Waters Corp (WAT) 2009 Q4 法說會逐字稿

Good morning. Welcome to the Waters Corporation fourth quarter 2009 financial results conference call. All participants will be able to listen own only until the question and answer session of the conference. This conference is being recorded and if anyone has any objections, 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 fourth quarter and full year financial results conference call. With me on today's call is John Ornell, Waters's 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 will start with an overview of the business highlights. John will follow with details on our financial results and provide you with our outlook for the first quarter and the full year 2010. But before we get going, I'd like John to cover the cautionary language.

During the course of this conference call, we'll make various forward-looking statements regarding future events or future financial performance of the Company. In particular, we'll provide guidance regarding possible future income statement results of the Company, this time for Q1 and full year 2010. 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 that the Company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results except during our regularly scheduled quarterly earnings release conference calls and webcasts.

The next earnings release call and webcast is currently planned for April, 2010. During this call we'll be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measure is attached to the Company's earnings release issued this morning. In our discussions 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 diluted share included in this morning's press release.

Thank you, John. Well, for Waters, 2009, I think, as you all realize was a very challenging year. The year, of course, started with a high degree of uncertainty in the midst of a global financial crisis and severe recessionary conditions. It was around the midpoint of 2009, the uncertainties for our markets began to abate a little bit and a more stable but significantly weaker demand pattern emerged. During the second half of the year, demand appeared to remain fairly stable with some indications that certain segments of our end markets were potentially seeing a modest level of recovery. The second half dynamics continued through the fourth quarter and we find ourselves entering 2010 somewhat optimistic that our end markets will improve, but continuing to feel that the recovery may be slow. Fortunately, we were able to see the storm clouds building in late 2008 and we adequately anticipated end market weakness as we designed our 2009 business plan.

Early in 2009, steps were taken to tightly control spending, while continuing to support critical growth program, including new product introductions. Now, with the year behind us, we can appreciate the results of our business strategy as we're able to grow our earnings, generate strong free cash flow and introduce exciting new products in this most difficult demand environment. You look at the fourth quarter, our sales and earnings came in roughly as we had expected with currency neutral revenues just under flat and our earnings per share up 5%. Geographically, our revenues were largely in line with our expectations. Moving down the P&L, our profitability remains strong due to favorable currency translation, discipline pricing and continued tight expense control. On the product side, we began shipping our SYNAPT G2 mass spectrometry system in the fourth quarter.

As you will recall, this new technology system was showcased at the ASMS conference earlier in 2009 and was quickly well received by the scientific community as offering novel capabilities for a wide array of applications. In fact, the order ramp for SYNAPT G2 during the second half of 2009 was stronger than for any previously-introduced high-end mass spec instrument from Waters. even without significant governmental stimulus orders in the US. A topic I'll come back to a little later. On the chromatography side, ACQUITY UPLC continued to displace HPLC's system sales and now represents our most popular chromatography platform. In our view, recent competitive introductions into the UPLC product space corroborate the technology and will help accelerate the conversion of the overall LC market to proven sub-2 micron particle chromatography as pioneered by Waters.

Looking at customer segments in the fourth quarter, we saw a continuation of the trends from earlier in the year. The weakest segment was the chemical industry, a business that's about 15% of our overall sales. The declines that we saw in this segment were less severe as we anniversaried the onset of the weakness that began in the fourth quarter of 2008. Our TA instruments division has a large exposure to this industrial segment, as many of their customers are involved with the production of materials that find their way into automobiles and other consumer goods. Within our TA division, we saw a more moderate decline in the sales for the quarter and order flow dynamics suggest that demand was strengthening in the quarter. These data suggest that we likely saw the low point of demand from industrial chemical customers in mid 2009 and that a modest recovery has started to materialize during the past few months. Demand from our pharmaceutical customers modestly improved in the fourth quarter.

Factors contributing to increased demand included rebound in sales in India and small improvements in demand from CRO and generic firms. Sales to our larger pharmaceutical accounts declined modestly in the quarter. ACQUITY and high end mass spectrometry continued to account for the growth in pharmaceutical demand but we have yet to see the onset of a return to historical rates of instrument replacement. Waters's sales growth in applied markets, including food and environmental testing, were affected by the significant business we transacted late in 2008 associated with melamine testing, primarily in Asian countries. Factoring out the effects of these sales, the applied markets represent a growing business for Waters. Our sales to government and university labs were flat with last year's.

However, this result does not fully reflect the demand we saw in the quarter as we built an order backlog for multiple SYNAPT G2 systems. Interestingly, our orders and sales in the quarter did not include meaningful activity from US governmental stimulus spending. From our perspective, the funding of these programs has been delayed and will likely influence our business by mid 2010. We remain optimistic that the strength of our research product offerings, such as our SYNAPT G2 and Xevo platforms will afford us a fair share of stimulus-related spending. I would now like to focus on new product initiatives that will impact our business in 2010 and beyond. Earlier this year, I discussed with you our new mass spectrometers, including the Xevo series of bench-top instruments and our exciting SYNAPT G2 HDMS and MS systems. Through 2009, orders and sales for these systems have ramped very nicely and we have entered 2010 with considerable business momentum.

Installations of G2 systems in the fourth quarter proceeded smoothly and we look forward to presentations at this year's ASMS conference in Utah that will highlight the performance advantages of G2 technology for a wide range of applications. 2010 should be an exciting year for Waters and mass spectrometry. As some industry participants work their way through new management structures and sort out new strategies, we plan to execute our established product and market plan. Our focus will be on continuous innovation and in 2010, we plan to introduce new mass spectrometry systems that will push the performance envelope while broadening the attractiveness of MS technology to a wider base of customers. On the chromatography front, I have spoken to you about the dramatic impact of the Q of the UPLC on numerous occasions. And early this morning mentioned that UPLC now accounts for most of our chromatography system shipments.

