Waters Corp (WAT) 2002 Q3 法說會逐字稿

Good morning. Welcome to the third quarter financial results conference call. All participants will be able to listen only to the question and answer session of today's call begins. At that time, you will be given instructions on how to ask a question. Today's call is also being recorded so, if you should have any objections, you may disconnect at this time. I would like to introduce the leader for today's call, Mr. Douglas Berthiaume. Sir, you may begin when ready.

Thank you and good morning and welcome to the waters corporation third quarter 2002 conference call. With me on the call this morning John Nelson, the President and Chief Operating Officer, John Ornell, the company's CFO and Gene campus, the Vice President of investor relation. As is our normal practice, I will cover the third quarter results, then John Ornell will take you through the financial details and our forecast and then we will open it up for Q & A. Before I begin, I would like to ask John to cover the safe harbor language. John?

During the course of this conference call, we may make various forward-looking statements regarding financial events of the company. In floor particular, we will provide guidance regarding income statement results of the company tilt for full year 2002 and 2003. We caution that you all statements are only predictions and actual events or results may differ materially. For detailed discussion of some of the risks and contingencies that could cause our performance to differ significantly from our present expectation, see our 10K annual report for the fiscal year ended December 31, 2001, in part one, under the caption business risk factors. We caution you that the company does not obligate or commit itself by providing this prediction. We do not plan to update predictions except during our regularly scheduled quarterly conference call and webcast. The next call and web cast is currently planned January, 2003.

Thank you, John. Overall, our third quarter business results were pretty close to our expectations. At 29 cents per share of earnings, we were about a penny under our point estimate as our sales growth was just a little off our original estimates.

Our particularly strong element of the quarter's performance was our cash flow. We generated over $50 million of free cash flow and that was up 60% from 2001 and that brought our three-quarters unit date cash flow to over $131 million and that represents over a 40% growth in free cash versus the nine months of 2001. So even in a very tough year for us, the cash generating capability of our business was still outstanding.

In terms of the individual business performance, once again, we are pleased by the results of our HPLC product line. These products produce low double-digit growth. Again, the results were consistent across the broad geographical areas and product line. Of particular note in product terms is the strong performance our core HPLC products. Our 2690 alliance fluidics line, for example, was up over 20%. Data, particularly large network data, continues to do well with good mid-teens growth. Chemical products, our column consumables business, continues to crank out 10% revenue growth. And our service and support revenue delivered another good double-digit growth quarter. Strong performance in this recurring revenue section of our business is encouraging. Consumables and service and support additionally contribute strong differential profitability and cash flow.

Geographically, HPLC was also balanced with the UF up in the high single digits and Europe and Asia, up in the double digits. We saw an interesting dynamic when we cut our HPLC business by industry. The pharmaceutical industry continued to grow in the double digits, but we also saw university and government accounts grow in the low double digits and interestingly, and also importantly, our industrial accounts. Now, when I say industrial accounts, I include industrial chemical companies, environmental laboratories as well as food and beverage accounts. They also came in at low double digit growth. So this broad and well-balanced performance, I think is encouraging.

Turning to our mass speck business, we saw in assets the confirmation of the dynamic we have seen in the last four or five months. Overall, our business was down in the low double digits, but the principal cause, the falloff in the U.S., as a result of pulling the high end technology from the market in response to an unfavorable patent ruling in march. We expect the general dynamic to be prevalent for the next several quarters weak U.S. performance and good international results from mass spectrometry.

We continue to target the launch of new technology into the market during the first half of 2003. Specifically that means either fit con in March or ASMS later in June. This is, of course, most important to the U.S. business, where we are currently constrained with the older products. We continue to believe that the market remains vibrant for this technology and continue to believe that our business can regain good double digit growth rates in 2003.

When we talked last July, we reported that we were going to reorganize our HPLC and mass spectrometry field organizations around the world. The reorganization is driven by customer needs and technology evolution that we think makes it imperative that the customer has one principal interface with waters for both these technologies. We announced our plan to reorganize in July and I'm pleased to report that we are substantially down the road to full execution of the reorganization. New reporting points have been communicated and are effective, understaffing is in the process of being resolved and the combined organization is already implementing plans to market systems in a new way to take advantage of their combined strengths. I'm very optimist that this new structure will serve us well to efficiently drive growth in 2003.

Finally in our thermal division, we continue to see sluggish conditions. TA had a single digit revenue decline in the third quarter, as industry conditions continue to be weak. We did recently announce an agreement to acquire a leading rheology product line, which represents approximately $20 million of additional annual sales revenue. And rheology is one of the fastest growing of the industrial measurement technologies and with this acquisition, Waters would be the market leader by far in rheology. We anticipate this field to close in the fourth quarter.

At this point, I would like to turn it over to John Ornell.

Thank you, Doug. Good morning. Results for the third quarter were just shy of our expectations with sales growth of 4% before currency impacts and 7% after. Favorable sales impact from currency continued throughout the quarter as the dollar remind weak. Earnings per diluted share were 29 cents for the quarter, which is one cent below estimate and up 4% over the prior year. Looking at sales growth by product line before currency impasse we saw the HPLC product line perform better than expected with sales growth in the low double digits. Sales in the U.S. grew in high single digits and across all geographies grew in the low double digits.

Turning to our mass speck business, we experienced a sales short fall, partly due to a production issue that we believe is now behind us. This coupled with the litigation related sales deficit in the U.S. continued to cause this business to decline year-over-year with sales down in the low double digits. While we continue to see growth outside of the U.S., the deficit from lost cue [toss] and quatro ultima sales were a challenge. Sales of thermoanalysis products were in down in the low single digits.

