Waters Corp (WAT) 2003 Q2 法說會逐字稿

Good morning and welcome to the Waters Corporation Second Quarter Financial Results Conference Call. All participants will be able to listen-only until the question-and-answer session of the conference. This call is being recorded. If you have any objection, you may disconnect at this time. I would like to introduce Douglas Berthiaume, Chairman, President and CEO.

Good morning and welcome to the Waters Corporation Second Quarter 2003 Conference Call. With me on the call this morning is John Ornell, the company's CFO, John Nelson, the company's CTO and Gene Cassis, Director of Investor Relations. As our normal practice I am going to cover the second quarter results then John Ornell will take you through financial details of the third quarter and full year 2003 forecast. Then, we will open it up for Q and A. Before I begin, I would like to ask John to cover the Safe Harbor language.

During the course of this conference call we may make various forward-looking statements regarding future events our future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company, this time for Q3 and full year 2003. We caution you that all such statements are only predictions and that actual events the results may differ materially. For a detailed discussion of some of the risks and contingencies that could cause our actual results to differ significantly from our present expectation see our 10-K annual report for the fiscal year ended December 31, 2002, in part 1 under the caption Business Risk Factor.

We further caution you that the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future results, except during our regularly scheduled quarterly earnings release conference call and Web casts. The next earnings release call and Web cast is currently planned for October, 2003.

Thank you, John. Well, in the second quarter we saw largely a continuation of the business conditions that we described in our last quarterly call. Trends in pharmaceutical spending did not appreciably improve and were particularly weak within discovery-oriented labs. Again we saw healthy spending in late stage development and quality control labs. Other life sciences customers and smaller biotechnology firms academia and government labs continue to spend conservatively.

For Waters, these market trends had a negative impact on our high-end mass spec offering. Futalk (ph) Systems sales were weak compared to last year's second quarter and contributed to an overall disappointing double-digit decline in our mass spect business. Yet despite the short fall in mass spectrometry growth in our HPLC and thermal analysis businesses, prudent expense control and effect of foreign currency allowed us to grow earnings in the high teens or on the high side of the range of our EPS forecast.

Free cash flow was once again quite strong, up over 25% from 2002 levels at $51 million before the litigation payment that we made in this quarter. This ability to generate profit and free cash in the face of a challenging market highlights the fundamental strength of what is business. We have the international presence, a range of product technologies and a diversity of end user customers to meet the challenges inherent in today's analytic instrument market.

If we look more closely at our product lines, we saw predictable performance for HPLC business. We anticipated a mid single digit organic growth rate in this business and achieved that growth, even with continued weakness in instrument sales within the U.S. based pharmaceutical customers.

We are especially pleased with double-digit growth rates of chemistry consumables and our service businesses. These sources of recurring revenue, along with continued improved business in our non-pharma industrial accounts give us confidence of future improved HPLC growth once the pharmaceutical business improves. We are seeing some indirect signs of potential improve pharma business in the second half. But, we do remain cautious in our financial forecast.

At the ASMS conference in June, we introduced a new tandem quadrupole mass spectrometry system called the Quattro Premier. This system is designed for drug development laboratories and will enable us to compete globally in this attractive market segment. The Quattro Premier is more than a replacement product, it is the next generation tandem quadrupole platform for our company and incorporates exciting patented technologies that will eventually migrate across our mass spectrometry offerings.

I'm pleased to tell you that the performance of the early production units has met all expectations and we are on schedule for customer shipments later this quarter. I mentioned earlier that our high-end Qutos mass spectrometry systems had a difficult quarter. As you recall, our Qutos has been closely associated with the growth of the prodioms [ph] application, as historically the customer base is consisted of relatively equal proportions of pharma, discovery, biotech, and government academic labs.

We cited weakness during our last conference call and the weakness is continuing. It is our observation it is primarily related to weaker overall spending in the market place. Despite the current slowness, we remain committed to this market segment. We notice these research customers are driven by new technology and accordingly we plan to introduce a new Qutos platform in 2004. Our TA Instruments business continues on positive growth track.