Since its introduction in 2004, ACQUITY has allowed hundreds of organizations around the globe to realize improved data quality, increased sample throughput and reduce cost per analysis. With all the proven benefits of ACQUITY UPLC, many have been quick to embrace UPLC technology. However, many more have been attracted by the promise of UPLC but remain reluctant to change largely because of their comfort level with existing HPLC systems and techniques. In our industry, there is no substitute for working with thousands of UPLC customers to gain insights for product improvements and the ideas for next generation systems. And it is in that light that I want to tell you about our new ACQUITY, UPLC H class system that we've just introduced this week. Working closely with our customers, we saw the need to provide a bridge to UPLC performance that builds upon the widespread knowledge and comfort laboratories have with HPLC operation.

We feel that ACQUITY UPLC H class is this bridge and it has been designed to fulfill the needs of mainstream customers, especially those working in methods development and routine analysis laboratories. It does this by combining UPLC performance with the operational familiarity of traditional HPLC, a combination of high performance and simplicity that we believe will facilitate adoption by a broader range of industries, applications and operators. All of whom will realize the scientific and workload benefits of UPLC. I encourage you to visit our website for a detailed description of our new ACQUITY UPLC H class, as well as descriptions of our complete family of application tailored ACQUITY systems. Before turning you over to John for a more detailed review of our financials, I want to share some thoughts about 2010 and reiterate some our key business strategies. Looking at the competitive landscape and the strength of our product portfolio in 2010, I believe that we've never been in a stronger product position.

Our strategy of focusing on our technological strength and staying close to our customer base has allowed us to protect and grow our market share and deliver superior financial results, even in these difficult economic times. 2009 was one of those difficult times and yet we were able to grow our earnings per share and introduce exciting new products. I believe that 2010 will be a better year for Waters than 2009. Most signs suggest that the worst of the recession, in our markets at least, is behind us and that demand for our products should increase. However, we feel that there is ample reason to manage our business cautiously, as we are not expecting a dramatic change in economic conditions and do expect that there may be some lumpiness to the recovery. Accordingly, we'll continue to manage our expenses closely, while we follow an improvement plan for the deployment of capital. In 2010, we will continue on the path of globalizing our manufacturing operations that further balances our production capacity with global demand patterns for our product. This strategy provides us with high quality, cost-effective manufacturing in tax favored jurisdictions.

Lastly, we anticipate continuing to look for acquisition opportunities that are consistent with our history on this front, smaller, technologically-focused targets with growth and profitability profiles that are in line with our current business. We expect that 2010 will be another year of strong free cash flow, providing us the resources to continue our multi-year share repurchase program. So, with that, I would like to turn it over to John for a closer look at our financials.

Thank you, Doug. Good morning. Fourth quarter sales increased by 3% and non-GAAP earnings per diluted share were $1.12 this quarter compared to earnings of $1.07 last year. On a GAAP basis, our earnings were $1.08 this quarter compared to $1.01 last year. A reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning. Looking at our Q4 sales results, sales were up 3% this quarter with currency translation providing 4 points of growth. Without the benefit of currency translation, sales were down 1% versus prior year. Acquired businesses added about 2 points of growth this quarter. Looking at our sales growth geographically and before foreign exchange effects, sales in the US and Japan were up 1% and 7% respectively. In Europe, sales declined by 5%. And in Asia, sales were down 3% against a strong base of comparison, which included shipments related to melamine testing requirements in 2008.

Turning to the product front, within the Waters division, instrument system sales were flat and recurring revenues due to fewer selling days this quarter declined by 1%. Within our TA instruments division, sales declined by 7% versus prior year. Now, I would like to comment on our non-GAAP financial performance. Gross margin came in at 60.3% this quarter, which is up 140 basis points from Q4 last year. Gross margins benefited from favorable product mix, product cost reductions and slowing currency translations. SG&A expenses increased 6% this quarter compared to prior year and R&D expenses increased by 1%. Our full year operating effective tax rate came in at 18.4%, down modestly from Q3 as a result of a shift of income into lower tax rate jurisdictions. As a result, Q4's pretax income was tax affected at 17.1%. On the balance sheet, cash and short-term investments totaled $630 million and debt totaled $632 million bringing us to a net deposition of $2 million.

On the stock buyback front, we continue to purchase our shares in the open market. During the fourth quarter, we purchased 907,000 shares of our common stock for $54 million. For the full year, we purchased 4.5 million shares of common stock for $210 million. We define free cash flow as cash from operations, less capital expenditures, plus any noncash tax benefit from FAS 123R accounting and excluding unusual nonrecurring items. Q4 free cash flow was $112 million after funding $13 million of CapEx and adding back $5 million of FAS 123R benefits. For the full year, free cash flow was $341 million after funding $94 million of CapEx and adding back $5 million of FAS 123R benefits and excluding $12 million of payments associated with a litigation provision and a lease termination settlement. Accounts receivable, day sales outstanding stood at 67 days this quarter, up three days from Q4 last year. And inventories were up about $5 million from year-end last year, likely due to currency translation.

