Waters Corp (WAT) 2002 Q4 法說會逐字稿

Good morning, and welcome to the Waters Corporation fourth quarter financial results conference call. All participants will be able to listen only until the question and answer portion of the conference call. By request of Waters Corporation, today's conference is being tape recorded. If anyone has any objections they may disconnect at this time.

I would now like to introduce Mr. Douglas Berthiaume, chairman and CEO of Waters Corporation. You may begin when you're ready, sir.

Thank you. Good morning, and welcome to the Waters Corporation fourth quarter 2002 conference call. With me on the call this morning is John Nelson, the president and chief operating officer, John Ornell, CFO, and Gene Campus (ph), investor relations.

I will cover the fourth quarter results. Then John Ornell will take you through the financial details of 2003 forecast and open it for Q & A. I would like to ask John to cover the safe harbor language.

Yes, during the course of this conference call we may make various forward-looking statements regarding future events or future financial performance of the company. In particular we will provide guidance regarding possible future income statement results of the company at this time for Q1 and full year 2003. We caution you such statements are predictions. Actual results may differ materially. For detailed discussion of these risks and uncertainties that could cause the actual performance to differ from our present expectations see the 10-K annual report for the fiscal year ended December 31, 2001 in part one under business risk factors. We caution you the company does not obligate and commit itself to update predictions. We do not plan to update predictions regarding income statement results except during the regularly scheduled earnings release conference call and web casts. The next webcast is currently planned for April 2003.

Thank you, John.

As you can tell, if you had a chance to go through the press release, there has been a lot that has gone on in the fourth quarter. Most of the items have been discussed at some level in either previous conference calls or filings. But clearly some of these items came to full fruition and are reflected in the fourth quarter financial results. Between John and myself, we plan to cover in some manner all of these items. I would like to start, however, with the key product lines and how they performed. I will first turn to HPLC results.

As you will recall, through the first nine months of 2002 our HPLC business had been growing nicely. Revenues were up about 10 percent in organic terms year-over-year. And we were anticipating a good fourth quarter. Well, the fourth quarter didn't repeat the strength that we saw in those earlier quarters. As the quarter progressed, it became clear to us that the large pharmaceutical companies in particular in both Europe and in the U.S. were slowing or not making planned purchases. It was at that point that we revised our expectations and published new revenue and earnings estimates for the fourth quarter. While in the final accounting the fourth quarter for HPLC finished a little better than the revised estimate. Large pharmaceuticals did in fact remain soft as expected. But industrial accounts picked up a bit and contributed somewhat more than we had originally anticipated.

As a result, HPLC grew their revenues about 2% in the quarter before currency effects. Geographically we saw similar results in both the U.S. and Europe with low single digit declines in organic growth. While Asia including Japan continues to be strong with growth in the double digits. Continuing areas of strength in the HPLC arena are the chemistry consumables and the service operations. We continue to see good double digit growth in these lines, each of which have both strong operating margins and very strong flow -- strong cash flow attributes.

The micro mass (ph) operations came in near our reduced expectation levels. Revenues were down about 10% before currency effects. We are continuing to be affected by the adverse patent ruling we received earlier in 2002. As well as the slow pharmaceutical conditions in the fourth quarter that I mentioned above.

And as I described in earlier conference calls, we did decide to restructure many of our business operations to combine what were previously separate micro mass and HPLC organizations. Principally to align our forces to meet strategic goals of presenting a unified face to our customers. Although cost reductions were not a principal focus of this restructuring, we did identify several areas with duplicative functions and have taken actions to streamline our structure. As a result, we have recorded a restructuring charge in the fourth quarter of approximately seven and a half million dollars and will have a lower cost structure in 2003.This new structure is anticipated in our 2003 forecast. We don't think we have exhausted every opportunity for improving our structure. And I anticipate that we will announce further steps in 2003.

Although I don't anticipate that the 2003 charges will be as large as this fourth quarter charge. As you know, a key strategic issue for our mass spectrometry line is the planned reintroduction of a high end triple poll instrument in 2003. In previous discussions we said we targeted either a pit con or a.m. S introduction of the new instrument, but we continue to update you on our progress. It now appears that in June is a pretty firm estimate of the launch of the new instrument. We forecasted volume shipments will be made in the second half of 2003.This is essentially what our previous financial guidance had been based on.

