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Executives

Douglas Berthiaume - Chairman, President & Chief Executive Officer

John Ornell - Chief Financial Officer

Arthur Caputo - President of Waters Division

Gene Cassis - Vice President of Investor Relations

Analysts

Quintin Lai - Robert W. Baird

Pete Lawson - Thomas Weisel Partners

Mike - Deutsche Bank

Sung Ji Nam - JP Morgan

Marshall Urist - Morgan Stanley

Rob Hawkins - Stifel Nicolaus

Jon Groberg - Macquarie

Brigermen [ph] - Cowen & Co

Isaac Ro - Leerink Swann

Dan - UBS

Chris Arndt - Select Equity Group

Waters Corporation (WAT) Q3 2009 Earnings Call October 27, 2009 8:30 AM ET

Operator

Welcome to the Waters Corporation third quarter financial results conference call. All participants will be able listen only until the question-and-answer session of the conference. This conference is being recorded. If anyone has any objections, please disconnect at this time. I would like to introduce your host for today’s call Mr. Douglas Berthiaume, Chairman, President and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Douglas Berthiaume

Well, thank you. Good morning, and welcome to the Waters Corporation third quarter financial results conference call. With me on today’s call is John Ornell, Waters’ Chief Financial Officer; Arthur Caputo, the President of the Waters Division; and Gene Cassis, Waters’ Vice President of Investor Relations.

As our normal practice, I will start with an overview of the quarter’s highlights and then John will follow with details of our financial results and provide you with our outlook for the remainder of the year, but before we get going, I’d like John to cover the cautionary language.

John Ornell

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 statements results of the company despite Q4 2009. We caution you, that all such statements are only predictions and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our 10-K annual report for the fiscal year ended December 31, 2008 in part one under the caption business risk factors.

We further caution you that the company does not obligate or commit itself by provide this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results except during our regularly scheduled earnings release conference call and webcasts. The next earnings release call and web cast is currently planned for January 2010.

During this call, we’ll be referring to certain non-GAAP financial metrics. A reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure is attached to the company’s earnings release issued this morning. In our discussions of results of operations, we may refer to pro forma results, which exclude impact of items such as those outlined in our schedule entitled reconciliation of net income per diluted share included in this morning’s press release.

Douglas Berthiaume

Thank you, John. Well, we are encouraged by the moderately improving demand patterns that we saw in the third quarter. I think the enthusiastic reception to our new product introductions. The sense of optimism is somewhat tempered in the recognition that our customers overall spending levels have not yet enabled us to grow our top line, as these customers continue to deal with the effects of the global recession.

However, it is our view that the weakest demand for advanced scientific instruments is most likely behind us and we believe we’re poised to begin to see organic growth as we move into 2010. The Waters Division, to remind you our business that accounts for approximately 90% of our sales, shipment volume in the quarter was about flat with last year’s result. This is an improvement in comparison to the mid-single digit declines that we saw in the first half of this year.

From a management segment viewpoint, the declines that we saw in the quarter for our economically sensitive industrial chemical segment, were more moderate and declined at a mid single digit rate in comparison to the double digit declines in the first half of 2009. Our third quarter sales to the biopharmaceutical customer base, were consistent with a moderate declines that we saw earlier in the year.

However, this result is encouraging in light of our significant back log build for new mass spectrometry instruments. Shipments to government in academic accounts were up in the quarter, despite a similarly, strong backlogs built for high end mass spectrometry systems.

Geographically, sales growth in China remains strong and declines in India were less severe than we saw in the first half of the year. In America, Europe and Japan, revenues were generally balanced and stable in light of base border comparison dynamics. Government stimulus spending in the U.S. did not significantly contribute to sales volume in the third quarter, but we think we will begin to see this governmental spending impact our fourth quarter results.

Looking at product lines for the Waters Division, our recurring revenue product lines, that is the combination of our chemistry consumables and services businesses improved in the third quarter in comparison to the second quarter result and grew in constant currency at a mid single digit rate.

Instrument system sales for the Waters division declined modestly in the quarter as customers continue to delay instrument replacements, and to focus their capital spending on research purchases. Sales of our mass spectrometers and clearly chromatography platform grew in the quarter and we continue to build a healthy water back log for our technologically leading Synapt G2, a high resolution MS platform that we showcase at this year’s ASMS conference.

Researchers around the world are looking at our G2 Hdms system as much more than an incremental improvement to offer the technology platforms that have been introduced over the past few years. Customer feedback from scores of demonstrations of the G2, positively confirms that new levels of sample information are enabled by this new platform. They complement and expand the technological capabilities of their labs.

The continued sales growth for ACQUITY UPLC Systems, even through these tough market conditions, indicates both its compelling performance advantage and an increased adoption level of UPLC Technology for regulated methods. We’re confident that our successful implementation of UPLC Technology, our large and satisfied user base and our exciting future development plans, will allow us to maintain and grow our leadership position in this expanding segment of the chromatography market.

For our TA Instruments division, a combination of strong growth in the prior year’s base and continued weakness in industrial chemical account spending resulted in the double digit decline this business. However, within the TA instrument product line, demand for advance systems used to monitor biological processes is ramping up nicely.

As we anniversary the on set of the recession and continue to benefit from innovative new launches from TA’s research and development team, we feel we have a possibility to see better business results as we exit 2009 and move into 2010. Earlier this year, we announced the acquisition of Thar Instruments, the world leader in supercritical fluid chromatography, a separation technology closely related to HPLC that primarily uses more environmentally friendly carbon dioxide as the mobile base.

