Waters Corp (WAT) 2014 Q1 法說會逐字稿

Good morning, and welcome to the Waters Corporation first-quarter financial results conference call.

(Operator Instructions)

This conference is being recorded.

(Operator Instructions)

I would like to introduce your host for today's call, Mr. Douglas Berthiaume, Chairman, President, and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Thank you. Good morning, and welcome to the Waters Corporation first-quarter 2014 financial results conference call. With me on today's call is Gene Cassis, the Waters Chief Financial Officer; Art Caputo, President of the Waters Division; and John Lynch, the Vice President, Treasurer and Investor Relations.

As is our normal practice, I will start with an overview of the quarter's business dynamics. Gene will follow with details of 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 Gene to cover the cautionary language.

Thank you, Doug. During the course of this conference call, we will make various forward-looking statements regarding future events, and for the future financial performance of the Company. In particular, we will provide guidance regarding possible future income statement results for the Company.

We caution you that all such statements are only predictions and that our actual results may differ materially. For a detailed discussion of some of the risks and contingencies that could cause our actual results to differ significantly from our present expectations, please see Form 10-K included with our annual report for the fiscal year ended December 31, 2013. Specifically, examine Part 1 under the caption Business Risk Factors.

Also, see the cautionary like which included in this morning's press release and Form 8-K. We further caution you that the Company does not obligate or commit itself by providing guidance to update predictions. We do not plan to update predictions regarding future income statement results except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is planned for July 2014.

During today's 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 measures is attached to the Company's earnings release that we issued this morning.

In our discussions of results and operations we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled Quarterly Reconciliation of GAAP to Adjusted non-GAAP Financials. This schedule is included in this morning's press release. Doug?

Thank you, Gene. Clearly, our first quarter results were significantly weaker than what we had expected. The strong business momentum that we saw at the close of 2013 was encouraging for us as we entered this year.

However, as we move through March, we began to see our bookings forecast weaken as pharmaceutical capital budget releases slowed, and as our sales opportunities in China and Latin America were adversely affected by ordering delays, primarily from governmentally funded programs. This weaker than expected top line performance, combined with negative currency translation, resulted in a decline in operating margins within the quarter.

The year over year decline in our net profitability and adjusted earnings was also affected by an anticipated increase in our operating tax rate. As you might expect, we are most focused on the top line weakness, as the currency and tax issues are likely to lessen in significance as we move through this year.

You're looking at the first quarter, our constant currency sales were flat with last year's and our adjusted earnings per share were down 14%. For the Waters division, our pharmaceutical end market sales were flat in the quarter due to delayed budgetary releases, most notably in the United States.

Global government and academic business slowed in the quarter in comparison to last year's strong results in Europe and Asia. We anticipate government funded research in the US to improve this year as funding levels have increased, as the business pipeline looks strong, and as the first quarter's results were promising.

Geographically, weakness in Latin America and Canada, and slower sales growth in China, were below expectations for us in the quarter. In these markets, weaker than expected governmental spending adversely affected demand for our products.

In China, we believe that these spending delays are temporary and that we will see a recovery in our sales growth. The business in China that we had anticipated booking and shipping in the first quarter is largely expected to be secured during 2014.

Waters division constant currency sales in Japan was strong in the quarter and grew at a high-single-digit rate. In comparison to last year's first quarter, sales growth benefited from healthy increases in governmental and academic spending.

In addition, sales for our products to Japanese industrial chemical customers suggest improving economic activity for these exporting companies. First-quarter's positive momentum appears to be continuing in the second quarter, the first quarter in Japan's fiscal year.

In the US, and staying on the Waters division performance, sales were slightly down in the quarter in comparison to a mid-single-digit increase in the 2013 quarter. Sales to pharmaceutical customers were flat in the quarter with budgetary delays in larger accounts offsetting stronger performance by smaller and specialty firms. Chemical analysis end markets in the US were also soft in the quarter and down from the prior year's more robust results.

As I mentioned earlier, government and academic spending in the US was up in the first quarter, and our pipeline for future sales is encouraging for our full-year outlook. In general, our developing markets in Latin America were under pressure in the quarter due primarily to weaker governmental funding for academic research and from weaker demand for food and environmental applications.

As I mentioned in prior calls, business in these developing markets can be lumpy and a single quarter's outcome has historically not been a harbinger of future results. Our European Waters division business in constant currency was about flat in the first quarter. In contrast to the US, pharmaceutical sales were strong and up at a high-single-digit rate, while government and academic spending was meaningfully down in comparison to a very strong 2013 performance.

Our TA division started off 2014 with a mid-single-digit decline in shipments following a strong 2013. After a slow January, orders began to build through the quarter and the division closed the quarter with year over year orders growth and a backlog build. Within the quarter, a significant investment was made to integrate newly acquired product lines into the TA portfolio and to train the worldwide sales and service organizations on these new technologies.

Geographically, Europe performed well in the quarter and enjoyed strong sales and orders growth. However, the division saw weakness in developing regions and a sales decline in the US. From a product perspective, rheology instruments had a strong quarter, thermal systems saw significant growth variability by region, and there was essentially no contribution from newly acquired product lines in the quarter.