The good news is we believe we will have a very competitive technology available on a worldwide basis and we are very enthusiastic about our opportunities in 2003.In our third and smaller business units, the TA instruments, we saw good progress in the fourth quarter. Revenues were up in the double digits after three tough quarters. So one quarter doesn't mean we are out of the woods in this tough industrial market. But with this bit of light and the January closing of our purchase of the re--a metrics product line we think we are in good position to have a successful 2003.I would like to briefly cover a few other items.

As part of our re-look at our mass spec operations we took a close look at our inorganic product lines. As a result of that we made a discussion to discontinue and exit these lines. They represent about 14 to $15 million of annual revenue that has been declining marginally over the last couple of years and it is a product line that has been operating about break even profit wise. So we anticipate that we will be able to effect a disposition of this product line in the first half of 20032003.Secondly, we have been subject of an investigation by the Massachusetts Department of environmental protection concerning a noncompliance with state environmental laws that are at our Tahoe ton, Massachusetts, manufacturing plant.

We believe we are close to resolution with the agency with substantial agreement on the remedies that are required. As a result we recorded the estimated cost of the remedies in the fourth quarter results. A plant has been allowed to continue to operate during this investigation and these remedies should not unfavorably affect future operations of our plant.

Finally, I would like to also point out one compelling fact about our company. That is even in 2002, a year which will be remembered as one of the worst we've ever had, we generated $192 million of free cash. That was up over 25 percent from 2001. So this remains a very strong company with strong financial fundamentals. As we turn to 2003, I'm sure you have questions about the outlook for the new year. Clearly there are some caution flag flags flying on large pharmaceutical plants. We believe it's appropriate to be cautious. We believe long-term that large pharmaceutical companies are well positioned in an industry that will return to historical buying patterns. But for 2003 and particularly the first half, we will be cautious in our growth expectations.

We have crafted our operating budgets for 2003 with what we believe is a conservative eye on the top line and are driving our operations to achieve good earnings growth through productivity and staying very conscious of lower SG&A growth. If business conditions evolve more favorably in 2003 with stronger demand we hope to be able to over achieve these estimates.

Now I would like to turn it over to John Ornell.

Thank you, Doug. Good morning.

Results for the fourth quarter were slightly better than our most recent expectations, with sales down 1% from last year's volume before currency impacts and sales growth of 3% in actual exchange rates. Currency benefits accelerated through the quarter as the dollar weakened across the board but most notably against the user. Forty-one cents EPS before unusual charges, one cent above our estimated range and represents a 5% decline from 2001 before unusual charges.

On a reported basis, earnings per diluted that I remember were 30 cents versus a two cents loss for Q4 2002. Looking at the product line and before the currency impacts we saw HPLC perform slightly better than expected but significantly less than historic growth rates over sales growing in the low single digits. Sales in the U.S. and Europe were down slightly, Japan, Asia and Latin America continued to grow at double digit rates as all year. Major depressant was the slowing in demand in large pharmaceutical companies.

We believe the shortfall to be mostly a short-term dynamic at large pharm accounts and not a fundamental demands shift. We will take a more conservative view of this segment in our planning for 20032003.Turning to the mass spec business, performance in the fourth quarter was just about as expected with sales down in the 10% range as a result of both a strong base of comparison in the prior year and our continuing loss of product sales in the U.S. relating to the patent suits. We saw a dynamic similar to the, large pharmaceutical accounts in the U.S. and Europe.

On a bright note, sales of thermal analysis products this quarter were up in the double digits. Before I discuss margins and expenses I want to turn to the reclassification of service labor. As disclosed in the last two conference calls, we have concluded an analysis of service labor activities and reclassified $58 million of service costs associated with revenue generating activities for SG&A to cost of sales for full year 2002.

Full year 2001 results had a similar adjustment for $51 million. This re-class, which has no bottom line impact, has reduced SG&A as a percent of sales by 6.5 percentage points in 2002 and 5.9 percent in 2001 with a corresponding reduction in gross margin. The fourth quarter contains a comparable reclassification. This expense reclassification lips the reporting conventions with the majority of other companies in our industry. Turning now to gross margins using our new reporting basis, margin for the fourth quarter was 57.7 percent versus 58.7 for Q4 2001. This gross margin performance is below last year due to increased service labor costs and an additional provision for inventory obsolescence.

