Waters Corp (WAT) 2008 Q3 法說會逐字稿

Good morning. Welcome to the Waters Corporation third quarter financial results conference call. All participants will be able to listen only until the question-and-answer session of the conference. This conference is being recorded. If anyone has any objections please disconnect at this time.

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

Thank you. Good morning and welcome to the Waters Corporation third quarter financial results conference call. With me on today's call, as usual, is John Ornell, the Company's Chief Financial Officer, and Gene Cassis, the Vice President of investor relations. And as is our normal practice I will start with an overview of the quarter's highlights and then John will follow with details on our financial results and provide you with our outlook for the full year. Before we get going I'd like John to cover the cautionary language. John?

During the course of this conference call we will make various forward-looking statements regarding future events or future financial performance of the Company.. In particular, we will provide guidance regarding possible future income statement results of the Company at this time for Q4 2008. We caution you that all such statements are only predictions and that actual events or results may differ materially. For a detail 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, 2007, in part one under the caption "Business Risk Factors."

We further caution you that the Company does not obligate or commit itself by providing its guidance to update predictions. We do not plan to update predictions regarding possible future income statement results, except except during our regularly-scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for January 2009. During this call we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure is attached to our 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 items such as those outlined in our schedule entitled "Reconciliation of Net Income Per Diluted Share" included in this morning's press release.

Thank you, John. Well, the fundamental trends that we saw in the first half of 2008 pretty much continued through the third quarter. These trends included flattish spending by pharma customers, strong growth from applied markets, and continued strong demand from customers in developing countries. In the third quarter we continued to leverage a solid sales performance to generate truly superior earnings growth and free cash flow. Recurring revenues, including our chromatography consumables and instrument services businesses, performed well in the quarter. The large existing base of HPLC and UPLC instrument users depend on us to provide high-quality chromatography columns and sample prep cartridges to perform, in many cases, regulated testing. In addition, our large installed base of instrument systems requires highly-trained service engineers for regular maintenance upgrades and systems repairs.

For the last few quarters our recurring revenues have consistently accounted for nearly half of our total sales and have typically seen year-over-year growth rates in the neighborhood of 10%. This growth rate has been significantly independent of instrument system sales growth in any quarter. So is I'll spend a little more time than usual speaking about our chemistry and services business because they represent a real advantage to our business model. At Waters we have endured economic cycles over our decades of operations, and through these prior ups and downs I'm pleased to tell you that our chemistry and service growth has been well insulated. In short, I'm confident that looking into 2009 and beyond our recurring sales will most likely provide an attractive foundation of top-line growth for the corporation and importantly, a foundation that generates high operating margins and particularly strong cash flow.

If you turn to our instrument systems businesses, and looking first at the Waters division, newer technology products, including ACQUITY UPLC, and Synapt HDMS, were key drivers of our growth in the third quarter. Global sales to nonprofit institutions, including government and university customers, were especially strong in the quarter. Sales for industrial applications including systems for food, environmental and chemical analysis, saw double-digit growth in the quarter, with ACQUITY UPLC MS systems leading the way.

As we witnessed throughout the first half of 2008 flat sales to pharmaceutical customers were again a drag on the Company's overall top-line performance in this quarter. It is interesting to note, though, that most of our larger account did show a growth in sales over last year's levels, some growing quite impressively. However this growth was more than offset by a minority of these large account that delivered significantly weaker results. In all, pharmaceutical spending is, at best, a mixed bag, and we see no reason that the situation will materially change from where it is in the short term.

Geographically, the quarter's sales growth was relatively balanced in light of last year's base year comparison. On the surface, the growth in the US seems light. However, last year's nearly 20% third-quarter growth in the US has to be an important consideration. I am pleased to tell that you we have begun to he see growth in Japan, as some tough quarterly comparisons are behind us and as we saw strong demand from both university and industrial accounts. We expect this improved trend in Japan to continue into the fourth quarter. Our third quarter sales in Europe suggest a continued stabilization in demand and improvement from the weaker results we reported earlier in 2008. The European pharmaceutical business exhibited a continuation of the recovery that we saw in the second quarter and our university business also delivered nice growth in the quarter.

Throughout the quarter there were rumblings about potential weakness in China, usually accompanied by some mention of the completion of the Olympics. Concerns also surfaced about issues in other developing nations. I'm pleased to tell you that our business momentum in China, India, and South America has remained strong. As worries about a global recession and its effect on these developing economies grow we will continue to closely monitor our quote and order activity. However, at this point we have seen no material change in demand and are encouraged that we'll finish 2008 with strong results in these regions.

