Waters Corp (WAT) 2009 Q1 法說會逐字稿

Good morning. Welcome to the Waters Corporation first quarter 2009 financial results conference call. All participants will be able to listen only until the question-and-answer session of the conference. This conference is being recorded. If you have any observations, please disconnect at this time.

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. Well, good morning and welcome to the Waters Corporation first quarter financial results conference call. And with me on today's call is John Ornell, Waters' Chief Financial Officer, and Gene Cassis, the Vice President of Investor Relations. As is our normal practice, I will start with an overview of the quarter's highlights, and then John will follow with details on our financial results and provide you an outlook for the second quarter and the full year. But before we get going, I would 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 at the company. In particular, we will provide guidance regarding possible future income statement results of the company, this time for Q2 and full year 2009. We caution you that all such statements are only predictions and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our 10-K annual report for the fiscal year ended December 31, 2008 in Part One, under the caption, Business Risk Factors. We further caution you 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 statements, except during our regularly scheduled quarterly earnings release conference calls and webcast. The next earnings release call and webcast is currently planned for July 2009.

During this call, we will refer to certain non-GAAP financial measures, a reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures is attached to the company's earnings release, issued this morning. In our discussion of the results of operations, 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 share", included in this morning's press release.

Okay. Thanks, John. Well, in the past couple of quarters, we have seen significant change in demand trends in our markets. Concerns about tightening capital markets were followed quickly by a souring global economy, compounding issues related to an already skittish pharmaceutical spending environment. Certainly these turbulent times stress even the most successful business strategies, as slower demand and weaker visibility allow little flexibility for less than optimized business decision making. Though we have been through tough end markets before, none have matched the current environment, and I think thus our business model has been and is being subjected to a new test.

I'm pleased to tell you that we are weathering this storm, and that in the first quarter, the agility and the resiliency of our business has allowed us to deliver higher operating profits than earnings despite a top line that was under pressure. Our sales in the quarter were down 5% on a currency neutral basis, and we were able to deliver 7% earnings growth due to tight cost control, currency-related cost reductions, leverage from our share repurchase program, and favorable product and geographical mix. We benefited from investments in a global manufacturing and distribution strategy that allowed us in the quarter to more than offset the adverse top line effects of a stronger US dollar, with reduced British pound and Euro-based manufacturing and SG&A costs to yield a nice pickup in our margins.

In addition, our global sales strategy that focuses on delivering innovative system-based solutions supports a market-leading pricing position that can be quarter after quarter seen in our superior gross margin. Looking at the top line, the strong performance of our recurring revenues, including our service and chromatography businesses, helped to partially offset slower instrument sales. Over the years, our recurring revenue growth has remained fairly consistent, and somewhat insensitive to the quarterly fluctuations we have seen in instrument demand. That dynamic has benefited us during the past couple of quarters, and we expect to see this trend continue through 2009.

In the first quarter of 2009, the calendar treated our recurring revenues kindly, and we estimate that more selling days added about 1 to 2 points of growth to our corporate sales. Instrument revenue saw our mid-teen decline in the quarter, as demand from industrial chemical accounts and from some developing countries was particularly weak. We attribute the weakness in chemical spending to global recessionary pressures, while declines in our sales in India and eastern Europe, seen due to a combination of economic factors and significantly weakened local currencies. Looking at our instrument system business more closely, demand for high-end and application-focused systems was stronger than for more routine analysis instruments, that were often purchased to replace older systems. Customer interest was strongest for our new mass spectrometry and Acquity instruments.

Looking at our end markets, pharmaceutical segment sales growth was in line with the company's overall performance, while weaker industrial sales were offset by stronger government and university spending. Among our larger pharmaceutical customers, we saw some capital releases in the first quarter, while others are expected to begin spending later in the year. Overall, we enjoyed a slight growth that is a slight growth in large account spending in the quarter, compared with last year. So we feel that spending by large cap pharma remains relatively weak, and that recent merger activity may inject more uncertainty into capital spending plans, our sales volumes to these accounts during the past two quarters suggest that our business here is stabilizing.

Geographically and within our more mature markets, including western Europe, North America, and Japan, our currency neutral sales performance was balanced in the quarter, and declined in a midsingle digit rate. Currency neutral sales in the developing world finished with a similar growth rate, with growth in China offsetting weaknesses in India and smaller markets. Within China, sales to government agencies, universities and applied markets were strong. Weaker sales in India impacted our global pharmaceutical sales, and the slower demand from firms there is largely associated with the rapid devaluation of the rupee and a strong base quarter comparison. As we transact much of our business in India and US dollars, the weak rupee has resulted in customers having to delay orders while they rebudgeted to account for the higher dollar values to fund their capital purchases.