As we reported earlier this year, the division is successfully absorbed the rheology business we acquired in early 2003 and has layered it upon a solid double-digit growth basis. The expansion of the business is geographically broad-based with solid increases among core industrial chemical companies, as well as pharmaceutical accounts. We anticipate continued strong performance from the TA division in the second half of the year.

In summary, first half 2003 has been a challenging period. We have experienced a more difficult mass spec business than we expected. However, we are cautiously optimistic as we look to the second half of this year and onward to 2004. On the product front, our new product pipeline is strong. Initial customer response to our new mass spec systems has been positive.

On the HPLC demand front, our large pharmaceutical customers are beginning to signal potentially higher levels of spending toward the end of the year. Thermal analysis business looks to continue its positive momentum going forward. We will continue to maintain tight controls on expenses, as we look for improved levels of spending from our life sciences customers. We are confident in our ability to provide the quality products and services our customers require, which will drive higher level of sales growth in the future. At this point, I would turn to John Ornell for detailed financial summary. John?

Thank you, Doug. Good morning. Financial results of the second quarter met our expectations with earnings per diluted share of 33 cents versus 28 cents in Q2 2002. Sales for the quarter continue to benefit from favorable foreign exchange dynamics and contributed 7% of growth for the quarter. Slow to the end for pharmaceutical research and development customers limited our HPLC growth to mid-single digits and significantly impacted our high-end mass spectrometry product sales. Overall this weakness led to a decline in mass spectrometry sales of about 20%. Sales growth for thermal analysis products were strong and continued in the mid-teens this quarter, excluding the impact of the recently acquired rheology business. Gross margin improved this quarter by about 50 basis points over Q2 last year, due to our efforts to reduce cost within the supply chain, the integration benefits accruing within our Waters division and foreign exchange benefits.

Operating expenses came in as expected and were up less than sales growth, both heavily affected by currency. Unfavorable foreign currency translation is responsible for all of the SG&A increase this quarter. We continue to closely monitor our spending in the difficult economic environment to hold the growth in SG&A spending below sales growth. Our effective tax rate remains at same as last year at 23%, which we believe is sustainable for the foreseeable future. The Quattro ultimate litigation culminated this quarter with the payment of $53.7 million final calculations of interest cost on the settlement were less than accrued and resulted in reduced interest cost this quarter of about $900,000.

As previously disclosed our Board of directors approved $400 million two-year stock buyback program in May. We have been busy executing the program in May and June with $67 million used to purchase 2.4 million shares to date. Continuation of this program will result in short-term borrowings in the United States over the next few quarters due to the timing of cash movement from other international locations.

We continue to maintain a strong balance sheet with free cash flow of $51 million for the quarter, excluding the $54 million litigation settlement. Inventories increased modestly in this quarter and were down from Q2 last year. Accounts receivable base sale outstanding stood at 75 days versus 75 days last year at this time, excluding the impact of foreign exchange, DSO performance would be favorable to last year by about one day.

As we look at the remainder of 2003, we continue to see a cautious economic environment. We believe we will achieve sales growth in the high single digits, which assumes exchange rates remain at today's levels and add approximately 5 to 6 points to sales growth for 2003. At this estimated sales volume, we do not see other factors that would cause us to deviate from our original profitability projections, so therefore we leave full year guidance unchanged at $1.43 per diluted share with normal 1 to 2 cent tolerance per quarter before unusual charges.

For the third quarter we expect sales growths in mid to high single digits, which includes an estimated 4% to 5% favorable impact from foreign currency at today's rates. Q3 last year saw HPLC products grow in low double digits, which creates a difficult base of comparison for 2003, thus tampering our sales growth expectations in the third quarter. Earns for fully diluted share of estimated to be 33 cents with a normal 1 to 2 cents tolerance for the quarter. Back to you Doug -

Thank you, John. I - at this operator , I think we can open it up for Q and 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, 1. You will be announced prior to asking your question. To withdraw your question, you may press star, 2.

Once again to ask a question, press star, 1, one moment. Our next question comes from David Simbolis (ph) with Blaylock (ph).