Earnings per share grew modestly for the quarter, sales revenues were up, margins improved, but operating expenses grew faster than sales. As Doug stated earlier, progress on the combination of field operations has been significant and a byproduct of this activity is projected to be a 6 to 8 million reduction in SGandA beginning in 2003. We currently expect to take a 4 to 6 million dollar charge in the fourth quarter as a result of these actions. Our balance sheet continues to be strong at the end of the third quarter, with the benefit of free cash flow of $52 million for the quarter and $132 million year-to-date.

Inventory grew modestly this quarter and accounts receivable day sales outstanding improved to 71 days down from last quarter and from Q3 last year. We anticipate seasonal improvements to bring DSO even lower by year end. In reviewing our business prospects for the reminder of 2002, we now believe we will be slightly below our prior guidance and feel that our best single point on a line estimate for 2002, the $1.30 a share of four one-time charges with a 1 to 2-cent tolerance for the quarter.

This projection assumes current exchange rates remain at today's levels. We expect sales growth for Q4 to be around 4% before currency impacts. Currency at today's rates would add 3% to sales growth for the quarter. Our estimate for EPS for Q4 is 46 cents per diluted share with a 1 to 2 cent tolerance for the quarter before one-time charges.

Turning to 2003, we continue to remain confident that the return of our high-end triple core product offering in the United States later in the first half of the year will yield overall sales growth of about 10% for the year with [PTS] of $1.50 with a 1 to 2-cent tolerance per quarter.

Finally, I would like to update you on where which are in our review of service labor-related costs classification.

In July, I told you we were working to reclassify service labor associate with revenue-general rating activities from SGA to cost of sales. While not finalized as we speak, preliminary information indicates that this reclass will reduce gross margins by approximately 6% damage points with a corresponding SGA reduction. As stated before, we will complete this reclass for year-end reporting. This change has no impact on earnings. Doug?

thank you. I think we can open it up for Q & A now.

At this time, if anyone should have any questions or comments, you may press star one. Again, at this time, if you have question a, please press star one now. Our first question comes from David Whiffy.

Good morning.

Morning.

A couple of questions, one, look at the relaunch of the reengineered triple quad as well as the global --( inaudible ) assume the global more -- events and the triple quad towards ASMS?

John, you want to lay out product plans he --( inaudible )?

I think actually the relaunch of the high end triple, as Doug said, the timing of that is going to depend on really where our final tests are, but it is going to be somewhere between pit con and ASMS. What we are doing with regard to the triple, the high-end triple, also has an effect, a positive effect in the cue top family in general in the United States and with regard to the global options there are still one or two different things that we are considering doing there. So I don't put one in front of the other necessarily. But I would say there are certainly when we introduce the high-end triple it does have an uplifting effect on the cue toss as well, because some of the front-end technology is the same and depending on how we see that our global response would be defined accordingly.

okay. And turning to the cue toss, relaunch of the ( inaudible ) -- how is that being received?

In the -- I would say the relaunch in the U.S. of the U.S. version of the cue toss is probably doing a little softer than we would hope. But I would say, you know, the maldy configuration is a big piece of the business on the cue toss side anyway. In terms of our forecast and our plans it hasn't been a big factor in one way or the other in terms of where we thought we would be.

I think is a fair amount of noise going on around the business in the U.S. right now, some of it we have induced with the deal force reorganization and some of it's with the patents and the relaunch of our new products. So there is clearly a fairly frothy time that, you know, we are trying to, you know, stay the course through with the key issues being the relaunch of the product lines next year. So, I think we are going to continue to see this kind of, you know, an extrapolation of the current conditions for the next couple of quarters.

Okay and might have missed it, but do you give actual backlog in how that change from the prior quarter?

no we don't give detail on backlog. We get billed back logs principally in the mass speck area in the third quarter.

very good, thank you.

Our next question from Corissa Marino from Goldman Sachs.

Thanks so much. Could you provide a little bit of color around the production issue that led to the mass speck short fall?

Sure, John can fill in where I, you know, get too high-level. But basically what this was a subcomponent provided by a supplier. And, you know, we had seen intermittent issues earlier in the quarter but unfortunately, these problems got greater late in the quarter and what they really resulted in was systems having to dwell in test, final test, much longer than we had originally planned. And that was to test the subcomponents that were being resupplied by the supplier. So, we think -- we think we are beyond that. I must say that we have, in fact, at this point shipped a number of those systems that we thought we were going to ship, you know, late in the quarter. It was, you know, a component issue. John is there -

probably one other thing I would add to that this is a he -- obvious lay critical component because it is in the detector end of the product. And in the end, the way tough test these things is under extremely high documents, which is what we end up seeing at the tail end of the production process. Since we got a good fix this quarter on what we thought the actual problem was, we were also implemented some additional capital for test equipment that we think is going to help us sigh this problem in the future before it get factory floor. So we think we have well define it had and think we have a ray way to see it before it impacts us, which then makes the problem more a yield problem at the subcontractor than it is a final test problem for us. So the fourth quarter obviously is going to prove that out us to that we do, in fact, pick these things up well before they get into final test. You that is the status, I think is behind us, but proof is in the doing.

Okay. And with the production issue, you know, 90%, 100% of the actual short fall, understanding the other patent issues have been going on for a while and I guess were order rates consistent with your expectations?

I think it is fair to say that overall, our mass spec order rates very close to our original expectations. And it was on the shipment side that we saw this problem and that was reflected in a backlog built in the product line.

okay. And then the lower guidance for 2002, does that relate to this production issue or a change in expectations for other areas?