As I noted in July, customers are increasingly interested in reducing chemical waste and running their labs in more green manner. As far as SFT technology in combination with the dramatic solvent savings enable by ACQUITY UPLC have allow Waters to assume a leadership position in cost effective and environmentally friendly laboratory technologies.

We continue to look for acquisitions like Thar and will stay consistent with our strategy of targeting companies that are close to us technologically profitable and with top line potential to be accretive by overall growth rate. In the third quarter, acquired business added about two points of growth to our top line performance.

Looking more broadly at our financial results for the first nine months of 2009, I’m pleased by how well we have adapted to these most difficult end market conditions that we have ever experienced. Our global presence on the sales product development, manufacturing fronts has allowed us to access funded laboratory, accelerate new product launches and optimize our production costs.

At the same time, we have effectively contained our expenses without compromising our level of customer support in our leading company image, factors that have contributed to our strong market position. For these results, I must thank the employees of Waters for their hard work and dedication during these very trying times.

In a long run, we’re confident that our end markets will rebound and I feel that our efforts to streamline our internal processes and leverage our global structure, during this recent down cycle has strengthened Waters and will allow us to deliver superior financial results with improvements in global demands.

Before I turn you over to John for look at our financials, I’d like to say a few words about our outlook. Historically, we have typically waited until our January call to discuss our next year thoughts. In general, we will follow that tradition today. However, as we are going through an unprecedented time of market turbulence, I feel strongly that the worst is behind us and that 2010 is more likely to represent a transitional year in which we experience a period of improving demand for Waters products.

As we’ve been formulating our budgets for 2010, we are planning our top line will begin to grow again. Not at our historical rates, but grow nonetheless. We’re also prepared for some stops and starts as the recovery takes shape. To that end, we will start the year continuing our current pattern of conservative expense control until we’re certain that it’s somewhat smooth and sustainable business recovery is materialized.

Philosophically, we will strive to grow our operating income at a faster rate than our sales growth, while we continue to drive faster earnings per share growth by deploying our strong cash flow for a continued share repurchase program.

With that, I thank you for your attention and here’s John with a more detailed review of our financials and guidance for 2010.

John Ornell

Okay. Thank you, Doug and good morning. Third quarter sales declined by 3% and non-GAAP earnings per diluted share were $0.81 this quarter, compared to earnings of $0.79 last year. On a GAAP basis, our earnings were $0.79 this quarter compared to $0.71 last year. Our reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning.

Looking at our Q3 sales results, sales were down 3% this quarter, with currency translation representing 1% of this decline. Looking at our sales growth geographically, and before foreign exchange effects, sales continued to be soft in the U.S. and Europe where sales declined by 3% and 2% respectively. In Japan, sales were down 8% versus a strong base of comparison, and sales in Asia outside of Japan grew by 4% against a strong base of comparison.

Turning to the product front, within the Waters Division; instrument system sales declined by 6% and recurring revenues grew by 6% this quarter. Within our TA Instruments division, sales declined by 17% versus prior year. Acquired businesses gathered about two points to sales growth overall Now, I would like to comment on our non-GAAP financial performance.

Gross margin, came in at 59% this quarter, which is down 30 basis points from Q3 last year. Gross margins came in stronger earlier in the year, and this quarter’s slight decline is largely a foreign exchange dynamic associated with product mix. This quarter, we had fewer high end mass spec shipments, as we built a backlog of orders for our new Synapt G2 system, which we expect to ship in the fourth quarter.

SG&A expenses declined 5% this quarter compared to prior year, as a result of our actions to control expenses and currency translation effects, R&D expenses declined by 3% this quarter as a result of currency translation effects on our expenses in our U.K. R&D.

We currently expect our full year operating effective tax rate to be approximately 18.9%. This modest increase in our projected full year rate is the result of anticipated shifts of income into our higher tax rate jurisdictions. The impact of this change resulted in the operating effective tax rate of 19.7 in the quarter, or a $0.01 reduction in earnings per share.

On the balance sheet, cash in short term investments total $578 million, and debt totaled $645 million, bringing us to a net debt position of about $67 million. On the stock buy back front, we continue to purchase our shares in the open market. During the second quarter, we purchased 930,000 of our stock for about $48 million.

We define free cash flow, as cash from operations plus capital expenditures plus non-cash tax benefit FAS 123 of our accounting, excluding unusual items. For Q3, cash flow was $102 million after funding $23 million of CapEx. CapEx expenditures this quarter included $4 million facility costs, related to our UTIS facility [ph] site.

Accounts receivable, day sales outstanding stood at 71 days this quarter, up three days from Q3 last year, primarily the result of foreign currency translation and inventories were down modestly from Q3 last year, as we continue to adjust our manufacturing plants. As we look to the fourth quarter, we currently expect economic conditions to marginally improve as we move through the end of the year and then 2010.

Four, we were selling days in Q4 will likely flatten out growth of our recurring revenue business in the quarter, but an easier base of comparison and marginally improving economic conditions should provide for better instrument sales performance. At this time, we expect overall sales before currency effects to be about flat in the quarter with currency at today’s rate adding above 4% to sales growth in the quarter.

