John Lynch - Waters Corp. Christopher James O'Connell - Waters Corp. Eugene Gene Cassis - Waters Corp..

Isaac Ro - Goldman Sachs & Co. Derik De Bruin - Bank of America Merrill Lynch Jonathan Groberg - UBS Securities LLC Doug Schenkel - Cowen & Co. LLC Ross Muken - Evercore Group LLC Tycho W. Peterson - JPMorgan Securities LLC Dan Arias - Citigroup Steve C. Beuchaw - Morgan Stanley & Co. LLC Tim C.

Evans - Wells Fargo Securities LLC Matthew Mishan - KeyBanc Capital Markets, Inc. Steve Barr Willoughby - Cleveland Research Co. LLC.

Good morning and welcome to the Waters Corporation Third Quarter 2016 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 objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr.

John Lynch, Vice President of Investor Relations. Sir, you may begin..

Thank you, operator, and good morning, everyone. Welcome to the Waters Corporation third quarter earnings conference call. Before we begin, I will 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 for the fourth quarter and full year 2016. We caution you that all such statements are only predictions and those 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, 2015 in Part 1 under the caption, Risk Factors, and the cautionary language included in this morning's press release and 8-K.

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.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is attached to the company's earnings release issued this morning.

In our discussion of the results of operations, we may refer to pro forma results which exclude the impact of items such as those outlined in our schedule entitled, Quarterly Reconciliation of GAAP to Adjusted Non-GAAP Financials, included in this morning's press release.

Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to third quarter of fiscal year 2015. In addition, unless we say otherwise, all year-over-year revenue growth rates including revenue growth ranges given on today's call are given on a comparable constant currency basis.

Lastly, as you recall in January of this year, we announced a new integrated structure for what was traditionally referred to as the Waters Division and TA Instruments Division. So, on this call and into the future, we will continue to refer to Waters products and markets and TA Instruments products and markets.

Now, I'd like to turn the call over to Waters' Chief Executive Officer, Chris O'Connell.

Chris?.

Thanks, John and good morning, everyone. Also here for our commentary and the Q&A session is Gene Cassis, our Chief Financial Officer. As with past earnings calls, I will provide an overview of our third quarter results as well as some broader commentary.

Overall, we delivered a solid third quarter performance with sales growing 5% and adjusted non-GAAP EPS increasing 11%.

Growth was driven by continued strong performance in our core biopharmaceutical business, sustained momentum in China and reliable recurring revenues globally, offset by flat sales in our industrial markets and general challenging governmental and academic demand.

Earnings growth in the quarter continue to outpace our top-line performance due to ongoing operating expense discipline, as well as positive foreign currency translation effects in the P&L.

Taking a closer look at our business in major markets, our broadly defined biopharmaceutical market for Waters products and services once again led the way with 13% growth in the quarter. We saw this growth across all significant pharmaceutical workflows and in all major geographic regions.

Year-to-date, our sales to the biopharmaceutical customers have grown 12%, which is particularly impressive in comparison to double-digit growth rates in the first nine months of 2015.

While growth contribution can be seen across multiple and customer types, our biopharmaceutical growth continues to be strongest in smaller, specialty and biotech firms. This is further evidence of a steadily increasing diversity and balance in our core business.

Our global industrial sector, which includes sales to the material characterization, food, environmental and fine chemicals market, grew 1% in the quarter. Global weakness from the chemical industry contributed to slower growth in both our TA Instruments and Waters product lines.

Demand for food safety and food quality related applications fared better, however, with sales growing by 7%. Looking at governmental and academic markets, we saw a 15% decline in the quarter, particularly influenced by softness in Japan, Europe and the U.S. As we have stated before, demand from these markets tends to be lumpy quarter to quarter.

This past quarter, additional dynamics relating to the timing of order shipments skewed the results and we expect more stability in the fourth quarter. This decline was partially offset by low to mid single-digit improvements in Asia, excluding Japan. Turning to product line dynamics in the quarter, Waters instrument sales grew 4%.

Continued strong uptake for LC systems featuring the ACQUITY Arc module and for LC-MS systems incorporating our bench-top Tandem Quadrupole technologies were highlights of the quarter's performance.

Speaking of Tandem Quad mass spectrometers, Q3 saw an acceleration of sales for our Xevo TQ-S micro and the more recently introduced Xevo TQ-XS high performance Tandem Quadrupole instrument.

These instruments are used for demanding quantification applications where high sensitivity, speed of analysis and reproducibility are required, whether analyzing small or large molecules, a single analyte or a panel of compounds.

On the research mass spec side, more labs are adopting our newly introduced Vion IMS QTof system as the advantages of seamlessly coupling ion mobility and high-resolution top (06:25) measurements are enabling new research workflows. Waters' total recurring revenue, the combination of servicing, chemistry consumables, grew 7% in Q3.

Breaking out our recurring revenues, service grew at an 8% rate with global demand for service plans continuing to increase. Sales of chemistry consumables were up 6% in the quarter with relatively balanced regional growth.

Continued strong uptake for our protein columns and GlycoWorks labeling kits highlighted the robustness of our biopharmaceutical consumable sales trends. Additionally, sales of ACQUITY UPLC columns continue to demonstrate the increasing usage of UPLC technology in regulated workflows.

Turning to our TA Instruments business, revenues were up 1% for the quarter with flat sales in instrument systems and 6% growth in service revenues.

These results were below our expectations given TA's strong product position in the current Discovery Series launch and seem to signal slower demand from industrial chemical customers, particularly in developed markets.

