciano, who is the head of global operations, I believe he's also taken retirement, and Ian King is approaching close to 35 years, he's been excellent to technology and new product introduction. So, my question here is how are you thinking about the next round of leadership? Should we expect them to rise from within the company as traditionally been the case or should we expect maybe potentially outside of the LC-MS business? Just wanted to get your views there. Thank you.
Chris O'Connell -- Chairman and Chief Executive Officer
Sure. Well, thank you for the question. Because certainly investing in our organization in a very broad, deep, and diverse management team is a very top priority, mind I spend an awful lot of my time on this, and you've mentioned some outstanding people. Our current executive team is a very strong balance between deep, credible, proven industry experience with sprinkling in of some fresh perspectives which is exactly the way you want a management team to look. Some of the retirements you mentioned were long-planned retirements, both on those individual's parts as well as our part. We had robust succession plans for all of them.
You mentioned Ian, he's the head of our product development organization and doing a fantastic job and we continue to leverage that expertise. But one thing that's been a real joy for me coming into the company is getting to know management at the next level and employees throughout. I brought in a really transformational talent review organizational development process that has substantially increased the rigor and development and investment in our top talent. I've even personally designed and teach a three-day leadership course to our top up-and-coming people and all of our management is involved in that process, and furthermore, leading and developing, teaching others.
I couldn't be more excited about the talent pool at Waters and you do see the tenure and the depth and the expertise at many levels and we're increasingly tapping into that as a leadership community. So, I could go on and on other than to say I just want to express confidence in what we're doing and I do expect that as any organization evolves over time, that we have a very strong and increasingly strong bench that we're developing from within and then opportunistically supplementing that with new skill sets and new perspectives from the outside where warranted. So, it's a great equation.
Puneet Souda -- Leerink Partners -- Analyst
Okay. Thanks, Chris.
Operator
Thank you. Our next question will be from Brandon Couillard of Jefferies. Your line is open.
Brandon Couillard -- Jefferies -- Analyst
Thanks. Good morning.
Sure. A couple of housekeeping items for you. First, could you walk through the impact of currency in the second quarter on the gross operating margin lines as well as EPS. Then when you alluded to free cash flow normalizing by the end of the year, what exactly does that mean? Does that mean return to growth or are you referring to more like a free cash flow conversion metric?
Sherry Buck -- Chief Financial Officer
Sure. Yes, so your first part of the question about the FX dynamics in this quarter, maybe just recapping for the top line, the euro and the yen is really what drove the FX of 2% on the top line. We saw that favorability flow through to gross margin. We had probably a slight positive impact on the gross margin. But the dynamic that happened in the second quarter was because of our euro and pound and particularly our cost base that we have in the pound, it impacted our operating expense. So, that flowed through on operating expenses as a headwind on our operating expense line. So, we had guided on the EPS, we thought it would be 1% to 2%, $0.01 positive and we ended up a little bit more positive than that.
As far as the cash flow normalizing, I would say it would be more of a return to growth. We like to look at our cash flow conversion, we're at $0.27 for the half. We've also probably see that improving but really, returning to growth. The second quarter was really a dynamic of timing of some of our estimated tax payments as a result of the U.S. tax reform. Our balance sheet and working capital are in good position.
Brandon Couillard -- Jefferies -- Analyst
If then, now, what exactly did the $15 million litigation settlement payment relate to?
Sherry Buck -- Chief Financial Officer
We have some ongoing litigation and we disclosed in our queue that that had gotten settled. So, we got that settled and paid in the quarter.
Brandon Couillard -- Jefferies -- Analyst
All right. Thanks.
Operator
Thank you. Our next question will be from Doug Schenkel with Cowen. Your line is open.
Doug Schenkel -- Cowen -- Analyst
Hi. Good morning. I just want to start with two follow-ups on some earlier questions and then I'll come back with a buyback question. So, on the follow-ups first, in the first quarter, you noted that India represented a what you called about a 3% year-over-year headwind to total pharmaceutical growth which I believe implies that this was about an $8 to $9 million revenue headwind. With that in mind, how much of the Q2 strength you saw in India, specific to pharma was a function of improvement in demand versus just a recapture revenue you didn't get in Q1? The second follow-up is recognizing U.S. revenue declined 2% year-over-year and that this was down 2% to 2.5% comparison from last year, do you expect U.S. to grow in the second half given you're going to face tougher comparisons than you did in the first half where you actually maybe struggled relative to expectations?
Chris O'Connell -- Chairman and Chief Executive Officer
Yes. So, thanks, Doug. I think for the most part, I would just say in India, just to follow up on those questions, the Q2 incremental strength we saw in pharma was probably some combination of a little bit of pent-up demand plus just a warmed-up purchasing tone of the customers as I mentioned. Pharma was positive in Q2. It's certainly not where we want it to be in India where we expect it to be in the back half of the year. I guess looking at the big picture, it doesn't necessarily surprise us that as we anticipated when we were on the call last quarter, that it would rebuild.