Service cost reduction actions initiated in 2004 in connection with the field will improve in 2003.Operating expenses continue to grow faster than sales as we have yet to realize the full benefits of the combination of HPLC and mass spec field operations. We have taken a charge of $7.4 million in the quarter for severance and other related costs resulting from the business integration. In addition to this charge, we also expect to incur additional charges during 2003 as we continue to review cost savings opportunities that will most likely benefit into late 2003 and beyond. We expect the cost savings of all integration activities to be approximately 7.5 million in 2003.The tax rate for Q4 was 19.7% as a result of tax affecting the various charges taken at local rates based on country of origin. This impact on full year brought the effective rate to 22-point 1%. The effective rate for the quarter and year without these unusual charges remains at 23%.Interest income was 1.7 million for the quarter before being partially offset by interest accrued on the patent settlement that could not be set up at the beginning of 2001.

In a parallel effort to the field integration process we have reviewed the outlook of our various product lines and concluded we will exit the mass spectrometry line in 2003. This $14 million business has had relatively flat to declining annual sales growth recently and only is marginally profitable. Working on the disposition of the business early in 2003 and we will report back to you later on this front as news develops. In addition to the restructuring charge I discussed earlier, we have taken the litigation provision for one -- 5.1 million, an asset impairment charge of 2.4 million written down our investments in non-affiliates by $6.1 million. Litigation provision, as Doug relates, relates to an estimated settlement of an outstanding case with the Massachusetts Department of environmental protection regarding our cotton, mass facility. We are close to final agreement on this charge and this remains the best estimate of the likely cost we will incur. The asset impairment and write down charges investment to investment Waters made in recent years in emerging life sciences companies

As you are aware the economic landscapes for these companies changed dramatically and the long-term outlook is less certain. Recently completed review of the assets led us to write off our acquired technology license from generics from $2.4 million write down the investment in Jean products by [inaudible] dollars. After the write downs we will have $14.5 million of asset value on the books for investments in non-affiliates. These investment are subject to future valuation adjustments. The balance sheet closes strong at the end of the year with the benefit of free cash flow of $50 million for the quarter an $192 million for the full year. Inventory declined this quarter as planned. Accounts receivable day sales outstanding stood at 70 days, down one day from Q3 but up three days versus Q4 last year principally due to foreign exchange dynamics.

In cost and currencies DSO was unfavorable to 2001 by just one day. Looking to 2003, we are planning on organic sales growth before currency effects of about 6 percent for the year. Although 6% growth is lower than our long-term goal we think that in the current economic environment a 6 percent growth rate estimate is warranted. Currency in today's rates would add about 3% to sales growth for the year. The organic sales growth assumes HPLC sales growth in the mid to high single digits. Thermal analysis growth in the low single digits before the ray metrics and mass spectrometry in the single digits before considering the distribution of the mass spectrometry business. After the disposition is expected to be about flat. Benefit of a new triple quad product is expected in the second half of 2003.Looking at other financial metrics, gross margins are expected to be up about 50 basis points in 2003. SG&A spending is expected to grow at a point or so less in sales growth and R & D spending is expected to grow at a rate equal to sales. We expect to complete our share buy back program in the first half of 2003.

With this completed we estimate our average fully diluted share count at about 131 million shares for the full year. All of this we would expect earning per share for 2003 to be a dollar 43, with a normal four to eight cents tolerance for the year. 15% increase over 2002 earnings before one time charges. Free cash flow for 2003 is projected to be around 200 plus million. Regarding the first quarter of 2003 we expect sales to grow in the low single digits before currency and in the high single digits at actual currency rates. The estimate for earnings per share for Q1 before any additional restructuring charges or charges related to the ray metrics acquisition to be 30 cents per diluted share with a one to two cents tolerance for the quarter. Doug?

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

Thank you, sir. At this time we are ready to begin the question and answer session. If you would like to ask a question, please press star one on your touch-tone phone. To withdraw the question press star one. Once again, to request ask a question, star one.