The outlook for TA for the second quarter and full-year is for improvement across the division's product lines and regional markets. For the full year, TA expects to generate incremental sales growth from businesses acquired in 2013 and mid-single-digit organic increases from our core product offerings.

Now I will talk about some product line dynamics that we saw in the quarter. Our recurring revenues, the combination of service and chromatography consumables, grew 5% the first quarter.

Within the quarter, severe weather conditions, particularly in the US, had an adverse impact on recurring revenue growth as restricted traveling conditions resulted in lower lab productivity. We believe underlying demand for chemistry and service offerings is marginally stronger than our first quarter sales growth may indicate.

On the chemistry front, ACQUITY UPLC columns, after 10 years in the market, now represent our largest column product line with broad penetration across research-focused end markets. Waters service business was generally strong across all regions, as the trend toward higher penetration for service maintenance contracts was apparent in the quarter's results.

Looking at our Waters division instrument system sales, and in contrast to the strong demand we saw late in 2013, UPLC MS system revenues were generally weaker than expected. In our higher end instruments, which incorporate advanced orthogonal Q-Tof technology, the quarter's weaker performance was somewhat expected due to the particularly strong demand in the base quarter.

We anticipate stronger sales growth from our SYNAPT and Xevo Q-Tof systems in subsequent quarters this year due to increased funding levels for government and academic research labs in the US. In addition, the release of capital budgets at larger pharmaceutical accounts will benefit research instrument sales.

Of greater significance was a year over year decline in tandem quadrupole instrument sales. We believe that this weakness in the first quarter is largely attributed to lower demand for food analysis and environmental testing systems, especially in Asian Latin American, and European markets.

At this year's Pittsburgh conference in March, we introduced a new ion source technology for our Xevo TQ-S tandem quadrupole system. This new ion source, called ionKey, couples the demonstrated advantages of our StepWave technology with an integrated tile-based ACQUITY column separation to deliver improved sensitivity for challenging applications.

Initial customer demonstrations for this new technology have evidenced the competitive edge over more conventional source designs. Accordingly, we anticipate stronger high end tandem quad system business as we go through 2014.

On the chromatography front, ACQUITY instrument sales benefited from another strong quarter for our ACQUITY QDa mass detector. Demand for this compact mass detection technology, that has the potential to redefine the capability of research-focused liquid chromatography, exceeded the unit shipment volume in the fourth quarter of 2013.

The primary application area for this new detection technology continued to be in the area of small molecule drug research, and in the first quarter we saw drug research customers purchase the QDa as a detection module for existing UPLC or HPLC systems, as well as within new system orders. The demand that we saw in the first quarter is particularly encouraging as we believe it represents a rather small proportion of the likely full-year sales, given that many capital budgets were not released in the first quarter.

Now we can take a look at the second quarter and the full year. On the new product front, we expect that the positive momentum established for the past two quarters for the ACQUITY QDa will continue to build through the year. In addition, and based on positive customer feedback, we expect that our tandem quadrupole position will be strengthened by ionKey technology and meaningful new product launches planned at the ASMS conference this June.

In addition, we are confident that our recurring revenues will continue to contribute profitable and stable growth throughout the year. On the TA front, we will ship against the first quarter backlog and begin to meaningfully benefit from newly acquired product lines beginning the second quarter and through the year. If you look towards future M&A, we do see some encouraging opportunities to strengthen our technology portfolio and broaden our reach into medical research.

I hope to provide you with more details later this year. In the meantime, it is likely that we will see more M&A activity from our TA Instruments division over the next few quarters, as we see more opportunity to continue a consistent and focused business acquisition plan here. As you know, a key deployment of our cash flow has been our share repurchase program and this will also continue in the future.

Before passing it on to Gene, I want to say that we anticipate delivering full-year 2014 results that are improved over the first-quarter's performance. We have an exciting set of new products to drive business growth, most notably our ACQUITY QDa, and new system launches planned for this year's ASMS conference.

The medium- and longer-term outlook for our businesses in China, and in fact all of Asia, continue to be promising, and our competitive positions in these areas are strong. Academic and government spending in the US are expected to improve as governmental agencies will be better funded in 2014 in comparison to the budgetary pressures that we saw in 2013.

I believe that 2014 will be a successful year for Waters. Though I would have liked to have seen a stronger start than our first quarter's performance, our new product flow is strong and we are well-positioned in the most promising market segments. Organizationally, I feel we have fine tuned our structure at the onset of this year to better address growth opportunities in a cost-effective manner.

On the leadership transition front, we are steadily progressing to identify and position my successor in a manner that assures a smooth transition in the continuation of the core strategies that have accounted for our long-term success. I hope to share with you more information on developments in this area in upcoming communications. In the meantime, we will direct our operational efforts to securing the business that was not captured in the first quarter, and we will modulate our spending to provide a return to operational leverage and earnings growth.

Now I'd like to turn it over to Gene for a review of our financials.

Thank you, Doug, and good morning. Our first quarter revenues of $431 million were flat with last year with currency translation neutral to sales. Our non-GAAP earnings per diluted share were down 14% to $0.92 in comparison to earnings of $1.07 last year. This was primarily due to adverse currency effects and a higher operating tax rate.