Over the course of the rest of the year, so that's moving along as we expected it to. Relative to the U.S. I think it's a fairly simple answer to your question, which is yes, we do expect the U.S. to grow in the back half of the year and that was just based on as I mentioned earlier, reasonable expectation for typical year-end purchasing activity in somewhat of the pattern that we saw last year. So, we're just focused on the basics there and making sure that we understand the tone of our customers, the quoting activity and how we translate that into their deployment of their budgets which have been conservative in the first part of this year as I mentioned.
Doug Schenkel -- Cowen -- Analyst
Okay, thank you for that. Then then on buy backs, last quarter you noted your share count guidance for the year assumes $800 million in buy backs. You're on pace for $1.1 billion in total buy backs, just annualizing what you've done thus far. Given the significant authorization last quarter is there any reason you don't continue to buy back shares at the current pace of around $270 to $280 million per quarter?
Sherry Buck -- Chief Financial Officer
Yes, Doug. So far through the first half, your numbers there, we've had about $550 million, and I'd say we couldn't maintain that through the second half, and we'll evaluate that over the course of the coming month.
Doug Schenkel -- Cowen -- Analyst
Okay. Thanks, Chris. Thanks, Sherry.
Operator
Thank you. Our next question will be from Catherine Schulte of Baird, your line is open.
Catherine Schulte -- Baird -- Analyst
Hi guys, thanks for the questions. Chris, when you look at Waters branded instruments, what do you think the most important factors will be in order to get that piece of the business back to mid-single digit growth and how long do you think that takes?
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah, that's a fair question and certainly it is a portfolio effect. Obviously, we need to continue to step forward in our progress we're making in mass spec and continue to leverage the strength of our tandem-quad portfolio in that regard while also competing well on the high-resolution side as we continue to invest for the future and on the LC side. There are ebbs and flows in the LC business, we have a fantastic portfolio and feel better about our portfolio now probably than any time over the past few years given some of the refresh we've done there. I mentioned the ACQUITY Arc has done well, but now we have the ACQUITY Arc bio.
The ACQUITY plus which brings in a whole new set of capabilities to our core UPLC platform. Really, if you look at broader trends and just the stand-alone LC business, the first half as a whole, U.S. LC was more like a mid-single digit grower with worldwide being in that same range, and so, it's just really matter of making that whole portfolio work and leveraging the benefit of some of the newer technology we have and continuing to meet the needs of our customers, but we certainly have an expectation, as well as, goals to make sure that that overall portfolio of Waters branded instruments performs at the levels we expect.
Catherine Schulte -- Baird -- Analyst
Great, thank you. Then Sherry, can you just give us a bridge for the EPS guidance change, sounds like seven or eight cents of less favorable FX, but any other change assumptions there?
Sherry Buck -- Chief Financial Officer
Yeah, Kevin, you hit that one on the head. So our guidance change we lowered the midpoint about 7% and it's really because of the change in our FX guidance or the second half of the year, and really our all of our assumptions for the guide remain unchanged.
Catherine Schulte -- Baird -- Analyst
All right, great. Thank you.
Operator
Our next question is from Derik De Bruin, Bank of America, Merrill Lynch. Your line is open.
Derik De Bruin -- Bank of America Merrill Lynch -- Analyst
Hi. Good morning, everyone.
Sherry Buck -- Chief Financial Officer
Hi.
Chris O'Connell -- Chairman and Chief Executive Officer
Hi, Derik.
Bryan Brokmeier -- Head of Investor Relations
Hey.
Derik De Bruin -- Bank of America Merrill Lynch -- Analyst
A couple of questions. So, first one is, the DESI Technology has been around for a while and obviously it's been partnered with some other mass spec companies. I'm just curious as to why you're doing that acquisition now? Then, can you give us some metrics in terms of what M & A is going to contribute to your constant currency growth in 2018?
Chris O'Connell -- Chairman and Chief Executive Officer
Sure, yes. Just a couple of additional comments on DESI. This technology has been around. For sure, it's been in a semi or co-exclusive type of an arrangement with other partners. Frankly, we see a huge opportunity to personally, within waters development technology to make it even more robust, usable, and widespread for mass spec imaging. Frankly, we see a significant pull from our customers it's one of the key sources of differentiation in some of our high-end systems. I think, we were held back probably from doing all we can with the technology in that type of model.
There is obviously a transition period in there relative to other technologies. We want to support our customers as they evolve to the next-generation of sort of waters driven DESI technology and having full control over the technology was a really critical step in doing that. I think, it's also reflective of our belief in the direct mass spec technology category, mass spec imaging, as part of that and the really interesting technology portfolio we have. We just see more and more direct sample mass spec applications coming for all the reasons I mentioned and want to control our destiny even more significantly. As it relates to M & A metrics and inorganic growth, there's very little of that in the business and even on the DESI side. It's completely immaterial at this point. So, really the growth we're getting this year is truly organically driven.