First question comes from (inaudible)

Thank you. Good morning. Could you please tell us your outlook for industrial orders on the HPLC side of your business? Do you see the strength that you saw towards the end of the fourth quarter to be sustainable through '03? Or what are your customers telling you there?

Well, I think our -- we are probably substantively more optimistic than our financial forecast would lead you to believe right now. We are feeling pretty good about the success that we have had in the HPLC arena in the industrial accounts. Now, we have dedicated more resources to that this year. We are focused some people specifically on that. They have returned that investment. I guess we are still a little bit reluctant to declare victory on an industry that has spent more than a year watching their pennies in terms of capital improvements. We don't think -- we think we have seen the worst. I think the question is, what is the rate of increase? And I think you can assume that right now our financial forecast presumes that we are in the kind of mid single digits in the industrial area, with what we believe is more up side than down side to that.

Okay. One further question. Thank you. The combined sales forces for Waters and micro mass, how many people have left or been replaced? Could you give us an idea of your structure there now?

Well, in terms -- I'm not going to talk specifically about -- let me put it this way. We have had no high levels of unplanned turn over. So we are not, you know, specifically losing people. The restructuring that we are going through and in the process of going through is looking at redundancy and territories and accounts and I think at this point across all areas, including field, administration, and other territories -- John, how many people have been made redundant?

We are in the neighborhood of 50.

A great deal of that number is indirect people as opposed to actually people in the field. We are continuing to look at that. It is not unlikely that we won't tweak our actual field territory management as we go forward in '03.Most of the activity is looked at support and administrative activity around those organizations. So the people in face-to-face contact with the customers are, have not changed that much. If you think about how we are approaching the customer now, I think for those of you who know us from years past, we have always in certain areas had both a generalist sales force that would generally be responsible for the overall focus on a customer set, and then groups of specialists. Particularly in things like our large data product lines where a salesman might be responsible for identifying an opportunity, but then the specialist would come in and specifically deal with the higher order needs of the customer. That's essentially the model that we are going to apply with our higher order mass spec. We are going to have generalists responsible for our accounts, but mass spec specialists to deal with the more higher order requirements of these customers. Net, net that means fewer people in the field covering those customers, but more than just one salesman per account.

Right, thank you.

Our next question comes from Kenneth Goldman (ph) with Lehman Brothers.

Good morning. Could you give us a breakdown on a reported basis of the three business categories? HPLC, mass spec and thermal analysis?

From a growth rate perspective?

Growth rate or percentage of sales or what the reported sales were.)) JOHN ORNELL: In terms of percentage of sales, John -

HPLC is roughly at this stage about 63 or 64 percent of sales. Mass spec around 28, there abouts and TA the rest. So mass spec has come down a little bit this year, obviously given the patent situation and the reduced sales in the states -- you want growth rates for the other question?

No, expect take it from there. Another thing. I know you mentioned SG&A would be growing at less than sales and you would be getting a little bit of leverage there, off of which number? Because

Yeah, off of the -

Off of the annual number?

Yeah, the annual number.

Our next question comes from Sherry Walker (ph) with Deutsche Banc.

Good morning. Hi, could you give me just the operating cash flow and cap-ex for the quarter?

The operating cash flow was also about 50 million cap-ex was 9.4.

Cash flow from operations. Do we have from cash flow -- hold on, I'm sorry. I'm sorry. It's -- CAP-EX was 9.4. Operations was oh, fine

Fifty-nine, great. Just some more qualitative information on the HPLC market. Can you talk a little bit about what you saw in manufacturing versus discovery? Or was it the same? And then also if you are hearing anything about your customers' CAP-EX budgets for '03?

Sure. For those of you who aren't as knowledgeable about the makeup of our HPLC business, one of the advantages that we have in that business is, you can think of it in three packets. Our pharmaceutical business goes into pharmaceutical discovery, as one chunk. Then drug development in another chunk and then Q A QC and the manufacturing environment for a third chunk..

