Waters Corp (WAT) 2010 Q1 法說會逐字稿

Good morning. Welcome to the Waters Corporation first quarter 2010 financial results conference call. All participants will be in a listen only mode until the question and answer session of the conference. This conference is being recorded. 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.

Good morning and welcome to the Waters Corporation first quarter financial results conference call. With me on today's call are John Ornell, the Waters Chief Financial Officer; Art Caputo, the President of the Waters Division; and Gene Cassis, the Vice President of Investor Relations. As is our normal practice, I'll start with an overview of the quarter's highlights, then John will follow with details on our financial results, provide you with our outlook for the second quarter and for the full year, and then we will open it up for Q&A.

But before we get going, John will cover the cautionary language.

During the course of this conference call we will make various forward-looking statements regarding future events or future financial performance of the Company. In particular, we will provide guidance regarding possible future income statement results of the Company, this time for Q2 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, 2009 in part one under the caption Business Risk Factors.

We further caution you that the Company does not obligate or commit itself to providing 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 call and webcast. The next earnings release call and webcast is currently planned for July 2010. During this call we will refer to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most rectally comparable GAAP measure is attached to the Company's earnings release issued this morning. In our discussions of the results of operation we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled reconciliation of net income per diluted share, included in this morning's press release.

Thank you, John. Well, our results in the first quarter, I think, signify continued improvement in customer demand and also strong early acceptance of our key new products. Though we're not totally prepared to believe that the economic conditions that have challenged industries since late 2008 are fully behind us, we are increasingly optimistic about our business prospects for 2010 and are very excited about our strong new product positions. The difficult business conditions in 2009 required us to improve our operational efficiency, and with these efficiencies still in place, improving end markets in 2010 should allow us to transition toward our more traditional sales growth rates in 2011 and beyond.

Turning to the first quarter of 2010, our organic sales growth was 6% and we delivered 9% adjusted earnings per share growth. However, more important, we executed well on our new product initiatives, most notably our new Synapt G2 and our H-class ACQUITY UPLC systems. Demand for our Synapt G2 has been strong, and we successfully delivered and installed a record number of Synapt class mass spectrometers in the first quarter.

Sales of new Synapt instruments were strongest in North America, Europe and in Japan. Key application areas for Synapt continue to be in proteomics and metabolite identification. However, we have more recently begun to see uptake by customers in organic synthesis and central analytical labs and pharmaceutical, academic and industrial accounts.

Our decision to introduce the H class ACQUITY UPLC early in 2010 helped to drive order growth in LC instrumentation in the quarter. Our H-class UPLC system was designed based on consistent customer feedback regarding key performance features required to accelerate UPLC uptake in regulated testing applications.

As you may recall, we introduced this new instrument configuration in late January and began customer shipments in early February. Though significant new launches often result in the delay of orders as customers reevaluate and modify their purchasing plans to adequately consider a new system offering, our positioning of the H-Class appears to have resulted in little disruption of our sales momentum while setting the stage for an acceleration of ACQUITY business as we move through 2010.

Some our largest ACQUITY users, companies that have globally deployed UPLC instruments through their development organizations, have told us that they are now more confident of transferring UPLC technology throughout their quality control laboratories. For many, this new outlook is based upon new H-Class instrument features that allow for the running of legacy HPLC methodologies while providing an easy upgrade path to UPLC performance. With the introduction of the H-Class, overall interest in UPLC has significantly increased. We see this in seminar attendance and requests for customer demonstrations and in our lead and quotation volumes.

Most interesting, we have started to see new orders and sales from competitive users who have been motivated to try small particle chromatography but had not been sufficiently confident to move forward until they learned about our new H-Class UPLC.

Within our Waters Division, recurring revenue sales, that is, the combination of our service and chromotography chemicals business, performed about as expected and grew in the mid-single digit range. We expect this trend to continue through 2010 with the chemicals business growing a bit faster than the service business.

Sales of our TA Instruments division grew a little faster than those of the Waters Division with strong performance across TA's lines of thermal analysis, rheometry and [biotelemetry] systems. Given TA's heavy exposure to the economically sensitive chemical industry, its sales growth and even stronger double-digit orders growth are indicative of a recovery in our industrial end markets and of TA's continued strong product positions.

Business activity for TA as indicated by sales leads and quotes for new instruments appears to be continually improving, and sales growth for the division is likely to accelerate in future quarters. Sales to industrial accounts for the Waters Division were also positive in the first quarter. We have historically included sales to the chemical, food and environmental testing industries within our broadly defined industrial segments. Within these subsegments chemical and environmental sales were strong in the quarter while food testing growth was affected negatively by strong Asian melamine testing business in the base quarter's comparison.