We will continue to watch these markets closely and look to capitalize on opportunities to address pent-up demand as it materializes. In the quarter, TA completed the acquisition of Rubotherm, a developer of a unique and high-performance thermogravimetric technology based on magnetic levitation.

This exciting product line will fit squarely into our broader thermal analysis portfolio and sales channel and open up adjacent growth opportunities. Finally, looking at the quarter geographically, Asia continues to be our strongest region with 13% growth, while sales in the Americas grew by 2% and European sales declined by 1%.

The strength of our business in Asia was highlighted by strong double-digit sales growth in China and this in comparison to a strong prior year's quarter. Within China, we saw growth across all of our markets and product lines with particular strength in pharmaceuticals.

Looking specifically at our Chinese business with pharmaceutical customers, growth drivers included new regulatory requirements by the CFDA, which is China's Food & Drug Administration, which focus on increasing analytical rigor across key workflows to assure consistency of results and integrity of archive data.

Our strength across LC optical and LC and MS as well as with our Empower chromatography data system has us well positioned to meet these needs. Furthermore, TA posted double-digit growth in China.

In Japan, sales from our Waters portfolio declined modestly at constant currency with growth in pharmaceutical sales offset by declines in industrial, government and academic spending. TA's performance in Japan was flat. Revenues in the Americas included a slight decline in the U.S.

against the challenging base of comparison, offset by growth off easier comps in Latin America. Our performance in the U.S. was a tale of two cities, with continuing strong pharmaceutical demand offset by lower governmental and academic spending. Pharmaceutical demand in the U.S. was strongest from specialty and biotech firms.

Europe also saw strong biopharmaceutical trends, driven by demand for service and mass spectrometry technologies. Offsetting solid mid single-digit growth in Western Europe was weaker demand in Eastern Europe and the Middle East.

Stepping back and looking at our year-to-date results, I am pleased with our overall performance as revenues have grown 6%, and adjusted non-GAAP EPS has grown 12%.

Revenue through the first nine months has been solidly above estimated market growth rates, and the team has also effectively managed our spending to deliver operating leverage, while continuing to invest appropriately in new innovations and customer support to fuel our future growth.

From the beginning of the year, we expected our big three growth drivers, namely the biopharma market, our China geography and recurring revenues of chemistry and service to all be sources of strength. If anything, performance from these sources has exceeded our expectations.

And while our other market and geography segments have materialized somewhat differently than we originally expected, we don't see any factors that affect our ability to deliver the overall results we are targeting for the year.

Moreover, we feel we are poised to benefit from improvement in market conditions in the industrial, government and academic markets when they occur.

So as we look at the fourth quarter and beyond, we will continue to emphasize execution in our core business and key growth drivers and are pleased that business trends in these areas suggest a continuation of strong and sustainable operating performance. Now, I'd like to pass the call over to Gene for a deeper review of the financials.

Gene?.

Well, thank you, Chris, and good morning. In the third quarter, our revenues came in at $527 million, an increase of about 5%. The impact of currency translation in the quarter was about neutral. Our non-GAAP earnings per diluted share in the third quarter were up 11% to $1.57 in comparison to earnings of $1.42 last year.

On a GAAP basis, our earnings were $1.53 compared to $1.40 for the third quarter of last year. On a year-to-date basis, our non-GAAP earnings per diluted share were up 12% to $4.41 in comparison to earnings of $3.94 last year. On a GAAP basis, our earnings were $4.26, compared to $3.82 for the comparable period in 2015.

Our reconciliation of GAAP to non-GAAP earnings is attached in our press release issued this morning. On the product front, our Waters products and services sales were up 5%, while TA's were up 1%. Breaking that down somewhat, LC and MS instrumentation platform sales increased by 4%, and TA's instrument sales were flat.

Our total recurring revenue associated with both Waters and TA products grew by 7% with TA service revenue up 6%. Looking at our growth rates in the third quarter and before currency translation, U.S. and European sales were down 1%, Japan is down 2% and sales in Asia outside of Japan were up 18%.

As Chris noted, sales of Waters products were particularly strong in China. As for TA, global product sales were up 1% overall with mid single-digit decreases in the U.S. and Europe, offset by strong double-digit growth in China. Now I'd like to comment on our third quarter's non-GAAP financial performance versus the prior year.

Gross margins for the quarter came in at 58.6% versus 58.7% in the third quarter of last year. The year-to-date gross margin percentage is about equal to that of the first three quarters of 2015 with currency still a slight headwind. Moving down to P&L, SG&A expenses were up 2% on a constant currency basis and flat on a non-GAAP reported basis.

R&D expenses, including those associated with new product development and incremental investments, grew 8% in the quarter on a constant currency basis, but decreased by 1% on a reported basis, this primarily due to the weaker British pound.

On the tax front, our effective non-GAAP operating tax rate for the quarter was about 14% versus 12.7% in the third quarter of 2015.

In the quarter, net interest expense was $6 million, and our average share count came in at 81.4 million shares or approximately 1.4 million shares lower than the third quarter of last year, this being a net result of our ongoing share repurchase program.

Turning now to the balance sheet, cash and short-term investments totaled $2.7 billion and debt was about $1.8 billion, bringing us to a net cash position of $931 million. As for third quarter share repurchases, we bought 440,000 shares of our common stock for $69 million. This leaves $206 million on our authorized share repurchase program.

We define free cash flow as cash from operations, less capital expenditures, plus non-cash tax benefits from stock-based compensation accounting and excluding unusual nonrecurring items.

In the third quarter of 2016, free cash flow came in at $128 million after funding $21 million of capital, and excluded from this amount is approximately $2 million of investments associated with facility expansions. Accounts receivable days outstanding stood at 76 days in the quarter.

