Waters Corp (WAT) 2008 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 anyone has any objections, please disconnect at this time.

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

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

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 Q3 and full year 2008. We caution you that all such statements are only predictions, and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that 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, 2007 in part one, under the caption, business risk factors. 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 income statement results, except during our regularly scheduled quarterly earnings release conference calls and webcasts.

The next earnings release call and webcast is currently planned for October 2008. 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 measure is 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 purchase intangible amortization, retirement plan transition charges, and prior period adjustments.

Thank you, John. Our financial results through the first half of 2008 I think, truly highlight the strength of Waters business model. With our technologically focused, and yet market diversified and global strategy, we've demonstrated an ability to prosper in a very tight spending environment, maybe the toughest conditions that we've seen in our industry in recent years. Through the first half of '08, we've grown our sales volume by 13%, our adjusted earnings by 24%, and have generated exceptional free cash flow. Needless to say, I'm pleased with our first half performance, and I am encouraged that 2008 will be another successful year for us. If you look at the recently completed second quarter results, we experienced a continuation of the trends that we saw in the first quarter, accompanied by some improvements that we'd noted were already materializing when last we spoke.

Our business in Europe improved, as some delayed capital budgets were released early in the second quarter, and globally our chemical products sales rebounded from the weakness in the first quarter that was primarily associated with fewer selling days. Generally speaking, the key drivers of sales growth in the second quarter were; strong demand from developing markets in Asia, continued expansion of our industrial businesses, and another impressive quarter for our TA Instruments division.

Overall there were few surprises in the quarter. Demand from our pharmaceutical customers, which is a market segment that's been under pressure, was in line with our expectations, and was just about flat with the prior year's results. On the other hand, our industrial, chemical, food testing and environmental testing segments all saw double digit increases in sales. It's interesting to note that the general economic concerns that we're all hearing about in the news, are not reflected in the demand that we're seeing from chemical producers. For the Waters division, instrumentation sales growth was pretty evenly balanced between chromatography and mass spectrometry.

ACQUITY UPLC and tandem quadrupole MS systems were faster growers, especially outside the classical pharmaceutical applications. Interest in Synapt based systems continues to be strong, primarily for life science applications such as proteomics and metabolite identification. We anticipate a strong second half for these systems.

Sales growth from our recurring revenue products including service in chemical consumables, positively impacted the quarter's results, as ordering rates for our chromatography columns and sample prep devices rebounded to more typical low double digit rates. Geographically the US and Western Europe were positively affected by strong chemical analysis demand, offsetting weak sales from large pharmaceutical accounts. It's important to note that pharmaceutical sales were particularly strong in the second quarter of 2007, and that this year's second quarter results to our largest pharmaceutical accounts, were sequentially higher than in the first quarter this year.

Asia, ex-Japan, continued to see strong double digit sales growth with all major market segments growing nicely. In Japan we saw an expected modest improvement in our business, due primarily to industrial demand for our new products. On the new product front, I'm pleased to tell you that we enjoyed a very exciting ASMS this year, as we showcased significant new chromatography and mass spectrometry techniques. Highlights include our new XEVO tandem quadrupole mass spectrometer, and a preview of our TRIZAIC microfluidic Tile based UPLC platform. The XEVO system offers researchers new levels of performance and convenience, not before brought together in a tandem quadrupole system. Incorporating features that enable rapid instrument set up, a new performance optimized ion source, and a proprietary scan wave feature for enhanced qualitative analysis. The XEVO defines a new category of tandem quadrupole systems. We plan initial customer shipments of XEVO this quarter, and I'm pleased to tell you that interest in this new system is very encouraging.

TRIZAIC is a new UPLC platform offering nanoACUITY chromatographic performance, and a microfluidic tile format. It's an industry first. TRIZAIC delivers the separation capabilities derived from small particles, i.e. ACQUITY packing materials, including high efficiency and fast chromatography in a compact and easy to use consumable, that's designed to seamlessly integrate with our Synapt and XEVO mass spectrometers. TRIZAIC is different from chip-based chromatography platforms in that it's compatible with small particle packing materials, and the resulting pressures that these particles generate. We plan to begin shipment of integrated TRIZAIC MS systems next year.

