Waters Corp (WAT) 2009 Q2 法說會逐字稿

Good morning. And welcome to the Waters Corporation's second quarter financial results conference call.

(Operator instructions). 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 conference call, Mr. Douglas Berthiaume, President and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Thank you. Good morning, and welcome to the 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 will start with an overview of the quarter's highlights, John will follow with details on our financial results and provide you with an outlook for the full year. But before we get going I'd 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 at this time for Q3 and full-year 2009. 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 could cause our actual performance to differ significantly from our present expectations see our 10-K annual report for the fiscal year ended December 31, 2008 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 earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for October 2009. 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 our results of operations we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled "reconciliation of net income per diluted share" included in this morning's press release.

Thank you, John.

Well, the demand patterns that we talked to you about in April largely continued in the second quarter. Overall, our business with industrial accounts, firms closely tied to the production of chemicals that are used in the manufacture of consumer goods was the weakest. Similar to the first quarter, our pharmaceutical end market showed modest decline in line with the Company's overall sales results. On the bright side we continued to enjoy strong growth from our combined government and academic customers. Our sales in the quarter were down 4% on a currency neutral basis, and we were able to deliver 3% earnings growth due to favorable product mix, disciplined price and cost controls, favorable currency translation and leverage from our share repurchase program.

If you look at the top line, our recurring revenues, the combination of our service and chromatography chemicals businesses grew more modestly in the quarter, while the decline in our instrument business was more moderate than in the first quarter. The slower second quarter year-over-year growth rate for our recurring revenues was primarily due to a tough comparison with the prior year's quarter. We feel that the 2009 half-year growth rate for our recurring revenue is more indicative of underlying demand, and we expect mid single digit currency neutral sales growth for our chemistry and service business during the second half of the year. Looking more closely at instrumentation, we attribute the quarter's revenue decline to weak demand from industrial chemical accounts and from some developing countries.

We believe the weakness in industrial spending is related to global recessionary pressures, while declines in developing countries, most notably India and Latin America seemed due to a combination of economic factors and the residual effects of weakened local currencies. Similar to what we saw in the first quarter, demand for high-end and application focus systems was stronger than for more routine analysis instruments that are often purchased to replace older systems. Customer interest was strongest for research mass spectrometry and acuity UPLC instruments. If you look at our end markets, overall pharmaceutical sales volume declined modestly in the quarter and was in line with the Company's overall performance, while weaker industrial sales were offset by stronger government and university spending.

Sales to our top pharmaceutical customers, our 15 largest drug accounts, were up in the second quarter and showed some acceleration from the growth we witnessed in the first quarter. We were particularly encouraged by more broad adoption of acuity UPLC by these firms. Geographically our fastest growing major market was China, where sales to government agencies, universities and applied markets were all strong. In India, the declines that we saw in this quarter were not as severe as in the first quarter, and there are some indications that we are likely to see continued improvements in the second half of 2009.

As I mentioned earlier and now speaking specifically for the Waters division, we continue to see stronger demand for research-oriented instrument systems. Acuity UPLC shipments grew in the quarter and were positively impacted by broader adoption of the technology by large drug companies, a trend that we believe will continue throughout the second half of this year. Sales of acuity columns, the family of chromatography consumables specifically designed for our acuity UPLC systems suggest a continued near-complete column utilization rate for the installed base of acuity systems, and were up double digits in the quarter. Sales of our newly introduced [Zebo] mass spectrometry systems, research instruments that offer advance performance and ease of use with space-saving bench top designs were also strong in the quarter.

At this year's ASMS conference, we introduced a new high-end mass spectrometry platform called the SYNAPT G-2. We feel that the G-2 has the potential for redefined performance standards in research mass spectrometry and displays alternative high-resolution geometries with it's unique combination of high speed, high resolution, high mass accuracy and proprietary shape characterization capability. We booked several orders for new SYNAPT G-2 systems in the second quarter, and plan to begin shipments in the fourth quarter of 2009. Our TA instruments division core thermal product lines were again affected by industrial chemical manufacturers, continuing to rein in their spending. In addition, the division had a tough prior-year comparison. We believe that we are either maintaining or gaining market share with our TA product line and are encouraged by sales growth of our life science thermal line. Despite the tough market conditions, TA has successfully maintained high profitability through disciplined pricing policies and prudent expense control.

Earlier this year we announced the acquisition of Thar Instruments, the world leader in supercritical fluid chromatography, a separation technology closely related to HPLC, that primarily uses more environmentally friendly carbon dioxide as the mobile phase. I'm pleased to tell you that Thar delivered a strong second quarter sales result, and have plans of proceeding to further leverage Thar technology in the second half of 2009. Customers are increasingly interested in reducing chemical waste and running their labs in a more green manner. Thars SFC technology in combination with the dramatic solid savings enabled by acuity UPLC have allowed Waters to assume a leadership in cost-effective and environmentally friendly laboratory technology. A company such as Thar represents the type of firm that Waters is targeting on the MNA front, and that it is close to us technologically, profitable and has top-line potential to be accretive to our overall growth rate.