Inventory levels were up approximately 6% in comparison to the prior quarter, reflecting typical seasonal patterns. As we think about our expectations for the fourth quarter of 2016, we anticipate constant currency sales growth of approximately 5%. Currency translation at today's rates is expected to modestly increase the sales growth.

Moving down the P&L, we expect gross margin percent for the fourth quarter to sequentially improve from the third quarter's and approach 60%. Operating expenses will continue to be carefully controlled and will grow moderately from those in the prior year's quarter while we continue to fund R&D initiatives.

Moving below the operating profit line, net interest expense is expected to be approximately $7 million, and we expect our operating tax rate to come in at 14%. Rolling these figures together, we anticipate non-GAAP earnings per fully diluted share within a range of $2.08 to $2.18.

Combining this fourth quarter outlook with the results of the first nine months of 2016 and assuming a fully diluted share count of about 81.5 million shares, we now anticipate full year 2016 reported sales growth of about 6% and adjusted fully diluted earnings per share in the range of $6.48 to $6.58, which maintains the midpoint of our full-year guidance as communicated at the end of the last quarter.

And with that, I will turn the call back to Chris..

Great. Thank you, Gene. Before we open the phone lines for Q&A, I just like to add one comment. Since I started at Waters a little more than a year ago, the investment community has been very supportive and engaging as I dug in with the team to operate the business, build the team, and chart the future.

Given my interest in providing you deeper insights into Waters and our future direction, I'm pleased to communicate that we will host an Investor Day on Thursday, March 2, 2017 in New York City.

Preliminary planning is under way for an agenda that will feature presentations from our management team on a more comprehensive view of our business and future goals and strategies as well as an opportunity for Q&A and informal interaction. We'll provide more details as this event approaches. And with that, we'll now open the lines for Q&A.

We are rarely able to get to everyone's questions, so please limit yourself to one question and one follow-up. And if you have additional questions, please contact our Investor Relations team after the call. Thank you, and, Natalie, please open the lines..

Thank you. Our first question is from Isaac Ro from Goldman Sachs. Your line is now open..

Hi. Good morning, guys. Thanks for taking the question. I appreciate your comments on the academic markets in the prepared statements, but I was hoping you could put a little more context. We've seen a few companies this quarter now kind of echo a similar pressure in that channel, and I was wondering if you could maybe help us reconcile.

It seems like funding in the U.S. is better this year, but it's not translating into dollars. So, just thoughts on why that's the case and when we might see a turn..

Yeah. Thanks for the question, Isaac. I'll make a few comments, and Gene may want to follow up as well. And I agree with your point that we don't really see a funding problem out there.

In fact, if anything in the broader picture and you see this in headlines and in terms of what the government is interested in and a number of different funding sources, there definitely seems to be a renaissance in medical research and other areas that will ultimately translate into spending in the academic sector.

As I commented in my comments, the patterns here tend to be quite lumpy. There is less recurring revenue, as you know, in these segments, more oriented towards high-end mass spectrometry. And frankly, we have pretty good visibility to orders.

And just looking at a bunch of timing factors around orders, I think that tends to distort numbers quarter to quarter sometimes. So, again, our outlook is in this particular area to be conservative and to be cautious but looking for opportunities to do better, and that's the way we're looking at it..

Great. Maybe just a clarifying question on that last comment you made about orders.

So, could you maybe quantify the extent to which delayed orders might have had an impact on that part of the business, either to total top line or to growth in the academic channel and should we assume that the majority of that translates into the fourth quarter based on your current guidance?.

I'd rather not quantify that specifically, Isaac, other than to say that we do try to calculate that and try to get a sense as to what the overall end market is capable of in the foreseeable future, and that's why we don't see this as a crisis per se but really the vagaries of timing and a cautious outlook on these markets which are a little bit less predictable given our revenue composition in the area..

Got it. Thanks so much..

Next question comes from Derik De Bruin from Bank of America Merrill Lynch. Your line is now open..

Hey. Just a couple of clarifying questions. Could you clarify the M&A contribution in the quarter and the full year expectation? And then on the fourth quarter guidance, you do have two extra days in the quarter, if I'm not mistaken. So, that's sort of implying a general slowdown in the business from the year-over-year comps.

Is that the wrong way to sort of look at it?.

Derik, I'll let Gene comment mostly on this, but the M&A contribution is very small at this point. And in terms of the extra days, yes, there are extra days, but it's generally within the noise, and we didn't bank too much on the two extra days. So, Gene, go ahead..

Hi, Derik. In terms of looking at the M&A contribution in the quarter that we just reported on, it was around 20 basis points of revenue growth. And in terms of looking at the effects of the selling days on the fourth quarter's performance, as you know from following this company for many years, the days typically affect our recurring revenues.

And a good rule of thumb is that each day, additional day can contribute about a percentage of growth to our recurring revenues. And with recurring revenues being about half of our business, that would translate into a benefit of about a percentage point of growth.

So, it is really not the caution on recurring revenues that leads to our assumptions about the fourth quarter's performance. I think our conservatism is much more around the capital spend....

Yeah..

...concerns about continued industrial weakness, and again, as Chris so well characterized, the government and academic that it's a little bit tough to call just given the lumpiness of it. So, there's a little bit of conservatism on the capital spend that's built into the fourth quarter outlook..

Great. And just one final clarification.

So, you're not expecting as big a budget flush in pharma then?.

Well, you know what? The pharmaceutical performance was strong in the prior-year quarter. The momentum that we see in pharmaceuticals early in this fourth quarter continues to be encouraging.

