Waters Corp (WAT) 2016 Q4 法說會逐字稿

Good morning. Welcome to the Waters Corporation fourth-quarter 2016 and full-year financial results conference call. (Operator Instructions). This conference is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. John Lynch, Vice President of Investor Relations. Sir, you may begin.

Thank you, operator and good morning, everyone and welcome to the Waters Corporation fourth-quarter earnings conference call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the Company. In particular, we will provide guidance regarding possible future income statement results of the Company for the first quarter and full year 2017. 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, 2015, in Part 1 under the caption Risk Factors and the cautionary language included in this morning's press release and 8-K.

We further caution you that the Company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for April 2017.

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 issued this morning. In our discussion of the results of operations, we may refer to pro forma results, which exclude the impact of such items -- of items such as those outlined in our schedule titled Quarterly Reconciliation of GAAP to Adjusted Non-GAAP Financials included in this morning's press release.

Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the fourth quarter of fiscal year 2015. In addition, unless we say otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis. Now, I would like to turn the call over to Waters' Chief Executive Officer, Chris O'Connell. Chris.

Great, thanks, John and good morning, everyone. Thanks for joining us today. Along with John Lynch, joining me on this morning's call are Sherry Buck, Waters' newly appointed Chief Financial Officer and Gene Cassis, Waters' outgoing CFO, who is transitioning into a new corporate advisory role.

During today's call, I will provide an overview of our operating results for Q4 and 2016 and will add some broader commentary on the business. Gene will then review financial details for our reported results and Sherry will then provide our 2017 financial outlook before the Q&A period.

I'm pleased to report that we finished 2016 with strong broad-based sales growth across our major market categories and productlines. The quarter capped off a 2016 fiscal year that featured robust organic revenue growth, operating leverage and double-digit earnings-per-share growth. In the fourth quarter, revenues grew 9% and adjusted earnings per share increased by 13% as reported. For the full year 2016, sales grew 7% and adjusted earnings per share increased by 12% as reported. These full-year results were especially encouraging as they followed strong growth in financial performance in 2015.

Taking a closer look and starting with a review of our market categories at the corporate level. Sales to our broadly defined pharmaceutical category grew 6% in the quarter and grew 10% for the full year. The strength in pharma demand over the course of the year was driven by macro trends of rising global regulatory standards, increasing global patient access to prescription drugs and the growing testing needs of newer biologic drugs that feature ever-increasing complexity and molecular structure.

Sales to our worldwide industrial category, which includes the material characterization, food, environmental and fine chemical markets across all productlines were robust in the fourth quarter growing 14%. This category continues to be led by demand for food quality and safety testing and was also aided by demand for fine chemical applications that rebounded from levels seen earlier in the year. For the full year, the industrial category grew 6%.

Looking at our governmental and academic category, we saw a general rebound in the quarter with sales growing 6%. Growth was led by improved performance from academic customers in Europe where we saw a notable increase in installations of new research-grade mass spectrometry instruments, as well as strong performance from governmental agencies in Asia-Pacific. Like Europe, the US was strong in Q4, but negative for the year, which contributed to a full-year decline in our overall government and academic category by 3%. As we have consistently conveyed, this category is small and somewhat lumpy quarter to quarter for Waters, so we tend to focus on rolling trends versus any particular quarter result.

Now I'd like to review productline dynamics, which I will cover by our Waters and TA-branded lines. Waters' instrument sales grew 12% in the fourth quarter with LC and LCMS platforms performing about equally as well, accompanied by continued strong performance for laboratory informatics offerings.

Looking at the full year, Waters-branded instrument platform sales were up 7%, a rate that reflects our strong product positions and the excellence of our field operations in a very competitive marketplace. On the LC front, ACQUITY Arc and workhorse alliance-based systems for regulated testing drove overall LC system growth. For LCMS applications, benchtop systems that incorporated our ACQUITY QDa and Xevo family of tandem quadrupole mass spectrometers grew impressively. With thousands of installations now, the ACQUITY QDa mass detector continues to expand the adoption of mass spectrometry molecular characterization to the larger liquid chromatography market and user base.

Waters' recurring revenue, the combination of service and chemistry consumables, grew 9% in the quarter. This rate includes the positive effect of two additional selling days in comparison to the prior year's quarter. For the full year, Waters' recurring revenues grew 8% marking the third straight year of high single digit growth. This consistent performance is indicative of strong instrument utilization, growth in service plans for regulated workflows and leading technology positions for advanced consumables.

Our differentiation in consumables continues to grow with innovations in LC columns such as CORTECS and application-specific testing kits such as GlycoWorks and ProteinWorks. Additionally, sales of ACQUITY UPLC columns continue to demonstrate the increasing uptake of UPLC technology in more challenging biopharma workflows.

Turning to our TA productlines, revenues were down 2% in the fourth quarter. Sequentially, we saw a nice pickup of orders and shipments in comparison to the third-quarter result and the fourth quarter's modest decline was more a reflection of the mid-teens growth that we delivered in the prior year's fourth quarter. From a product perspective, we saw increasing customer acceptance of our newly introduced Discovery line of thermal analyzers. In the quarter, we began shipping our Discovery Thermal Gravimetric Analyzer, or TGA, an instrument that is often purchased alongside differential scanning calorimeters or DSCs. Customer feedback on the new Discovery line continues to be favorable and our installations have gone very well.