We expect gross margins to remain strong and tight expense control will continue to contain SG&A growth in Q4. On the tax front, we currently expect a Q4 non-GAAP effective tax rate of 18.9%. In Q4 last year, we had a non-GAAP effective rate of 13.5%, which provides a difficult base of comparison this year.

Free cash flow continues to be strong and will allow us to continue our share repurchases into the fourth quarter. We expect to exceed our original free cash flow budget of $300 million by $10 million to $15 million for 2009. For Q4 then, we currently expect non-GAAP earnings for fully diluted share to be in the range of $1.7 to $1.11 per share. For the full year, earnings for fully diluted share are then expected to be between $3.40 and $3.44. Doug.

Douglas Berthiaume

Thank you, John. I think at this point, we can open it up for question-and-answer.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) For the first question, Quintin Lai with Robert W. Baird, you may ask your question.

Quintin Lai - Robert W. Baird

Hi, Good morning and congratulations on a nice quarter.

Douglas Berthiaume

Thanks, Quintin.

Quintin Lai - Robert W. Baird

You kind of mentioned during the call a backlog of the high of end mass spec, has the G2 begun to ship now and could you touch a little bit about the backlog and your capacity to meet that back log?

Douglas Berthiaume

Yes, sure. The direct answer is the G2 has not begun to ship as of yet. We fully anticipate it will start to ship in the next few weeks. The interesting thing is that even though we don’t have any G2s out in actual customer hands right now. The initial response has been a strong for a new introduction as we’ve ever seen.

So the backlog build is something we totally expected, because we knew we weren’t going to be able to ship this until the fourth quarter and the third quarter build in this order rate is very encouraging. So watch this base for further notice, but we’re very high on the initial reaction to the G2.

Quintin Lai - Robert W. Baird

So then the guidance that you gave for the fourth quarter really only assumes just about a month and a portion of a month of shipment for G2 then?

Douglas Berthiaume

That’s right. Although, we anticipate shipping a fair amount of G2, as you appreciate the manufacturing process fees, a bolus goes into production and then all go on test kind of at the same time, that being brought up to shipment status. So while it’s true we’ll only get the equivalent of a month or month and a half that truly reflects a lot of instruments that were kind of in process for most of the quarter. So I wouldn’t have you believe that what we wind up shipping in the fourth quarter is going to be a small amount. It is not going to reflect total full quarter output, but it will reflect a pretty representative sample.

Quintin Lai - Robert W. Baird

Then with respect, you put out a press release a couple weeks ago about the FDA adopting ACQUITY for food testing. Is this similar to kind of what you saw in maybe emerging markets where governments maybe standardized and then with those regulations, maybe the suppliers then have to then start to think about conforming to what the Regulatory Officials are using?

Douglas Berthiaume

As you probably know, the whole area of food safety regulations is in a nascent stage. It would be wrong, because I think it’s anywhere near like where the FDA is for testing drugs and there’s a lot of things on the table now about how those regulatory agencies will evolve in the short term and who’ll be responsible for all these regulations, but certainly it’s a very encouraging first step, that the regulatory authorities are looking at our state-of-the-art technologies and kind of looking at that as a basis for what they can embody in the regulations. I’d say, we’re at the early phases of that regulatory process, but we’re encouraged by it.

Operator

Pete Lawson with Thomas Weisel Partners, you may ask your question.

Pete Lawson - Thomas Weisel Partners

Doug, I wonder if you could talk through your ability to maintain operating costs into 4Q and 2010 and drive the operating margin line.

Douglas Berthiaume

Certainly, Peter. I think it’s a fair question, because, a lot of companies has included kind of responded to the initial signs of the downturn last year with significant constraints on spending. It’s a fair question to say, how long can you restrain spending and expect to service your customers? I think the operating answer, is you should expect us to see constrained spending through the fourth quarter and through the first quarter.

I think as we move into the second, third quarter and fourth quarter of next year again, somewhat dependent on the response to our new products. If we’re right about the response, if we’re right about the amount of capital that our customers will have available, you’ll begin to see that spending take on more normal characteristics, but, I assure you that early on, we’re going to keep a pretty strong governor on that spending sprang until we’re more convince about the outlook for 2010.

Again as I said, preliminary planning we’re expecting an improvement next year. We’re not expecting a V-shaped recovery. So, we’re going to continue to be cautious until we get a little further into the year.

Pete Lawson - Thomas Weisel Partners

John, I wonder if you could just give us some kind of breakdown on the effects on gross margins this quarter, the moving parts and expectations for 4Q.

John Ornell

The biggest issue with margins this quarter was really the fact that our high-end mass spec business, as we said really built backlog versus shipments this quarter. So from that perspective, we ended up capitalizing some of the variances favorable FX variances associated with production in pounds. You will see that turn around and come back to the P&L in fourth quarter as we ship those units.

We had a little bit of a difficult base of comparison in the quarter as well. Q3 last year was actually our highest quarter for gross margins. It was a very good high end mass spec shipment quarter. So the basic comparison is a little more difficult as you look at it from a year-over-year perspective. I would say that for the fourth quarter, we expect to see an improvement on a year-over-year basis. As is the G2 begins to ship in some volume towards the end of the quarter.

Pete Lawson - Thomas Weisel Partners

Then just on this backlog you’ve talked about. Can you give us some reference how large that backlog is versus historical?

John Ornell

It represents a couple to a few points of growth that have built into the backlog it’s different than what we’ve seen historically.