Looking at 2010, we currently expect economic conditions to marginally improve as we move through the year. Geographically, we expect that Asia will continue to see overall favorable business conditions and provide solid growth in 2010. In the US, Europe and Japan, we expect to see gradual improvements across the areas as these geographies begin to lift out of recession and grow modestly in 2010. Product-wise, we feel we have a strong product line-up across our technology platforms and are well-positioned in our end markets as we begin the year. From a customer segment perspective, we expect 2010 to see sluggish performance from our industrial base customers, mid-single digit growth from our broadly defined pharmaceutical customers and near double digit growth from our government and academic customers heavily affected by stimulus spending. Overall, this should provide for mid-single digit growth before currency effects. Currency at today's levels should add about a point to sales growth for 2010.

Currency comparisons to sales growth for the quarterly basis comparison will start off more favorable early in the year and become more difficult as the year progresses. Now I would like to comment on our expectations for non-GAAP financial performance of 2010. Gross margins were heavily affected by foreign currency translation in 2009, which will provide a difficult base of comparison this year. We currently expect margins to start off the year at around 59% and end the year over 60%. These more difficult currency comparisons will provide slower than average EPS growth in the first half of the year. On the expense front, our efforts to control costs during 2009 again creates a difficult comparison and while we will continue to be cautious on spending, we currently expect that SG&A and R&D will grow at about the same rate as sales as we make modest investments to support growth in our businesses, specifically in our Asian geographies.

On the tax front, during 2010, we anticipate upward pressure on the tax rate from continued success of our high end mass spec products manufactured in the UK and downward pressure on the rate from the transfer of additional production to Singapore. At this time, these effects look to principally offset each other and we expect our non-GAAP effected tax rate to remain at around 18.5%. And a continuation of our buyback efforts should provide for a full year of fully diluted share count of around 93.5 million shares. Interest costs are expected to rise somewhat this year and we expect to have about $12 million of net interest expense in 2010. Non-GAAP EPS for the full year 2010 are currently expected to be between $3.70 and $3.85 per fully diluted share. Free cash flow is expected to remain strong and should approach $400 million in 2010. For Q1, we expect mid-single digit sales growth before currency translation effects and currency translation at today's levels would add about 3 points of growth.

Gross margin as a percentage of sales will have the most difficult comparison in Q1 and is expected to be around 59% this quarter. And expenses are expected to grow a bit less than sales for the quarter. Non-GAAP earnings per fully diluted share are expected to be in the range of $0.75 to $0.79 per fully diluted share. Doug?

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

(Operator Instructions) We do have several questioners in line. First person is Mr. Ross Muken of Deutsche Bank. You may ask your question.

Good morning, gentlemen. I just want to get a quick financial question out of the way. John, what was the days impact in the quarter, particularly on the consumables business and how many days did you lose year on year?

Yes, there were a few days difference, Ross. As you might recall, at the start of the year, we had an extra three days in the first quarter and that principally turned around in the fourth. It is probably three or four points of consumable, service consumable, mostly consumable growth that was impacted 1 to 2 points of growth overall, down in the fourth quarter which we picked up in the first.

Ok, great. From a more macro perspective, Doug, you sort of talked about the idea that you're not looking for a substantial recovery from any of the industrial players or any sort of meaningful kick-in, particularly on the chemical side. We've seen chemical company results improve fairly significantly. Today, we had one of the big players putting up some pretty decent results. In terms of the conversations you're having with these organizations broadly, whether it is within TA or within the Waters business, is there any sort of sign of hope they are or is there just a belief that they built out so much capacity the last few years there's not really a need for new instrumentation?

Ross, I think -- well, first of all, I think you're right. As you said, I think we saw the lowest point in these industrial companies in the midpoint of the year. And it has been marginally better since then. We also have the fact that the first half of last year was so weak that we think the first half of the coming year is going to be better simply because of that base dynamic. I also read the DuPont news this morning, they seem to have clearly turned the corner there. That's a good sign. TA also saw some underlying improvement in terms of the attitudes of their major customers, their quote rates and, in fact, their business rates. So, that is a pretty good barometer of the industrial market place and they're feeling, again, cautiously optimistic that that's continuing as we move into the new year.

So, I think there are some good signs. We also see counter vailing signs that they're very tight with their capital spending. I still think we're going to see a lot of these big companies in both industrial arena and in pharmaceutical arena be slow to open the purse strings in the new year. And they're probably going to wait, as it becomes somewhat traditional, a little on in the year before they see any major capital releases.

And just quickly, Doug, as you sort of look back historically, what's been sort of the sign to say that ok, it is safe to get back in the water in terms of some of those industrial players from a CapEx perspective. What have you -- was it two consecutive quarters of GDP growth, is it six months post the original sort of inflection point in GDP? How should we think about sort of what we need to see from an economic data point perspective and from a top-line perspective at some of those players until when they actually start to spend.

Yes, I would say it is six months kind of data on GDP growth. Ross, the auto industry is such a big player in the basic chemical production in a lot of these companies and what's going on in auto clearly went so low and now is coming back. But what the total dynamic on that is with these large chemical producers, I think it is hard to call and overlay into kind of a normal recession. So, I think the worst of that is clearly behind us. But whether this six months rule will hold or could be a little faster, could be a little slower.

Thank you very much.

the next question is from Quintin Lai from Robert W. Baird. Your line is open.

Good morning.

Good morning, Quintin.

With respect to the H class, could you talk a little bit about kind of the timing of the release now instead of waiting for like Pitcon and then your expectations in 2010? I mean how much, I guess, expectations of adoption have you built in? And then how much of the cost of going out and promoting this have you also baked into your SG&A?