For the full year, sales of TA products and services increased 2%. This growth is slower than the business's long-term trend and reflected moderate weakening in demand from industrial end markets against the prior year's strong performance. We now enter 2017 with a strong product position, a growing business pipeline and some early indications of a cyclical recovery in industrial demand.

Finally, I will review performance by geography at the corporate level. Asia-Pacific continued to pace our global growth for the fourth quarter while Europe was also a region of strength and the Americas grew more modestly. Asia, outside of Japan, has been strong over a multi-year period and this performance continued throughout 2016 with growth in the high teens range in the quarter and mid-teens range for the year.

The strength in our business in Asia was highlighted in 2016 by strong double-digit sales growth in China, as well as consistent double-digit growth performance in India. Within China, we saw growth across all of our market and productlines with particularly strong demand from pharmaceutical customers.

Looking specifically at this category, growth drivers included new regulatory requirements by China's Food and Drug Administration, which focused on increasing analytical rigor across key workflows to assure consistency of results and integrity of archived data. Our industry-leading and power chromatography data systems has us well-positioned to meet these rising regulatory needs.

In Japan, sales increased 6% in the quarter and 4% for the year. Growth over the course of the year was somewhat balanced between the pharmaceutical and industrial categories. Revenues in the Americas grew by 2% in the quarter with strong growth in specialty pharma, chemical materials and government and academic markets, offset by weaker growth from newer clinical diagnostic installations in applied industrial markets.

For the year, America sales increased by 3% with balanced contributions from the pharmaceutical and industrial categories offset by modest declines in governmental and academic business. Europe as a region was a strong contributor to the fourth quarter, growing 9% behind strong trends in pharmaceutical applications for both LC and MS instruments, as well as service plans. Offsetting stronger growth in Western Europe was weaker demand in Eastern Europe and the Middle East. For the year, Europe grew 6%, impressive when considering the backdrop of economic uncertainty in a number of countries.

Stepping back and looking at the corporation broadly, 2016 was a year of great performance and also great progress. It all starts with our 7000 employees worldwide, for it is our people, culture and values that make the Waters difference. I want to congratulate our entire organization for a job well done. The team works tirelessly and executed all year long.

While we delivered strong financial performance in 2016, we also transitioned to our new leadership structure, advanced our innovation capability through development of a rigorous portfolio of management process and created a strategic framework to guide our continuing growth and performance for the long term. It was a busy and rewarding year and I feel very grateful to be part of such a fine Company and team of people.

In a few minutes, you will have the chance to hear from Sherry Buck, our new CFO, as she outlines our financial outlook for 2017. Though Sherry has been at Waters for only a few weeks, she has already immersed herself in the business, participated actively in financial planning activities and contributed strongly in her new position. We are very excited to have Sherry and welcome her warmly as our CFO. Her background, skills and character are the perfect fit for Waters at the right time as we navigate the changing landscape of corporate finance and chart our next phase of shareholder value creation.

I also want to salute Gene Cassis as he supports Sherry's onboarding and transitions to his new corporate advisory position focused on technology and strategy. You will continue to see Gene, but I wanted to thank him at this time for a truly impactful and memorable three years as our CFO. I know everyone in the investment community will miss interacting with Gene on a daily basis, but rest assured his positive impact on Waters will only continue.

Finally, I want to comment on our upcoming Investor Day scheduled for Thursday, March 2 in New York City. Our goal as the Waters management team for this meeting is to provide investors with a fresh look at our markets, products and growth strategies. While much of what you will hear will feel familiar and consistent with our development to date as a company, our aim is to provide fresh new insights on our evolving global markets, our unique competitive position and our strategies for growth and value creation.

Perhaps more importantly, you will have the opportunity to hear from our experienced and talented executive management team. I know you will enjoy meeting them and I am confident that their remarks will add new texture to Waters as a compelling investment opportunity.

Now I'd like to pass the call over to Gene for a deeper review of the 2016 financials. Gene.

Thank you, Chris and good morning. In the fourth quarter, our revenues came in at $629 million, an increase of about 9% before currency translation. Currency translation reduced sales growth in the quarter by about 2% resulting in 7% reported sales growth. Our non-GAAP earnings per diluted share in the fourth quarter were up 13% to $2.21 in comparison to earnings of $1.96 last year. On a GAAP basis, our earnings were $2.15 versus $1.83 last year.

For the full year, 2016 sales grew about 7% before currency effects while currency translation reduced sales growth by 1%. Our non-GAAP earnings per fully diluted share were up 12% to $6.62 per share versus $5.89 last year. In all, the impact of foreign exchange benefited full-year earnings by about $0.07 versus the prior year. On a GAAP basis, full-year earnings per share were $6.41 versus $5.65 in 2015. A reconciliation of our GAAP to non-GAAP earnings is attached to our press release issued this morning.