Well it is principally related to our mass spec business and guess it is fair to say that it is -- it is more related to a sum of factors that we just are a little bit more cautious, I guess, about the fourth quarter, give than we have all of this internal stuff going on. We had a production problem in the third quarter that we think is behind us. And so, fair to say that you can take all the facts that I gave you and say, well, gee, should the fourth quarter be a little bit better? We are striving to overachieve those results, but I guess we are - a little cautious at this point about the -- all of those factors coming together to pull out a slightly better result.

okay.

It is more an -- it is a little on the intangible side.

okay. And then just one more -- cue toss that you discuss in the prior set of questions, can you describe in more detail what is driving the softness compared to your expectations in the re-engineered cue toss.

I'm sorry, I -- we said overall the order rate of the mass spec business is on our expectations.

I thought with David's question, that you had said that the relaunch of the cue toss in the U.S. was a bit softer than your expectations?

Yeah, I guess is fair to say that and it is made up for strength outside. I mean it is -- it is clearly -- you know, I hesitate to say that one point on a line being this last quarter that we can extrapolate cue toss results. We did totally change the mindset of the field force during the quarter and it is clear that competitors are trying to, obviously take advantage in as broad a way as they can and we are have to re educate customers, you know, as a regular part of, you know? We can do this the competition isn't quite right in what they are saying about that. So, I mean, overall, the net result of that was a slower rate of cue toss in the quarter than we had planned, but I am not ready to make any broad conclusions about that. I think, you know, some of it could be market related. Some of it could than we induce it. Some of it could be product related. I think we will -- we will probably need to see a little bit more of what's going on in the U.S. before we can draw a clear conclusion.

okay, great, thanks a lot.

Our next question comes from Donna Ducetta Merrill Lynch.

Thank you. Good morning, everybody.

Good morning good morning, Donna.

You mentioned that the industrial piece of HPLC was a little bit stronger than you have been seeing, which is a nice -- nice surprise. Was there anything specific in some of the vertical markets or geographical basis than others in I guess you mentioned you had chemicals, food and beverage, environmental in there anything that we could pinpoint as the source of the strength?

Donna, interestingly enough, I would say what we are seeing there is generally across-the-board. If you look at Asia, Europe and in the U.S., and if you then look at the three or four biggest segments of that market.

I would say industrial, chemical, classic industrial chemical is probably still the weakest and that is kind of what we see in our TA business too, that is really [inaudible] and focused on those customers. But if you look at environmental, food and beverage and food and beverage is everything from soft drink manufacturers to pesticide analysis in AGRI businesses. Those applications are pretty strong. And I, you know, that's our particular way of characterize industrial. So you know, some people wouldn't characterize food and beverage as industrial, of course, but we have always consistently characterized our business that way. Kept it out of the pharmaceutical segment. But I am encouraged it is broad-based and it is -- cuts across those application.

do you think it is a market issue or something you are doing specifically?

Well, let me answer it this way. I think in our HPLC business, we are growing faster than the market. And I think a number of things we have done in the last couple of years have been specifically targeted at the nonpharmaceutical marketplace. So, if you look at the ease of use characteristics of our new empower software, that's kind of aimed at making it more user friendly to the some what less sophisticated HPLC user. If you look at our breeze systems that we introduced a couple of years ago, you know, again, they focused on ease of use into that more industrial-type customer rather than the pharmaceutical development customer. If you drill back into our product line detail, those are a lot of the factors that are making up the strength that we are seeing. So, it may not be that all these markets are growing at the rate that we are seeing, but, you know, we only have what we would characterize as an overall systems market shares, 20 to 25% range. You know, there is a fair amount of market there with us focusing on these industrial applications that give us an opportunity to continue to grow.

Yeah. Good. Um, a couple of quick financial things. This new line on the balance sheet this quarter, the restricted cash. Is that mostly for the loss -- the patent suit?

yeah, it is, Donna. That APPLERA case, we set aside a sum of money that respects judgment interest, along with a hedge for currency fluctuation, give thin was done in the UK as a way of providing for settlement in the case. As you know, the appeal is likely to go through mid-next year.

That is why it is higher than the original numbers?

Rather than putting up a bond, typically these cases, you put up a bond and you have to pay for the bond. That is just a part of, you know, appealing a verdict like this. Rather than putting up a bond, you can keep the money, keep earning the money on it, you just have to segregate it, if, in fact, you lose the case the court has access to those funds.

So, it is nothing more magical than that.

Well, looks like you still have a little bit of money beyond that to use. On the accounts receivable, looked like a great job. The inventories took a little bit of a turn up, but you mentioned you had this production issue and already shipped some of those mass spec units. How much of the inventory was actually the mass specs that were sitting there waiting to be delivered out?

If you look at the increase in inventory about 70% of it or so the increase quarter over quarter is a result of what took place at the micromass facility. So that I attribute to the production issue. The rest of it is a slight build in HPLC that I will say is somewhat seasonal that will go away by year end.

Okay and then finally, on the field service integration, I think John you mentioned that we would be looking at savings for about $6 to $8 million. How much of that will you capture in 2003?

I think we will capture just about all of that, Donna. We are -- some of the actions that we are taking could be a bit longer term than what --just the fourth quarter, but I think the six to eight is a fair number as to what we will actually achieve in 2003.

you might get a little bit in the fourth quarter, but I would say it is going to be not material.

Thanks a lot.

Our next question from Scott Jones of A.G. Edwards.

Good morning.

Morning.

My question has to do with your mass spec product line. In the past, you have broken it down into various areas and talked with growth rates and talked with growth rates and each particular line. Would you be willing to do that today?

