Waters Corporation (WAT) Q1 2011 Earnings Report, Transcript and Summary

Good morning, welcome to the Waters Corporation First Quarter 2011 Financial Results Conference Call. [Operator Instructions] This conference is being recorded. [Operator Instructions] I would like to introduce your host for today's call, Mr. Douglas Berthiaume, Chairman, President and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Thank you. Good morning, and welcome to the Waters Corporation First Quarter Financial Results Conference Call. With me on today's call is John Ornell, Waters' Chief Financial Officer; Art Caputo, the President of the Waters division; and Gene Cassis, the Vice President of Investor Relations. As is our normal practice, I'll start with an overview of the quarter's highlights and John will follow with details on our financial results and provide you with our outlook for the second quarter and for the full year. But before we get going, I'd like John to cover the cautionary language.

During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company, this time for Q2 and full year 2011. We caution you that all such statements are only predictions and that the 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 10-K Annual Report for the fiscal year ended December 31, 2010, under the caption Business Risk Factors. 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 earnings release conference call and webcasts. The next earnings release call and webcast is currently planned for July 2011. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure is attached to our company's earnings release issued this morning. In our discussions of the results of operation, we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled Reconciliation of Net Income Per Diluted Share included in this morning's press release.

Thank you, John. Well, we're very pleased with our first quarter results and encouraged by the broad strength that we saw across our product lines, geographies and markets. The trend of improving end markets and strong acceptance of our new systems that we've now seen over multiple quarters is very encouraging. During this quarter, our organic sales growth was 14%, and we delivered 28% adjusted earnings per share growth due primarily to strong shipment volume and effective expense leverage. Instrument sales, that is the hardware sales, grew organically at more than 20%, led by continued rapid uptake of our ACQUITY H-Class UPLC and Xevo UPLC/MS Systems. As you may recall, we began shipping our H-Class UPLC system in the first quarter of 2010. And during the past year, H-Class has been a remarkable success for us, as we've seen consistent and growing demand for this innovative system across our customer segments and especially among our pharmaceutical users, as they've upgraded their laboratories. Bringing in our business geographically, I'd like to start off by speaking about our situation in Japan. Most important, we are grateful that our employees are safe, and we are not aware of casualties among our many loyal customers. The resiliency of our staff and their dedication to ensuring the continued operation of instrumentation in our customers' labs has been very impressive. For weeks, they've endured disruptions in electrical power and in the public transportation system while working long hours under extremely stressful conditions. We're thankful for these extraordinary efforts and certainly continue to keep all of the people in Japan in our thoughts and prayers through these trying times. During the first quarter, our sales in Japan were roughly flat against a very difficult basic comparison. You may recall, we benefited from significant government stimulus demand in Japan during the first quarter of 2010. In fact, for the quarter, our sales volume was in line with the expected demand included in our January guidance. Moving forward, we remain concerned about the situation in Japan, but are hopeful that the most difficult conditions impacting our business may be behind us. Adjusting for currency, Japan has represented about 10% of our sales. And at this time, we have only marginally reduced our revenue outlook for the full year. However, a further deterioration of infrastructure in the country is a potential risk to our business that we will continue to monitor as the year goes by. Our business in Asia, outside of Japan, performed very well in the quarter, especially in China and India. Our business in India benefited -- excuse me, our business in China benefited from significant governmental investment in instrumentation accompanied by strong broad underlying business growth. In India, sales of instruments for QC testing to support generic drug manufacturing were augmented by a nice pickup in demand for mass spectrometry, mass spectrometry-based systems for a variety of research and testing applications. Coming into this year, we have been somewhat concerned about demand in Europe for new instrument systems as general economic conditions there appear to be somewhat fragile. Having those expectations, we were pleased with our sales growth in the first quarter. In Western Europe, pharmaceutical and applied chemical analysis sales, largely driven by our new mass spectrometry systems were particularly strong. University and governmental spending, a concern for us given publicized austerity measures showed reasonable growth in the quarter. In addition, our Eastern European markets delivered another strong quarterly performance with nice double digit year-over-year sales growth. Finally, looking at sales in the Americas, developing markets in South America continued to deliver a strong double-digit growth, while in the U.S., pharmaceutical and applied chemical analysis sales more than offset expected weaker [ph] combined government and university shipments. Continuing to review the Waters division business. As many of you know, the broadly defined pharmaceutical market has historically accounted for more than half of Waters sales and accordingly it has been a significant factor in our success and a consistent focus of our product development and marketing efforts. Over the last few quarters, I've spoken to you about early trends signaling a recovery in pharmaceutical spending for liquid chromatography and mass spectrometry technologies. In addition, we have over the past year introduced significant new instrument systems well suited for applications that span the drug discovery development and quality control processes. While in the first quarter, our level of confidence in a meaningful recovery of pharmaceutical spending improved further, as sales to this segment grew even faster than our overall revenue. Looking more closely at our breakdown of pharma sales, the strength was very broad as generics, CROs and our larger ethical [ph] accounts all delivered strong double-digit growth. As I mentioned earlier, our newer system offerings, including the ACQUITY H-Class and our Xevo MS Systems helped accelerate our business in the quarter. And I'll now mention that a significant proportion of that growth was for pharmaceutical applications. Our outlook for the remainder of this year assumes that we will continue to benefit from a healthy level of demand from our pharmaceutical customers, as we feel capital budgets are in place and that our current and upcoming new products will generate healthy order flow. On the new product front, we have planned significant new instrument system introductions during the first half of this year. At this year's Pittsburgh conference, in early March, significant launches included a new supercritical fluid chromatography platform for analytical SSC applications that leverages design and performance features of our ACQUITY UPLC system. This system was introduced with a suite of new SSC columns based on our small particle UFC technology -- UPLC, excuse me. At the conference, we also showcased a new analytical systems specifically targeted at biopharmaceutical applications. This new system brings together our ACQUITY UPLC separations technology with a new high performance Xevo time-of-flight mass spectrometer, all running under a new software offering that we have called UNIFI. UNIFI is a key new operating system that uniquely brings together key workflow functionality from our successful Empower, MassLynx and the Genesis software platforms. In this first commercial embodiment of UNIFI, it enables an easy-to-use system solution that is designed to help UPLC/MS migrate more easily from research to quality control applications or bio synthesized pharmaceuticals. Our plan is to gradually expand the range of tailored systems utilizing UNIFI and at this year's upcoming ASMS Conference in Denver, we plan to speak about future systems offerings that leverage this unique and leading software capability. I'll also tell you that this year's ASMS is likely to be a very exciting event for Waters as significant product launches are planned and many technical presentation highlighting new applications will be presented by our scientific staff. Return to our TA Instruments division. Sales grew at 12% organically for the quarter. Its performance was highlighted by strong growth in developing markets, new applications for thermal systems, particularly in the energy area and for biocalorimetry instruments. During the quarter, TA saw a strong demand for its new discovery DSC [Differential Scanning Calorimeters ] system. The strong demand in combination with new product launches planned for this year suggests that 2011 can again be a strong year for our TA division. On the financial front, our confidence of the top line growth for 2011 has resulted in plans to selectively increase our internal spending. To support higher shipment levels of new instrument systems, we have begun to modestly increase our field staffing levels, especially in developing markets. Generally, we have and will continue to plan for overall annual organic expense growth but are slower than our top line growth and in this way create meaningful leverage to ensure that our operating income will grow faster than our revenues. As a management team, we have always focused on strong cash generation as we feel it is a metric that best measures the strength and efficiency of any business. Now I'm happy to tell you that our free cash flow in the quarter was an impressive $112 million. A rate of about $0.25 for each sales dollar. So in closing, I'd like to say that we're encouraged by our start to 2011. We feel that the factors that drove growth in the first quarter are largely sustainable, that our new product pipeline will enhance our competitive position, and our strategy of focusing on select technology and faster growing end markets will allow us to continue to deliver superior top line and bottom line performance. So with that, I'd like to turn it over to John for a look at our financial analysis.

