Waters Corp (WAT) 2007 Q2 法說會逐字稿

Good morning. 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 conference is being recorded. If you have any objections, you may disconnect at this time.

I would like to introduce your host for today's call, Mr. Douglas Berthiaume, Chairman, President and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Thank you. Well, good morning, and welcome to the Waters Corporation second quarter financial results conference call. With me on today's call, as normal, is John Ornell, Waters' Chief Financial Officer, and as our normal practice, I'll start with an overview of the quarter's highlights and John will follow with details on our financial results and provide you with our outlook for the third quarter and the full year. Before we get going, I would like John to cover the cautionary language.

During the course of this conference call, we will make various forward looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company, this time for Q-3 and full year 2007. We caution you that all such statements are only predictions and actual events or results may differ materially. For a detailed discussion of some of the risks and contingencies that can cause our actual performance to differ significantly from our present expectations, see our 10-K annual report for the fiscal year ended December 31, 2006 in part one under the caption "Business Risk Factors". We further caution you the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible income statement results except during our regularly scheduled earnings conference calls and webcasts. The next earnings release call and webcast is currently planned to October 2007.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures was attached to the company's earnings release issued this morning. In our discussions of the results of operations, we may refer to pro forma results which exclude the impact of restructuring and purchased intangible amortization.

Thank you, John.

Well, we are pleased and encouraged by our second quarter performance. Our strong second quarter revenue growth supports our belief that our new instrument systems are allowing us to increase our share in nearly every segment of this very competitive market.

In reviewing the quarter's results, several factors stand out as significant drivers for our business. First, we are seeing continued improvement and demand from our large pharmaceutical customers, the market segment that, if you remember, was under pressure for most of the past couple of years. In addition, we have seen strong demand for our new instrument systems, especially Acquity UPLC and UPLCMS instruments. This acceleration in demand was supported by the pickup in pharmaceutical spending and indicates renewed interest in acquiring advanced technology for drug discovery and development activities. Additionally, industrial, academic and government customers were also very receptive to our new systems offerings. Geographically, the continuing strength in our businesses in the developing world, including China, India and eastern Europe, was coupled with a strong growth performance in the Americas.

Looking at our recent acquisitions, Vicam, ERA and our microcalorimetry product line, I'm pleased to say all performed well and added to our sales growth this quarter as planned. And finally, our TA division completed still another double digit sales growth performance as industrial markets continue to show strength and demonstrate a desire to buy the latest technology in materials characterization.

I would like to now review these growth drivers in a little bit more detail. When we last spoke in April, I mentioned that we were seeing a strengthening of our pharmaceutical business with even our largest accounts beginning to show improved spending trends. In the second quarter we saw improved demand you by just about all laboratory types in this market, including drug discovery, drug development and QC testing. From businesses associated with orders, for new high resolution mass spec systems, to the replacement of older HPLC systems, to the replacement of network information systems, the entire range of our product offerings benefited from this healthier spending environment. While we were seeing this pick up from our large pharmaceutical customers, sales to smaller and specialty firms continued to grow nicely. This resulted in a very positive quarterly result for our broadly-defined pharmaceutical market segment.

Historically when our larger accounts were under pressure to reduce capital spending, we saw a delay in budget releases to later months in the calendar year. We have not seen these delays this year and feel the current spending pattern suggests 2007 may well mark a turning point for this segment of our business.

Turning to our products, demand for our instrument systems and associated software was very strong in the quarter. As I mentioned before, designing and delivering application-tailored system solutions that seamlessly combine instrumentation, software, chemistry and services clearly leverages Waters' competitive advantage and defines our business strategy. This approach has served us well and has been key to our strong sales of instrument systems and most recently to our successful in introduction of new proteomics and metabonomics systems offerings at the 2007 ASMS conference.

Acquity UPLC had a very strong quarter, with sales increasing significantly over last year's results. The demand for UPLC and UPLCMS systems was broad-based, including a very nice pick up in sales to our large pharmaceutical customers. Given its level of says sales to technologically leading labs and the positive feedback back we received from highly regarded researchers, we feel AAcquityUPLC now dominates the top-performance segment of the liquid chromatography market and is generally regarded as the premier inlet technology for mass spectrometry applications. Utilization of UPLC and regulated methods, including pharmaceutical QC, is increasing, and continues to offer us significant future growth opportunity as drugs currently under development make their way into production. In fact, we expect sales for UPLC instrumentation will approach demand levels for HPLC systems in the near future. The strategic implications here are significant when you consider the positive impact this transition will have on our overall market share, not just for instrumentation but also for Acquity columns, specialized software and instrument service.