Our TA instruments division delivered another stellar performance in the second quarter. The division saw balanced growth geographically, and benefited from initial shipments of its performance leading ARES-G2 Rheometer that was introduced at this year's Pittsburgh conference. TA's prospects for the second half of 2008 look strong, as we anticipate a continuous ramp in demand for our new products, including the ARES-G2 and Microcalorimetry systems from a recent TA acquisition. Over the past few years, TA has demonstrated an ability to rapidly and successfully integrate new instrument technologies into its product line. Given this track record, we will continuously look to acquire new product lines, and technologies, to accelerate the expansion of TA's business, and we will share more information on this front in the near future.

John will walk you through the P&L in some detail, however, I would like to point out that we have continued to improve our operational efficiency, through product cost reduction programs, and expense management. These improvements in combination with our share repurchases have led to superior profitability, and faster earnings growth. Through the first half of 2008 we have delivered a record level of free cash flow, of more than $190 million. The period cash flow provides us with the flexibility to further enhance the value of our company, through a creative acquisition share repurchases, or the retirement of debt.

Looking toward the second half of 2008 and into 2009, I'm encouraged that we'll be able to maintain the momentum that has benefited us for the first six months of '08. So we expect global economic conditions are unlikely to improve in the near term, we feel that our strong product position, the continuing expansion of our businesses in the developing world, and the sustainability of our recurring revenues in total, position us very favorably for the future. However, understanding the economic and political uncertainties that all companies are facing in the coming quarters, we will remain cautious in our financial outlook, and will pursue a balanced strategy that will involve the continued commercialization of our new instrument systems and technologies, with a careful eye to growing profitability and maintaining a high level of cash generation. With that, I would now like to turn it over to John.

Thank you, Doug, and good morning. Second quarter results delivered 13% sales growth, and 27% growth in non-GAAP earnings per diluted share. Earnings per share was $0.76 this quarter compared to $0.60 last year. On a GAAP basis, our earnings were $0.82 this quarter compared to $0.59 last year. A reconciliation of our GAAP to non-GAAP earnings is included in our press release, issued this morning.

Included in our income statement this quarter is an $0.08 EPS benefit related to a cumulative adjustment of prior periods. For several years we have been capitalizing and amortizing software development costs, on our US books, and tax effecting the net income statement impact of these items at US tax rates. We recently realized that because of all of the economic rights to this capitalized software reside in one of our Irish subsidiaries, we should have tax effected their net impact at Irish tax rates. Across a ten-year period, the cumulative tax impact of this overcharge is $0.14.

Additionally, because these capitalized software amounts were accounted for as a US asset, it was not amortized in appreciated Euros across this same timeframe, which resulted in understating our cost of sales by $0.06. The net impact of this correction is then an increase to earnings, this quarter of $0.08. These amounts are immaterial to all prior periods, and therefore, have been recorded as a prior period adjustment this quarter. On a going forward basis, the impact of this change will be a decrease in our tax rate this year of nearly 1%, and an increase in cost of sales that will reduce our gross margin by nearly 25 basis points. The net P&L impact for 2008 is essentially neutral.

Turning now to our operational performance for Q2. Sales grew by 13% this quarter, with currency providing 6 percentage points of growth. Looking at corporate sales growth regionally, and before foreign exchange effects, sales in the US were up 6% this quarter, and within Europe, sales were up 3%. Sales within Japan remained somewhat soft and were down by 6%, and sales in Asia outside of Japan remained strong, and were up 22%.

Turning to the product front, within the Waters division, instrument systems grew by 3% against a very strong base of comparison. Our service business grew by 11%, and chemistry had 11% growth as well. Our TA instruments division had another strong quarter, with sales up 15% versus prior year, resulting from strong new product sales.

Now I would like to comment on non-GAAP margins and expenses excluding the items noted in this morning's press release. Gross margin remained strong this quarter, and came in at 58.2% versus prior year, margins expanded by about 140 basis points. We continue to benefit from product cost reductions, favorable product mix, and currency translation. SG&A expenses grew by about 10% this quarter, compared to prior year, and were heavily influenced by currency translation. R&D expenses grew by 16%, as new product introduction costs raised our spending somewhat this quarter. We currently expect our full year effective tax rate to be about 17.5%. To adjust year to date taxes within the second quarter, our Q2 tax rate is 16.9%. The decline in our full year effective rate is principally the result of the capitalized software adjustment I previously described.

On the stock buy back front, we continue to repurchase our shares in the open market, and during the second quarter we purchased 1.25 million shares of our common stock, for $77.6 million. Fully diluted average share count was 101 million shares for the quarter.