Thank you, Doug, and good morning. First quarter sales increased by 16% and non-GAAP earnings per diluted share were up 28% at $1.04 this quarter compared to earnings of $0.81 last year. On a GAAP basis, our earnings were $1.01 this quarter versus $0.79 last year and a reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning. Reviewing Q1 sales results in comparison to Q1 last year, sales were up 16% with currency translation contributing 2 points to the sales growth. This result is much better than we expected as our customers capital spending started of the year stronger than forecast, especially in our pharmaceutical end markets. Looking out our sales growth geographically and before foreign exchange effects, sales within the U.S. were up 8%, Europe sales were up 12%, Japan was down 1% and sales in Asia, outside of Japan, were up 29%. Turning to the product front, within the Waters Instruments -- within the Waters division. Instrument system sales increased by 23% and recurring revenues grew 7% this quarter. Within our TA Instruments division, sales increased by 12% versus prior year. Now I would like to comment on our Q1 non-GAAP reported financial performance versus prior year. Gross margin performance came in at 60.3%, the same as Q1 last year. The positive effects of manufacturing cost reductions and volume leverage were offset by unfavorable currency comparisons this quarter. SG&A and R&D expenses increased about as expected, and this quarter's double-digit growth percentages were affected by difficult base of comparison where in early 2010 discretionary spending was constrained exiting the recession of 2009. Our full year effective income tax rate came in at expected at about 16.5%. On the balance sheet, cash and short-term investments totaled $1.04 billion and debt totaled $790 million, bringing us to a net cash position of about $250 million. During the quarter, we closed on an additional $200 million of term debt refinancing in the private placement market, taking advantage of market conditions that allowed us to layer 5, 7 and 10-year financing at fixed rates that averaged 3.2%. As for share repurchases, the board of directors approved a new $500 million 2-year repurchase program. And in the first quarter, we bought 847,000 shares of our common stock for $67 million. We define free cash flow as cash from operations, less capital expenditures plus any noncash tax benefit from stock-based compensation accounting and excluding unusual nonrecurring items. For Q1, free cash flow remained strong and came in at $112 million, after funding $17 million of CapEx and adding back $6 million of noncash tax benefits from stock-based compensation. Comparable free cash flow in Q1 last year was $95 million. Accounts receivable, days sales outstanding stood at 74 days this quarter, down 4 days from Q1 last year. Inventories typically rise in the first quarter from year-end levels and were up $20 million this quarter. Currency translation accounts for about $6 million of this increase. Overall, we are pleased with our financial performance as we start this year, consistent with the improving trend, we saw our developing across 2010. Our first quarter's result indicate more normal market conditions in the majority of our end markets and our new product positions have been well received in key application areas. Operating margin improved by 170 basis points this quarter as we saw a continued strength in our gross margins and significant leverage about our operating expenses. Continued execution in our share repurchase program and a lower tax rate added to the operational results of the business and together resulted in a 28% growth in our fully diluted earnings per share this quarter. As we think about the remainder of 2011, we continue to see stability in our end markets and continued momentum in the acceptance of our new products. We expect to see around a 10% growth in sales for full year 2011 before currency translation. And at today's rates, currency is likely to add about 2 points to reported sales growth for the full year. Moving down the P&L. Gross margins for the full year are expected to be between 60.5% and 61%, as we continue to be favorably affected by product cost reductions and volume leverage, offsetting margin pressures from new product introductions. Currency at today's levels, looks to be a modest to present to gross margins in the first half of the year and favorable later in the year. Operating expenses are expected to grow at a lesser rate than sales growth. Net interest expense is expected to be approximately $18 million, and we expect our operating tax rate to be about 16.5%. Our fully diluted average outstanding share count is likely to decrease by about 1.5 million shares in 2011. Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $4.80 to $4.90 per share. For Q2, we expect organic sales growth of about 10%. Currency translation at today's level is expected to add about 5% to sales growth this quarter, bringing reported revenue growth to about 15%. We expect to see continued operating income expansion this quarter and plan to proceed in our share repurchase under our newly authorized $500 million program. All of this is expected to result in Q2 non-GAAP EPS of between $1.10 and $1.15 per fully diluted share.