Well, Scott, I think -- I'm reluctant to do it because of the, you know, the U.S. situation and the dynamics that I have already talked about. But I feel a little more comfortable talking outside the U.S., but let me give you some things that I am willing to talk about and then, you know, you can go to the edges. What we said outside the United States this at patent issue has not affected our business. And if you look at our international business, you know it continues to be, you know, the strongest element of mass spectrometry. Cue toss continues to be the strongest product line and triple plus as was the case in the second quarter are not as strong as they were but their maintaining about the same pace in the international marketplace as they were earlier in the year. Other than those two product lines, there is nothing remarkable about what is going on in the international marketplace. We are still led by cue toss. You know, maybe we are seeing a little bit of what you might characterize as market weakness. Frankly, it is hard for us to tell at this point with a single point on the line. As I say, overall, our business achieved essentially our expectations in terms of incoming order rates. So, that is driven by cue toss. So I think we are all right. We are just -- we are just a little bit more cautious probably than we were a little bit earlier this year.

The U.S. business is full of noise, so, I'm -- I'm reluctant to talk about specific unit data in the U.S. market.

Sure. Could you quantify if I even in rough terms how fast the cue toss line is growing overseas?

Continues to grow north of 20%.

Okay. And one last question and that is to John or Nell, the 10% sales growth that you mentioned is expected for '03, does that include acquisition or any currency?

Yeah, the 10% is a composite number so I'm rolling the various product lines in there -- product lines in there micromass, HPLC and TA. Obviously, they could be upside for acquisition and foreign exchange as well but we are not going to quantify that as we speak today. We want to be somewhat cautious from the perspective of having upside brought into the 1.50, at least this early on, Scott, in the process.

Who the 10% be organic or would that be including the terminal analysis acquisition you have already announced?

It is organic, but we are -- again, I'm not going to bring that up for you from 10% right now.

Our next question come from Malov Chirov Galic from UBS Warburg.

Hi, this is Malov and Derek. Just to clarify. If you are going to go from $1.30 to $1.50 that is about 15% EPS growth, 10% of that is gonna be top line growth and you saying you still not counting on currencies and other things. So I would assume that 5% of that is going be cost cutting or margin improvement?

Yeah almost by definition. But we are certainly looking at, you know, having an impact on our SGA growth rate by rationalizing, you know, the cost in the field organization and that's what John's talked about. We still continue to believe that we can improve our margins and, you know, that's obviously more of a struggle when you're volume isn't as robust as you thought it was. We thought we would get back to more normal growth next year.

And all you really need to do is look at a model that comes, you know, somewhere around 25, 26% contribution margin, which historically, as you look at our trend is not an unreasonable expectation going forward to get to the $1.50.

And in terms of the share buy back, how much are you planning to do in the fourth quarter and then onwards?

Well, we have always planned to execute the $200 million authorization that we have. We have done a little over 50 so far. And our plan was to more or less do that radically over the year. I wouldn't say it is a guarantee but we haven't made chances to our plans at this point.

okay so we should think about 50 million, give or take a quarter?

I think that is not a bad plan.

Okay.

Okay. And what was -- what was cap EX during the quarter?

7.5 million.

And in just in terms of the looking at your sales of triple quad in outside of the U.S. and Europe and stuff, what, you know, could you talk about how that market is looking? Is it still being driven by developmental? Do you thank you some of the softness in the cue toss you are seeing could be because that is more of a research instrument?

In terms of the triple quad, I think, again it is important to characterize the two different markets. There is the high end market, which is what we base the problem with in terms of our quatro Altima in the U.S. and that we lost the patent case on. There is a lower end mark that's we compete in with our quatro micro, and that's a very robust segment of the market for us. As a matter of fact, our field reorganization, bringing both the Waters Sales Force and traditional Micromanage sales force together on this, we think is going to leverage the quatro microapplications very strongly. We are very optimist about our ability to take triple quad technology and now penetrate much more quickly into a number of applications that haven't traditionally used triple quad. On the higher end, it's -- it was a competitive market before we saw the pat tint case. You know, for us, it is something that we don't have the replacement technology for the U.S. right now. We are competing outside the U.S. but that is a very competitive battle.

Okay. Thank you.

Our next question from Sherry Walker of Deutsche bank.

Good morning. I just wanted to get your thoughts on how sustainable you think the strength in HPLC is. Will as we enter the fourth quarter what are you hearing from the customer base?

That is a good question, Sherry. Because a lot of people, I think have been surprised at the strength in our HPLC business. You know, I think the elements that give you encouragement are the fact that it is across our business. We are seeing the strengths in, you know, essentially every geography that we play in and we are seeing it in these different types of customers, the pharmaceutical life science customer, the industrial accounts and in the university and government accounts.

Now, I can tell you that we have recently spent a lot of time with our sales force and, you know, the sales force in the HPLC area pretty confident about what we are going to see in the near term. So, we are counting on high single digit growth in the HPLC line in the fourth quarter. That should be a little bit conservative, based on what we have seen this year, the kind of position that we are taking and the competitive balance. So, I don't -- if anything, I guess I would say if there was a dip in the traditional pharmaceutical market over the last 12 to 16 months and a lot of people have speculated in that and it is hard to tell by technology, you know, because for the most part our HPLC business drove through that. But if there was, then I would speculate that we are more likely to be coming out of it rather than going into more of it. We see no signs in any real respect that if it did exist it is getting worse. I think those are, you know, perhaps reasons to be little optimistic.

That does sound encouraging. You could potentially see some -- a little bit of upsnide this product line in the fourth quarter.

Yeah, that is certainly not impossible. I would say we are trying to structure this so we don't see downside.

John, could I just get a few housekeeping -- what was the operating cash flow in the quarter?

Hold on. Operating cash -- care from operation, somewhere close to 57 or so

Great, thank you very much.

)) Yep.

Our next question from Thomas Clayton of RBC Capital Markets.