Curious to know more about Qutos business. In particular this business got weaker from one quarter to the next, how have we done sequentially in that business? Second, if you could talk about your mas spec expectations for second half of the year.

David, it did get weaker in the quarter. And again, we're seeing the preponderance of that piece in discovery applications. The preponderance of that in proteomics application. We think that is a broad market dynamic that is most of the influence in that. The second part of your question was what do we see for the second half, was that -

For the overall mass spectrometer business, can you talk about micros and how they have been doing?

Actually the triple quad business overall was pretty good for us. The major influence of that is the Quattro Micro in the U.S. Our Quattro Ultima business outside the United States did pretty well this quarter. Overall we saw good performance in the triple quad market. Of course, we're awaiting the return of the Quattro Premier to really impact things in the second half of this year. So, we expect improving triple quad business in the second half and we would expect that the Qutos business stays in the range it is at.

OK.

Our next question comes from Kenneth Goldman with Lehman Brothers.

Good morning. Congratulations. Could you tell us how many shares were purchased in the quarter and if this represents an accelerated share repurchase count?

Yeah, shares worth $2 million, 450 or thereabouts in the quarter. It is at a rate that is a little bit higher than pro rata. It is a two-year program, $400 million. So $50 million per quarter would be the expectation. I would say at this point we are very comfortable with the rate at which we are procuring shares given the current price. Our expectations are perhaps to go out a little bit quicker than $50 million pace per quarter at this stage. The two-year program was the longest limit, if you will, that the Board put on the program and there were no restrictions on accelerating that program a bit quarter-by-quarter through the rest of the year.

Thanks.

Our next question comes from Cheri Walker with Deutsche Bank.

Good morning. Could you just elaborate a little bit more on what is going on with the new Quattro Premier? Are you done in the U.S. and Europe? Give us an update there.

Sure. As you know, we introduced it at ASMS in June. And we plan to have the first production run to fill out our demo portion and begin to satisfy initial customer orders. So, we have now produced the first run for demos who are actually beginning with just at the front end of beginning to actually run customer demos. But, we will of course, run through the final quality control of these systems and we are very pleased with how these systems are performing. There is always some question for your initial production runs whether you are going to match the beta build and the late-stage R&D build. But, these systems are performing in the production quantities very, very nicely. So, we'll be gearing up the volume of customer demos as I speak. And we intend to be shipping to somewhere late in the quarter.

What are your expectation for sales for the rest of the year?

Well, we're not going to give specific units, but -

For the fourth quarter, we plan to be back in the U.S. market space. There was a point in time when we talked about the U.S. market being roughly $20 million full year. Obviously it has grown since we participated with this product. We should be gaining back that share in the fourth quarter pretty significantly.

Great. Finally, could you update the Qutos new product development, is that something we should think about as an '04 event?

Yeah, I can sketch it and then I will ask John Nelson to lay it out more in lavender. Clearly, you know, we believe that that market place is highly influenced by new technology and new capabilities. We have been targeting the next generation of technology all along to be introduced in 2004. So, our primary focus this year was bringing the new triple back into the market place. There are interesting capabilities that look to be appropriate across our product line. Specifically about the Qutos, John, maybe you can flush that out.

Sure. The -- Doug eluded to the point that we have launched really two significant broad launches at ASMS. One was the new triple, the Quattro Premier. The other was actually a new LCT product, which is also performed in terms of our expectations very, very well. As we think about the Qutos family, there are several pieces of technology built into both of those launches. Traveling Wave is one of them and the Triple Quadrupole will play a major role in a new Qutos family. Our current plans are for a launch next year. Obviously we will target for launch sometime in the first half, but ASMS is the big show with shipments in the second half of the year. We're looking fundamentally for something that would give us excellent performance and improvement in several major areas. At this stage I think we've got a good program in front of us and that's a rough idea of the timing, but it is important to remember that we can continuously build on the technologies that are in some of these products and enhance them and bring them forward. That served us well in the past and I expect it will for the new Qutos launch.

Great. Thank you.

Our next question comes from Larry Neibor with Robert W. Baird & Company.

