Waters - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning and welcome to the Waters Corporation Third Quarter 2020 Financial Results Conference Call. All participants will be in a listen-only mode until the question and answer session. To ask a question, please press star and then one. 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. Sir, you may begin.

Bryan Brokmeier (Senior Director, Head of Investor Relations, and Member of the Finance Leadership Team)

Thank you, Operator. Good morning, everyone, and welcome to the Waters Corporation Third 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 anticipates for the fourth quarter and full year 2020. We caution you that all such statements are only our present expectations and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see the risk factors included in our annual report on Form 10-K for the fiscal year ended December 31st, 2019, in Part 1 under the captioned risk factors, and in our most recent quarterly report on Form 10-Q for the quarter ended June 27th, 2020, in Part 1-A under the captioned 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 respect to risks related to the effects of the COVID-19 pandemic on our business. We further caution you that the company does not intend to update any of its predictions or projections except during our regularly scheduled earnings release conference calls and webcasts, or as otherwise required by law.

The next earnings release call and webcast is currently planned for February 2nd, 2021. 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 are in comparison to the third 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. Udit Batra, Waters President and CEO. Udit?

Udit Batra (President and CEO)

Thank you, Bryan, and good morning, everyone. Before I begin with the content, let me say I'm honored and thankful for the opportunity to lead Waters and work with such a talented and dedicated team. It has been a very busy eight weeks. Along with Bryan, our CFO, Sherry Buck, is joining me in today's call. During the call, I will provide a brief overview of our third quarter operating results and then share some of my early impressions of the company and the opportunities that I see. Sherry will then review our financial results in detail and provide comments on our fourth quarter financial outlook. We will then open up the phone to take your questions. Let's start with the third quarter. Our teams have worked tirelessly during the pandemic to stay close to our customers.

We've seen a cautious return to work by our customers, and this is reflected in our results. After a steep decline in the second quarter, third quarter sales were up 2% year-over-year on a constant currency basis, and adjusted earnings per share grew 1%. First, from a customer perspective, our largest segment, Pharma, was the primary growth driver in the quarter with 4% organic growth, followed by Industrial, which grew 3%, and Academic and Government, which declined 7%. From a product perspective, our Waters branded products and services grew 3% organically, while TA declined by 8% on a constant currency basis. Improving access to labs, especially in Pharma, continued to help drive growth in the recurring revenues. Services grew 4%, while Consumables business grew approximately 7% organically, driven largely by Pharma. Consumables remain a growth area for us.

In fact, earlier this month, we introduced our ACQUITY Premier Columns, which reduce variability, risks, and save time when analyzing metal-sensitive analytes ranging from oligonucleotides, peptides, glycans, and phospholipids. The chemistry on the surface reduces unwanted analytes or surface interactions to produce real improvements in sensitivity, peak shape, and recovery. The third quarter was strong for our mass spec systems with double-digit growth. We were encouraged by the demand of our high-resolution mass spec systems in Pharma and Biomedical research, particularly in the U.S. and Europe, and the demand for our tandem quad systems in food safety in China. BioAccord also grew nicely in the quarter. However, it still does not represent a material portion of our revenue.

With its simplicity and dedicated workflows in peptide mapping, glycan analysis, intact mass, and oligonucleotide analysis, we believe it is the right instrument to bring LC-MS into the manufacturing and QA/QC space. I have spent time with several of our customers who are using BioAccord instruments, and many of them highlighted its ease of use and a robust feature set that can be utilized across multiple lab applications. So I think BioAccord has a good future, but I also think it will take longer than originally anticipated to significantly impact our core growth. This is a dynamic Waters has seen with prior new product launches such as ACQUITY, which took almost four years to reach its peak sales. LC instruments also saw a better quarter after double-digit declines in the first half of the year, with a modest decline in Q3.

Some of this improvement can be directly attributed to Arc HPLC, which was launched in June. Finally, to TA, revenues continue to decline in the high single-digit due to constrained capital spending at our industrial customers. Pharma and Electronics revenues saw a nice double-digit increase, but this was not enough to offset the industrial declines. Turning to our key geographies, both the Americas and Europe grew mid-single digits, while Asia was flat. In the U.S., the growth was driven by Pharma, Food, and Academia, partially offset by declines in Materials Science and Clinical. We saw especially strong engagement with customers who are assisting the fight against the pandemic. Latin America remained soft, mostly due to the continued impact of closures due to COVID-19. Europe also experienced a recovery with mid-single digit growth, largely driven by biologics, CROs, and genetics, including strong growth at large pharma accounts.

After very significant declines in the first half, China grew at low single digits, driven by an acceleration in Food and Pharma, as well as strength in TA Instruments driven by investments in 5G networks across the country. This was partially offset by continued weaknesses in Academia and Government. India also recovered with double-digit growth. The third quarter benefited from some catch-up of revenues, which was delayed from the first half of the year, and looking ahead, while customer activity and access are improving, we remain cautious. We continue to face variability in our end markets and macroeconomic concerns tied to COVID-19, and Academic customer trends remain depressed. Moreover, we are uncertain on the level of capital spending in the fourth quarter, particularly by our Pharma and Industrial customers. Now, let me share with you some of my early thoughts on the company.

As a former researcher who has used Waters products in the lab, as an engineer who has modified rheometers and DSCs, and as a former customer, I believe my 25-year experience in pharma and tools has prepared me well to work with my colleagues to transform Waters. Indeed, it is a transformation to return a champion to where it belongs. Since the announcement in mid-July, I've spent most of my time listening and learning. I met with investors and shareholders, including many of you, talked with and visited customers, read and researched, and conducted many deep dives with my colleagues around the globe. My learning is far from done, but today, I can share with you three ideas that resulted from this deep transparency phase. First, Waters has built a solid foundation with exposure to a number of attractive end markets.