Pharmaceutical segment sales in the first quarter grew at about the same rate as our overall sales growth. You look across the segment and we benefited from a recovery of sales to generic firms in India and strength globally from generic, CRO and specialty pharmaceutical accounts. As we had expected, merger activity among certain of our larger pharmaceutical customers affected their purchases from us in the quarter. However, we are encouraged that recent feedback from some of our largest accounts indicated that an instrument replacement cycle, especially in light of their excitement from our ACQUITY H-Class UPLC launch, may be on the horizon.

If you look at our business geographically, sales in the quarter were strongest in Asia with India and Japan driving the lion's share of the improvement. As you will recall, last year we endured a very difficult first-half performance in India as the severe devaluation of the rupee helped depress demand for dollar-denominated laboratory instruments. In Japan strong sales to academic institutions, primarily for research Mass Spectrometry Systems, resulted in solid double-digit revenue growth.

Our sales growth in China was consistent with our overall mid-single digit sales performance and was, as I mentioned earlier, affected by strong melamine sales in the 2009 quarter's results. Factoring the melamine business out of the quarter's results, sales would have been up a strong double-digit rate, and that's an encouraging factor to consider as melamine-related comparisons should not be a factor in future quarters.

Looking ahead towards the second quarter and full year, 2010 will be an exciting year for new product launches. I've already reviewed the ACQUITY H-Class introduction and am pleased to now tell you that significant new mass spectrometry-based systems are planned for the upcoming AS/MS conference in Salt Lake City. We expect that this year's AS/MS will be just as exciting as last year's, when we showcased the Synapt G2 HDMS system.

With the improving demand pattern that's emerging this year and our commitment to overall cost containment, we are expecting another year of strong free cash flow. As we have for the past several years, we will continue to deploy our cash towards smaller acquisitions and our share repurchase program. We are off to a strong start in 2010 with $100 million deployed for stock repurchases in the first quarter.

So in closing I would like to say that we are encouraged by the trends that we see developing in 2010. Furthermore, we are confident that with our strong product portfolio and broad access to growth markets, we are very well positioned to benefit from a continued global economic recovery and for an ongoing opportunity to deliver industry-leading top-line and bottom-line performance.

Now here's John to take you through a more detailed financial analysis.

Thank you, Doug, and good morning. First-quarter sales increased by 10% and non-GAAP earnings per diluted share were $0.81 this quarter compared to earnings of $0.74 last year. On a GAAP basis our earnings were $0.79 this quarter compared to $0.75 last year. A reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning.

Reviewing Q1 sales results compared to Q1 last year, sales were up 10% this quarter with currency translation representing 4% of this increase. Looking at our sales growth geographically and before foreign exchange effects, sales within the US and Europe were up 2%, sales within Japan were up 22% and sales in Asia outside of Japan were up 12%.

Turning to the product front, within the Waters Division instrument system sales increased by 7% and recurring revenues grew by 6% this quarter. Within our TA Instruments division, sales increased by 8% versus prior year.

Now I would like to comment on our Q1 non-GAAP reported financial performance versus prior year. Gross margin performance was stronger than originally anticipated this quarter and came in at 60.3%. The Company continues to benefit from manufacturing cost reductions and more significant foreign currency translation benefits than expected. The combination of the relative strength of the yen and weakness of the British pound versus the US dollar had a beneficial impact on our gross margin percentage based on our geographical sales and production mix. We experienced a similar and even more pronounced currency impact in Q1 of 2009, and this accounts for the year-over-year decline in gross margin percentage.

Going forward, the 2009 base of comparison becomes more favorable and we expect to see year-over-year growth in gross margin percentage in future quarters. SG&A expenses increased 8% this quarter compared to prior year and R&D increased by 10% this quarter as we prepare for new product releases later this year.

Income taxes came in on plan at about 18.5%. We are on track for the transfer of additional LC production to Singapore later this year, which helps to lower our tax rate, but the success of our Synapt systems, manufactured in the UK, puts upward pressure on our effective tax rate. Our present view has not changed from January, and we expect these effects to principally offset each other and that our full-year effective tax rate will remain around 18.5%. However, that is dependent upon many new product introductions and manufacturing transfers that could bring some variation into the picture as the year unfolds.

On the balance sheet, cash and short-term investments totaled $692 million and debt totaled $712 million, bringing us to a net debt position of about $20 million. Earlier in the quarter, we took advantage of improving capital markets and diversified our debt structure by entering into an agreement to issue $200 million of notes in a private placement to qualified investors. $100 million of the notes bear a 3.75% coupon for a five-year term and another $100 million of notes bear a 5% coupon for a 10-year term.