Well, we've baked in all of the cost of the promotion and the cost of training. Some of that actually happened in the fourth quarter, as you would expect, because in order to introduce it now, we had to have fulfillment literature and training, et cetera are all in place to be able to launch this. It's -- you can clearly, I think, hear our excitement over this new system. And we do think it is a very important, exciting launch. On the other hand, I also have to tell you we're being fairly cautious in terms of the net overall impact on our business. So, there's clearly a little bit of a dichotomy there, because we have to look at cannibalization, we have to look at the speed of the uptake and so I suppose it is fair to say we talk a little bit out of both sides of our mouth here. But trust me that we really think that this is an important introduction and an important system for us.

Typically the way companies and Waters has fit this mode in some years past is that you're really struggling to get a new product to Pitcon. And a typical launch pattern is you've got the product. You're confident about being able to ship it sometime at the end of the first quarter. You launch it at Pitt con but you're still struggling to build inventories and to get the product out there, so, you don't have a very strange order pattern that you can't fulfill at the end of a quarter. But that's always a struggle and trust me, over 30 years in this industry, we've talked about it enough and talked to competitors enough to say that's a pretty typical pattern. What we do with the H class is the total fulfillment is done. The training is done. Inventories are now ready to ship. And we've actually begun to take real orders for the H class. This is very unusual for a launch of this magnitude. So, that's why we launched it when we did. It was ready. We're ready to ship it by the end of the first quarter.

We're not going to be in a position to have a large built backlog. Art is chastising me in the background here when I said by the end of the quarter. Orders taken now will ship in 30 days. That's our quote pattern. We're very comfortable with it. This launch pattern has been as smooth and as on-time as I've ever seen in my history here. So we have high expectations. You don't necessarily see that because of this whole level of confusion in the economic pattern and in some our customers. So, if we're right, I think long-term this is going to stimulate our growth rate.

All right, thanks. I'll jump back into the queue.

Hello?

your next question is from Tycho Peterson from JPMorgan. Your line is open.

Hi, good morning.

Good morning, Tycho.

Question maybe about Pharma. I think in your comments, Doug, you talked about mid-single digit growth from Pharma for this year and in this quarter it looks like large Pharma was down a little bit more modestly. So, can you talk as to how you're thinking about Pharma and what's behind that mid-single digit growth expectation for this year?

Yes. We're expecting that it will improve over the fourth quarter, Tycho. We clearly saw some weakness in the large Pharmas going through mergers. That was probably a little bit more pain than we had originally expected. And so we're anticipating that that improves a little bit in 2010. Early indications are that that will be the case, but it is still a forecast at this point. Was there a second part to your question?

Can you talk a little bit about consumable growth for 2010 and how you're thinking about that both with ACQUITY and then if you can just comment on what consumable pull-through will be like on the new UPLC system, that would be helpful, too.

I'm sorry. I got -- could you just repeat that?

Yes, your outlook for consumable growth for 2010 and then any color you can add on consumable pull-through on the new UPLC system.

Yes. The consumables outlook is mid-single digit growth. It should be a more -- we shouldn't have the calendar irregularities in 2010 that we had, although we still have the fact that we had the first quarter of last year with the outsize number of selling days, but the calendar itself in 2010 is pretty consistent. And so right now, with our -- we've got a very strong launch pattern, new chemistries, particularly in the ACQUITY product line that we're very enthusiastic about and we think that that should deliver that mid-single digit growth rate. In terms of the new system, the great advantage of the H class is that it allows customers to adopt UPLC at their own pace and allows them to run their traditional systems, methods, the way they wanted to at the same time being able to lead them on to the greener pastures of UPLC capabilities. To the extent that they adopt UPLC, we're highly confident that they will be buying our UPLC chemistries.

To the extent that they run HPLC methods, they can -- one of the advantages of this is that they can run their existing chemistries. So, if they're on Waters chemistries, they're likely to continue to run that. So, probably in the early phase of this, it probably doesn't dramatically change market share dynamics in the consumables business. In the later stages, as we think this moves them faster to UPLC, it should improve the growth rate even further in UPLC chemistries.

That's helpful. Maybe, actually, just going back to the original question on Pharma spending. Is more the growth you're going to see in Pharma from standardization across, with the ACQUITY across QA and QC in application areas?

Well, don't forget that Pharma spend, when we talk about Pharma, we're talking about the all-in pharmaceutical industry, including India, including generics, including CROs. Where we saw an improvement in the India generic marketplace in the fourth quarter, we're pretty confident about seeing a consistent, sustainable return to strong business in India as we go forward. We're also seeing generally a stronger conditions in generics and in the CRO marketplace. So, those are probably more significant to us in terms of maintaining growth in Pharma than the large Pharma dynamic. Don't forget that for years now we've been seeing reduced business in the large pharmaceutical that kind of moved into the generic and the specialty pharmaceutical segment of the market.

Ok. That's helpful. On your spending guidance, SG&A and R&D growing at kind of the same rate as sales. Can you talk about your ability to adjust that as needed throughout the course of the year? Do you feel like that's kind of an active approach that you'll be taking or how do we think about that?

Well, I think we'll have to continually monitor it. We act like a lot of companies, out of the chute we're reluctant to commit to too much headcount additions until we see how 2010 is it really going to shape up the way our plans have it? So, I think we've got some flexibility early on. I think one of the hurdles that we face, as a lot of companies do, I think, is that we reacted so quickly and took significant steps to sustain our profitability in 2009 that it was unlikely that you continue all of those steps as you move forward into 2010. The dynamic of that is you have to make up some ground in terms of salaries, merit increases, commissions that you took out in 2009. So, structurally, you've got more of a hurdle as you go into the new year than you did last year. We think we've accommodated that. We think we can manage our way through it, but it does make it structurally more difficult than we saw early on last year.