Good morning a couple of good questions, John Ornell, you made reference to operate willing margins in '03 and I was just wondering if you could repeat what you said. I missed your comment.

Yes, we were just talking about the $1.50 and how we would leverage from a 10% topline to a 15% EPS growth. And I was indicating that we did expect improvements year-over-year to continue in gross margin, though rather small but with some of the measures that we are taking in the combination of the business and looking at more reasonable growth, perhaps year-over-year in SGA we would see operating margins improve to the 25 1/2 to 26% range perhaps as we model 2003 going forward. Again that is more SGnA leverage than gross margin leverage.

If I could ask what the buck 50 for '03, what share count does that take into account?

something just a bit less than where we sit at the end of the third quarter. So, we are not projecting full leverage from the buy back at this stage?

There is still some outside left?

Depending on what transspires yes.

As it relates to triple quad sales, ex-U.S., anyway you can provide some -- at least anecdotal information on how well the quarto ultima platinum versus how the quarto micro were doing?

I think consistent with what we said in the last quarter it is a competitive marketplace, we certainly compete better outside the U.S. because of the platinum. You know, we see some places were we wish we were doing better and other places that we think we are more than holding our own. It is our intention that when we introduce the new technology in 2003 it will replace the platinum technology with the triple quad. That will be a world wide introduction.

So the growth you are saying -- the growth you are seeing internationally is split between the two instruments is that fair, fairly evenly is that not a fair characterization?

In terms of the quatro microand quatro platinum?

No the Mike Joe doing better world wide.

great, thank you.

Our next question from Macshee Mahora of Salomon Smith Barney.

Hi, good morning. Just to follow up on Sherry's question on the strength in the HPLC business, just to clarify, are you still baking in high single digit growth rates in your guidance of '03 and has that changed to the double digits? And secondly, how much accretion if any are you factoring in from the rementoring acquisition in the '03-150 number?

we have talked about HPLC being a 9 to 11% grower. So we have -- in the $1.50, in the middle of that range. To give you a roundabout specific answer. As it relates to the remetrics acquisition, which is second?

Yeah.

That -- we are not factoring in the upside of-to-that in the guidance at this stage, though we have talked with that being a --accretive transaction going forward. I mean, an upside of a couple of cents perhaps as we look at melding that business into TA going forward but we are not going to raise guidance of that.

we will model that when the deal actually gets done.

okay. Great.

Our next question from Kenneth Goldman of Lehman Brothers.

Good morning. Just two quick questions. In the past, you have broken down the percentage of your business by product line, HPLC, mass spec and CA. Would you be able to do that today for us?

yeah. Certainly in terms of what is the relevant growth rates were.

no I mean percentage of sales?

Yeah. Yeah.

HPLC we have talked about in the past being somewhere around 60. That is probably closer to 65 at this stage, based on where the business is gone this year. TA is probably closer to 7% and micromass is the reminder.

And one last question, the guidance for this upcoming quarter of 46 cents is that predicated on the 7% growth in the top line or including the FX if it remains stable or predicated upon a lower number you mentioned?

predicate on a 7% growth in sales for organic and 3 FX.

great, thanks, I appreciate it.

Next question from David Wood of Stevens Inc.

Hey, guys, John Sullivan here. Can you just tell me -- I know that you are working to integrate the mass spec and HPLC seams sales forces, et cetera. Did costs associated with the that raise this quarter's SGA number and by how much?

No doubt we had some expenses in SGA associated with those activities, travel and a few others. Somewhere just under $1 million of expenses associated with that activity that are included in SGA as we speak. And we will review that in the fourth quarter, certainly, as we look at the charge.

But those are costs that the accounting rules department allow you to treat as one-time costs.

Correct.

I understand. But will there be a like at amount in the fourth quarter of those --of those types of charges that you can't throw in to the one-time number?

I would say it would be less. I mean, it was a lot of preparation work that was done in the third. As you can imagine, getting this aligned, so I would imagine we would be able to get most of what occurs in the fourth into the charge.

Okay. Thank you very much.

Sure.

Our next question from Abe [Grockteen] Glennhood Capital.

Good morning. I'm sorry, I missed the beginning of the call. Did you explain how the receivables dropped so substantially in the face of the sales increase?

2) Outside of exceptional management of the process, we have been working on bringing AR down in the number of different geographies and businesses throughout the course of the year. We have got obviously groups focused on and insented to look at those, look at reduction opportunities across-the-board. We have been very, very successful in the U.S. market space, many not so overseas, had improvements there as well. But really just a constant work that has been done to go after, you know, the various balances to bring them down into current state and --

14 no securitizations or anything?

no not at all. Just managing the business.

Are the receivables different between the HPLC business and the mass spec business and do the shift in that business account for part of it?

No it is different by geography more than by business. Obviously, the U.S. is less than Europe and Europe and Japan and the like, but it is really an improvement across-the-board as it relates to collections than it is mix of business.

Okay. Just curious about your guidance. In 2001, without problems in mass spec, sales gains were 8%. And yet going forward, you're projecting a sales gain of 10%, which is -- would be the best in two years and not far below your -- 2000 number. It seems a little hard to fathom exactly how or why sails should accelerate so substantially should accelerate so substantially to a period when you had his patent issues, less technology issues and cap expanding of your customers are considerably freer. I'm not certain why you think that is going to be so easy to achieve.

Well, the principal reason is that we are operating in double digit growth right now in our biggest division, that being HPLC. And we believe we can continue to operate more or less in that range.

Is that different than '01 and the early part of '02?

a little bit stronger than '01. But it is not, you know, a light year ahead of it. But the difference between '02 and '03 is our expectations for the mass spec business and our mass spec business this year has taken a large hit because of our necessity to stay, you know, basically out of the U.S. market for a big piece of our business in the triple quad business and then had significant ramifications on our cue toss business, certainly for the first half and we think that -- certainly for the first half and we think there is fallout for that even going on in the second half.