Looking at the fourth quarter, our growth was balanced with all of our major customer-defined markets contributing nicely. Our pharmaceutical end markets grew 6%, industrial markets grew 14% and sales to global, academic and governmental customers grew 6%. Productline growth was also balanced with total instrument sales growing at 9% and recurring revenues up 8%. Breaking that down further, our Waters products and services sales were up 10% while TAs declined by 2%. Breaking that down even more, LC and LCMS platform instrument sales increased by 12% and TA's instrumentation system sales declined by 4%. Our total recurring revenues associated with both Waters and TA products grew by 8% with TA service revenue up 3% in the quarter. Looking at the full-year, instrument and recurring revenue sales for the corporation grew 6% and 8% respectively.

Now looking at our growth rates in the fourth quarter geographically and before currency translation, US sales were down 1%; European sales were up 9%; sales in Japan, up 6%; and sales in Asia outside of Japan were up 18%. As for TA, global product and service sales were down 2% overall with growth in Europe offset generally by declines elsewhere.

Looking at the full year, Asia-Pacific showed strong and consistent growth throughout the year and grew at 12%. Europe was also solid growing 6% and the Americas grew 3%. This over a strong prior-year performance.

Now I would like to comment on our fourth quarter's non-GAAP financial performance versus the prior year. Gross margins for the quarter came in at 60% compared to 59.4% in the prior year's quarter. For the full year in 2016, gross margins were 58.9% versus 58.7% in the prior year. In the fourth quarter, foreign exchange impacted gross margin's percent positively by about 60 basis points and for the full year, the impact was neutral.

Now moving down the P&L, in the fourth quarter, operating expenses were up 9% on a constant currency basis and 5% on a non-GAAP reported basis. In the quarter, higher variable expenses associated with higher volume and performance incentives contributed to spending growth. For the full year, operating expenses were up 5% on a constant currency basis and 3% on a non-GAAP reported basis.

On the tax front, our effective operating tax rate for the quarter was 14.3% and for the full year 14.1%. This versus 13.8% in 2015. In the quarter, net interest expense was $6 million and our average share count came in at 81 million shares or approximately 1.4 million shares lower than in the fourth quarter of last year. This being a net effect of our ongoing share repurchase program.

Now turning to the balance sheet, cash and short-term incentives totaled $2.8 billion and debt totaled $1.8 billion, bringing us to a net cash position of $986 million. As for fourth-quarter share repurchases, we bought 595,000 shares of our common stock for $82 million. This leaves $123 million on our 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 nonrecurring items that are unusual. In the fourth quarter of 2016, free cash flow came in at $151 million after funding $21 million of capital. Excluded from this amount is approximately $2 million of investments associated with facility expansion. This brings our full-year 2016 free cash flow to $555 million or approximately $0.25 of cash flow for each $1 of sales.

Accounts receivable days outstanding stood at 71 days in the quarter, which is equal to that in the fourth quarter of last year and sequentially down five days from the third quarter. In the quarter, inventories declined by $40 million in comparison to the prior quarter. This is in line with our typical seasonal patterns.

At this time, I'd like to hand the call over to Sherry Buck, Waters' CFO, for further comments on our future outlook. Sherry.

Thank you, Gene and good morning, everyone. I'm very happy to be a part of the Waters team and I'm looking forward to connecting with many of you during our engagements with the investment community in the coming months.

Looking ahead to 2017, our outlook generally assumes continued stable demand from our pharmaceutical end markets, consistent growth in our recurring revenue and balanced growth rates from our other end markets. These dynamics lead up to a mid-single digit constant currency sales increase in 2017.

At current rates, currency translation is assumed to reduce 2017 sales growth by about 2% to 3%. Gross margins for the year are expected to be consistent with the prior year, in the range of 58.5% to 59% as volume-related manufacturing efficiency gains are expected to be offset by negative effects from foreign currency translation. Our plan is to continue to manage operating expense growth at a rate that is less than our sales growth rate.

Moving below the operating income line, net interest expense is expected to be approximately $26 million. Our current operating tax rate is estimated to be approximately 14%, similar to our 2016 rate. Our 2017 guidance regarding capital allocation assumes continuation of our share repurchase program through 2017 at a rate that will result in an average diluted 2017 share count of about 80 million shares outstanding.

Rolling all this together and on a non-GAAP basis, full-year 2017 earnings per fully diluted share are projected to be within a range of $6.85 to $7.10. At current rates, currency translation is assumed to negatively affect EPS growth by approximately 4%.

Looking at the first quarter of 2017, sales growth is expected to be in the range of 3% to 5%. At today's rates, currency translation is expected to reduce first-quarter sales growth by about 2%. This sales growth rate includes the effect of two fewer selling days in the quarter that we assume will reduce sales growth by approximately 1%. These top-line factors combined with moderate increases in expenses result in an estimated first-quarter earnings per diluted share in the range of $1.26 to $1.36. Now I would like to turn the call back to Chris. Chris.

Great. Thank you, Gene and thank you, Sherry. As we turn to 2017, we will continue to emphasize execution in our core business and believe the trends in our key business drivers suggest a continuation of solid operating performance. As always, when entering a new fiscal year, we will strive for balance in our results and seek to cover unexpected changes in our assumptions with the breadth of our growth opportunities. Additionally, as we have stated consistently, we will seek to balance growth, operating leverage and investment in the business.

With that, we will now open the phone lines for Q&A. We are rarely able to get to everyone's questions, so please limit yourself to one question and one follow-up and if you have additional questions, please contact our Investor Relations team after the call. Jay, first question, please.

