Waters Corp (WAT) 2011 Q1 法說會逐字稿

Good morning. Welcome to the Waters Corporation first quarter 2011 financial results conference call. All participants will be able to listen-only until the question and answer session of the conference. This conference is being recorded. If 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. Good morning and welcome to the Waters Corporation first quarter financial results conference call. With me on today's call is John Ornell, Waters Chief Financial Officer; Art Caputo, the President of the Waters Division; and Gene Cassis, the Vice President of Investor Relations. As is our normal practice, I will start with an overview of the quarter's highlights, then John will follow with details on our financial results and provide you with our outlook for the second quarter and for the full year. But before we get going, I would like John to cover the cautionary language.

During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the Company. In particular, we will provide guidance regarding possible future income statement results of the Company, this time for Q2 and full year 2011. We caution you that all such statements are only predictions and that actual events or results may differ materially. For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our 10-K annual report for the fiscal year ended December 31, 2010, entitled under the caption business risk factors. We further caution you that the Company does not obligate or commit itself by providing this guidance to update predictions.

We do not plan to update predictions regarding possible future income statement results, except during our regularly scheduled earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for July 2011. During this call we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measure is attached to our Company's earnings release issued this morning. In our discussion of the results of operation, we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled Reconciliation of Net Income Per Diluted Share included in this morning's press release.

Thank you, John. Well, we're very pleased with our first quarter results and encouraged by the broad strength that we saw across our product line, geographies and markets. The trend of improving end markets and strong acceptance of our new systems that we have now seen over multiple quarters is very encouraging. During this quarter, our organic sales growth was 14% and we delivered 28% adjusted earnings per share growth, due primarily to strong shipment volume and effective expense leverage. Instrument sales, that is the hardware sales, grew organically at more than 20% led by continued rapid uptake of our ACQUITY H-Class UPLC and Xevo UPLC - MS systems. As you may recall, we began shipping our H-Class UPLC system in the first quarter of 2010 and during the past year H-Class has been a remarkable success for us, as we have seen consistent and growing demand for this innovative system across our customer segments and especially among our pharmaceutical users, as they have upgraded their laboratories.

Looking at our business geographically, I would like to start off by speaking about our situation in Japan. Most important, we are grateful that our employees are safe and that we're not aware of casualties among our many loyal customers. The resiliency of our staff and their dedication to ensuring the continued operation of instrumentation in our customers' labs has been very impressive. For weeks they have endured disruptions in electrical power and in the public transportation system, while working long hours under extremely stressful conditions. We're thankful for these extraordinary efforts and certainly continue to keep all of the people in Japan in our thoughts and prayers through these trying times. During the first quarter our sales in Japan were roughly flat against a very difficult base of comparison. You may recall we benefited from significant government stimulus demand in Japan during the first quarter of 2010.

In fact, for the quarter, our sales volume was in line with the expected demand included in that January guidance. Looking forward, we remain concerned about the situation in Japan, but are hopeful that the most difficult conditions impacting our business may be behind us. Adjusting for currency, Japan has represented about 10% of our sales and at this time we have only marginally reduced our revenue outlook for the full year. However, a further deterioration of infrastructure in the country is a potential risk to our business that we will continue to monitor as the year goes by. Our business in Asia, outside of Japan, performed very well in the quarter, especially in China and India. Our business in India benefited -- excuse me -- our business in China benefited from significant governmental investment in instrumentation, accompanied by strong broad underlying business growth.

In India, sales of instruments for QT testing to support generic drug manufacturing were augmented by a nice pickup in demand for mass spectrometry -- mass spectrometry based systems for a variety of research and testing applications. Coming into this year we had been somewhat concerned about demand in Europe for new instrument systems, as general economic conditions there appear to be somewhat fragile. Having those expectations, we were pleased with our sales growth in the first quarter. In Western Europe pharmaceutical and applied chemical analysis sales, largely driven by our new mass spectrometry systems, were particularly strong. University and governmental spending, a concern for us given publicized austerity measures, showed reasonable growth in the quarter. In addition, our eastern European markets delivered another strong quarterly performance, with nice double-digit year-over-year sales growth.