And so you know, absolutely, you're right that we haven't performed that way in '02 and we think our performance is going to be different in '03.

And the engineering issues with respect to getting around the pat tent problem, these are completed, done, finished or still more to do?

no they are not finished, but John you want to --

Yeah the general direction that we are going to take with a few -- a few backup positions are more or less well defined. We are going to see in the fourth quarter a system level out of the normal fly of the serial what we -- flow out of the sire y'all what we would think of as deliverable performance.

Are there any beta models in existence yet?

we generally would not put out a beta model of something like this, this far in advance of when we would be thinking of introducing it. The units will be evaluated would be evaluated within the factory in Manchester. We may have some triple customers come into Manchester, but we normally wouldn't go through sort of the beta scene Nair grow. And particularly since we know the product and the specs of the products, we would use beta evaluations when there is a bigger set of new features and so forth coming in and we want to get customer reaction. When we are talking about physical performance, we pretty much understand what the reaction will be. We are going to keep this close to the vest because we like to, obviously, preserve our competitive launch position.

Well, where we are, just so that you understand, with this -- with this product where we are today and what our anticipated launch date is really, you know, no different than what we would have been talking about with the introduction of the cue toss or the quatro micro. It is not like, you know, you should read this as we are being extremely aggressive with our positioning right now, given what we have been able to prove in the R&D labs. You know, we are pretty confident that we can deliver this. It is not, as John would say few lines of code to complete it, but neither is it new science that we think -- neither is it new science that we have to generate. We have to engineer it and we have to build it. I think we believe that the risk here is that it may take a little bit longer and that is one reason why we are not, you know, pinning down that it will be march 1st when we are able to launch this product line.

We think it is in that order of risk, not a risk that can we do this.

Okay. On the inventory issue, I thought I heard you say that part of the buildup was 70% had to do with the mass spec issues and 30 was buildup in HPLC inventories. Sales are accelerating why are inventories building in that line?

we ended up with some excess inventory on a couple of particular lines with didn't expect. So it was more a --

have to be written off or billable?

No, not at all, inventory that will work off of the floor but just as you sit and plan from a production standpoint where you are going to need inventory, not always as correct as you need to be, such that you know, sales increase, you chase after, you know, the incremental production to hit the sales in the area that are doing well but end up with other inventory, perhaps not doing so well, takes longer to burn off. And that was the situation.

Circle back to the parts problem you refer to in the mass spec product. I find it a bit disturbing that something -- a critical component could disrupt your production and you discover you have no quality control in place before this on something that has been your hottest product line the last few years. What -- how does something like that occur?

I think it is fair to be concerned about it. I mean, obviously, we are concerned about it but, John, you want to --

yeah I think -- it is not as if there is no quality. The real question whether or not you're -- you ran process quality checks, measuring the right variables, wouldn't be correct to think, receive the parts and never check anything. I think we are talking about a subtle difference. We are not talking whether it just didn't work or not, talking about a shift in final performance to below specification, not to no specification, so, what we learn in this process is a very small effect at the sub assembly level was getting us at the system test level and we then this had to put in place something that is far more specific in terms of QC, but we didn't go no QC to some QC.

Were there other changes made with respect to other parts at the same time, that you discovered this issue?

I don't think so I mean, in any product, you are always, you know, seeing ebb and flow of things, but this is fairly -- quite a detective caper to figure out what was actually going on.

Is there any possible that there are units out in the market that have similar issues this are undiscovered at this point?

We don't think so I mean, quite honestly, sort of --

Are any checks being made or --

Not so much checks being made as this there are ways that, you know in operation and in servicing products, we want to make sure that, you know, certain procedures followed but this is a very measurable system dynamic out there.

These systems all pass final test.

absolutely.

About before we ship them and install them in the customer. So, that's just -- in this case, in this particular subcomponent place it took us longer for those systems to dwell in final test before they met our final spec.

Okay. Okay. Good, thank you very much, I appreciate your candor.

Our next question from Scott Wilken of SG Cohen.

Thank you. Just a clarification on your guidance for Q4 for HPLC, you said high single digit skew growth. I was just wondering if you that is net event FX or including FX? And also talk about in the past you have addressed this, if you could talk about maybe orders versus shipments for HPLC in the quarter to give us some idea of backlog.

The high single digit forecast for the fourth quarter is before currency impact. So that is organic. And backlog, as Doug had said earlier for the company was up slightly, but that was related mostly to mass spec with HPLC not participating, no great change.

It was pretty significant backlog build in mass spec, Scott, I think that is fair to say. Millions of dollars.

Just related to HPLC, should we think about backlog being stable?

essentially as order rates and sales rates as being pretty similar. In terms of growth rate.

And just again a little bit who are detail here just on mass spec, you did give guidance on HPLC, could you do so for mass spec in Q4?

Yes.

We think that mass spec versus being down low double will be down low single in the fourth quarter.

And just addressing your kind of your caution for mass spec in Q4, you know is this more the reorganization that is going on or would you call this caution more driven by the market that you are getting?

More internally focused than it is externally focused, Scott.

Okay and just on the market environment for mass spec, maybe for your business, could you just talk qualitatively about pharma trends versus academic government trends?

As it relates to mass spec?

yeah, just mass spec.