Our TA Instruments division delivered another strong performance in the third quarter. The division saw balanced growth from both a geographical and product line perspective. Sales for the new products from TA that I discussed in our last call, including the ARES-G2 Rheometer and Microcalorimetery systems ramped nicely in the quarter, and advanced technology continues to drive new customers to our calorimetery and rheology offerings. TA has demonstrated an ability to rapidly and successfully integrate new instrument technologies into its product line, and given this track record we have continuously sought to acquire new product lines and technologies to accelerate the expansion of TA's business. In the third quarter, we successfully completed the acquisition of a small specialty developer of advanced moisture analysis systems, that was VTI Corporation. The acquisition of VTI, along with the earlier acquisitions of Microcalorimetery product lines, will significantly enhance TA's ability to penetrate new life science applications.

On the new product front, when we last spoke I reviewed the new products that we introduced as this year's ASMS conference, and I'm pleased to tell you that at ASMS our new [Zevo] tandem quadrupole mass spectrometer was a major hit and was subsequently recognized by IBO, a leading industry publication, as the best new product showcased at the conference. Now as many of you know, tandem quadrupole mass spectrometers have been workhorse instruments in drug development labs for quite a few years and have recently been rapidly adopted in food safety and environmental testing applications. In addition, attendees of ASMS annual conferences fully appreciate how important innovation is to a successful new product launch at that venue. It is this combination of factors that fuels our excitement about our new Zevo platform, specifically the potential to offer differentiated technology capabilities to a large and expanding market.

We began shipping Zevo in the third quarter and throughout the quarter we saw heavy demand for product demonstrations. It is interesting to note that our first delivery was to a leading food safety lab in Latin America, where after extensive evaluation of Zevo and other tandem quadrupole instruments it was determined that combination of Zevo's superior MS sensitivity and higher level user functionality resulted in a significant step forward in overall system performance. In short, we're very encouraged by the market's reception of our new mass spec systems and feel that our competitive position is significantly enhanced as we close 2008 and move into 2009.

John will walk you through the P&L in more detail, however I would like to point out that we have again continued to improve our operational efficiency through product cost reduction programs and expense management. These improvements, in combination with our share repurchases, have led to superior profitability and faster earnings growth. Through the first three quarters of 2008 we have delivered a record level of free cash flow, nearly $280 million. This level of superior cash flow has provided with us with the flexibility to continuously enhance the value of our Company through selective acquisitions, share repurchases and the retirement of debt. We've been moving on all these fronts as of late.

Looking toward the fourth quarter of 2008 and into 2009, I'm encouraged that we'll be able to benefit from the business momentum that has helped us so far this year. Though we expect global economic conditions will remain under pressure in the near term we feel that our strong product position, the continuing expansion of our businesses in the developing world, and the sustainability of our recurring revenues in total position us favorably. That said, we will remain cautious in our financial outlook and we'll plan conservatively for 2009. Accordingly, we will manage our expenses carefully while continuing to optimize our manufacturing costs. We currently believe that despite the potential for more challenging market conditions and currency dynamics that are likely to present a headwind, we feel that we have the ability to manage our P&L and balance sheet to generate double-digit earnings growth and continued strong free cash flow.

With that I would now like to turn it over to John.

Thank you, Doug, and good morning. Third quarter results delivered 10% sales growth and 27% growth in non-GAAP earnings per diluted share. Earnings were $0.79 this quarter compared to earnings of $0.62 last year. On a GAAP basis our earnings were $0.71 this quarter compared to $0.52 last year. A reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning.

Before I discuss Q3 results in detail I would like to describe a legal entity review process that culminated in early October just after the close of the third quarter. To better align our legal entity structure with our current business objectives we reorganized certain of our foreign operations resulting tin transfer of ownership of certain foreign assets into our US business. The majority of this reorganization meets the requirements of a tax-free liquidation under the US tax law and allows us to bring $572 million of offshore cash into the US for domestic use. There is a small portion of the transaction that could be subject to US tax and we have fully provided for that exposure in our third quarter as part of a $5.1 million tax provision.

Subsequently, we have utilized about $490 million of domestic cash to prepay a $150 million term loan facility and to pay down $340 million of debt outstanding under our revolving credit facility. These actions subsequ -- substantially reduce our exposure to interest rate risk in the currently volatile capital and money markets. We currently have full borrowing availability under our committed $600 million revolving credit bank agreements and sufficient cash on hand to fund our capital needs for the foreseeable future. Also included in our income statement this quarter is a small restructuring charge resulting from minor regional realignments of manufacturing resources.