Our TA instrument's position was affected by its high exposure to the chemicals and plastics industries. As you might expect, TA's core thermal product lines were pretty hard hit, as chemical suppliers to many consumer product manufacturers scaled back their spending. However, the division did see a nice pickup in service revenue and continued growth of new Life Science product lines. TA has significant new product introductions planned for later this year. However, despite TA's technological and market leading market positions, the next couple of quarters are likely to be challenging, given the poor outlook for the global economy and tough comparisons to strong sales in 2008.

Moving down the P&L, in the quarter, we carefully controlled our spending while targeting profitable business. While talk of steep discounting and price deflation seems to dominate the news these days, we have been able to maintain our pricing by focusing on the overall value proposition that we offer our customers. We have found, in fact, that during these times of depressed capital budgets, customers appear more willing to purchase instrument systems that enhance their productivity and meaningfully enhance their research efforts, rather than settle for more generic capabilities at lower prices.

Within Waters and recognizing the importance of technological leadership to our long-term business strategy, we have maintained funding of our R&D programs to insure timely delivery of new product and production. Already this year, we had significant introductions at this year's Pittsburgh conference. On the mass spec front, we showcased our new Xevo platform, and formally introduced the Xevo QTof, an instrument that sets new standards for sensitivity and ease of use for high resolution, accurate mass measurements. The Xevo QTof joins the Xevo TQ tandem quadrupole system that we began shipping in 2008. Both instruments combine leading performance, ease of use, and versatility in compact bench top design. Customer acceptance of these new products has been very strong.

This year's Pittsburgh conference also marked the fifth anniversary of our Acquity UPLC system. It's hard to believe that five years have passed, given the level of excitement that continues to surround Acquity UPLC technology, and how Acquity continues to transform the chromatography market. What's more exciting than looking back on what was accomplished with Acquity is looking ahead toward where UPLC technology is going. At this point, it's clear to see that we have transformed the LC market and that nearly all significant competitors are introducing systems that claim to leverage the performance advantages of subtwo Micron particles. After five years, and many thousands of successful instrument placements, no competitor can offer the proven performance and application support that's only available from Waters. At this year's Pittsburgh conference, we introduced new Acquity instrument configurations and also expanded UPLC column offerings. Our [Trisaic] microfluidic tile technology demonstrates the future direction for incorporating Acquity technology, within advanced mass spectrometry instruments, while other embodiments of Acquity are directed towards process control and quality assurance applications.

In short, be assured that we continue to build on the Acquity success and plan for new and exciting innovations on this front in the quarters and the years ahead. In the first quarter, we also announced the acquisition of Thar Instruments, the world leader in supercritical fluid chromatography, or SFC. SFC is a separation technology closely related to HPLC, that primarily uses carbon dioxide as the mobile phase. SFC can be used to purify, as well as analyze a wide array of compounds that are soluble in carbon dioxide and can be interfaced with mass spectrometry. We were attracted to SFC due to the similarity to HPLC, compatibility with mass spectrometry, and because the technique is environmentally friendly.

As we have found with the drastic reduction in solvent usage with our Acquity system, our customers are increasingly concerned with the cost and the environmental impact of the reagents that they are using in their experiments. Thar technology allows us to highlight our partnership with our customers on this green chemistry trend. In all, Thar remembers the type of company that Waters is targeting on the M & A front, in that its close to us technologically, it's very profitable, and has top line growth potential to be accretive to the overall growth rate.

During the quarter, our board approved another $500 million stock repurchase plan, and we continue to deploy our cash flow towards share repurchases in the quarter. Before I turn you over to John for a deeper look at our financials, I would like to say a few words about our outlook for the remainder of the year. I'm cautiously optimistic -- emphasize "cautious" about the second half of the year. Some day we may look and determine that the past two quarters were the most difficult for us in this recessionary period, however, what is certain is that we are in uncertain times. I am, however, encouraged by the potential for our new products in combination with higher research spending associated with various stimulus plans around the world. Already, we have seen a significant pickup in quotation activity associated with plans in the United States. Most of the interest is for research mass spectrometry, and Acquity UPLC. At this year's ASMS meeting in June, we are planning significant new product introductions that we feel will help attract additional stimulus spending in our direction.

Finally, as we move into the second half of the year, we will have less difficult prior year comparisons as we begin to see tighter money and the weaker economy adversely affect our business in late 2008. So quarterly demand for our markets may improve later this year, let me assure you we will remain cautious and continue to manage our costs carefully. While many of the factors that are pressured our markets are clearly outside of our control, we will continue to do our best to manage our business to optimize our profitability and insure Waters' long-term competitiveness. Thank you very much.

Now I will turn it over to John.

