Waters Corp (WAT) 2005 Q3 法說會逐字稿

Good morning. Welcome to the Waters Corporation third quarter financial results conference call. [OPERATOR INSTRUCTIONS] This conference is being recorded. If anyone has any objections please disconnect at this time. I would now like to introduce your host for today's call, Mr. Douglas Berthiaume, Chairman, President, and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Well, thank you. Well, good morning and welcome to the Waters Corporation third quarter financial results conference call. With me on today's call is John Ornell, Waters' Chief Financial Officer, and Gene Cassis, the Vice President of Investor Relations. As is our normal practice I'm going to provide an overview of the third quarter, then John will take you through the financial details and lay out our fourth quarter and full-year 2005 expectations. And finally we'll open it up for Q&A. But before I begin I'd like John to cover the cautionary language.

During the course of this conference call we may 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 Q4, 2005. 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, 2004, in part 1 under the caption Business Risk Factors.

We further caution you that the Company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for January 2006. During this call we may 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 in the Company's earnings release issued this morning. In our discussions of the results of operations we may refer to pro forma results which exclude the impact of restructuring one-time facilities related charges and other matters.

Thank you, John. Well, our third quarter results were disappointing. Our sales growth came in at 3% instead of the 8% that we had projected. This shortfall was primarily due to weakness in sales to our larger pharmaceutical customers, and this softness was most evident in the United States and Europe, and had its greatest impact on our hardware sales, instrument sales. And generally sales that are tied to these companies' capital budgets. We have seen this type of spending behavior before. To some extent, and most recently in the first quarter of this year. When we last spoke in July, we felt that the situation was improving, and that our larger customers were showing some signs pointing towards a return to more customary spending trends. However this optimism was obviously premature and capital spending again tightened during the third quarter.

Continue to believe that Waters is well positioned in these large pharmaceutical accounts. We have technologically leading products, and we have a very well earned reputation. However, we now cannot assume that we're yet out of the woods in this industry, and we think we must be cautious about our business prospects for at least the remainder of 2005. Our key new products initiatives, the Acquity UPLC and Q-Tof premier-based systems did well in the quarter with our Acquity-based systems orders growing sequentially to about $30 million, and that's a new quarterly high for us. Laboratories within large drug companies are continuing their extensive evaluations, and in most cases have confirmed to us that they see real value in the technology and that they anticipate wider adoption rates within their institutions.

Sales of Q-Tof premier grew at a strong double-digit rate with small molecule applications such as metabolite identification driving demand in this product line. Despite the strength in Q-Tof, our mass spectrometry sales moderately declined in the quarter primarily due to weaker demand for single and triple Quadrupole systems. You may recall that these Quadrupole systems are heavily used in pharmaceutical discovery and development and accordingly sales of these instruments were negatively influenced by the overall weakness in spending by our large pharmaceutical accounts.

Looking at another customer segment, sales to governmental and academic institututions were down in the quarter with a portion of sales to the United States Government apparently affected as a result of the hurricanes in the Gulf Coast towards the end of the quarter. But the hurricanes aside, spending by this group was weak in both the United States and in Europe, and it's difficult to predict what the longer term ramifications of the third quarter results are. On a more positive note, demand from our industrial and biotech customers was strong.

On the industrial front our TA Instruments group benefited from strong overseas demand and a successful new product update, while the environmental and food testing applications fueled growth for the Waters division. Biotechnology firms and many of our smaller pharmaceutical customers did not appear to be under the same kind of budgetary restraints as our larger pharmaceutical accounts. And we expect these positive trends with these customers to continue into the fourth quarter.

Looking at the quarter's results from a geographic perspective the U.S. was clearly weak. Sales declined in the quarter. Europe performed a little better and as we expected, but still with low single-digit growth in Europe. Sales growth was quite strong in Asia. So one question is clearly where do we go from here. Although we are in a period of slow demand from our key pharmaceutical customer segment, we feel we're well positioned to take advantage of the growth opportunities when this market improves. We feel that it's still prudent to continue to invest our money, time, and efforts to develop the new products and continuously support this customer base.