Thank you, John. At this point, I think we can open it up for Q&A.

[Operator Instructions] Your first question comes from Quintin Lai of Robert W. Baird. Quintin Lai - Robert W. Baird & Co. Incorporated: So very encouraging to hear that pharma, CapEx is continuing its trend. Through the quarter, I think clients were concerned about the headline news of some of the big pharma companies laying people off. Could you talk a little bit about where that demand -- You kind of say that was very broad base, but is this a return to a more normalized growth Or are we just coming off of tough comps? In your opinion, Doug.

Well, Quintin, depending on how you cut the term pharma. For large, the top 15 to 20 accounts, it's been a continuing story of tough conditions over at least a 5-year period. So I don't think we're going to say that -- maybe one quarter we would had a peak or something. But generally, it's been a tough time, particularly as they have outsourced some of the R&D or manufacturing analysis to CROs. Some of its gone generic. So you've seen our Indian business pickup. But I think, we have at times said the large research-based pharmaceutical companies have continued to kind of go down a track that sooner or later ought to kind of add methodically, flatten out and perhaps begin to pick up. We think that, that's probably happening. We think that, that install base has -- we have got a lot of old equipment in it that needs to be upgraded. There's a limit to which some of these laboratories can go where they cannot utilize some of those older systems. And we think we're seeing some symptoms of that in those large research-based pharma accounts. To look more broadly, I think as we've said for many years now, the overall broad pharma industry, pretty healthy. And again, it's kind of hard to tell sometimes when you're growing substantially your CRO business whether their clients are Pfizer or Glaxo [GlaxoSmithKline] or Bristol-Myers. So I think it's a little bit more diffused now. But where the benefit lies is probably still with some of those big pharma accounts. So we continue to see very good strong business from those CROs, as well as during a time when we're seeing good conditions from our research-based pharmaceuticals.

Next question comes from Doug Schenkel, Cowen and Company.

Thanks for taking my question. I guess a question on H-Class. Is there any way to describe how H-Class is varying and say expanding biopharma markets? So I guess what I'm thinking about kind of generics and CROs and India and China versus traditional pharma accounts where you're actually replacing instruments. I guess I'm just trying to get at how much of the growth is driven by an actual replacement cycle versus market expansion in certain parts of the world?

Art, do you want to give some color on that?

Yes, Doug. It turns out it's fairly balanced with H-Class. The primary position of H-Class was to bring UPLC downstream into the more routine developmental areas. And that's been the case. Additionally, we introduced a inert [ph] H-Class for the biopharmaceutical segment. So one of the things we've been doing with UPLC is to -- after having spend several years in the developmental side of building the confidence of the technology with our Class ACQUITY was to be ready when they said, 'Okay, we're going to push this into border utilization.' So with H-Class, what we're experiencing is a lot of generic adoption, a lot of adoption in large pharma, quality control, CROs are starting to look at the technology. And in particular, the mass spectrometry driven application, where you see a lot of use in regulated bioanalysis, it turns out over the past several years that UPLC has essentially been adopted as a de facto front end to a mass spectrometer because of the characteristics of extremely small sample volumes, the flows are very amenable to how a mass spectrometry develops its operational capabilities. So I have to say that the most exciting part of our H-Class success has been its broad-based adoption. And it went beyond utilization just in the manufacturing segment we're seeing it used much broadly. And we see no end in sight -- with the order sizes are increasing. Where large multiples, which for us, as is a combination of replacement going on as well as people looking at the developmental areas, using it for new applications. So we have to claim it to be a broader penetration in this particular segment.