The tax rate for 2013 benefited from $3.5 million in US R&D tax credits, this opportunity is no longer available. On a GAAP basis, our earnings were $0.82 versus $1.39 last year.

A reconciliation of our GAAP to non-GAAP earnings is attached to our press release that we issued this morning. The GAAP results in the first quarter of last year benefited from a $31 million reduction in reserves for tax audits, and the $3.5 million that I already mentioned in US R&D tax credits.

Looking at our growth geographically, and before foreign currency effects, in the United States sales were down 2%, Europe was up 2%, Japan was up 8%, and sales in Asia outside of Japan were up 1%. Rest-of-world sales, notably including Latin America, were down against a strong performance in the prior year's quarter.

On the product front, and in constant currency, within the Waters division, instrument system sales decreased by 5% and our recurring revenues were up by 5%. In all, Waters division sales were up 1%. For our TA Instruments division, constant currency sales, including instruments and services, decreased by 3%.

Now I would like to comment on our first-quarter's non-GAAP financial performance versus last year. Gross margins came in at 56.4%, down from the first quarter of last year, largely due to foreign currency exchange dynamics. SG&A expenses were up 1% as a result of continued tight spending controls and cost reductions from a modest restructuring early in the quarter.

R&D expenses decreased by 2% due to higher than normal project-related expenses in the 2013 quarter. On the tax front, our effective operating tax rate for the quarter came in as expected at 16%. This rate was meaningfully higher than in the first quarter of 2013 when we benefited from both the 2012 and 2013 R&D tax credits that I cited earlier.

For full-year 2014, we expect our operating tax rate to be between 15% and 16%. In the quarter, net interest expense was $6 million and share count came in at 85.9 million shares, or approximately 1.3 million shares lower than in the first quarter of last year, this is a result of our share repurchase program.

Turning to the balance sheet, cash and short-term investments totaled $1.85 billion and debt came in at $1.33 billion, bringing us to a net cash position of about $521 million. As for first quarter share repurchases, we bought 769,000 shares of our common stock for $86 million. This leaves $262 million remaining on our existing authorized share repurchase program.

We define free cash flow as cash from operations, less capital expenditure, plus non-cash tax benefits from stock-based compensation accounting and excluding unusual non-recurring items. In the first quarter of 2014, free cash came in at $108 million, after funding [$16] million worth of capital. Excluded from this amount is $6 million of investments associated with major facility expansion. On this front, we expect our new Wilmslow, UK mass spectrometry centre of excellence to be fully ready for occupancy and full utilization by mid-this year.

Accounts receivable days outstanding stood at 85 days this quarter, up five days from the first quarter of last year. This increase is primarily the result of the particular timing of overseas sales in the quarter and does not signify a change in the long-term character or quality of our receivables. In the quarter, inventories increased by $31 million as we built instrument systems to accommodate a stronger than realized shipment volume, and as a consequence of a plan to build safety stock during the transition of manufacturing at our new UK mass spectrometry facility.

Now I would like to discuss our 2014 full-year outlook. Clearly, we had a meaningful slower top line growth rate in the first quarter than what we had expected. We currently attribute this slow start largely to ordering delays, and to a lesser extent, shipping delays at our TA Instruments division.

In the upcoming quarters of 2014, we anticipate that positive new product momentum, the release of delayed capital budgets, and a general improvement in our Asian businesses will allow us to recover most of the first-quarter shortfall, and to finish the year with a mid-single-digit growth rate, or similar to the constant currency growth rate that we delivered last year. On the currency translation front, at current rates, we are estimating that for the full year currency will be approximately neutral to our sales growth, but potentially slightly dilutive to operating margins.

Moving down the P&L, gross margins for the year are expected to be around 59% and consistent with those for last year. Operating expenses are expected to be up moderately from 2013 levels, but below our sales growth rate. Moving below the operating profit line, net interest expense is expected to be approximately $28 million, and we expect our full year operating tax rate to be in the range of 15% to 16%.

Turning to share count, our full-year average diluted share count is now expected to be reduced to around 84.5 million shares outstanding, this is a result of our continued share repurchases. Rolling all of this together, non-GAAP earnings for a fully diluted share are expected to be in the range of $5.25 to $5.50.

As we think about our expectations for the second quarter of 2014, we anticipate organic sales growth to improve from our first-quarter's results and come in at or above a mid-single-digit range. Currency translation at today's rates would be about neutral to sales growth. This level of growth, in combination with continued tight expense control, is expected to result in non-GAAP earnings for a fully diluted share within a range of $1.15 to $1.27 in the quarter.

Thank you. Doug?

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

(Operator Instructions)

Our first question is Brandon Couillard, Jefferies.

Hey, thanks. Good morning.

Good morning.

Gene, in terms of the revised outlook for the year, could you give us a break down of how you see that developing geographically, and then by end market?

Sure. Thank you, Brandon. Generally, for the full year outlook, it is pretty safe to look at our business in the United States and our pharmaceutical business and assume that sort of the midpoint in our top line guidance is right around what our expectations are for that geography and for the pharmaceutical industry.