While discovery, if you went back two or three years was the fastest growing, the largest actual size of that market is in the Q A QC piece of the marketplace and in the drug development piece. So if you look at our results, coming out of the fourth quarter, there is no question that the manufacturing piece of that business did better than the early stage operations. It seems like it is in the front end of that process where companies delayed. And so, you know, that's -- that looks to be the issue in the fourth quarter. As we talk and acquire intelligence about what is going to happen in the 2003 time frame, frankly we are taking a lot of it with a grain of salt because a lot of people we talked to in the second half of '02 didn't see the slow down coming in the fourth quarter. Or didn't see it coming at the rate that they, in the end, slowed down to. So what we believe we are hearing is that budgets are going to return to more normal levels in 2003. That you are not going to see a continuation of the fourth quarter dynamic. That was a kind of one-quarter dynamic.

Now, I'll also tell you over the last two or three years we've seen about as many quarterly patterns as you can have. You know, last year we saw a relatively slow start to the pharmaceutical customer base and HPLC. It picked up markedly in the second and third quarter. We saw a big slow down in the fourth quarter. You know, what we think we are going to see is a pickup off the fourth quarter levels, but probably a lower than expected full year demand in large pharmaceuticals. That's why we are targeting this kind of mid, you know, six, 7 percent in the HPLC arena for 2003.

Great, thank you.

Our next question comes from March -

It's actually Dennis Brown. Did I hear you say in the mass spec business it was down 10 percent year-over-year?

Yes.

That's great.

Before currency effects.

Before currency, yes. You are going to be discontinuing the Z Q single quad?

Discontinuing the inorganic product lines. Our ice owe prime, noble gas, I CPM S product lines.

Okay, great. And what do you expect the metric acquisition to add to thermal analysis. That was 14 to 15 million?

No, that would be 19 to 20 million in sales.

Oh, okay.

The 14 million was the reduction from the inorganic product line.

Right, okay. And could you just give a little bit more color on the margin declines this quarter, please? Go through that again?

Sure. If you look at the margin decline, quarter versus quarter it's down [inaudible]% and the service re-class we did accounts for about, that full 1% because we ended up re-classing more labor, if you will, in 2002 than we had in 2001, just based on the increases that we've seen in expenses year-over-year. There was also about half a point or so of cost relating to a charge for inventory obsolescence as we reviewed our inventory position at the end of the year and took into account some of the combination activities with the micro mass stocks. We felt that an increase in that provision was warranted. Those are the two principal factors for the margin change from expectation.

Great. And I guess just one final question on the reclassification. It was 15.7 million in the fourth quarter and 58.4 million for the full year. How did that roughly, how is the remainder of that? It's 42.7 million for the rest of the year. How dc does that break out when you look at it on a quarterly basis for the rest of the year?

I don't have the quarterly splits right in front of me, but you can get them.

I'll be happy to supply it to you.

I don't have it in the room.

I'll follow up afterwards. Thank you.

Next question comes from Scott Wilken (ph) with SG Cowen.

Thank you. A couple of questions on the guidance. As far as the year, I'm assuming the 6% top line assumes sort of an offset between the mass spec sale an the re-owed on -

Re-owe metrics.

There is a re-owe dine, Scott.

I screwed up there.

But yes.

Q1 you said low single organic. How much re-re-owe metrics is included in that?

There is about three and a half to 4 million by the time we ramp that up and get it on board.

Just given some of the moving parts here, you talked about in '02 there was a slow release of pharm spend and that impacted the Pam HPLC. How does that change how it looks? HPLC had a slow start in '02. If I look at mass spec, last two quarters it has been down double digits. What should be looking at in terms of pacing by quarter?

I think it's a fair question because, you know, we have had a lot going on in the last four quarters. If you think about the base off which our businesses have to grow, the HPLC business didn't start off terribly strong last year, but then had strong middle quarters and a weaker fourth quarter. The micro mass business, you know, the patent case hit in March, but we were going to be rear end weighted in the first quarter because of product developments. So we didn't have the strongest first quarter in our mass spec operations in the first quarter of 2002.

So we think, you know, if you are thinking about either strong base or weak base, we think we've got, you know, a reasonable place to be growing from. And that's why, you know, establishing a fairly conservative growth plan in the first quarter, if things move at all to the better side, we stand a good chance of over exceeding these guidelines. But as we said, I think it's still the prudent road to take here because, you know, we are dealing with a more uncertain environment, I think, in our mind than we thought we were deal with at this time last year.

Doug, is it possible we could see similar growth in Q1, Q2 than we saw in the second half of '02 for mass spec?