Second, despite this strong foundation, our momentum has stalled in the last few years. Third, and finally, we are already developing a transformation plan with tangible short-term actions. Let's take each of these in turn. First, we have a solid foundation in attractive markets. Our largest end market, Pharma, is benefiting from growth of biologics and continued development of novel modalities. Moreover, our strong base in small molecules, which represents approximately 75%-80% of pharmaceutical industry sales, will benefit from the growth of CROs, oligonucleotides, and mRNA therapeutics, as well as the increasing potential for repatriation of small molecule manufacturing. We have a global footprint with 25% of our sales coming from China and India. We have a solid base in these markets that is characterized by trusted brands, deep customer relationships, and a culture that is rooted in science and engineering.

In my customer meetings, Waters employees are acutely aware of the issues facing our customers and are so tightly integrated with them that I often had a tough time distinguishing between our employees and that of our customers. Finally, as we look to further strengthen this base, our high margin and free cash flow gives us the flexibility to continue to invest. Second, despite this strong foundation, we have underperformed both our historical growth and that of the market for the last few years. Our performance has trailed the market in LC, mass spec, and thermal analysis. We were slow to respond to the transition of food testing from government labs to contract testing labs in China. Our product launches have not met expectations that we set. BioAccord, while a product that clearly meets a need, has been slower on the uptake than anticipated.

Our culture is one that appreciates deep scientific insights, but one that has lacked focus and urgency. Strategically, the focus on our portfolio on LC, LC-MS, and thermal analysis has limited our ability to keep up with emerging trends like bioprocessing, contract manufacturing, and testing or diagnostics. This is evident in our lack of exposure to tailwinds from COVID-19 as compared to some of our peers. Third, so where to from here? While we are still continuing an in-depth analysis and developing our transformation strategies, some themes are already emerging, and let me break these into three. First, in the near term, we're focused on making changes to regain commercial momentum. Second, in the midterm, the focus is on the pipeline and organic growth with intense focus and urgency. And finally, as we strengthen our organic growth, we will start to examine strategic investments.

Let me give you some concrete examples in the near term. First, we're squarely focused on regaining our footing in LC instrumentation. For instance, we have identified all the units in both our installed base and in the larger Empower network and implemented a specific program to upgrade and replace older systems with Waters HPLC instrument portfolio, including with the new Arc HPLC. For example, there are thousands of Alliance systems in service that are more than 20 years old and in need of an upgrade. Second, approximately 20% of our consumable sales go through the e-commerce channel. For many of our competitors, this number is over 50%. In the near term, we're implementing actions to increase traffic to this channel, such as increasing paid search and improving search engine optimization. Third, our penetration in CRO channel trails our competition.

We will increase our commercial presence to penetrate this growing channel at a level that better aligns with our peers. Fourth, as I mentioned earlier, we still have a lot of faith in the success of BioAccord. Customers in QA/QC are conservative, and we need to spend a lot more time developing methods in collaboration with them and further developing enterprise-level software to help them deploy the system seamlessly. As you can see, there are near-term actions that are backed by detailed targets and KPIs. However, I want to be clear. These changes will take time and will not significantly impact our results overnight, especially as we implement these initiatives amid the background of COVID-19. However, I can assure you the team is very engaged, and I have seen an impressive increase in drive and ambition in the eight weeks that I've been here.

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

Sherry Buck (CFO)

Thank you, Udit, and good morning, everyone. In the third quarter, we recorded net sales of $594 million, an increase of approximately 2% in constant currency. Currency translation increased sales growth by approximately 1%, resulting in sales growth of 3% as reported. In the quarter, sales into our pharmaceutical market increased 4%. Sales into our industrial market increased 3%, while academic and governmental markets declined 7%. Looking at our product line growth, our recurring revenue, which represents the combination of precision chemistry products and service revenue, increased by 5% in the quarter, while instrument sales declined 1%. As we noted last quarter, there was no year-over-year difference in the number of calendar days during the third quarter.

Chemistry revenues were up 7% in the third quarter, driven by strong pharma market growth. On the service side of our business, revenues were up 4%, as on-demand service bounced back to mid-single digit growth, along with continued growth in service plan revenues within the Waters product line. Breaking third quarter product sales down further, sales related to Waters branded products and services grew 3%. Sales of TA-branded products and services declined 8%. Combined LC instrument platform sales and LC-MS instrument platform sales were flat, and TA's instrumentation system sales declined 10%. Looking at our growth rates in the third quarter geographically and on a constant currency basis, sales in Asia were flat, with China up 3%. Sales in the Americas grew 2%, with U.S. growing 5%, and European sales grew 5%.

Before I comment on our third quarter non-GAAP financial performance versus the prior year, I'd like to update you on the progress of our cost actions in response to the COVID-19 pandemic. We are on track to achieve cost savings of approximately $100 million for the year relative to our pre-COVID internal plan. We achieved approximately 25% of our planned annual savings in the third quarter, bringing our year-to-date savings against our internal plan to 85%, with the majority recognized in the second quarter. We expect to realize the remaining 15% in the fourth quarter. Returning to our third quarter non-GAAP financial performance, gross margin for the quarter was 55.8% compared to 58.2% in the third quarter of 2019, primarily as a result of unfavorable effects, as well as fixed cost absorption and sales mix.