Before I turn you over to John for a look at our financials, I'd like to qualitatively say a few words about our outlook for the remainder of this year. I'm cautiously optimistic about the second half of this year, as I feel we have likely already seen the worst effects of the weak economy on our instrumentation demand, and have now experienced three sequential quarters of fairly stable pharmaceutical spending. Jumping ahead to the fourth quarter, we will anniversary the on-set of the economic troubles that have pressured our industrial segments and should begin to see benefits of stimulus-related governmental spending in the US. Though consolidation in the pharmaceutical industry and uncertainties related to governmental healthcare proposals could impact future business, we're not currently feeling that these issues are likely to pressure our second -half results. Some of the sales growth that we will see in the fourth quarter will come as a result of orders for new mass spectrometry instruments that we have already booked or anticipate booking in the third quarter, specifically, I'm referring to systems that incorporate our new SYNAPT G-2 platform. Again researchers are very excited about the potential for this new technology on their scientific work flow, and some are opting to wait for fourth quarter deliveries rather than accept shipment at an earlier time of a less capable instrument from either us or our competitors. Though the timing of G-2 shipments will result in lower sales of high-end mass spec in the third quarter, our outlook for the fourth quarter and for the full second half of 2009 is now better than we could have expected prior to our ASMS launch of the SYNAPT G-2.

Generally we expect that the market conditions that we've experienced in the first half of '09 will extend into the third quarter. Operationally, we will continue to carefully control our spending and continue our efforts to improve efficiencies. On the R&D front, our new product pipeline is very strong, and we plan significant new product launches in the coming quarters. In closing, despite current challenges, I feel we are close to seeing an improvement in our business. In the second half of this year, the combination of our new mass spec platforms, continued penetration of the LC market with acuity UPLC, and reaching the anniversary of the beginning of last year's economic slowdown give me confidence in a stronger finish to 2009. Longer term, 2010 and beyond, we believe we are poised to deliver advanced instrument systems to our customers, return to a top-line growth that's more consistent with our history, and generate superior earnings growth and cash flow for our investors.

Now I'd like to turn it over to John.

Thank you, Doug, and good morning. Second quarter sales declined by 9% and non-GAAP earnings per diluted share were $0.78 this quarter compared to earnings of $0.76 last year. On a GAAP basis, our earnings were $0.72 this quarter compared to $0.82 last year. Our GAAP results this quarter contain a charge for exiting rented facilities at our TA instrument site in Delaware. A reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning. Reviewing our Q2 sales results, sales were down 9% this quarter with currency translation representing 5% of this decline.

Looking at our sales growth geographically and before foreign exchange effects, sales continue to be soft in the US and Europe, where sales declined by 6% and 4%, respectively. In Japan, sales grew by 5% versus a weak base of comparison last year, and sales in Asia, outside of Japan, grew by 1% against a strong base of comparison. Turning to the product front, in the Waters division, instrument system sales declined by 8% and recurring revenues grew by 2% this quarter. Recurring revenues were somewhat softer than anticipated this quarter, and through the half, are on plan with 5% growth. We believe the consumables demand might be a bit more variable this year, but should still be around mid single digit growth for the full year. Within our TA instruments division, sales declined by 12 % versus the prior year.

Now I would like to comment on our non-GAAP financial performance. Gross margin continued to be very favorable versus prior year and came in at 60.3%, up 210 basis points. This improvement was, again, heavily affected by continued favorable foreign exchange diamants this quarter. Year over year, the yen continued to provide a positive translation benefit of our Japanese sales, with no off-setting local manufacturing costs impacting our cost of sales. And in the UK, we have more local production and a larger service cost base than local sales, providing for significant margin improvement given the relative weakness of the pound. Additionally, we experienced favorable product mix as a higher proportion of our sales came from chemistry and service, where productivity was high given the head count and cost controls in place. SG&A expenses declined by 8% this quarter compared to the prior year as a result of our actions to control expenses and currency translation effects.

We continue to take a strong position on expense control, and plan to continue to hold back on discretionary spending in response to the depressed economic conditions we face. Our R&D expenses declined by 11% this quarter as a result of currency translation effects on expenses in our UK R&D group. We currently expect our full-year operating effective tax rate to be approximately 18.5%. The slight increase in our rate from Q1 is the result of an anticipated shift of income into higher tax rate jurisdictions. The impact of this change resulted in an operating effective rate of 19% this quarter, or a $0.01 reduction in earnings for the quarter. On the balance sheet, cash and short-term investments totaled $506 million, and debt totaled $631 million, bringing us to a net debt position of about $125 million. On the stock buyback front, we continue to purchase our shares in the open market; and during the second quarter, we purchased 1 million shares of our common stock for $45 million.

We define free cash flow as cash from operations, less capital expenditures, plus any non-cash tax benefit from FAS 123R accounting and excluding the usual non-recurring items. For Q2, free cash flow was $63 million after funding 36 million of CapEx and excluding a $6 million lease termination charge relating to our new TA facility. Capital expenditures this quarter included $18 million of facility costs related to our TA instrument site. Comparably, without this outlay, cash flow would have been $81 million this quarter versus $89 million last year. Accounts receivable day sales outstanding stood at 74 days this quarter, two days better than last quarter, but up four days from Q2 last year. Inventories were about flat this quarter, as we adjusted manufacturing plans to align with demand.