To that end, we have kicked off this quarter with a series of Acquity UPLC enhancements, and these enhancements were developed based on feedback we received from earlier Acquity users and include new high sensitivity detection capabilities. We feel that these enhancements will help us in our goal of accelerating the broader adoption of UPLC in this broader marketplace. In the meantime, we have to acknowledge that business conditions are likely to continue to be challenging until we reach a more stable and predictable level of investment by our large pharmaceutical accounts. In response to these conditions, we will strive to adjust our spending to better bring it into line with a more conservative view of revenue growth. I can assure you that our company's focus on introducing and supporting new technology products will continue as we see these activities as key to our competitive advantage. But now I would like to turn it over to John with a more detailed view of our financial results.

Okay. Thank you, Doug, and good morning. Earnings per diluted share were $0.43 this quarter compared to earnings of $0.42 last year, an increase of 2%. On a GAAP basis, including a $0.21 per share tax provision related to qualified dividends distribution under the American Jobs Creation Act of 2004, earnings per diluted share were $0.22 this quarter versus $0.42 last year. Sales grew 3% for the quarter versus last year on a reported basis, with currency translation being neutral to sales growth this quarter. Our sales results were positively influenced by strong sales in Asia with 20% growth this quarter. Sales in Europe were up 1% and in the U.S. we saw a 9% sales decline this quarter. Sales to large pharmaceutical accounts declined this quarter as these customers continued to constrain capital spending. Outside of our life sciences business, industrial demand grew moderately across both the LC and thermal analysis markets.

Looking at product line revenues in constant currency terms, sales of LC products grew by 4% versus prior year and mass spectrometry product shipments declined by 4% as they were negatively affected by sluggish single and tandem Quadrupole sales. Our thermal analysis business continued its positive performance with revenue growth of 5%. Our gross margins were down about 40 basis points from Q3 last year and came in at 57.7%. This decline is a result of increased costs associated with the launch of our new products and lower sales of higher margin instruments. SG&A expenses increased 6% over the third quarter last year. We continue to review our SG&A spending with an eye towards balancing these expenses with our revised sales growth expectations.

Moving down the P&L, R&D expenses were flat this quarter, bringing operating margin to 22.9%. Our projected tax rate for 2005 before the effect of the dividend repatriation tax provision has been reduced slightly from 19.3% to 18.9% based on our latest assessment of anticipated profits among our business units. The effect of this tax rate change was less than $0.01 to the third quarter's earnings. Incorporating the $24 million charge for repatriation made under the American Jobs Creation Act of 2004 our effective tax rate for Q3 was 57.6%.

During the third quarter we transferred approximately $200 million from overseas accounts to the U.S. and plan to transfer an additional 300 million in the fourth quarter. We plan to utilize this cash to fund current and future operating expenses all within the parameters of the IRS guidelines. During the third quarter, we purchased 4.3 million shares of our common stock for $195 million, completing our approved $500 million program. Over the last three years or so Waters has utilized $1.1 billion to buy back 31.4 million shares of its common stock reducing the outstanding shares by approximately 22%.

As described in yesterday's press release, the Board of Directors has authorized another $500 million two-year program, and we plan to begin purchasing shares under this newly authorized program in the fourth quarter. Cash and short-term investments totaled $489 million, bringing us to a modest net debt position of about $165 million. With our strong balance sheet and liquidity we feel we have adequate flexibility to fund our future capital needs.

Cash from operations after funding $12 million worth of capital spending this quarter was $64 million. And through September, cash from operations after funding $39 million of capital spending was $200 million. Accounts receivable days sales outstanding stood at 74 days this quarter, down 4 days versus Q3 last year.