Moving down the third quarter P&L, operating expenses increased by approximately 1% on a constant currency basis, and foreign currency translation increased operating expense growth by approximately 2% on a reported basis. The increase was primarily attributable to the timing of variable costs in the prior year quarter and effects. In the quarter, our effective operating tax rate was 15.8%, which was about flat for the prior year. Net interest expense was $7 million, a decrease of about $1 million. Our average share count came in at 62.3 million shares, a share count reduction of approximately 7%, or about four million shares lower than in the third 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 third quarter increased to $2.16 in comparison to $2.13 last year. On a GAAP basis, our earnings per fully diluted share decreased to $2.03 compared to $2.07 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 third quarter results and activities. We defined free cash flow as cash from operations plus capital expenditures and excluding special items. In the third quarter of 2020, free cash flow grew 53% year-over-year to $190 million after funding $28 million of capital expenditures. Excluded from free cash flow was $7 million related to the investment in our Taunton Precision Chemistry operation and a $38 million transition tax payment related to 2017 U.S. tax reform.

In the third quarter, this resulted in $0.32 of each dollar of sales converted into free cash flow and $0.31 year-to-date. Our increased free cash flow is primarily a result of our cost savings actions and improvements in our cash conversion cycle. We continue to make good progress on our working capital improvement plans. Accounts receivable day sales outstanding came in at 76 days this quarter, down 4 days compared to the third quarter of last year and down 11 days from the second quarter. Inventories decreased by $42 million in comparison to the prior year quarter, reflecting stronger revenue growth and 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 $397 million and debt of $1.6 billion on our balance sheet at the end of the quarter.

This resulted in a net debt position of $1.2 billion and a net debt to EBITDA ratio of about 1.6 times at the end of the third quarter. We also have $1.2 billion available on our bank revolver for total available liquidity of $1.6 billion at the end of third quarter. Our capital deployment priorities remain consistent: invest for growth, balance sheet strength and flexibility, and return of capital to shareholders. We remain committed to deploying capital against these priorities. Our future capital structure target of approximately two and a half times net debt to EBITDA remains unchanged, while our near-term focus is maintaining financial flexibility in light of variability in the macro environment. While our share repurchase program is paused during the fourth quarter, it still remains an important part of our capital deployment priorities.

We will provide an update on our capital deployment plans during our Q4 earnings call in February of 2021. Lastly, I would like to make a few comments on our outlook. Market conditions remain variable, largely due to the COVID-19 pandemic. As a result, we are not in a position to provide detailed guidance. However, I'd like to provide you with color on how we're viewing market conditions in the fourth quarter. We assume similar levels of customer access as we saw in the third quarter, which reflects the challenging macro environment. Our outlook does not anticipate a return to lockdown seen earlier in the year at the height of the pandemic.

And in addition, we believe that some delayed purchases from the first half of the year were realized during the third quarter, and there is limited visibility into year-end capital budgeting plans for both pharma and industrial customers in the fourth quarter. In light of these dynamics, we anticipate that fourth quarter revenue on a constant currency basis will most likely decline at a low to mid-single digit rate. In addition, I'd like to provide a few other assumptions that will be helpful for modeling purposes. Recurring revenue benefits from two additional calendar days in the fourth quarter of 2020 compared to 2019, which is factored into our outlook. We now expect full-year operating expenses to be in the range of down 1% to flat year-over-year in constant currency.

For the full year at current rates, currency translation is expected to be about neutral to sales growth, to positively impact operating expense growth by less than one percentage point, and to negatively impact earnings per share by about three percentage points. For the full year, net interest expense is expected to be in the range of $38 million-$40 million, primarily due to lower debt levels. Now I'd like to turn the call back to Udit for some summary comments. Udit?

Udit Batra (President and CEO)

Thank you, Sherry. In summary, we're pleased with the third quarter results, but market conditions remain variable amid ongoing macroeconomic uncertainty, lingering concerns around fourth quarter capital spending by both pharma and industrial customers, and academic customer trends.

Overall, I believe that we have a solid foundation, but to return to our deserved place in the tools industry, we need to improve our operational execution in the short term and focus our teams on what matters. And then in the midterm, our focus will return to strategically building our portfolio. With that, we will now begin the Q&A session. Operator?

Operator (participant)

Thank you. We will now begin the question and answer session. Our first question is coming from the line of Tycho Peterson from JPMorgan. Tycho, you may now open up your line.

Tycho Peterson (Managing Director of Life Science Tools and Diagnostics)

Hey, good morning. Good to connect with you, Udit. I think as we thought about kind of the portfolio review, prior management had obviously acknowledged some share loss in the high-resolution part of the market. If you look at the portfolio today, has your view on the share loss differed from what we heard previously from management? How much do you think could be captured by revitalizing the R&D organization? Can you talk a little bit more about the upgrade opportunity you alluded to, and where do you see gaps or potential divestitures if those are on the table as well? Thanks.

Udit Batra (President and CEO)

Broad question, Tycho. Thank you very much, and good morning. Look, I've been here only eight weeks, and I've been spending most of my time listening and learning. But let me start by reemphasizing that we have one of the best bases in the industry. If you ask me, what do you want as a starting point, I would have said Pharma, Informatics, and China. And there you have it. That's Waters.

So as I've said, we have indeed lost the momentum in the last few years, and I think you're right to call out the share loss in LC, in mass spec, and thermal analysis. We have indeed lost some of this momentum, and we need to build it back step by step. While the long-term plan is far from complete, some of these near-term actions to address the commercial momentum are really clear. We've already actively started to work on identifying and replacing LC instruments that are almost two decades old in most cases, and the Arc HPLC is a good new product to do so. From a channel perspective, I think we can increase our e-commerce presence, given that close to 20% of our consumables business goes through this channel. And from a customer perspective, we have the opportunity to increase our penetration in CROs.