Turning now to our operational performance for the third quarter, sales grew by 10% this quarter, with currency providing three percentage points of growth. This foreign exchange effect is two percentage points less than what we had expected in our July call as a result of the strengthening of the US dollar since our July guidance. Looking at corporate sales growth regionally and before foreign currency effects, sales within the US were up 1% this quarter, largely the result of weak large pharma demand and a very strong prior-year [base of comparison.] Within Europe sales were up 7%, sales within Japan improved this quarter and were up by 10%, and sales in Asia outside of Japan remained strong and were up 11%.

Turning to the product front, within the Waters division, instrument systems grew by 3%. Recurring revenues grew by 9% this quarter led by double-digit service growth. And TA Instruments had another strong quarter, with sales up 14% versus prior year, resulting from strong new product sales and acquisitions.

Now I would like to comment on our non-GAAP financial performance. Gross margin remained strong this quarter and came in at 59.3%. Versus prior year margins expanded by about two percentage points. We continue to benefit from product cost reductions of favorable product mix and favorable currency translation effects. SG&A expenses grew by about 9% this quarter compared to prior year, and R&D expenses grew just 1%, an unusually low rate of growth due to the timing of project costs. We currently expect our full-year operating effective tax rate to be about 18%. The slight increase from our rate over the first half of the year is the result of small mix changes in our production facilities worldwide, as well as foreign exchange impacts on legal entity products. On the stock buy back front we continue to purchase our shares in the open market and during the third quarter we purchased 875,000 shares of our common stock for $57 billion. Fully-diluted average share count was 100.6 million shares for the quarter.

On the balance sheet cash and short-term investments totaled $893 million and debt totaled $1.028 billion, bringing us to net debt position of about $135 million. As described earlier, our recent debt repayment actions have reduced our cash and debt balances by about $490 million. We measure free cash flow as cash from operations, less capital expenditures, plus any noncash tax benefit from FAS 123(R) accounting, and excluding unusual nonrecurring items. For the quarter free cash flow was $88 million after funding $17 million of CapEx and adding back $2 million of FAS 123(R) benefits. Comparable free cash flow in Q3 last year was $72 million. Year to date, our free cash flow was up 15%. Accounts receivable day sales outstanding stood at 68 days this quarter, two days better than Q3 last year, and inventories were about flat versus Q2 balances.

Now we'd like to turn to our outlook for the remainder of 2008. Our third quarter's organic sales results were in line with both our prior expectations and our first-half results, and we believe the current business conditions will provide for a continuation of this trend into the fourth quarter. While there is some concern that reaction to the current financial crisis will slow customer spending, our current assessment of both our -- of our end markets that we serve suggests the businesses will continue to spend on the technologies and solutions we provide, and allow to us grow around 6% organically in the fourth quarter. Currency at today's levels would reduce sales growth by about 2%, bringing our overall drought to around 4%.

Moving down the P&L we expect to see continued gross margin favorability to prior year resulting from improved production, with efficiencies on higher production volumes, continued favorable sales mix and product cost reductions. The favorable foreign currency translation effect experienced earlier this year will turn against us given the weakening dollar. We presently expect gross margins of around 59% in the fourth quarter, operating expenses are expected to grow about equal to sales, we expect our operating tax rate to be around 18% for the quarter, net interest expense is expected to be in the neighborhood of $4.5 million, and our fully-diluted average share count is currently estimated to be about 100 million shares. Rolling all of this together we currently expect Q4 non-GAAP earnings per fully-diluted share to be in the range of $1.08 to $1.12 per share, where sales growth is around 4%. For the full year this would result in 10% sales growth and 20+% growth in earnings per fully-diluted share. Doug?

Okay, thank you, John. I think we can open it up for Q&A now, operator.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Quintin Lai of Robert Baird.

Hi, good morning.

Good morning. Morning.

Thank you, again, for all the commentary on the fourth quarter and he longer term outlook. What gives that you confidence on the especially the applied markets and the regulatory areas? Do you think that the regulations, as they stand now, such as like in the case I noticed last week you launched some products in melamine -- for testing foods for melamine. Do you see that the macroeconomic environment really doesn't change that and, if anything, the need to test food and water continue to be greater than ever?

Yes, Quintin, in those emerging applications, I think food safety and food [analysis], in particular, I don't think the economic climate has much of an impact on that. We've seen -- of course the melamine is a very current example where we have seen substantial order activity, both in the third quarter and continuing into the fourth quarter. And both in places that are directly affected, like China, as well as receiving regions, like particularly the EU. Turns out that these milk products find their way into many, many -- as intermediates into many, many manufactured food products, so there's a great deal of interest in extensive testing in that application, So we don't see that tailing off early.