Thank you. (Operator Instructions). Tycho Peterson, JPMorgan.

Thank you. Chris, want to maybe ask on pharma dynamics. It looked like you had a little bit of a slowdown there when you take into consideration the extra selling days and easier comps. Can you maybe talk about what you saw in the channel at the year-end? Was there any kind of budget flush dynamics that you could call out? And then what's embedded in guidance for both pharma growth and then separately for biotech for 2017?

Sure. Thanks, Tycho. Yes, the pharma quarter, as we talked about, was up 6% on a year of 10%. So I think the fact that we saw fairly balanced demand at the end of the year is evidence -- maybe to answer your question -- on budget flush that we did not see any significant budget flush. In fact, we saw the strength in our business generally across the quarter and most of the growth in the quarter came from the smaller and specialty accounts as we have consistently talked about that we do have a broadening base of pharma demand that is not as reliant on the large pharma companies that have historically been a question of budget flush. And so really you can see from the result in the fourth quarter growing more modestly than the year that we did not necessarily experience that type of flush.

And I would also point though to the prior year where we had a strong pharma year as well in 2015. We saw the same pattern of moderating growth towards the end of the year. And so when I look at the pharma performance for the Company, I really look at the total year result, which was that double-digit result.

In terms of guidance and what we are assuming for 2017, to answer the last part of your question, I think we do what we always do is to be a little more moderate in our outlook and look at more historical trendlines when forecasting a line of business such as pharma and, as I pointed out in my prepared remarks, we seek to achieve more balance across our portfolio, at least from a planning standpoint. It doesn't mean we are not going to be going for upside like we've been able to achieve, but I think we've taken a very pragmatic outlook in terms of our guidance that we have given.

Okay. And then just if I could ask one follow-up. What is in guidance for China and India? These have been big sources of strength for you guys over the past year. Can you just clarify what you are expecting there?

Yes. Certainly China and India, as we pointed out, had another strong year and it's a strong year on top of a strong year. Those performance trends reflect the underlying positive conditions in those markets for sure, but also the strength and consistency of our approach executionally in those markets. But, again, like the pharma story, when we look at guidance for the year, we do look to moderate our expectations to set a bar that we can achieve and don't necessarily assume that everything goes right in every geography. And so really when you look at what we are assuming for 2017, it's a moderation off the performance we have seen from 2016 and 2015, but again that's a baseline and we will attempt to improve upon that over the course of the year.

Thanks.

Dan Arias, Citigroup.

Good morning. Thank you. Chris, just to drive home the point on Tycho's question there, should we take your comments to mean that the mid-single digit assumption overall is in line with what you are thinking for biopharma? I'm sorry to ask the same question twice, but just given the magnitude of decline, I am just trying to get a number for the assumption on biopharma.

Sure. I think mid-single digit overall guidance for our Company is very consistent with the type of guidance that we've given heading into prior years, again looking at an overall balanced portfolio, not assuming everything goes perfectly and wanting the ability to cover changes in assumptions over time. I would say that the historic rate of the pharma market for us has been a little bit better than mid-single digits, more in line with the Company's long-term trendline growth rate of around 6%. And I think it's responsible to begin the year with that more moderate type of an outlook, but really underlying that is a set of market dynamics that we think are sustaining.

We have talked about these in the past and certainly conditions we saw in the fourth quarter continued to reinforce to us that those core drivers are intact, drivers such as the rapid rise of prescription drugs in the world really fueled by generics, factors such as the increasing research and now commercial activity of large molecule drugs that carry with them more significant characterization requirements due to the complexity of those molecules and just a general rise in standardization of regulation around the world, and that is particularly fueling our business in the emerging markets like China and India. So really a lot of those drivers are very much intact and again, we try to make prudent assumptions when we head into a new fiscal year.

Okay. Thanks. That's helpful. And then maybe within industrial, can you just put some color to the comment on the early signs of potential cyclical recovery? And then maybe if we just look at the four subsegments that you typically tease out, would you mind just listing them in order of strength? It sounds like food is at the top. I would love to just get a relative sense for your expectation around materials, chemical, environmental as you look at 2017. Thanks.

Sure. Yes, I think our comments on the industrial sector reflect our own experience, particularly as we close the year, but also just the broader backdrop of what we are seeing in the economy and certainly we are seeing probably a little bit better tone in the market among some of our end customers in terms of capital spending. Now, obviously, we need that to be proven in terms of orders as we get into the year, but it does seem like the broad tone is a little bit better.

In terms of the quarter, obviously, we had a good industrial quarter at 14% growth and actually 6% for the year, so when you really step back and look at industrial for the Company, there were definitely puts and takes, but a pretty solid performance for the year. At the top of the leaderboard, if you will, for the industrial businesses indeed, the food and environmental, those applied markets, which are really a reflection of rising testing standards in the food safety industry and the continued adoption of LCMS technology. We have a particularly strong product position right now in that area with our tandem quadrupole mass spectrometer offerings and that's really a combination of the TQ-S Micro, which has been on the market for several years, as you know and the newly launched in 2016 product, the TQ-XS, which is our new high-end tandem quadrupole mass spectrometer. So we have a good product position. We have favorable trends in those market segments that are really leading our industrial category.