On the stock buyback front we continue to purchase our shares in the open market, and during the first quarter we purchased 1.7 million shares of our common stock for $101 million. We define free cash flow as cash from operations less capital expenditures plus any non-cash tax benefit from stock-based compensation accounting and excluding the mutual nonrecurring items. For Q1 free cash flow was $95 million after funding $11 million of CapEx and adding back $2 million of non-cash tax benefits from stock-based compensation. This strong start to the year allowed us to accelerate our buyback program and puts us on a path to approach $400 million of free cash flow this year. Comparable free cash flow in Q1 last year was $64 million.

Accounts receivable days sales outstanding stood at 78 days this quarter, comparable to Q1 last year and inventories were up about $10 million from year end, as is typical at this point in the year.

Overall, our Q1 results were somewhat stronger than anticipated in January. Many of our end markets improved as the quarter progressed, and they appear to be on a path to continue to do so. We presently expect our currency neutral sales to grow between 5% and 7% for the full year 2010. Currency translation based on current rates looks to be about neutral to sales growth for the full year.

Moving down the P&L, gross margins continue to be favorably affected by product cost reductions and foreign currency translation, given the relative weakness of the pound and strength of the yen. Additionally, product mix is favorable to margins and our new products are performing well early in their production ramp up. Given these factors, we now expect full-year gross margins to be up by about 75 basis points versus 2009.

Operating expenses are expected to grow at a rate almost equal to sales. We expect our operating tax rate to be about 18.5% and net interest expense is expected to be approximately $13.5 million.

Our fully diluted average outstanding share count for the full year 2010 is currently estimated to be about 93.5 million shares. Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $3.85 to $4 per share. For Q2 we expect our currency-neutral sales to grow around 7%. At current exchange rates, currency translation should increase sales by about 1%, bringing our reported sales growth to 8%. At this sales level non-GAAP earnings per fully diluted share for the second quarter are expected to be between $0.86 and $0.90. Doug?

Thank you, John. Operator, I think at this point we can open up the phone for Q&A.

(Operator instructions) Ross Muken, Deutsche Bank.

The introduction of the H-Class seems to be off to a pretty strong start. Relative to your initial expectations, if you had to parse out what positively surprised you with customer feedback versus where you had to reposition or maybe augment the marketing angle, what has been your take on how that has gone so far, and what customer bases are showing the greatest interest in terms of the initial orders?

I think it's important that this introduction of the H-Class was a little bit different than major platform introductions that we've had in the past. Art refers to it as a -- what is it, Art? -- a zero-lag launch where, when we announced the product we started shipping essentially immediately. We had trained the sales force, we had the marketing literature already. It was introduced -- typically, you introduce these platforms rushing to get to Pittcon and then you are shipping by the end of the subsequent quarter.

This was -- and part of it is just the way our business has evolved. So we were very happy, first of all, with our ability to drive the development and the manufacturing to the point where we are able to do that.

Then I would say the most interesting dynamic, I think, has been with competitive accounts. We knew we had some early indication in some of our classic Waters accounts about the reaction to it. We are clearly aiming this technology at trying to bring a faster uptake curve into the QA regulated applications part of our business, and taking this instrument into competitive accounts has been very, very positive.

So I think that's probably the early indication. The other thing, I think, as we commented on, oftentimes you introduce a new platform like this and the immediate response you see is delay because customers are used to buying your old products and they put things on hold to evaluate. And sometimes they run new systems through months of evaluation studies. I'm sure we saw some of that, but overall the net effect was really a positive effect rather than a delayed effect.

Art, do you want to add anything to that?

Yes. I'd say the thing about the H-Class was -- and keep in mind that we introduced UPLC now going about six years ago, and something very unique in our business is we were left alone for all intents and purposes for about five years before any significant competition decided to try and participate. But throughout that period and after several thousands of systems being installed and evaluated, we had the luxury of working with these customers and very precisely understanding what does it take now to move this technology downstream. and for all intents and purposes replace the traditional HPLC marketplace while, at the same time, taking into consideration a large installed base of HPLC's that have been in play for 30 years.

And so we really took our time. We focused on the customer need. We delivered a product that probably has hit the mark so precisely in terms of what the customers were asking for and now seeing it, it's hard to argue with something that you said, if you do this, [we'll] buy it. And so we are experiencing this, and the beauty of it is the demonstration units are in place, there's no delay on delivery, it utilizes the same broad systems chemistry solution we've had out for six years. So it's really the experience that we have that's paying off for us on this strategy.