Operator

Ross Mukin with Deutsche Bank, you may ask your question.

Mike - Deutsche Bank

Hi guys. It’s actually Mike in for Ross here. So it’s been a lot of noise made about one of your competitors on a new UPLC launch. Have you seen any change on the competitive landscape since that product has gone to market?

Douglas Berthiaume

Hi Mike. There have been a number of competitors who have been contending for some period about their competing ultra performance chromatography instruments. I would say for the most part, we’ve seen very, very few if any of those actually show up in the market place. People have talked about launching it. As far as I know, no major chromatography competitor is actually officially shipping product yet.

So it’s hard to see in real terms, what the competitive dynamics are. We’ve always contended that sooner or later some instruments would actually begin to show up. It’s certainly been more of a case of later, rather than sooner and I think interestingly, as you know, we spent a lot of time with customers in our building here, going through technology seminars. Going through evaluations of what’s going on in the market place.

In just in the last two weeks, we’ve had major pharmaceutical customers in our building here and have been hearing universally about how strongly they feel about our ACQUITY technology, and the fact that any competitive instruments are likely to take along time getting through evaluations and getting through approval processes.

Whereas, ACQUITY has all gone through that process over the last, while since its introduction now five years ago, so we’re still feeling very good about it, in current conditions, we’re not seeing any competitive instruments actually be sold, that could change, but I think it’s a future event not a current event.

Mike - Deutsche Bank

Then again on the ACQUITY front, Doug, you did mention that you’re seeing, increased UPLC adoption. Can you give a little more color in terms of where the increased adoption is coming from and whether there’s actually trends showing broader use of the total platform?

Douglas Berthiaume

I’m sorry, Mike, you got clipped a little bit, could repeat that question?

Mike - Deutsche Bank

I’m just curious about whether you’re seeing improved broader trends of the ACQUITY platform into different market areas?

Douglas Berthiaume

Well, it’s interesting with ACQUITY. To refresh you, traditionally, ACQUITY has been most successful in the research and into the early development stages of company processes. It’s been very successful as a front end for mass spectrometers. Given it’s the physics involved care.

What we’re seeing in a number of placements were made into methods developed Ross, kind of the people who set the standards for downstream instruments and things like biopharmaceutical labs. We’re now seeing a clear up tick in interest in the regulated applications, meaning into QA/QC laboratories that have a very high volume of usage of instrumentation.

We’ve always kind of known that this is going to be the secondary applications, because these labs are slower to convert, but what we’re seeing is the productivity that now it’s proven with ACQUITY. The environmental friendliness, the savings and solving consumption all are adding and we’re now seeing the very clear beginning of that adoption period in the regulated applications.

Mike - Deutsche Bank

Great, thanks.

Operator

Tycho Peterson with JP Morgan, your line is open.

Sung Ji Nam - JP Morgan

This is Sung Ji Nam in for Tycho Peterson. Thanks for taking the question. As we look toward 2010, could you comment on kind of what the key drivers are for the recurring revenue portion of your business? You kind of commented on the instruments given the new product cycle, but could you comment on kind of how we should think about what the key drivers are for recurring revenue as we look ahead. Thanks.

Douglas Berthiaume

Yes, I think clearly we saw this year some inventory reductions across the world and our customers who are major users of our chemistry. We also saw frankly, some customers move off longer service contracts, trying their best to save money, wherever they could. Both of those dynamics we see clear evidence of them letting up and in fact reversing as we go into the last part of this year and into next year.

We’re seeing customers come back on service contracts. As they realize that they’re better off getting regular service out of their installed base, rather than pay higher time and materials charges, it’s kind of penny-wise and pound foolish there.

In the chemistry side, we believe that we’re even currently seeing a modulation of that inventory effect. I don’t think we’re seeing people rebuild inventories, but we’re seeing probably the end of the inventory reduction phase. Particularly, in some of our areas that have traditionally held higher inventories like India, we saw some pretty significant inventory reductions early in the year and we’ve seen that modulate as we move through the year.

I think those two dynamics are likely to lead to better comparables in 2010. I think with economic activity, we’ll see some baseline improvement in usage of chemistry, but at this point, we’re not going to bank too much of that early on in 2010. That’s an area as I talked about where we’ll probably have to prove to ourselves that’s underway before we build that into our budgets.

Sung Ji Nam - JP Morgan

Also just a quick question with regard to your combination LC GC/MS, is that an interesting opportunity for you guys kind of in items of where you might put additional investment, or could you kind of comment on that, talk about that business?

Douglas Berthiaume

We are the GC/MS piece of our business as always been a relatively small and focused piece, with our very high end, inorganic mass analyzers. So it’s a meaningful, but not terribly significant part of our business and overall, you should expect us to be principally focused on LC/MS applications.

Sung Ji Nam - JP Morgan

Great, thank you very much.

Operator

Marshall Urist with Morgan Stanley, you may ask your question.

Marshall Urist - Morgan Stanley

So, question on, I apologize if this has been asked before, but I was wondering if you could give us a little more granularity around exactly what to the FX sort of headwind was in GM for the quarter? How we can think about that developing. I know you talked about qualitatively, but any numbers would be helpful.

John Ornell

If you look at the gross margin pieces, the significant pickup that we had seen earlier in the year in the first half was largely currency. We talked about it being two-thirds to three-quarters depending on the quarter. Principally, all of that favorability turned around this quarter as the mix of business moved away significantly from the high end to max spectrometry shipments.