As we look to the second half of the year, we currently expect difficult economic conditions to persist. We will continue to hold back wherever possible on discretionary spending, but doing so could become more difficult as the year goes on, so I expect a modest additional spending increase will be required later in the second half of the year. Gross margin as a percent of sales should be less favorable as the year progresses, as beneficial foreign exchange dynamics diminish and as instrument shipments become a larger proportion of sales later in the year. So for full year 2009, we believe our recurring revenues will likely grow at a mid single digit rate for the year, while instrument demand is expected to be down between mid single and high single digits for the full year. Overall, we are expecting full-year sales to be down between 2% and 4% before currency effects. Foreign exchange translation will reduce 2009 sales growth by about 3% at current rates. Therefore, on a reported basis, we are expecting sales to decline between 5% and 7% for the full year.

Moving down the P&L, we expect gross margins to be up from 2008 as a result of the factors I described earlier. Currency translation benefits have been discounted, as I said earlier, and product mix will become less favorable, as instruments sales volumes increases. For the full year, we now expect to see a margin improvement of around 150 basis points. Operating expenses are expected to decline at a rate about equal to the sales, and our operating tax rate is expected to be about 18.5%. Net interest expense is expected to be in the neighborhood of $11 million, and our fully diluted average outstanding share count for the full year 2009 is currently estimated to be 97 million shares.

Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $3.28 to $3.38 per share with sales declining between 5% and 7%. For Q3, we expect our currency neutral sales to decline at a rate comparable to the first-half results. Any potential sequential improvement in customer demand this quarter could easily be offset by a shift into Q4 of orders associated with stimulus spending and Q4 shipments of our new high-end mass spec systems. At current exchange rates, currency translation will reduce sales growth by about 3%. Considering these factors, non-GAAP earnings per fully diluted share for the third quarter are expected to be between $0.74 and $0.79. For Q4, we expect our currency neutral sales to be about flat, and currency translation to increase sales growth by 1%. Non-GAAP earnings per fully diluted share are expected to be between $1.01 and $1.06 for Q4.

Doug?

Thank you, John.

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

Thank you. At this time we are ready to begin the formal question-and-answer session. (Operator instructions). One moment, please.

Thank you. Our first question comes from Tycho Petersen from JPMorgan Chase.

Hi, good morning.

Good morning.

Wondering if you can kind of elaborate on your pharma comments - - around acuity. You have talked in the past about standardization. I'm wondering if this is a process that's been accelerated at all with these deals closing. Or if you can provide additional color around what's going on with acuity at pharma. Is this mainly in the QC labs or - - any additional details would be helpful.

I think one of the most positive, one of the most encouraging is related to those - - broad-based applications closer to QC's than in the traditional acuity stronghold in R&D Tyco. We saw one particular very large domestic pharmaceutical company. I think I've talked about it before. I mean, last year, we saw our European based live pharmaceutical company basically decide to go across the board to UPLC. And we saw a similar dynamic domestically this time. So even in a time of tough instrument placements, we're seeing acuity continue to grow year over year. And that's largely a pharma dynamic. So I think what you are seeing is penetration into those more - - the benefits of UPLC on the research side have been overwhelming. The cracking more deeply into the regular QC side, where companies have got to face the issue of - - how many do they change out - - do they change them out all at one time, particularly at a time of reduced capital spending is a tougher sell, we're seeing progress on that front.

Okay. That's helpful. You talked in your comments as well about some of the deferred orders for the new SYNAPt system. I guess I'm just trying to get a sense as to - - how big the magnitude is here. Is that something that was significant in this quarter. And maybe some color on what you're expecting for the third quarter ahead of the fourth quarter launch?

Well, we just showed it ASMS really at the beginning of June. So - - we weren't even able to demo it until that time. We're now demoing it very extensively, and I'd say the customer response has been as strong as any instrument we've introduced in the last five years. So I would say we're - - we're very, very enthusiastic about the customer response. We have seen a number of orders already in the second quarter. We've seen that accelerate into the third quarter. It needs to be clear that we're not going to ship any of these in the third quarter. Our production plan doesn't really start shipping until the fourth quarter, but we're reasonably confident we can ship a substantial number in the fourth quarter. I would say our financial forecast tries to draw a mid-line in that fourth quarter expectation. It's very possible that this could be a defining factor of exceeding that number if we are successful in getting as many manufactured into the marketplace as we think. So it's probably as strong as I can talk about G-2.

Okay. And then just one last one on capital deployment. Can you talk a little bit about the outlook on MNA versus buybacks. Obviously, with some of the deals we started to see, it looks - - like the valuation gaps start coming in a little bit. So if you could just talk about priorities there.

Yes, I imagine. Valuations certainly came down across the board last year. Valuations in the past six months have clearly come up a bit in our industry. - - our idea of what suits Waters appropriately in the MNA front, hasn't changed from the low valuation to the high valuation. We still like our core capabilities, our core businesses. I mean, we're absolutely convinced that we could - - do some accretive mergers that are larger than the mergers that we typically do. But we're not convinced that - - two or three years down the road that that we can grow that consolidated business at the pace that we can grow our core competencies. So that's the conundrum. You can deploy more capital; but in the end, you have to wake up in the morning and be happy with who you're living with. And we are not convinced that the larger ones that we have kicked the tires on - - satisfy those objectives. So we'll continue to do the far kind of deals, the targeted smaller technology deals, or some bolt-ons. We've done some bolt-ons to our testing businesses that we're very happy with. It doesn't deploy a huge amount of capital that way; and so we're left with buying in more of our stock in all likelihood.