So in summary, we are acting on some short-term plans, and overall, we hope that in the midterm, we are able to return to a sustained growth, hopefully in line with the market, but it's too early to get into any more specifics.

Tycho Peterson (Managing Director of Life Science Tools and Diagnostics)

Okay. And then for the follow-up, two of the questions we've gotten a lot from investors are on the level of reinvestment that's going to be required. So I'm wondering from a higher level, I know you don't want to talk too much about 2021, but to what degree should we think about you guys sacrificing margins for growth going forward and really reinvesting more in the business? And then number two, on capital deployment, I know it's early. You're not ready to talk about M&A yet, but you obviously have a good track record from your experience at Merck KGaA with some big transformative deals.

So how should we think about your broader views on M&A over the long haul? Would you consider something more transformative for a little bit down the road? Thank you.

Udit Batra (President and CEO)

Tycho, thanks for the question. I think the answer is as expected. Look, everything's on the table. I mean, right now, we're just delineating the plan. All I've focused on is to get going with the no-regret moves. And if some of them require additional investments, we'll look at it, and we'll look at the return, and we'll do it. From a long-term perspective, in rebuilding the portfolio, all options are on the table, but I think it's too early to comment on it. I think we first need to get our operational execution back on track, and we'll continue to identify near-term actions, and as we identify them, we will get going.

So I'm not waiting to finish the planning before starting motion. So basically, I've just given you three, four examples of what we've already started. I hope that clarifies the current focus. It's really on getting the momentum back while we build the long-term plan. And as that emerges, we'll share it with you.

Tycho Peterson (Managing Director of Life Science Tools and Diagnostics)

Okay. Thank you.

Operator (participant)

Our next question is coming from the line of Vijay Kumar. Vijay, your line is now open. You may open up your line.

Daniel Markowitz (Equity Research Associate)

Hi, this is Daniel on for Vijay. Thanks for taking the questions. So first, any color on quantifying the instruments catch-up benefit in 3Q? And is there any change to how you're thinking about the 4Q budget flush, or is it the same as three months ago?

Udit Batra (President and CEO)

I think on the catch-up, no, I don't think we'll be able to quantify that for you any further.

As far as Q4 is concerned and catch-up, look, we're first very, very relieved and happy with the low single-digit growth that we've seen, and it is better than anticipated, especially after the decline in the first half. So under the circumstances, we're quite happy with these results. As to Q4, while the long-term prospects for the business are quite robust with solid growth in Pharma and nice exposure to China and India, it's really difficult to predict what will happen in Q4, especially given the uncertainty that many customers are still facing due to COVID-19 and the fact that close to 50% of our sales for the fourth quarter comes in December. We remain cautious. Additionally, as I mentioned, we had some catch-up from the first half of the year in Q3, which might not repeat. So despite all of this uncertainty, our focus is really on short-term execution.

So really not much more to say about the capital outlay in Q4, but we're closely watching.

Daniel Markowitz (Equity Research Associate)

Totally understand. Thanks for the color. And then my follow-up, any more color on the drivers of margins? It looks like gross margins came in below street models, but then you guys beat on the OM lines. So just any color on drivers there would be very helpful.

Sherry Buck (CFO)

Thanks for the question. Yeah. So if you look at our gross margins, it came in at 55.8%, and there were primarily two big drivers around that. About half of that impact was driven by FX, and then the rest of that was primarily strength, primarily mixed due to the strength in our MS portfolio, with our mass spec being at double digits.

And just if you step back a little bit and look at our gross margin performance over the course of the year, it's been variable due to a variety of factors. The quarter, it was impacted by COVID. Second quarter, our gross margins were really helped by our cost actions. And so if I really step back and look at our year-to-date gross margin performance, we're at 56.5% versus 58% last year, and about 100 basis points of that was really due to FX factors. And so as I look at the top line being down in the 6% range through year-to-date, I think we've done a pretty good job of managing the costs in a challenging environment. So those are the primary drivers for our Q3 gross margins.

Daniel Markowitz (Equity Research Associate)

Awesome. Thank you for the call.

Operator (participant)

Our next question is coming from the line of Michael Ryskin from Bank of America. Michael, your line is now open. You may now raise your question.

Michael Ryskin (Managing Director)

Thanks. This is Mike on for Derik. First, I want to follow up some of your earlier comments. You had some interesting specifics on the BioAccord, just given it's been promised for so long as the next major future growth driver. I'm just curious, what specific steps do you think you've outlined to accelerate that and to get that to deliver up to promise? And it's interesting you also flagged the ACQUITY and the time it took for that to ramp up, and obviously the major contributor it is today. Is that something we should use as a roadmap for BioAccord specifically? And how do you feel of that being a major growth driver going forward?

Udit Batra (President and CEO)

Well, thanks for the question.

Look, let me first start by saying that there is a clear unmet need in QA/QC release of biologics, and this is especially apparent to me given my previous background in bioprocessing. BioAccord is exactly the right product to fill this gap. I've had a chance to talk to some of the customers and many of my old colleagues who are using BioAccord for testing of biologics. And with its simplicity and dedicated workflows in peptide mapping, glycan analysis, intact mass, and oligonucleotide analysis, this is the right instrument to bring LC-MS into QA/QC. And I want to make sure that I stated that before I made any other cautionary statements. In fact, we've seeded BioAccord virtually in all large pharmas already. However, as you know, it takes years for a new product to embed itself in the conservative QA/QC environment.