Turning to our outlook for the remainder of 2005, we anticipate overall pharmaceutical sales growth to remain sluggish as our large accounts continue to control spending. On the other hand, our industrial markets continue to look positive, and we believe we will meet our original growth expectations. In all, we believe these factors will allow us to grow sales by about 4% in the fourth quarter before the impact of foreign currency translation. Currency at today's levels should reduce Q4 sales growth by about 3% resulting in reported sales growth of 1%. Gross margin as a percent of sales should be close to results achieved in Q4 last year. We continue to examine our SG&A spending and plan to minimize any discretionary spending that is not associated with revenue recognition. At this time I would estimate SG&A and R&D expenses are likely to grow at about 2 to 3% for the fourth quarter.

Assuming a modest impact from the new buy back program, interest costs of approximately $4 million, and a continuation of the 18.9% tax rate, we expect earnings per diluted share of $0.64 for the fourth quarter of 2005, with the normal tolerance of $0.01 to $0.02 and before unusual charges. This would bring full year earnings per fully diluted share to $1.91 before unusual charges on sales growth of 4%. Doug.

Thank you, John. Operator, I think we can now open it up for Q&A.

Certainly. [OPERATOR INSTRUCTIONS] Okay, our first question comes from Tycho Peterson of JP Morgan.

You talked about pharma delays, not cancellations. How do we get comfortable with the fact that that is indeed the case?

Well, I think that's a fair question, Tycho, because it's very rare, in our experience, that you get absolute confirmation that something has been cancelled. Most of the quotes that we made during the quarter, which were very strong, are still out there and operating. But I think -- coming out of the second quarter we saw some signs of pick-up in that customer base. That was obviously premature. Certainly through the summer and then when you anticipate coming out of August and into the typically stronger September time frame, we didn't see the -- any continuation of that kind of momentum. So I think -- we have clearly done a lot of effort in terms of polling this customer set, we've in the past three weeks had numerous large pharmaceutical scientists in this building in here for technology reviews, and I would say a pretty constant message is that spending is going to remain pretty tight the rest of this year, and it's not going to -- for this group it doesn't look like there's going to be this tsunami of capital spending that starts early in '06, but I think the encouraging part is, is that they think that they're going to be able to spend on technology answers that give them a competitive advantage. That's why they're very interested in Acquity, they're very interested in the new data products, they're very interested in the system solutions.

Now, I won't say that we haven't heard that earlier in the year, but I think it's encouraging to us that this set of customers keeps coming back and saying they're getting ready, they are going to buy. As long as they can make the kind of case that we've been making concerning the productivity advantages. So I think the feedback in light of these results is reasonably positive, but needless to say, you can hear from John's outlook that we're still cautious about the rest of this year.

You also talked about the academic market in Europe being weakened. That's a noticeable contrast from the weakness in European bio pharma spending that you talked about back in March. What -- I mean are you seeing a noticeable change there in what's going on?

Yes, in that area I confess that we were surprised at the shortfall in the university and government spending area in Europe. That has tended to be a more constant source of demand. It's not normally strong double digits, but it's pretty constant. That's why we think that the third quarter is a bit of an anomaly. In the U.S., we know that we saw some anticipated business that were going down in laboratories in Houston and in New Orleans that on the fringe cost us business because of the hurricane business in September, and we're now a little cautious because of all sorts of rumors about where government money will be redirected as a result of the damages done. So the next six months, in terms of government-funded initiatives, is subject to probably more uncertainty than it has been in the past.

Okay. Thank you very much.

Okay, our next question comes from Darryl Pardi of Merrill Lynch.

Good morning.

Good morning, Darryl.

You guys predicated your cost structure for this year on 10% organic top-line growth, and we're at about half that rate year to date. And now you're talking about growing costs at a slower pace than sales. Why not reset the cost base in light of slower growth rather than try to grow SG&A at a slower pace and hope that the top line will grow to fit a larger cost structure that you have?