Thank you, Doug, and good morning. First quarter sales declined by 10% and non-GAAP earnings per diluted share were $0.74 this quarter compared to $0.69 last year. On a GAAP basis, our earnings were $0.75, this quarter compared to $0.67 last year. A reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning. Reviewing Q1 sales results, sales were down 10% this quarter, with currency translation representing 5% of this decline. Versus prior year, the first quarter has three more selling days than 2008, which we believe added between 1 and 2% to our overall sales growth this quarter.

Looking at our sales growth geographically and before foreign exchange effects, sales declined pretty much as expected, with all of our regions feeling the impact of the global recession. Sales within the US were down 6%, European sales were down 3%, sales within Japan were down 7%, and sales in Asia outside of Japan declined by 6%. Turning to the product front, within the Waters division, instrument systems sales declined by 16%, and recurring revenues grew by 9% this quarter. Within our TA Instruments division, sales declined by 6% versus prior year.

Now, I would like to comment on our non-GAAP financial performance. Gross margin was very strong this quarter and came in at 61.7%, and versus the prior year, the margins expanded by 350 basis points. This improvement was heavily affected by a very favorable combination of foreign exchange dynamics this quarter. In Japan, where the yen strengthened 10%, versus the US dollar, we had favorable translation of our Japanese sales and no offsetting local manufacturing costs. In the UK, we have significantly more production than local sales, and the British pound depreciated by 25% versus the US dollar, significantly improving overall gross margins.

Additionally, we experienced favorable product mix. There was a higher proportion of our sales came from chemistry and services at high incremental margins, especially given the head count and cost controls in place. And finally, we started the year with favorable results in our manufacturing operations, with savings for lower warranty costs, great savings for the use of ocean transport, favorable price variances from vendors, all largely offsetting unfavorable manufacturing costs. SG&A expenses declined 9% this quarter, compared to prior year as a result of our actions to control expenses and currency translation effects. We took a strong position on expense control as we started the year, and plan to continue to hold back on discretionary spending in response to the depressed economic conditions we face. R&D expenses declined by 7% this quarter, as a result of currency translation trends.

Income taxes came in on plan at about 18% this quarter. On a GAAP basis, our tax rate was reduced by the reversal of a $4.8 million tax provision relating to last year's legal entity restructuring, which based on recently issued regulations, is no longer required. On the balance sheet, cash and short-term investments totaled $431 million, and debt totaled $588 million, bringing to us a net debt position of about $157 million. On the stock buyback front, we continued to purchase our shares in the open market, and during the first quarter, we purchased 1.7 million shares of our common stock, for $64 million.

We defined free cash flow as cash from operations, less capital expenditures, plus any noncash tax benefits for FAS 123R accounting, excluding unusual items. For Q1, the free cash flow was $64 million after funding $22 million of CapEx, and excluding a $6 million litigation fee. Capital expenditures will be lower later in the year as we complete construction of our new TA facility in Delaware by mid-year. Accounts receivable day sales outstanding stood at 76 days this quarter, one day better than Q1 last year, but resulting from favorable foreign currency translation. Inventories were $18 million, from year-end, as is typical at this point of the year.

Before I update our guidance for 2009, let me put our forecast in perspective versus the results we just delivered. The difficult economic conditions we faced in Q1 are expected to persist throughout the year. We plan to continue to hold back where possible on discretionary spending, but doing so could prove more difficult as the year goes on, so I expect some additional spending will be required in the second half of the year. Current foreign exchange environment could continue to provide improved gross margins on reduced sales, but we have largely discounted that in this guidance, given the unusual currency movements that produced that in our first quarter result. I believe a cautious posture is warranted, given the economic backdrop we face and baking a continuation of all of our Q1 favorabilities into our full year guidance this early in the year is not good.

So for full-year 2009, we believe our recurring revenues will continue to provide a level of stability to our business and are likely to grow at midsingle digit rates during the year. Instrument demand is expected to be down midsingle to low double digits for the full year. Overall, we are expecting sales to be down -- between down 4% and up 1% for full currency expense. Foreign exchange translation will reduce 2009 sales growth by about 4% at current rates. Therefore, on a reported basis, we are expecting sales to decline by between 3 and 8% for the full year 2009.

Moving down the P&L, we expect the gross margins to be up in 2008 as a result of the factors I described earlier. Currency translation benefits have been discounted as I said earlier, and product mix will become less favorable as instrument sales and volume decreases. For the full year, we expect to see the margin improvement of around 150 basis points. Operating expenses are expected to climb at a rate about equal to sales. We expect our operating tax rate to be in the neighborhood of 18%, and net interest expense is expected to be in the neighborhood of $13 million. And our fully diluted average outstanding share count for the full year 2009 is currently estimated to be about 96 million shares.