Ok. And then one quick financial one. On the SYNAPT backlog, can you comment on how that impacted margins if at all?

We talked about the SYNAPT in the fourth quarter being somewhere between $10 million and $15 million of shipments. It was, in fact, in that range. In spite of that, we did build backlog within the quarter for that particular product and it didn't have -- it was a little bit accretive to margins, but not that meaningful.

Ok. Thank you very much.

Sure.

The next question is from Rob Hawkins. Your line is open.

Thank you. You on the new ACQUITY H class, this is really kind of a modification of an existing platform. Is that being built in the US or is that something that you can now, with this type of launch, fast track that to Singapore?

Well --

You want to comment?

Let me just make sure I understood the question. Are you asking about where it is manufactured?

Yes. I mean, it is a modification, as I understand it, it is a modification of kind of the existing ACQUITY platform, I guess, kind of streamlined. And before you've kind of been having this best practice of engineering, building here, refining the product over say a year and then kind of moving it abroad. But does this, this type of modification for some of these more mainstream customers, does it give you the ability to maybe start the process over in Singapore where it is a little bit more cost-effective?

Yes, actually, the H class with our experience now in moving product, new designs, the exciting thing about the H class and what enables us to position it in the market place at its value point is that it will very quickly, for all intents and purposes, it will be manufactured in Singapore out of the chute. So, that was exactly our strategy and it is that experience we've had with ACQUITY, the alliances and the historical ramp-ups that have enabled us to do that.

This is a follow-up. Can you remind us like what type of product volume, what products are being made over in Singapore and how that's benefiting gross margin? Is that something you guys can disclose?

I would tell you that principally all of our HPLC products are manufactured over in Singapore. A lot of the detectors, even for the ACQUITY product line, are manufactured over in Singapore. So, it is better than half of our production is there and the movement of this new technology will certainly tilt the scale significantly towards the majority of the LC production being done in Singapore.

Okay, great. Then, you also mentioned further globalization. Do you think that will be greenfield production facilities in new countries or do you think this is going to be through acquiring assisting platforms.

The globalization we talked about in terms of manufacturing?

Yes.

We have no plans to open up new manufacturing sites. So, our expansion will be within the existing platforms that we have in, principally in Singapore and in Ireland. As you know, our R&D and the initial runs get done in either Milford or Manchester or Delaware and then typically get pushed out into Ireland or Singapore.

Ok. Thank you. I'll jump back in the queue.

Thank you. The next question is from Isaac Ro of Leerink Swann. Your line is open.

Thank very much for taking the question. Good morning.

Good morning, Isaac.

Just first off, wondering if you could comment on the -- on TRIZAIC and kind of where we stand with that platform.

Art, you want to take that?

Yes. We introduced the product not last year's ASMS, but the ASMS beforehand. To be honest, we did, in fact, run into some technical difficulties with the chemistry platform. Progress has actually been quite excellent in the last quarter and we fully anticipate to begin delivering products and actually exceeding the original claims on the product by ASMS of this year.

Great. Thanks very much. And then just in terms of the H class in terms of how it maybe factors into the pricing environment for the existing ACQUITY and in broader HPLC market, how should we think about where it is positioned versus those existing products?

The H class is -- think about it, if you think about three ranges of product, you have an HPLC at one end of the price spectrum. You have the current ACQUITY that we've had in the market place at the other. Think of this as being between 25% and a third higher than an HPLC in terms of its relative price position in the market place.

Great. And then just lastly, sort of a big picture question. I think there was initial body language out of Washington this morning around the State of the Union and how we might see a freeze in broader discretionary spending items going forward. Clearly, the stimulus benefit right now helps the NIH, but maybe looking past that, do you guys have opinions on what the government funding outlook might look like in that kind of an environment? And specifically, [be said] to what you thought, you think your contacts hope that NIH might continue to power upwards in its growth rate even in a flat budget environment.

Typically, the NIH, growth in the NIH budget or flatness in the NIH budget is very hard to see the impact on our underlying business. It obviously exists. It gets dispersed in terms of NIH grants. So, in the long run it is always better for us to have the NIH, budgets going up. But the kind of environment that is described, of course, we both know that it is easy to proclaim a price or a budget freeze, whether it actually happens or not will remain to be seen. But assuming that it does, I think it won't be very noticeable in our operations, certainly not in the first half of the first three quarters of this year. But, boy, it is rank speculation to think what they actually will do to this budget, when it will occur.

Sure, totally understand. Thanks so much for taking the questions.

Thank you. The next question is from Marshall Urist from Morgan Stanley. Your line is open.

Hi, this is actually [Jennifer Lu] in for Marshall. My question is on gross margins. I was hoping you could just walk us through the drivers of your gross margin guidance and what takes it progressively higher through the year.

Yes. If you look at 2010 versus '09, it is down modestly overall for the full year, principally associated with a less favorable foreign currency environment. The 59% starting point in the first quarter is a portion of the starting point is the fact that we have much lower volumes going through the first quarter than the fourth. So, you traditionally see this business start off with a somewhat lower gross margin and with a much higher gross margin in the fourth quarter. So, the significant Delta year-over-year is all currency. And as we ramp the products that we've talked about introducing, first here but then ultimately in Singapore, we'll get more of a gross margin pickup as the year goes on and then in the fourth quarter, with the volume lift that we'll get, we expect to get with budget flushes that exist at the end of the year pushes the margins well over 60%. So, the absolute difference year-over-year is the foreign currency dynamic and then it is mostly a volume and a new product cost reduction type play as we make our way across the quarters.