Okay.

And for the year, if you look at the buyback program, we're just over a hundred million dollars at the halfway point. We talked about executing about 200 million for the full year. So we're pretty much on plan to meet that original expectation.

Okay. And John, actually, just one housekeeping on the tax rate. Have you quantified - - the potential impact of the Obama proposal?

- - until we get to the point where that's - - somewhat clearer as it makes its way through Congress, it's difficult to quantify that. I mean, some very early views of that would suggest that perhaps based on some of the deductions that perhaps won't be allowable in the US going forward, that it could be - - a 300 to 400 basis point impact on us. But it's very early. It's still up in the air. I don't think we can really nail that down to a specific number at this point in time. I think I've heard others in our space quantify it. Similarly, I don't think - - based on our starting point that we are going to be impacted dramatically different from others in the space. But I quantify it somewhere in that range based on what I know today.

Okay. That's helpful. Thank you very much.

Thank you. Our next question comes from Quintin Lai from Robert W. Baird.

Hi. Good morning.

Good morning.

With respect to kind of the industrial side, could you delineate - - you talked about price discipline. Is it that the customers that are buying are not price-sensitive, or is it - - and is it just that - - no projects, so there's just no buying. And then as it comes back, is it more binary, or is there kind of elasticity in demand as well.

I think there's relatively little elasticity, Quintin. In times like this, I think we've seen certain competitors struggle; and in the end, try to use price to disgorge orders. And I think, in many cases, the desperation tactic, over a long period of time, in most of our instrument businesses, experience has taught us that price isn't a long-term determinant of how these customers react. They're much more concerned with service, support, continuity, and as price falls relatively low on their list. Which is not to say that in any one circumstance, particularly if it's a university account or certain others, that - - somebody might not squeeze an order out with a large discount.

We have a golden rule that we treat our customers with the respect that they deserve, and we live to our worldwide contract, and it is very, very rare that we wander outside those discount guidelines. So I think our customers respect that and in the end it holds us in good stead. I don't see us losing significant orders to price competition in this environment. I think it's - - it's substantially a case that those customers are not - - are not really seeing any capital money, or any capital money, probably a little bit strong. But they're substantially diminished capital budgets. - - that may improve largely because of the weak base in the fourth quarter. I don't see that improving very much in the third quarter. I do see, from the people, particularly TA and the people who are most focused on those industrial chemical accounts in the US. It's not getting worse; but - - it's not very good. So I think we've seen the bottom of that, but I wouldn't expect you to see any light at the end of that tunnel until possibly the fourth quarter.

All right. Thank you. Very helpful. John, just to reconfirm, the pro forma EPS guidance - - you updated. Was it 3.28 to 3.38.

That's right.

All right. That seems to be an increase from your last guidance. Is that right?

Yes. The upper end of the range is higher by $0.08, and then we narrowed the range as well, because I think we're feeling a little bit more confident in the second half of the year in hitting these numbers. So there's a $0.10 differential, $0.05 a quarter, which is a little bit closer to where we've been historically in trying to call the bottom line. So it is raised as a result of expectations really more in the fourth quarter as a result of - - the stimulus spend and some of the shipments of the G-2 that we talked about that we're a bit more confident about, as we said today.

And we were at the high end of our guidance in the second quarter, Quintin, so - -

That's right.

We think that there, on balance, there are probably more things that could go right for us in the second half than wrong.

And that even offsets - - so the outlook plus the G-2 even offsets kind of what looks like to us a little bit higher tax rate and share count?

Yes.

That's correct.

Okay. All right. Thank you.

Thank you. Our next question comes from Isaac Ro from Leerink Swann.

Hi guys. Thanks for taking the questions. First thing on the pharma in markets. I think you kind of mentioned in the beginning comments that it was down a little bit. And then later, you said it was sort of sequentially stable. So I was wondering if you could give us a little more color on what you're seeing there maybe between demand for equipment versus the utilization of the consumables. And then - - given that you are taking that sort of higher guidance outlook for the rest of the year - - what's your level of confidence in the fourth quarter as a lot of these mergers close that you won't see any disruption in the business. That underlying business beyond the stimulus and the synapse catalyst that you talked about.

Yes. I would say on the pharma business in total, while overall the pharma business was down slightly in the quarter, the trends that we saw in large pharma, where we said that - - we've seen some sequential stability in the results. We actually saw some growth in the first half of the year, and that accelerated a little bit in the second quarter. So even - - and I would say that - - we've talk about weakness in large pharma for - - for a few years here. So they're a little bit - - the effects of the economy, I guess I would say, are a little bit different on this group of customers than industrial chemical and GDP centric type businesses. So the large pharma accounts, at least for us at this time, we would say, feel more stable, feels like - - the interest in acuity, the interest in the new mass spec products will continue to allow us to see growth in that segment of our business. - - outside of large pharma, the other accounts are - - still under pressure, some of the generic accounts, CRO's - - continue to struggle for us. But all in, we're looking at - - a low single digit decline for that group of customers, with large pharma really being the best performer.