But I think to assume that the pharmaceutical world continues on a trajectory that's close to a mid-teens rate would be something that we're not particularly comfortable with. So, I think....

Yeah..

...as we begin to look at our expectations for the fourth quarter, a little bit of moderation of that pharmaceutical growth I think is warranted, still very healthy, but just not at the rate that we reported in the third quarter, Derik..

Great. Thanks for the clarification..

All right. Thank you..

Our next question comes from Jon Groberg from UBS. Your line is now open..

Great. Thanks. Hey, Chris. You guys ended the year with just under $1 billion if net cash, and Danaher just bought Phenomenex, which I know is an asset that you would think would fit kind of nicely under your guys's umbrella.

Can you maybe talk a little bit about how you're thinking about capital allocation and use of that cash?.

Sure. Yeah, I think the story on capital deployment, Jon, is very consistent with what we've always done. As you know, we have a well-established share repurchase program that we anticipate continuing.

As far as M&A goes, I've been very clear since the day I walked in here that we will actively look at those opportunities, but it's not a core strategy of the company.

M&A is really a tactic to execute a business strategy, and certainly, we'll say more about this over time including at the investor meeting early next year, but suffice it to say, we'll look at everything out there, but we're going to be very disciplined about those types of decisions.

So, certainly, if the right opportunities presented themselves and they made sense strategically, they made sense financially, we'd be interested, but at this point in time, we've taken a more conservative approach on that..

And this is my quick follow-up.

I guess, as you look out there and you see some of these chess pieces that are moving around, are you seeing any signs, either on the instrumentation business or the chemistry business, are you seeing any signs in terms of the way your customers are behaving or any changes in the way your customers are behaving or any impact of what some of your competitors are doing?.

Jon, that's absolutely the right question to ask, and it's the question we ask as well, which is, is there benefit to breadth in the customer purchasing process. And at this point, we don't really see any signs that that is the case. We believe we benefit from our focus and our depth in the particular workflows we're focused on.

And within those areas, we're actually more comprehensive than any of our competitors, say, for example, in the five main areas of chromatography, mass spectrometry, chemistry, service, and informatics.

When you look at that bundle and the workflows that surround those areas, we're number one altogether, and we've got strength in every one of those components but also an ability to put those together as a system for the key workflows in our chosen markets. And so, it's a very fair question.

It's the right question and it's one we'll continue to evaluate, but at this point, I certainly don't see any competitive advantage from just having more product categories in a purchasing type of scenario..

Okay. Thanks..

Next question comes from Doug Schenkel from Cowen and Company. Your line is now open..

Hey. Good morning.

Just to start on TA, what were new product contributions to growth in the quarter? What's current backlog? And as we begin to think about 2017, do you still believe the series of new TA instrument launches can help drive at least corporate average growth even if industrial end market challenges persist or based on what we're seeing now, should we tamper our expectations?.

Yeah. Good question, Doug, and you've pointed out an important point which is that from a product position standpoint in TA, we're in a great situation. We're I'd say midway through the early stages of the launch of the Discovery series with the DSC and the TGA instruments in the market with still several more versions to come.

I would say the contribution from those particular product lines is relatively modest right now and that the situation in TA relative to the top line is more reflecting of the industrial chemical end markets and just a little bit of sluggishness in those markets right now.

We're extremely vigilant about trying to understand that and feel that whenever there is sign of life in those markets that we're going to do very, very well. That particular instrument product line actually gives us new capability, increasing pricing power, actually better margins.

And so, we're actually in the general sense quite optimistic about the performance of TA and giving that particular product line a lot of support right now and just trying to manage our way through a little softer end market..

Okay. That's helpful. And then I guess, a margin question. So, SG&A was flat year-over-year reported, up 2% in constant currency terms. And really that type of leverage was really the most important driver to you meeting EPS expectations in the quarter.

How much was the leverage there? How much of that was that driven by revenue weakness versus true operational discipline? What's the sustainability of this type of leverage at the SG&A line looking forward? And then moving up the P&L, looking at the gross margin line, could you provide some more color on the puts and takes to gross margin in the quarter? By our estimates, the weakening of the pound may have provided around 50 basis point benefit and in spite of that gross margin decline, 10 bps year-over-year.

If you could provide a little more detail there as well, that would be helpful..

Sure. Thanks, Doug. Let me make a couple of comments, and then Gene can provide some additional data points. You're right.

We did get SG&A leverage, and that's a combination of, I would say, three factors, certainly a little bit of revenue weakness lowered some of the sales-type spending, very strong operating discipline, and this team, as you know, has a history of disciplined operating management, and so we obviously have the ability to manage expenses tightly while still making sure we're doing the right things for growth.

And we got a little bit of FX benefit as well. I think it's important to say as well SG&A will be an area that we continue to look for operating leverage over time, especially in the interest of maintaining or even enhancing our investment in R&D.

I've said before that as long as we can cover it and still get operating leverage in the P&L and as long as I'm convinced that there is good R&D productivity, I'm even interested in increasing our commitment to innovation. Being the most vital organic grower and innovator in the industry is an important strategy of ours.

And so, I'm very pleased that we're able to get operating leverage primarily through the SG&A line, at the same time, increasing our focus on innovation and fueling the new product pipeline. So, I think there is a good balance in the P&L right now.

And I think many of those factors are indeed sustainable, and we want to obviously have that type of philosophy going forward. So, I'll let Gene comment a little more specifically on the puts and takes in the gross margin..