We also had a higher proportion of our European sales that were U.K. based. Our U.K. business actually did very well on the quarter as the expense of some of the other geographies. So that the margin mix unfortunately with that was negative. So all of the favorability that we had with the foreign exchange really turned around in the quarter. A lot of that like I said, was inventory and it’s going to come back around and provide, you know, maybe about a 50 basis point type of a benefit, by the time we get to the fourth quarter.

On a full year basis, we are still pretty much on plan as it relates to where we thought we would be from a gross margin perspective. It’s the build of the G2 and the slight mix change, where we had more U.K. business in the mix in the third quarter this year that turned the FX dynamic around for the quarter.

Marshall Urist - Morgan Stanley

Okay, great. Thanks guys.

Operator

Rob Hawkins with Stifel Nicolaus, you may ask your question.

Rob Hawkins - Stifel Nicolaus

Yes. If you don’t mind, could you guys maybe go a little downstream for us and talk about what the strategy is for the food testing QA/QC, approach to your Asian markets. How this kind of the lower end strategy, what changes you guys expect in the landscape there?

Douglas Berthiaume

I’m sorry, when you talk about the lower end strategy, Rob?

Rob Hawkins - Stifel Nicolaus

Well, I mean I want talking, I guess not proteomic so much as more the line on QA/QC testing for the food service business?

Douglas Berthiaume

Okay. The food safety business has been a pretty robust area for us for awhile now. As you remember, the Asian and European segments of that probably have led the way with stronger regulations for imported foods as well as things focused on genetically modified organisms. So we’ve been at the forefront of the food testing area in those geographies for awhile now.

You will recall that last year, the melamine issue in China was very hot right now and right through the end of the year and we did a substantial amount of business because we’re able to quickly get to market with a test for melamine. So it’s a robust area. It’s nowhere near as big for a world wide today as the biopharmaceutical applications, but it is growing.

It’s growing in those areas of the world and it shows great promise to be a faster growing application in the United States. The United States is struggling with how to regulate this area. Who’s going to be responsible for regulating it, but clearly there are regulations that are going to be here.

We are very active in the whole area and trying to make sure that our views are considered in this and I having the feel like we’re in an excellent position to take advantage of this evolving market place, but I think that’s going to be an area of that’s going to be the next two or three years as you’ll see that expand. The serve market will still be larger outside the United States.

Rob Hawkins - Stifel Nicolaus

I’m sorry, I guess I’m having trouble connecting the dots between what the FDA announcement is and then maybe how you connect from some of the higher end things you’ve been doing and then down streaming the technology or taking that and I guess, dumping it down into what you’ve already kind of built out in Asia on a food strategy standpoint. I mean is that part of the strategy or is it more bringing Asia up to a higher level?

Douglas Berthiaume

Rob, the FDA has acquired a great number of the ACQUITY’s principally for drug testing.

Rob Hawkins - Stifel Nicolaus

I’m sorry. Again I misunderstood.

Douglas Berthiaume

Obviously, our commercial accounts view that and say, poise of the regulators are beginning to see what can be evaluated using UPLC technology, it has a follow on effect down the road for those industrial accounts having to adopt faster that technology and I think that’s something that we anticipate will lead in the QA/QC market to a faster adoption rate, because the regulators are looking hard there.

Rob Hawkins - Stifel Nicolaus

My apologies, I misread what the comments were and then just real quickly, I may have missed these comments. What is your take on the NIH awards and what this in a lot of these proteomics awards and what this may mean relative to the new products?

Douglas Berthiaume

Are you referring to stimulus spending, Rob?

Rob Hawkins - Stifel Nicolaus

Yes, I am.

Douglas Berthiaume

I think a number of us in the industry are kind of looking at extraordinary quote rates for stimulus possibilities and if you ever thought that those quotes were all going to come to fruition, we’d all be probably celebrating with alcoholic beverages right now. I think it remains to be seen. We think that there will be some significant orders placed on stimulus spending, but it’s still largely a fourth quarter, first quarter, second quarter event. There’s no question that the quote activity has been extraordinary.

Measured in the tens and hundreds of millions of dollars, I personally don’t think all of that’s going to come to fruition. So you have to look at people who are trying everything but the kitchens sink in those submissions.

Rob Hawkins - Stifel Nicolaus

There’s enough quality in there that it would be wrong to think that some significant business isn’t going to come out of it,

Douglas Berthiaume

We preferred to think about it in terms of the low single digit effect on our growth rate probably in the fourth and first quarter.

Operator

Jon Groberg with Macquarie, you may ask your question.

Jon Groberg - Macquarie

Just a quick question, can you maybe comment Doug on replacement sales. I know that’s been a business was been just down. Doesn’t sound like it gotten much better in this quarter. Is there any reason to believe in terms of what you’re hearing from customers or anyone else that some of this could come back in 2010?

Douglas Berthiaume

There’s no questions it’s what we considered replacement business that’s been the most under pressure during this timeframe. Companies that just sit at their normal cycle was replacing on six or seven or eight years, if that would stretch that out a year in many, many cases. Now that cost them in throughput. Cost them in higher repairs and maintenance, but there’s no question that they can do that for a short period of time.