The ASMS conference is generally regarded as the premiere venue for showcasing advanced mass spec technology. At this year's conference, which was held in late May in Indianapolis, researchers had the opportunity to hear from their colleagues at a number of presentations and poster sessions on how Synapt-based systems are already solving real world analytical problems that could not be addressed by conventional mass spec approaches. From basic research studies investigating protein shape to more practical problems involving successful fast metabolite ID and more effective drug formulation, Synapt systems are extending the technological boundaries of mass spectrometry. At this year's ASMS, we also extended the application range of Synapt HDMS by introducing a new MALDI ionization option, which allows researchers to quickly switch between API and MALDI modes of operation. With the new MALDI front end we feel we can offer an unmatched combination of performance and versatility to leading research centers.

For protein researchers we induced an exciting new system called Identity HDMS that offers researchers a new level of confidence in the correct identification of proteins from complex biological samples. This new level of performance is derived by combining Acquity UPLC technology, Q-tof mass spectrometry and a new set of proprietary database searching algorithms. These algorithms utilize chromatographic retention information in combination with high resolution resolution mass measurements to improve peptide coverage and establish higher confidence levels in protein ID. The Identity HDMS system is an excellent example in demonstrating how Waters can leverage its expertise in chromatography and mass spectrometry to design unique application for specific solutions.

Geographically our growth in the quarter was broad-based with all major regions showing strong results. In the U.S., sales to pharmaceutical and university customers were particularly strong, with rapid uptake of our new mass spec technology being a significant growth driver. Strong pharmaceutical sales growth in western Europe was somewhat offset by a tough year to year comparison for our university business and for environmental and food applications. Globally, sales for food safety and environmental analysis, however, were particularly strong in 2006, as new regulations, primarily in Europe and Asia, drove the procurement of new instruments. Given the recent visibility of food contamination problems in the U.S. and the likelihood of more stringent environmental standards globally, we are very excited by the opportunity presented to us by these markets and will continue to work with influential laboratories to ensure that we can provide optimized system solutions to address future testing requirements.

Let's turn now to our recurring revenue.

Service and chromatography consumables combined to deliver another strong quarter of double digit growth. Our chromatography consumables business benefited from exceptional growth of Acquity UPLC columns and delivered double digit growth before factoring in the positive effects of acquisition. Last year we acquired three businesses: Vicam, ERA, and Thermometric. I'm pleased to tell you all are performing well and that these businesses were accretive to our overall sales growth rate and profitability in the second quarter. We will continue to look for similar acquisition opportunities and feel confident that we'll have good news to report on this front in the coming quarters.

Of course, we will also pursue new business opportunities through internal development efforts. Last week, at the American Association of Clinical Chemistry, at a meeting in San Diego, we announced that we had received FDA approval for a new diagnostic kid for immunosuppressant therapeutic drug monitoring. Operationally we have established a business unit within Waters to pursue opportunities for leveraging our analytical expertise for its clinical application. To date this group has very effectively driven the growth of our business associated with newborn screening and a variety of more research-focused clinical applications. We feel that the growth of our Clinical Diagnostics business is an important long-term business initiative for us, and we will continue to fund internal development programs while seeking business collaborations and selective acquisitions on this front.

Our TA instruments division continues to broaden its product portfolio and increase its market presence in materials characterization, and now, in select biological research applications. Recent acquisition of microcalorimetry technology in combination with new thermal analyzers tailored for drug formulation and stability testing applications will help TA facilitate a larger market presence in pharmaceutical and biotechnology labs.

Overall we feel thermotechnology has more broad applicability than historically envisioned, and we will look for ways to expand the current mark through internal new product development programs and selective acquisition.

Well, John will where he view the financial details with you momentarily. But before I turn the discussion over to him, I want to say that I'm confident that our top line momentum that we have created through an exciting array of new products and prudent acquisitions puts us in a very favorable position to deliver market leading profitability and cash flow. We are in a rather unique time in our history when you consider the strength of our new product portfolio and the improving conditions of the global markets that we serve. We look forward to the opportunities for continued top and bottom line growth for the second half of this year, and remain very optimistic about our longer term prospects.