Okay. That's interesting and helpful. And then maybe if I can sneak in one more. Maybe just turning to Japan, which is obviously been an area of focus for many. Any chance you would provide some detail on how business trended over the last few weeks of the quarter and what's been going on in the first few weeks of April? And I guess more broadly, has there been any communication from the government there that would suggest there is a business opportunity for you, as Japan presumably invest more in enhanced water and food testing?

I think what we're willing to say is that, the tsunami and the earthquake effects did not -- maybe showed -- we were frankly running a little bit stronger than we expected in Japan through the middle part of the quarter. We were expecting probably a little bit of upside over our core forecast. And with the tsunami and the earthquake, that probably came back to our original expectation. It wasn't a big dynamic, but it was a little bit slower than it probably otherwise would have been. We're seeing so far, as we go into the second quarter, no real significant influence or downside from the tsunami and all of its various side effects. As it relates to what the ultimate effects will be, I think we're expecting that there was damage to laboratories and upset to laboratory instruments in the quake area that will have to be rectified. We've already received some notification of that from our laboratories. We expect that there will be some additional testing. But I think it's way too early to see how the government shakes out on that. It's also probably important to notice that most of our business is not conducted in the tsunami and main quake areas. As you think about Japan, you have the East of Japan, which includes Tokyo. In the West, generally considered Osaka. More of our business is in the West, very little of our business is in the Fukushima area where the tsunami and the quake was centered. So we're not expecting to see long significant effects in our business given the current state of affairs in Japan.

Your next question comes from Amit Bhalla, Citi.

I wanted you to just expand on your comments about the U.S. market specifically in the government and academic sectors. I think you mentioned that it was a little bit weaker than the other end markets.

John, I think you've made the comment about the academics.

Yes. I mean, government and academic really in the quarter, the dynamic there was just more outside Japan in its orientation with a large amount of shipments that went out in Q1 last year when we really pushed our new G2 product into that market space. You know we had a low to mid-single digit expectation for government and academic. That was principally what we got. As you know, we don't have a large exposure to any particular government organization, NIH, as an example, is maybe $10 million to $15 million for full year business that we do. There might have been a little bit of U.S. stimulus business in the base. So I'd say overall, I think the result was pretty much on plan and while our expectations going forward is kind of low to mid single-digit growth of this, given the products that we're offering and just given the fact that these businesses have to be constrained with all of the things that we read about budget woes around the world.

Okay, John, and then just one additional question on Europe. Last quarter, the chemical and applied markets were growing a little slower than your other end markets. And this quarter, it looked like that turned around. Could you just expand a little bit more about the chemical and applied markets in Europe?

Yes, I would say -- particularly as you look at Europe, the real strength that came through there is comparable to what Doug had said regarding pharma, and that is the large [ph] pharma accounts did very well. That really did drive the growth in Europe. The applied markets did well in Europe. And I'd say, the chemical, industrial space was slower. So that type of performance, overall, that we saw in Europe that led to overall a surprisingly good result, I'll say it's 12% for the overall geography.

Your next question comes from Jon Wood, Jefferies. Jon Wood - Jefferies & Company, Inc.: Thanks. Doug or John, is it possible, you mentioned the Instrument business up 23%, obviously, pretty elevated there. Can you tease out LC versus MS just qualitatively which major category grew faster?

Yes. Basically, Jon, they both grew north of 20% very similar growth rate. And we think they're largely, that's indicative of the strength of both product lines. It's not one dragging the other. They're both showing independent strength. And it is kind of indicative of our system strategy. Although not all LCs are sold with mass specs or vice versa. But it is, I think, a very clear sign of the strength of our systems offerings. Jon Wood - Jefferies & Company, Inc.: All right. Great. Thanks for that. And last one, on the buyback, so it looks like a little bit slower in the first quarter than is traditional. Are you guys still expected to do about 100% of free cash flow towards that buyback for all of 2011? And then as kind of an adjunct to that, any update to that free cash flow guidance at this point?

We had indicated the original guidance had assumed somewhere around $250 million of buyback. We look to retain some amount of cash should an acquisition come up, particularly early in the year where we don't know what we might find. So I would characterize the Q1 level of buyback as being at least on that plan, actually ahead of that plan on a dollar basis. We're looking to generate somewhere close to $450 million of free cash flow. If we don't find M&A targets as the year goes on, we'll look to perhaps deploy that cash more incrementally into the buyback effort. But early on, like I said, we put it in there at a rate of about $250 million on a full year basis and then ratchet it up as the year goes on.

Your next question comes from Tycho Peterson, JPMC. Tycho Peterson - JP Morgan Chase & Co: Thanks for taking the question. Just first one on H-Class, can you talk to utilization whether you've seen the consumable use really pick up as you've seen broader adoption in pharma. I think you mentioned CROs a little bit earlier. And then just talk to your overall attached rate with columns for H-Class, assuming it's closer to ACQUITY than it would be for Alliance, but if you could just give color that would be helpful.

Do you want to give some color that, Art?