Finally, looking at sales in the Americas, developing markets in South America continued to deliver strong double-digit growth, while in the US pharmaceutical and applied chemical analysis sales more than offset expected weaker combined government and university shipments. Continuing to review the Waters Division business, as many of you know, the broadly defined pharmaceutical market has historically accounted for more than half of Waters sales and accordingly, it's been a significant factor in our success and a consistent focus of our product development and marketing efforts. Over the last few quarters I have spoken to you about early trends signaling a recovery in pharmaceutical spending for liquid chromatography and mass spectrometry technologies. In addition, we have over the past year introduced significant new instrument systems, well suited for applications that span the drug discovery, development, and quality control processes. While in the first quarter our level of confidence and a meaningful recovery in pharmaceutical spending improved further, as sales to this segment grew even faster than our overall revenue. Looking more closely at our breakdown of pharma sales, the strength was very broad, as generics, CRO's, and our larger ethical accounts all delivered strong double-digit growth. As I mentioned earlier, our newer system offerings, including the ACQUITY H-Class and our Xevo MS systems, helped accelerate our business in the quarter. And I'll now mention that a significant proportion of that growth was for pharmaceutical applications.

Our outlook for the remainder of this year assumes that we will continue to benefit from a healthy level of demand from our pharmaceutical customers, as we feel capital budgets are in place and that our current and upcoming new products will generate healthy order flow. On the new product front, we have planned significant new instrument system introductions during the first half of this year. At this year's Pittsburgh conference in early March, significant launches included a new supercritical fluid chromatography platform for analytical SSC applications that leverages design and performance features of our ACQUITY UPLC system. This system was introduced with a suite of new SSC columns based on our small particle USC technology -- UPLC, excuse me. At the conference, we also showcased a new analytical system, specifically targeted at bio-pharmaceutical applications.

This new system brings together our ACQUITY UPLC separations technology with a new high performance Xevo time-of-flight mass spectrometer, all running under a new software offering that we've called UNIFI. UNIFI is a key new operating system that uniquely brings together key workflow functionalities from our successful empower, mass links and the Genesis software platforms. In this first commercial embodiment of UNIFI, it enables an easy to use system solution that is designed to help UPLC MS migrate more easily from research to quality control applications for biosynthesized pharmaceuticals. Our plan is to gradually expand the range of tailored systems utilizing UNIFI and at this year's upcoming ASMS conference in Denver, we plan to speak about future systems offerings that leverage this unique and leading software capability. I would also tell you that this year's ASMS is likely to be a very exciting event for Waters, as significant product launches are planned and many technical presentations highlighting new applications will be presented by our scientific staff.

We turn to our TA Instruments Division. Sales grew at 12% organically for the quarter. This performance was highlighted by strong growth in developing markets, new applications for thermal systems, particularly in the energy area, and for biocalrimetry instruments. During the quarter, TA saw strong demand for its new discovery DSE system. This strong demand, in combination with new product launches planned for this year, suggest that 2011 can again be a strong year for our TA Division. On the financial front, our confidence in top-line growth for 2011 has resulted in plans to selectively increase our internal spending. To support higher shipment levels of new instrument systems, we have begun to modestly increase our field staffing levels, especially in developing markets. Generally, we have and will continue to plan for overall annual organic expense growth that is slower than our top-line growth and in this way create meaningful leverage to ensure that our operating income will grow faster than our revenues.

As a management team, we have always focused on strong cash generation, as we feel that it's a metric that best measures the strength and efficiency of any business. And I'm happy to tell you that our free cash flow in the quarter was an impressive $112 million, a rate of about $0.25 for each sales dollar. So in closing, I would like to say that we are encouraged by our start to 2011. We feel that the factors that drove growth in the first quarter are largely sustainable, that our new product pipeline will enhance our competitive position, and that our strategy of focusing on select technologies and faster growing end markets will allow us to continue to deliver superior top-line and bottom-line performance. So with that, I would like to turn it over to John for a look at our financial analysis.