Okay. And then, if you could maybe walk us through, as we look at sort of forward quarters on the gross margin line, aside from currency. How should we think about the last few years in the acuity, the progress you made, and maybe growing the gross margin on that product line. And now that it's full scale here, and how much headroom do you have left considering the Singapore, potential move in the Singapore manufacturing?

Yes. I'd say, if we look at the all end margins on the acuity products. I mean, we started off, as you know somewhere in the 50's. We're in the low 60's at this stage, and we're at the point now where we're looking at, as you know, moving that product to Singapore. It's in the early phases of the move. - - there's nothing, from a technology perspective that would prevent it from moving into the mid and high 60's - - across a few years as we make that transition, and ramp up the production in Singapore. So for that product alone, I would say that there is - - there's definitely some margin improvement that we can expect, as these transitions occur. As we think about - - gross margins going on a year-over-year basis, as we start thinking about next year, you certainly have to take into account, though, the fact that we've had some significant improvements in margins associated with currencies. So - - currency movements could to some extent offset whatever that pickup could be.

Okay. Great. And then last one here on fourth quarter assumptions. Did I hear you right in assuming you have some expectations for stimulus orders to be booked in that quarter?

Yes. They'll be booked in that quarter, but they'll also be booked - - some were booked in the second quarter, more in the third. We talked about it. But, yes, they will be booked and shipped in the fourth quarter as well. And the expectation is that that stimulus spend will - - level or resume next year as well. So - - it's a multi quarter impact where the beginning of it for us, we believe will be in the fourth quarter.

We are seeing a huge amount of quote activity related to stimulus spending, Isaac, and we have also seen a pretty clearly some delays in orders that probably would have come through without stimulus money. But some of those academic government accounts are waiting for the stimulus money - - to take the place of some of their own internal monies. So it's hard to imagine that all of this quota activity doesn't make its way through shipments in the latter half of this year. Frankly, we're not - - we're not counting on a huge amount of that in terms of our sales expectations. That could be another piece that if we're conservative there, that may turn out to be a little better than we've baked in.

Okay. Thank you.

Thank you. Our next question comes from Derek Debrawn from UBS.

Hi. Good morning.

Good morning, Derek.

What did SAR add to 2-Q, and then, on a further note, it's like, what's the latest in terms of what you see in the nitrile shortage?

Acquisitions added, in total, about 2% in the quarter, and about a percent for the first half results. So SAR was successful for us. We're looking at - - continuing to ramp that technology up through the second half of the year. - - being able to sell that under the Waters umbrella seems to be an opportunity that is at least on plan for us as we look at the second half of the year. So - - acquisitions look like they will continue to be a small ladder to sales across the second half.

Okay. And do you see the nitrile shortage - - does that show any signs of being alleviated?

Not substantially at this point. There are some forecasts that those plants are coming back a little bit on stream; but even if it does come back on stream, Derek, I think the attention on acetonitrile, the risk of supplies is still very high in the minds of our customers. And together with this whole green initiative, I think it has swung our accounts to really paying attention to solvent consumption and solvent usage. So while the absolute status of acetonitrile might get a little bit better, I think, from our point of view, it still works to our advantage, that it had to go through this.

Great. So I'm just trying to - - just trying to reconcile the comments here. So the organic growth is lower, and the expenses are going to creep a little bit higher in the second half, and yet the - - so expenses are going to go higher. So I guess is there going to be a big change in some of the below-the-line items to kind of get you to the higher end of the guidance range.

If you look at the second quarter, the growth without MNA, it's down 6%, which it was in the first quarter, too. So I'm not sure what you're comparing against.

Okay. No. I was just saying that, I guess, if you kind of look at it for - - well,, I mean, because you changed your FX impact from down 4% to down 3% FX impact on the top line - - so.

That's right. That's in the third quarter. And then by the fourth quarter, FX is actually positive.

Okay.

The big difference in the second half really is the fact that in the fourth quarter, we anniversary, if you will, the recession.

Got you.

And where we grew in the base about 7% a quarter across the first three quarters. In the fourth quarter, we were organically flat. So - - we're expecting to be - - flat on that base with a percent of sales pickup from FX. So FX and the anniversarying of the recession, if you will, is really the delta in the second half that makes it different than the first half. We're really not saying that the pace of the business, if you will, dramatically picks up in that guidance.

Okay. Thanks, John. That was clear. Thanks. I'll get back in line.

Thank you. Our next question comes from Rob Hopkins from Stifle Nicholas.

Thanks. Can we go into a little bit in detail about what's behind the consumables decline, and maybe what's happening in some of your end markets that maybe did not grow as fast as you guys thought?

In the consumables business, we're a little bit slower in the second than it was in the first. The first quarter, we had a calendar dynamic that gave us several extra days. In the second quarter, we had a relatively strong base, where we had some customers placing large standing orders in last year. So when you look look at 2009, I don't think the actual customer demand pattern was all that different between the second quarter and the first quarter, but the reported results were - - slower sales growth. That's why we think that the second half is kind of an average of the first and the second quarter. The real demand patterns, our - - what we talked about pretty much in the first quarter, customers have run fewer samples. They're looking at various ways to save expenses across the board, and I don't think that that dynamic is going to change too much in the second half of this year. We're not expecting a seat change in the way our consumables and services business operates in the second half. And probably, we think that we have a somewhat brighter picture for next year, but we're not anticipating that in the second half.