The other economic areas or the areas -- one of the -- the good news/bad news things about our business is that the pharma customer base has been under pressure. The pharma base doesn't react to the financial crisis around us to any large extent because these accounts have very strong free cash flows and they're really worried about same things they've been worried about for a number of years, which is the patent situation, and replacing their product flow. So I think we've been dealing with their struggles there for a long time and we'll continue to. We see in that our run rate, and we're not really seeing their plans or our approach there to be much different than it's been for awhile now. And then on the basic R&D area, one of the things that we've thought of, just in general, is that most of those scientists, they're charged with pushing the edge of research and the leading edge of technology, so I'm encouraged to see that Synapt and UPLC continue to be adopted, especially in that area.

Is that how you can continue to show growth in that area in a tough environment by simply just continuing the new product development, and if you stay on that leading edge you feel like that you can still continue the growth?

Well, we definitely feel like we have to continue to push the new product, both in terms of its sensitivity, reliability, and importantly, its productivity. One of the areas that we've made inroads into but we think still has plenty of opportunity for us is in a product line like UPLC. The productivity potential for a number of customers is extraordinary, because, of course, you can run analyses so much faster under UPLC than under traditional HPLC. And so rather than buying an instrument at 10% less the customer can buy an instrument that costs them a little bit more actually but may improve his productivity by a factor of two or three. And we're really beginning to see that have an impact in a number of our high-volume applications, both in research and in QC. So I think it is absolutely a lot of evidence that customers are perfectly willing to invest in something that gives them a strong payback, and I think that's what you're seeing in our results.

Last question, and I'll jump back into the queue. The R&D, John, you said was a timing issue, so should we expect kind of a jump back up in Q4?

Yes, I'd say -- if you look at R&D it's about mid single-digit growth rate as you look at it more on a year-to-date basis and we would guess that it would be about that for the full year, as well. So there's a little bit of lumpiness with prototypes, alpha units that need to get built and expensed as you look through current year and prior year basis, so it's more just an aberration of orders than it is a signal that we're really doing anything to cut back expense in that area.

Okay, thank you.

You're welcome.

You're welcome.

Our next question comes from Doug Schenkel from Cowen & Company. Your line is open, sir.

Thank you. Good morning, guys. Thanks for taking my questions.

Good morning.

You typically place a lot of instruments at the end quarters and I think this is a little bit more pronounced in Q1 and Q4 than it is in Q2 and Q3, but with that as the premise of my question, did the timing of the deterioration in the broader markets lead to any delay in instrument bookings in the second half of September?

First of all, the third quarter actually does -- has a little bit more pronounced end of the quarter tilt to it because you get the classic July and August vacations that tend to slow down business activity early in the third quarter and then it builds up in September. That's, of course, pronounced in Europe, when August is a very, very popular vacation month in Europe, so you do see a lot of activity tilted towards September in Europe. And as we said, we did well in Europe, so the economic indicators coming into Europe were pretty good. We saw very good activity in the nonprofit areas in Europe, government and university accounts, but I don't think that there's anything to be particularly read into that. I think, to be fair, we could have had even a little bit better quarter. I'd say that most of that is tilted towards the US, where we're working a lot of interesting opportunities, business that we don't think we lost, but we think that the financial chaos going on did at least make some customers wait a little bit. So while we hit our numbers, maybe did a little bit better, I think the actual demand side of the equation, if you didn't have the overlay of the financial markets, might have been a little bit better.

Okay, that's helpful. Then another dynamic is the launch of Zevo in the quarter. Did that at all -- I'm trying to think of the best way to describe this, but I would think that that may certainly slow the placement of legacy instruments, and you may not be placing as many instruments as customers evaluate a new launch. Is this something that played out in the quarter, and if so, how do we think about that heading into Q4?

I think that's a fairly insightful question, actually. First of all, overall our mass spec product lines did very well in the quarter, but the product lines that boldly, if you just look at the actual placements, were somewhat weaker than other pieces was triple quad product line, and we do think that's related to this -- the legacy products coming out of our portfolio. With the new products coming in, many customers have to revalidate on the new technology, they want their samples rerun. So we definitely think there's some piece of that as we change over the product line.

Do you think you're turning the corner on that dynamic heading into Q4, or are you still maybe in the fourth or fifth inning?

I think we're well into it. As I said, our demonstration labs have been running overtime for the last three months, so we're pretty sure that we're making a dent in it.