Just remember, as John talks about foreign currency dynamics, the principal reason for the foreign currency effect was the very weak British pound in the first part of last year. And since we do manufacture, a significant amount of manufacturing in pounds, that lowered the cost of our UK manufacturing and improved margins. The British pound has strengthened since that point, although it does bounce around a little bit. Where it is right now is, in terms of pound cost, higher than it was in the first quarter of last year. So, that's why this foreign exchange effect impacted. Overall, we're actually pretty pleased about how we manufacture in local currencies as well as make sales in local currencies. It kind of balances our overall foreign currency exposures. But in that one margin line issue, it does swing from year to year.

Ok. That's helpful. And just one more follow-up. I was just wondering about service margins relative to last year. To what extent is this discretionary spend in terms of building out your infrastructure there.

Yes. There's no doubt we'll be adding at some level service headcounts as service grows in 2010. Some of those heads are going to be Internationally-based, not quite as expensive perhaps as heads here in the US. So, there will probably be a slight decline in those service margins, but you're not going to see a precipitous drop as we make marginal investments there.

Great. Thanks.

The next question is from Derik deBruin from UBS. Your line is open.

Hi, good morning.

Good morning, Derek.

A lot of my questions have been answered, but I just want to talk a little bit about column utilization and basically you've said UPLC instruments have basically outplayed placement of HPLCs. What are going on in the consumable dynamics. I guess I'm just trying to figure out just -- and the fact you have longer pull-through on both platforms right now. And particularly how do you look at the dynamics given that the QD columns have longer lives than some of the HPLC columns. I'm just trying to figure out what's the diff and kind of how the H class figure into this whole method of looking at your consumables stream.

Sure, let me give it from 30,000 feet and Art can jump in at any altitude he wants. Don't forget, our consumables is a complex picture for us, which is sample prep devices, traditional HPLC columns as well as ACQUITY. Unequivocally, ACQUITY columns continue to grow at a very strong pace. So, our model here that we have more of a razor and blade model with UPLC is clearly playing out. What we've seen in terms of our overall consumables business in 2009 is much more related to fewer samples being run in the traditional market place, inventories coming down in the sample prep world, particularly in places like India, where they dramatically reduced inventories. We're beginning to see some sign that that's turning around, but I think 2009 was a pretty aggressive inventory management cycle. So, I think ACQUITY consumables are playing out largely the way we've modeled it and very positively. But it still represents a smaller piece of our overall consumables market than our more traditional products and our sample prep product.

Ok. And I guess along those lines, I know some of your competitors have introduced UPLC columns. I guess what that is is like how -- but I would assume that just because you guys had the first ACQUITY columns out, do you still commanding the lion's share of your consumable stream in that platform. I guess, what do you -- I mean, what feedback have you heard from other people offering UPLC columns. Do they perform as well on your instrument and I guess how -- what would make somebody choose a non-Water's ACQUITY column?

Sure, Art is very up to date on this. So, Art, you want to.

Yes, Derek. If you think about the introduction of this system, you had a couple of challenges. We're taking HPLC, which ran a 3,000 PSI, up to as high as 15,000 PSI. And we're taking the column particle size down from 3 microns to 5 microns down to sub-2. So the big question in the world was how can you maintain the robustness of the system. So, when we designed both the ACQUITY instrumentation and the column, they were designed hand in hand. The instrumentation contains capabilities that actually monitor the column and it is what has given the ACQUITY column the reputation of being equal but for even more cases, more robust than a traditionally PLC column. The column itself has electronic devices that actually connect to the ACQUITY system. It tells you what's going on in the system. It tells you what's going on in the separation. So, think of this as a fully integrated system. The traditional HPLC column was a free-standing device. It got connected. There was no real system-based interfacing between the column and the system. The customers immediately realized this.

And the psychology in the marketplace right now is that there is no viable chemistry alternative at this time that gives you this full systems approach. And even those companies that are coming in trying to sell instrumentation for all intents and purposes, the viable approaches of trying to attach an ACQUITY column to their system, but they lack all the documentation, the information, the element that has made this combination so powerful in the marketplace. So, for the moment, we're finding very high compliance. Column utilization for ACQUITY runs greater than 90% for traditional HPLC for almost everybody and anybody in the marketplace. 10% to 20% of your columns are used on your systems because of the long-term availability of all sorts of different columns. We really changed the game in this marketplace and for at least for the moment, it looks like it is going to get stronger before it gets weaker.

Great. And just -- so, the mid-single digit growth in the consumables and some low single growth in instrumentation is probably a good way to look for the full year?

I mean, instruments I think will be probably close to mid-single digit growth, too. Certainly, with the new high end mass spec, we're pretty excited about growth opportunities for the overall aspect business. And I think this new launch that we've got here, too, should be able to push LC close to mid-single digit growth as well.

Great. Thank you.

The next question is from Doug Schenkel of Cohen & Company. Your line is open.

Hi, good morning. Maybe a follow-up to Derik's last question. In the context of 2010 sales growth guidance, how much do you expect new instruments including G2 and the H class to contribute. Is it right to assume that that's going to get you a point or two or is that too high or too low?

I think if you look at our first mass spec, I would say that the mass spec market should continue to turn around and perform better. I would think that the high end G2 is likely to move our mass spec growth a few points perhaps overall as it continues to hopefully grow near double digit as we make our way across the quarter. Certainly, the early indications based on order backlog and customer interest would suggest that's true. On the LC side, I would say that ACQUITY, even in a very poor year, 2009, grew nicely. And I think that this transition product that we now have that really begins to help people transition from HPLC to UPLC, should expand the base against which we can grow our LC products. Hard to kind of say what the cannibalization will be of perhaps some of the HPLC products, but I think net/net looking at that new product driving at least mid-single digit growth for LC in total makes sense.