Darryl, I don't think anything that you've heard should suggest a particular business strategy that we're operating on. I think John's comments really are just telling you -- to try to help with you the financial model in terms of what the net results expectations are in the short run. You can be assured, as you can see from our SG&A growth this quarter, we've brought it down. We've -- even from the first quarter to now, we have reduced our discretionary SG&A spending. Unfortunately, the top line has come down further. And I can assure you that, really, as we look at our 2006 plans, some of which, of course, could be implemented in the fourth quarter, we're definitely looking at what the right structure of our cost spending is in a less robust growth environment.

Okay. Would you guys continue to leverage the Company to accelerate this new share buyback program, or accelerate the pace of share repurchase?

Would we continue to borrow money to do that?

Yes. You've been buying back stock at at slightly faster pace than you've been generating free cash which has slightly leverage the Company. Would you continue to do that?

Yes. We don't have problem doing that. Clearly, as John said, our free cash flow this year is clearly going to -- is going to be the one area that we have positive results. I mean, our nine-month free cash flow is up 30% over last year, so even in tough economic conditions we're certainly driving the cash side of the business. And so our free cash flow should certainly approach 250 million. When you're talking about a $500 million buyback, you're talking about two years of free cash flow. That's not extraordinarily aggressive I don't think.

We certainly have the borrowing capability to the extent that we have issues relating to cash in the U.S. versus cash overseas and how cash is generated to be able to borrow and continue the program. So that's not an issue.

Okay. And, sorry, just lastly, what's the geographic mix of your industrial sales at this point?

We'll have to -- it wouldn't -- it's not -- it wouldn't be dramatically different than pharma. There's going to be more of a focus certainly in Japan and Asia in some of the growing markets there. We're getting more growth, I guess I would say, out of those geographies on the industrial side than elsewhere in the world, but I don't think that the installed base would be dramatically different than the complexion of pharma sales.

I think what you see, Darryl, is that the classical industrial-chemical business is still a bigger business in the United States than it is outside the United States. But food safety applications are growing faster outside the United States, particularly in Asia. And environmental applications are about evenly divided across the world.

Great. That's helpful. Thank you.

You're welcome.

Okay, our next question comes from Steven Salamon from Infinium Capital. Sir, you may ask your question.

Just wanted to ask about a few things if I could. The triple quad market, if you could talk a little bit about the, actually the triple and single quad market and what you're seeing there? And also maybe a little bit about gross margin. You talked about costs being up a little bit due to UPLC and lower sales of high-end instruments. If you could just provide a couple more details there. And finally, if you could rhyme off the growth rates for -- within HPLC for instruments, consummables, and service.

I'll talk about the Quadrupoles and then I'll leave it to John to talk about margins. Both of these instruments, the largest market is the pharmaceutical market for both single quads and triple quads. Single quads, the biggest served application has been in high throughput screening, laboratory purification, excuse me, library, purification of libraries of, compounds, and that's one of the areas that's been under a great deal of pressure. There hasn't -- we haven't seen a great deal of investment in that area. So our single quad business has been under significant pressure this year.

The triple quads break down really into two areas. The high-end product, which in our case would be the Quattro Premier, and that's aimed at a number of applications, but in pharmaceutical, drug metabolism, pharmacokinetics application is probably the largest marketplace there. We also have a lower end triple quad product, our Quattro Micro. I'd say the application, the large pharma applications continued to be the area that was most stressed with the demand very soft in those large pharma applications for the triple quad market. We continue to believe that we have by far the strongest product in the lower end triple quad. That business, though, however, was also a little bit soft this quarter. I would say that's probably more of a -- unrelated to the large pharma dynamic and more related to the university and government issues, and we don't expect that that issue is likely to be longer term issue. John. You want to talk about margins?

Sure. As we looked at the third quarter's margins you saw a shift away from the higher gross margin products within the mass spec line, the singles and the triples end up being the highest gross margin products, and we saw movement towards Q-Tof and other product in that line Also, the data products, which have a heavy pharmaceutical influence were off dramatically in the quarter. As you know, data has very significant margins.