Well, I think it's not likely, Scott. I mean, we are obviously not planning that. Because you know, in '02 we were looking at a normal good year in micro mass in the base. So now you've anniversaried -- the first quarter you have haven't anniversaried all of it. But if the look at the fourth quarter results, micro mass had a strong fourth quarter of '01 comparing to the fourth quarter of '02.The first quarter, while you hadn't seen all of the pain coming from slow pharm and from the patent case, it was definitely a much weaker fourth quarter of '02 than the first quarter of '01. As you look and make the quarterly comparisons, we are taking that into account. We think we are at -- you know, we think we are on the conservative side of our expectations. Now, that doesn't mean that you can't be wrong, bop we think we've taken those into account.

That's really helpful. One more question and I'll get back in the queue. Your rule, Doug, is you have to be able to shift ship in 90 days of showing in something. When you talk about the new mass spec, ASMS., does the 90 day rule still apply or do you actually plan to be able to ship it at the meeting?

No, you're probably -- I wouldn't say it's impossible for us to ship anything in June. That's not our plan. We would be shipping in the third quarter.

Okay, thank you.

Thank you. Our next question comes from John Sullivan (ph) with Stevens Inc.

Guys, can we talk for a second about the way the currency benefit worked its way through the income statement? How much do you suppose the currency benefit helped the bottom line in the fourth quarter?

We got about, from the four points in sales growth, we got about a cent and a half on the earnings line.

Okay. I appreciate that. And was there any, were there any pricing issues in HPLC regarding growing the industrial business in the fourth quarter? Was the growth in the industrial business stimulated by price changes on your part, by chance?

No. If you look at the margins in that area or the end market prices, they have been consistent.

Okay, thank you very much.

Our next question comes from (inaudible) with Salomon Smith Barney.

Good morning. Just a couple of questions. John just as a follow-up. What was reported revenue growth by business in the fourth quarter? That would be helpful. Secondly, could you translate your gross margin SG&A and R & D guidance for '03 into percentage of sales? You know, in order to get to that dollar 43 number? And secondly, just you mentioned business acquisitions in your press release and I was wondering if you could give us a little bit more color there as to what we can spending, expect, if it's going to be similar to the re-owe metric acquisition where you are looking at something small and potentially accretive? Are you planning to do something more sizable? If so, what time frame are we looking at?

Let me start with the Q4, you were asking about the growth rates by business area. For HPLC, we said we were in the low single digits, somewhere in the 2% range, as Doug indicated --

I meant actually reported revenue growth.

With foreign exchange?

Yes, exactly.

Okay, with that, then HPLC would be up in the four or 5% range. Mass spec probably in the six to 7% range, down. And D H is about the same, up low double digits, break that out. The next question was on the model for the budget projection for next year?

Yes, the expense sums of as a percentage of sales.

We said that sales in total, we said was 9%, which was free organic plus free foreign exchange and SG&A we said would be about a point less than that. Somewhere around eight. And then R & D we said would be equal to sales, so about 9%.

Okay. Those are growth rates, right?

Right.

Now, I was just looking for as a percentage of sales because you had reclassified between the cost and SG&A, but I can get that off line.

Give me a ring and we can talk through that as well.

And your last question, mar shay was about business acquisitions? I'm not sure what you are referring to in the press release.

You say you will continue to pursue new business acquisitions. Could you give us a little bit more color there as to your strategy?

Oh, yes. We believe that we are -- that we are well positioned to do more, but we are not ready to talk about anything that is really in the works. We continue to evaluate, continue to be involved in I say early phase discussions. I think you should think that right now we are principally focused on getting ourselves back on a trajectory that is more traditional Waters financial performance. That is by focusing on our operations and making sure they are in good shape. I think we believe we will see that in '03.So that is number one on our priority list and we will still continue to look at opportunities to expand the portfolio, but I wouldn't suggest that there's anything of any aggressive size that we are looking at in the near term.

Okay, thanks.

Our next question comes from Bob Bridges (ph) with Sterling Capital Management.

Hi. Can you give us a break out of what you expect your growth to be in consumables and service in '03?

Yeah, I think we expect both of them to be in the low double digits, probably service a little bit better than consumables.

The most recent revenue in 2002, do you know about where that is going to flush out?

Of those two pieces?

Yes.