Okay. And then you mentioned that industrial demand and TA is bottoming, and you don't - - you say there might be a little bit of light in the fourth quarter. Does that also translate to the industrials for the Waters division; and when you're talking about this demand, is it kind of the usual seasonality related to people just kind of finishing out the year and spending the money that they didn't spend already. Or do you think it's kind of a real recovery demand that you're getting a sense of?

Speaking specifically about TA, and as we monitor - - requests for quotation and demo activity, we saw that dynamic flatten out at the end of the first quarter; and as we move through the second quarter, we saw our internal statistics improve. Now that didn't manifest itself in orders and sales in the second quarter, but we think that's an early indicator that customers are getting - - hit their bottom, and are looking to improve in the second half. Now that's off a much lower run rate, so we're not declaring victory on that, but it's better than (inaudible). You get into the fourth quarter, and clearly you've got a lower base, because you've got the dynamic of - - the financial crisis and the demand reductions in the fourth quarter. So you've clear got a lower base to compare against. Also, it may be more important in the pharmaceutical and the life science areas, but - - in the fourth quarter of '08, you saw a massive reduction in confidence, and people took early action to just carve back on their spending. And it was as fast as I've ever seen in this industry.

I think - - it's altogether possible that you'll see just the opposite happen at the end of this year, that - - people get more confident. They get - - they're not cutting back on capital spending. They may not get a [bull in] but I think it's very possible you'll see some end-of-the-year money. That's certainly what we'd hope to see. We're not banking on that in our forecast, but I think you could see that in the industrial accounts. But particularly you can see it in the science area, too.

Thank you . I'll jump back in

Thank you. Our next question comes back from Ross Muken from Deutsche Bank.

Could you talk a little bit about some of the end-of-year expenses that are going to be needed to reaccelerate - - as growth reaccelerates into 2010, sort of how you're thinking about some of the different - - lines that may have changed this year, whether it was salaries or bonus or other. And how we should think about modeling that as we enter 2010?

I guess I would say first off - - where we've held back on some of the service side of the business is probably one that's going to get some of the most attention. - - there's been a headcount freeze in place across the organizations - - with rare exceptions from locations outside of the US where we've had to keep up with increased demand. So - - adding some service headcount in the field in support of that business is probably one of the first areas we'll start looking at. There was a full pay freeze in place based on the conditions this year. We're going to have to reassess that based on market conditions for next year. I mean, that's certainly another area that we'll look at.

Some of the more discretionary items on travel and - - meetings and that type of spend - - we can be a little bit more conservative on depending on - - how the economy picks up as we move into next year. So - - I wouldn't say that at this stage that there's going to be a huge sum of increased spend - - across the board that's going to be dilutive, if you will, to the earnings growth, should we have - - a modest increase in the top line. But - - it's very early on to be able to try and quantify that. Some of these expenses will begin in the fourth quarter. They'll probably be some amount of service head that we're just going to just have to put in place, but I think you'll see a rather modest increase in expenses as we exit the year. It's really more of a budgetary planning cycle effect for next year that we can talk more about perhaps on the October or January call.

And from a market perspective - - you noted India was weak. That's been a function of currency . That's started to unwind a bit. Has that shown any signs of life, or is that sort of a difficult FX comp scenario. And to that effect, are you seeing any kind of change from the zero demand there or anywhere else inclusive of

Yes. Ross, the second quarter was a bit better than the first quarter. We anticipated that it was going to be a relatively short-term dynamic, and I think that's what we're seeing. We anticipate that the third quarter will be better than the second quarter, and the fourth quarter will be better than that. So I think it will be 2010 before we see a relative return to normalcy. But the encouraging thing about India is that their actual shipments of generic drugs has continued to grow robustly quarter after quarter. So I they think there isn't too long that they can put off the instrumentation needs of that kind of growth, and I expect that we'll see the second half significantly better than the first half.

Okay. And just because I'm getting a bunch of e-mails here, even though I think I may have it, John. In terms of the sort of top three things that changed on the guidance line to get to the new EPS range, I mean, it seems like FX improved, and you have a slightly better outlook for the back half. Can you just sort of - - delineate the three key changes to sort of get us there again? I'm sorry. I just feel like people are a bit confused.

Yes. I guess - - I mean, the upper end of the range was raised by $0.08.

Correct.

And - - the improvements there are really the FX on the top line, and currency is going to be - - favorable now by the time we get to the fourth quarter. That wasn't the case before. And we've continued to hold back on spend to a larger extent than perhaps than I had originally estimated as well. - - the benefits on gross margin continued in the second quarter, not at the rate they were in the first. But - - better than I had originally anticipated into the second. So I'd say - - those factors, coupled with the G-2 release and the early excitement on what we might be able to deliver in the fourth quarter made us feel much more confident in the numbers that we're rolling up from the field on possible shipments on the high-end mass spec later in the year are probably the biggest factors.

Okay. Thank you, John. I appreciate the clarity.

You're welcome.

Thank you. Our next question comes from Doug Schenkel of Cowen.