As it relates to the new products, we did have a situation where we had some upgrades to field units as we proactively kept the installed base on parity with the units coming out of the factory to date. That would include some hardware upgrades as well as firmware, some service time to take care of that. The new products have typically higher production costs, lower margins than standard products as well. So that's the margin impact. You had also asked about the sales by category of consumable service, instrumentation, or LC instrumentation was actually flat, service and chemistry both grew about 8%.

All right. I just -- maybe a little bit more clarification in the higher end triples with the Premiere, your sense is, just to confirm, that it's the market and that you're not losing share in that area?

Well, let me put in this way. In the drug metabolism pharmacokinetics applications, I think it's fair to say we've never had -- or we haven't recently had a very high market share, and where we're selling our Quattro Premier is into laboratories that are around that application. So into drug discovery as well as into nonpharmaceutical applications. We see no evidence that we're losing share in the triple quad market in the areas that we've been strongest in. And we think that that's a general market dynamic that's overall affecting our Quadrupole sales.

Thank you very much for your answers this morning..

You're welcome.

Okay, our next question comes from Sara Michelmore of SG Cowen.

I guess just to follow on that triple quad question. Doug, could you talk about if there's been any change in the pricing environment for those high end triple quads? I know that there's a bunch of new instruments out in the field, including yours. I'm just wondering if we've seen sort of a repeat pattern of the old [INAUDIBLE] move which is to put out a high end system and cut the price on the older one and if that's had any impact on the market as well?

Sara, I can't say, as you know, individual case by case examples, we often see some off the wall price that you say, where the heck did that come from, in terms of a competitive bid. And I guess I'd say we're probably seeing a somewhat more price competitive marketplace, and I would say that we might be seeing that more because we upgraded our Quattro Premier this year, and we probably brought it into a few more applications that we weren't looking at before, and that made for a more competitive situation. We certainly have some other major suppliers who are fighting it out on various fronts, including legal fronts, and they've made revisions to their product line, and we've seen certainly at least isolated examples where that competition has resulted in some head scratching pricing. But I'm not -- I'm not saying at this point that you really -- it's an across the board dynamic. I'd still say it's probably more selective, it's maybe a little bit greater than we've seen in the past, but it's not wholesale.

Okay.

One of the interesting -- when we talk about triple quads, and the triple quad marketplace, particularly for pharmacokinetics and drug metabolism, one of the greatest areas of interest that we're seeing is from laboratories in this marketplace for Acquity. There's no doubt that drug metabolism laboratories are very close to making wholesale moves, I'd say, towards Acquity, regardless of whose triple quad is in their laboratories. So I'd say that's not a dynamic that's in our run rate, but I feel pretty confident that that's going to be a favorable impact for us over the next one to four quarters.

Okay. Well, just as a follow-up to that, where do you think you are in terms of some of these larger applications where you'd have customers instead of buying one or two of these Acquity systems at a time that you'd have more pick up in the QA, QC, or even in this drug development area? Where are we in terms of people evaluating protocol changes and things like that?

I'd say, Sara, we're making progress. I'm as frustrated, I think, as you are behind that question, as to the pace of decision making, and I know it probably sounds defensive and excuse making, we clearly thought that the pace of some of these major decisions for investments would pick up. We sense the frustration in our user base. As I said, the scientists who were in here feel they desperately need this capability, but in a very tight capital spending environment, they're having trouble -- they're having to redo studies, reevaluate, prove it again. I'd say from our point of view, we haven't -- we haven't lost any of those things that we're working on, and I can say that in the fourth quarter we've begun to see, some of those things start to fall. Whether that -- whether that's going to really pick up momentum now -- we certainly forecast that it will, but I'm leery to take that to the bank in terms of sales revenue. And you're probably going to see us adopt that policy until I can demonstrate it in real live run rates.

Okay. That's helpful, Doug. And I guess lastly, just some color on the Q4 guidance. If you're assuming 4% organic growth, can you just give us an idea of what the assumptions are for the LC business and the mass spec business within that number? Thank you.