Sure. Yes, Tycho. The attached rate -- understand that the H-Class, unlike the original ACQUITY, was marketed to those remaining customers who are still committed or were having more difficult time to convert from LC to UPLC largely due to regulatory context and having to be revalidate and so forth. So the marketing of H-Class with that it was anticipated that we would sell UPLC capability to an HPLC user. That could use it for the 6 to 12 months in either a LC or a UPLC mode. And therefore, have that capability for the future, most HPLCs are purchased with the idea of running them from 5 to 7 years. And once you buy them, you're kind of stuck. So I'll say that the people who buy H-Class with the intention of utilizing it right out of the shoots [ph] for UPLC, the column utilization rates have maintained their consistency at plus 80%, meaning that we see that 80% of the time customer contingency is our own chemistry, which is radically up from our standard HPLC position of about 10%. For those who are starting off with the system to run LC, what we find is, once they do begin to use a system for UPLC, they do utilize our column chemistry at the same rate as one who had decided to do that initially. The columns they use on an HPLC side, that is the method that they were using. About half of our sales appeared to be going in and taking competitive positions. So it's not likely you would have our column in those situations. The other half are old users or people familiar with us and they have a higher majority where originally on our HPLC column consumables in the first place. So that's a rough idea of what's occurring with that product. It doesn't have the purity of use that the original UPLC had. Almost 100% of them were used right out of the shoot as a UPLC system. A little different than with H-Class because we wanted to continue to penetrate the market with that strategy. Tycho Peterson - JP Morgan Chase & Co: Okay. And then to the comment that you made before, Doug, about pharma and I appreciate additional color there. But we've heard over the years this concept of standardization as well to some degree standardizing QA/QC labs around ACQUITY. Are you seeing more of that from pharma as well essentially sole sourcing instruments from one vendor as they look to basically upgrade their facilities?

We've seen more standardization go into H-Class, Tycho, but you are still talking about some laboratories that have many instruments in there. And so we're not claiming that you're having a universal change out. But that momentum has certainly picked up in that direction. Tycho Peterson - JP Morgan Chase & Co: Okay, and then just a last quick one on Japan, and appreciate your additional color there. Can you just comment on the supply chain side given that's a focus for people as well.

Yes, we've seen no current significant issues on the supply side. We have completed an evaluation of our principal vendors and one level down to our most principal subcontractors in their supply chain. And I'd say, we don't see any current problems. I think that carries us probably out a quarter, maybe 2. And I think once you get out a couple of quarters, then the likelihood that the supply chain won't be able to deal with those issues gets reduced. So you can't say with absolutely certainty but it doesn't look like a real issue for us at this point.

Your next question comes from Peter Lawson, Mizuho Securities.

Doug, just regarding the pharma CapEx spend. Could you perhaps tease that spend down versus CROs, generics, top 15? Any way you can read that?

You mean in terms of how our growth occurred, Peter?

Regarding your comment about the return of pharma CapEx. I just wondered where that was coming from whether it's CROs, whether it's the strength in generics or top 15 pharma?

We saw it across the board. Actually, a little bit surprising because -- a big pharma, the research pharmas are releasing their capital budgets later and later in the year it seems. And I think it's important to recognize, it wasn't really -- it's not like every research pharmaceutical had a banner quarter for us. But on balance, it was a very good quarter amongst those research pharmaceuticals. But it was certainly not limited to them. I mean, their results were very strong across the board of those broad-based pharmaceutical segments, CROs, generics and bio. So I think the encouraging sign is that maybe we saw research pharma will begin to spend their budgets a little earlier in the year than maybe we have seen in the past.

Thank you. And then just on the current balance between industrial and pharma end markets. Is there any way you can quantify the strength between those 2 end markets in the quarter?

Well, pharma grew faster than our average revenue growth in the quarter. So certainly pharma broadly described was the stronger part. The industrial markets, of course, a mix of industrial, chemical, environmental. In general, most of those subsegments were pretty good. So while not every single segment of our business performed at double-digit, it was pretty good across the board.

Great. Thank you so much.

Your next question comes from Marshall Urist, Morgan Stanley.

I was wondering maybe if you could talk about Alliance versus UPLC mix in the quarter and kind of what you're seeing year-on-year and quarter-over-quarter and maybe the pockets of demand on both sides and kind of what residual you're seeing for Alliance? And then also, John, if you can just give us a little bit tease out gross margin in terms of the positives, negatives and just quantify that a little bit would be helpful.

Sure. Maybe I'll start and let the others chime in subsequently. I think the strongest Alliance markets for us are in Asia right now. That's still principally true in India, where the methods that they follow are largely the methods that were established elsewhere and they buy to ramp up their lab. We are seeing some switch to ACQUITY in those markets. But it's still predominantly an Alliance marketplace. I'd say that's still very true in certain segments in the China market where alliance is a very strong performer. In certain segments of the China market, ACQUITY is also penetrated. But those 2 markets are probably our strongest Alliance markets. And Art do you want to add anything to that?