And as I mentioned, ACQUITY took close to four years. You can start to use that as a reference, but I'm sure we'll dig out other references of products that have taken probably equally long in that space. So while the product is very good, I don't expect it to move the needle in the short term. Over the long term, it has very, very good prospects, and we continue to develop its applications. So I hope that gives you color on BioAccord. In terms of specific steps, really, it's about talking to the customers, getting it seeded, and doing the market development cautiously and diligently. That's where we're focused now.

Michael Ryskin (Managing Director)

Okay. Thanks. That's really helpful. And I want to stick on some of the new product launches in the pipeline.

I mean, Waters has had a pretty steady cadence of products in the last 12-18 months, a lot more on the mass spec side, the SELECT SERIES Cyclic, the SYNAPT XS. I'm wondering, as you reexamine the portfolio and sort of lay out the roadmap, is there any promise in these products? Is there something in the pipeline that you think you can point to, or is this a little bit more of a harder reset on the innovation front?

Udit Batra (President and CEO)

It's also a very good question. Look, apart from BioAccord, you mentioned the refresh of the mass spec portfolio, both on the high-res end, this is Cyclic and SYNAPT, and on the tandem quad end, this is Xevo TQ-XS, GC, Xevo TQ-S cronos. And coincidentally, all of these products have done very well in Q3.

This is why we see a double-digit growth of mass spec, a high-res mass spec in the U.S. and in Western Europe, and our tandem quad portfolio for food safety testing and traditional Chinese medicine in China. So we're seeing some good uptake for these products. So the focus on new product development will continue. And on the LC side, you've seen Arc HPLC launch, and this is really a major contributor to our revival and, I would say, less decline in the LC instrument space that you saw in Q3. And we're continuing to focus on that. So in a nutshell, even a higher focus on portfolio development, and secondly, realizing the full potential of the launches that have taken place, not just BioAccord, but also the rest of the mass spec portfolio, as well as the LC and the consumables portfolio.

Michael Ryskin (Managing Director)

Thanks, Udit, and congrats.

Operator (participant)

Our next question is coming from the line of Doug from Cowen. Doug, your line is now open.

Ryan Blicker (Healthcare Equity Research VP)

Hi, this is Ryan on for Doug. Thank you for taking my questions. Maybe following up first on the last question, I just want to confirm, again, really encouraging mass spec commentary. Can you talk a bit more about how you view the portfolio today versus competitors? And do you believe that Waters is positioned to at least maintain mass spec share moving forward after these new product launches, or do you believe that more work is needed on mass spec innovation to sustainably return to market growth in MS?

Udit Batra (President and CEO)

Look, I'll go back to saying I've been here only eight weeks, and I'm still listening and learning, so I have the full right to change my view as I learn more about our portfolio.

I am excited by what I see, especially on the mass spec side. I am excited by the breadth of the portfolio we have. If I'm not mistaken, it is one of the widest in the industry, ranging from high-res to tandem quads and to also BioAccord as a first in somehow first in class. So I feel we are reasonably well positioned. That does not mean we will stop our investment in the area. Now, don't ask me how fast we will get back to our original share. We are intensely focused on realizing the full potential of these products, as you already saw in Q3. The commercial teams are very focused on this. Our collaborators are giving very good feedback on the product launches.

So I'm very optimistic, but I would say it's early days, and I want to learn more before I can give you any more concrete information.

Ryan Blicker (Healthcare Equity Research VP)

Got it. And then on LC, so competitors have talked about share gains and chromatography in recent years. I believe this is the first time that Waters has acknowledged LC market share loss. Did I hear that correctly? And if so, can you talk about why you believe Waters is losing share in LC and what actions can be taken separate from a more active focus on upgrading older instruments?

Udit Batra (President and CEO)

Yeah. Look, I mean, I cannot judge what the exact loss in share is, but we definitely have lost some momentum in the last few years. I think that you can be certain of comparing our results to our past and perhaps even some competitors.

I would break the action down into three parts. We're very focused on rebuilding our portfolio, and you saw what I talked about on the Arc HPLC, and this will allow us to replace the already installed base in Alliance, which is now roughly two decades old. So this is something we have a lot of attention focused on. Secondly, on the consumable side, our Premier Columns were just launched, and these are for metal-loving analytes, and oligonucleotides are some of those, which I don't need to tell you are a strong contributor to growth in the future. And then finally, we think from a channel perspective, we have been underrepresented in the CRO channel, and the teams are highly focused on developing that.

So it's a rather comprehensive examination of our LC presence, and we're really pulling all the levers ranging from portfolio to portfolio both on the instrument and the hardware side, sorry, on the hardware and the consumable side from a channel perspective. This is CROs and also from a geographic perspective. And the last thing I'll mention is that many of our competitors have a significant portion of their consumables business going through e-commerce. And given my recent experience on e-commerce, I believe we can take some short-term tactical actions to start catching up. I mean, 20% of our revenues in consumables goes through e-commerce, and for many of our competitors, it's close to 50%. So a pretty broad-based push towards LC, and I'm confident that we'll start to see some shift in momentum.

Ryan Blicker (Healthcare Equity Research VP)

If I could sneak in one more, you talked in your prepared remarks about Waters' inability in recent years to keep up with emerging trends like bioprocessing, contract manufacturing, and diagnostics. Do you believe that you have the right products to more aggressively go after those opportunities and it's a matter of commercial execution, or do you believe that there's gaps in Waters' current ability to address those emerging trends? Thank you.

Udit Batra (President and CEO)

I think the answer is a mix, right? And as I said, it's only been eight weeks, so it's with all the necessary caveats. Look, the answer is a mix. From the overall, we're very happy to have about 60% of our business go to pharma. Pharma remains the most attractive end market. 30% of that business is focused on large molecules, right, which, as you outlined, is the faster-growing segment.