Generally, we anticipate the growth rate in Asia will be faster and we are a little bit more conservative on the full-year growth rate in Europe. We started the year off pretty strong in Japan, where we see positive signs coming into this quarter, so we are expecting that the Japanese rate may come in at about the mean or maybe slightly below.

Okay. And then, in terms of the to Q2 outlook, it seems to suggest a snap back in the organic growth rate. Was there something in the order book late in the quarter that gives you the confidence in that rebound sequentially? Any color you can give us in terms of the backlog for the period would be helpful.

And then, the EPS range implies a slightly wider band than is usual for Waters in terms of the $0.12 delta. Is there something unusual in that low-end to high-end range?

Yes, those are both good questions, Brandon. In terms of the backlog, the one thing that we cited already in Doug's commentary is that we did have positive growth for our TA Instruments division even though we reported slightly negative sales result. We do have that backlog.

I also want to point out that as you look at the base year comparison, for the full year, we had a relatively strong first and fourth quarters, and the two middle quarters were relatively flat in terms of our instrumentation growth. There is a base of comparison benefit as we go from the first quarter to the second quarter. Also, as you look at the range of EPS, and you look at what the expectations are on the top line, I would say that the bottom of the range makes very minimal assumptions on the level of snap back that we see from the first quarter.

In that our original expectations were that our growth rate in the second and third quarter be stronger than the fourth quarter. But based on what we're seeing in the market now, we do have reason to believe that a portion of the delays that we saw in the first quarter will, in fact, come in in the second quarter.

At the high end of the guidance in the second quarter, we are anticipating a more full recovery of the sales delays that we saw in the first quarter. So that is one of the reasons for the expanded delay is kind of encapsulated in that rationale.

Great, thank you.

Our next question is Doug Schenkel, Cowen.

Hey, good morning, and thanks for taking my questions. Some of your peers have already talked about the delay of capital budgets in China. I don't think anyone has talked about delays in US pharma capital budget releases.

Why do you think US pharma budget release delays would be more impactful for you? And I'm just wondering if at this point in Q2 you've seen some improvement in that dynamic specific to US pharma?

Doug, I think a couple of reasons. Number one, in many of those comparables, our life pharma business is more significant to us than it is for a number of our competitors. And so a delay there is probably going to show up more significantly in our results than in some of the competitors.

We clearly -- we talk about this delay, and it's not a dynamic that we haven't seen before in terms of late releases of big pharma's capital. It is something that seems more common than I would like to believe, but if you look at the request for quotes, our typical time of turning a quote into an order, and particularly look at the non-competitive, that is labs that are almost totally dedicated to Waters business versus anyone else, you can see that this quarter that time delay stretched much longer than has been typical from quote rates to delivering the orders.

Obviously, we've gone back at this since the quarter completed. We have queried those customers. We feel reasonably confident that as it affects us, these are delays and not lost business. Gene, you want add anything to that?

No, I think that is accurate. It's interesting, we're seeing this continued trend of increasing percentage of our pharmaceutical business moving towards more specialty pharmaceutical accounts, more on the bio outside. And the top 15 accounts, that at one point in our history made up about 25% of our sales, continues to -- that percentage continues to attenuate and it is now approaching closer to 10% of our sales.

Okay, that is really helpful. And, I guess, one or two quick related questions. In hindsight, looking back at Q4, I'm just wondering if you think some of that Q4 strength, in a quarter that was really great and where you attributed a lot of that strength to essentially recapturing revenue that you didn't get earlier in 2013, now if there are any signs that maybe there is some revenue pull forward out of Q1, was that a dynamic?

I know you guys talked about having a lot of momentum heading into Q2, and further into the year, but I am wondering if maybe you think Q4 maybe benefited to some extent in hindsight at the expense of Q1?

It is not impossible, Doug. I would say, if you look at where we continue to see strength in the fourth quarter, the strength that we saw in China was a continuation. We saw a minor slowdown of releases in the third quarter in China, and that all kind of came back robustly in the fourth. I don't think there was much pull forward in China. I think what we're seeing this quarter is a new dynamic there.

And the pharmaceutical business that we saw in the developed countries in the fourth quarter, it is just kind of so typical of what we see in a budget flush year where that momentum starts off slow and builds up through the end of the year. The only thing I could say would be that our performance with the QDa was very strong in the fourth quarter.

That might have been a little bit of a disproportionate piece of business because it hadn't been available for sale. But then you look at the QDa and orders and shipments in the QDa were even stronger in the first quarter than they were in the fourth quarter.

So, clearly, we ask ourselves many of these same questions because we don't want to be diluted as we go forward. But we can't find too much significant evidence that the fourth quarter represented a big pull out of the first quarter.

Okay. Thank you very much.

Our next question, Amanda Murphy, William Blair.

Hey, good morning. I just had a question on the QDa. You mentioned that some of the platforms were sold to people who already had solutions.

I am curious, just, can you give us a perspective on some of the (inaudible) between how many are buying for an existing platform versus how many are buying QDa as part of a new platform? Just trying to get a sense of how penetrated the existing opportunity is?