Thank you. Good morning. Can you give us some idea of growth by geographic areas that you saw in the quarter, both in units and currency?

Sure. Specifically our strongest area of the world is Asia. We're seeing overall good growth generally across technologies. Interestingly, we're seeing very strong performance in India, which I think is a manifestation of the investment going on in the pharmaceutical industry in India. But, as a business that was a year or two ago a $5 million business for us, that could well be over $20 million for us this year. China continues to be strong and Japan, you know, we've had good performance in Japan for a number of years, actually. Even in a continuing tough climate in Japan, our business continues to grow in the low double digits. So, we've got a good management team there and an overall optimistic outlook for Asia. John --.

Yeah, if you look at the remainder of the world, Europe was relatively flat as we looked at the impact of the slowdown that we talked about in mass spec certainly impacted pharmaceutical companies there as well and the U.S. was down in the low double digits, again, impacted mostly with mass spectrometry and R&D side of HPLC was rather weak.

OK. If you look at the HPLC business, can you differentiate between the life sciences-related and industrial-related in terms of growth that you have seen year-to-date and what you expect to see for the rest of the year?

As it relates to the quarter, we saw the pharmaceutical business in total or life sciences, I should say, in total spill up around kind of 3% or 4%, basically due to the strength of the manufacturing QC related products, as well as service and chemistry keeping the business moving ahead. We saw university and government down slightly in the quarter, relating just to HPLC and industrial, food, beverage and others, surprisingly, up in high single and low double digits this quarter, which is similar to the TA business. That is kind of the complexion of HPLC.

The weakest area we are still seeing is the U.S. Instruments and large pharma. I would say that is the weakest area. We are seeing similar functions in Europe. We see none of the symptoms in Asia. So, that is kind of a matrix of dynamics. Our strongest accounts are non-pharma, industrial accounts and that's true across the world. We think that we're riding the bottom of this dynamic in the large pharma. We get symptoms and are seeing increased quote rate. We're seeing more optimism coming out of our sales force that the second half will be better than the first half. That's encouraging, but I'd say we are not taking that to the bank in our forecast at this point.

OK. Thank you.

Our next question comes from Meirav Chovav with UBS Warburg.

Good morning. It is Derik deBruin, couple of questions. What was the impact of currency on the bottom line?

I am sorry - we didn't catch that.

what was the impact of foreign exchange on the bottom line?

That was about 3 cents on the bottom line from the 7 points of sales growth.

OK. And the gross margins were up about 1.4% sequentially. What was the reason for this very strong improvement?

Gross margin change -- gross margins were up for a few factors. We have continued our integration activities with the mass spec side of the business with the HPLC side that are accruing benefits into both the service costs and manufacturing costs that are up in the cost of sales line, as well as down in SG&A. That is a piece of what you see. We also have programs to extract costs from our vendor base as we look for opportunities to reduce material costs. It has been an ongoing program and been very successful last year and this year. You are seeing that accrue.

Lastly, foreign exchange was also a contributor to the improvement we saw this quarter, though not as significant as the other couple that I just mentioned.

Looking at thermal analysis segment, I believe you said there was organic double digit growth

Excuse me, Derik, I think you ought to get back in the queue. We would like to limit it to one or two question. We will stay on as long as necessary.

OK.

Our next question comes from Sam Harvey with Harvey Investment Company.

Couple of questions about thermal analysis. Are the operating margins for that division comparable to those of the company as a whole? Then, what sort of market share do you have in that business? Also, it looks like that business is actually growing I know it is industrial-related to some extent, but growing faster than the industrial economy is actually moving forward. Can you talk about that section of the business?

Sure. Fundamentally, the operating margins are similar to other operating margins. Uh, we invested more in the last couple of years in R&D to bring the product line all to a state-of-the -art condition. Our operating margin suffered a little bit in '01 and '02. But they are back. We target operating margins in this business as a plus 20% level the same as we do for other businesses. It is a smaller business so doesn't get quite to the level of our HPLC business. But, it's right in the ballpark. In terms of growth, the growth we are currently reporting is influenced by the fact we have the acquired rheology business in the first quarter. But, even without that, the organic growth here is in the mid-teens. That's, of course, growing faster than any overall indication of industrial growth in the developed world.