Thank you, Doug, and good morning. First quarter sales increased by 16% and non-GAAP earnings per diluted share were up 28% at $1.04 this quarter compared to earnings of $0.81 last year. On a GAAP basis, our earnings were $1.01 this quarter versus $0.79 last year and a reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning. Reviewing Q1 sales results in comparison to Q1 last year, sales were up 16% with currency translation contributing 2 points to this sales growth. This result is much better than we expected, as our customers' capital spending started off the year stronger than forecast, especially in our pharmaceutical end markets. Looking at our sales growth geographically and before foreign exchange effects, sales within the US were up 8%, Europe sales were up 12%, Japan was down 1%, and sales in Asia outside of Japan were up 29%.

Turning to the product front within the Waters instruments, within the Waters Division, instrument system sales increased by 23% and recurring revenues grew 7% this quarter. Within our TA Instruments Division, sales increased by 12% versus prior year. Now I would like to comment on our Q1 non-GAAP reported financial performance versus prior year. Gross margin performance came in at 60.3%, the same as Q1 last year. The positive effects of manufacturing cost reductions and volume leverage were offset by unfavorable currency comparisons this quarter. SG&A and R&D expenses increased about as expected and this quarter's double-digit growth percentages were affected by a difficult base of comparison where in early 2010, discretionary spending was constrained exiting the recession of 2009. Our full year effective income tax rate came in as expected at about 16.5%.

On the balance sheet, cash and short-term investments totaled $1.04 billion and debt totaled $790 million, bringing us to a net cash position of about $250 million. During the quarter, we closed on an additional $200 million of term debt financing in the private placement market, taking advantage of market conditions that allowed us to layer 5-year, 7-year, and 10-year financing at fixed rates that average 3.2%. As for share repurchases, the board of directors approved a new $500 million 2-year repurchase program and in the first quarter, we bought 847,000 shares of our common stock for $67 million. We define free cash flow at cash from operations less capital expenditures, plus any non-cash tax benefit from stock-based compensation accounting and excluding unusual nonrecurring items.

For Q1, free cash flow remains strong and came in at $112 million after funding $17 million of CapEx and adding back $6 million of non-cash tax benefits from stock-based compensation. Comparable free cash flow in Q1 last year was $95 million. Accounts receivable day sales outstanding stood at 74 days this quarter, down 4 days from Q1 last year. Inventories typically rise in the first quarter from year-end levels and were up $20 million this quarter. Currency translation accounts for about $6 million of this increase. Overall, we are pleased with our financial performance as we start this year. Consistent with the improving trend we saw developing across 2010, our first quarter's results indicate more normal market conditions in the majority of our end markets and our new product positions have been well received in key application areas.

Operating margins improved by 170 basis points this quarter, as we saw continued strength in our gross margins and significant leverage of our operating expenses. Continued execution in our share repurchase program and a lower tax rate added to the operational results of the business and together resulted in a 28% growth in our fully diluted earnings per share this quarter. As we think about the remainder of 2011, we continue to see stability in our end markets and continued momentum in the acceptance of our new products. We expect to see around a 10% growth in sales for full year 2011 before currency translation. And at today's rates, currency is likely to add about 2 points to recorded sales growth for the full year. Moving down the P&L, gross margins for the full year are expected to be between 60.5% and 61%, as we continue to be favorably affected by-product cost reductions and volume leverage, offsetting margin pressure from new product introductions.

Currency at today's levels looks to be a modest depressant to gross margins in the first half of the year and favorable later in the year. Operating expenses are expected to grow at a lesser rate than sales growth. Net interest expense is expected to be approximately $18 million and we expect our operating tax rate to be about 16.5%. Our fully diluted average outstanding share count is likely to decrease by about 1.5 million shares in 2011. Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $4.80 to $4.90 per share. For Q2, we expect organic sales growth of about 10%, currency translation at today's levels is expected to add about 5% to sales growth this quarter, bringing reported revenue growth to about 15%. We expect to see continued operating income expansion this quarter and plan to proceed on our share repurchase under our newly re-authorized $500 million program. All of this is expected to result in Q2 non-GAAP EPS of between $1.10 and $1.15 per fully diluted share.

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

(Operator Instructions) Quintin Lai of Robert W. Baird.

Good morning. Congratulations on a nice quarter.

Good morning, Quintin. Thanks.