Does that cover everything, Ross?

That's good. And just so I understand, so if you had to look at the industrial and the biopharma end markets, where you both had pretty strong growth, if you had to parse out market recovery versus new product momentum in terms of contributing to the strong growth, how would you weight the two, just to get a sense of how much of it is actually customers coming back and how much of it is actually Waters maybe taking a bit of share with some of the new product momentum that you have?

I think probably in the industrial arena, particularly for Waters, that's probably more market related. It would surprise me if you didn't see others servicing the industrial market to see some good results, because I think it was so tough that they are bouncing off more modest comparisons. We clearly had some good uptake in response to our new products, but more in the industrial arena, I'd say, is probably a market dynamic. In the biopharm, boy, I think our new products are really striking a chord, not only the ones that we've already let you peek at, but early advice on some of the new stuff that's coming. It's very enthusiastic, I think, in that biopharm segment.

Marshall Urist, Morgan Stanley.

A question on guidance -- you upped your organic revenue view for the year. So maybe you could just talk through what are the things that are specific things that are better than when you guys first looked at the year, maybe if anything is worse, then how you got to that view for the full year.

Sure, I'll give the 30,000-foot view, and then John can bring me back to Earth. Clearly, the industrial market recovery is better than we had banked on in our budget. Now, we thought we were being perhaps a tad on the conservative side because we didn't want to overstate our spending budgets coming into the year. But industrial -- we see that very clearly in the TA piece of our business. We also see it in the Waters piece.

So I think that. I think the strength of the recovery in the India generic pharmaceuticals is pretty clear. That's a not insignificant piece of our business. The reaction to the H-Class and the seamlessness with which it's coming to market and the continued interest in the high-end mass spectrometry product lines are all encouraging.

I think the things that keep us from being maybe slightly more optimistic at this point is waiting to be sure that, overall, the developed markets in the United States and in Western Europe can show sustainable strength. Pockets there -- as I said, the industrial markets there. But big pharma is still going through some of their merger pains. We see a lot of encouragement from that segment of the business, but we probably don't want to take it to the bank quite yet. John?

I think the only other thing I'd say is that we had a relatively strong Q1 with Japan. We're not expecting Japan to grow full year at those rates, certainly. But on the other side of that, within China, we had a very difficult base of comparison with large amounts of melamine business that drops off in the rest of the year. So that's a natural offset so that Asia, in full, I think, has balance going forward relative to what you saw in the first quarter.

Okay, great, thanks; and then, just another one on gross margins for the year. Is the change mostly due to currency? Or maybe just walk us through the moving parts of that as we go through the year in terms of some of the manufacturing transitions, how that's going to impact gross margin, and anything else we should be thinking about on that line.

The currency dynamics that we saw in the first quarter principally continue. However, the base of comparison becomes less difficult, if you will, as you look at the going-forward quarters of last year. So a piece of the improvement in gross margin, a significant piece, is currency. But, that being said, I would also say that right out of the gate we have some very good product costs on the new H-Class that are contributing even in the first quarter to improved margins. We've had a relatively strong chemistry business, so that has provided a little bit of upside on mix as well. We expect that to continue. And our thermal analysis business has done very well at some of these industrial accounts, and within the TA product line that tends to be the line that has the higher mix. So all of these factors, we think, will continue and contribute to the pickup in gross margin for the year.

Okay, and then anything on the manufacturing piece that's going to be especially impactful in the back half?

I'd say that that's pretty much on plan. We still have the H-Class transfer in the works. We're looking to see the benefits of that as we move through the second half of the year. I'd say there's probably nothing different from where we started the year in January from a guidance perspective.

On the Americas and Europe, maybe you could just give us -- because growth was obviously a little bit slower there. So maybe you could just give us a sense of the different markets there. You talked about pharma, but beyond that, what's driving that? You talked about 2%. What are you seeing specifically out of those geographies?

I'd say, if we look at the developed world, Europe and the US specifically here, large pharma was really the problem as it relates to -- the decline that we saw in that business was a little more than we might have anticipated. Offsetting that was some pretty interesting strength in the pharma business out of large pharma.

Government/academic in total was good in that part of the world, and we saw the industrial business begin to come back in those regions. So I would say, really, the only serious pocket of concern is large pharma. A lot of that, I'm certain, is merger related. I think we're going to see that dissipate as we make our way through the year. Some of those accounts were up, but many weren't. I think there was maybe a little bit of a lag in the CapEx release, perhaps, at some of those accounts. And it's not impossible to think that the H-Class launch, while it was very successful right out of the gate, there's some accounts where they're going to do a little bit more work on that before it gets implemented. And I think that's a potential upside at some of these large pharma houses, too, as we go forward.