But, we'd never contend this is solely a GDP-type of business. It is a value-added analytical technology and we continue to bring products that are value-added in all of these applications. We certainly were influenced by the downturn in the last couple of years in the industrial chemical market. This technology is heavily used in the polymer analysis applications. And we are beginning to see some of those companies with three M of the world and in specialty material companies begin to report better numbers and I think we see some influence there. But fundamentally, it is a brand new product line aimed at bringing value-added analytical capabilities to users across this group. We're having great deal of success penetrating with that new product line into that customer base.

What market share do you think you have overall in that market?

I think you would split our technologies into thermal analysis on the one hand, which is about probably 70% of the market and rheology which is about 30%. Rheology I'd say we now have a very, very strong market share, with the acquisition at Reometrics business, is certainly north of 50% probably upward of 75. In the thermal analysis side, we are probably in the 25% product market share, strongest in the United States. Little lower market share outside of the United States.

Thank you very much.

Our next question comes from Sara Michelmore.

It is SG Cowen. Good morning. I think most of my question have been answered .One quick one, John. I was wondering if you could tell us what the impact was of the Reometrics acquisition and maybe if you could talk about in terms of the net impact of Reometrics (inaudible) inorganic aspect particularly on the top line.

OK, from a top line perspective, it is pretty much a wash. We had an inorganic business that was somewhere in the $15-16 million range. It was a pretty lumpy business annually. Fairly lumpy, so it was filled by quarter and varied a lot. That was the typical annual run rate. In the Reometrics business that we just purchased was some were around $18 or $19 million business. We have been pairing off some of the lines we will not continue. So, from a net sales perspective, I would say we've pretty much at a wash. But at the time we get to the bottom line now, we did talk about the inorganic business being a very small contributor basically a neutral business. We've eliminated just about as many costs as existed gross margin dollars relating to that business. The Reometrics business that we acquired fits nicely into the TA line and has similar operating characteristics from a financial perspective as the base business does.

OK. For the remainder of the year, then, you expect business in the top line to be a wash, as you say? Then, it could be accretive impact from the Reometrics side?

Right.

I missed your interest income. Related to the paying out the litigation settlement what impact that has on the interest line going forward?

Basically we made calculation as it relates to prejudgment interest, post-judgment interest. By the time we got the final settlement of dollars we found among all interest calculations we were over accrued by about $900,000, which went back to P&L on the interest income line this quarter. So, that will not repeat as we go forward, obviously.

That was one time?

Yes.

Lastly, I know free cash flow looks like it was little bit ahead. Any update on what free cash flow target for the year would be?

For the quarter it is a little ahead perhaps versus expectations. If you look at where we are through the first half, we are pretty much where we thought we would be. We were lighter in the first quarter than we thought. I would say as it relates to full year expectation, we talked about approaching $200 million in free cash flow before litigation payments and the like. I think we are still on target principally to get to the same result.

Great. Thanks very much.

Our next question comes from William Baker with Garden Research.

Just wondering -- you were talking about the Premier product and the technology being improved. I was wondering -- you mentioned this Traveling Wave, which I don't know a whole lot about. Can you kind of explain how the technology is improved and how and what part of it might transfer to other product lines, specifically in Qutos?

Sure. John Nelson will handle the heavy lifting here, but I think while Traveling Wave is an important ingredient and a novel new patented technology, one of these things that we did in the system is totally redesign a standard quadrupole system. The enhancements come across the various elements of system performance. I think that is one of the big advantages that we have in here, strong software, and strong mechanical engineering capability in understanding the science. John, maybe you can cover that in a much better fashion than I can.