Sure. Thank you very much, Chris, and hi, Doug. Looking at the gross margin like in every quarter, there are pushes and pulls. And you're right that we did get some FX benefit in the gross margin line, primarily from the Japanese yen and yes, some benefit from the British pound.

Offsetting that was some dynamics in terms of product mix and geographical mix of the business. Historically, TA has been a very high gross margin business for us and was a little bit weaker in the quarter. So, that was one of the factors that influenced gross margin.

And we had a very strong quarter in the area of service, which is a little bit dilutive to the gross margin, but it's nicely accretive to the operating margin.

There's been a lot of focus on the valuation of the British pound post the Brexit vote, and I just wanted to comment that we didn't really see the full effect of the pound's current value in these third quarter results as the pound weakened throughout the quarter.

So, the average rate of the pound wasn't quite as favorable as it is today, but where we see it most dramatically is in our R&D expense. I think we had talked about there being about a 9 percentage point difference between the constant currency R&D growth and the actual reported R&D growth.

So, those are some of the factors where currency affected our P&L in the quarter..

Okay. Thanks, guys..

All right. Thank you, Doug..

Next question comes from Ross Muken from Evercore ISI. Your line is now open..

Good morning, guys.

Just want to get back on the CapEx side and again, just I know we're not going to get detailed bookings color, but can you just give us a sense in some of the markets where you either saw choppiness like academic and government or actual weakness in Europe or industrial, what the cadences looked like in those markets and how you feel about visibility? So, what I'm trying to get a sense of – because it seems like you're suggesting a lot of these issues are sort of temporal.

Are you seeing something like in the very early parts of sort of the booking cycle where you're feeling like there are signs of recovery? Are you just looking at the period at which some of those markets have been depressed? And assuming you see some shift back, is some of it based off of maybe a lack of political uncertainty? Obviously, we've got with what's going on with the Brexit and the presidential election in the U.S.

kind of uncertainty. I'm just trying to get a little bit of color for how you're thinking about that cadence, particularly in some of the markets where it's been a bit choppy..

Yeah. Thanks, Ross. Let me try to add some value on that comment that you're making. I think overall, I want to reiterate that I think the approach we're taking in these markets and really separating some of those growth drivers I talked about, which are really doing so well, pharma, China, recurring revenues, and we continue to focus on those.

But in the areas that you mentioned, I think we're being quite balanced actually and cautious and conservative. And I don't think we have a feeling that there is some major cyclical trend that we're heading into. I think we see the normal back and forth of some of these markets particularly at the later point of the year.

I don't have any evidence that political uncertainty is causing any abnormal issues here, certainly from a Brexit standpoint. Our business in the UK and in Europe has actually been pretty steady.

And just in the Europe context, while the overall number looked a little bit lower, you really have to separate Western Europe from Eastern Europe and the Middle East. The Western Europe part of that business is, as I mentioned, is quite stable and even the UK itself. Same comment on the U.S. political environment.

We don't really see any linkage to the current election cycle to behaviors or attitudes in terms of the end customers. We do have more visibility to certain of those subsectors, say, particularly in the academic world where we have a longer view into the pipeline.

And as I mentioned before, without trying to quantify it, we see enough evidence in the trialing and the quoting and the ordering to say that hopefully, we'll have some opportunities to improve on what we did last quarter coming up here.

So, again, a conservative and a pragmatic approach in terms of the outlook in those markets but really truly looking for an opportunity to do better..

And maybe just quickly going back on the biopharma side, I mean, we talked about this last quarter. But the sort of length of this cycle is probably atypical versus prior, but there's a number of reasons for that, and obviously, pipeline success has been quite good.

As you talk to the sales force, many of which have been there for a long time or looking into that customer base, obviously, on a regular basis more deeply, how do they kind of characterize sort of the staying power at least on the CapEx side of demand and how they're thinking about how the order book sort of maintains over the next 12 months or 24 months? And again, I'm not looking for quantitative guidance because I know we're not going to get that, but just more like anecdotally what their conversations are like today versus 12 months ago or what they are most keyed in on to sort of understanding the trajectory of that demand base?.

Yeah. That's a terrific question, Ross, and that's exactly the right question, and it's probably the question I spend most of my time thinking about, embrace your core business, love your core business, and try to understand it at a deeper level.

And clearly, this question of cycles in pharmaceutical and staying power of demand, as you say, is exactly the point.

And I guess my perspective – and I welcome Gene's more longer historical perspective as well – but my perspective is the pharma market we see today and that we expect to see just feels like a very steadily changing and different type of market than historical, potentially with less cyclicality, more balanced geographically, more balanced from an end customer standpoint.

I used the word earlier renaissance in medical research, but I think that term also applies to the drug development process.

And we're seeing less and less dependence on the biggest customers, less and less dependence on traditional, large, integrated biopharmaceutical companies, more and more growth and innovation in the specialty area, the biotech area, obviously, on one end of the spectrum, a real growth in the generic category driven by rising patient access to medical therapies around the world, but on the other end, an increasing drive for innovation and increasing complexity of molecules that are under development and frankly, that have more challenging characterization requirements.

I'm personally spending a ton of my time with customers still, and many of these factors are reinforced. And so, we're excited about what's happening in the pharma world and all of those factors, and we'll continue to try to quantify that and really lean into that.

So, we're really maximizing our performance in our core business which is our strategic goal number one..

Thank you..

Our next question comes from Tycho Peterson from JPMorgan. Your line is now open..

Hey. Thanks. Maybe, Chris, following up on that last point, you had another sequential increase in biopharma. I think last quarter, you talked about large pharma picking up a bit. I think it was up mid-single digits.