Doug Schenkel, Cowen & Company.

First question, how was the pacing of the quarter? It sounds like you still have pretty good G2 backlog and it sounds like TA orders were maybe decently stronger than the actual sales numbers. So I'm just wondering if momentum actually built as the quarter progressed and as we turned the page into Q2.

I wouldn't say it was a homogenous dynamic, as it rarely is. I would say, overall, yes; the last part of the quarter was stronger than the first part. That's always the case with January being a tough start to a year.

But some geographies finished stronger than others. Overall, I would say our more interesting dynamic is the early indicators, both requests for demonstrations, requests for quotes, quote activity. Some of the softer, more intangibles that I think are much stronger than we anticipated would be at this stage of the game. So that's the kind of momentum that I think -- it doesn't result in sales the first quarter, but we are optimistic it could mean for stronger sales as we go forward.

We also, in the first quarter -- this quarter ended with the Easter season. You had Good Friday. That always throws a little confusion, particularly into areas like Western Europe and the more traditional religious areas. We didn't have that last year. It's always a guess as to how much that affects your order activity. We had some strong orders coming in the next week, so again, intangible feelings that it's all pretty good going forward.

Okay, that's helpful. You beat the midpoint of your guidance by $0.04. You bumped up full-year EPS guidance by I think it's $0.15 at the midpoint. You did bump up your revenue outlook, but I think just a little bit; I think you guided to mid-single digit growth, maybe, or a little bit higher than that. But it doesn't sound like it changed a lot, and it sounds like you still expect this to be a year where you spend a little bit more operationally than the norm.

So what's changed here? Is it really the revenue number? Is it gross margin, or should we be a little bit more positive when it comes to modeling out nonoperational items?

I guess what's changed is we certainly have taken a slightly different view on gross margins. We've had some good experience right out of the gate on some of the new products in addition to some of the currency benefits that we've seen. Yes, we are continuing to make investments, small investments in headcount where we need to. We'll continue to do that so that you are not going to see a significant gap in the growth of our expenses versus the top line. But that's no different than what we said in January. Currency for the full year is a little bit less of a top-line benefit, but offsetting that and more is the fact that we did move the organic growth from what we defined as mid-single digit, or 4 to 6, to 5 to 7.

So it's little bits here and there that basically say that the incremental profitability that we saw out of the business in the first quarter principally continues for the next three, and that comes pretty close to the full-year increase that you've seen in guidance for the EPS.

Last question -- it sounds like you guys are spending a little bit more on SG&A than you normally would. I think that's associated with just the spending ramp as you build towards some of these new launches. Any way to quantify that just so we can think about leverage potential moving forward?

I guess one of the things when you look at the first quarter is you have to recognize that currency on SG&A was about 4%. So the 8% growth in SG&A was really only about 4%, ex-currency. Normally, when we look at this business we typically say that when you have sales growing in the 7%, 8%, 9% range on an average year, you're able to grow your SG&A a couple of points less than the sales line. And I would say that that model is likely to be what we'll continue to say going forward beyond this year because of, as you pointed out, because of the investments that we need to make this year. And this year being a year of recovery on the spend line, there's not likely to be quite as much leverage. I don't think the expenses will grow exactly the same rate as sales, but there's not likely to be the full 1 or 2 points of differential. But for 2011 and going forward, I would submit that we're back to that traditional model.

(Operator instructions) Peter Lawson, Thomas Weisel Partners.

I wonder if you could talk to the impact from NIH stimulus, if you saw that this quarter.

Frankly, Peter, no, we didn't see much stimulus. We keep hearing it, we keep tracking the quote activity. But the actual spending was really not material, not in the US. Now, we are seeing very active academic/government activity in China and in Japan, but it's a little bit harder to tie that directly to incremental stimulus money. But frankly, in the US, we still have not seen a significant amount.

And the growth you saw in Japan -- so a bit from academia, a bit from mass spec -- what else was there?

That's the most notable in terms of a changed dynamic. I would say the base level of pharmaceutical and industrial business was pretty consistent with what we saw in the latter half of 2009. And Japan has been pretty consistent. Japan didn't have a big falloff in demand with the '08 industrial slowdown.

So I'd say we've seen pretty consistent business in the Japanese pharm, biopharm, industrial activity, and we saw an uptick in academic. That's why John says we don't think we're going to see a continued pace that we saw in the academic business going through the year. And we temper our forecast to not anticipate quite so much strength there.

Quintin Lai, Robert W. Baird.