Okay. Changing gears -- and I'll just ask one or two more and then I'll get back in the queue -- but something we're hearing more and more about is really the current status of the NIH budget. It's essentially frozen with last year based on recent congressional action, or I guess inaction, depending on how you look at it. How much exposure as a percentage of sales do you believe you have to NIH funding and have you seen any signs of the current in-limbo status of the NIH budget is affecting or will affect either instrument or current revenue streams?

Historically the NIH budget hasn't had much of a direct affect on us. Something less than 1% of our sales is directly related to the NIH budget. Now, of course, the NIH has a multiplier effect in some business that you can't track directly to NIH, but unlike some of our competitors who deal very significantly with -- directly with NIH labs our business doesn't tend to be significant in that area. So when you've seen NIH budgets go up by 7% or 8%, or when they're flat to a little bit down, it doesn't have much of a discernible effect on our overall sales.

Okay, and last question. Last I checked Japan accounted for about 10% of sales. You said Japan was improving in the quarter. Keeping in mind last year in that Q4, I believe Japan sales were down double digits and that you're, as a whole, now only guiding for -- or I should say to 6% constant currency growth heading into Q4, I'm just trying to get at is there a specific geography, I guess presumably it would be the US, where you're expecting some challenges in the Q4 year over year?

Yes, I would say that the US was our challenge in the third quarter and I'd say of all of our geographies, we're still keeping our eye most closely on the US. We think Japan, both for underlying economic reasons as well as for having anniversaried some very tough quarters, that we're pretty confident that we will continue to see growth in Japan.

Okay. Thanks a lot for take my questions.

You're welcome.

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

Thanks for taking the call. John, in your comments you mentioned cost reductions a few times. Can you just give us a sense as to -- given the economic backdrop here whether you guys have accelerated some of your initiatives to cut costs out of manufacturing -- obviously beyond the move to Singapore -- just on the raw material side?

I'd say fortunately, at least for us in the short term here we haven't had had dramatic pri -- cost inflation amounts on the manufacturing side of our house, at least at this stage. In spite of that, though, we've recently moved a couple more HPLC detectors to Singapore. We took a small action to rebalance the workforce recently on that front, as well, and we continue to cost reduce specifically the ACQUITY product. Those plans are in place and on track for the year, and obviously we've been holding back on replacing headcount and putting some temporary resources in place where we can where we need to, at least in the short term, have the labor available. So I'd say we've done a number of different things, both on the manufacturing front and on the support and SG&A side to continue to cost reduce this business. And if you look at the organic growth in SG&A, R&D, and even on the manufacturing side it's been less than the growth in organic sales this year.

Okay. And then as we think about the market opportunity for Zevo, obviously sounds like you've had had good interest initially from some of the food safety customers. How ultimately do you think that product line is going to be positioned between pharma and then biotech and then some of the applied markets? And then if you can also comment on how we should be positioning for the [Trizaic], which I guess you'll introduce early next year, too, that would be helpful?

Tycho, I think we're going to position Tivo as a workhorse triple-quad instrument across a broad range of applications and I think that the initial reaction is very good. Now, as you know, traditionally we haven't had a large share in pharmacokinetic drug metabolism labs, and maybe that's a good thing now because those labs tend to have been slow during pharma's tough time. So we're seeing initial interest, even in those regulated bioanalytical labs, so we're hopeful with this new generation we have something to show those accounts and early signs, albeit very early, are encouraging there. So I think clearly where we're seeing continued strong interest is in all of the applied areas and I think we'll continue to see those kinds of -- that kind of interest grow.

And can you comment just briefly on the clinical markets, as well, m Maybe on the neonatal screening business but also we're hearing a lot more about vitamin D testing and some of these other opportunities emerging?

I think vitamin D testing is a very interesting area. Our systems are currently being used in vitamin D. Our clinical applications have grown over the last four years, I'd say north of 15% a year, and continue to be good performers this year. I think neonatal has actually been more of a flattish area this year, but certainly one particular application that continues to be strong is therapeutic drug monitoring, particular for antirejection drugs, where I think mass spec techniques are now really the analytical method of choice in that application.

Okay. And then just one last one on the customer base. I appreciate the color you gave on pharma. Can you just comment on the CRO base today and what your level of visibility there is? We're still seeing the capacity expansions happening, but just wondering how comfortable you are with your visibility on the CRO business going forward.

I think the worldwide CRO business continues to be robust. I think you can have quarterly up or down, depending on how strong your base was, but certainly what we see is large pharma continuing to look to outsource more and more of their business, and that's directly adding to the large CROs having a good business opportunity in front of them. I think we're also seeing other somewhat less traditional CRO customers, including generic accounts, make more use of some of the CROs. So I'm -- I also look at those guys' stock prices, they've been under pressure this year and so I wouldn't be surprised to see a little bit of breathing room creep in a little bit. But I don't think over the medium term we're likely to see a move away from CROs. I think we're going to continue to see that be a pretty robust area.