I -- again, our view is colored because which have our biggest market where we have got a lot of noise being in the U.S. marketplace. And obviously, with the high end triple quad drug metabolism, you know that market hasn't gone away, it has just been substantially reduced for us. So with all of those caveats, I think the market for mass spectrometry is still very strong. I believe that it is still growing in the -- at least in the mid-teens. And I think that we have every reason to believe that it will continue to do that and we are not growing at that right now so you can, you know, take that for what it's worth, but I have every reason to be confident that it is going to be the fastest growing area of analytical technology that we see and we are going to be back in the middle of that in 2003.

Okay, just relative Q4 and the op expenses, you talked about SGA maybe not growing as fast as it did this quarter, could you talk about R&D, because that was above expectation as well?

Yeah, R&D, expense in the third quarter related to technology licenses that won't repeat in the fourth, so we would expect that to come back down to the normal growth rate quarter after quarter, closer to 8 to 10 than where it is now O

it fair to say for Q4 that the FX upside is in the EPS guidance, but then the share repurchase of 50 million here is not?

I -- I -- the -- definitely the FX chances our end of the guidance and as Doug said, we are anticipating another 50 million of repurchase. There is potentially some upside of that but not going to suggest it is material.

the 50 million is in the 46 cent guidance?

It is truly not but not going to bring that -- I would not bring that into the guidance, given than it is not a done deal.

Thanks a lot that is all I have.

Next question from Aaron Cohen of Cars Capital Management.

Good morning, guys. Can you give more color on the share repurchase? When do you plan to finish the existing program and when would you look to re-up it?

Well it is a year program and -- have always anticipated would be completed within a year. And unless conditions change markedly, which seems to be, we plan to basically do, you know, one-fourth, one-fourth, one fourth over those quarters. So, our plan would be to do 50 this year, 50 next quarter and 50 the following quarter. And the board will take up the various uses of our cash as it normally does, at least on an annual basis and evaluates whether we have a boater use for cash rather than returning it to shareholders.

When are you left to be back in the market?

two days from today.

Okay. Thank you.

Our next question from Donna Ducatta of Merrill Lynch.

Hi. I'm back. A couple of quick things. Cap EX in the quarter?

about 7.5 million, Donna.

Okay, anything in particular that was spent on? I'm sorry, particular was the wrong word. I'm sure the people at appropriations were happy, any big process in there?

I think the -- nothing really noteworthy. I will say that again in the giant scheme of things it is not huge, but one of the things we are doing in connection with this restructuring of the field organization is that we are put more dim model equipment into place, but, you know that is not a huge number. The other thing we are doing is bringing all of micromass into the SAP world. Whereas Waters has been on saps really for about five years now, micromass has operated a different MRP system. And one of the things that we are really looking forward to is having one world wide universal MIS and database system that pulls all that data together. That's probably a million and million and a half for information systems, but we think we are going to do that within our original budget actually. We are tweaking around the edges. So, you know, that is a relatively new dynamic but not unusual within the context of what we are currently spending.

Well, as I recall, your own implementation of SAP went virtually without a hitch, thanks to John Ornell's work on that.

I wouldn't take the credit for that, Donna.

But that is clearly an outlier on the bell curve of these European implementations. Do you think this one will go anywhere close as smoothly?

I think it will. I think it will because we are two-thirds of way down the road. You know, we, you know, un -John's organization and with -- with the users, the teams were set up three months ago. The interim targets were highlighted and we are going to cross over by the end of this morning, we will be running our order books through SAP rather than through the predecessor system.

Worth noting, Donna, our implementation of SAP, tough make it fit your business practices and that means tough make a lot of decisions. In this case, we are staying with our SAP implementation and with just moving the micromass systems into it. So it is more or less a very directed activity. We know what the end point looks like.

Is there some of the reason for the caution on the fourth quarter numbers?

People like John and John and me get, you know, daily and hourly the same kind of information for the mass spec product lines that we get for the HPLC product lines and that kind of good, timely information, you know, helps you make decisions in a timely watch I wouldn't overstate it, it is not going to be a miraculous change overnight, but there is no question that one of our competitive advantages in our business is our ability to implement world class systems in a very cost efficient manner and we are now expanding that to all of our business rather than just two-thirds of it. So, I think it is going to be a very, very useful change.

The official switch over takes place the end of next week.

Going back to the mass spec business for a bit, given the nature of the appeal process and the -- appeal process and the jury verdict, do you need to get the approve designed approveed by the court to get the production on them?

Absolutely not. We obviously, we want to be really clear in our own minds where we stand, so, you know, making sure by means of physical measurements that we know exactly where we stand. We really do understand this particular pat tent issue very well, as you can understand now. So it isn't a question of trying to figure out what we have to miss and I think what we are doing in terms of moving forward, where we are trying to well characterize it where we need legal opinion in terms of any nuance. We are certainly soliciting that, but you don't deal with the courts in these cases.

You end up dealing essentially with your interpretations of a particular situation, the wording of the patent, so would you see any -- I don't see any issue happening we are going to say we launched something new, we run afoul of the same piece of idea. I doubt that very much.

Okay. It maybe too early to actually is a discussion about this, but let me just throw out the question. The President's recent proposals on the generics. Do you see that -- what kind of effect will that have on your pharmaceutical customers in terms of their spending.

if is a subjective call right now. You know it -- you will have -- you know, unanticipated ripple effects through the industry one way or the other, right? It is -- I think the good news is that we have a strong market share across-the-board in the pharmaceutical industry. Generics and ethical pharmaceuticals and biotech alike. Unless you posit that across an industry reduces capital spending, then I don't think you will say that it has a major impact on U.S. as a supplier.

Although it could shift some of the focus I guess, or your own sales proportions across the company?

yeah, but, boy, it is awfully preliminary to make any guesses where that will wind up.

Okay. We will stay tuned on that one, that's for sure. Thanks a lot.

You're welcome.

Our next question comes from Thomas Fladden of RBC Capital Markets.