The fine chemicals market, the chemical materials market was softer during the year, but did have a rebound towards the end of the year and really normalized I would say in the fourth quarter for an overall year look and so that would be really the next on the list and perhaps hopefully signals some stability in the coming year.

The TA instruments business, as we pointed out, had a softer year obviously on a tougher comp, but reflecting really a broad year of relatively soft demand in the material science, polymer, metals market, but, again, we feel really good about the TA franchise overall from the standpoint of the product position that we enter 2017 with and so if there is a pickup in demand in those end markets, we stand to benefit as we head into 2017.

Okay. Thanks very much.

Dan Leonard, Deutsche Bank.

Thank you. I guess I will start by following up on that last bit. Chris, can you comment on how TA performed versus plan in the fourth quarter and would the expectation on 2017 just be mid-single digit like the rest of the Company and an assumption that markets improve?

Yes, TA was soft in the fourth quarter and they missed their plan and obviously, we are not happy about that, but we also are putting the right context around that, which is they had a terrific quarter in the year prior, so their comp was tough. Their comp was 15%-type growth in the fourth quarter of 2015.

As I pointed out in the prepared remarks, we did see a nice sequential improvement in their result in Q4 from 3% to 4% and we are encouraged by the work they are doing in their pipeline. And so in terms of the year we expect TA to have, we certainly model them in and around the corporate average, which is primarily organic growth, but we will get a small benefit from a small acquisition we made in 2016 that we talked about in one of the prior calls. But like I said earlier, we are really keying off of the Discovery productline as our main lever to achieve better growth in 2017.

Understood. And I know it is a smaller part of your business and you are not a great barometer, but can you discuss maybe what you are seeing in the academic market? It sounds like the US was still weak and maybe what the outlook is there for 2017?

Sure. Yes, the government and academic market, as we talked quite a bit about last quarter, is smaller and lumpier and we had a good quarter worldwide. It was strength in Europe and Asia offsetting relative weakness in the US, but nothing off the radar. And for the year, the category overall was down in the low-single digits as I pointed out.

Like we have stated before, we always have relatively modest expectations for this sector because it does tend to be lumpier and really more research-grade mass spec-oriented. We do like our product position and to the extent there is an approved spending profile coming from those types of sources, we stand to benefit. That market is generally driven by medical research where there is certainly a lot of interest in broad-based funding and really is an interesting proving ground for the latest and most exacting measurement technologies and so we like the market. It's a good market for us, but it is smaller and lumpier and we have a relatively modest outlook because of that.

Got it. Thank you.

Isaac Ro, Goldman Sachs.

Good morning, guys. Thank you. Wanted to start with a question on just the strength in Europe and academic globally where it looked like your performance was better than most would've expected. I know you guys are at the beginning of the earnings cycle here for the group, but I'm wondering if you have any views as to whether or not marketshare was part of the driver and I know it is hard to measure, but it just seems like you guys at the very least might have gained a little share, at least in those two areas?

Yes, Isaac, that's a good question and I think I don't have a very good answer. Marketshare, as you point out, is tough to ascertain, particularly the further you get out in the world and in different pockets. I would say that we had, in Europe, particular success with our new Vion high-resolution QTof mass spectrometer in some of the key academic centers. It has attracted some interest with an increasing perspective, I would say, on ion mobility in workflow and solid execution by the team. That was true in Asia as well.

So whether we picked up share is hard to say. Because of the lumpiness of those markets, I wouldn't want to draw conclusions based on very limited data, but we obviously like the performance and we are going to continue to attempt to play with the hot hand as the year unfolds here.

Great. And then just a follow-up on the maybe financial side with regards to margins. Sherry, if you could comment that would be great. I know you are new in the seat, but just curious if, in your initial overview of the business, anything really stands out in terms of areas where you could drive an improvement in margins? Waters obviously has been a very profitable company with great margins for a long time, but I think the assumption here is that there is still opportunity. So if there is either a category or a theme here that we should think about as you take the reins, I would be interested in where you think there is opportunity for improvement.

Sure, yes. So as you pointed out, there has been a very strong history of product performance and really as you look at the margins we've achieved historically, I'd say it's really a factor of the kinds of businesses that we are in that generate those kinds of margin profiles. I would say, like all companies, I think we have opportunity to improve in our operations through various efficiencies and that will be one of the areas that I will be focused on this year.

Okay. Thank you.

Ross Muken, Evercore ISI.

Good morning, guys. Just curious on the capital equipment side. It seemed like obviously strength broadly, but how much lumpiness was there in some of the order patterns and obviously, you didn't see much flush in pharma, but I'm just trying to get a sense of, in the industrial and some of the other nontraditional businesses, how that cadence looked and then obviously it's tough to see any look into 2017 as we are only in January, but as your sales has had conversations on capital equipment purchasing, is there any areas you would highlight for us to monitor where it could be improving or decelerating?

Thanks for the question, Ross. The instrument category, generally, the hardware category, was pretty solid across the year. We had in total instruments 9% growth for the quarter and 6% growth for the year, which is really right in the zone of where we expected and hoped to be, then with the recurring lines giving some improvement to that. And what was nice to see, particularly as we came to the end of the year, was more balance between LC and MS. We were a little softer in the beginning part of the year in the mass spec business, pretty solid throughout the year in LC and really as we got towards the end of the year seemed like better balance and anytime we see better balance, we are encouraged.