Now here's John with the financial details.

Thank you Doug. Good morning.

We are pleased to report another strong quarter of financial performance with second quarter results delivering 17% growth in sales and 22% growing in non-GAAP earnings per diluted share.

Earnings per share were $0.60 this quarter, compared to earnings of $0.49 last year. On a GAAP basis earnings were $0.59 this quarter compared to $0.46 last year. A reconciliation of our GAAP to non-GAAP earnings is include in our press release issued this morning.

Sales grew by 17% this quarter with currency and acquisitions each providing about two points of growth. Examining corporate sales growth regionally and before foreign exchange effects, our sales results were positive in our major geographies with continued strength in Asia where we saw 14% growth this quarter versus a very difficult base of comparison. Sales within Europe were up 14%, and in the U.S., sales were strong and grew by 18%. Sales to large pharmaceutical accounts continued positive momentum and again drew double digits. In global sales, the smaller pharma and industrial-based customers remained robust.

Turning to the product front, as we have discussed in the last several calls, our migration to a systems selling strategy has combined LC, mass spec and software into a single product offering. Our quarterly attempts to apportion revenues from each system sale into technology categories of LC and mass spec has become a bit too artificial and is certainly no longer in line with how we conduct business and measure results internally. So going forward we will provide product line revenues for Waters division instrument systems which will include LC, MS and software together. We will continue to provide individual growth rates for services, chemistry, and the TA division as well.

Within the Waters division instrument systems growth this quarter showed continued strength and grew by 18%. Our services business grew by 8% and chemistry had 21% growth which was aided by acquisitions. Without acquisitions, our chemistry business grew by 10%. And our TA instruments division had another strong quarters with sales up 13% versus prior year.

Now we would like to comment on non-GAAP margins and expenses excluding purchased intangibles amortization and 2006 restructuring charges. Gross margin came in at 56.8% this quarter. We continued to experience foreign exchange cost pressure on European sourced products which reduced margin by 70 basis points versus prior year results. A higher volume of new technology instrument systems in this quarter's mix reduced margins by 50 basis points versus Q2 last year. SG&A expenses grew at a rate less than sales and were up 15% this quarter compared to a modest spending level in the prior year. Foreign exchange translation and acquisitions account for about 5% of this growth. R&D spending was down slightly this quarter because of large project spending on prototype materials incurred last year for new product development.

Our effective tax rate for the quarter was just over 15%. During the second quarter, we purchased 1.2 million shares of our common stock for $75 million. Cash and short term investments totaled $544 million, bringing us to a net debt position of $345 million. We continue to believe we are well-positioned to fund our future working capital needs and acquisition opportunities.

We measure free cash flow as cash from operations less capital expenditures plus any noncash tax benefit from FAS 123-R accounting. For the quarter free cash flow was $91 million after funding $14 million of capital expenditure and adding back $2 million of fas 123-R tax benefit. Comparable free cash flow last year was $55 million. Accounts receivable, days sales outstanding stood at 70 days this quarter down two days versus Q2 last year and inventories ended about flat sequentially and contributed to the improved cash flow results versus prior year.

Now we would like to turn to our updated outlook for 2007. Our business prospects continue to look very positive with most of our end markets and geographies enjoying strong customer demand. On our April call, we said that we thought our full year organic sales growth would be 9%, and that favorable currency effects and acquisitions would bring overall sales growth to 12%. Given our strong organic sales results to date, the success of our recent acquisitions and a slightly more favorable currency environment, we now believe that we can achieve a 14% sales growth this year. For the full year currency of today's levels should provide about 2 points of this sales growth and acquisitions should be around 2 points of growth as well. For the full year 2007, we believe margins will remain under pressure from foreign currency translation effects and the accelerated placement of newer instrument systems with somewhat lower gross margins. At this time we believe our gross margins will continue to show improvement as the year progresses, and that by the fourth quarter we will likely show higher margins versus prior year.

For the full year gross margins are likely to be about 50 basis points lower than 2006 overall. Operating expenses are expected to grow at about 10% in 2007. At the operating margin line we expect to see an improvement in 2007 of around 75 basis points versus 2006. Interest expense is expected to be around $27 million for the year, and we expect the effective tax rate to remain around 15% for the full year. And the net impact of our new share repurchase program is likely to reduce outstanding share count to around 102 million fully diluted average shares for 2007.