So, can you maybe talk to whether that trend continued? And then on the biotech side, how much is the strength that you're seeing is a result of investments you're making into that channel? And are you seeing any shift in product mix with the growth in biotech?.

Yeah. First of all, as it relates to large pharma, I would say we continue to see steady performance out of large pharma. It's not our fastest growing segment but it's there. It comes in and out a little bit quarter to quarter, but we're certainly not declining in that segment.

And actually, I think large pharma is doing pretty well right now as a sector and end market but really, a lot of the growth, as you point out, is coming from specialty and biotech and so forth.

I guess, I've spent a lot of time studying this this year, and I think the company made a bet five or seven or eight years ago, something in that timeframe to really develop more application support for the biotech world.

And we've used a couple of examples of that in terms of some of the consumables and kits but also the workflows around the mass spec product line. And I think what we're seeing is we've seen a steady increase in market share in the large molecule segment.

The large molecule segment is growing faster than the small molecule segment in general for the future, and it's a very, very different market. And that's what we're trying to do is really unstack the stack and understand it with more granularity, what the demands are in each of these subsets.

But I think our biotech offering and you see this reflected in our current products but also as we share more of our product pipeline for the future continued strong emphasis on this biotech sector..

And then maybe one on Japan. It's been core for a while. Obviously, there's been volatility in the yen.

Do you see things kind of bottoming out there or what's the outlook?.

Japan is mixed as we commented. The pharma sector in Japan is solid right now. And like I said, the pharma sector around the world has been pretty balanced, and that's true in Japan.

In Japan where we've been through a little bit of a cycle and saw it again this quarter with less spending on the government side and declined some pretty good size declines in that sector as the government has prioritized other national investments in the wake of some of the unfortunate disasters there.

There are some infrastructure rebuilding that has what we believe temporarily moved money away from some of the research government-type research business, but Gene may want to comment more on that..

No, I think that's very accurate. And as Chris mentioned, the pharmaceutical spend in Japan continues to be robust.

The other thing that we're seeing is that, that is a country that is very receptive to new technologies, and the uptake of some of TA's new Discovery products is something that we're very optimistic on as we look at the industrial opportunity in Japan..

Okay. And then if I could just ask one last quick clarification. I think it's an important point. As we think about next year, obviously, there's been a lot of focus on the pound movement implications to earnings. It sounds like from your comments, Chris, you may use that as an opportunity to take up investments.

Is that the right way to not actually think about it all flowing through?.

I'm sorry. Can you repeat the last part of that an opportunity to what -.

I'm just trying to think about given the currency moves and the implied benefits for 2017 earnings, it sounds like you're going to actually be taking up spending a bit next year. Is that the right interpretation? So, the currency moves may not necessarily flow through..

I don't think that's necessarily fair to say. We're right in the middle of our budgeting cycle, and I think like history and we've implied all the way along here, we're going to be prudent and cautious.

It's our goal to sustain very attractive top line growth and to deliver some modest operating leverage while continuing to invest in R&D and in our sales force. And so, I don't anticipate any sort of a step change spending increase program. We're just going to continue to be very, very disciplined about how we deploy our capital internally..

Okay. Thanks for clarifying..

Next question comes from Dan Arias from Citigroup.Your line is now open..

Hi. Good morning. Thanks. Chris, maybe just some color on new products and the competitive environment and industrial.

Do you feel like the instruments that you're coming to market with are coming at a time when your competitors are doing a similar thing or do you think you're a bit off cycle, so to speak, which maybe has your – the potential for your portfolio to stick out a bit for those that are thinking about purchasing?.

That's a good question, Dan I would say I'm still learning about the competitive landscape relative to product cycles and what they're trying to do. But frankly, I'm 100% focused on what we're trying to do and making sure we're doing the right thing for Waters. So, I don't know that I have a perfectly clairvoyant vision on your question.

I look at what we're doing in product development and take the last four or five big products we've done like the QDa mass detector, the ACQUITY Arc, a couple of really great new entrants in the mass spec category with Vion and then Xevo TQ-XS in the quantification area and then the stuff on the TA side.

I like the way these products are shaping up for the priority segments, these particular products that we're newer in the market with. And keep in mind, product launches in this sector continue to impress me as things that really deepen and build and scale more steadily over time rather than being quick hits.

But you think about the key priorities around our core business in small molecules and technologies like the Arc and the advantages that gives us in a more flexible approach to methods in geographies like China.

You look at the biotech development phase and the food safety area and some other things and the strength we have in the tandem quadrupole area. And so, I think some of the products that we're emphasizing right now in our portfolio are very much at the core of the most important trends that we're trying to drive in the marketplace.

And we'll over time give you a little more visibility into the pipeline for the future, but I've had an opportunity to spend a lot of time thinking about our portfolio and working with our engineering teams to make sure that what is coming next continues to build on this momentum..

Got it. Okay. That's helpful.

And then just as a follow-up, if we look at some of the M&A activity that's taking place in the chemical space, any reason to think that that's having a role in demand or the way that timing is shaping up?.

In the chemical space. I don't know. I think that's a fair question. I mean, obviously, you have Dow, DuPont out there, and those have been good customers for us. I haven't seen any evidence that there is some discontinuity in terms of demand from those types of customers.

So, I think the industrial backdrop that we have been talking about on this call is something that many people have seen.

It's across sectors and we're just trying to be very clear right about it and certainly not panicking and being conservative and cautious like I said but looking for opportunities and making sure we're poised to seize those opportunities because what happens when you're in a cycle like this is that pent-up demand builds, and we're looking for opportunities to get some big wins in that regard..