Sure, Amanda. Gene, do you want to handle that?

Sure. Amanda, I think, to the last point, I think we are still very much at the beginning in terms of looking at penetration rates, and we think that there is a tremendously large market for research-focused chromatographs that can benefit from this technology. But take a look at the fourth quarter last year.

We were somewhat surprised to see how many of the QDa technology modules were sold as part of a complete system package. It was about half of them in the quarter. We saw that people had some money at the end of the year and they decided to invest in a complete system at a rate that was a little bit higher than what we anticipated.

If I look at this last quarter, two-thirds of the instruments that we sold in the first quarter were additions to existing chromatographic systems, which was much more in line with what we were envisioning last year. Although the unit volume was up in terms of modules shipped in the quarter, from a revenue point of view the fourth quarter of 2013 was comparable to what we saw in the first quarter of 2014, and kind of consistent with the outlook that we had coming into this year that the QDa could contribute about 1 point of growth for the whole Company in full year 2014. I would also just add that in terms of the uptake of this technology, it continues to be most sought after by people doing small molecule drug research.

Got it. And have you guys said how much of your LC installed base you think might be candidates for a QDa? And then also with the ASP differences are if you were to buy it as an add-on versus as part of a broader system?

Sure, go ahead, Gene, you can do that.

Generally speaking, we think that about -- if we look at the installed base of chromatographs, Waters and non-Waters, we think is pretty evenly divided between those that are being used for research purposes and those that are being used for quality control compliance-type purposes. The key market in the short term for QDa technology is going to be on the research side.

There is a tremendously large installed base of instruments that are using photodiode array technology. The usage of that technology implies that the customer is interested in getting qualitative research or compound identification. We think that this customer base, which might be a quarter to a third of the installed base of chromatographs, is a great candidate for QDa technology.

And in terms of looking at pricing for this technology, we are able to offer a complete system for less than $100,000, a very comprehensive system. And we're able to offer an upgrade to an existing system for something less than $40,000. We think these price points are very attractive for the end markets.

Got it. Thanks, guys.

Our next question is Jon Groberg with Macquarie

Good morning. Thanks for taking the question. Doug, I'm just looking at your new guidance, and if you look back over the last three years now, and I recognize every year has something different, but kind of 2% EPS growth, maybe 2% mid-single-digit EPS growth this year. I'm just curious if anything that you are seeing in terms of newer challenges in the business, or just how you are seeing the business, maybe can you talk about how that is impacting, if it is impacting, the type of candidate that you are looking at to succeed you to run Waters?

I think that is a fair question, Jon. I think the answer is, no, we think that the basic Waters strategy and the strength that we've seen over the years hasn't and shouldn't change. It is not like we believe that long-term opportunities in the high-value added technologies that we bring to market and have sustained our growth over the years have petered out. I think if you look at the last couple of years, and last year in particular, if the yen had stayed stable, our earnings would have grown at double digits, or thereabouts.

So, yes, I do think it is possible to pull things in and out of any given year, but the focus that we have on developing new technologies and new products with this opportunity to selectively enhance our product portfolios in areas that directly related to what we do, where we are currently focused more on TA than anywhere else, but the emerging medical applications and clinical diagnostics offer, we think, some real opportunities for us. I'd say, we haven't changed the specs on what we are looking for, and we haven't changed what we think the success of Waters long term is likely to be.

And, Doug, would you say in terms of the process, are you pleased with the candidates that you have seen? I know you are going to say you hope to update more in the future, but maybe can you give us a little bit more color on the process?

I think the process has shown that there is a broad array of very interesting candidates who have shown real interest in the opportunity, Jon. I won't say that that surprises me. It is a great Company with great technology and great opportunity, but it is nice to see that as you go out there that is reinforced by the response that we're getting from very qualified candidates.

Okay. And then, Gene, if I can just ask you quickly, obviously, the gross margin, down 56%, is one of the weakest, just go back over the years, it is a pretty weak number. You are still expecting 59% for the year, you said?

In telling a fairly strong final three quarters. Can you maybe just talk a little bit about why it was so weak in the first quarter, and why you are confident that you're going to be able to get back to a more normalized number for the year?

Yes. The year over year comparison, going from the first quarter of last year, Jon, to the first quarter of this year, you need a little more detail to fully understand the dynamic there. The biggest thing is that the currency impact on gross margin.

The lion's share of the difference that you see between last year's gross margin and the gross margin that we delivered in the first quarter is related to currency. And this includes the strong flow-through that we get in our business in Japan where last year for most of the first quarter we were dealing with the yen that was at around a $92 average value. It was a significantly weaker this year. Also, on the currency front, we had the pound move in a direction that was unfavorable to us.

It had the impact of increasing our cost of goods sold for product that we made (inaudible) in the United Kingdom. Those are the big dynamics. Now superimposed on that, there is a natural progression of gross margin with volume as you go there any of our full-year -- as you look at Waters over a full year period.

