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Waters Cassis Discusses Q2 Rebound and Capital Equipment Market

Following a difficult first quarter in which it reported anemic organic revenue growth of 3 percent, Waters last week reported that its organic second-quarter revenues rose 8 percent year over year. The rebound brought relief to investors and others in the life sciences capital equipment market who have been closely monitoring pharma spending trends. This week, Gene Cassis, Waters' vice president of investor relations, spoke with BioCommerce Week about reasons for the firm's improved quarterly results and the current capital equipment market.

The firm's sales growth rebounded to 9 percent in Q2 after a difficult Q1. What was the primary reason for the turnaround?

Whenever you have a rebound it's because you had a disappointment. If you travel back to the first quarter, our disappointment was our business in Europe. We had some significant delays in orders, primarily among our large, European pharmaceutical customers. And, if we take a look at what happened in the second quarter, that business did come back, and the growth that we had in the second quarter in Europe pretty much offset the softness we saw in the first quarter. So, at the half-year point we're at a net positive growth in Europe.

And you expect this to continue through the rest of the year?

Our expectation is that our European [business] will not likely be as robust as the business in our other regions. But our expectation now is that for the full year our European business will show positive growth, probably in the low to mid-single digits.

What about the overall state of the life sciences capital equipment market? Is there something in particular that has made it weaker than it has been in the past?

From our business, it's always difficult to comment on such a large marketplace. Pharmaceutical companies spend a tremendous amount on capital [equipment] and only a small subset of that is for analytical instrumentation. We have seen a gradual pick-up in our pharmaceutical instrument sales. I'd characterize it as not being very robust, but it's certainly improved over where it was in the first quarter, and it seems to be carrying the same trend that it had throughout 2004.

One of the things about Waters' business in particular is that we have a strong percentage of our business in liquid chromatography, and a considerable amount of the business that we do is replacement of instrumentation that is physically worn out. One of the nice things about liquid chromatographs is that they do have a finite life, and there is a very large installed base, so even in times when laboratories are not expanding they continue to have samples coming in and they have the requirement to analyze those samples. So, the instruments that are worn out have to be replaced.

We have significant recurring revenue — about 40 percent of Waters' sales are recurring in nature. That's for our service and our chromatography columns. So, when we take a look at that recurring piece of our business and we recognize that the 60 percent of our business that is instrumentation also has a heavy component that's just replacement of worn-out gear, maybe we're not as susceptible as some other companies are who don't have that recurring nature to their business.

What can you say in general about geographic regions? What are the particular areas that you think are strong and growing, and where is it weak, other than Europe?

I'd say that if we think about it strategically over the next five years, we really feel that the growth is likely to be in Asia, and within Asia principally India and China. We think that the growth is likely to be slowest in Western Europe, and we think that the growth will be right in the middle for North America. Our feeling is our business in Asia can sustain a double-digit growth pattern, as it has over the past couple or three years.

Many firms that have struggled with capital equipment sales have said they intend to place greater emphasis on the sale of consumables to provide a more predictable revenue stream. Does Waters intend to go in this direction as well?

It's something that we have done all along. We have a nice recurring revenue stream. Our instrumentation is used heavily in regulated processes [particularly by] the pharmaceutical industry. HPLC is the primary tool for quality control testing of your final product. So, given the nature of the applications that make up much of the liquid chromatography market, our feeling is that our capital business does have a certain amount of sustainability to it.

The other thing is that we're much more diversified in terms of geographical distribution of our business, as well as the application distribution of our business. One of the high points for us has been our non-pharmaceutical, non-science sales over the past couple of years. So, we may be less susceptible to some of the dramatic swings than companies that are more focused may experience.

Some industry observers have said that they're finding it difficult to identify a 'normal' spending pattern by pharmaceutical companies. Is this a view that is shared by Waters?

I think that the things we're seeing, in terms of capital expenditures, is that it seems to be that a lot of the purchases are being weighted toward the end of the year. So, [pharmaceutical companies] are starting off their years more cautious, they're seeing how they look financially, and they're holding off their spend until later in the year. We certainly saw that last year. We see it materializing this year also.

What are the key drivers of growth for Waters in the future?

Three things come to mind. The first one has to be new products. Our new form of liquid chromatography, called Ultra Performance liquid chromatography and based on our Acuity system, is a substantial growth driver for the company, as well as our mass spectrometry products coupled to chromatographs.

Another dynamic for us is geography, which we spoke of before. We'll take a look at our business in Asia, recognizing that between India and China you have 3 billion people. We've talked a lot about the growth potential in China, and one of the things that often drives this home for me is that our business in China is roughly the same size of our business in New England. So, you think about the potential as that country modernizes to be able to get better healthcare, get the tools into that country that help them deliver better healthcare, and as the sophistication of their exports increases their reliance on chemical testing increases.

Number three is the demographics that we have going for us. We think that pill count will continue to increase, and as populations age they're going to be swallowing more pills. Right now, the primary tools for looking at finished product testing are liquid chromatographs, so we think that's a macro-trend in the long-term.

Waters has repurchased roughly $395 million worth of its own stock over the past 9 to 10 months. Is it safe to say that management feels the stock market is undervaluing the company?

I think it's a couple of things. In order to buy back the stock, you have to have the resources. And we're fortunate as a company that we are profitable. We do have the resources to make a meaningful investment. The question is where do you want to invest? We've always said that we're interested in expanding our franchise. If we can find companies or product lines that fit our growth and profitability footprint, then we're very interested in doing that. But not having those opportunities in front of us, a very attractive alternative, given the fact that we have the resources and our stock is a good value, [is buying back shares]. It's accretive to our earnings to buy back stock at these price levels.

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