Just two quick follow questions, one for John Ornell. I'm assuming the 6 to 8 million SGA savings you will incur as a result of the sales force alignment is included in '03?

That is right.

One question for John Nelson or Doug to clarify, Q 3 was all of the downside seen in the mass spec space relative to your initial expectations can that all be attribute to the production issue or something else floating around there?

Well, you know, a significant part of this related to the production issue. I hesitate to say all of it, but in a mathematical sense you can say that our underlying order rate was on our expectation and our shipment rate wasn't. So when you drill down, we got some orders for things that weren't able to ship that weren't related to that production problem. Not everything was related to it some of it was, orders came in at a different mix and a different rate than we had anticipated and we hope to get better balance in the fourth quarter and thereafter.

Great, thank you.

Our next question from Paul Medley of IGN.

Yes, this is on the production issue, is there any product that was shipped that has this particular issue that you have to go out and fix or recall or anything like that?

no anything that was shipped passed the final specification.

And with respect to the mass spec, so for the second half of the year in your guidance, are you assuming mid-teens run rate there?

For the second half of '03?

yep.

Yeah. We are anticipating that once we get the product launches, you know, somewhere between pit con and ASNS, as we've said, that we will begin to take orders and shipping contract for the second half of the year and put mass spec back into that 15ish% growth rate.

Okay, thank you.

Our next question comes from Abe Brockteen of [inaudible].

Is there any reason we have to think about the current quarterly estimates for next year as going down in the first half and up in the second half because of the timing of that mass spec ship change?

well, I mean, we have not yet broke the $1.50 down into its quarterly components. As we go through the budget process this quarter, we will get a feel to that. But I think it is fair to say until we get the replacement products on track that we are going to have, obviously, lower growth as it relates to mass spec element in any way in the first quarter, perhaps a portion of the second, so yes, we are going to have reduced growth -- in the first half versus the second from that dynamic.

You are aware that current estimates are in quart letter terms 15%21%, 13, 11 sequentially in '03 versus '02. Sounds like it is inverted S that a fair statement?

I mean, those estimates are not my estimates. We have placed $1.50 out there we did that back in the July call, we are reiterating it now and not come out with, you know, specifics by quarter.

I was interested in your comment that the board would consider the use of cash other than the buy back. The buy back seems to be a rather empty gesture. You are buying back earnings, even if I use the $1.50, something like 6 1/2, just under 7% pretax rate doesn't seem like a very good return on investment and that is not even netting out interest you give up on the cash. What are the other options available? Are any acquisitions of consequence or size being considered by the board? I can't imagine you would want to keep just spending money to get 6.8% pretax return. If that is the best the high-tech company can do it is rather --

Which acquisition do you think we ought to do?

Well, I am I do know this it is very clearly established in financial history that if you can only reinvest your money in under 7%, then it is just not worth as much as if you can invest in the current returns. If that is the message that the buy back conveys, then I find it disturbing.

I think what the board considered, the business that we have has some very clear strong cash generation attributes to it. Whether in the short term, the earnings are growing at double digit growth rates or not, as evidenced in the quarter we just put, where we can throw our cash flow of 40% or greater, even though earnings are flat. So that attribute of a business has to be part of the long-term strategic plan. And I don't think there's too much new under the sun as to what you can do with cash, other than you can keep it around in financially liquid devices. You can return it to shareholders, either in the form of a dividend or stock buy back or you can deploy it in growing assets, businesses. And we --

I suggest you consider a dividend. I can invest a money better than 6% pretax rate in any number of companies. So if you care what the shareholders think, I would rather pay the tax, have the dividend and be able to you the putt it into companies that can earn 20% than 6.8%.

We have talked to a number of shareholders and there's actually more of a consistent thrust on shareholders that they prefer a tax advantage return to a stock buy back rather than a dividend.

They just hoping you will call the stock up so they can sell it to you. That is just idiotic. Thank you.

Our next question from David Mallowa of JP Morgan.

Just a quick question on the timing of the reclassification of the service labor. When does that take place?

We will be working our way through that, David, in the fourth quarter, 2% with the K at the end of the year.

Okay. So we should think about that going forward starting 2003 though for a molding standpoint?

no we will be restating the results of 2002 using this new classification, but we will do that with the, you know, the full year results for 2003 with the K.

Okay, thank you.

And of course, all prior years have to be restated, that is part of the issue why it is taking so long.

Okay.

Our next question from Aaron Geist of Robert W Baird.

Good morning, gentlemen. Two questions. First, can you remind us what kind of impact delay and a release of funds last year had on your business and secondly, what component of your business you would think comes from government-funded research in the U.S.?

Well, overall, our -- our university government segment of our business can range from 15 to the high teens of our world wide business. And, of course, a lot of university businesses government-funded, not only here but outside the U.S.

Our direct NIH sales are not anywhere near that 15% level. I mean it is less than 1% of our total revenue. So, -- and it relates to the -- whatever slowdown in NIH funding that occurred last year impacted on us. We said at the time and we continue to believe that there was no real discernible impact on our business from that dynamic. You know, maybe there was something in the base, but there were no identifiable orders that we said, well, we were going to get that order and bus of delayed NIH funding, you know, we didn't get it. We don't think that it was a material impact.

Okay. Thank you very much. That is very helpful.

Our next question from David Cohen of Fair Lawn.

Yeah just wanted to say, I radically disagree that idiotic analysis by the short seller on trying get you to do dividends, completely forgetting the growth in the company and we are bag big fans of the share repurchasing.

I appreciate that comment.

I'm not showing any further questions at this time.

Well, thank you all for your attention and we will look forward to the next quarterly call. Goodbye.

( end call, 9:53 A.M. )