Sure. Perhaps without getting into too much technology, one of the important things, as Doug mentioned, in the new Quattro Premier there is several different improvements and changes in technologies, which are directly applicable forward to the Qutos family. I also mentioned new LCT product that we introduced. There are improvements in that product, which are applicable going forward because that is essentially a Tos-based product. Things like Traveling Wave are an example of technologies that allow you greater control of where the ions are within a system, and how you move them around. So, it's sort of the basic building block technology and we think it will be something that has a lot of different utilizations. So, it sort of just begun its history with us. We are quite excited about it and think it will play an important role in the future.

OK. So, it is not just a reliability or mechanical engineering thing. It is improving performance?

Yeah it gives you another element of control of where ions are timing and you ability to synchronize various things. All these things play together. As we said, a few times earlier, it is when you add all these different platform technologies up, you can go to your next step and that is where we think the next generation Qutos is really has a strong foundation already from some things we put in place. We are pretty confident looking forward.

OK. Thank you.

I think perhaps one of the important things as it relates to the new Qutos is that we think we are pretty sure that we understand the science of what is going into the new Qutos. It doesn't now require new novel inventions. I hate to say it is just a few engineering hours, but it is not new science. I think it is the scientific problem well in hand and now it is a matter of executing on that plan. We are in pretty good shape for delivering on that promise next year.

Great.

Our next question comes from Steve Saba (ph) with (inaudible) Capital.

Thanks for taking my question. The settlement charge, was that taken in the quarter? I'm not clear when that charge flows through your P&L. On the interest adjustment, I'm also unclear about what exactly that had to do with. Thank you.

The settlement relates to a case with Applera that was reserved for back at the tail end of 2001 where we had put aside $75 million for this case and potential other issues relating to the patent that was disputed in that particular case. So, this payment that was made of $53.7 million relates all the way back to what was accrued back in the tail-end of 2001. As it relates to the interest calculation, we have been expensing interest through the interest income expense line in the P&L for interest costs over the last number of quarters since this judgment was set up. We were doing that based on an estimated rate and compounding calculation that unfortunately led to an over expense over the last number of quarters of $900,000, which we took back into the P&L in the second quarter as we made the payment it was very clear the final liability was the $53.7 million.

You made the payment in the second quarter?

Correct.

So, your cash reflects the payment having been made?

When we talk about free cash flow of being $51 million, that is before taking into account this payment. It would have been minus 3 if you looked at it more from a GAAP perspective.

I'm talking about cash on the balance sheet.

Yes, out of the cash on the balance sheet at the end of the quarter.

Thank you.

Our next question comes from Kenneth Goldman with Lehman Brothers.

Hi, just want to get more detail on the mass spec, two or three things. First of all, the negative growth of 20% year-over-year, is that pro forma, meaning that you excluding the inorganic from both quarters? Secondly, could you just tell us approximately what percentage of the business mass spec now comprises? And then lastly, when can we expect analysis of new triple quad from media sites or access customers or what have you?

Coming in last to first, I would expect you will be able to get independent customer responses -- you know, probably in fair quantity in the fourth quarter. I mean, we're only going to be shipping these products to customers at the end of the third quarter. To actually have them installed in customer accounts and have a fair amount of behavior on the systems, you are probably looking at the fourth quarter. If you are talking your ability to call up your favorite accounts and see how this system is doing.

I was under the impression in August you would be shipping a few to -- I don't know what you call early-access customers or sort of people to test the system or is that incorrect?

We are shipping for revenue this the third quarter. You will be seeing regular customers. Yeah, I'm sure you could call them good customers. All of our customers are good customers.

Any customer is a good customer.

You will see that activity going on in the third quarter. They are not getting beta units. They are not getting early engineering models. This is a final product.

We are fitting demo labs around the world. That is the start of the sales cycle for that process. Customers will be getting results from the demo activities over the next several weeks.

OK.

Your first question, yes, 20% is pro forma for the inorganic. It is an apple and an apple.

Great. Thank you very much.

Our next question comes from David Simbolis with Blaylock.

Can you talk about your status of your sales force integration and what kind of spect with - in U.S. and outside U.S. in this quarter? And, second if you talk a little bit about the reception of your other mass spec systems? You indicated early positive feedback, but if you could give us a sense as to what kind of contribution you expect those to get? Can you answer a question about the contribution of the sales inorganic business down 20% number?