Rolling all of this together, we currently expect non-GAAP earnings for fully diluted share to be range of $2.95 to $3.30 per share with sales declining between 3 and 8%. For Q2, we expect our currency neutral sales to again decline at a rate near the bottom of our 2009 full-year sales range, and as a result of the difficult economic conditions, and a difficult base comparison versus Q2 last year. The current exchange rate, currency translation will reduce sales growth by about 5%. Considering these factors, non-GAAP earnings per fully diluted share for the second quarter are expected to be between $0.75 and $0.79.

Thank you, John. Operator, I think we can now open it up for Q&A.

Thank you. At this time, we are ready to begin the question-and-answer session. (Operator Instructions.) And one moment, please, for first question. Our first question comes from Marshall Urist with Morgan Stanley.

Hey, sorry about that. Didn't expect to be first. A couple of things. First one, can you kind of walk through in more detail what happened on the gross margin side in terms of how we netted the improvement we saw in terms of head winds on volumes, how much was FX, and how much was cost control?

Sure. If we look at the margin impact, FX was the biggest player this quarter. If we look at the end, the end was up about 10% on a year-over-year basis, and that probably provided around a $3 million sales pickup with no corresponding increase in cost of sales. We have no manufacturing ops there. The British pound was down 25% versus the dollar and so our cost of sales were higher in mass spec products did very well in the quarter. It was depressed and that probably added another $3 million to $4 million of net benefit to the gross margins.

And then just the mix of high-end mass spec, the chemistry sales versus US dollar cost production, which was proportionately lower, added a little bit more to that as well. So, about somewhere between 75 and 80%, perhaps of the overall benefit is associated with these dynamics in currency mix that I'm describing. In addition to that, product mix was favorable. As I have said, we have different proportions this quarter of chemistry, services. There weren't a lot of costs added to those operations, so the incremental margin is pretty rich. And we had some savings within the manufacturing ops world as well. There were a couple of engineering cost reductions that went into place.

We had lower freight costs. We switched some of our shipments to ocean freight. We had lower warranty costs, all of which tended to offset the volume of currencies. In addition to all of that, we had incredibly stable pricing around the world. So while I was a little fearful early on we would see some pressure on the price side, that did not materialize in the quarter whatsoever.

And Marshall, I just might add that 30,000-foot perspective on this currency issue. I think one of the dynamics of the Waters, the way we run our business is over the last 15 years, we have added most of our incremental manufacturing capacity outside the United States. So we're manufacturing in local currencies. In Ireland, somewhat in the Far East and importantly in Manchester with our mass spec product line. What that means is that in those years when the dollar was quite weak, we had a lot of manufacturing costs. So you didn't see our bottom line being that much favorably impacted by a weak dollar. Now when you have a period of a strong dollar, we have these natural hedges built into the way we run our business that provide -- in this case, surprisingly -- greater upside because of the way the pound moves, versus everything else. It's fundamentally related to the long-term notion that we want to balance our manufacturing and sales to a much greater degree than I think most companies in our position are able to do, and besides that, we get the net results of substantial tax advantages by doing that too. It's all a result of that strategy that you are seeing some of the benefits come through in this P&L.

Absolutely. That makes sense. Just a couple of other things on the top line. So the consumables at 9%, was there anything special this quarter or anything kind of -- that pushed that number a little bit above expectations?

Well, I think the only thing special versus what I would call a normal quarter is that we had a few more selling days in the first quarter of 2009 versus 2008, and that affects, to some degree, our service revenue, because you have more days, for service guys to bill their time, and you have got -- it's a little hard to see how many of those flow through depending on Easter one year to the next year. That's why we think overall, that dynamic affected us 1 to 2 points in our growth rate. Other than that, there was nothing unusual in our recurring revenue dynamic.

Okay. Great. And then just one other question on the selling days issue, the -- just the quarter ended April 4th, so was that -- so was that just how the calendar fell for you guys? And then are we going to sort of give back those three days next quarter or how does that work out? Did you decide to close it on the 4th or what --

When you have the year starting on a Thursday like this, you have to make a call as to how many full weeks you will put in the first quarter. Then we have 13 week quarters in Q2 and Q3, and whatever you've done to yourself in the first quarter falls out in the fourth. So these days that we picked up in the first quarter will fall out in the fourth quarter.

But, Marshall, it's consistent with how we have done it over 15 years. It's just --

Where the calendar fell.

How the calendar fell this year and next year it will be a little more consistent.

Okay. Great. I will stop there. Thanks guys, and good quarter.

Thanks, Marshall.

Thank you. The next question comes from Ross Muken with Deutsche Bank.

Good morning, gentlemen.

Good morning.

So I'm trying to get a sense for kind of the optimism about the second half pickup. When you look at the commentary at pharma and that's big pharma, small pharma. Aside from the obvious on the M & A front, you are hearing more about portfolio rationalization, and taking down R&D spend significantly and head count significantly based on poor return on capital. I'm trying to rationalize that versus some of the comments about stabilization. We are seeing obviously some pretty big instability in the CROs and their results, which are obviously part of that pharma customer base.