In terms of lumpiness, I guess I am still in the broad sense of the word getting to know the business and understand the different patterns and there are always a lot of puts and takes. And so I tend to see the lumpiness factor within certain subcategories like government and academic with more consistency in the bigger categories like pharma and then really in that broadly defined industrial trade class, if you will.

What I have been looking for is strength and consistency in the factors that tend to drive that category like the applied markets in food and environmental and that was really a good story in the year driven by both a good product position, as well as relatively healthy end markets. And I think the trends that are driving some of those end markets in the applied areas are ones that are sustainable just because of the general rise of regulatory standards and expectations for quality and safety in the world's food supply.

Got it. And just to be clear, on the operating margin side, obviously, a bit of a shift on the FX benefit this year turning obviously to a headwind. Just give us a little sense of what the underlying implied operating margin expansion and/or incrementals look like because obviously it doesn't look like we are getting much on gross.

Yes, the gross margin, just one quick comment and I will defer to John as well for any further comments, but the gross margin was relatively flattish, but keep in mind that a couple of key drivers for the business this year, for example, were China and then broadly the global service business. Both of those areas of business tend to carry slightly lower gross margin, but they are accretive to the operating margin. And so really by the time you get down to the operating margin, one thing we feel best about over the course of the year was the modest operating leverage we were able to achieve and the improvement in the operating margin really on an-as reported basis, as well as on a constant currency basis. And so to get the 7% top-line constant currency to reflect in double-digit operating income growth was a good achievement by the team and really reflected the mix of the business overall rather than being too fixated on one particular line or the other. But it was good spending control. It was efficiency gains and it was, at the same time, making sure we are making the right investments back into R&D and things that drive our growth for the future.

And maybe just to add to that, Ross, what Chris said. I think that the major dynamic in margins for 2017 is that we are expecting a bit of an FX headwind in margins. I think other than that, the dynamics will be similar to what Chris described.

Great. Thanks.

Jon Groberg, UBS.

First of all, welcome, Sherry, to Waters and good luck.

Thank you.

Jack Meehan, Barclays.

Thanks. Good morning and maybe I just want to start off on FX and just what your thoughts are on pricing philosophy there and just more broadly what's baked into the guidance on that front.

Baked in in terms of the overall FX headwind?

Yes. I guess just with some of the recent changes whether it impacted the way that you think about setting price for some of your products.

No, I would say that we tend to be pretty consistent in our pricing philosophy. We do try to achieve annual modest and sustainable price increases, especially where we demonstrate that value to our customers. So I don't think there is anything unusual in terms of our pricing policy or strategies right now related to FX. Obviously, we try to protect our revenue in some of the more volatile currencies through a combination of pricing in dollars and local currency, but I wouldn't say there is anything unusual heading into this year.

Got it. Thank you. And then I just want to follow up one more time on biopharma. Getting a few questions on it. And I was wondering just paring your commentary around biotech and some of the smaller accounts driving a lot of the growth with the 2% organic you had in America, just what should be the readthrough in terms of the trends with large cap pharma and just the confidence looking into 2017 that that can continue to sustain the growth? Thanks.

Sure. You have to piece apart the overall pharma picture and the US picture to see some of the underlying points there and, like you point out, Jack, we are less dependent on large pharma. That has been a consistent trend over time where, 10 years ago, 25% of our pharma business was large cap multinationals and today, that is only about 11% and so it is a broadening base of that business and a globalization of that business. And when you really piece it apart, US pharma was comparing to a tough year of 10% growth in prior year and when you exclude the effects of some slightly negative government and academic and flattish industrial, US pharma was more of a mid-single digit, which reflected pretty good performance.

I think we generally feel good about the US. It's steady as she goes and we continue to seek the balance that I described, but certainly not forgetting about large pharma. It's been a really core customer base for a long time and actually some of the most innovative work going on in the world right now is from the traditional large pharma companies and we are very excited to participate in that.

Great. Appreciate all the color.

Jon Groberg.

Thanks. So I just had two quick questions, one on -- I know you don't want to think about this, Chris, but for QDa, can you give a sense as to how penetrated you think that market is from an adoption standpoint? And then the second question -- they are both kind of detailed questions -- given the rhetoric going on in Washington, how are you thinking about or what percent of your products are manufactured outside the US today? I know it's a pretty significant percentage and how are you thinking about what you are hearing going on in Washington? Thanks.

Sure, sure. No, fair question. First of all, QDa, I know I have trouble hiding my enthusiasm of the QDa. QDa is a fantastic product; it's revolutionary in terms of bringing mass spectrometry to a package that is far more usable and integratable into many more workflows. The bottom line is, today, mass spectrometry is used in far less than 10% of traditional chromatographic workflows.

And so we are only at the very beginning of mass detection and this is particularly true as it relates to the use of QDa in mass detection generally in biopharm workflows as biopharm becomes bigger and bigger. And so it's actually hard to put a specific number on percent penetration of addressable market even though we do strive to do that because the other thing we see is that new uses for QDa continue to present themselves. It's a fairly diverse range of uses that people are finding for it and we will put some more color on that when we get to our investor conference in early March. But we really do like the QDa platform and we like what it will do for the field of mass spectrometry broadly.