Congratulations on an excellent end to the year. Just going back to the H-Class and the launch you had, the early adopters that have brought it -- are they running primarily just HPLC applications, or are you seeing some of the -- are they starting to work in UPLC columns as well?

Art, do you want to answer Quentin?

Yes. If you think about UPLC in general, I'd say right now 90% plus of the people who are buying a UPLC-based product, whether it's the H-Class or the original ACQUITY UPLC system, they buy it with, usually, the intention of incorporating the UPLC capabilities. They believe that that's how they will justify the performance of the equipment and that's how they will ultimately use it. The H-Class, for the most part, is in account the ability to have more flexibility. So if they buy an application where they are utilizing UPLC but at the same time couldn't justify the purchase because they still have three or four legacy methods that are HPLC, the interest in the H-Class is that I can, if I need to, also run an HPLC separation on it.

So, while some people are buying it to future-proof for potential UPLC applications, and we think this will be the case moving forward, for the most part now people are still focused on purchasing any of our UPLC products with the prospect of taking advantage of the superior performance capability.

Jon Groberg, Macquarie Capital.

Can you just maybe talk about your view of the impact of health care reform and maybe how it flows through to clients and put that in conjunction with I guess, trying to think specifically of your pharma, your biopharma clients? And I also heard you mentioned that you are getting some indication that maybe your replacement cycle could be on the way. And maybe I'm just trying to understand a little bit better your view, I guess, of how some of this shakes out, kind of flows down to where you guys are at.

I think it's an excellent question as to where health care under this model winds up. I think the direct impact is clearly mostly, I think, on the medical device manufacturers who are hit with incremental costs directly in the plan. For pharma I think most of the effects are indirect, the same way there are on all of us. You've seen some companies who have plans, have to record one-time charges as a result of that. I don't know that I've seen too many big pharmas do that, but you certainly seen some industrial accounts do that.

(Multiple speakers).

I think I'm speaking specifically around they've had these big Medicaid rebates so the revenues are going to be lower, I'm assuming maybe they would have to spend less on some of the other -- on R&D, perhaps, as a percentage of their sales. And maybe, if volumes don't really pick up as they expect going forward -- I guess I'm just trying to -- I don't know if (multiple speakers) --

There are many, many parts of this bill, and of course I don't think we are seeing the manifestations of all of them yet. I don't think we've seen the Medicare dynamic -- it hasn't currently popped up as a particular issue. Maybe we're seeing it in the optimism in the generics, who clearly by default get a favored position in this bill. We're certainly seeing great activity amongst our generic accounts.

We haven't seen a direct result of Medicaid/Medicare concern. It's certainly reasonable to think it has to be factored into their business plans. I think, the way we interpret our results so far, it has become very traditional in our big pharma accounts to see slow starts to the year, and this was no different. We're still seeing an enormous amount of interest in our new products in those accounts. We are already, I think, as we start the second quarter seeing some order flow that we didn't see in the first quarter. So I think, right now, they are probably on the business plan that they started the year with, and they are going to struggle to see how they deal with the health care issues as they go forward.

And specifically on the replacement cycle comment, are there maybe some more details, some backdrop to that, that you said you got a little bit more comfort that there could be a replacement cycle coming up?

I think there's two things in play. There's clearly -- they have [longed out] replacement cycles over the last two or three years. We've had major departments managers complain to us that they've had to make use of their equipment much longer than they ever anticipated, and we still firmly believe that that's going to ultimately result in some pent-up replacement demand coming through the system.

But I would say even higher in the dynamics is emphasis on cost control and productivity. And I think we've been talking about that for a long time now. It's really making itself felt in the innards of pharmaceutical, and they are really looking at the productivity that H-Class and ACQUITY can give them because it really means doing a lot of their jobs with a lot fewer people. If they can replace multiple traditional HPLCs with fewer H-Class or fewer ACQUITYs, it can dramatically change their productivity. So that, I think, has really ticked up in terms of the level of interest, and specifically in big pharma.

Great, and I think you mentioned stimulus was not a big contributor. Specifically, you guys were giving some targets for Synapt G2. Did you hit those targets in the quarter, even without stimulus?

Yes. G2, we were very satisfied with our G2 Synapt results. We're hopeful that stimulus money can still add to that result, but frankly in the US we are still waiting.

I guess the layers of questions here are trying to understand, going back to, you've only finished one quarter -- obviously, you don't have a lot of visibility in your business historically. You're now guiding to much better, getting closer to historical growth rates. So just trying to find those pressure points or maybe if things don't go -- I know you mentioned some of the things that could go better. But maybe some of the things that might not go according to plan. Anything else we should be thinking about in terms of that potential negative throughout the rest of the year?