I'm kind of curious on your assumptions there. It seems like you think that that's going to be stable through the year. And then on the industrial and chemical side, are we assuming kind of flat lines from Q1 levels or are we assuming some pickup in the back half of the year, in some of those traditional industrial markets?

Okay. That's a lot to pack in but I will try to handle it and John can meet us on the other side. First of all, on the big pharma side, Ross, our results were actually pretty stable. Our big pharma customers actually grew this quarter, and that's the dynamic that we saw in the fourth quarter too. So if you look at the top 20 large pharmas around the world, actually there, we saw most of their rationalization of their business happen prior to that period. Now, I won't tell you that it's all behind us, but one of our dynamics is we've been so intense in those accounts that we saw a factor of that really early on. The other thing is those accounts have been really focusing on productivity, and how to really drive their important processes faster and more importantly.

And we have actually seen a lot of success in it our new capabilities in all facets, Acquity and mass spectrometry and data, and making penetration into those accounts, so we're not anticipating that that drive up dramatically over the rest of the year, but we are not seeing the kind of pressure that maybe some others are seeing in some of those applications. Secondly, we believe that there will be a stimulus impact in the rest of the year.

It probably is in the second quarter, it's a second half dynamic. We have certainly seen stimulus programs passed by the US, by China, by Brazil. It's really western Europe that has probably seen almost nothing on the stimulus front. So we haven't banked a lot of stimulus money into our outlook, but if you want to look at a reason to be a little more optimistic, I think the stimulus spending will provide some hedge factor in what we are looking at.

CROs clearly have been under pressure. They are under significant pressure in India and these results show negative results from CROs. But once again, our discussions with CROs say that where they are going to spend is going to be on the high productivity, high throughput range, where we think we have very competitive systems. So, all in the question of whether the combination of CROs and pharmaceutical is going to go dramatically down from where they are now, I think if we are not at the bottom, we don't think that there's a whole hell of a lot of room to drive that capital spend down much further.

If you look at the developing areas that were very soft in the first quarter, you're talking about areas like Poland, Czech Republic, India, where they had pretty dramatic currency dynamics, even more so than the Euro zone or other areas of the world. We saw demand be dramatically affected as a result of that, and our most recent discussion is that those accounts and those economies are working their way through how to create money available to support their business plan, particularly in India. The underlying volume in those generic pharmas in India are up 25 or 30% in the last quarter, but the results are dramatically affected by liabilities that are non-rupee denominated and currency dynamics that they have to move through. But if you look at 30 to 35% demand increases, there, somehow they have to fund the capabilities of increasing their output and we feel like over the next several quarters we'll see a more normalization of the demand in those quarters.

When you talk about the impact of the stimulus, you are assuming this impacts both the industrial and the academic side of your business or just --

Principally Life Science and the academic and the government lab area.

Okay. Was there any -- John, just quickly was there any impact on M & A on the type line?

Yes the acquisition of Thar added about $2 million or so of sales. It was probably a few hundred thousand of sales for the TA as well that were incremental year-over-year.

And going forward, THAR should be $4 million to $5 million a quarter?

Yes, something in that range.

All right, thank you very much.

Sure.

Thank you. The next question comes from Quintin Lai, with Robert W Baird.

Good morning. Nice quarter. Could you give us an update on the impact of the acetyl nitrile shortage? Are you seeing any impact in terms of increased adoption or switching over to Acquity?

Frankly, Quintin, I think if you gauged the amount of discussion on the part of our -- particularly our significant customers, the answer is it's definitely got their attention. Frankly, if you asked me to point to actual orders that are coming in as a result of it, it's a little harder. I think that this is still a building momentum that we've seen some impact of customers, but I don't think we've seen the real impact that's still to come. There's no reason to believe that the acetyl nitrile shortage is going to be impacted any time soon. It's affected by a dynamic outside of the laboratory industry, as you know, acetyl nitrile is a byproduct of acrylo nitrile production, and that's dramatically affected by industrial demand. So the cost of acetyl nitrile is up significantly. That's probably still only being significantly felt by a number of these customers as we speak, and I expect it to have a significant impact, but I don't think I can say that it -- it's significantly affected our current order run rate.

Great. That's interesting. So then in this quarter, where you had really strong consumables and services -- and I understand the services component of it with the extra dates, but on the consumable side in column usage, it sounds like that even with the shortage, even with the macro economy, your customers must be across board still doing day-to-day business.