Okay, thank you very much.

Our next question comes from Jonathan Groberg of Merrill Lynch. Your line is open, sir.

Thanks a million for taking the call. Congratulations on a solid quarter. Can I just get -- John, can I just clarify on the balance sheet again exactly -- you were able to repatriate, I think you said $572 million and you used $490 million of that to pay down debt and I was just curious exactly what you paid down again? It looks like at the end quarter you had about $377 million in shorter-term debt and $650 million in longer-term debt.

Yes, the transaction occurred in the beginning of October, so obviously you have to get from me on the call here what the impact is on the balance sheet versus seeing it live. We had had to book to transaction in the third quarter because of the change in the -- the tax impact of it, which forced to us pull the tax effect into the quarter but not the balance sheet impact of it. But in any case, to answer your question, we paid down a $150 million term loan. It was a four-year term loan. It went into effect earlier this year and there was no prepayment penalty, so we just eliminated that term loan at the start of fiscal October. And then we paid down $340 million on our revolving credit agreement. That was what was outstanding against that agreement. The balance against that agreement now is zero, so we have a full $600 million of capability, if you will, under that revolving debt agreement.

Okay. And so effectively the $650 million in long term now is closer to around $500 million then, is that right?

Right. $500 million (inaudible exists now, right.

Okay. And then just following up from a few comments, Doug, that you made in the second quarter and just seeing where we are this quarter, I think you mentioned last quarter that Synapt you'd expected to have a strong second half given what you had been hearing, and then you also had mentioned in the second quarter that some of your pharma accounts were talking about a better spending in the second half, releasing some delayed investments, and I was just curious, you gave a lot of color around pharma, but has that commentary now been dampened on the pharma side, and what are you seeing on the Synapt side in terms of the second half?

Synapt was very positive in the third quarter. As I said, our mass spec products did very well. Our triple quads didn't have that strong a quarter because of the transition that I talked about with Zevo, which means that our high-end products did that much better. So Synapt I think that comment in the second quarter proved to be true in the third quarter, and we're optimistic going forward. The pharma is, I'd say, a mixed bag. I would say where we saw some of that pent-up demand come through was in Europe, where we saw some significant orders break in the large pharma area.

In the United States I'd say we saw some of that happen, but we also saw some things that we thought were going to happen not happen. So that's this whole story. It's really not a very homogeneous story in large pharma in the United States. We have half of those accounts who seem to be on track, investing in major new products, going very well. We have another half of those customers who come right up to the edge of saying they're going to expand some projects, expand some opportunities, and then tend to back off. So I'd say that's the current state of things. Overall, I'd say it's more of a consistent industry dynamic. Some of the players have changed their momentum, but overall I'd say it's still pretty much what we were seeing in the second quarter, Jonathan.

And on the pharma side, as you describe that, is it your sense that this is kind of a top-down mandate that capital budgets are actually being shrunk and is there any reason to think that they won't remain lower next year, or is this just -- is the sense that this is -- they still have the budgets and there's a discretionary sense of how to use those budgets?

I think it's different strokes for different folks. I think that some of our large pharma accounts are showing great interest in major strategic manufacturing initiatives. They're looking to significantly improve the productivity in a lot of their processes and I think they're serious. They've been out here and we've been there for major meetings. I think it's going through that normal process of, are we certain we can deliver, are they certain that they've got the labs in place, et cetera. In other cases, I think, yes, I think capital is tight. I think not a lot tighter than it's been. I think we all ought to realize that overall big pharma has been in pretty tight investment conditions for awhile now. Some get a little bit tighter this quarter. Some loosened up a little bit. Overall I'd say the temperature of that water is pretty much what it's been for the last couple quarters.

Okay, and then last question. John, I think if I was going back and looking at your gross margins in the third quarter and I think this was about the highest that I could find, anyway, is -- and I was curious, how much of that was due -- you mentioned a few of the different things, but how much of that was due to favorable FX given the fact that the pound weakened considerably earlier than the euro?