Yes. We're looking at the LC business to probably grow mid single-digit type rates. Mass spec, we're a little bit more cautious on. We're thinking that's going to be about flat perhaps in the quarter. TA we're thinking will still be up about its traditional 5%, so that we think will bring us to 4% before the 3% impact of currency.

Great. Thanks so much.

Okay, our next question comes from Quintin Lai of Robert W. Baird. You may ask your question.

Kind of following up on Sara's question, you mentioned that you are in the process of making some enhancements for Acquity. Do you think that some of those enhancements will -- or need to be done before you see wider adoption, or is there just an evolution of the Acquity product?

I would call it more of an evolution of the Acquity product. We certainly brought Acquity to the market with a detector -- with an array of detectors that were largely based on our traditional HPLC detector technology, clearly designed to operate more effectively with Acquity, but we never thought that the ultimate goal in our Acquity detector line. And what we've done now is kind of deliver on that promise where the photo diode array and the UV detector capabilities now clearly take advantage of the Acquity fluidics improvements, the fundamental improvements that Acquity brings in the fluidics area, and now being matched with the fundamental detection capabilities that fit that system. So we're very pleased with it. On the other hand, I'm not going to suggest that it's anywhere near the kind of breakthrough that Acquity was in coming to the market.

Thank you. And then just a couple of financial questions, John. With respect to your Q4 guidance, what is the share count you're using to come up with your EPS calculation?

We're assuming kind of a similar decline from the -- that you saw in the third quarter to move into the fourth. We'll watch the share price and moderate our program perhaps based on what we see, but something to that magnitude, I think, will get you there.

Thank you. And then just a quick follow up. I know it's probably a little early for '06 is, but with respect to the tax rate that you've got now, assuming for 18.9 for 2005 is that a good run rate to go out into 2006?

Yes, I mean, that rate gets tweaked a little bit each quarter as we look at the profitability forecast for each geography, but something around 19%, 18.9, I'd say is a fair starting point as we at least take a preliminary look at 2006.

Thank you.

Okay, our next question comes from Derik De Bruin of UBS. Sir, you may ask your question.

Could you give any thought about potentially accelerating the buyback and have you thought about potentially doing all of it in the first year?

We absolutely think that our time frame for these buybacks, all other things being equal, are likely to be the limit of the time frame that we would execute the buyback in. So as you've seen from our history, we've tended to execute these buybacks faster than the two years that the Board is typically comfortable about allotting to us. And I won't say that the Board hasn't entered into discussions or -- about different amounts of buyback, and the pace at which we do the buybacks. Those discussions have tended to be, should we do more or proceed faster. So we think we've got enough flexibility to execute those buybacks on a pace, and that flexibility has tended to mean faster rather than slower.

Okay. On the competitive landscape, are you hearing anything to suggest that your key LC competitors may introduce a answer to Acquity in 2006?

Yes, we definitely hear speculation all over the lot. I can tell you we heard that speculation a year ago, and we heard it the day we introduced Acquity. So yes, we fully expect it, that our competitors are going to bring to market something that deals with higher pressure systems. And whether that comes at Pittcon next year or later in the year, it's our expectation that we'll see something in 2006. We think that the advantages that we have with Acquity, including the IP around the chemistry, and additional things that we have planned for '06 will keep us in very strong competitive position.

Okay. And on the informatics business, the E-notebook and E-Genesis could you just give us some ideas on what you're thinking about that? You said it was dramatically down in the quarter. Could you just give us some more specifics on that?

Well, yes, dramatically down is probably not -- it's basically been pretty flat from quarter to quarter over the last four quarters. But that's lower, significantly lower, than our expectations for this business. And certainly what we're seeing, and what we feel we're seeing, is this kind of capability is probably the most significant product line that's fighting this dynamic in large pharma. It's a product that's aimed almost exclusively at large pharmaceutical companies. It's something where we thought those companies would be moving aggressively to take advantage of the data management capabilities. We thought they would be under greater regulatory pressure to do it, and what we're finding is in this climate, they're apparently finding while you still get the salute that, yes, we need to do this, it's absolutely in our future.