I think -- yes, I think one of the things that is -- perhaps isn't as well understood about our consumables business, is it's not a catalog business that is full of relative -- a mix of low value added items and perhaps, PH meters and things like that that are perhaps even more instrument kind of related. Particularly with Acquity, that's a much more captive stream. And of course, every Acquity instrument that we put into play increases that run rate of Acquity consumables. Now Acquity is still the smaller part of our overall chemistry consumables line, but it's a much faster growing piece. And together with the baseline of throughput in the QA/QC market place, requiring quality control of drug output, we've never seen and didn't anticipate a dramatic fall off in our chemistry sales.

Thank you.

And thank you. The next question comes from Isaac Ro with Leerink Swann.

Hi, guys. Good morning.

Good morning, Isaac.

First question is a follow up a little bit on the stimulus money and wondering on a relative basis how you compare your exposure to stimulus dollars that are maybe in the health care segment and then perhaps outside of healthcare sources. If not on an absolute basis, I know that's a hard number to come across. Maybe relative.

I would say that most of what we see in terms of quotes that we're actually making, which are substantial. In the product sense -- or in our highest value added systems, that is high end mass spectrometry and Acquity-based systems, and the great preponderance of them are what we call Life Science applications. They are in NIH-supported laboratories. They are in medical centers, hospital medical centers, and in government laboratories. That's where where the preponderance of interest is, I would say.

Okay. And if we just look back historically to take this one step further. For a lot of -- for today, it looks like a lot of the grant applications for the NIH-related dollars are due now or there abouts. If you look back historically at government funding, how would you parse it out between academic -- or healthcare versus non-healthcare type of applications?

The mix is heavily weighted towards Life Sciences, healthcare, if you will. Breaking it down any further than that within Life Science is difficult, but there is really no way of looking at the industrial side, if that's where you are headed.

The only thing that I would say is an interesting fact. I think most of this stimulus money, almost all of it is going to go to support existing investigators, that funding new investigators with new NIH grants, in the area of life sciences is not where it's targeting. If you don't have an existing approved investigator, an existing grant that you are looking to augment, my guess is you are not going to get much stimulus money.

Okay. And then just on customer exposure, you mentioned before top 20 accounts, without getting too specific, could you give us an indication of how those top 20 accounts would be broken out between branded versus generic drug companies and CROs.

They are almost all branded ethical pharmaceuticals.

Okay. And then just lastly thinking about pharma, M & A outlook, I know it's a lot of moving parts here. If you could remind us how that marketplace impacted equipment sales, not chemistry, but specifically equipment in the '02 and '03 time frame as just sort of a reference point relative to what we might see this time of around?

I think with we have seen historically is that two large pharmas come together. There's normally a quarter or two of reduced -- if you looked at the two independently, versus the two combined, there's a couple of quarters of reduced instrument purchases historically, that then moves through and you see the line, returning to a more historical level of growth, as if they hadn't combined to start with.

It's not clear. I mean, you have so many other dynamics that are entering the picture now with much more generic competition and much more cost control on the part of these companies. The fact that they are coming off five years of independent cost controls in a lot of areas, I think the interesting part is in the quarter just completed, with some fairly major kind of consolidation activities underway, those major accounts grew in the mid-single digits. So as I said, I think the significant depressed conditions in big pharma have been apparent for a while. We have come through two quarters now where our actual demand from those accounts grew. So, I don't think that there's a whole lot of room for major down sides.

Okay. And then just lastly looking at your earnings guidance, you obviously put up a good number this quarter and then next quarter is above the street. If you just take the back half of the year and assume the earnings are flat year-over-year, it would suggest to me that your guidance is pretty conservative. Without putting words in your mouth, can you say whether or not you feel confident that your full-year guidance is pretty achievable, given all the uncertainty you mentioned.

Yes, I guess I would say, all of the difficulties that we talked about in forecasting coming out of the fourth quarter, or moving into the first quarter and as we sit here today, life isn't dramatically clearer. Yes, there's some reason for optimism, based on stimulus money and perhaps a few other factors, but I would say, it's unclear exactly what we are going to pull out of this. So I just want to be as conservative as I can, as we are living through difficult times and, as we always do, we hope we have more up side than down in the numbers we put out there, but I think we have a realistic forecast that we are going to stick by.

Okay. Great. Thanks a bunch.

The next question comes from Derik De Bruin with UBS.

Hi, good morning.

Good morning, Derik.

Can you talk a little bit about the capital budget releases of your customers and I'm trying to get a sense of, is the money going for new instrumentation, placement. But ultimately trying to get here is how much of your equipment business is replacement and then if you kind of look at the big pharma mergers that have happened, I guess, were these accounts that were going to be a surplus of instruments out there when the deals are closed or that's going to be potentially longer in getting the stuff through the system than you would have expected?