I think it's roughly 40 percent of the HPLC business.

Yes.

And HPLC is 3% of the total business.

Okay.

We will keep giving you equation equations with one unknown and you have to work it out.

That's fine. Cap-ex and depreciation plans for '03?

We think in total the cap-ex spending will be somewhere around 35, no more than 40 million. We are [inaudible], but for planning purposes that's fine.

And software development.

That's included in that.

I'm sorry, the depreciation number again?

Depreciation? Hold on. It's about probably five or 6 million lower than the CAP-EX.

Great, thanks a lot.

Next question comes from (inaudible) with First Analysis.

Good morning, everyone. Thanks a lot for taking the question. I'm curious, most people have been talking about pharmaceutical companies doing spending in Q4, particularly in the end of Q4. I'm curious if what you are seeing is one a delay in spending and two is it more of a question, if I can make due with a cheaper, less high end instrument as a pharmaceutical company, I'll take it right now because I'm not sure what the budgetary constraints or issues might be next year?

I would say we see almost none of that.

All right.

I think one pharmaceutical companies have been doing is saying: Can I stretch my use out of a particular instrument for another quarter, for another six months? Don't forget that these companies are about operating in regulated applications. If you look at what they are valuing in a supplier, there's good reason why our service business grows so fast. It's because these companies need 24-hour service. They value it. They need validation, support. They need all of those kinds of hand holding and attention that they typically don't get from a supplier who is, you know, selling an inexpensive product.

All right.

So I think that's a continuing dynamic in the industry and I think it will continue to be. If anything, I think we saw Waters -- I believe we made share gains in the past year. So I think we are very well positioned to continue that. And I think that the pharmaceutical industry, you know -- if you look at what the pattern has been, what I believe it will continue to be, is that they have lowered the depreciable lives on things, on instruments like HPLCs. So over the past five or six years, most of them have gone from depreciable lives of seven, eight, even nine years, to going to depreciating this equipment more in a five or six year pattern. That's a statement more of the technology change and they want to make sure that they are not sitting there with undepreciated equipment as they want to upgrade to the higher through put, stronger data product, et cetera. So I think that's going to continue to happen. And we believe that the fundamentals of the pharmaceutical industry are likely to pull out of this period. It's just a matter of when.

All right. Continuing on that sort of macro trend with overall research dollars having reached somewhat of a high in terms of percents of GDP. Pharm you said you have pressure to some extent. How do you think in broad terms this macro environment might affect you and how would you react over the next quiet few years or the long-term?

I think over the long-term pharmaceutical companies, and you know define that as something like the five hub billion dollar worldwide pharmaceutical market, you know, it's got to invest to grow their business. They have been through a period of, whether it's dry holes or just lower productivity in bringing new products to the marketplace. And I guess if you say that industry is going to not focus on bringing new products to the marketplace and is going to be confined to kind of spiraling down, then you will assume that they don't have the wherewithal to make the investments to grow their business. But I mean, over the past 15 years there have been a couple of points like that where people have forecasted kind of the ongoing malaise of the pharmaceutical industry and after a brief sessions of that the pharmaceutical industry has fueled pulled themselves out of it. Now, I don't want to minimize the issues that they are dealing with. They are real. But in the end, it's an industry that is very profitable. It is packed with talent. And it deals better with the political issues today than it probably did during the early Clinton years.

So count me as an open miss that this is an industry that is opt miss that will continue to fight for this business rather than cap it late to something else. The good news is that they need our instruments to grow the business. Whether it's directly or through joint ventures with life science labs or biotech organizations, I think that's our view of the future. I think it's played itself out the times that we go back into history. So it doesn't mean that you can't have a year with a look at saving money and pinch their pennies. But typically what we have seen is that after a period like that, then they've got to come back and invest faster to make up for it. We definitely saw that in the '95, '96, '97 time period coming out of the more physical low period of '93, '94 -

I appreciate those thoughts. One final question. Coming back to -- acquisition question. As you look through the portfolio, one of the things you might like to add on over time that you think you are missing and things that you might look for?

Well, I'm not going to get into too much detail.

Okay.