On the balance sheet, cash and short-term investments totaled $831 million and debt totaled $984 million, bringing us to a net debt position of about $153 million. We measure free cash flow as cash from operations less capital expenditures, plus any noncash tax benefit from FAS 123R accounting and excluding unusual nonrecurring items. For the quarter, free cash flow was $89 million, after funding $18 million of CapEx. Comparable free cash flow in Q2 last year was $91 million, and for the first half of 2008 our free cash flow is up 12%. Accounts receivable day sales outstanding stood at 70 days this quarter, equal to Q1 last year. Without currency effects, DSO improved by about three days versus prior year. Inventories increased about $10 million this quarter, with currency translation comprising $3 million of the increase.

Now I would like to turn to our outlook for the remainder of 2008. Our second quarter sales results were in line with our prior expectations, and we believe the current business conditions remain comparable to those we assessed last quarter. Therefore, we continue to believe that we will be able to deliver sales growth in the range of 6% to 8% before currency effects. Currency at today's levels should add about 5% to growth this year, bringing our overall growth to 11% to 13%. Moving down the P&L, for the full year, we expect gross margins to improve by about 120 basis points, as a result of improved production efficiencies on higher production volumes, favorable mass spec sales mix, product cost reductions, and continued favorable foreign currency translation effects. Operating expenses are expected to grow at a rate about equal to sales. We will moderate our spending on additional resources to keep our expense growth aligned with actual sales volumes.

We expect our tax rate to be about 17.5% for the remainder of 2008, incorporating a lower tax rate on capitalized software costs. Net interest expense is expected to be in the neighborhood of $20 million. Our fully diluted average shares outstanding are currently estimated to be about 101 million shares for the full year. Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $3.25 to $3.35 per share where sales growth is between 11% and 13%. For Q3 we expect sales growth of 11% to 12%, gross margins should continue to see significant improvements versus prior year, and operating expenses are expected to grow at a rate comparable to sales. Earnings per fully diluted share are expected to be between $0.73 and $0.77 for the third quarter. Doug.

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

Thank you. (OPERATOR INSTRUCTIONS). One moment. Your first question comes from Ross Muken, with Deutsche Bank.

Good morning gentlemen. Congratulations, good quarter.

Thank you.

I wanted to talk about the developing markets, specifically China. There was a recent GDP report that was slightly below trend over the last several quarters. You guys obviously had really nice growth this quarter, 20% plus in that market. Are you seeing any sort of slacking of demand there, and where would you characterize sort of the different pockets of strength or weakness within that market?

Ross, we're seeing -- I'd say we've seen remarkably consistent demand from China for a while now. In the second quarter, there was remarkably no change from the last several quarters. Actually, in China, I'd say it's a pretty balanced mix across our typical applications, including pharmaceutical, but I would say the strongest areas continue to be in what we classify as industrial applications, environmental, food and beverage, are particularly strong, and food and beverage, it's both in quality evaluation, and in regulated export type of applications. A lot of soft drink applications growing in that whole southeast Asia marketplace, so I'd say it's-- and that's what we've seen consistently. I'd say it didn't particularly move in the most recent quarter.

And, you know, as we look to the consumable piece of the business, you saw a nice rebound off of Q1 levels. Can you talk about sort of the differential there? Was there any impact from more selling days in the quarter, or was that just purely sort of demand related making up for some of the weakness we saw in Q1?

We think that the weakness that we saw in the first quarter was largely due to calendar items, the timing of Easter, and the way the year end fell, versus the way the first quarter ended, losing a couple of selling days on top of Easter. It might have been just a smidge of pharma weakness that crept in there, but by far we thought it was calendar items, and in fact, the second quarter largely returned to our traditional low double digit growth rates across those product lines. So we're pretty confident that the first quarter was the anomaly, and that our business in that area is pretty predictable going forward, at this current rate.

Great. Thanks, guys, I'll get back in the queue.

Quintin Lai, with Robert W. Baird.

Good morning, congratulations on a nice quarter as well.

Thank you, Quintin.

With respect to the European -- I guess return to spending from some of your big pharmaceutical customers, did you see just a gradual increase, or did you see kind of a make up from Q1 and Q2? And can you talk a little bit about do you see, is it drug discovery, is it moving to CROs, or any kind of color on that return?

Yes, I wouldn't have you believe that Europe is all that different from what we're experiencing across the pharmaceutical marketplace. We did see -- because we saw some specific orders that we thought were delayed in the first quarter, we did pick those up in the second quarter, so that helps us believe that our sales intelligence is working. But overall, I'd say the Euro pharma market is pretty consistent with the US pharma market, and that's very cautious.