No. I think we've covered most of them, and I want to be conscious of the number of people in the queue. So maybe we can move on to the next question.

Tycho Peterson, JP Morgan.

I know you talked a little bit about early interest in H-Class from some of your ACQUITY customers. Can you comment specifically on how much of the interest is coming from ACQUITY users versus some of the lower volume Alliance users at this point?

Okay, a little bit. Art, do you want to give a flavor of that?

Yes. If you think about ACQUITY, you think of that in the context of accounts. If you look at the number of ACQUITYs sold over the last five years or so, we have had very broad-based penetration. It is almost impossible to find a large account that doesn't have multiple traditional ACQUITY UPLC systems. So what you are dealing with is the ACQUITY has been purchased by early adopters, development people and some method development and even QC departments.

So what we are really looking at is it's -- while we are selling H-Classes to people who have had very little exposure to UPLC at all, it's probably less than a quarter of the sales. The bulk of the sales are really the early adopters testing it, verifying it, setting up an understanding of the technology, coming to us and saying here are the areas within our corporation that we want to utilize this technology. But here the attributes, I think, are different for them than for us. The system we purchased traditionally was designed for us early adopters to get a very broad versatility, full capability research type view of the product. Here's what's required of people and method development, quality control, more routine applications. The more typical HPLC user would look to attributes that emulate more of our Alliance product than the full research grade.

So I'd say that the bulk of our focus of interest is to progress the technology downstream in the already dominant position we have across large and, for that matter, even intermediate companies throughout the technology laboratory world out there.

Can you comment on how you look at the pull-through opportunity for mass spectrometers with H-Class?

Right now, while there is some, the predominance of mass spectrometry sale is so oriented towards our traditional UPLC system. The primary reasons for that is the technical attributes of the product lend itself very well to extremely high speeds that mass spectrometry operates within -- extremely fast changeover volumes. And, while H-Class will work nicely with a mass spectrometer for many applications, most mass spectrometers are really looking at the attributes of the full research-grade, super high-performance UPLC system that has great levels of versatility.

So we think that will shift over time as you may go downstream and mass spectrometry gets more prolific in the more routine applications. But for the time being, we are finding that nanoACQUITY and traditional ACQUITY -- the bulk of those sales are clearly with the original ACQUITY system.

That's helpful; maybe one for Doug. I know you don't like to talk about product cycles ahead of time, but you did lay the bait for ASMS, and I think the quote was "significant product cycles". Is there any kind of color you can give us in terms of whether this is a high-end system targeting the academic markets or something more for pharma? Or, can you just point us directionally in terms of where you're going?

I think the best I can do for you, Tycho, is to say look broadly. I think you'll be seeing -- very interested in things that augment the high end G2 Synapt kind of thing. You'll be looking at multipurpose capabilities, and I think you will also see us work (inaudible) closer to the mid line and on the bench top.

So it's still a little bit early. We are several weeks away from ASMS, but I think it's, watch this space for further notice.

Can you just quantify how much the margin this quarter was currency versus cost reductions? I know you talked a little bit about how you're thinking over for the rest of the year.

On a year-over-year basis there was about a 200 basis points decline associated with currency, and then there was about a 60 basis point improvement associated with the cost reductions and mix that offset that.

[Jeff Ares], Leerink Swann & Company.

I know you gave a little bit of color on India being a little better in the generic pharma, and as well as last year I remember it was pretty weak in Q1 and through the first half of the year. How much of the improvement in India was more of a function of year-over-year comps and the rupee doing a little better versus actual demand?

Well, it's certainly better demand compared to last year. I think India at this point is about flat in the first quarter of 2010 with 2008, which gives you an idea. It's not huge growth over 2008, substantial growth over 2009. But, I think, a very clear indication that things are on the mend there and that generic industry is coming back to at least equilibrium, if not prepared to grow strong.

You know, they went a year, essentially, without preparing the growth for all these drugs that are coming off patent. So we are optimistic that there's stronger growth ahead.

So looking at this 5% to 7% organic growth guidance, how much improvement in India do you have baked in there outside of just easier comps?

We don't go into that much -- I'd be willing to say that we anticipate that the India business is on the trajectory that it's on now, for the rest of this year.

Switching gears a little bit, you made some comments about stimulus. Now you are taking a more conservative approach. Are you still looking for $20 million to $30 million, I think was the number you gave for this year, or has that changed?

We are more cautious about our outlook for stimulus business this year, in this outlook. We're probably looking at more like half of that level than that level.

But it would appear that the demand for the high-end instrumentation, whether it comes through government support and stimulus dollars or not, we are pretty confident that high-end mass spec is going to do well.