First of all, we think we've got technologies that over the long-term we have the wherewithal to grow these businesses well into the double digits and produce even better profit growth, given our position growing, given the needs of the customers and our ability to service those customers. As we said, we continue to generate out size cash flow. Pound for pound I don't think anybody generates the cash flow from the business that we do. And that's a sign of the strength of the technologies and the business model. So we don't want to wander far away from that. We know how to compete in this world. We have problems, but we think we know how to fix them.

And yet we have also seen that over the past five, seven years we have been able to build on the HPLC franchise with mass spectrometry. We have been able to bring the thermal analysis product line in. They all are businesses that have kind of similar attributes to our core HPLC franchise where we thought we could affect the marketplace through the application of R & D, strong service components, and the ability to fund R & D through a value-added approach to the customers. I think if you think about what we will continue to be interested in, it is the kinds of things that we have in our portfolio now, you know, that's not easy to find them at the right price. But we continue to look.

All right, thank you.

Our next question comes from Kenneth Goldman with Lehman Brothers.

One more question. Looking ahead to the resurgence of mass spec from micro mass in the second half of the year, are you sill maintaining the gains guidance, forgetting the mass spec of approximately 15 percent growth of that business in the second half and in the quarter just reported, can you tell us what kind of growth, the three different segments of the mass spec did, Q, triple quad and the other?

Sure. In the model that John laid out for mass spec next year, that doesn't bring it to 15 percent 2nd half growth. In mass spec. You are looking more at high single digit growth in mass spec in the second half of next year. Now, obviously we hope that's conservative. In terms of our mass spec performance in the fourth quarter, I think we would be happy with saying that the whole business was down about 10%. Our high end Q tops were a little bit worse than that. And our triple quad positions because of the strength of our Quatro micro product lines were a little bit better than that even though the tripled quad in the high end area didn't perform that well because of our ability to bring that relatively new quatro micro into play, the overall triple category did better.

Okay, thanks.

Our next question comes from (inaudible)

I had a couple of questions. Doug, could you explain the HPLC growth between industrial versus pharm-a, what you saw in the fourth quarter? Am I interpreting you expect the organic growth in HPLC to accelerate in the first quarter? I'm trying to understands why you see that.

Yes, we expect the organic growth rate to be up a couple of points. It's not with the -- the organic growth in the fourth quarter was about 2%. With large pharma down, and industrial up. And we expect large pharma to be better in the first quarter than the fourth quarter, but not supremely better.

Right. Are you seeing that in January yet? Or is that what you your indications or for the [inaudible]?

I would say what we are seeing in January is consistent with our forecast, but you and I both know that January is the lightest month of the year

Right.

The first two weeks of January are, you know, not very meaningful events. So it's not affirm data point.

Okay.

But it is fair to say that in the U.S. we've seen some encouraging signs early on. But I just want to make clear that while we are anticipating the first quarter will be a little bit better, it's not hugely better.

Okay. Then on the inorganic, what product lines are those? Is that the magnetic sector?))

No, it's not the magnetic sector. It's ice owe prime, ice owe probes, noble gases and ICP.

Great, thanks a lot.

Once again, if you would like to ask a question, please press star one now. Our next question comes from Scott Jones with A.G. Edwards.

Good morning. Just one question on the gross margin. You mentioned you expected it up a full point, I believe. I was wondering if you could sort of talk us through exactly what is going to cause that.

We said it would be up 50 basis points or half a percentage point. We talked about the cost benefits that we took in the fourth quarter that will accrue in, right away in 2003 and throughout the year that would have some impact on that. As well as some of our ongoing cost reduction programs on the manufacturing front where we were able to obtain price concessions from our suppliers that we believe we can continue to leverage into 2003.We are not really expecting much of anything on the price increase, if you will, to customers. So it it's really more of a cost leverage equation that is going to allow us to gain that half a point

Okay. If we look out on the intermediate term basis say over the next few years, what level do you think you can leverage your operating margin per year?

Again, now, it depends on what you want to talk about for a growth assumption. We are looking at this year as being a leaner year, obviously, with the growth rate that we are talking about at least organically. Between 50 and 100 basis points a year would be a fair estimate. I still submit we can hit something in the upper 20s before we cap out at, with the which is business model that we are running with today.

Great, thank you.

You're welcome.

I show no further questions, sir.

Okay. Well, thank you very much for participating. We will see you on the next call.

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