Rolling all of this together, we currently expect non-GAAP earnings of $2.80 for fully diluted share with the normal tolerance of $0.01 to $0.02 per quarter. This represents a 22% increase over earnings per share of $2.29 last year.

For Q3, we estimate sales growth of 14%, comprised of 10% organic growth, two points of M&A impact and 2 points of currency impact. At this sales level we expect non-GAAP earnings per fully diluted share of $0.58 with the normal tolerance of $0.01 to $0.02 for the quarter and before any unusual charges. This represents a 16% increase over earnings per share of $0.50 in the second quarter 2006.

Thank you, John. I think at this point, operator, we can open it up for Q & A.

Thank you, sir.

(Operator instructions)

Our first question comes from Quintin Lai. Sir you may ask your question.

Congratulations on a nice quarter.

Thank you.

So with respect to the demand you are seeing and the improvement in large pharma, is it possible, I mean, to decouple how much of that is demand for your products versus just overall increase in demand for, from your customer base? And in particular, some of your more older products like the Alliance products?

That's, it's a tough question. And I would say, let me answer it this way. We are not seeing universal strength across the large pharmaceutical universe. But if you look at the top 15 to 20 pharmaceutical accounts, we definitely saw very good double digit growth across that universe. And that is, you know, consistent, but a little bit better than we saw in the first quarter of this year. We are seeing it I would say most significantly in our instrument systems, as opposed to the consumables and the service piece. So it does show kind of a more aggressive investment dynamic on the part of those accounts.

We also as we monitor those accounts pretty carefully, believe that if anything, we are gaining share, particularly with our new products on the hardware front. So, you know, there is clearly a piece of it that is generally approval the temperature in those accounts and I think there is a piece of it specifically related to the share position in those accounts.

Thank you. With respect to some of the food safety issues, especially on some of the recent issues that have popped up here over the last few months, you kind of mentioned that you are looking forward to something happening in that arena. How should we be monitoring that? Is it regulations by government? Or is it self regulation by some of the food industry?

I think the most dramatic impact would be U.S. food regulation. FDA kind of related. I think it's pretty clear that compared to western Europe, the governmental regulations in the U.S. are not as stringent and do not require as much analytical testing as we are seeing principally related to western Europe import requirements. And that effects the shrimp industry, the chicken industry, as well as others. And you see it both on the part of exporters in Asia requiring analytical technology, as well as the labs in Europe. We haven't seen nearly that kind of dynamic, traditionally, in the United States for food. So, I think if the FDA acts, then we're going to see more of that likely to spur investment in the United States. And probably see it a similar dynamic in exporters, having to increase their analytical requirements offshore also.

I expect that you are going to see some sympathetic investment on the part of the food industry. But I'm not, I'm not convinced that we are seeing much of that dynamic, currently.

In a related area, environmental, we are seeing a great deal of interest in environmental investment in the developing world. So even in a world where the regulation are still murky, we are definitely seeing increased activity, certainly increased quotes, and certainly increased business in the environmental world in the developing world. In a somewhat related sense we are seeing some finalization of investments in places like Japan, where the drinking water regulations, you know, kind of spurred a great deal of investment, I would say up through 2006. And you are seeing that begin to tail itself off. But overall, I would say the food safety and the environmental markets, the sum of those dynamics is very encouraging over the next few years.

Thank you. I'll jump back into the queue.

Ross Muken of Deutsche Bank, you may ask your question.

Good morning, gentlemen.

Good morning.

Can you talk a bit about the sustainability of the recovery you are seeing in the pharma market specifically? You noted double digit growth. Clearly we are coming off of a pretty weak period historically in terms of pharma R&D spend. Can you talk a bit about -- is this coming back to normalized levels? Do you think we'll see pharma going back to a more traditional R&D growth spend in your key markets or are we sort of going through a more short-term recovery and then a flattening out?

I think that if you'll look at, you know, again the group that's the top 15 to 20, if you go over the last two to three years, we clearly saw a downward slope in their investment in our kind of technology. And we kept saying boy, if that just evens off, you know, we'll stop feeling the downward drag. I think what we are seeing, in terms of the gross dynamic, is at least that dynamic. Where they've stopped, you know, a total downward slope; they're not up to where they were three years ago. So it's not like the performance that we're seeing has been a big bounce off that bottom, in my opinion. We've just seen, you know, the trough of their downward slope, and then somewhat of an up tick. I don't -- we frankly have been seen it in the largest pharmaceutical account that we have. So these results don't show a dynamic from these single largest account that we have, which is encouraging, I think, because I think we believe that we're near the trough there, too. So we are clearly seeing some favorable impact this year. We've seen it for a 6-month period. We anticipate that it's going to continue and we are reasonably hopeful that we are going to see an improved dynamic in 2008.