So, very encouraging to hear that pharma CapEx is continuing its trend. Through the quarter, I think clients were concerned about the headline news of some of the big pharma companies laying people off. Could you talk a little bit about where that demand -- you kind of say that it was very broad-based, but is this a return to more normalized growth or are we just coming off of tough comps in your opinion, Doug?

Well, Quintin, depending on how you cut the term pharma, for large, the top 15 to 20 accounts, it's been a continuing story of tough conditions over at least five-year period. So I don't think we're going to say that maybe one quarter we would of had a peak or something. But generally, it's been a tough time, particularly as they have outsourced some of their R&D or manufacturing analysis to TROs, some of it's gone generic, so you have seen our Indian business pick up. But I think we have at times said the large research-based pharmaceutical companies have continued to kind of go down a track that's sooner or later ought to kind of add (inaudible) flatten out and perhaps begin to pick up. We think that that's probably happening. We think that that install base has a lot of old equipment in it that needs to be upgraded.

There's a limit to which some of these laboratories can go where they cannot utilize some of those older systems. And we think we're seeing some symptoms of that in those large research-based pharma accounts. You look more broadly, I think as we've said for many years now, the overall broad pharma industry pretty healthy and again, it's kind of hard to tell sometimes when you're growing substantially your CRO business whether their clients are Pfizer or Glaxo or Bristol-Myers. So I think it's a little bit more diffused now, but where the benefit lies is probably still with some of those big pharma accounts. So we continue to see very good, strong business from those CROs, as well as during a time when we're seeing good conditions from our research-based pharmaceuticals.

Great, thanks. I'll jump back in queue.

Doug Schenkel, Cowen and Company.

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

Art, you want to give some color on that?

Yes, Doug, it turns out that it's fairly balanced with H-Class. The primary position of H-Class was to bring UPLC downstream into the more routine developmental areas and that's been the case. Additionally, we introduced a inert H-Class with a biopharmaceutical segment. So one of the things we've been doing with UPLC is to, after having spent several years in the developmental side of building the confidence of the technology with our class ACQUITY was to be ready when they said, okay, we're going to push this into broader utilization. So with H-Class what we're experiencing is a lot of generic adoption, a lot of adoption in large pharma, quality control, CROs are starting to look at the technology, and in particular the mass spectrometry driven applications, where you see a lot of use in regulated bioanalysis.

It turns out over the past several years that UPLC has essentially been adopted in the de facto front end to a mass spectrometer because of the characteristics of extremely small sample columns, the flows are very amenable to how a mass spectrometry developed its operational capability. So, I would have to say that the most exciting part of our H-Class success has been its broad-based adoption. And it went beyond utilization. Just in a manufacturing segment we are seeing it used even much more broadly and we see no end in sight. The order sizes are increasing with large multiples, which for us there's a combination of replacement going on, as well as people looking at the developmental areas using it for new applications. So, we have to claim it to be a broader penetration than just a particular segment.

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

I think what we're willing to say is that the tsunami and the earthquake effects did not -- maybe showed -- we were frankly running a little bit stronger than we expected in Japan through the middle part of the quarter. We were expecting probably a little bit of upside over our core forecast and with the tsunami and the earthquake, that probably came back to our original expectation. It wasn't a big dynamic, but it was a little bit slower than it probably otherwise would have been. We are seeing so far, as we go into the second quarter, no real significant influence or downside from the tsunami and all of its various side effects.

As it relates to what the ultimate effects will be, I think we are expecting that there was damage to laboratories and upset to laboratory instruments in the quake area that will have to be rectified. We've already received some notification of that from our laboratories. We expect that there will be some additional testing, but I think it's way too early to see how the government shakes out on that. It's also probably important to notice that most of our business is not conducted in the tsunami and main quake areas. As you think about Japan, you have the east of Japan, which includes Tokyo, and the west is generally considered Osaka. More of our business is in the west, very little of our business is in the Fukushima area, where the tsunami and the quake were centered, so we're not expecting to see long, significant effects in our business, given the current state of affairs in Japan. Is that okay?

Amit Bhalla of Citi.