I think, the best way to characterize it is, if you go back to the early 90s. Particularly in the last healthcare governmental scare, we saw particularly our pharma customers go through a very similar dynamic. Long out their replacement cycles and look at really putting off making capital improvements.

Then once that got behind them, we clearly saw pent up replacement demands begin to shake itself through and we saw a period of three or four years of catch up replacements in those applications. I see no reason to believe that we won’t see some similar kinds of dynamics. Whether it happens early in 2010, or it has to wait a little bit longer, I don’t think that the physics has changed.

These instruments are going to wear out. They need to be replaced. We’ll see the down time begins to tick up on them and the demand for new technologies begin to click in. So, I think, we well could see some of that next year, as we go into 2011.

Jon Groberg - Macquarie

Last question, if you think about kind of the portfolio of technologies that you have and the cash that you’re generating I know a lot of that’s going to buy back shares. Is there any reason to think, are there any technologies or adjacencies or things that you might be looking at to also put that cash to work in?

Douglas Berthiaume

We’re always looking. I think the compelling kinds of things that if we look at tend to be smaller, rather than larger. So while it’s never impossible, that we wouldn’t deploy our capital, in a larger framework. In general, that hasn’t been the case and there’s nothing that we look at today that says, if we deployed a major sum of capital in a particular area, that in a reason timeframe, it would accelerate our growth rate or accelerate our returns.

We continue to look at some of these smaller niches oriented that do exactly that, they have the potential to accelerate our growth rate, be accretive to our earnings, improve our return on capital and do that what’s left over with our stock where it is today. There’s no question that our stock is a very good investment continues to be immediately accretive and poise is a good place to spend your money, I think it continues to be a very good investment for us.

Jon Groberg - Macquarie

Perfect. Thanks.

Operator

Quintin Lai with Robert W. Baird, you may ask your questions.

Quintin Lai - Robert W. Baird

Thanks for the follow-up. Just some clarification, so on the fourth quarter guidance when you talking about, is that zero percent organic offer of Q4 and 4% FX. Is that right, John?

John Ornell

That is correct.

Quintin Lai - Robert W. Baird

Then acquisitions, what should we be expecting?

John Ornell

Acquisitions will be a couple of points, but, days in the quarter will take away a couple of points. So you’re still back to kind of the zero if you will include all of that.

Quintin Lai - Robert W. Baird

Okay, so constant currency is zero?

John Ornell

Correct.

Quintin Lai - Robert W. Baird

Okay and then FX had 4%. So net 4%?

John Ornell

Correct.

Quintin Lai - Robert W. Baird

Got it, great and then with respect to kind of your comments on 2010. Historically, Waters has been in that kind of high single digit, low double digit organic. So I know this is maybe a little early to talk about 2010 guidance, but I mean is that kind of implying that you budgeting now to assume kind of low single digit, mid single digit type of organic revenue growth in 2010?

John Ornell

Yes, I think it would be fair to say that’s the neighborhood that we’re looking at starting out the year Quintin. Now I’d say that and there’s a reason why we normally don’t want to do this until we finish the fourth quarter and we’re a little bit further I had and that’s because there are a number of factors that could make that look conservative.

We’ve got a very conservative base this year that we’ve come off. We’ve a very strong new product year in front of us. We’ve got low interest rates. We have got a very much improving FX scenario, but we still have some companies that are in tough shape. How much capital will they have? That’s a long winded mealy-mouthed way saying and there are upsides and there are downsides, but having said all of that, I think that mid single digit area doesn’t feel bad to us at this point, as we look forward.

Quintin Lai - Robert W. Baird

Thank you so much, guys.

Operator

Doug Schenkel with Cowen and Company, your line is open.

Brigermen – Cowen & Co

Hey, guys. This is Brigermen [ph] in for Doug. Thank you for taking the questions. Most of them have been answered, but quickly on geographies. First in the U.S. to follow-on Rob’s stimulus question, you mentioned kind of some backlog to Synapt and you start to expect some stimulus beginning in Q4. Is there a similar backlog dynamic there? You guys kind of getting ready to ship maybe multiple products heading into the fourth quarter?

Douglas Berthiaume

The only real backlog dynamic we have, Doug, is the G2. That we clearly knew we’re launching to the market, taking orders, and would not be shipping until the fourth quarter. So that’s the only product that creates a significant backlog dynamic for us moving from the third and to the fourth. Now as it relates to stimulus spending, I’m not quite sure what your question was, what was that?

Brigermen – Cowen & Co

I guess based on the orders you said there are some big numbers out there for orders. Are those kind of beginning to come through and I guess begin to start in the fourth quarter?

Douglas Berthiaume

Well, what I said was we’re seeing quotes. So these customers who are putting in for grant money, request a quote for you and they will say what will it cost me for a G2 configured in a certain way, and we monitor those quotes and so they go principally to NIH labs and to university in academic areas and those numbers frankly are huge. We’re quoted millions and millions of dollars of quotes on those and many of those are likely to come through, we know that not all of them will come through.

So they’re not in backlog as such. They haven’t actually been reduced to an order or commitment to buy, but they’re one step previous to that. We’ve always monitor our quote rates, and typically they run in a consist manner. The stimulus spending is result in this huge bolus of quotes and it remains to be seen how many of those quotes actually get reduced to orders and to shipments, but…

Brigermen – Cowen & Co

In OUS, guys talked about a good quarter for the U.K. and it’s potentially some restocking in India and looked like Japan might have been down. Can you maybe just a one-liner on a couple of those different end markets and maybe if things are turning in different regions or continuing in certain directions?