Yes, there's no doubt that the margins were a little more favorable than we had originally anticipated. We had a strong euro. Euro up about 8% on average but the pound was only up about 4%, so currency from that perspective was favorably impacted. Additionally this quarter we had really a full quarter of benefit on the cost-of-sales line as the inventory impacts, if you will, of currency make their way through the process. There was little impact on cost of sales whereas on the sales line we had a drop off at the end that took a couple of points off our top line. So the combination of those two probably pushed the currency benefit to maybe two-thirds or so of the overall lift that we saw this quarter. But we also had favorable mix this quarter. As Doug said, our high-end mass spec did very well that had an impact. The incremental chemistry and service sales had an impact. The product cost reductions, lower warranty on mass spec. It was a number of operational and currency impacts this quarter that were significant.

Okay, great. Thanks a lot.

Our next question comes from Isaac Ro of Leerink Swann. Your line is open.

Hi, guys, thanks for taking the question. Just first off, are you seeing any delays to 2009 budgeting from your customers in pharmaceuticals or elsewhere given the uncertainty in the economy, and just heading into fourth quarter how would you say your visibility has changed versus previous years?

I wouldn't say that we're seeing any specific budgeting delays. These organizations are pretty rigorous in their processes and they don't vary them significantly year to year, so I think you're seeing a reliable set of processes. I'd say one of the dynamics that we've seen in the last several years is that they go through their budgeting processes and they all culminate around the October, November, early December timeframe, and -- but then in terms of releasing the bu -- the cap -- particularly the capital budgets, they can have things in their budget but then they don't release them until they see how the first quarter is going or see how the first half is going. So we've seen that traditionally that people will get their budgets, but they won't be authorized to spend against those budgets for a period of time, and frankly I don't think that that's going to be much different. You're going to see companies be as conservative as they've been in the past and the companies that have been spending normally will continue to spend normally. So I think that dynamic's something that's happened for the past three or four years anyway and will likely continue.

Great, okay. And then on the food environmental testing side can you point to any specific regulatory changes that you think are mandating greater demand or use of your products, and how would you characterize the nondiscretionary nature of those markets?

Well, I can certainly see the melamine as stimulating investment, both in Asia and in Europe, so while -- it's not like a new regulation came about because of melamine, it was just obvious in those applications that you had to do something. I think certainly the most formally regulated market in terms of food safety is Europe. The EU has very clear regulations and where you do have comparable regulations between Europe and the US Europe tends to be more rigorous than the US. I think there's a general move in the US that we sense -- although I can't point to exact regulations right now -- that is increasing regulations for -- particularly for food imports and that's you'd say very normal because of all the heightened interest in things like melamine and other products coming out of Asia that have had known problems with them. Pet food's certainly another obvious one. So I think there's certainly a greater interest in Washington. We're being called with some of our experts to testify in front of congressional committees and even in the background to advise people in Washington about what we do in Asia and what we do in Europe. So I think that's going to result in more specific regulations in the US, but I -- you don't see those right at this point.

Okay, great. And then in terms of a couple of specific product questions, how do you guys feel about your market share in the mass spec side of things right now? Are you seeing any competitors maybe using price as a weapon?

Well, we always see certain competitors use price, particularly depending on where they are in their product life cycle, if they're trying to move old product versus new. I think the mass spec customers on the whole do not buy really based on price. They're really looking for technology, productivity, sensitivity, and if all of those things are equal then you'd know seventh or eighth on the list will be price. That has been the way it was, and I think that's the way those customers continue to react. I continue to say our mass spec product lines did very well, have done very well recently, even in a transition period of triple quads, so if we're not gaining share then must be that everybody else is doing very, very well.

Okay, great. And then last question would be on Zevo and then maybe ACQUITY. Can you remind us, was there -- how much of a contribution from Zevo in the quarter? It sound like you guys shipped a couple. And then on the ACQUITY, where do you think you are in the adoption cycle?

I think we're still early in the adoption cycle of ACQUITY. ACQUITY had another very strong quarter for us, but we've seen no lack of opportunities in ACQUITY. We -- and we don't see any strong new competitors entering into the scene at this point. So I'd say we're very encouraged about THE continuing opportunity for ACQUITY in both R&D applications and in QA/QC. And I think it's fair to say that we think the Zevo is only in the early phase. Zevo and triple quads didn't contribute a whole lot to our overall mass spec performance in this past quarter and we think that only gets better.

Great.Thanks a bunch.

Our next question comes from Derik deBruin of UBS. Your line is open.

Hi, good morning.

Good morning, Derik.

What was the M&A impact on the quarter and also what's your expectation for M&A on the full year?

M&A for TA Instruments provided about 4% gross, so it would have brought their growth to 10% without that.

Less than a half a point for the corporation. For the corporation it didn't round to even half a point.

Okay, that's what I thought. Great. Based on -- how do we look -- you're getting an FX headwind going into 4Q, given the current exchange rates right now, what type of FX headwind would we be expecting going into 2009? I'm calculating around 3% head wind, is that about right?