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

John, you, I think, made the comments about then academic. So--

Yes. Government and academic really in the quarter, the dynamic there was just more, I'll say, Japan in its orientation with a large amount of shipments that went out in Q1 last year, where we really pushed our new G 2 product into that market space. We had a low to mid-single digit expectation for government academic. That was principally what we got. As you know, we don't have a large exposure to any particular government organization. NIH, as an example, is maybe $10 million to $15 million of full year business that we do. There might have been a little bit of US stimulus business in the base. So I would say overall, I think the result was pretty much on plan and our expectation going forward is kind of a low to mid single-digit growth of this, given the products that we're offering and just given the fact that these businesses have to be constrained with all of the things that we read about budget woes around the world.

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

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

Jon Wood, Jefferies.

Doug or John, is it possible -- you mentioned the instrument business up 23%, obviously pretty elevated there. Can you tease out LC versus MS, just qualitatively on which major category grew faster?

Yes, basically, John, they both grew north of 20%, very similar growth rate and we think they are largely -- that's indicative of the strength of both product line. It's not one dragging the other. They are both showing independent strength. And it is kind of indicative of our system strategy, although not all LCs are sold with mass specs or vice versa. It is, I think, a very clear sign of the strength of our systems offerings.

All right, great. Thanks for that. And last one, on the buyback, so it looks like a little bit slower in the first quarter than is traditional. Are you guys still expecting to do about 100% of free cash flow towards that buyback for all of 2011? And then as kind of a adjunct to that, any update to that free cash flow guidance at this point?

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

Tycho Peterson, JPMC.

Just a first one on H-Class, can you talk to utilization, whether you've seen the consumable use really pick up as you've seen broader adoption in pharma and I think you mentioned CROs a little bit earlier. And then just talk to your overall attach rate with columns for H-Class, assuming it's closer to ACQUITY than it would be for Alliance, but if you could just give color, that would be helpful.

Do you want to give some flavor on that, Art?

Sure. Yes, Tycho, the attach rate -- understanding H-Class unlike the original ACQUITY was marketed to those remaining customers who were still committed or were having a more difficult time to convert from LC to UPLC, largely due to regulatory context and having to revalidate and so forth. So the marketing of H-Class with that, it was anticipated that we would sell UPLC capability to a HPLC user that could use it for the six to twelve months in either LC or UPLC mode and therefore have that capability for the future. Most HPLCs are purchased with the idea of running them five to seven years. And once you buy them you're kind of stuck. So, I'll say that the people who buy H-Classes with the intention of utilizing it right out of the chute for UPLC, the column utilization rates maintain their consistency at plus 80%, meaning that we see that 80% of the time customers (inaudible) are all chemistry, which is radically up from our standard HPLC position of about 10%.

For those who are starting off with the system to run LC, what we find is once they do begin to use a system for UPLC, they do utilize our column chemistry at the same rate as one who had decided to do that initially. The columns they use on an HPLC side, that is the method that they were using. About half our sales appear to be going in and taking competitive positions. So it's unlikely that you would have our column in those situations. The other half are our own users or people familiar with us and you have a higher majority were originally on our HPLC column consumables in the first place. So that's a rough idea of what's occurring with that product. It doesn't have the purity of use that the original UPLC had. Almost 100% of them were used right out of the chute as a UPLC system. A little different though with H-Class because we wanted to continue to penetrate the market with that strategy.

Okay. And then to the comment, though, that you made before, Doug, about just pharma and I appreciate the additional color there, but we've heard over the years this concept of standardization as well to some degree standardizing QA, QC labs around ACQUITY. Are you seeing more of that from pharma as well, essentially sole sourcing instruments from one vendor as they look to basically upgrade their facilities?

We've seen more standardization go into H-Class, Tycho, but you're still talking about some laboratories that have many instruments in there and so we're not claiming that you are having a universal change out, but that momentum has certainly picked up in that direction.

Okay. And then just a last quick one on Japan and appreciate the additional color there, can you just comment on the supply chain side, given that's a focus for people as well?

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

Peter Lawson, Mizuho Securities.

Just regarding the pharma CapEx spend, could you perhaps tease that spend out versus CROs, generics, top 15, any way you can?

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

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

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

Thank you. And then just on the kind of the balance between industrial and pharma end markets, is there any way you can quantify the strength between those two end markets in the quarter?

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

Great. Thank you so much.