Douglas Berthiaume

I think the U.K. is the significance of our mass spec portfolio. Our mass spec business has been headquartered in Manchester in the U.K. So the customers in the U.K. tend to get early looks and then are very responsive to our new product. Not only the G2, but the full Xevo product lines, that’s been very encouraging, because as you know the U.K. isn’t generally in very strong economic conditions right now.

So that’s been strong. I think some of the other areas have been strong, but the large other countries in Europe haven’t been particularly strong underlying dynamic. That being France, Germany they actually negative growth, so all in Europe has been okay, but it’s been a little bit skewed towards the U.K.

In India, we clearly saw slow conditions start around this time last year. That the strength of the Indian currency or I should say the weakness of the Indian currency plus the economic turmoil, resulted in a lot of insecurity in India. We’re beginning to see that turn, I think, in the third quarter. We think that that gets better quarter-by-quarter. Because certainly the Generic shipments coming out of India, plus the potential for other drugs going off patent mean that’s the underlying dynamics the India, we think are still pretty secure.

We’ll return to a pretty strong growth environment. China continues to be very strong, as one of our strongest areas in the world and that even considering that we saw some melamine business begin to really ramp up at this time last year. Melamine really hit in the fourth quarter, so we’re going to have some very tough comparisons in the fourth quarter, with China, but I think absent to that kind of one-time blip, China continues to be diverse, remarkably strong.

We’re in excellent competitive shape across our product lines in China. Even in Japan. Japan, was a flattish kind of quarter, but we may be seeing some initial signs that Japan has some opportunities for growth. Not taking it to the bank, but there is some encouraging early signs in Japan.

Brigermen – Cowen & Co

Just one quick one and then I’ll get off. With regard to the AV Synapt divestiture, are you seeing maybe a potential opportunity there for market share pick up in the mass spec business and just maybe a comment on that move?

Douglas Berthiaume

Frankly, we’re always trying to gain market share. That’s goes without saying the any time of a business like that, changes hands, of course customers may be disrupted. You never know. I am sure they’re trying their hardest to keep everything smooth for their customer base, but facts are oftentimes face a little disruption when you change owners.

We think much more important, is the fact that our technology is as strong as it has ever been, we’re always planning to make this year a very strong introduction for us across many of the applications. The competitors have been stronger in traditionally and I think we’re in the best position that we’ve been in a long time to make significant inroads in that. So I don’t think that’s specifically related to that competitive situation. It’s just more a statement of where we think we are in our product cycle.

Brigermen – Cowen & Co

Just doesn’t hurt. Okay, thanks guys, I appreciate it.

Operator

Isaac Ro with Leerink Swann, your line is open.

Isaac Ro - Leerink Swann

Good morning, guys thank you for taking the question. If I could just ask to start here, wanted to see if you could maybe talk about what your seeing in the broader pricing environment within former and specifically you said we should maybe consider any disruptions in demand either through sort of changes in the budgetary process within those customers and/or the availability of used equipment in the marketplace. I know it’s historically a small market, but I’m wondering if there’s potentially a short term disruption there as, a lot equipment is made available in the secondary marketplace?

Douglas Berthiaume

I’ll turn it over to Art, but in general, we haven’t seen too much. Number one, we are the price leaders. We have always been the price leaders and as you can see from our gross margins, there’s been no disappointment coming as a result of significant price competition coming into our infield, but, Art really runs that segment of the business. We’ll ask him to comment on specifically has any price dynamic coming into play in the major segments of our infield.

Arthur Caputo

Yes, interestingly enough, we will see customers hold off and differ before we will usually see them back off too much on price. They equate price and capability and so we fortunately for us, particularly in a regulated market. They don’t seem to be willing to make the tradeoff or take a risk for a lower price.

In the end they have a feeling that, they’ll have to end up re-buying it if they make a mistake, you’re better holding offer and going with what their test specified. Very little risk taking we see on behalf of customers in the way of trying to take shortcuts. They will keep the equipment they have and extend the utilization and then when they have to replace they will replace.

Douglas Berthiaume

Your second part of that question, Isaac was on the secondary market. People selling used equipment. Was that just be your second part?

Isaac Ro - Leerink Swann

Yes. I know it’s historically a smaller market, but I’m just wondering in extend what you see the changes in the availability of that channel in terms of meaningful volumes of products?

Douglas Berthiaume

Art, you seeing much of that…?

Arthur Caputo

The only thing I would say is that to the extent of some of the larger accounts, particularly in the pharmaceutical industry, probably the only made at the station of that is, if they take one plant, they’ll a equipment and move it to another plant and so those be shipped assets around.

While there’s some secondary market to be honest, it is not enough for us to even, we really don’t see it and therefore we find customers are usually reluctant to cope with the ordeal of having to figure out how to handle warranty and serviceability and traceability. So it’s something we don’t run into very much.

Douglas Berthiaume

You’ve always seen a little bit of it kind of in parts of the market that we generally don’t play very strongly in. Some of the low end academic situations, some of the more traditional industrial accounts, particularly in lower, the less global accounts, but frankly we’re not really seeing it, as I said, pop-up in any of our traditional Waters customer base.