Okay. Very good. Thanks..

Our next question comes from Steve Beuchaw from Morgan Stanley. Your line is now open..

Hi. Thanks. Good morning. Just two quick ones for me. One is a regional question. The growth in India doesn't get as much attention on this call as sometimes I think it maybe deserves.

Can you give us a sense for what India growth specifically was in the quarter, what it's been year-to-date? And how the balance of the drivers there is evolving between some of the regulatory demands coming from parties outside India, and how much of it is volume and how are you thinking about the structural growth drivers (49:19) going forward.

Thanks..

Yeah, sure. Thanks, Steve. I'm glad you raised India, we do tend to talk about China a lot as a huge market and a high performing market, but India has been the same category. I very much think about India a lot and work with the team there. Our growth there has been in recent quarters and years, really solid in the mid-teens.

And I think that reflects a couple of different things. Number one, it reflects the vibrancy of the generics market in terms of both the Indian companies and the multinational companies that are operating there, developing generic pharmaceuticals – producing generic pharmaceuticals for the world.

As you allude to in your question, the regulatory requirements from the FDA and other notified bodies and regulators around the world has been increasing.

And so, we've done particularly well in that market and believe we built our market share position and actually have quite a high market share position in India based on our competitive advantage in chromatography data systems, i.e., Empower.

It's a huge competitive advantage for us, it's one we continue to build upon and we're building a stronger and stronger foundation of loyalty in that market.

The other point about India that I find interesting is that not only is India an interesting market from a multinational standpoint and an export standpoint, but it's going to become over time a vibrant domestic market as well.

And so, the strength of our franchise there over time, the strength of our relationships and our team sets us up well for other new waves of growth in India, so India is a huge priority, it's challenging to be our third-largest country in the world after the U.S. and China and will continue to be one of our top priorities..

Thanks, Chris. And then just one update on the mix of the business to help us think about how to model going forward, I know historically the company has had a pretty healthy balance of revenue exposure within the pharma category between, let's call it R&D/drug development on one side and then production and manufacturing on the other side.

Given that we've seen so much growth in pharma as a category for you guys over the last couple of years, can you give us an update on what the balance is there between those two segments of pharma and where you're seeing more relative growth and how you're thinking about that over the next year or two? Thanks..

Yeah. We're pretty well balanced between development and production, more 50-50 between R&D and then the QC/QA side. The QA/QC side, as you know is more oriented towards recurring revenue and the service and the consumables, whereas the R&D side, a little more oriented towards capital.

We've traditionally been strongest in late-stage development and then QA/QC and certainly as we – based on the earlier conversation we had on the changing nature of pharma, as there's been more activity in development in recent years from more sectors, particularly specialty and biotech, that's been an area of strength for us.

But we also have opportunities, we can do better in earlier-stage development and even in the research side. And we're excited about some things we're working on to augment the strength we have on late-stage development in QC and to earlier stage development in research, and we want to continue to improve in all areas.

So, I don't know that there's been any drastic changes in mix, I don't think so in terms of our overall business composition between those areas. But like anything, there's areas we do particularly well and areas we can improve..

Got it. Thanks and a good morning..

Thanks, Steve..

Your next question comes from Tim Evans from Wells Fargo Securities. Your line is now open..

Thanks. I was hoping to put a little bit of a finer point on the academic, government decline. In particular, you called out the dynamics in the U.S. as being strong pharma offset by weaker academic, but I think the academic piece in the U.S. is fairly small. I guess first of all, can you quantify how much of your revenue is kind of U.S.

academic, government, and then, how much was what particular piece down?.

Yeah. That's a fair question, Tim and we don't want to quantify all the different growth rates by sub-segment, but just in a broad sense, about 15% of our worldwide business overall for the corporation is government and academic. And so, to your point, it is a smaller mix.

Within the U.S., the pure academic sector may be around 10% and it ebbs and it flows a little bit and government adds to that. So, you can see how a decline in these segments affects the overall result. And so, like I said we're taking a balanced view on one hand.

We're not happy with the decline, and we want to do better and we believe we will do better. But on the other hand, keep it in perspective, and keep our number one focus on the core business and the sectors like pharma, like food and others that are giving us a lot of growth right now.

So, affecting the overall geography, it wasn't just as simple as pharma and then academic, there is a lot of other sectors within industrial too that as we pointed out have had more moderate growth, particularly in the industrial side that the chemical, materials, polymer environmental type end markets..

Okay.

And would you just mind quantifying your exposure on the revenue and cost line to the yen, now that things have moved around so much?.

Yes. Tim, I just wanted to mention just as a follow up to Chris' comments on the U.S. that in this particular quarter, we were comparing against a mid-teens growth in the prior year quarter. So, please bear that in mind as you think about the particular growth rates in the U.S. in the third quarter.

And thinking about the yen, as we mentioned we had a slight decline in Japan on constant currency, but we had a double-digit growth rate at actual because of the appreciation of the yen, and Japan has been and continues to be a high single-digit percent of the corporation's business..

Great. Thank you..

Good. I think we're coming closer to the top of the hour, but we have time for one or two more questions. So, maybe a couple more..

Does that answer your question, Tim?.

Yes. Thank you..

You're welcome..

Thank you. Our question comes from Matt Mishan from KeyBanc. Your line is now open..

Hello, good morning and thank you for squeezing me in. On the recurring revenues, at least sequentially versus the first half, there was a modest deceleration of the sales growth. I was hoping you could tease out academic and government instrument versus recurring revenue.

Did that also have an impact on the recurring revenues for the company as a whole, or is that too small?.