Hi. Good morning, guys. Thanks for taking the call. I'm sorry to beat a dead horse on guidance but I just went back to look at the transcript from Q1 to make sure I wasn't missing anything. And in fact, doesn't look like I did. On the Q1 call you guided the street to expect full-year constant currency growth of down 4% to up 1%. You've revised that to down 4% to down 2% for the full year. So again, assuming that this is an apples-to-apples comparison, you maintain the low end of the range, but you lowered the high end of the range. I just want to make sure I'm not missing something here. Is there a market where you're actually taking a more conservative stance - -?

Yes. The essence there is that the financial guidance that I provide on the earnings line is more associated with the bottom of the organic sales range. To the extent that we had gotten anywhere near zero or plus one, that we would have gone well over the earnings per share guidance that was provided. I did not want to create a financial model of the bottom line that assumed we had gotten all the way to the top of the organic sales range. So I typically try to construct the earnings of the bottom line somewhere near the bottom of the expectation for organic growth. That's the difference. And at this stage, just based on where we've landed in the third quarter - - it's less likely that we're going to get - - that plus one. So we've been, I don't want to say more realistic in with what the full-year expectation will be on the sales range, and the continued profitability of sales, even when they decline in the mid single digits - - is encouraging enough that we are able to still leverage positive earnings growth through the first half of the earnings guidance and for the second half, in reality, we're looking at earnings per share relatively flat compared to the prior year to get from the 3.30 - - 3.28 to 3.38 number.

Okay.

So in that respect, you could say the earnings flow-through is more conservative in the second half than the first, much of it associated with the currency environment that's getting a slightly less favorable from a gross margin in the bottom-line flow-through perspective.

And in the past, you've talked about - - a 1% FX move equating to about $0.05 on the bottom line. On a full-year basis, is that still a good rule of thumb?

I'd say, once we get past this year and currencies behave the way they've historically, that's probably right. That wasn't true for the first half of this year. We haven't had the full amount of pain on the currency line because of the fact we've had a positive yen, a negative euro and an extremely negative British pound dynamic, all of which have leveraged to better flow-through at the gross margin line. To the extent that currencies behave more normally and move in the same direction to the US dollar, the rule of thumb that you described is accurate. It just hasn't been accurate this year.

Okay. And then one last question. Doug, you in your prepared remarks talked about at a high level level, about returning to top-line growth in 2010 that resembles your historical norms. How dependent is this on a rebound in industrial; and - - what is the risk to this target associated with the pharma consolidation?

In terms of big pharma consolidation, if we see a major change in existing dynamics, I suppose that's a wildcard. For the already announced mergers, I don't think it means too much to our expectations. I think 2010, I'm frankly probably a little bit more confident in my heart than I'm willing to put down on paper right now. - - we're seeing a real demand reductions in 2009 that with all of the dynamics moving for us, I think - - if you just go back to 2008 dynamics, you're going to see mid to high single digit growth.

We continue to see strong demand coming out of Asia, and frankly I don't see a whole lot that's putting that at risk. I think India returns to a more normal dynamic next year, which coming off this base, could be a substantial piece of growth. Our Latin America business, I think we'll actually see a better return in the second half of this year, but better dynamics next year. The key question marks are western Europe and the United States, which are - - the major pieces of our business. - - coming off this year, I'm more confident that 2010 is going to be better. But - - it remains to be seen. The industrial piece has been terrible for three quarters now specifically related to this chemical business specifically tied to the consumer, to the auto industry, or the auto derived demand. - - your guess is probably as good as mine in terms of have we seen the worst of that? Do we seen another year of that? I frankly think it's hard to imagine you can see another year as bad as 2009, and I'd project it gets better in 2010.

Okay. That's great. Thanks a lot for taking the questions.

Thank you. Next question Marshall Urist from Morgan Stanley.

Yes. Hi, guys. Good morning. On the gross margin line, do you mind walking us through the moving pieces in terms of currency contribution year-on-year. And then what sort of changed sequentially from the first quarter.

Sure. If you looked at the gross margin improvement of about 210 basis points, the yen was up on average about 7% year-over-year. That's a couple million dollars of benefit. There's no cost of sales associated with - - any production in that country. So there's about a 60 bips improvement associated with that. In the UK, we have about $10 million or so of costs greater than sales. The currency movement there was about 20% year-over-year within the quarter, that's another couple million dollars of improvement. That's 120 basis points coming from currency, and there was a little bit of spillover effect from capitalized variances in the first quarter. So maybe about 150 basis points or two-thirds or so of the improvement that we saw in gross margin was associated with these currency dynamics that I'm describing. And beyond that the service margins continued to be much higher year-over-year as you saw in the first quarter. And that, along with some cost reductions in mix, were another about 60 or so basis points. Versus the first quarter - - the yen was up closer to 10% to 12%, the pound was off almost 30% instead of 20%. So these benefits were just much greater just because of currency movements within the quarter; but still on a year-over-year basis, very significant.

Okay, got you. And you alluded to this before. So should we think about, as you re-staff on service, is that a second half '09, or is that into 2010?

It's going to be more of a 2010 event. You're going to continue to see - - and even that could be - - could take a while to staff that up a bit; and - - or you're unlikely to see the service piece of this benefit decline substantially between now and the end of the year.

Okay. Got you. That's good for me. Thanks, guys.

Okay.

Thank you. Our next question comes from Jon Groberg from Macquarie.