I'm being more conscious about the length of the queue. I like to try to get as many questions as we can. So if we could move ahead, we're getting near the end point of the session. So could we have the next question?

(Operator instructions) Rob Hawkins, Stifel Nicolaus.

I'll keep it to one question, but probably the one you don't like to answer. It's capital allocation. You picked up your purchasing, your share purchases in the quarter, and you are on track for $400 million in free cash flow. You've got an optimistic outlook. I know you guys are being cautious. Now what do you think about where you spend the cash?

It's kind of what we said. We'd like to continue to focus our acquisition policy on these smaller tuck-in acquisitions and we'll to use excess cash to continue a stock repurchase program. I don't think it's any more complicated than that.

Maybe just one [added set]. You said you're making some investments in people in some of these things. I know it's not typically the way you think about capital allocation, but any specifics there?

All the investments we're making are within the cash flow expectations and the operating budgets that John described.

Maybe we call them investments only from the perspective of last year we had a very belt-tightened situation where people who had left weren't replaced, and so we're coming off of a base that's a little bit depressed so that we are beginning to add some of those headcounts back. Both those are -- as Doug said, those are in the operational expectations of the business and the free cash flow estimate.

And I think that's important, just to interject here. Last year, even in very difficult top-line conditions, we grew our earnings per share. And we did that by being ultra-cautious on our spending controls. Bonuses were not present last year. Pay increases were few and far between. Travel money -- and we [controlled] hard on that, and we knew as things came back we were going to have to replace a lot of that. And we've got a structural comparison there, the same way we've got an easier comparison on the top line, which has clearly got a more difficult comparison as you have to provide for sales commissions, for bonus payments and for things like that. That's life, that's business. But it's a reality of life. John emphasizes that it's highly unlikely that we're going to be able to see that same ability to leverage our operating expense spending this year. I think we can come back to it in a more normal year, but this year that's going to be tough.

Stephen Unger, Lazard Capital Markets.

John, what was the asset impairment in the quarter? And this is the second straight quarter now of some restructuring charges -- is that now complete?

There's probably a little bit of a trickle into the second quarter of some of this restructuring that has to do with how we have to account for some of the restructuring that's taking place within Europe. But I think in Q2 you will see the end of that. And the asset impairment is related to the consolidation of facilities, a project that's beginning in the UK, where we went through a fixed asset inventory and found some assets that were no longer of value. So that should be a one-time event, principally. You may see other tiny bits going forward, but it's a rather modest amount and related to the consolidation of facilities in the UK.

Derik De Bruin, UBS.

John, just to make sure I heard right -- so, you're looking for a 75-basis-point increase in the gross margin year-over-year for this year?

That's right.

So I guess when we think about how much more juice there is (technical difficulty) I'm trying to figure out how much of that 75 is FX-based. And I guess when you look at this on a currency-neutral basis and you start thinking about where the gross margin can go in 2011 and such, how much more room is there for expansion in that?

I guess I'd go back to the traditional budget model that we have, where if you hold currency constant -- it's kind of tough to predict where that's going -- generally, we are able to provide maybe 10 or 20 basis points of gross margin improvement out of the business, just based on the incremental volume of instrumentation that we ship, more than getting it through price. I don't think that that model has changed going forward.

I would also point out to you that some of the product transfers that are currently in place are only going to have a partial-year benefit this year. So I would say that we could be a little optimistic that we are not at the end of the road in gross margin improvement and you are likely to see a continuation of that as we talk about next year, later this year.

I seem to be underestimating the gross margin. I think last year it was a 150-basis-point swing coming out of Q1 from where you originally gave guidance, and other times a little bit more than that. So I'm just wondering if it's -- I seem to be underestimating or overestimating currency impact on this. So I'm just trying to get the growth there. So that's good. I'll just leave it with that; I'll catch you guys off-line.

Jon Wood, Jefferies.

John, can you just quantify what the broadly defined pharma account based in terms of organic revenues in the quarter, and then major pharma within that, and then just provide your expectations for that account base for 2010?

I'd say it grew about what the corporate average is, somewhere around 6%. Large pharma was -- the top 15 accounts, the way we define them, were actually down in the quarter, and the remainder of the accounts, all of the biotechs and the generics, CROs -- they were up high-single digits. So the large pharma was a significant anchor to the results in the first quarter, and we're, at this stage, convinced that we're going to see better performance out of those accounts as we make our way through the year.

Operator, I think we can close the call now.

Thank you. Thank you for your participation. Today's call has concluded. Please disconnect at this time.

Thank you all, and we'll see you next quarter.