It's probably too small. It's good question, but probably a little bit too small. And once we start breaking our own numbers down in that level of granularity, there is too many exogenous factors to draw good conclusions but, yeah, I mean we did see a slightly moderating pattern there.

But keep in mind earlier in the year, in a number of categories that continue to do well, we constantly, out of conservatism, expect some degree of moderation, and that was, as Gene said for the fourth quarter, even our best growth driver.

So, these particular product lines or service lines, if you will, in the recurring revenues are a really core part of our story, and our competitive strength and the robustness of our ongoing business model. So, I think we're pleased overall with where that's at..

And then just a follow-up on the gross margin side.

Is there a lag on the pound impact to COGS not just as far as the actual pound coming down through the quarter, but actually on when it impacts you? And then, in other words, like in an FX neutral or FX positive environment, how should we be thinking about the appropriate contribution margin on increasing sales for the business?.

Let me start on that. I think that if the pound stays where it is today, Matt, we will get more of a full impact in the fourth quarter. As I mentioned earlier, the pound devalued within the third quarter.

And to your point, some of the positive effects of the pound on cost of goods sold are going to be dependent on just the product mix, and whether or not we sell the higher volumes of high resolution mass spectrometry systems, which are manufactured at our UK operation.

And I have to say that as a higher ticket item, those tend to be lumped a little bit more towards the closing months of a year. Chris had already mentioned about some orders migrating from the third quarter into the fourth quarter on the academic spend, and that was mostly represented by – in our higher-end mass spectrometry space.

Looking at next year, some things to consider is that we have had historically between 10% and 15% of cost of goods sold is pound-denominated. And probably more significantly, about a third of our R&D expense is denominated in sterling.

So, those are some of the opportunities that we have maybe as we begin to look out into upcoming quarters to get a little bit more favorable impact on our P&L..

Good. I think we have time for one more please..

Thank you, Gene..

Thank you. Our next question comes from Steve Willoughby from Cleveland Research. Your line is now open..

Guys, thanks for squeezing me in here at the end. Just two things for you.

First following up, Gene, with you regarding your talking on the pound, is there any way that you can quantify what you're seeing now in terms of maybe an EPS impact from the weaker pound in your full year guidance versus what you were expecting three months or four months ago? And then secondly, just wondering if you could comment at all a little bit more color on geographic trend, particularly within China and the UK, just wondering if you could give us a little bit more color on how strong China has been here recently and then also what you've seen in terms of end market demand in the UK since the Brexit.

Thanks, guys..

Well, why don't I start out on the FX side and then I'll leave it to Chris to finish up on the second part of your question. Yes, we are enjoying a little bit more favorability in FX during the fourth quarter of this year than we had originally anticipated and to quantify it.

It's about $0.05 more benefit across that period, more than we had originally anticipated. So, you're looking at $0.02 or $0.03 a quarter associated with total currency benefits in the third and fourth quarter..

So, Steve, just quickly on your geographic questions to finish up and those are good questions to finish up, maybe I'll start with the UK and finish with China. We've seen very steady market conditions in the UK. Our UK business is roughly 4% or 5% of our global turnover, so it's one of our bigger countries, but it's also one that's quite balanced.

There's a strong pharmaceutical sector there, of course, and also a strong government and academic sector in the UK as well and so that market is an important market for us. We've seen steady performance and in the near-term don't see any impacts of Brexit, but we're very – we're paying very close attention to Brexit.

In fact, I've dialed up my participation in the UK and been there a number of times, including to key thought leaders in government and in other sectors, to really advocate for the types of policies that will continue to promote the life science industry in the UK.

The ecosystem of the life science industry in the UK is very critical to us, to Europe and to the world and I'm actually despite all the uncertainty confident that everybody understands that and will keep the interest of that industry in mind as the negotiation gets underway.

So, again much of that is out of our control, but to the extent we have a voice in what some of those policies are, we're going to be active in that process. From the standpoint of China, again we don't want to get too specific other than to say we're operating at a high level in China right now. I thinks that's a function of two or three things.

First of all it's just a strong overall economic backdrop relative to the priorities of government.

We're between year one and year two of the 13th Five-Year Plan, and we studied that very deeply and very well aware as to what the government is trying to do particularly around advancing and incubating the local pharmaceutical sector and rising quality standards there and rising data standards there, as well as in the food industry and the area of traditional Chinese medicine, those are three of our big priorities.

We're seeing a lot of balance across those right now. We're seeing the rapid adoption of some of our newer technologies like the ACUITY Arc that really allow many of these sectors to get up to speed quickly, but also advance to more innovative, up-to-date methods.

And so it's a pretty robust market, but I think one of the reasons we're having success there is that we've got a very strong team. We've been in China for a long time, we're coming up on nearly 500 employees in China, we have a huge commitment there. We're very active with a number of the key opinion leaders and academic centers there.

I'm actually heading back over to China in a few weeks to dig even deeper because we think that what's happening there is very positive for our industry, for our business and it's at the very top of our list. So, anyway, thanks for that question and let me also now just move to conclude the call..

As we move into the fourth quarter of 2016 and begin to focus on 2017, we're very encouraged by our year-to-date performance. The strength of our key growth drivers has enabled us to deliver double-digit earnings per share growth through the first three quarters of the year.

So, on behalf of our entire management team, I'd like to thank you for your continued support and interest in Waters. We look forward to updating you on our progress during our Q4 2016 call, which we currently anticipate holding on January 24, 2017. And with that I thank you and wish you a wonderful day. Bye..

That concludes today's conference. Thank you for your participation. You may disconnect at this time..