Good morning. Thanks for taking the call.

Hi John.

Can you I guess just looking again - - a lot of people kind of saying, okay, let's get past 2009, looking into 2010. John, give me your comments around gross margin. It sounds like you're kind of on track with the acuity move to Singapore. With the puts and takes, I know it's kind of a first blush but, what would be your expectations with respect to gross margins on a year-over-year basis between 2009 and 2010 just given - - what you know.

I think, currency aside, I guess I would say that - - the product movements that you described - - hopefully some growth in the instruments next year versus this year, to help cover some of the inflation on that front - - would certainly allow us to provide some organic improvement in gross margins on a year-over-year basis. But I have to say on the FX side - - given the outstanding performance of currency - - kind of that perfect storm that we have talked about coming through the first half of the year. It's just unlikely from my perspective that I think that that's going to repeat itself or be in a position where we're going to see that it doesn't creat a difficult base of comparison - - it's probably going to eat away a significant amount of that organic improvement or everyone more than that. That has yet to be proven. So I would say - - for what we can manage on the gross margin side, I'm feeling very comfortable that we can deliver - - an improvement next year. And it's really going to come down to what the basket of currencies will do to us, and that's not something that is easy to predict this early on.

So just kind of flowing that through on your commentary on costs as you move through 2010 and assuming as Doug said that you have some of the top - - historically you've got quite a bit of leverage on mid, mid to high single organic growth. Is it fair to say, moving into 2010, you expect a little bit of less kind of earnings leverage relative to your history?

Yes. I mean, that's probably fair to say. I mean, we've done a lot of belt tightening certainly this year. And so we've created a difficult base of comparison from that perspective. I don't think we can ask the business - - to grow without some amount of investment next year. So keeping the traditional two or three percentage point gap between the growth in sales and the growth in expenses. If we're going to be somewhat cautious on the top line as we move into next year, it's going to be a bit more difficult. So I think it's fair to say that we're going to start off with a cautious perspective. We hope that we'll still be able to continue to provide some leverage between the growth in expenses and the top line. We'll work to do that, but it might not be quite as great as it's been historically.

And then, Doug, can you maybe just comment on a couple end market dynamics. One, you mentioned in your comments just recently that with respect to the announced mergers, you don't expect many surprises moving into next year. I'm just curious of what your salespeople are saying with respect to those mergers. And what gives you the confidence, maybe what's happening in the QA/QC market on the pharma side. And then the second question has to do with this merger yesterday or this acquisition of [Adjulan] and Varian and just kind of what impact, if any, you see from that, and kind of pricing expectations, I guess, from some of the generic and CRO customers that you mentioned are under cost pressures.

Sure. On the big pharma side, we clearly saw a little bit of a slow-down when they announced - - the sharing merger for example. But subsequently, we've seen very good performance out of the two parts of that equation. So I think there's some initial question mark, no question in parts of those businesses. You get kind of grid locked. But - - these businesses have, for five, six years now, have been living largely hand to mouth. And I think, in various parts of those businesses, they've realized that they just can't get more out of their equipment bases than - - there's a diminishing return.

Plus, in our particular case, acuity continues to gain share of mind as well as share of market and I think partly what you see happening with us in those large pharma accounts is acuity staying strong, while other more conventional technologies suffer. So I really don't think, if you look at that industry broadly - - I don't think there's too much more than they can crawl out of the base, and as a matter of fact, I think - - sooner rather than later, we're going to see some pent-up replacement demand And hopefully that pent-up replacement demand moves to acuity rather than to more conventional technologies. In fact, we know that's happening in some cases. The question is, does it happen more broadly.

If you look at - - what's happening in the analytical industry, the tool space - - I think that there's clear companies that are going to look to - - buy sales, and I think you see some of that happening. I frankly don't see how in the particular one you mentioned that the combined entity is going to be more competitive than the two entities on their own. - - the smaller company wasn't a particularly big competitor in the liquid chromatography business. I think they probably do more in the GC business than the LC business, not particularly big in the mass spectrometry world. Obviously, they have a very strong position in NMR. So I don't see that changing a whole lot of competitive balance in the tool space. Probably - - they're going to cut costs out of the combined entity and try to leverage their bottom line. But - -that's from reading the press releases so far.

Do you expect the pricing though - - I'm just thinking of generic and CRO. Some of the companies that could grow faster but that you base their services on lower costs. What's your share outlook there? What's it been? Do you think you've been gaining, losing, staying equal of share - -

What are you talking about, John?

Yes.

- - those accounts - - interestingly, some of the least competitive - - price competitive accounts. They are looking for time to market. They're looking for standardizing on the thing that gets them into the marketplace the fastest. So if you look specifically in India, there are some competitors who try to compete on price. We still have the overwhelming market share, and probably the highest-priced provider. So I just continue to tell you that I don't see low-priced competition as being a key determinant of market share in our world. It's just has never been the case. On the fringe, it does operate in some segments of the market, but not largely in the areas that we focus on.

Okay. Great. Thanks a million.

Thank you. Operator, maybe we have time for one more question if there's anybody there.

There's no other questions in the Q2 at this time, sir.

Thank you all for for being here. We'll look forward to talking to you later on in the year. Thanks very much.

This concludes today's conference calI. Thank you for joining. You may connect at this time.