And you know, specifically when we think about LCMS on sort of the low end of the market, I'm thinking here you know, could you talk a bit about pricing in that market? You know you have a competitor that's been fairly aggressive there in price. Could you talk about what's that done your business? Obviously you have had great success given the numbers that we see today. Could you talk a bit about the competitive position there and how you are sort of combating that method of competition?

Sure. I would say, in general, if you look at 2007 versus 2006, our average, in-market prices have not declined. I would say that's true for the lower end. Single quadra-pull technology, as well as the higher end high resolution mass spectrometry. So the margin issues, and I use that term advisedly, that we have seen in our business, come from the fact that we have introduced a slew of new product technologies that are at the high end of the cost curve probably at the highest end of the cost curve as we speak, and they are likely to come down as you have seen traditionally with us as we build the volume and drive the cost dynamic in those product lines. So yeah, there is no question that we'll probably see a few more competitors with a few more products and some of them have a tradition of being, you know, using price more as a competitive weapon, but we continue to believe that these customers are driven by factors other than price, primarily. And we have not seen our prices erode, on average, across our markets either in liquid chromatography or LCMS.

Thanks very much. Congratulations on a good quarter.

Tycho Peterson of J. P. Morgan, you may ask your question.

Good morning.

Good morning, Tycho.

Quick question I guess to start out on the food testing business. Can you just give us a sense of how big that business is for you today? And if you don't want to give a lot of color on the numbers, maybe some color on what products are doing well. Is it maybe the alliance or specifically what you are showing in the market?

I don't think we want to get too specific on the size of the market. I can tell you that most of the systems we sell into food testing are tandem mass spec -- LC tandem mass spec technologies. It is a very strong business in Asia and western Europe. It is a good business by the United States but it's typically focused in Asia and western Europe.

Okay. You know following up on the ASMS and the introduction of the MALDI Synapt, can you give us a sense of where you anticipate the demand to materialize there and how the view the overall MALDI opportunity, going forward?

I would say we think the long-term MALDI opportunity is maybe a little bit smaller than the API. But not a lot. Particularly in proteomic applications. I think the MALDI will be successful. I can say the order activity we have seen on the MALDI side, even though we haven't delivered any yet is very encouraging. So I think that's within a response on Synapt that has been very strong. We are very enthusiastic about the overall response to Synapt and it is coming from what you would expect -- the high end proteomics and metabolite ID type of applications, where you would expect the early adopters to move to a more proficient higher-sensitivity application.

Then on the margins I think you talked more about the FX costs associated with some of the foreign-based components and maybe some of the micro mass manufacturing. Are there programs in place to try to improve margins, in particular for manufacturing out of the UK?

Yeah, there are. I would say if we look at the biggest contributor to the margin issue in the quarter, outside of the FX dynamic, it is really more of a increased volume issue with Acquity-based systems than it is a mass spec product cost issue. A lot of those costs have been fixed. But we got some pretty extraordinary growth from Acquity systems this quarter that was certainly at the high end of our expectations. And you know those systems versus Alliance still has a bit of a penalty, if you will. But we are seeing improvements with the Acquity across the year. But you know, our Alliance margins are over closer to 70 percent or high and Acquity isn't quite there yet.

And then on the foreign exchange side, it was a little bit of an issue for us there because of the success of mass spec placements in the United States. Mass spec growth in the U.S. was very strong. So you know, taking European based systems and bringing them to the U.S. brought about a 10% penalty in costs associated with those placements. So I think we do have a cost improvement opportunities in front of us. I think what you have seen in the second quarter is probably the low point for the year. I would expect to see an improvement moving into the third quarter, where I would believe you would see margins that would be less than 100 basis points different than what we saw in Q-3 last year. And I'm pretty certain we'll see improved margins, margins that are up in the fourth quarter year over year.

So I think we've seen the issue bottom out and I think we have some improvements coming as the year closes.