Now, that said, the small molecule segment of pharma is also very attractive. I mean, look, it's still 80% of the pharmaceutical company's revenue, and that's in small molecules. With recent events, antivirals have grown quite rapidly, as have oligonucleotides, and we've seen that show up in our business in small molecules. So small molecules is not something that we shy away from, but your question was more around portfolio towards biologics. So 30% of our business is, 30% of our pharma business is focused on that direction, and we intend to continue to innovate and continue to push organically on that side. And once we've done that, once we feel comfortable and confident with our commercial execution, given our existing portfolio, we will look at portfolio expansion, and there will be a time for it. It's just simply not today, and I don't have any specifics on that front.

I simply mention that because when you look at Waters' results, it's very much a core business performance, and we're very happy with it. We don't have a lot of COVID-19 tailwinds in our results, so whatever change in momentum you see is meaningful and sustainable over the long term because we're really getting it from the core business. Next question.

Operator (participant)

Thank you. Our next question is coming from the line of Dan Brennan from UBS. Dan, your line is now open. You may now raise your question.

Nathan Treybeck (Equity Research Associate Director)

Hi, this is Nathan on for Dan. I guess just to start things off, can you break down the pharma growth in the quarter, I guess, between small and large molecule? And then I guess what percentage of pharma customers are back in the lab? How much did that change from Q2, and was this percent return similar to your expectations?

Udit Batra (President and CEO)

I didn't understand the second part of your question, so I'll start with the first one, and then I'll give you the opportunity to come back. Small versus large. Look, both small molecules and large molecule pharma saw very nice growth, and regionally, especially in the U.S. and in Europe, it was actually double-digit across both of those segments. In fact, our top pharma customers, top 25 pharma customers, grew in the mid-teens. And in China, also, we saw low single-digit growth in large molecules, and small molecules were mid to high single-digits. So really nice broad-based growth, and you can also see that reflected in our consumables strength. And again, looking at China, this was in the high double-digits. So nice growth across both small and large molecules as many of our pharma customers start to increase their experiments in labs. I didn't catch your second question.

Would you mind repeating it?

Nathan Treybeck (Equity Research Associate Director)

Sure. The second question was focused more around how many of your pharma customers are back in the lab, and how did that trend kind of to your prior expectations, but I guess just to add on to that, can you give a little more color on the low single-digit to mid-single-digit decline you expect in Q4 kind of was baked into pharma and industrial growth expectations, and I guess how much of a benefit do you expect from the two extra days?

Udit Batra (President and CEO)

So I'll start with the first one, and I'll let Sherry comment on the Q4. Look, in terms of customer activity, I can give you three sort of dimensions: the service dimension, the consumables consumption dimension, and access for our sales teams. Let's start with consumables.

I mean, we've seen the experimentation go up in the labs, and our consumables growth is mid to high single digits and went into the double digits for China. So across all regions, especially in pharma, we start to see activity in the labs as measured by our consumables revenue. As far as our service access for our service teams is concerned, we saw some return to normal, especially in China and in Europe and increasing steadily in the U.S., but I would not conflate that with pre-pandemic levels, right? So our service engineers have a very different experience these days when they visit customers. Apart from having PPE and doing testing before they go to many customers, the duration of the visits is much shorter as customers have them in, and they want them out after a certain specific period of time.

While the overall activity and access to labs for service engineers has increased, it is still not like it used to be prior to the pandemic. And then finally, from a direct sales perspective, our sales engineers, I would say, have 15%-20% access, especially in the U.S. and in Western Europe versus what they used to pre-pandemic. And they have really leveraged the webinars and a lot of virtual interaction. And many of them, in fact, I was with the sales team in the U.S. recently, and many of them say, "Look, we hope the customers are willing to engage in the same way even post the pandemic because this is highly efficient and effective. It prevents unnecessary travel when you don't need to." And of course, there is no substitute for face-to-face interaction when we're able to do it.

Yet that said, there are some benefits that are coming out. So I hope that gives you more color on the access. For the Q4 question, I'll pass it on to Sherry.

Sherry Buck (CFO)

Thanks, Udit. As we are looking at our Q4, I'd say, first of all, just as we saw our Q3 results, we were pleased with the trends that we saw there. As Udit mentioned, we did see in the Q4 some realization of delays from the first half. So there's quite a few variables that are really happening. And as we're looking to Q4, the visibility to year-end capital budget plans is very limited, especially in pharma and industrial. And we do think we'll still continue to see the same level of customer access.

But just due to those different variabilities, we're guiding or have an outlook of low to mid-single-digit rate growth, not really breaking down the visibility into the end markets just because of a lot of differences there. But some of the trends we saw in Q3, we would expect to continue to see some of those strengths in the pharma business.

Nathan Treybeck (Equity Research Associate Director)

Thank you.

Operator (participant)

Our next question is coming from the line of Dan Leonard from Wells Fargo. Dan, your line is now open.

Dan Leonard (Managing Director and Research Analyst)

Thank you. For starters, Udit, I appreciate your repositioning on the BioAccord messaging. How are you thinking about waters_connect, which was the other effort put on a pedestal a couple of years ago at the investor event?

Udit Batra (President and CEO)

Yeah. Look, I mean, Dan, firstly, thanks for your question and your interest in informatics. It's early days.