Yes, we've got old, unreliable data management systems, and we need to improve on it, tada, tada, but when it comes to making an investment in a brand-new area for them this climate is one of the most difficult climates to sell that kind of product into, I think. And so that's the kind of situation we're dealing with. It's a very difficult situation. We're clearly looking at, if is kind of continues, where do our other development projects on the whole data line bring us to, because many of the things that we're doing may offer similar capabilities as the scientific database management product over the long term, and as we enhance our basic data products, how is that going to compete with the products that we've got in the market now. So there's no question, we're going to look at this, we're going to look at it hard for '06 and look at how we -- how we continue to bring these products to the customers in the most efficient way as we look longer term at the development of our core data products.

Okay. And finally just one other question. Looking into '06, and clearly pharma is going to be having a lot of repatriated cash sitting around, are you hearing anything at all that there's a potential for infrastructure upgrades or any accelerated R&D spending? Just any color you can provide whatsoever would be helpful.

I think, yes, we're hearing potential for accelerated programs. I wouldn't say that it's related to the remittance of cash. I just don't think that too many people are looking at that and saying we're going to put in place a new R&D program, because I've moved cash from Europe to the United States. But where I think our opportunities lie in 2006 is these businesses are under extraordinary productivity pressures. And I think, and what we're told, is that while adding people is very difficult, if not impossible in a number of these companies, productivity plans -- and if you can show investments that will help save on people, or help drive throughput, those projects are getting -- are much more likely to get green lighted. Now, you would think they would be, too, in this environment, but I still think this year these companies are absolutely focused on other things. And we're told that as they move into 2006 that looks a little bit brighter. As you can tell, I'm not expecting that that's going to be glorious release of capital, but I think -- it's fair to say that we don't think that this marketplace is likely to get worse than it is. I won't say it's impossible to get worse, but we don't think that it's likely.

Okay. Thank you very much.

Okay, our next question comes from Steve Unger of Bear Stearns. Sir, you may ask your question.

Good morning. First off, could you characterize the LC sales in the traditional QA and QC customer base in pharmaceutical manufacturing?

I'm sorry, characterize? I'm not sure what your question is.

Characterize the sales in the quarter into that traditional QA/QC customer base.

Yes, I'd say they were slow, flattish in most respects, but, yes, I mean, soft. I'd say -- we think these customers are longing out the replacement cycle even in their core application.

So the replacement cycle is lengthening?

Yes, in the current environment. We've seen this in the past, by the way. This is not -- it's relatively unusual, but not unheard of. We think that they can't keep it up forever, and that once normal replacement cycles kick in, then you get a compression of replacement cycles, but we think right now under this kind of pressure that there's no question that things that they would have replaced this year they're pushing into next year.

Okay. Then several companies have articulated a desire to rationalize manufacturing plants. How does that impact your business, or has that impacted your business this year?

I don't think under margin it's maybe had an impact, but generally as long as they're producing batches of drugs, in terms of the QC and manufacturing environment, the pharmacopeia and the procedures require them to analyze them more or less in the same fashion. If they're not building new plants, and you'd say they're not adding QC laboratories to QC it, but it's much more of a pill count kind of question. As long as pill count is going up, they have to QC the drugs in the same fashion.

Great. Are you anticipating, then, better sales performance in '06 associated with the Medicare drug plan, increased pill counts there, generic or--?

I would say it's not a significant dynamic in our current plants.

Moving to the Acquity and Q-Tof products, the new products, has the initial price points for those products, have they been sticking throughout the year?

Yes.

They have been.

Yes.

And then where are you seeing the success in the Q-Tof sales? Is that stand-alone -- both stand-alone systems, or just Acquity-based systems?

I'd say almost all Q-Tofs are sold with Acquities. There might be an exception here or through, but it would be unusual. I'd say more of them these days are being sold with nano Acquity's with the enhanced capabilities, but almost all of them are sold with either one or the other Acquity's technology.