And then with respect to gross margin, I think that as input prices -- input costs seem to be going up, like steel, copper, resin costs, you've been able to still, in fact if anything, increase your gross margin expansion expectations. So tell us a little bit about how you're dealing with the cost of the input prices for you, and what is the pricing environment for your products to be able to pass that through to your customers, if you need to.

I think it's a very fair question. I would say we're seeing some pockets of strength in producer pricing and certainly in the freight area, anything that requires fuel. We're certainly hearing rumblings and we're seeing some real increases. In some areas, where we deal with some reasonably rare metals in our products, we're seeing some movement to higher pricing. But it represents a relatively small part of the overall inputs to our product line. And I would say what you're seeing is the continual focus on driving improved processes to the ACQUITY product line, to a lesser extent on a number of our other product lines.

But also the fact that as our new mass spec products come online, they're inherently better margins, and as they take up a better overall level of the sales volume, that's what you hear John refer to as product mix. A lot of that is happening in our product line as these -- as we drive efficiency through the plants, we're getting just a better gross margin mix of the existing sales volume. So that's -- we've been talking about that with ACQUITY. We continue to focus on it, that when we introduced it, it's at a high point in its cost structure, and we continuously move that along. And that's really what you're seeing, combined with some benefit from the foreign exchange -- the weakness in the dollar.

Thank you for that. And then last question and I'll jump back in the queue, for the second half of this year, your tax rate assumption, so should we just assume kind of that 18.5 or 18.6 range?

No. As we go through the second half, we're currently expecting about a 17.5% rate, Quintin. And that incorporates the going forward effect of the cap software. So that's offset by a slightly higher cost of sale, associated with higher amortization costs, or the FX piece of the amortization costs. So 17.5% rate for us now, is the rate we expect to see for the future.

I see, so what we saw here in this quarter continues on for the next couple of quarters, then?

Yes, yes.

And then when does that anniversary then, Q1 of next year?

Next year we'll have to reassess again what the rate will be, given the mix of income across legal entities, but until the situation changes with cap software and perhaps there's a different mix of how much is being capitalized versus amortized, the 17.5% rate is likely to stay, at least for the next couple of quarters, and perhaps longer.

As we look at next year for that, the effect of cap software in and of itself, we don't think that's going to be a significant dynamic in moving that 17.5% tax rate.

Correct.

So if everything works out in our plan, tax rates are not the easiest thing as we've seen to forecast, all other things being equal, we'd expect it to be around the 17.5% next year, also.

That's right.

Okay, thanks.

Doug Schenkel with Cowen and Company.

Good morning and thanks for taking my questions.

Good morning.

In a seemingly tough raw material environment, you increased your expected year-over-year full year gross margin improvement from 100 basis points to 120 basis points. You pointed to mass spec as one driver to why you expect gross margins to improve year-over-year. Does this imply anything about changes in end market dynamics, or your market share expectations for the full year?

No, not really. I mean, we think it's a tough marketplace out there, and we think we've got good new products, so I wouldn't shy away from saying we think we are doing better than many others in the marketplace. I think the margin dynamics just are kind of as we explained it, foreign exchange is better, the efficiencies in our existing product lines are better. And as we've introduced in the mass spec area, with the new products, came in with a better cost configuration than the old products, and we didn't have to trade down on price, so we have a better gross margin dynamic, as they take up a bigger share of our mass spec volume. So that's really what's happening there.

And as Doug explained earlier, the impact of commodity pricing really hasn't come through in our cost of sales in a big way. So I'm certain in other environments or other companies that's a much larger issue, but for us it just isn't right now.

We're -- the reason how that effects our business, it's a factor in why we're cautious, and not getting more exuberant about the potential to grow faster. We think the cost dynamics may effect our customers a little bit more than they effect us, and that's why we continue to look a little more cautiously at our top line growth. But we don't think it's going to have a material impact. It does have an impact, we do have a lot of travel costs, our sales force travels, and so we've factored that into our budget estimates, but we think it's in there at a reasonable level.

Okay. That is helpful, and then maybe another guidance question. Could I just confirm that there were no changes in your year-over-year expectations for pharma demand incorporated into your new guidance, and as a follow-up to that, keeping in mind recent announcements from Roche, Genentech, Teva, Barr, can you talk about how consolidation in big pharma and biotech may impact demand, and pricing moving forward?