The reduced volume that we had in the first quarter, combined with typically lower volume that you get in the first quarter, contributed to less absorption of fixed cost in the quarter and had a negative impact on gross margins. So broadly speaking, it is that dynamic, as well as the currency dynamic, that caused the 56%-plus gross margin in the quarter.

But just so that I am clear, if the currencies stay where they are, the yen and the pound, how do you make that up in the next few quarters?

In fact, there is a big difference in the value of the yen as you move from first quarter last year to the second quarter. If you go and take a look at how the yen progressed across the year, you will see that as we come into the second quarter that will be much more favorable. The pound, I made some commentary that foreign exchange might over the full-year be a little bit dilutive.

If the pound continues to strengthen, well, that can work against us. But as we go from the first quarter to the second quarter, implied in the guidance is a recovery in the growth of our instrumentation business, and that will have a positive effect on our cost absorption.

Okay, thanks a million.

You're welcome.

Our next question is Paul Knight, Janney Capital Markets.

Hi, Doug. I think it is on the same topic, and that is the operating margins were severely decremental in the quarter. Is that due to in China when you sell the product you are probably operating at a higher level of profitability than maybe other markets? What are the dynamics going on that kind of cause that decremental to occur?

No, Paul, the margins that we get around the world are remarkably consistent. Certainly, at the gross margin level. So the effect of a shortfall in China would be really no different than what we would see from a shortfall in the United States.

If you look your way down our P&L, the shortfall in earnings -- clearly, the shortfall in sales had a significant impact on us. We were $17 million, $18 million shy of where we thought we were going to be for all of the reasons that Gene talked about.

Now at the same time, we under spent SG&A because we are careful, and that is traditionally our bent. SG&A spending is clearly under control, but when you are flat at the top line, it is still tough to get any leverage out of that.

So the real story on the profitability side was the gross margin line. That is the 2.5 points that Gene talked about, largely affected by currency, and the fact that we have such a shortfall on the instrumentation mix in this quarter.

We see ways for that to reverse itself as we go forward in 2014. We think that is a reasonable forecast. And if the currency behaves itself, as it seems to be more or less, with a little bit of question on the pound side, we think that recovers.

With the completion of the UK facility, what portion of product is made in the UK now?

Yes, if I take a look at our mass spectrometry centre of excellence in Wilmslow, the high end mass spectrometry that incorporate time-of-flight technologies is primarily manufactured in the United Kingdom. If I take a look at mass spectrometers that heavily utilize quadrupole technology, the lion's share of production is at our Wexford, Ireland facility.

Most of this new facility is not dedicated to manufacturing, Paul. We still are manufacturing more intensely in Ireland for our mass spec products. It's really a focus on R&D, marketing, and administration.

Okay, thank you.

Our next question is Dan Leonard with Leerink

Hi, good morning. This is Justin on for Dan, and thank you for the questions. Just was curious if you could elaborate on what you saw in China this quarter? Maybe across product lines and some of the end markets? Maybe hone in on the change in dynamics you saw there or alluded to in your prepared remarks?

I think Gene can chime in in a minute. The thing that surprised us versus our original expectations is the fact that the incoming quote rates and the desires on the part of customers is still very robust, still looks like kind of what we saw typically in the last several years.

As a matter of fact, the number of very large projects with customers being very interested in talking to us about outfitting labs in the multiple instrument levels is going up. So the amount of grassroots level of interest, if anything, I think is growing.

What we clearly saw is getting those quotes through the orders phase, and then through the banking system to approve the shipment, and then the payment of the orders. That all slowed in the first quarter. That is kind of what we have spent a lot of time in researching the current status, why do we think that that is more or less a temporary dynamic.

There is some risk issue will continue, but we don't think so. We think that we saw a little of this in the third quarter last year that then corrected itself in the fourth quarter.

We are anticipating that our business for the year in China will be less than we originally forecasted, but that this significant slowdown will not repeat in the second quarter. Gene, do you have anything to add to that?

Just that, if you look at our business in China historically, it has been a consistent year over year double-digit compounded average growth rate business for us. We don't see any change in that long-term trajectory, or any meaningful change in that long-term trajectory.

But we also recognize that a significant portion of our business in China is funded by governmental agencies. I guess that is a risk factor going forward as you begin to think about how governmental spending might have an impact on our business.

Okay, thank you. And then, just one more. Can you talk a little bit about customer receptivity to the ionKey, and then what kind of contribution to top line growth you are banking on this year from that product?

Art, you want to talk about customer, initial customer reaction?

Sure. The aspect -- primary aspect of the ionKey is that it is designed for applications where you are dealing with very small samples requiring very high sensitivity. Traditionally, standard liquid chromatographs were used, which in conjunction with a mass spectrometer, made for a fairly sophisticated and complex system with a lot of plumbing and tubing.

The ionKey, for lack of a better term, is almost a solid-state chip-based system that really replicates the performance levels that you find with the ACQUITY-based type of performance systems. About two years prior to its introduction at Pittcon, we tested it, roughly 25 major pharmaceutical houses with people doing high sensitivity, regulated bio-analysis. It probably had one of the most expensive pre-introduction evaluations and it got outstanding reviews.