Yes. Well, probably the only thing when we first introduced the H-Class, we thought for sure, we're going to see a rapid drop off in conversion to H-Class over Alliance. And to our surprise, even with the high growth of H-Class because of the emerging markets as in Latin America -- into that equation. We find the emerging markets are -- they are beginning to convert now. But they're behind the Western markets in terms of converting from LC to UPLC. But for all intents and purposes, we have essentially maintained our Alliance growth rate at the rate quite comparable to our UPLC rates.

And was that a margin...

Margin question?

Yes.

Marshall, on the margins, the gross margin came in maybe a tick, less than what we might have expected originally and it is due to currency. We picked up about, "a half a point or so" improvement in the quarter associated with manufacturing cost reductions, volume leverage, which was offset by some currency, unfavorability from a year-over-year comparison perspective. The strengthening yen that we saw was less impactful this quarter as the Japanese sales were lower proportion of our overall mix of business. And then the U.K., the pound advanced about 3% across the quarter and that currency hit margins a tad too. But I'd say, generally, not that far off, but those are the components of the margin issue.

Your next question comes from Isaac Ro, Goldman Sachs.

Just wanted to dig a little bit more into the HPLC business this quarter. I think you said the recurring revenue growth was about 7%. So is it fair to say that underlying market growth for the HPLC market is in that sort of high single-digit range? And then maybe if you could layer on top of that the components in your business this quarter that really drove the outperformance beyond just sort of H-Class adoption, and what I mean by that specifically is was there any real change in your view around market share and dynamics within some of the significant markets that were perhaps above long-term trend line for HPLC?

Well, we hesitate to and I think everybody should hesitate to take too much on market share dynamics based on one quarter's results. It's just very difficult to do that. And frankly, not all that meaningful. Clearly, when you're growing your instruments at 20%, anybody else who's doing that has to be having a good time also. So we don't think that this market would never contented that it's got secular growth rates of north of 20%. So we think we're doing pretty well. Clearly, our chemistry business and our service parts and spare parts, not, and never will grow north of high single digits or something around 10%. But with our hardware and systems business growing as fast as it is, we feel pretty good about pacing the industry right now. I also say, though, I think it's -- the laboratory and the analytical market feels pretty good. So wouldn't surprise me if others servicing this marketplace are also producing pretty good results.

Okay. If I can just ask a quick follow-up on that dynamic. I mean, as we look to the middle part of the year, how do you feel about your visibility on that continued hardware growth being in that -- it seems the 20% growth rate. Do you see any reason to expect the change aside from the end markets dynamics in Japan that you mentioned?

Well, I think it's fair to say if you look closely the numbers that John described for the second quarter and the rest of the year that we're not going to count on that level of year-over-year strength going out. It was a stronger quarter than we had originally budgeted for or originally forecast. I can't tell you that right now, we're seeing market conditions that have deteriorated from that. But I think it would be dangerous for us to take that kind of performance to the bank for the rest of the year. So while we've increased our expectations, we think that it would be prudent to keep them within a range that offers us -- clearly offer some opportunity that the market could perform better. But we think it's well within our range of opportunity to perform against.

Got it. Thank you.

The next question comes from Jon Groberg, Macquarie Capital.

Just a couple of clarification questions, I guess. Appreciate, Doug, the color on the Asia and Japan growth. Can you maybe just remind us that business growing close to 30% organically kind of the mix, the margin mix impact that Asia has on the business? And my second, just kind of clarification question, John, if you could again just kind of rundown kind of what you're balance sheet currently stands at from a debt perspective. I think you had some debt that moved into from long term to short term, and I think you said, you raised some debt. So just maybe give us kind of the latest -- current up-to-date view of the balance sheet.

Yes, John, if I get your question properly, the Asia business margin dynamic certainly the operating margin dynamics are at or above the average for the company. So it's a very profitable business. The gross margins may be a tick below average margins, but not tremendously different. But on balance, I'd say, if you model Asia for a little bit slower gross margins and a little bit higher operating margins, you'd have the right picture for Asia. Does that answer that question?

Yes. Perfect. Thanks.

And then on the balance sheet, Jon, what we've done is we have a revolving credit agreement with a consortium of banks that expires at the start of 2012. So what you've seen is you've seen a movement on the balance sheet from long-term into short-term debt associated with that debt. So we have efforts in place to begin the process of re-upping that credit agreement. We're looking to create another 5-year agreement that will be in place second half of this year. In the interim, to be able to diversify away from having just a bank debt, we've moved into the private placement market. Last year, we made our first foray into that market with a couple hundred million dollars of refinancings and we added to that in the first quarter with another $200 million of debt refinancing as well. And we decided to do fixed debt for this $400 million portion of the portfolio. And we'll likely, re-do the credit agreement with the banks as we make our way through this year on a variable rate basis. So that's the current thinking on the balance sheet and the debt structure.

Okay. Thanks a lot, that was helpful. I appreciate it.

Next question comes from Paul Knight, CLSA. Paul Knight - Credit Agricole Securities (USA) Inc.: When you look at emerging markets, do you have any concerns that year-over-year comps on large contracts are out there or is it a right number of contracts that, that's not going to be an issue now or in the foreseeable future?