Well, it's -- I guess the best way for me to answer it is to put it in the context of the the period that I have seen that's been most like this, which would have been the early '90s. And that period you had some pharmaceutical mergers and you had a great deal of concern about government policies. You had pressure on margins, and you had significantly reduced capital budgets. And the capital budgets were most affected during that period, and I think it's similar in this period, are the QA/QC capital budgets, where companies in that period made a decision to long out their replacement cycles. And, a lot of our big accounts have absolute policies to say that at five years, six years or seven years they change out all their instruments that hit those prime deadlines. And they pretty rigorously during regular periods then go through a replacement cycle. In the 1993, 1994 time frame, we clearly saw them move from that, and they longed out their replacement cycle. We see some of those dynamics going on in recent times.

We don't see it so much going into important strategic programs, strategic R&D programs, where they are looking to significantly increase or change their processes, improve their productivity, but with just regular replacement cycles, we definitely see some pressure on them longing that out. So that's kind of where I -- I say we -- we probably see a similar dynamic. I happen to think that in the long run, we are probably going to see the same thing. You may remember back in the '90s, we saw almost a couple of years of reduced replacement demand and then from 1995 to the end of the 1990s, granted it was only one dynamic, but we saw pent up replacement demand kick in. I wouldn't be surprised to see some element of that as we move through the next two or three years.

Okay. Hey, John, you guided towards -- if I heard you correctly, [$13] million in net interest?

Yeah.

What's going to drive -- You ended 2.2 this quarter. What is going to drive up the interest expense this year?

Our debt was very short this quarter. So we had an effective interest rate of just 1.5% and I was just a little nervous, extrapolating for the entire year interest at that rate. So I think the rate was more likely to pay on debt as we go through the second half of the year will be somewhat higher, bringing us to the $14 million.

Great. Thanks.

Yes.

I guess on the -- when I kind of look at this margin, obviously, the unusual FX mix that was happening in this quarter are going to roll over. I guess FX, and when the business normalizes, how do we look at the gross margin in 2010 and out there? I mean, you can't -- I mean, is that 150 -- is the gain sustainable?

Well, I mean, you have to anniversary it. You are not going to be able to repeat it. How far, I would just point out that predicting what currency markets are going to do and, the relationships that exist today between the pound and the dollar and the Euro is such an oddity that, it's just too difficult, I guess I would say to predict what 2010 will really look like until it's -- at least we make our way through the September quarter end.

And then one final question. I was surprised to hear -- I wasn't surprised to hear that your instrumentation was down mid-teens. Did I hear you say that organically the TA was only down 6%?

That's true. Based on a small amount of acquisition activity, it would have been nine without that and even that you could argue is a surprising result, given the market and, our estimates for the next couple of quarters is that the business is more likely to be down mid-teens based on what we see. So I think we didn't see the full impact of the business conditions that are out there affecting the business in the the fourth quarter. They also had a pickup in their business to academic. They have a pretty significant piece of business that's down almost a third and their pharma business did relatively well in the first quarter also.

And also TA has about 25% of their business on service that tends to be very resistant to the downturn also. So they have a bit of a push.

And I guess with -- so what -- what was the weakest instrumentation line? Was it the -- the -- I assume the HPLC business.

Yes, I think that's fair to say. The replacement QC HPLC business is the one most under pressure.

All right.

It may not be second quarter, but we think that at a low point.

Thank you.

You're welcome.

Thank you. The next question comes from Doug Schenkel with Cowen & Company.

Hey, good morning, guys.

Good morning, Doug.

Maybe just start with a quick follow-up to one of Derik's last questions. How much industrial exposure is there in the Waters division.

If you count the chemical business, that's probably somewhere between maybe 8 to 10%. We tend to say that 75% of our business is Life Science, 25% is industrial, if you will, but in there is environmental, food safety. By the time you really pare out the chemical, the industrial chemical bit of that, it's closer to 10%.

Okay. Thanks for that. And then I want to try to get a better handle on momentum coming out of the quarter. A lot of commentary from your competitors was pretty bleak, January and February, I think many would assert that you didn't sound so positive in the early part of March. So did something materially change in mid-March versus how you thought things were coming together in advance of that point in the quarter, and what does this mean in terms of momentum you had heading into Q2?

Let me put my spin on it. John did most of the talking in March, so it's his fault. I tend to be more conservative.

Sorry John.

I think generally what we are seeing is our industrial -- our developed markets, US, Japan, and western Europe, if you look at the underlying activity, quotes, orders, momentum, that all in turned out -- held up better than our initial forecast. And I would say it's fair to say probably the month of March was a little bit stronger than we had factored into our modeling. And -- that was across the board. So it's interesting. There's a mix of companies. Japan is all old, traditional, Japanese pharma. It's not a -- the biggest pharmaceutical company and Japan has been coming off a couple of years of very tough conditions in our world. So you have a mix of what was in the base and what's coming. Western Europe was encouraging with the flow of interest flowing out of western Europe. And while the -- the shipments were able to drive through in western Europe and the US were consistent with kind of our outlook, maybe a little -- a little bit more underlying optimism. I hesitate to use the word "optimism" because we're clearly not really optimistic, but versus our previous expectations, a little bit more -- a little bit more strength than we might have expected to see.