I think in general the level of potential consolidation going on in big pharma, isn't as material as it was when Pfizer bought Pharmacia or Warner Lambert or when Glaxo bought Wellcome and others. I think the level we're looking at well could influence those companies in their investments. You know, Roche owned half of Genentech anyway. I don't think it's likely to have a huge impact there. So, overall, I'm not feeling all that bad about what's likely to happen on that score. We're forecasting the second half to be conditions along the lines of what we're seeing now. We're not expecting a robust improvement in the pharmaceutical world.

I would tell you that some of the pharmaceutical accounts are talking about a better second half, but they have delayed investments and they think they'll be investing in the second half. I can also tell you we're not taking a significant amount of that to the bank in our forecast, so if it happens, I think we'll benefit from it, but it's -- I think it's still a tough environment for those larger pharmaceutical accounts.

Great. And if I could just ask one more question, and I'll get back in the queue. You talked about strong early indications in terms of demand for XEVO. Could you share anything in terms of which end markets have been -- in which end markets where you've seen the strongest interest?

Interestingly enough, as you probably know, our market share in the quantitative bioanalysis segment isn't that great, hasn't been for the last five or six years, for a number of reasons. Some restructuring on the part of some competitors. I think a lot of those traditional accounts have started looking at alternate suppliers. So we're seeing a great deal of interest in some of those traditional pharmaceutical markets about XEVO in particular. And I think some of it's just being careful on their part, and I won't say that we've seen a lot of that manifest itself in real business yet, but it's an encouraging sign.

Failing that, it's -- XEVO basically now operates -- incorporates some significant qualitative features, into what traditionally has been a more quantitative set of customer applications. We're seeing interest in the academic world, in the governmental world, as well as in our classical applied markets in food and beverage and environmental. So it's encouraging, but I think it will be another couple of quarters before we can really point to tangible business, that I can report, yes, we think we've taken some share here.

Great. Well, thanks again for taking all the questions.

You're welcome.

Tycho Peterson, with JPMorgan.

Hello, thanks for taking my question. Maybe just asking Doug's earlier question another way on the competitive front. Are you seeing anything meaningful in terms of share shift, in terms of competitive bid activity picking up, or anything out of the ordinary?

You mean specifically in pharma or--?

Yes. Both pharma and academics, so--.

I would not say anything on the competitive front, Tycho, that's of real note. I would say, just in the pharma world, as I said, we're seeing customers that say they want and need instrumentation, but they have delayed. I can say in one or two cases, as we've gone into the third quarter, early on we've seen some of that business fall in. But I wouldn't say that it's-- it reflects a big difference in what those accounts, are doing competitively, or they're looking for more quotes. My anecdotes on the triple quad side are just that, anecdotes, and as I say, I think we'll have to see that play out over the next six months.

Okay. And then with regards to the carry over from last quarter, you had some orders that got pushed through, and then the Easter impact, could you just quantify the impact of what that was, and then also, the margin contribution this quarter from FX mix and cost reduction?

Well, I think the calendar effect was largely on our consumables and service side of the business, and that -- all in that business went from about 7%, I think, growth in the first quarter, to low double digits in the second quarter. So -- and low double digits is what we always kind of expect out of that business, because it's very reliable and predictable, and so we thought 2 to 3 points kind of was the effect on that consumables business in the first quarter.

Yes.

It's much tougher call. We intuitively thought there was some effect on the instrument side, but not as quantifiable, and it's a lumpier consideration. In terms of the --.

The margin contributions, then, the relative impact of FX and cost reduction (multiple speakers).

FX was --.

About a half.

Better than half, just better than half in the quarter, currency was a little better than I thought it would be, versus initial expectations, so we ended up with a bit more of an impact from FX this time around, and then the cost reductions in the mix are probably about equally weighted, maybe 20%, 25% each, something like that.

Okay. And then you had at Pittcon introduced something for the QA, QC market with the petrol. Are you still kind of thinking that's a longer term, couple of year ramp there, or are you seeing anything from a regulatory standpoint?

No, we actually didn't budget for anything it, anything meaningful this year. We're still working with thought leader accounts to really work on the sampling end of it, and making sure that we can reliably, in a rugged environment, deliver the kind of performance that they need. So we didn't anticipate that was going to be a big dynamic this year. I'd suggest probably into the second half of '09, when we'll really -- we're hopeful that we can bring that to a reliable, ongoing source of revenue.