Derik De Bruin -- Bank of America Merrill Lynch -- Analyst
Great. Then, just one follow up. So, obviously the dollar has been moving quite a bit and getting stronger and I know previously there has been some issues with respect to your Indian customers losing some purchasing power and obviously things moving around and currencies in China. I'm just curious, have you seen any hesitation when people buy because of their budgets? Then, also, is there any indication that the trade issues that are going on or bleeding over into maybe some of the U.S. competitors like Shimadzu, maybe getting a little bit more business? Thanks.
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah, thanks. I don't know. I think, that's a really interesting question, Derik. One, we just really don't know. I personally don't see any evidence that the trade or tariff or currency associated currency issues that we all watch very carefully have changed purchasing behavior. Certainly, in India, the dynamics we've seen have been much more related to the specific kind of customer and country issues in India around some of the broader economy reforms. China, we really haven't seen any effect there.
Obviously, there's a lot of unknowns out there relative to trade more broadly. I guess, personally the way I look at that is, I just try to understand it and if there are any threats, but very much remain a kind of a free trader in terms of my mentality and offering my voice to that where I can. Hopefully, a lot of the rhetoric that's going on right now is really a negotiation that ultimately restores and affirms the sort of inexorable.
Globalization of our economies and enables free and fair trade. So again, no direct evidence that there's issues that get in the way of our normal commercial activities but will obviously stay focused on that question. I think in the interest of time here we have one more, time for one more question.
Operator
Yes, our final question will be from Patrick Donnelly of Goldman Sachs, your line is open.
Patrick Donnelly -- Goldman Sachs -- Analyst
Great, thanks for sneaking me in that Chris. Just on the sales force realignment, I know you mentioned positions were mostly filled by the end of 1Q, can you just talk through what historically has been the timing, kind of ramp up to productivity there, and have you seen the territories bounce back once positions have been filled over the last three or four months?
Chris O'Connell -- Chairman and Chief Executive Officer
Yeah, I appreciate the question, and like I said last quarter, we tried to just be extremely transparent about what's going on here, but I'd continue to reinforce that this is a very small impact in terms of the overall results. It's a relatively minor set of changes. Obviously, there's a difference when you hire new people, when you're hiring fresh inexperienced reps in the company that have big upside but have a longer curve versus competitive and experienced reps. We do have a mix there, so I don't want to put too fine a point on that other than to say that this is normal course of business. We feel good about the modifications we've made over time, and it's all about investing in our team to win in a changing environment. So, I'll just leave it at that.
Patrick Donnelly -- Goldman Sachs -- Analyst
That's helpful. Then maybe just a quick one on the P & L, and margins came in a little ahead of our expectations, can you just talk through any key initiatives driving expansion there? I mean, even in a lower-growth environment relative to where you guys have been historically driving some nice expansion, so I'm just kind of curious what the key levers there and how you feel and going forward?
Chris O'Connell -- Chairman and Chief Executive Officer
Just a quick comment, and I'll let Sherry comment as well, but one of our key parts of our value creation framework is continuous operational improvement, and since Sherry has come in, we've put together a comprehensive program to scale the company and drive efficiencies in all parts of the P & L, everything from how we design products and manage our cost to goods and non-product costs all the way through G & A, and in selling and marketing type expenses. Really, a lot of that's being done to preserve and enhance our overall commitment to our growth investments in R & D and sales force expansion. So, I don't want to put too much detail on it right now, we look forward to sharing more overtime. But we are really developing a comprehensive program in that regard and are excited about what it'll do to help us continue to grow scale and invest in the company.
Sherry Buck -- Chief Financial Officer
The only thing I'd just add for the quarter, we did see some favorable mix in the quarter that impacted that, and a little bit of FX as well.
Chris O'Connell -- Chairman and Chief Executive Officer
Good, thanks Sherry. I think we'll turn to the wrap-up here. I want to just say thank you all for your great questions as always. In conclusion, here at Waters, we remain focused on delivering our growth plans for 2018 headlined by an acceleration in the back half of the year within our pharmaceutical market continued growth in TA and broad-based growth in China. We believe that market conditions and our strong competitive position support continuing success. 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 Q3 2018 call, which we currently anticipate holding on October 23, 2018. Thank you and have a great day.
Operator
We thank you all for your participation in today's conference, that will conclude the call. You may disconnect. Thank you.
Duration: 64 minutes
Call participants:
Bryan Brokmeier -- Head of Investor Relations
Chris O'Connell -- Chairman and Chief Executive Officer
Sherry Buck -- Chief Financial Officer
Steve Beuchaw -- Morgan Stanley -- Analyst
Dan Arias -- Citigroup -- Analyst
Jack Meehan -- Barclays -- Analyst
Tycho Peterson -- JP Morgan -- Analyst
Puneet Souda -- Leerink Partners -- Analyst
Brandon Couillard -- Jefferies -- Analyst
Doug Schenkel -- Cowen -- Analyst
Catherine Schulte -- Baird -- Analyst
Derik De Bruin -- Bank of America Merrill Lynch -- Analyst
Patrick Donnelly -- Goldman Sachs -- Analyst
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