Marshall Urist, Morgan Stanley.

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

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

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

And was there a--

Margin question?

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

Isaac Ro, Goldman Sachs.

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

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

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

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

Got it, thank you.

Jon Groberg, Macquarie Capital.

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

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

Yes, perfect. Thanks.

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

Okay, thanks a lot. That was helpful. Appreciate it.

Paul Knight, CLSA.

When you look at emerging markets, do you have any concerns that year-over-year comps on large contracts are out there or is it the right number of contracts that that's not going to be an issue now or in the foreseeable future?

I think it's fair to say that in recent years, we have seen an increased volume of somewhat larger tenders, but in the emerging markets, emerging markets being the brick [side] and it would be specifically what we're talking about. But our forecasts take into account the kind of flow that we've seen in those large tender areas and we think that despite the fact that last year was a very successful year with some large contracts, we don't anticipate a great deal of difficulty in those territories achieving the kind of results that we've outlined for you. So the markets continue to be strong and the opportunities that we are working continue to be very encouraging.

Okay, thanks.

Dan Leonard, Leerink Swann.

Any indications from your customers that the recent food legislation signed in Q1 might spur additional demand?

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

Sure. I just picked up my handset. Any indication from your customers on the food safety front that recent legislation could spur an increase in demand?

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

Okay, thank you.

Derek De Bruin, UBS.

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

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

I mean, it's safe to say that we run roughly half research to development, half development to the QC. So our business tends to settle in those types of ratios. I would also say that probably the biggest change that we're seeing, particularly in big pharma, is that HPLC utilization and replacement could be a tricky thing. Some will see a new instrument and will replace a couple years earlier than the typical seven, some will stretch it out. The dynamic that we're seeing with UPLC is that we're going in and showing these customers, irrespective of where that product is in the depreciation cycle, how they can improve the productivity of their operation that goes along with the instrument (technical difficulty).

Hello, you're fading out.

That's a slight difference from the traditional replacement world we deal with. I'm sorry, you had a comment?

Yes, no, I'm sorry. You faded out on some of that question, some of your answer there. I guess the -- as a follow-up on that do you plan to basically obsolete the Alliance at some point in time, to basically force everybody over to the H-Class? At some point in time do you -- are you telling your customers you better switch over now because you're not going to support Alliance? I guess, what's your kind of product -- what's your plan?

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

There is a critical component to this industry and with a large portion of our product line being sold and has been sold into the pharmaceutical, regulated environment, there's a lot of assays. Every patent for every drug has HPLC data on it and it's used extensively from one end of the spectrum to the other. Once it comes off patent, it moves into generics. Keep in mind that the cost of converting in many cases for very basic analysis of a drug is way too high for a Company to implement that. So if they are using an Alliance system with a standard separation and it's not a critical analysis that can have huge benefits from moving to UPLC, they will stay with Alliance and that lifecycle could be quite long. We are -- first product of the '70s was Michael Bondipeck C-18. Those sales are still going strong. There are a lot better columns out there, but they are just not going to change those methods. So, unlike some industries where you see conversion of product, it is likely HPLC will be around for a lot of these older methods for a long time to come and to be frank, with the momentum coming out of India, China and Latin America with a lot of the generics, they are simply adopting the original methods and it's cost effective for them to do that. They are not complex separations. HPLC works fine for those applications.

It's still likely that the Alliance mix will continue to go down. I think that's very clear. But it's still both strong product lines. I notice it's 9.30. We're willing to stay on for a little bit longer. I realize that some of you probably have to get off, but we'll try to answer the people who are in the queue if they are still there, operator.

Thank you. Sung Ji Nam, Gleacher & Co

Going back to Derik's (inaudible) product replacement cycle, with H-Class, do you anticipate the product lifecycle to be shorter than for the legacy UPLC given heavier utilization?

I'm sorry, but for several people it's getting hard to hear. I think you may be on speaker phones and it's -- could you repeat that question?

Hi. Sorry. Can you hear me better?

Yes, much better.

Okay. I just wanted to ask about going back to the product replacement cycles for H-Class, do you anticipate the product lifecycle to be shorter compared to UPLC given heavier utilization for H-Class?