I did answer that David. 20% are restates for inorganic business. It is apple to apple. In term of the sales force integration, the sales force integration is complete around the world. We are now working with single management focus for both HPLC and Mass Spectrometry. Now, that's always an evolving process.

So, I won't tell you that it won't be tweaked. The systems have all been changed. The reporting points are all affected. We have some but distributor relationships around the world still have to be worked out totally. But, that's in the area of tweaking. I wouldn't over time, we're going to be pursuing this business on a more direct basis. But, we have to work through some of those dynamics. I think what you can see in our results, you know, last year as we were really coming to grips with reduced sales volume because of the (inaudible) situation and slowing life sciences market, you know, we couldn't overnight torque our organization around. You saw our SG&A grow faster than sales. We said the restructuring and the chance to budget more appropriately in 2003, we were going to come into a more traditional range where SG&A would grow more slowly than sales. That is what you see happening now that our -- even though both lines are affected similarly by foreign exchange, you are seeing us begin to grow our SG&A at a lower pace than our sales growth and improve our gross margins.

We've always talked about our commitment to improving our operating margin and we think we can do it by both continuing to improve gross margin and constant currency. Currency has helped us a little bit further, and by holding our SG&A growth to a rate lower than sales. We think we are well back on that track. We think over the next couple of years you will see us return to that kind of performance on the operating margins that, of course, we demonstrated through most of the '90s.

And the new mass specs?

Interesting dynamic in terms of the new mass specs. We think one of the reasons for actually a little bit lower performance in our mass spec business was introduction -of these new systems. In fact, the marketplace knew we couldn't ship the new systems. We had told them that. That is both the case with the new LT top, as well as the new Quattro Premier. So we are reasonably confident that we saw delayed orders from the introduction of these systems rather than increased orders.

So, that's another piece of our perhaps marginal optimism as we go into the second half. Certainly the qualitative response from customers has been very good. The new LTT, we are seeing significant performance improvement versus our old system. We know that has delayed some orders of the old system as these customers await our ability to ship the new one, which comes in the second half. So, we're I think that's the most significant thing as we look at this slower performance in the mass spec business in this current quarter that we think it is perhaps a little exaggerated because of the impact of the new introductions.

Where are you at in the manufacturing processes? Are you -- how validated they are, if you have had practice runs and know you can get these out?

Yeah, at this point, we are confident about our ability to meet the schedule that is inherent in our sales forecast. I mean, I wouldn't say it is ever impossible for a manufacturing process to fall out of line a little bit, but we're now have enough systems behind us that we're comfortable with our manufacturing forecast at this point.

It is less complex than the Qutos global issue you had a year and-a-half ago?

Yeah, the Qutos Global, of course, was all tied up in patent issues. So, as well as it was a complicated system configuration. We are not dealing with that kind of situation with our Quattro product or with the LC Tos (ph). You really not talking about multiple front ends here in this technology, which would add a complicating factor.

Thanks.

Our next question comes from John Sullivan with Stephens.

Hi, guys. How should we think about your revenue mix among your three product areas at this stage, HPLC versus mass spec versus thermal analysis?

Well, our current configuration of course is skewed by the fact that we have this product transition going on. So, I mean, I still think that we're generally comfortable with thinking about a configuration of 65-25-10, with 65% of our business being HPLC, 25 being mass spec and 10 being TA. You know, that's where I suggest that as we enter 2004 we'll be. We are a little bit less than that on the mass spec side currently.

OK. Is a number available, a comp number available for mass spec ex-Qutos by any chance?

I'm sorry. Comp number?

Percentage of growth if you compared 2Q '03 in mass spec, but took out Qutos-

It's not simple - with that, high-end magnetic sector instrument in the base and in the current year. I think what we can see is triple quads actually did well, even without the new high-end triple aimed at drug metabolism market. That is a reflection of the fact we are expanding the market with Quattro Micro and we have the breadth of the Waters sales force taking the technology into a number of non-traditional triple quad applications. But, we had a mixed year -- we did not have a good quarter in magnetic sectors in Japan. That is an environmental market in Japan. Those quarters can be very lumpy, depending on when those systems get reordered, basically.