Okay. And then lastly, does the buyback program, does that change your philosophy regarding acquisitions, and how does acquisitions then fit with your cash plans?

No, I'd say it doesn't change at all. We're still interested. We still continue to look at opportunities to expand the portfolio. We think our balance sheet and cash flow is eminently capable of handling even a significant acquisition even while doing these buyback. And I'd say with softness in some of our core customer areas, I'd say if anything our interest in acquisition probably ticks up a notch.

Okay. And then just one quick financial question, John. What's your expectations in terms of revenues, informatics revenues in the fourth quarter?

Informatics we're looking at something in the 5 to $6 million range. It's not a high expectation.

Is that a sequential increase from the third quarter?

It's a small sequential increase, yes.

Small sequential increase, okay. Great. Thank you very much.

Okay, our next question comes from John Sullivan of Leerink Swann. You may ask your question.

In HPLC do you think that there are potential buyers among drug companies of Acquity that are evaluating the product and holding off on both Acquity and Alliance purchases while they decide whether or not they're making a platform shift? It sounds like the Acquity ramp continues to progress, but I'm wondering -- and I appreciate your comments on replacement cycles extending, but I'm wondering if there are some customers that are evaluating from a more holistic basis which way they're going to go on a going forward -- going forward regarding HPLC and I'm wondering whether or not they're holding off on both Alliance and Acquity while they decide which platform they want to work with in the future?

John, you'll to have excuse me, but we're in the middle of a major thunderstorm here, and I lost half your question. But I think it went to are there customers who are still evaluating Acquity with an eye to adopting it on a broad basis. Is that the gist of it?

And the question was do you think that there are customers that are holding off Alliance and legacy HPLC purchases while they determine whether or not they're going to adopt Acquity not only in high-end applications but across the entire -- across bigger parts of the organization.

Yes, we think some of that's going on, but it's hard to tell whether it's a major effect of what's happened in our recent results. I think -- I happen to think that there's -- there's some of it going on, but I'm reluctant to say, therefore, next quarter that unleashing of that dynamic will come through.

I understand. Separately, have you been getting push-back from customers regarding price of Acquity relative to other HPLC products, including yours on the market?

Not to any noticeable degree.

Okay. Appreciate that. Have you heard from any of your bigger pharma customers that they have concluded their evaluation of Acquity and they've decided not to adopt the platform on a going forward basis?

No.

Okay. Thanks very much.

You're welcome.

[OPERATOR INSTRUCTIONS] And we have another question from Tycho Peterson. One moment. Okay, you may ask your question, Mr. Peterson, of JP Morgan.

Yes, two quick questions. One, any update on the PKI agreement for newborn screening? How is that going?

We have an agreement, we have a joint marketing agreement to -- for Waters to provide the mass spectrometry and PKI provides the chemistry. We're optimistic about that opportunity, but I would say that there's -- there's nothing unusual to report. I will say that overall our clinical business is on forecast for this year. So newborn screening is a piece of that clinical business, but we're very optimistic about the long-term opportunities there.

Second quick question. With regards to Asia, you've talked in the past about generic pharma being a nice opportunity. Just wondering if we can get some color on that and China and then Japan as well? I know there's some concern about the budgets in Japan going forward.

I'd say the area in Asia that's most active with generics is India. And India has been very strong investing in that area, and through nine months of this year and including the third quarter, it continued to be a strong business for us. I'd say that we don't see quite the same dynamic. China is -- whereas India is heavily influenced by generic drug manufacturers, China is a much broader panoply of applications. And Japan, in general, our Japanese business has been -- has been a good year for us. We're looking at high single-digit kind of growth rates, and I wouldn't say that generics are a noticeable dynamic one way or another in Japan.

How about the research market in Japan though, the academic market?

I'd say it's reasonably good.

Okay. Thank you.

And, sir, at this time we have no further questions.

All right. Well, thank you all for taking the time to be with us today, and we'll hope to have a more up-beat story when we talk to you in -- late in January. Thank you.

This does conclude the call.