And, Tycho, let me add that we are -- I am particularly happy about the amount of our European manufacturing in the mass spec area. That while it's true that in translation that means a higher cost mass spec, particularly when you are sold into a dollar-based currency, overall, the level of this foreign manufacturing effectively gives us a foreign currency hedge. And while, you know, if you are unhedged in a euro environment today you would get better translated profits, when the dollar inevitably goes in the other direction, you would feel the pain. So we are pretty effectively nationally hedged without having to enter into any unusual financial derivatives in order to hedge our exposure. So I like our foreign manufacturing.

We have a practice, too as you know of moving our higher volume mass spec products from the UK to Ireland. It has yet a tax advantage on top of everything else. You know. So that will remain our modus operandi, too.

Can you touch on Singapore? I guess you have moved Alliance there too are there other opportunities to move product lines?

There are. And certainly at this stage we are looking at you know, what those opportunities might be. We recently saw the acquisition of Selectron by Flextronics. So you know, we are assessing what that means to us. We want to be sure the same level of commitment exists from Flextronics before we make yet the next step. We have been very happy with the quality of the products that comes from that operation, as well as the cost reductions that we've seen on the Alliance. So we will look to expand that relationship as we exit the year and move into next year.

Thank you very much and congratulations.

Thank you.

Derek de Bruin of UBS, you may ask your question.

Hi, and good morning.

Good morning, Derrick.

Just following up a little bit on Tycho's question. Let's assume the big pharma market remains pretty steady from now until next year. You continue to get some up tick of the products. Overall other markets are pretty stable. Can you just give us an idea as what you see in the leverage in the model? If you are looking at 75 basis points in margin this year, where can we see the margins going on? Can we think about that? Does the operating margin creep above 25%?

Our internal targets are for operating margins to get over 25%. It's only a matter in our mind as to when. Not -- not compounding too many favorable forecast items.

Right. Right.

We know that, you know, there are some bad things out there that could happen. We've seen them happen in the past. And you know, they are tough to, to address overnight. I think, put it within the framework, we have been able, I think to successfully maintain our operating margins in the face of one of the worst climates for our largest customer base, and during a period where we have substantially revamped our core technologies in both HPLC and in mass spectrometry. So I think it is fair to say if a number of factors move the way we think they could, then we're probably being conservative on our outlook. You know, if we deliver what we think we can in terms of the ride down and the cost of our mass spectrometry product line and continue to focus as historically we have been to do in our core HPLC product line, then you can get pretty optimistic about the bottom line dynamics here. And I would say kind of our view forward is maybe you could be characterized as a midline approach to that, to those dynamics. And we don't think that we're taking all the good things that could happen to the bank.

Okay, that's extremely helpful. I guess, John, since you are not going to break out the different you know mass spec and HPLC segments are you going to provide us with some historical data in terms of the instrument and the incremental break outs?

Yeah, I can do that, you know, for the first quarter, I can do that to the extent that we want to do it off line. But at least for the first quarter, those instrument systems grew 6%. It was 18% in the second quarter, and our full year forecast is for those systems to grow at about 12%. If you were to look at that versus prior year, prior year those instrument systems in total grew 10%. So we can have a discussion, perhaps and some further details. But that is the top level, at least, as to what that looks like.

Okay. Great. Thank you very much. I'll get back in the queue.

Steve Unger of Bear Stearns, you may ask your question.

Hi. Good morning. First question. Would you say there is a bigger swing in incremental sales this year in replacement sales or in new instrument placements?

Let's see for big pharma, I would say there's some pent-up replacement demand. That we are seeing in those pharmaceutical results. But it's also coupled with the fact that Acquity is so successful, over across-the-board, that you know, it gets a little bit fuzzy when they say they're going from traditional HPLC technology to UPLC technology. Was it the dramatic improvement they could see that convinced them to go to the new technology? Or was it the fact that they finally were convinced that had they were wearing out their old instruments? So I think both dynamics are in play. But to be fair, you would have to say we have been talking about pent-up replacement demand in large pharma and we know that is some of the dynamic that we are seeing.

Okay. Moving to just a discussion on the Synapt, could you comment at all about shipments to date? Or any kind of order book that you have? And, well, we'll leave it at that.