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

No. We find most of the pharmaceutical companies are running their instruments, as I said, five to seven years, sometimes a little longer. The [bessage] that are being developed are going to be subjected to the same lifecycles for their products as has always been the case. So we have no indication that there will be any shift in those lifecycles and people anticipate that they will maintain the same type of use and depreciation.

Okay, great. Thanks. And just a quick question. What's the size of your emerging market or developing market business today?

Yes, we would say that Asia, eastern Europe, some of the Latin American countries all in sum total are probably about a quarter of our business.

Great, thank you.

Tony Butler, Barclays Capital.

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

Yes, I would say if we think about what's changing here year-over-year, we're certainly putting some incremental headcount in place in the developing parts of the business. We are beginning to spend a bit more on the discretionary side for promotional activities and the like, as we have a number of new products making their way to market. The expectation would be that we would have a point, maybe a couple of points differential on a full-year basis and the growth rate of our expenses versus the top-line, again, as you said on an organic basis. In the second quarter, where we have 5 points of currency on the top-line, we are going t have a similar dynamic of growth on the SG&A line. So, foreign exchange is going to make a difference in the reported growth, it will keep up with the top-line, but the differential will still be there.

So, I would say we have flexibility, certainly, to the extent that the organic growth is greater than what we say. We're not likely to instantly react to that with incremental headcount adds. There will be commissions and some variable pay plans that will take a little bit of a bite, perhaps, out of that, but not anything all that meaningful. And then certainly on the downside to the extent that there's an action there we need to deal with, I mean, we would go back on the discretionary spending, the variable pay programs come down comparably to the top-line. So there's a little bit of flexibility, I would say, on the downside as well, but based on what we see right now, I would say we're pretty comfortable with the top-line number that we have.

Thanks, John. And last question, the biopharma targeted ACQUITY plus the Xevo TQ-S system having the UNIFI software was interesting. I assume that LCMS system collectively is for QC applications, but I'm also curious if in fact this has been developed based on customer demand. And if so, we just had had the impression that the MS detector today might actually be too expensive for QC. Is that incorrect or would costs come down or any color there would be helpful? Thank you.

Yes, if you think about traditional pharma, the research ethical type companies, yes, you're probably right, unless the application clearly demanded the use of mass spectrometry, you would not likely find that in the quality control lab. That biopharmaceutical system would be ACQUITY and the mass spectrometer attached is really targeted at the biopharmaceutical segment, where you have a lot of high value-added processes taking place and therefore you are more likely, not in all cases, but you're more likely to see test systems that do in fact incorporate mass spectrometry than fairly sophisticated separations, largely because of the nature of these more complicated biopharmaceutical samples of haptides and so forth.

So that's a very focused segment we're going after and so far, the acceptance is quite well. And it was for probably the last five years, we've spent incredible amount of time bringing focus groups together, specifically from the biopharmaceutical industry in trying to find out what is it you need to help your process? And it's a very different discussion than you're going to find in the small molecule research grade ethical houses. So that's a very targeted system and we think over time that represents an increasing share of the activity in the analytical space in certain markets.

Thank you, Art.

Your last--

Operator, I think we probably better limit it to one more call. I think that's probably what's in the queue right now.

Thank you, yes, sir. Bill Bonello, RBC.

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

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

All right. I won't get really specific largely because, as usual, these things are unveiled, but what you can expect to see from us from ASMS this year, we're very focused on continuing enhancement, speed sensitivity and resolution. Those are the three elements that the people who go to ASMS show up for one reason and one reason only. The kinds of compounds they are working with, they are looking for the vendors to give them a major improvement in speed, sensitivity, and resolution for the types of compounds that they are working on.

So as we look at ASMS this year, both for mass spectrometry, as well as UPLC, we're going to bringing out major improvements in both of those technologies, not only individual capabilities of those specific technologies, but you'll see us beginning to focus on targeted applications using our system strategy of both. So we'll look at some areas of what we believe will be high activity, where we can offer a new system solution that can really offer these customers orders of magnitude in terms of the kind of results they are getting. So that's the type of direction that we're taking at this year's ASMS. You'll see about two to three major systems offerings targeted in that area.

Okay, thank you.

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

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