Okay. And then finally, just for John, did you say the normalized tax rate was 16.9% in the quarter?

No, the run rate tax -- the tax rate going forward that we should use is 17.5%.

Okay.

16.9% takes into account the impact of adjusting the year to date rate, within the quarter. So for the second half of the year, 17.5% is what we're expecting.

Okay. So what was the normalized tax rate, then, for the quarter?

17.5%.

17.5%, okay.

Because of the catch up, because the first quarter's rate was 18.6%, and we wanted to bring the year to date rate to 17.5% we had to bring the rate down in the quarter to 16.9%. Okay. So 17.5% is the rate we should think about for 2008.

Great, thank you very much.

You're welcome.

Derik De Bruin, with UBS.

Hello, good morning.

Good morning, Derik.

You know, your TA business has just continued to just outperform beyond all expectations. And you've done -- you've tucked in some nice acquisitions in there, and done that. I guess can we talk a little bit more about that market, and other acquisition opportunities out there? And I guess, was the 21% -- I mean was there any acquisition in the number this quarter?

15%.

The growth rate for TA we said was 15%.

Okay.

It's probably a couple of points, maybe, of rollover M&A in there, it's rather small.

But for the overall business, it's less than 0.5% for the overall business?

Absolutely.

Okay. What other opportunities are there out there in the TA market?

There are a number of opportunities. I would characterize them, they're not huge sales revenue acquisition opportunities. They tend to be on the smaller side. There are some that are maybe in the $40 million or $50 million in revenue side, but I wouldn't say we have many of those targeted right now.

There are a lot of applications that surround this industrial market, that are available for augmenting our current product line. So, this is one area where I think on average, doing one or two things a year is imminently doable. They'll tend to be on the smaller side. But they keep this business, I think, a predictable double digit grower over the long term. If you just look at the product lines and the applications that it's serving, this business continues to bring new products, particularly the new Rheometer product, it's a leader in the marketplace, and a lot of natural growth just from upgrading the installed base, that hasn't seen a new instrument here in a while. So I think the next two or three quarters are very predictable, from the source of growth that is driving the business today.

Okay. You've done about -- your growth margin is up 120 basis points this year. How much more room is there, when you start looking out at 2009? Is there another 100 points buried in there over the next couple of years?

I don't think I'd go 100 basis points. I'm a little too conservative to predict anything of that nature. Obviously we've had the benefit of foreign exchange. We're going to anniversary that, you could argue next year, so it's unlikely you're going to see the improvement again, associated with foreign exchange. But on the other hand, I would say that on the product cost side, we continue to identify opportunities for cost reduction on the ACQUITY product, some of which you've seen, some of which is still in the works. We've recently transferred a couple of our HPLC detectors to Singapore, they're ramping up, so we're going to see some cost reductions from those.

So I'd say from the normal course of business outside of foreign exchange, that 10, 20 basis points of improvement points that we generally look for every year, I'd say looks very positive, given the opportunities we have on the cost reduction side. And I do think, as we look at the chemistry business going forward, to the extent that the installed base of ACQUITY continues to grow, we're likely to see that being beneficial to our growth rate on the chemistry products, which will likewise improve margins. So I think a little bit of that mix sort of will continue, the product cost reductions look good for the next couple of years. I don't think that translates perhaps -- maybe we're talking 40, 50 basis points, it's not going to be 100 basis points, and then currency is anyone's guess I'd say at this stage.

That's helpful. I guess in the -- where have you seen your biggest pockets of growth from in Asia? Has it been mostly the industrial and chemical, from that standpoint? And is that across -- I'm excluding the TA business, let's just talk about the Waters specific business. Where has been the greatest growth coming from in that market?

If you look at region, our countries, outside of Japan, we're seeing strength almost everywhere and it's -- it's somewhat geographical. If you look at the smaller markets like Thailand, Vietnam, we're certainly seeing a lot of food analysis business there. If you look at Korea, we see a lot of industrial applications, but also a good mix of pharmaceutical. China, as I said before, is a very balanced mix across pharmaceutical applications, food and beverage, governmental labs. So I'd say, China is kind of across all the fronts, and that's the biggest marketplace for us in Asia. India is principally pharmaceutical, and that continues -- that pharmaceutical market continues to grow, at good double digit paces. So I'd say India is the most homogenous of all of our markets.