Yeah. I'm reluctant to talk about actual unit performance. I can tell you that you know, the ramp in orders is very steep, and we expect that the ramp in orders will continue to be, you know, steep over the last two quarters of this year, so that's probably as much as I really want to tell you. I'll tell you the -- the interest on the part of our target audience is extraordinary. If you'll look at the number of requests for quotation and the request for samples to be run, it's in my memory, it is unprecedented. And we are still in that building phase for this technology, so I think you're going to see the results, even though we won't want to talk specifically about unit data.

Okay, that's perfect. Now that you have had Acquity out for a couple of years now, is there some way you can give us a sense for the overall stickiness of your columns within that base? What is the like annual revenues that you are getting out of the installed base?

Well, first of all, I would say the stickiness, in terms of our customers using Waters columns with an Acquity is extraordinarily sticky. They are running UPLC tests with our UPLC columns. Of course, we are still in the phase with preponderance of the instruments are used in R&D and development applications and you don't run as many samples there as in the QC applications. So you definitely see that dynamic. But I would say I'm comfortable with saying that we're still in the phase where Acquity consumables are doubling annually, you know? So it's a very strong element. It still represents probably less than 10% of our overall consumable volume, though.

Okay. Just last question; I appreciate the time. In your experience in the food safety markets in both Asia and Europe, has there been a need for a higher precision instrument? You know a single quad instead of an LC to do recent food safety?

A single quad instead of a triple quad? Is that what you --

Single quad versus a liquid chromatographer.

Typically in those markets we are selling tandem mass spec, colloquially known as a triple quad.

Okay.

We think that's where the market's likely to stay. They'll want an improved, like most markets, I think they'll want improved performance, higher throughput and of course Acquity goes directly to that, to that desire. And as regulations get changed, they'll have to analyze for more impurities, or you know, a broader spectrum of antibiotics, for example.

So I think it will evolve in terms of more things being required that naturally go toward things like triple quad technology, possibly a broader spectrum like time of flight. But I think you'll see the evolution of more powerful triple quad technology rather than in all likelihood, single quad technology.

So the Acquity then is your wedge in that market in the United States.

Well, Acquity goes toward high sensitivity, fast through put. But the mass spectrometry capabilities are also important. I'm just saying that I don't think it's likely to go toward low-cost, low-technology applications.

Great. Okay. Thank you very much. Great quarter, guys.

Thank you.

Jon Groberg of Merrill Lynch. You may ask your question.

Can you hear me?

Yes.

Okay. So just one more quick follow-up on big pharma. You mentioned there was strength in drug discovery, drug development, and in the QA/QC. But some of the commentary you have been making seems to sound as though a lot of the new products that have been growing faster than you think those have been using primarily using Acquity, those are primarily using R&D. Could you maybe drill a little deeper there? Are the R&D applications in big pharma growing faster than QA/QC, which you might think of as being a bit more replacement? Just maybe expand on that a little bit more?

Yeah. I think that where we saw the crank down in investments was more in the front end of development rather than in the back end of QC. So the demand side we have seen drop off in the last couple of years was most notable. So I think the up tick is most notable in that area. As it relates to Acquity in QC, we are definitely seeing penetration into the QC marketplace. We are particularly seeing it in areas like generic drug manufacturers. We are seeing it in high throughput applications like CROs. So I wouldn't say we are seeing a huge part of our growth coming from early penetration into the QC marketplace and big pharma, but we are definitely hearing those accounts talk about it. They are talking about as their new drug applications come down into the manufacturing cycle if they are ready, willing and able to convert to Acquity technology there. But I would say that's longer-term dynamic.

So for your current Acquity sales, what% would you say goes into more front end R&D versus back end QA/QC applications?

I'm reluctant to talk about a specific percentage but clearly the preponderance are in the front end, not in the back end.

Okay. And then on the operating expenses, if we can drill a little deeper too, SG&A versus R&D. SG&A the first couple of quarters has been growing. R&D has been sha shrinking over the more rapid growth in 2006. Can you talk about expectations there you talked about gross margins. But maybe what you expect more for SG&A and R&D over the last couple of quarters and next year?

Sure. I think you should look at the 2006 base period just to begin the discussion. You may recall that we came into 2006 with a little bit more of a cautious attitude and really held back on any investment spending on the SG&A side until about mid year. We began to ramp up needed resources in service and support, particularly overseas, in the second half of the year. So the basis of comparison, when you look at SG&A growth become easier as we make our way through the second half of this year. I think for the full year, you are likely to see SG&A grow closer to 12% perhaps. And R&D, with just such a very large amount of expense in the base year associated with you know the new mass spectrometry products, principally, you are likely to see R&D growing perhaps mid single digits for the full year. So I think overall, that is about, expect about a 10% increase in operating expenses combined for the year.