Terrific. Thanks very much.

Our next question comes from Darrell Party (ph) with Merrill Lynch.

Hello. Is -- Service and consumables grew at double digits, does that mean service grew double-digit as well?

Yes, it did.

Is that largely at pharma you are seeing opportunities -- market?

Well, I say large pharma is the group that traditionally has had the highest penetration rate for service contracts. But, I would say that if anything in this tough period in the pharma area, you are also seeing some slowdown in the service contract and that group. I'd say we are seeing good performance on service kind of across the board. A lot of it, I think, is validation-related in both hardware instrument performance, as well as software. I mean, we are very strong in that area of preventative maintenance or total maintenance capability and in validation. We're seeing these accounts can't skimp on validation services. If they make any other changes in their processes, they are revalidating their process and more and more they are looking to us to do that kind of performance for them.

All right. Combination of the service organizations at Macro Mass and Waters contributed service growth on mass side at all?

I wouldn't say necessarily it has had much impact on top line, but it does increase our capabilities, particularly worldwide. You know, you've always had - we had a lot of critical mass in the Waters service organization in every major geography. On the mass spec side, we perhaps -- not perhaps, have had less critical mass in certain areas of the world. We've had to use a centralized service organization, which brings inherent slow capabilities or limits your response time. We are now seeing improvements in that across the board. That helps us with customer satisfaction. It lowers our overall cost because it requires less travel. I think in the end it will stimulate top line.

Great. Thanks.

Our next question comes from Doug Fisher (ph) with Metadore Capital (ph).

Two quick things. Given softness in mass spec, I want to make sure I understand your expectation for HPLC growth in Q3 and particularly Q4 and also talked about split between the businesses. I wonder if we took the mass spec business and tried to split it between Qutos, Triple Quad and another bucket that has service and magnetic sector, if you could do the same thing in round numbers for the second quarter?

John, do you want to take the first shot?

As it relates to our expectations going forward, for the third quarter we are looking for repeat performance on HPLC growth in the mid single digits, which we think it is achievable given - what we see in the market today in he performance we just turned in. On the mass spec side, we think it will probably have a decline year-over-year in the high single digits perhaps and with TA before, accounting for the Reometric acquisition, we will grow in high single digits. And I think overall that gets you to growth rates in the low single digits for the third quarter.

I think the fourth quarter is probably somewhere close to that. The mass spec business had a relatively strong Q4 last year on the base of comparison, otherwise we would be able to pick up the pace on even more. I'd say what I just described is true for growth in Q3 and Q4. As it relates to breaking out product line within mass spec in the bit more detail, the triple business did grow in the quarter.

Again, driven by the Micro product in the states and the high-end triple obviously overseas is doing well in Asia, Japan and even Europe. It grew in the maybe the high single, low double digits I'd say, somewhere in that range versus the Qutos being off somewhere north of 30% and the other lines are just very lumpy. It is tough to put a number on it, probably somewhere around the Qutos line. As Doug said, we have a lumpy business in Japan on that front. The LCT didn't do well in the quarter additionally given the new product launch.

Thank you.

Our next question comes from Meirav Chovav with UBS Warburg.

Hi, Derik deBruin again. I guess just trying to get clarity on something I don't understand. The increase in short-term debt is related to share buyback, is that correct?

That's right. We have geographic-wise, we've cash that generated overseas that, you know, isn't instantly available to us for use in the buyback program out of the U.S., in the short term we needed to extend ourselves on our revolver to be able to borrow some moneys to be able to sponsor that buyback in the short-term as we work out the movement of cash internationally over the next couple of quarters.

OK. What is the borrowing cost on that?

It is LIBOR plus 40, I think. So, it is small, couple percent.

OK. Thank you.

Our next question comes from David Simbolis with Blaylock.

Thank you. My questions have been answered.

No further questions.

OK, we'll thank you all. We appreciate you taking the time and look forward to talking to you next quarter. Thank you.