I think it's fair to say that in recent years, we have seen an increased volume of somewhat larger tenders in the emerging markets, emerging markets being the BRIC side [ph] -- would be specifically what we're talking about. But our forecasts take into account the kind of flow that we've seen in those large tender areas. And we think that despite the fact that last year was a very successfully year with some large contracts, we don't anticipate a great deal of difficulty in those territories achieving the kind of result that we've outlined for you. So the markets continued to be strong. And the opportunities that we are working continue to be very encouraging. Paul Knight - Credit Agricole Securities (USA) Inc.: Okay. Thanks.

Next question comes from Dan Leonard, Leerink Swann.

Any indications from your customers that the recent 2 legislations that you won might spur additional demand?

I'm sorry, could you repeat that? We got cut off here.

Sure. Any indication from your customers on the food safety front that recent legislation could spur an increase in demand?

We think, long term, there's no question that it's going to spur demand. What the pace of that will be I think remains to be seen. I think people are still kind of figuring out what their strategic reaction will be in terms of inside the U.S. A large agri-producers and importers probably have somewhat better position. Lots of questions as to how it's going to affect the mid-sized and the smaller affected organization. So I would say, we haven't seen a lot of business coming out of that yet. Our belief is that, it will impact our business outside the U.S. probably faster as exporters gear up a little bit more to meet the expected requirements. And probably as we move into 2012, you'll see more investment in the United States. We think we're in excellent strategic position, given our position with the FDA, the USDA, our standardized laboratory support in Maryland and emerging activities in China, in particular, position us very well to be at the forefront of these activities.

Okay. Thank you.

Your next question comes from Derik De Bruin, UBS.

So if the replacement cycle that you're seeing in the pharma continues, I guess, can you just remind us what your split is between your research installed base at pharma and in the UPLC/HPLC market and the manufacturing install base. I guess what I'm trying to get after is -- I mean, assume that most of the research market has already kind of moved to ACQUITY. I'm just trying to get a sense of how much juice is left in kind of moving over the manufacturing QA/QC base? Like how many more years would you think it would take to fully share on that base?

Sure. I will let Art give you the actual numbers. But in any one quarter, clearly, we could have a much stronger research segment of our business versus QA, QC. So it can switch around. Clearly, the install base doesn't switch around that -- I mean that is a much more standard. Art, you want to answer it however you please?

I mean, it's safe to say that we have run roughly half researched to development, half development to the QC segment. So our business tends to settle in those types of ratios. I would also say that probably the biggest change that we're seeing particularly in big pharma is that, HPLC utilization and replacement can be a tricky thing. Some will see a new instrument, and will replace it couple of years earlier than the typical 7, some will stretch it out. The dynamic that we're seeing with UPLC is that we're going in and showing these customers irrespective of where that product is in its depreciation cycle. How they can improve the productivity in their operation. That goes beyond the instrument that personnel [Technical Difficulty] A slight difference from the traditional replacement where we deal with. I'm sorry, you had a comment?

I'm sorry. You faded out on some of the question, on some of your answer there. I guess as a follow-up on that, do you plan to basically obsolete the Alliance at some point in time to basically force everybody to the H-Class? I mean, at some point in time, are you telling your customers, you better switchover now because you're not going to support Alliance? I guess, what's your plan?

No, we haven't. And we have no active plan to obsolete the Alliance. Of course, a lot depends on how the market evolves. Right now, there's certain segments of the market that are saying they really value the Alliance configuration and want to stick with it. Certainly, it is possible that over the next 5 years or so, it will move in that direction.

There is a critical component to this industry and with a large portion of our product line being sold and has been sold into the pharmaceutical regulated environment. There's a lot of assays. Every patent for every drug has HPLC data on it. It is used extensively from one end of the spectrum to the other once it comes off patent it moves into generics. Keep in mind that the cost of converting in many cases for very basic analysis of a drug is way too high for a company to implement that. So if they're using an Alliance system with a standard separation. And it's not a critical analysis that could have huge benefits from moving to UPLC. Those stay with Alliance and that life cycle could be quite long. We are the first product of the 70s, that would be [indiscernible]. Those sales are still going strong. There are a lot better columns out there but they're just not going to change those methods. So unlike some industries where you see conversion of products, it is likely HPLC will be around for a lot of these older methods for a long time to come. And to be frank, with the momentum coming out of India, China, and Latin America with a lot of the generics, there's simply adopting the original methods. And it's cost-effective for them to do that. They're not complex separations. HPLC works fine for those applications.

It's still likely that the Alliance mix will continue to go down. I think that's very clear. But it's still both strong product lines. I noticed it's 9:30. We're willing to stay on for a little bit longer. I realized that some of you probably have to get off. But we'll try to answer the people who are in the queue if there is still there, operator.

Your next question comes from Sung Ji Nam, Gleacher & Company. Sung Ji Nam - Gleacher & Company, Inc.: Thanks for taking the questions. Going back to Derik's product replacement cycle. With H-Class, do you anticipate the product lifecycle to be shorter than for the legacy UPLC, given heavier utilization?

I'm sorry, for several people it's getting harder to hear. I think you may be on speakerphones and it's a -- could you repeat that question? Sung Ji Nam - Gleacher & Company, Inc.: I just wanted to ask about -- going back to the product replacement cycles for H-Class. Do you anticipate the product life cycle to be shorter compared to UPLC, given heavier utilization for H-Class?