Some people have raised some questions about does China slow after the Olympics, and how cyclical is the food safety stuff, as people get worried about food prices, and stuff like that. Have you heard anything to suggest that those markets could potentially slow?

You know, the first thing is, I don't think any of our business has been effected really on the upside from the Olympics, so it's not like we've got a big bolus of business that's come in for that, other than maybe some environmental testing in general, you might say is influenced by the Chinese wanting to clean up their environment. But most of what we're seeing is much more infrastructure, has more of a long-term feel to it.

We don't-- if anything, I think, we think the food safety opportunity in China is much bigger. We think the soft drink analysis and testing market is bigger, both in China and throughout that area. So it's -- you can't ever tell in these somewhat command economies, what the command will decide to do, but I think it's going to be awfully hard to radically change the path that they're on, in a lot of these applications. We get no sense that they're tapping out. Certainly not in the next couple of quarters, and I wouldn't say we're seeing any advance signs of it. So your guess and others, are as good as ours in terms of what the '09,' 10 portends, but I think it's going to be tough for them to move out of this cycle that they're in.

Thank you very much.

(OPERATOR INSTRUCTIONS). Isaac Ro, with Leerink Swann.

Hello guys, thanks for taking the question, sorry about that. Real quick on new product introductions such as XEVO and TRIZAIC. Can you talk a little about how customer evaluation times might be changing relative to the tighter capital spending environment you mentioned, and then secondly on those products, how do you think margins compare on those systems relative to your corporate average for instrumentation?

The margins will be -- will not negatively influence --.

About average at the introduction.

Yes. With longer term opportunity to [badly] improve.

That's right.

I'd say in the evaluation side, it's bimodal. In applied markets, it's -- we don't think, again, we're early on in the introduction. We don't think it's going to be particularly long, because what we're really offering is a new capability with the qualitative capability in XEVO. In the quantitative bioanalysis market, I think that's likely to be a more traditional evaluation process. So that's one reason why we're saying it's going to be another six months before we probably have a good feeling in that marketplace, how this is going to shape up in terms of market share.

Okay. Great. And then just taking another look at the maybe lateral impacts of M&A in the drug industry, can you maybe talk about how your business with CROs has increased, either as a percentage of your total customer base, or an absolute basis in recent years? For example, are you doing more business with a measurably larger number of CROs today, or just doing more business with the same larger players in that market?

I'd say in general, in the western world, our business with CROs has been the strongest part of our pharmaceutical industry, or one of the strongest, generics have been very strong, too. So in -- for the most part though, CROs have been the same names that you would have recognized five years ago, they've just been growing much faster, and they've been investing in instrumentation much faster. The place where we've seen new -- and some of it's just different corporate names, is in eastern Europe, and in India, where you're seeing new CROs come on the scene, and new business opportunities there. We don't disclose particularly what those CROs grow, but your assumption is correct, it's been growing in the double digits consistently, and it's been a strong part of the pharma business.

Great. And lastly on -- just in the first quarter call, I think you mentioned a major pharma customer that had an especially delayed capital spending cycle in the first quarter, can you say whether or not that customer, or if it was a group of them, had snapped back in the second quarter? Or at least normalized?

I'd say in specific that was related to Europe, and we did, as I said before, that business did come in. We're seeing similar kinds -- it's always a question of something moves out of the first into the second, does something move out of the second into the third? We're seeing -- perhaps even a little bit more of that kind of anecdote, at the end of the second quarter, and in fact, we're seeing some of that business come in already in the third quarter. So we're kind of monitoring that very closely, because it's possible that that business could turn a little bit more favorable than we think. But we're very cautious about taking one or two data points, and thinking that this war is won.

Got it. Thanks so much.

John Groberg, with Merrill Lynch.

Thanks for taking the call. Congratulations on a very solid quarter. Can I just -- John, get a couple of clarification questions? What was your contribution from acquisitions? I know you had the calorimetry acquisition, and the also what was --?

That added maybe a couple of percentage points to the 15% TA, without it might have been 13.

Less than a point.

It's well under a point for the full corporation.

Okay. And the FX impact of the bottom line. I know you talked about the gross margin impact, but can you quantify?

It ends up being about $0.01 for every percent on the top line, so it's around a 6 percentish bottom line impact for the quarter.

$0.06, you mean?

Yes.

If I got the numbers right, you said US and local currency grew 6, Europe 3, Japan was down 6, and Asia was 22%. I think in Japan you had easier comps in this from the second quarter of '07 relative to the first quarter. Just curious.