As we have rolled it into the marketplace, the receptiveness, in a fairly narrow space which, again, is low-volume, high-sensitivity applications, typically clinical type trials and so forth, is quite strong. Having said that, these systems are sold in fairly high-end mass spectrometry-based systems, and they're going into a market segment that is well-established.

We're counting on -- excuse me -- the acceptance probably will take anywhere from 6 months to 18 months for the early adopters now in the broader marketplace to pick up on this technology and find its advantages. We think it has a fairly large audience in the pharmaceutical industry, but we also believe because it is regulated and it will require a shift from traditional methods, it is not going to be an overnight transition. It will take awhile.

But we are very excited about the technology, the customers are excited, as we think that the future is very promising. And it will probably represent the direction of separations technology on the front end of these types of mass spec systems.

Okay, great. Thank you.

Our next question is Isaac Ro, Goldman Sachs

Good morning. Thanks for taking my question. I just want to ask one on the pricing environment in general. Maybe talk a little bit about what's embedded in your guidance this year and what you've seen year-to-date?

I would say there have been no dramatic changes in the pricing environment. You always, Isaac, have some territory around the world that pops up out of the vacuum that all of a sudden a competitor seems to go on a rampage of offering special discounts. But those things happen in very small areas.

We, frankly, don't see a broad dynamic of significant difficult price competition. It is a very competitive market, so we are always cognizant of what is going on, but I would say that there is nothing -- certainly, if you just look at China, for example, it wasn't that all of a sudden somebody started charging lower prices. We just haven't seen those kinds of dynamics. It is more or less business as usual, as we have seen over the last several years.

Okay, that is helpful. And then, just a follow-up would be your visibility in the drug industry. We're, obviously, facing a potentially unprecedented year in M&A there. If you could just remind us, if we think about the cadence of spend from those customers when you have this type of M&A out there, is it the kind of thing where you have some sense of visibility on when the budget dollars get held up versus when they get released and spending comes back to normal, so to speak?

And if so, how much of that is kind of discounted in your current guidance? I think this question might have been touched on earlier, but was just hoping to tease out some more specifics relying on past precedent? Thanks.

First of all, I would say since, nothing in terms of a real merger, nothing is really underway. You see the transactions going on between Glaxo and Novartis and restructuring those R&D programs.

But that aside, certainly, the Pfizer/AstraZeneca, if it ever happens, wouldn't affect this year. On the largest front, I don't think you are likely to see those M&A activities affect 2014.

To the extent that they do happen, I'd say we've seen both kinds of effects in the last, go back over 10 years. Some of those deals were aimed largely at sales force consolidation and back-office and G&A. And I'd say in many of those cases we -- you always see a somewhat of a delay, but a pretty rapid return to our normal run rate of business.

In more recent years, we have seen more of a focus on R&D organizations, and, in fact, have seen a more significant effect -- short-term effect -- on R&D procurement as they have consolidated R&D operations, and significantly in some cases cut back. What we're clearly seeing in our broad pharmaceutical marketplace is that the strength and the activity in the generic and the specialty pharma, and biotech, has made up for that slowdown in the consolidation of big pharma.

But that's where I would say you really have to look at the specifics of any transaction. And who knows, if a US company really gets $100 million or more in tax benefits from doing this, maybe they will have more money to spend on R&D.

Got it. That is very helpful. Thanks for all the color.

Next question is Jeff Elliott, Robert W. Baird.

Good morning, thanks for the question. Can you talk a little bit more about the triple quad market? What do you see in there? Is there a change in the competitive environment or what is going on?

Gene can chime in here, too. The triple quad market, I would say, is one of the most competitive segments of the mass spectrometry market. It traditionally has been a marketplace where something happens with one product introduction and they kind of hold a stronger position for a while, and then a competitor adjusts and comes back.

And I would say that happens almost year-by-year where you see, no one gets knocked out of the box, but they have to respond to specific introductions. With us, I think you are seeing us, to some extent, respond with things like ionKey in terms of system configurations.

But I do think it is fair to say that we have seen a number of competitive introductions in the triple quad market in the past, oh, 9 to 12 months, and that has probably had some effect on what has gone on in the marketplace. And you'll see us respond over the next 9 to 12 months with our own introductions, some included at ASMS, and I think this is just the market that we live in. Do you, Gene?

Yes, I would just add that as we look at the tandem quadrupole market, we see the largest segment of that market being for regulated bio-analysis. And based on the performance of our Xevo and Xevo TQ-S, over the past few years we've made some inroads into a market that has historically been a tougher one for us. Over that time, though, I think we have made very good penetration into the food safety testing and environmental segments.

So we are disproportionately represented in our market mix towards these applied markets. I would say that, as you look at these applied markets by quarter it tends to be a lumpier business. As regulations come into place, you get a surge of business and it feels good then, but then a year later it is in the base.

I would say, along with the dynamics that Doug pointed out that looking at what has changed year over year from us is just been as not -- is not as robust a market for some of these applied market opportunities.

Got it. Okay, thank you.

You're welcome.

Next question is Tycho Peterson, JPMorgan. Tycho, your line is open. Please check your mute feature.