You are likely to see R&D have a more normal growth in 2008. This, we had a kind of unusual base period that modulated. We don't see 2008 as being, you know, another peak. But neither will it be a valley. So high single digit growth in R&D next year is more likely to be the norm.

On SG&A, looking forward, are you primarily investing there in overseas markets? You know you mentioned that was what was happening toward the end of last year. Is that kind of the outlook going forward? You are actually growing fastest in the United States. Do you feel like you have enough infrastructure in place in the United States.

We are making in western Europe and the U.S. as well. But you are right when you look at the absolute dollars, there are still you know significant investment needs that are needed just to keep pace with the business in the U.S. and Europe.

Yeah. And rather than geographically, I would say it is more related to experience and support. Yeah. Where you can think of how we are spending our SG&A dollar. And then, in the first half of this year, you know, clearly, versus 2006 we had the reins tight across all spending areas. So you know, we didn't spend a lot of you know, marketing money in the first half of 06. And so in 07 you are seeing you know a lot of that core marking money that we delayed spending last year, we didn't delay spending this year. But that's clearly not something that's going to continue as we go forward. That will normalize, too. But with close to 20% growth in instrument placements, you've got to install and service and support that business. So for that piece of the marketing spending we are clearly in a period where we are going to see investments continue.

Okay. And final question. Just lastly on Singapore, because I think you had mentioned or maybe it was just my assumption. But in the past it maybe in the second half of this year, you might actually start looking to move things like Acquity over to Singapore. Is that kind of on hold now? Or you know, maybe a little bit more specific about the plans there.

Yes. I would say our overall plans for Singapore are still kind of enthusiastic. But as we look at the current stage of the life cycle, for our product lines, we may be a little bit behind what we might have thought in terms of transferring products into Singapore because the new products have been so strong, we are a little reluctant to move that new technology from one site to another that quickly until we are absolutely certain that we've got the cost reductions in place and the serviceability well understood. So we may be a little bit further behind, but we fully anticipate if the if the merger of those companies takes place smoothly and the promises made continue to be checked off the list that we will continue to take advantage of that sourcing that will in the long run reduce product cost. To be fair we are probably a little bit slower than we had once thought that would occur.

Great. Thanks a million.

John Sullivan of Leerink Swann, you may ask your question.

First of all did you have a positive margin effect in 07 versus second quarter of 06 with volumes expanding in Acquity and when do you anticipate Acquity reaching normal margins?

John in terms of positive margin effect I'll let John correct me if I'm wrong here. But the dynamic that we are either in 07 versus 06 is Acquity takes on a greater proportion of our overall business and albeit very good margins, doesn't have the same margins of the 10-year-old product alliance. So the shift to Acquity in the short run does hurt our margin, so to speak. But of course in the long run, it's going to return. And the other thing is, is that in the first half of 06, we built inventories and in 07, we are holding inventories flat. And so that overhead dynamic switch year to year clearly hurts our overall margin performance in a manufacturing sense. And we think, you know, if you look at the next 12 months, that's going to normalize and also improve our margin performance versus the last 12 months.

If you look at the manufacturing plan for the second half I would say there is more upside from a volume perspective than has been delivered to date with taking place with inventories, as Doug mentioned.

And then, last question -- can you give us a sense of what percentage of your revenues are coming out of China and India? And is the sales of HPLC into India and generic drug maker still on the positive trend that you observed in previous quarters?

Yeah, I would say most of the business in India is related to generic drug manufacturing. Although CRO activity is picking up in India. So and that is still very positive. You look at you know what is probably relevant in India is the 6-month activity. And it's over our plan. If you look at China, it's also over our plan. So you know, we are very encouraged by the stretching that we are seeing broadly out of Asia. Frankly the other areas of Asia are also doing well. So I think that's probably what I'm comfortable talking about in terms of Asia.

Okay. Thanks very much.

At this time I have no further questions.

All right. Well thank you all very much for taking the time to be with us today. We think we are we'll put a good solid six months behind us and we think the second half bodes well. So we'll look forward to talking to you in October with the third quarter results.

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