But I think, John, it is a lot complicated by market dynamics. But if you think 1 to 2 points from the H class and 1 to 2 points from G2, that wouldn't be far off what our thinking is.

Okay, that's helpful. And then in terms of G2 backlog, can you just talk a little bit about how that differs across end markets in geography?

Our major geographies it was -- the orders were pretty balanced in terms of our overall geographies. And we tried to be very fair in terms of what we were shipping across those geographies. Of course, you can imagine our field was screaming, wanting all of it for their territories. But we basically parceled it out pretty ratably across the geographies.

Ok. And let me just jump to a couple end market questions and then I'll wrap up. Some of your peers have asserted that visibility on the big Pharma end market would improve as the merger started to close. Is that your view and has that started to happen yet?

Well, visibility is such a nebulous term. I mean, we certainly saw less business from those merged entities in the fourth quarter. And frankly, it was a little -- I mean we had planned on some of that. It was a little bit lighter than we had expected. We don't expect it to be quite that bad going forward, but I wouldn't say that the visibility of their budgets and their spending pattern is significantly better than traditionally at this point in the year.

Ok. I guess the hope would be that, as it typically does, that it would get better over the next quarter or so.

Yes. I mean, I think traditionally what we're seeing, not only for merger companies, is that they're very slow to release their capital and yet their scientists are all such screaming for increased capabilities. So, you're trying to kind of sort through the noise to get at the signal and sometimes one takes control and the other times, the other. I mean I do think this pent-up replacement demand, in a lot of these companies, we fully expect that over time will see business reflect that pent-up replacement demand, but we didn't see it in the fourth quarter.

Ok. And last question, another one on the industrial end market. If I remember correctly, in Q4 of last year, the industrial weakness was actually more pronounced within the Waters division, not the TA division. Correct me if I'm wrong, but I just wanted to see how that affected year-over-year comparability in the fourth quarter of this year and moving forward. Is it Q1 where essentially the comps get pretty favorable from the industrial end market within both divisions?

Yes, you're right. We saw a little bit more of a lag with TA, interestingly, on that front. And Q1 does become the easiest compare of the year for 2010 and as Doug said earlier, just given some of the early indications from this group of customers, we're expecting that we'll probably begin to see some positive momentum from that group, modest in the first quarter as we begin 2010.

Across both divisions.

Yes.

Ok. Thanks a lot for taking the questions.

You're welcome.

The next question is from Paul Lawson with Thomas Weisel Partners. Your line is open.

This is actually Patrick Donnelly filling in for Peter. Thanks for taking the question. I was just wondering, US stimulus seems to be delayed a bit. You didn't see too much for sales materialize in 4Q. You're now seeing the majority of the impact in mid 2010. How much slower are funds trickling in than you expected and what are customers citing as the primary reason for those delays?

Well, I think a lot of people, maybe including us, were hoping more than determining in terms of the stimulus spending. I think a number of these grants were affected by different administrative procedures. They had different finalization, different review committees that were set up by technologies. And so they had to go through kind of separate routes in order to get approved spending. That might be why you see some elements of technology getting a little bit early releases than others. We're told that the, particularly the mass spectrometry reviews have largely been completed and that those authorizations are in process and you'll -- we should begin to see orders late in the first quarter into the second quarter. Whether you see orders that can be fulfilled make their way to shipments, probably that's more second quarter weighted rather than first.

All right, great. Thank you. And then just in Japan, what was the primary driver of the growth reacceleration in the quarter?

Japan had a reasonable good mass spec quarter. So, some of those G2 shipments made their way to Japan.

Also had a pretty weak base in the fourth quarter of last year. You'll find that to be a fairly consistent dynamic in 2009 in certain territories, but, yes, mass spec and a weak base combined to give Japan a pretty good quarter.

Great. Thank you.

the next question is from Jon Groberg from Macquarie Capital. Your line is open.

Great. Just a few follow-up questions here. John, one, if we look at kind of Q1, I guess, is where the most of the visibility is. But is there anything going on, as you saw trends in Q4, that would make you think that it would be any different from kind of historical seasonality now that it seems like economic activity at least has somewhat stabilized, albeit at lower levels, if you think of kind of sequential -- the seasonality between Q4 and Q1 of previous years.

Yes. I guess I would say certainly starting off Q1 last year, it was a pretty dismal environment. So, from a basic comparison perspective, you would certainly argue we have a relatively easy base. That being said though, as Doug pointed out earlier, it is hard to believe that customers are going to be allocated funds very early on in this process to spend. But I would say that a mid-single digit expectation of growth, given that base of comparison and given some of the early signs that we've seen in demand volumes, would be a realistic place to begin. We do have on the one hand, additionally, this new product launch. We're taking orders, we'll be shipping on that front as well, but we need to be a little cautious in transitioning to that new product. So, I think there was a number of factors on one side or the other that, I think, weigh, come down and say that a mid-single digit expectation is a realistic place to be based on the run rates we see coming out of the fourth quarter.

Ok. And then just a clarification. On the acquisition front, is it -- Thar was the only acquisition-related revenue. Is that correct?

That's right.

And any update on just kind of the integration with that business? It seems like maybe revenues were a little bit higher than had been -- may have been thought or forecast at least by others?

Yes, I would say Thar integration is well underway. The volume from that acquisition was roughly on plan. It wasn't a full 2 points. So, it wasn't quite as strong. It rounds to 2. But I would say that the expectations certainly going forward in '10 is to see some meaningful growth out of that organization having spent a lot of this year getting it integrated and ready to go.