I mean, I haven't yet been able to dig into each and every area in the business to the extent I would like. But on our informatics, on our informatics presence overall, firstly, in this particular quarter, we have seen some nice return to growth, very much tied to our mass spec instruments. Now, if you break it down, and that growth has especially come on the back of MassLynx and UNIFI. As I think about waters_connect and my early orientation, the ambition is to set up a connected system across all our different platforms. It brings in Empower, NuGenesis, UNIFI, MassLynx, and Progenesis together in a single platform. The early uptake in some of our customers has been good, especially for certain mass spec instruments, and the BioAccord is also on the same platform. We've got very good feedback.

It's been quite robust, but the rollout still continues. So it's early days, Dan, but the early feedback on waters_connect has been quite good. And I've experienced that personally with some of my old friends and customers. I recently visited, just to give you an example, I recently visited our Immerse Center in Cambridge, and we had some customers from nearby come over and use the BioAccord as well as some of our more recent mass spec launches. And it's really a seamless experience. But more on that later as I learn more, and you'll hear more about it as it gets rolled out and you hear more from customers. But early feedback is very good, and waters_connect is already out there.

Dan Leonard (Managing Director and Research Analyst)

Appreciate that. And then maybe for my follow-up, you mentioned an opportunity in repatriation of small molecule manufacturing. Can you elaborate a bit on that more? How would you frame that for investors?

Udit Batra (President and CEO)

Yeah. Look, again, it's early days, Dan. I mean, we've been hearing early conversation from many of our customers that there is a potential opportunity to repatriate the production of small molecules. We've talked to some of our academic collaborators also on continuous processing of small molecules. So there is a lot of interest, but no real concrete opportunities yet to quantify what exactly that opportunity would be. So you can imagine as that happens, and if it happens and as that happens, Waters is very well positioned to serve as the QA/QC provider, especially for LC and MS in that space. So early indicators, and I was only referring to some early indicators and direct conversations I've had with some customers, but no quantification to date.

Dan Leonard (Managing Director and Research Analyst)

Okay. Appreciate the thoughts. Thank you.

Udit Batra (President and CEO)

You're welcome.

Operator (participant)

Our next question is coming from the line of Steve Beuchaw from Wolfe Research. Steve, your line is now open. You may now raise your question.

Steve Beuchaw (Life Sciences and Med Tech Analyst)

Hi, good morning, and thanks for the time here. Just two for me. One is, so Udit, when I hear your prepared remarks about the strategy, it makes a lot of sense. And when I think about what might be a little different for the Waters approach here relative to others, the size of your installed base is clearly one of the big deltas relative to what some others might be thinking about. But what I wonder is if you could give us a little bit of an appreciation for some details around why it is that that's something that you can catalyze when it hasn't happened previously, and how do you do that in the field?

And how do you think about the competitive dynamics going after this replacement cycle in that space? Why would that be different from other verticals? And then I do have a follow-up. Thank you.

Udit Batra (President and CEO)

Sure. Look, I wouldn't call it a strategic initiative. I would call it a tactical no-regret move. When you learn that roughly over 8,000 of your Alliance instruments in the field are over 20 years old, you obviously ask the question, can you go and replace it? And when I was presented with that fact, I asked the team, what can we do to replace it? Are there customers who would want to do it? And the obvious answer is, yeah, I mean, we should, but we haven't really gone after it specifically.

So if you ask me about the tactical execution, we have the names, the zip codes of the customers who have these Alliance instruments, as you well know from your Waters history. With the 80,000 or so installed base, 8,400 is about, I think, about 8,400 is the Alliance base, which is over 20 years old. So we know exactly where they are. And the intent is to go and have a conversation with the customers. Especially now, I feel more confident when I saw the results for Arc HPLC, given its superior performance for that particular segment. I would think that there is an impetus to move customers to it. From a competitive standpoint, we feel very well positioned because customers have had a very good experience with Alliance over the years. It's a robust instrument, especially with Empower as its informatics backbone.

And we think that the transition is possible. Now, don't ask me if all and at what fraction and what rate this will happen. This is why I'm not giving you concrete timelines and concrete quantification of how fast this will happen. But it is something that we feel has a potential to catalyze growth.

Steve Beuchaw (Life Sciences and Med Tech Analyst)

Okay. Much appreciated, Udit. And then I wanted to follow up on the commentary regarding expectations for the fourth quarter. It's always difficult to forecast the fourth quarter because of year-end dynamics, and of course, this year is more difficult than most.

But just to make sure that people have as much of a calibration as they can for how things are evolving, I wonder if you'd be comfortable speaking to order trends through 3Q here in October or even new indications of interest just to give folks a sense for how things are evolving because it's not necessarily true that you're seeing any kind of pullback in a situation where just because of budget flush dynamics, 4Q might in fact be down year-on-year. And then I'll jump back in queue. Thank you.

Udit Batra (President and CEO)

I'll let Sherry comment on Q4. Go ahead, Sherry.

Sherry Buck (CFO)

Yep. Hi, Steve. Thanks for the question. So as you look at our Waters business and how quarters play out, much of our business is done in the last month of the quarter.

Coming into this quarter, I mean, market conditions are still pretty similar, and things are kind of progressing as we expect. But it's really too early to pinpoint that, really given the variability with some of the dynamics with COVID, etc. And I'd say we're very much focused on our execution. We have several leading indicators that we're looking at as far as access to our service and to labs. And those are things that we will monitor and execute. But we're just really focused on those things. And just with the visibility and variability there, providing that kind of an outlook for the fourth quarter.

Udit Batra (President and CEO)

Yeah. I mean, Steve, just to embellish just a little bit, I think no real change in trends, but we are cautious because 50% of the revenue, as Sherry has informed me, comes in December for Q4.

It's very much dependent on the capital outlays. So it's very difficult to predict, especially in this uncertain environment, how much that capital outlay is going to be. And that's the number one reason why we feel a bit cautious. But really, I mean, nice momentum into Q3 and nice shift from Q1 and Q2. And we are all hoping that it remains, but difficult to predict.