Isaac Ro - Leerink Swann

Okay. Thank you and then just secondly, wanted to maybe get a better appreciation for the advantage you guys have within ACQUITY for the chemistry portfolio that you have and maybe highlight if you could, a few of the areas where you made investments, maybe more recently and that you think kind of gives you a material advantage over a new entrants in the coming quarters?

Douglas Berthiaume

Let me see if I hit it right and then, Art can embellish but a key strength of our ACQUITY platform, has always been that the whole technology was driven by a proprietary chemistry configurations that we designed really the instrumentation, coming from the invention of the chemistry. So, we’ve seen that there’s a very high level of tying of the chemistry to our instruments. The instruments in the field are almost totally using proprietary Waters chemistry in their applications.

When we launched ACQUITY five years ago, we basically had one flavor of chemistry and the five years with dramatically expanded the flavors in the configurations of that proprietary ACQUITY chemistry and that flood to certainly the highest growth rates in our consumables business around ACQUITY and for every new ACQUITY that we place, is almost that guaranteed razor and razor blade that now goes along with it, with the ACQUITY model.

So we are continuing, we’ve launched new acuity flavors in 2009, we’re going to launch more in 2010 and that continues to be a very significant part of our ACQUITY strategy. Did that cover the flavor of your question?

Isaac Ro - Leerink Swann

Actually a little more color there would be great in terms of maybe if you could talk about what in pharma specifically, is there an appreciable percentage of chemistries that are maybe entirely proprietary or customized to that getting customer to extend does that creates that much higher switching costs for them?

Douglas Berthiaume

No, there’s nothing really proprietary to a particular customer. Our chemistries are all broad purpose, useable and by any customer in most any application. They’re tailored to a specific application, you may want a particular activated chemistry for a particular compound that you’re looking for, but that could be used by anyone in the customer base.

Isaac Ro - Leerink Swann

Okay, thank you very much.

Douglas Berthiaume

Operator, I think we probably have time for two more questions.

Operator

Certainly, [Derek Duberlyn] with UBS; you may ask your questions.

Dan - UBS

Hi, this is Dan in for Derek. John as one of you could just break out these FX impact on EPS for the quarter?

John Ornell

It didn’t even round to a penny, so it was zero.

Dan – UBS

With the close of the Pfizer deal, do you have any comments on the resumption of quote and order activity if any and whether this has been in line with expectations and also historical norms for deals of this size?

John Ornell

You mean resulting from the merger?

Dan – UBS

Yes.

John Ornell

Yes, we don’t have specific status. I mean we’re not seeing any dramatic difference from what we’ve seen historically. They always go through a period of confusion, of who’s going to be their boss. Frankly, we’ve continued historically in the last couple of years sharing has been probably stronger coming off a base than Pfizer had been. We probably see a continuation of that currently.

So, I don’t think we’ve seen a dramatic falloff. I think we’d anticipate that the future combined entity probably is a somewhat better environment than the past nine months.

Dan – UBS

Perhaps just a comment on maybe outside the large pharma accounts, what you’re seeing with some of the smaller customers in CRS?

John Ornell

Did you say large pharma’s or small…?

Dan – UBS

Yes, outside of large pharma, that’s the contract resorts organizations in a smaller accounts in general.

John Ornell

I didn’t say, this quarter we saw probably a little bit better activity in the smaller specialty, CRO business than in big pharma, but it’s not so dramatically different than it’s worth highlighting too much.

Dan – UBS

A lot of big pharma softness was associated with G2 backlog too so?

Douglas Berthiaume

Yes.

Dan – UBS

Okay, but with those accounts fit were there was some sequential, because I know you say it was fairly weak or at least weaker than large pharma last quarter so, sequentially it was improved?

Douglas Berthiaume

Yes.

Dan – UBS

Okay, thank you.

Operator

Chris Arndt with Select Equity Group, you may ask your question. Please check your mute button. We’re not able to hear you.

Chris Arndt - Select Equity Group

Thank you, if you already addressed this I apologize. Could you comment on how the consolidation activity in the pharma industry has affected recent results and how you expect it may affect results going forward?

Douglas Berthiaume

That’s essentially the question that just got asked concerning Pfizer and sharing. We have seen some slowdown in business as a result of it. Nothing that we haven’t seen in the past and we say that, in general we think the next 12 months should be marginally an improvement in that climate versus the last 12 months, but frankly we have seen good activity on the part of the targets in these areas, probably less strength out of the parent organization. So you wrap up the lousy economic conditions and kind of it’s hard to tell, which is the chicken and which is the egg here, but I think we feel like the future is likely to be marginally improvement on what we’ve seen in the last 12 months.

Chris Arndt - Select Equity Group

Okay and I expect that what you seen in the CRO industry, it’s been relatively slow. Is there any change in that or do you have a comment on the CRO customer base?

Douglas Berthiaume

No. I think that CRO business has been flattish. We have probably done better than those accounts feel like they’re doing. They’re under a lot of pressure and, I think long term that CRO business starts to curve upwards. Although it may take awhile, but right now that business is pretty flat.

Chris Arndt - Select Equity Group

Okay. Great, thanks.

Douglas Berthiaume

Okay. Well, I want to thank everyone for taking the time and we appreciate the quality of the questions and we’ll look forward to talking to you again next quarter.

Arthur Caputo

Thank you.

Operator

This concludes today’s conference. Thank you for your participation. You may disconnect at this time.

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Source: Waters Corporation Q3 2009 Earnings Call Transcript
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