They get easier across the year. The second quarter was still a bit more difficult. I mean in constant currencies, Japan grew 8% in the second quarter, the minor 6 was pulling currency out. The comps get considerably easier in Q3 and Q4. Our expectation would be that Japan should flatten out to show some growth as we move through the second half.

I'm sorry, so the numbers you gave were the negative 6% included currency then, and local currency Japan grew 8%?

Whenever I talk about regional growth, I talk about it stripping currency out, so --.

Because the Japanese currency --.

The currency went down 6%, but again, if you just looked at it in yen, it would have been an 8% increase.

No, no. Let's make sure. In standard currency, in yen -- It was down 6%.

It was down 6%. Because the yen strengthened.

Because you had the yen strengthening, that raised the translated numbers --.

Correct. I'm sorry, that's right.

To growth. You were right, John.

Yes.

So in real organic terms, Japan was down -- it wasn't down as much as it was in the first quarter.

Right.

And we think that's the trend. It will improve in the second half of the year.

My overall question there on Japan is it looks like it's improving, but still kind of difficult, so I was trying to get an update on that (multiple speakers).

I think we share that. We think the worst is behind us. We had some very tough comps coming into the year. Japan pharma in particular, is not strong, but we're seeing the applied markets, and the chemical analysis piece to be reasonably optimistic.

Okay. And what was your -- you mentioned the growth. What's kind of your split now between the overall pharma life science as everyone defines it, and industrial chemical? Where do you see that bit kind of in your internal plans? Where do you see that being, a few, three to five years from now? It sounds like you're really focusing on expanding that industrial chemical piece of your overall exposure.

That's true, but pharma, broadly defined, pharma as a trade class is still the largest piece of our business. So that represents all in, about 60% of our worldwide revenue. But it is true that food and beverage, environmental, and those applied industrial markets are growing faster today.

I'd still say we see real opportunities for good, solid growth in the pharmaceutical market, maybe not from the traditional largest pharmas, but including CROs, including the developing markets, of Eastern Europe and in Asia, and in generic drug manufacturers, there's still -- we grew that business in the first quarter. It was flattish in the second quarter, and we still see opportunities for real growth going forward. Particularly, there comes a point when a lot of these companies that are -- have delayed, and delayed, and delayed, have got to invest in more of their replacement products. So we think there will be pent up replacement demand, even in some of the accounts that are pretty weak right now.

But for you guys, historically, I guess, you've been 75% life science, 25% more industrial, is that either via acquisition, or where you're focusing growth? I know what you just said, but do you anticipate that changing?

No, I think you include the government academic when you get up to the 75% level.

Sure.

You know, so the 60% I was talking about is just pharmaceutical. We're still at about that 75% level if you include government academic applications.

Okay. And my question was more just three to five years, either via acquisitions, where you focus your acquisitions, or what's your --.

Absolutely. I think you can say that right now we see that industrial world, we see TA in specific, kind of outgrowing our Waters business right now, and we're focusing our acquisition activity there, but it would just be wrong to think that that 75% is going to go to 45%, or something like that. On the fringe, industrial will probably grow faster in the next couple of years.

Okay. You don't have some kind of -- I don't know if you had an internal three to five-year target of what you'd like that mix to be, I guess, is kind of --.

No. I'd like that pharmaceutical world to go back to double digit growth.

Okay. And then last question, Doug, you defined this as one of the most difficult spending environments in some time, but you still put up a good quarter. I'm curious, did the timing in the quarter play out any differently this quarter than it has for you in the past? I know a lot of your sales come in kind of in the last three weeks to a month, but does that (inaudible)?

I don't think materially so. I would say at some points in the quarter, like all quarters, it looked like it would be better, and then maybe a few of those large accounts that have been talking about, that we really thought were going to buy this quarter pushed out into the next quarter or two. So if you talked to me at one point in the quarter, John, if I were willing to say anything to you, of course. I might have been a little bit more optimistic, but that happens to some extent in a lot of quarters, so I just think what we're seeing is that in the particularly large pharma accounts, you get one piece of that constituency saying we've got to spend, we've got to move these projects ahead, and then as it comes time to actually spend the money, they get a little bit more cautious sometimes. We think that that could change, but it hasn't changed significantly at this point.

Okay. Great, thanks a million.

Sir, at this time I show no questions.

Well, very good. Thank you all for taking part in this and we'll look forward to talking to you next quarter.