In terms of the rhetoric in Washington, there is a lot of rhetoric for sure. To answer your question specifically, we are actually relatively balanced today in terms of being a net importer or exporter. We've got a strong global manufacturing footprint with our major facilities between Singapore, Ireland, UK and the United States. And so from the standpoint of potential changes in corporate tax policy, we are actually excited about some of those directions. Certainly access to our global cash would be a benefit. Certainly lower rates in the US would be a benefit and operationally, depending on how significant some of those changes are, we are in a good position based on that global footprint to move production to where it is most optimized to benefit the Company operationally, but also financially.

So we are watching all that very, very closely. I guess I'm an optimist at the end of the day on matters like trade policy. I think we have too much to gain in terms of being a global economy and while there is a war of words from time to time among different countries, I think the US has shown over time to take a pragmatic view towards these questions and I think the US economy will only benefit from that. So I will be an advocate from my chair in terms of free trade-type policies and the growth of the US economy as a result of that, which would only benefit our Company and our industry.

Great. Thanks.

Amanda Murphy, William Blair.

I just have two quick questions for you. One, you mentioned the importance of regulatory dynamics and standardization and you also talked about the Chinese FDA. I was curious how much more runway do you have on that specific initiative, do you think and anything else that is coming down the pipeline that you see in terms of regulatory changes or movements that could help in various different geographies going forward?

Sure. It's a good question, Amanda. We've seen this theme in different markets. For example, two, three years ago, four years ago, we saw this trend play out in India, for example, as the FDA took a greater interest in on-the-ground resources in India and as a lot of these Indian generic providers, both local and multinational, began their efforts to step up compliance activities. To your point, we are seeing that in China real-time as the Chinese government is harmonizing on the greatest common denominator, which are the more exacting FDA level-type standards. We think we are in the middle of that. We are not going to try to predict how long that cycle may exist. We are just focused on executing within it, but we do think, at least in the near term, there is more runway there.

I think this regulatory theme is not just one for the pharmaceutical market, but it's also there for the food market as well and actually it's no coincidence that our food and applied franchise in China in particular has been a source of strength for the Company. We do see over time more transparency in the supply chain for food from farm to market and really the adoption of more sophisticated measurement technology such as LCMS. And so we are trying to pursue those trends. We are trying to advocate with governments for responsible regulation in that regard and we think we will benefit from it.

But rising regulation is also a trend in the material sciences. As new materials become introduced for industrial products of all types, there are increased testing standards and even regulation. So we think this regulatory theme is an important business driver for us and one we are going to key off of.

Yes, okay. Makes sense. I just had another question. I know this might be generic, so forgive me, but I was wondering if you could just talk a little bit about competition. And I know that is probably different in each part of your business and I think mass spec historically has been a little bit more competitive than others, but just trying to get a sense of how you feel about the competitive dynamics at this point and who you are running into type thing?

Yes, I will probably just give a simple answer to that, which is we think we have really great competitors. I have a lot of respect for the people we are up against. The dynamics are different obviously in different sectors. In LC, marketshare tends to be stickier for obvious reasons related to the standards that endure in terms of the methods used to develop and produce medications. Mass spec tends to be a little faster in terms of the innovation cycle and a little bit more dynamic in that regard and don't forget about competition on the service and chemistry side as well. TA instruments on the material side faces a more fragmented competitor base than we do in the LC and MS business, but overall I think we are up against smart, well-resourced, disciplined companies and I think that's good for the business and for the markets and for the customers. So I wouldn't really want to say anything more than that.

Okay. Fair enough. Thank you, guys.

Derik de Bruin, Bank of America.

Good morning. Just a couple of quick ones and then I have one longer one. Any M&A contribution in the quarter? And last quarter, you had a negative 15% academic result in Q3. Was there stuff that got pushed from Q3 into Q4 this quarter?

First of all, M&A was very, very minor, almost immaterial. We had a tiny bit from the Rubotherm acquisition within TA, but it was almost not enough to comment on. Academic, yes, was down in the quarter. We talked about that being sort of small and lumpy. There were one or two relatively modest examples of business that was pushed quarter to quarter, but that is also something that happens many quarters; there's always pushes and pulls. So we tend to look at that, as I said in the prepared remarks, that academic and government over a little bit more of a rolling period as quarters can -- there's sometimes a lot of noise in various quarters.

Great. And then just one longer one. I certainly agree with that certainly globally regulation is going up, but there's news out this morning that Mr. Trump has frozen EPA grants and he is talking about rolling back 75% of regulation. How do you deal with I would say the mixed messages that we've got wanting to push back regulation in the states and then sort of by global market? And I guess the question I am going to is how much of your market is US based that could potentially be impacted by some of the plans that Mr. Trump has been proposing?

First of all, I think the regulatory drivers of our business have a lot more to do with the emerging markets harmonizing on more global standards. Certainly I don't expect -- there's a lot of different types of regulations that I think people are probably talking about in some of those comments, but I don't think we have any expectation that regulations around the safety of medical therapies is going to be rolled back. I don't think there's any talk about that. I think there's a lot of talk about financial regulation and environmental regulation and some things of that nature, but there are a lot of messages out there and we just try to be a little more focused on what's in front of us, but I would say the two overwhelming factors driving our view of this topic are again the harmonization of standards around the world, particularly in the Chinas and Indias of the world and I think there's also an underlying consumer demand for safety, for purity, for quality in products of all types, whether they are medications, food or industrial products.