Steve Beuchaw (Life Sciences and Med Tech Analyst)

Got it. That's great color. Thank you again.

Operator (participant)

Our next question is coming from the line of Sung Ji Nam. Sung Ji, your line is now open. You may now raise your question. And by the way, Sung Ji is from BTIG.

Sung Ji Nam (Managing Director and Senior Analyst)

Thanks for taking the questions. Udit or Sherry, could you help me reconcile the growth in the Industrial segment and also the decline in the versus the decline in the TA business? I'm sorry if I missed it. Was it largely due to the Materials Science segment being weaker and then Food and Environmental Testing being stronger?

Udit Batra (President and CEO)

Sure. Firstly, on the TA segment, Sung Ji, on the TA business. TA has continued an 8% or so decline, as we mentioned. And China was really the bright spot with mid-teens growth, especially in the semiconductor space, and the U.S. with low single digits. The other regions continued to decline, and that affected the overall number. And you're right to say that it's especially in the materials and the polymer segment. I must say, you didn't ask, but I'll tell you, I had the chance to visit my colleagues at TA in New Castle lab virtually. I am so excited about the technological depth and the leadership in rheology, in calorimetry, in mechanical analysis. I also spoke to some of my old professors.

I'm a chemical engineer by training, both undergrad and graduate school, and our academic collaborators, and we see a terrific future for structure-property relationships that we are measuring with TA, so there are short-term challenges, and we've been pretty transparent about those, but I believe the future of this business is really, really, really good. As far as other commentary on the Industrial segment, I mean, we saw, and then you would recognize that we report Food under Industrial, and especially Food Safety in China, Food in the United States, both saw growth, and this is what also drove the Industrial segment in addition to the semiconductor growth that we saw in China. Europe was flattish in the Industrial segment. I hope that gives you the color you wanted.

Bryan Brokmeier (Senior Director, Head of Investor Relations, and Member of the Finance Leadership Team)

Operator, we have time for one more question.

Operator (participant)

Thank you. Yes. Our last question is coming from the line of Jack Meehan. Jack, your line is now open. And by the way, Jack is from Nephron Research.

Jack Meehan (Life Science Tools & Diagnostics Partner)

Thank you. Good morning. Udit, I wanted to push you a little bit more on some of the urgency around business investment. If you look across the landscape now, you mentioned how some of the tools companies, your peers, are seeing big COVID tailwinds, and they're also making pretty significant investments back in their business. Could you just help us understand why does it make sense for you to push ahead with some of the cost savings programs from earlier this year when you're trying to reposition yourself for better growth?

Udit Batra (President and CEO)

Yeah. Jack, I should have expected that question from you. I'll start on the cost savings part, and then I'll give you a view on how I see future investments and some concrete ideas there. Please go ahead, Sherry.

Sherry Buck (CFO)

Thanks, Jack. Yeah. So at the beginning of the year and as we saw COVID impacts, we felt like it was important to take these cost actions as we were going into Q2, particularly as seeing that as our most challenging quarter. So most of those cost actions have been completed through the end of July, particularly around employee-related items as we've had furloughs back and restored hours and salaries. And as we were doing this, though, we were also looked at projects that we would continue to support and prioritize. And so I'd say largely those are behind us. There's still a few things in fourth quarter, but things that we delayed we don't feel like impacted near-term milestones.

And I think we're very well positioned from both our cash flow results that we had this quarter as well as from a balance sheet to look at the right investments in the business for growth. And I'll let Udit carry on on some of those thoughts.

Udit Batra (President and CEO)

Sure. Jack, on the investment side, look, as I mentioned, there's need for commercial investment on the CRO side. We are underrepresented in that segment virtually globally. So as soon as we quantify what that looks like by region, in Europe, we've already started. As other regions come forward, I mean, we will be looking to support it. Second, on e-commerce, we're underrepresented in the market versus our peers.

I have some history in that area, so I can tell you that there will be some investment in e-commerce as we come back first with the existing platform, especially increasing paid search and search engine optimization, and then revitalizing the platform in the midterm. That'll require investment. I mentioned replacement of the old Alliance systems with Arc HPLC and with other hardware. That too will require specific training and focus from our field force. We're getting ideas for investments there. I expect to be able to leverage our existing infrastructure there. But if there's need for investment, we will not shy away from it. These are value-creating initiatives. One doesn't need to be a rocket scientist to understand that.

And then on new product development, I mean, while I have not finished examining our product development areas, it is absolutely clear that more effort needs to be placed in market development. And you guys were interested in BioAccord, but there are other launches also that have taken place recently on the mass spec side, on the high-res, on tandem quads. They require market development. There will be investments in that direction. So both from a market development standpoint and investments in commercial infrastructure, we will not shy away from any value-creating ideas. And I've already rattled off a few, and it's only been eight weeks since I've been here. I see tremendous, tremendous opportunity in our business. At this point, I want to go towards concluding the call. Thank you all for your participation.

Despite the uncertain environment created by COVID-19 and the challenges that Waters has faced in the last couple of years, I have never been more confident in my decision to join this company. I hope that was apparent to all of you in the statements that I made. There is an incredible amount of talent in our organization, and we have a tremendous opportunity in front of us to turn the business around with improved execution in the short term and then a renewed focus on growth in both organic and other strategic investments in the future. 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 Q4 2020 call, which we currently anticipate holding on February 2nd, 2021. Thank you all, and have a great day.

Operator (participant)

That concludes today's conference. Thank you all for your participation. You may now disconnect.