We clearly have -- are in the process of kind of Waterizing the systems offering. Still for most of this year it operated more or less as a standalone operation. So, I think we fully expect benefits on a number of fronts to come in the coming year as we integrated more fully into the Waters organization.

Ok. And then on the H class, I think you mentioned it was going to be priced around 25% higher than HPLC. Can you just talk about any -- the pricing environment on HPLC. Was there any degradation given new products that have been launched by competitors and just maybe where that instrument is falling out and maybe just pricing generally in the quarter?

When Art was talking about pricing of the new product, I think he meant to say that the ACQUITY has about a 20% premium to HPLC and the new product only has about a quarter of that premium. So, it is 5%, 7% higher, something of that ilk is the HPLC. So there's a modest premium to go from HPLC to the new H class. And then there is another more significant premium to go from the H class all the way up to the research grade product that we're currently selling.

Ok. And then just generally pricing on like HPLC has that been pretty stable or has that been -- has it kind of come down a little bit?

Very stable.

Yes, is very stable.

Ok. And then last question for you, Doug, kind of bigger picture. One, just going to wrap these into one kind of question if you talk about the market. But if you think about you had -- there was pretty strong demand for a few years. You come off of this early significant recession. What is your comment, I guess, just around excess instrument capacity, kind of generally on the analytical instrument front? And then, two, what should we be expecting from new products from you guys in order to kind of maybe broadly talk about some of the new product classes throughout the year that we should be thinking about to kind of drive that replacement that you talked about that you think there is some pent-up demand and what's going to make people determine that they have to replace some of the instruments.

Well, Jon, I think importantly, on the market front, I think what I believe is it is becoming harder and harder in the separations industry, particularly liquid chromatography, for many secondary or tertiary suppliers to keep up. I mean, it is just very hard to imagine that in the long run they can invest the money to compete across this line on both the engineering required to provide UPLC, more and more the data requirements, particularly the important to integrate HPLC and UPLC data with mass spectrometry data. So, the competitive issues, I think, really make it tough. And I expect you're going to see that over the next couple of years. That's not to say all competitors can't do that. There are a few who clearly can. But I think it does mean that the strong gets stronger. So, I think that has a competitive impact in the industry. I don't think in terms of capacity it is -- the capacity in this industry isn't bricks and mortar. It is much more of a product cycle capacity than it is -- and I think we're at the front end of that -- at that cycle right now. So, I think we're in good shape. I forget the second part of your question, Jon.

You had mentioned that you thought there was pent-up demand, people were going to have to replace some of the instruments. Presumably when they do so, they kind of need a rationale for doing so. So I'm just kind of wondering, from a new product standpoint, what we should be thinking about from the year in terms of where and what types of new products to expect.

Yes. I think -- I think the rationale, if you think about big Pharma and you think about their need to do more for less, they're under a great deal of pressure on the labor front. The great advantage of UPLC is that in many of these high volume applications, you can replace two or three instruments, traditional instruments, with one of ours. And now we're going to give them the ability to kind of make that transition much easier by starting off on an HPLC and quickly using the same instrument to ramp up to UPLC capabilities. So, I think it fits -- it is a product that fits dramatically well with the needs of that customer base. Now, to be fair, ACQUITY did some of that, but it wasn't easy to make that transition in these regulated applications, particularly in QC. We think that's what each class does extraordinarily well and should motivate a more rapid transition in these high volume applications. I think the other thing that you're going to see this year, certainly from us, is a continuation of this continuous improvement in mass spectrometry.

The G2 is not the last innovative mass spec that you're going to see from us in the next 12 months. And the technological playing field probably moves more attractively for us as we get through 2010. We've got a number of industry participants who are going through their own structural reassessments or merger activity on their own. I think that all in makes us a more, makes the competitive environment tilt in our favor a little bit more in 2010.

Ok. Thanks a lot.

Thank you.

Operator, well, I see we've gone well beyond 9:30. So, we could take one more question if it is available, otherwise, I think.

I do have one more repeat question. Rob Hawkins with Stifel Nicolaus. Your line is open.

All right, Rob, you will be the last.

All right. I didn't know we had gone this far. On your last question, so, kind of building on what you said here, I think it is kind of interesting. So, would the mass spec platform that you built off of maybe into some of these other end markets, would that be more on the Xevo side or is it something that you might take kind of the prior G2 and create a more mainstream platform? What's your expectation?

I think you should expect that our high end orthogonal tof we're going to drive the G2 further and probably not see anything revolutionary on that front. But I think you should look more toward the quadruple space in 2010 to expect it will have some exciting things coming forth there.

Would it be a fair assumption that the announcements you made about Taiwan and our own FDA relative to some of the quadruple buying there that these things might -- we may see more of those down the road?

Well, we think -- I'm not quite sure what you're referring to in terms of Taiwan.

They did -- they bought both LC and quite a few of the Xevo systems.

Oh, yes, right. Our specific order -- .

For the food -- I guess, for food and more FDAs, more government entities like that, I was thinking.

Yes, we continue to think, particularly in the food safety in those applied markets, that they're robust, particularly robust outside of the US and we're hopeful that the conditions and the regulations build momentum inside the US. Of course, with all this spending freeze talk and whether they're going to pass new regulations on food safety in the US, that's not a big serve market today. We're hopeful that that becomes a bigger market going forward, but that remains to be seen.

All right. Thank you for taking the extra time.

You're welcome. And thank you all for staying with us over a long conference call and we'll look forward to talking to you again at the end of the first quarter.

That does conclude today's presentation. Thank you for joining and you may disconnect at this time.