No, I don't think we anticipate life cycles to be materially shorter.

No. We find most of the pharmaceutical companies are running their instruments, as I said, 5 to 7 years, sometimes a little longer. The methods that are being developed are going to be subjected to the same life cycles for their products as it's always been the case. So we have no indication that there will be any shift in those life cycles and people anticipate that they'll maintain the same type of use and depreciation. Sung Ji Nam - Gleacher & Company, Inc.: Okay, great. Thanks and just a quick question, what's the size of your emerging market or developing market business today?

Yes, We'd say that Asia, Eastern Europe, some of the Latin American countries, all in sum total probably about a quarter of our business. Sung Ji Nam - Gleacher & Company, Inc.: Great. Thank you.

Next question comes from Tony Butler, Barclays Capital.

Just a brief housekeeping question and then one follow-up. You've commented that the growth of expenses would be below the organic revenue growth and you've given guidance for 10% organic revenue growth. So the question comes, can you provide some relative scenarios to what would happen for the incremental margin opportunity, if revenues are, say, a little bit better than expected or in fact a little bit worst. Appreciate the color there.

Yes, I'd say, if we think about what's changing here year-over-year, I mean, we're certainly putting some incremental headcounts in place in the developing parts of the business. We are beginning to spend a bit more on the discretionary side for promotional activities in the like as we have a number of new products making their way to market. The expectation would be that we would have a point, maybe a couple of points of differential on a full year basis and the growth rate of our expenses versus the top line [indiscernible] on and organic basis. In the second quarter, where we have 5 points of currency on the top line, we're going to have a similar dynamic of growth on the SG&A line. So foreign exchange is going to make a difference in the reported growth. It will give keep up with the top line but the differential will still be there. So I would say, we have flexibility certainly to the extent that the organic growth is greater than what we say. We're not likely to instantly react to that with incremental headcount adds. There will be commissions and variable pay plans that will take a little bit of a bite perhaps out of that but not anything all that meaningful. And then certainly on the downside to the extent that there is an action there we need to deal with, I mean, go back on the discretionary spending. The variable pay programs have come down comparably to the top line. So there's a little bit of flexibility I'd say on the downside as well. But based on what we see right now, I'd say, we're pretty comfortable with the top line number that we have.

Thanks, John. And last question, the biopharma targeted ACQUITY plus the Xevo TOF [time-of-flight] system having the UNIFI software was interesting. I assume that LC/MS system collectively is for QC applications. But I'm also curious if in fact, this has been developed based on customer demand. And if so, we just had had the impression that the MS detector today might actually be too expensive for QC, is that incorrect or would costs come down? Or any color there would be helpful.

If you think about traditional pharma, the research ethical type companies, you are probably right, unless the application clearly demanded the use of mass spectrometry. You would not likely find that in the quality control lab [ph]. That biopharmaceutical system would be ACQUITY and the mass spectrometer attached is really targeted at the biopharmaceutical segment where you have a lot of high-value added processes taking place. And therefore, you are more likely, not in all cases, but you're more likely to see test systems that do in fact incorporate mass spectrometry that it's fairly sophisticated separations largely because of the nature of the more complicated biopharmaceutical samples, peptides and so forth. So that's a very focused segment we are going after. And so far, the acceptance is quite well. And it was for probably the last 5 years we have spent incredible amount of time bringing focus groups together specifically from the biopharmaceutical industry and trying to find out, what is it that you need to help your process. And it's a very different discussion than you're going to find in the small molecule research-grade ethical houses. So that's a very targeted system, and we think over time, that represents an increasing share of the activity in the analytical space in certain markets.

Thank you, all.

Your last question comes from Bill Bonello, RBC.

Hey, thanks a lot for hanging in for my question. You mentioned in the prepared remarks, just some exciting things happening at ASMS later this summer. I'm just curious if you can give any more of a preview beyond that and what kinds of things we might be looking for?

Art, will come across at the desk at me if I do that, Bill. So I'm going to turn it to him, so then he can only blame himself for letting the cat out of the bag.

So I won't get really specific largely because, as usual, these things are unveiled. But what you can expect to see from us from ASMS this year, we're very focused on continuing enhancement of speed, sensitivity and resolution. Those are the three elements that the people who go to ASMS, show up for one reason and one reason only. The kind of compounds they're working with. They’re looking for the vendors to give them a major improvement in speed, sensitivity and the resolution for the types of compounds that they're working on. So as we look at ASMS this year, both for mass spectrometry as well as UPLC, we're going to be bringing out major improvements in both of those technologies, not only individual capabilities in those specific technologies, but you'll see us beginning to focus on targeted applications using our system strategy. So we'll look at some areas of what we believe will be high activity where we can offer a new system solution that can really offer these customers orders of magnitude in terms of the kind of results that we're getting. So that's the type of direction that we're taking at this year's ASMS. You will see about 2 to 3 major systems offerings targeted in that area.

Okay, thank you.

You're welcome, Bill. And thank you all for sticking with us this long. It's been a good start to the year. And we hope to talk to you with similar results as we go through the year. Thanks very much.

This does concludes today's conference. Thank you for attending. You may disconnect at this time.