Okay. Thank you.

(inaudible)

Good morning. Thank you, Chris. Thanks, Gene and welcome, Sherry. Chris, if I could try to understand the biomolecules dynamics. In the [dell] of the market pharma, could you help us understand in the QA/QC lab in terms of competitive dynamics, you have biomolecules that have been entering] the pipeline from the top from the discovery end and going through the approval. They are pulling in some of the competitive technologies into the QA/QC lab where traditionally you have had a very good position, very strong position. Help us understand a little bit in terms of those competitive dynamics and of course, you are answering that by your QDa detector, but help us parse out where do you see that in 2017 and how do you see that going forward?

Yes, I think it is a good broad question, (inaudible), as it relates to really the movement of a lot of biomolecules from the discovery and development phase into manufacturing. And there is ultimately going to be a technology set that may look quite different in that large-molecule category than we see in traditional chemical entity-type workflows. And this is why the Company is positioned for that. You mentioned QDa and that is certainly one aspect of it, but it also starts with separations and the advent of UPLC and the technology advantage we have on the UPLC side for speed and precision of separation sciences is clearly a key driver.

I would also say on the kits, in addition to the mass detection that we talked about with QDa, there's all the work around the kits required to characterize the various qualities of molecules, for example, in glycans. You've heard us talk about glycans and the GlycoWorks technology that has been a real boon to protein characterization. Additionally, our package around ProteinWorks that goes even further.

And then I really wrap it also with a comment on software. Please don't forget about the importance of the data integrity equation that continues to impress us as a need in the market and the validated software that we offer. So anyway, we put a stake in the ground a long time ago. We are continuing to develop this particular thought process around how the biomolecule world will increasingly look different and we expect to share more insights on that when we get to our investor meeting in March.

Got it. And just one quick follow-up on the food and environmental comments that you made earlier. As you look at the food and environmental market in China, again, my understanding of the LCMS world being in that in a past life is sort of the pricing on the biopharma and is less sensitive compared to the food and environmental guys as they look at the overall offering. Help me understand how you are able to penetrate those markets and gain share, especially in China, which is not only itself price-sensitive, but again food and environmental being a little bit more price-sensitive and you guys really have premium offering in terms of UPLCs and across the board. So help me just get a little bit (multiple speakers).

Let me give you just a quick simple answer to that and then I would like to go to the last question as we are a little short on time. The reality is those markets are still prioritizing the most exacting measurement technology and we are actually able to maintain a price premium. We've been hard at work for a long time with the government agencies to help define these new standards of analysis, which typically involve adoption of the latest technologies, not price-discounted lesser technologies. So we will continue to try to push that trend, but thanks for the question. Could we have one more question, Jay, from the queue?

Doug Schenkel, Cowen and Company.

Good morning, everyone. First, a welcome to Sherry and second, I want to take this opportunity to thank Gene for all your help over the years and congratulate you on the new role. So now for the questions; I have two. The first is on guidance. I was surprised that gross margin guidance wasn't a little bit better given the move in the pound sterling. Can you help educate us a bit? Are you embedding any assumption that product or geographic mix are a lot different in 2017 as part of the guide? And then the second question is really on TA and the industrial end market. I was a little surprised as well to see TA not do a bit better when commentary on industrial was so positive relative to what we have seen for a little while. I know some of this was attributed to the comp, but do you think there's also some potential that the market paused a bit, at least for you, due to all the new product launches that you have coming to the market right now? Thanks. I will get back in the queue and listen.

Sure. I will take the question on TA and then see if John and Sherry want to comment a little more on the guidance. But first of all -- and thanks for your comment on Gene as well. On TA, maybe what you suggest is possible that as the market seeks to absorb new technology, it does so in a little bit more of a measured fashion. But I think the TA performance really reflects what we talked about, which is strong comps and also maybe particular factors that are associated with the polymer and the metals-type of industry that TA tends to be more focused on.

Our better performance in the overall industrial category was really driven by, as we talked about earlier, the applied markets of food and environmental and those are markets that TA has some exposure to, but less than Waters' products. So again, a little bit of a softer year on a great year before, but a great product position and we are hopeful for TA for 2017. So any thoughts on the guidance?

I will comment on the gross margin guidance. I think that we do get some benefit from the pound, but we anniversaried that about midyear and what we are feeling some pain from is the yen and the euro for the full year.

Okay. Thanks, Doug. And with that, let me thank everybody for your great questions. Let me conclude the call now, please. So in conclusion, we are encouraged by our 2016 performance as we have described, really headlined by our ability to deliver strong organic top-line growth, modest operating leverage and double-digit earnings-per-share growth. So as we move into 2017, we remain focused on delivering operating results and feel that market conditions and our competitive position support continuing success.

So on behalf of our entire management team, I would like to thank you for your continued support and interest in Waters and we look forward to updating you on our progress during our upcoming investor conference, as well as our Q1 2017 call, which we currently anticipate holding on April 25, 2017. Thanks very much and have a great day.

That concludes today's conference. Thank you all for joining. You may now disconnect.