The only thing I can add to that is I think as we said, particularly in the first quarter, you wait for capital releases. You wait for capital budgets to be released for the year and working through this difficult year, I may look a little less well because I was holding my breath for the capital releases through the end of the quarter. They did. It wasn't obvious as we made our way through the entire quarter that that was going to occur.

All right.

The other thing that -- it's more mix dynamic is that, boy, we see a lot of interest in our higher value-added systems. Acquity and the new high-end mass spectrometry. There seems to be a lot of interest. We will see if we can convert that to orders and shipments, but particularly late in the quarter, where the customers had a much better handle on what they have to spend, we are seeing a surprising degree of, again, interest. I would say I fall short of optimism but interest.

All right. I really appreciate your candor. That was really helpful, and I think we all recognize that in this environment optimism is a relative term. The academic research market, that's historically been a smaller part -- or I guess I should say a smaller percentage of your sales. Do you envision having to make some incremental investments or shifting people around to better position yourself in this end market given the common stimulus funding?

We think we are pretty well situated to cover that. Yes, we are always, balancing territory. Last year, we went through a lot because we had to consistently look at this big pharma dynamic and see how our sales and service support for them, versus the emerging biotech and the CROs, et cetera. So it's more on the margin that we have to do it, Doug. It's not -- it's not a major restructuring that we find we have to go through. We have been pretty conservative in how we have allocated resources. We have been very tight with headcount adds because overall, our instrument placements were under pressure.

So we are going to be careful with how quickly we add. We think we have the capacity to cover the existing bolus of business. Frankly on the service side we may be under pressure to add a few more service people if we continue to keep up with this level of service. We will be tighter on the sales side, I think.

Okay. And last question, I have already got a few e-mails from folks regarding selling days and the impact in the quarter. I just -- I just want to make sure this assertion is correct that I think it will be helpful for people to understand it if it is. The benefit you get from additional selling days that mostly pronounced at the chemistry line. It doesn't have much of an impact on the services and instrument line?

On the service line and then on the chemistry line.

But really, we would say almost nothing on the instrument line.

Okay. Thanks a lot for taking my questions.

Operator, I think we have time for one more question and then we will have to close the call.

Thank you, sir. Our final question will come from Tycho Peterson with JPMorgan.

Thanks for taking the call. Maybe just some additional color on pharma. You have talked in the past about some of the pharma companies standardizing on Acquity, I think AstraZeneca has done it. As you look at the year ahead, you talked about cautious optimism. Are your discussions with pharma getting more strategic about standardizing around Acquity?

The simple answer Tycho is yes. I would say we have seen a high level of interest in almost all of big pharma. A couple of big pharmas, I think we are going to be in position to announce similar to the one you mentioned, but in this climate, again, you have to -- right until the very end, you have to be careful about whether they say, gee, if I make that plunge, I have to commit more capital, even though it will pay itself back in two or three years. Until I see the PO, I'm not ready to declare victory, but this -- somebody asked the question, gee, why are you a little more optimistic or it's such a great deal of interest in Acquity, that I think some of that has got to pay a dividend.

And have you seen any impact from kind of inventory management? We have seen some companies talk about destocking and it's a different dynamic when you are talking about glass slides versus columns but are you seeing tighter inventory management by your pharma customers?

A little bit, I would say. Probably not a huge amount. We saw some in some of our big CRO companies in India, for instance. So yeah, I think a little bit of optimism as we go further on in the year, is we don't think that there can be much more of that inventory management, but I don't think it's been a huge piece of shortfall for us.

And then could you please comment on the competitive landscape? We had a handful of triple quads come out of ASMS last year, and can you just update what you are seeing competitively? Do you anticipate you are going to continue to take share going forward or how do you look at the market?

Well, I think, it's a very competitive industry and we have got worthy mass spec competitors. I think the mass spec universe is more competitive than the chromatography universe. It's much more of an an oligarchy than the chromatography world. I think we are particularly happy with our current positioning in the mass spec world, and from what we see from customers, and what we think we're going to see at ASMS, we are very happy.

That doesn't mean that we think we have got the world by the horn. Well, "horn" is probably the wrong part of the anatomy. But it's a very competitive world. Others are going to introduce product. It's a very healthy, competitive world, but I think compared to some years, I feel more comfortable this year than perhaps I have in some years.

Okay. That's helpful. Thank you very much.

You're welcome. Operator, I think we will let these kind people get back to their regular jobs now.

Thank you, sir. That will conclude today's conference call. Thank you for participating. You may disconnect your lines at this time.

Thank you all. We'll see you next quarter.