Operator, I think if Tycho is not ready, I think we probably have time for one more question as I see we've reached the bottom of the hour.

Operator?

Yes, your line is open, sir.

Can you guys hear me? Doug, I was wondering if you could comment on (inaudible) trends? Now that you've had another month under your belt, do you see --

I'm sorry, I can't -- is that Tycho? I can't hear you.

Sir, can you -- he just disconnected. Did you want to take the next one, sir?

Okay, yes. We'll take this and we'll make this the final one.

Tim Evans, Wells Fargo Securities, you line is open.

Thank you. Gene, I think you said at the earlier part of the call that you got basically no contribution from acquisition revenue, inorganic revenue in the quarter. But it looks like you spent maybe about $45 million on acquisitions since the middle of 2013.

Can you comment there on what is going on? I don't think you are buying zero revenue companies there are you?

If I take a look at the acquisitions that were made last year, and look at those for the TA Instruments group specifically, we made about four acquisitions. We did not get product revenue for those acquisitions within the TA Instruments division.

Now within the Waters division, we also made acquisitions last year. But they were technology based. So it was technology that is embedded primarily in our SYNAPT line of mass spectrometers.

So it is a long-term technology play rather than a revenue stream that we acquired. That is the reason why you are not seeing revenue associated with the Waters division acquisition because we really were not buying revenue, we were buying technology.

And on the TA side, we have devoted a significant amount of time during the last quarter towards training the new organization and getting manufacturing processes honed for future growth this year, and I think you'll begin to see in the second quarter and beyond some nice contribution from the TA acquisitions.

Yes, Tim, the TA acquisitions were largely done late in the year, and they were smallish organizations. In many cases, they are doing businesses through distributors.

And so we decided, as part of the transactions, to take the time and renegotiate -- since we are going direct -- we had to renegotiate agreements in many cases, and thought that it would be much cleaner to not press these products through an old distribution channel, but to take our time and drive it out there later in the year. That is why you are seeing a de minimis effect in the early part of the year, but these sales will grow significantly as we move through the year.

Okay. Thank you. Can you just make a real quick comment on what you saw in India in the quarter?

Yes, our overall business in India was flat in the quarter, which is probably a little better than it was on average last year. And I still think we're seeing the effect of the regulatory issues in the generic drug manufacturers in India. And we're beginning to see the rupee beginning to settle down, so we have some optimism that as we get later in this year we could see an improvement in our India business.

Okay. Thank you.

Okay, operator, I guess we have time for one more question just to be fair here. And Tycho dropped off. So we will limit it to one more, and if there is anyone in the queue?

Yes, you have like seven in the queue. Our next question is Derik De Bruin.

Hi, good morning.

Good morning, Derik.

So, Doug, I don't mean to -- and, Gene, I don't mean to harp on this, but I am a little bit surprised that you are maintaining the organic revenue growth guidance at mid-single-digits given historically what has happened. There has been product delays as people have -- or purchasing delays as people have looked at to marshal their products.

(inaudible) to marshal their resources have had all these ills, and also in emerging markets they're not as strong. Academic and government markets are not strong as they were in the past, even applied markets are slowing.

I am just a little bit curious as to why you still think that this time is different from what we've sort of seen in the past? I'm still just a little bit flabbergasted.

I will start, Derik, and I will let Doug chime in. I think as you begin to look at the mid-single-digit growth rate assumption, here are some of the basic tenets that are beneath that. We think that market conditions are not drastically different from what we experienced last year. And last year, our constant currency growth rate was a little bit better than 5%.

If I take a look at the components that drive our growth, we have roughly half of our business grouped within the broad definition of recurring revenue, and historically it has grown at a consistent mid-single-digit or better rate. If we think about the recurring revenues growing at a rate that is historically in line, you would be looking at a 5%, 6%, 7% growth rate, which brings about 3 points of growth to the Corporation.

So superimposed on that, we think that we have some opportunities this year with products like the QDa, and with the TA acquisitions to ensure a certain level of instrumentation growth above the recurring revenue growth. So when you begin to break the business apart that way, and you think about what the implications are for the core revenues for the core revenues for instruments, they are really are not that dramatic to get you to the 5%-plus level. So that is the basic understanding that brought us to this position.

I think, Derik, to be fair, if you look at one of the most significant shortcomings in the quarter, China was a big piece of it. So if you look at the risk/reward equation, we clearly think that the rest of the year in China isn't going to be a continuation of the first quarter. We think we have analyzed that to a level that we're not crazy in that assumption.

In many ways, we are looking at significant projects that would even add to that enthusiasm, but they are not in hand yet. We're not going to take them to the bank.

But I would admit that China is a swing. If we're not right, and China doesn't come back -- but we don't think China can cut off forever their commitment to this technology. So that is an important part of why we think the future is better than the first quarter.

Great. Thanks.

Thank you.

All right, Derik. Well, thank you all for hanging with us this quarter. It was clearly not the strongest quarter that we've had recently, and we hope to be talking to you on a more enthusiastic bent next quarter. Thanks, again, and we will see you in the future. Goodbye.

This does conclude the conference for today. All participants may disconnect at this time. Thank you.