I'd say based on where -- rates move all over the place.

Obviously, John, yes.

It's been a difficult time, I guess, to sit here and try to forecast FX. But that being said, based on euro around $1.34 or $1.35, wherever it is today, that's probably a couple of points of headwind, maybe it's three. We need to understand the other basket of currencies, but I'd say you're in the ballpark.

Okay. And again, looking at the interest rate from -- or looking at the debts you paid down, what interest rate was that? I'm just trying to get a sense for interest expense savings as you go into '09.

Yes. It's fortunate for us that we paid that down, really, as the interest rate environment was becoming much more expensive. As you know, as we came to the tail of end September and the financial crisis hit there were very wide spreads between LIBOR and T-bills; debt was getting more expensive and interest earned was actually going in the opposite direction. So by being able to pay down the amount of debt that we, based on where rates are today, it basically leaves our interest -- our net interest cost about where it has been for the first three quarters of the year. Had had we not taken down that debt we would have seen maybe a $2 million or 3 million increase in costs in the quarter, so it affords us the opportunity to have a comparable Q4 result to what you saw in the third quarter.

Okay. And it should be lower in 2009, though, just based on paying it down, or does the higher LIBOR rate offset the savings?

It all dep -- I'd say right now we're still living in the bubble of uncertainty in the financial markets, and to the extent that we add some amount of sanity, if you will, to that marketplace and you see the traditional spreads that we've historically enjoyed between LIBOR and interest rates on T bills and government agencies, then I would say, yes, the run rate should perhaps come down a little based on where debt and cash balances are right now. But obviously we have to model the whole capital picture for next year. to really answer that question.

Right, which goes to my next question, which is you're doing about $250 million in share buy backs is your target for '08. Do you continue to believe you'll be able to do that going in 2009?

We'd like to, Derik. We're inclined in the absence of significant acquisition opportunities, and thats -- I think we'll continue to do the smallish ones, but we don't see any huge ones on the horizon -- our inclination would be to continue to use their cash to buy back stock. And I thought the stock was fine to buy when it was approaching $80, so you can imagine how I feel now.

Yes, yes. And I guess just one final question. When you -- you've managed to do really great cost controls on -- particularly on the SG&A line, and is there still a lot of significant savings as we look forward?

Significant savings I think is probably the wrong way to think about it. I think we believe that we can continue to leverage our sales growth with spending on SG&A and our fixed base of manufacturing spending, increase that at a lower rate than we increase our organic sales. And the beauty of it is we do it across a whole range of spending platforms. We do it in the manufacturing area, we do it in SG&A because we can continue to get growth out of our international organizations at a rate faster than we have to increase the infrastructure spending overseas. And we see that quarter after quarter and we see it pretty reliably. So it doesn't mean that you can grow your top line at 15 and grow your spending at two or three, but getting one, two, sometimes three points of vigorish out of that dynamic is what we aim to do. Some years we get two or three, some years we get one, but we almost always consistently get that leverage out of our operating spending versus organic sales.

Great. Thank you very much.

Our next question comes from Ross Muken from Deutsche Bank.

Good morning, gentlemen.

Good morning.

Somehow my first 40 questions I prepared were answered but I think I have at least one or two more that we can discuss today. In terms of the planning process for Q4 and '09, this is unprecedented market volatility, you've seen a whole host of negative earnings surprises from large industrial customers and the like. How often are you checking economic indicators? Are you just looking at orders? What's the key part of process for you as you're setting revenue targets next year for the sales force and when you're trying to think about Street-related guidance, given the degree to which economic shifts are happening here is on an unprecedented level?

Well, Ross, we clearly look at that time overall indicators, but largely -- our business isn't largely affected by things like overall GDP or overall inflation or unemployment rates. We have to look very specifically at the individual regions of our business because they're affected by significantly different dynamics. We weren't largely favorably affected by infrastructure spending in China, for instance. When they build roads and buildings and things like that, or invest in the Olympics, that doesn't really affect our business, but overall China GDP was exploding. What we look for in China is what they're spending on healthcare, new laboratory construction, food and food safety and food exports, and we think there they're going to continue to spend. We think they have to spend. We think in order for them to be viable on the international market they have to have a reliable, trusted product. And so that's why when something like melamine hits we immediately see them turn to us for a significant investment in instruments to upgrade laboratories.

Places like India, where generic drug manufacturers make up the bolus of our business are a subset of an Indian economy. So things may be buffeting India left and right aren't really very directly related to what we do, depending on how it affects this relatively small segment -- subsegment of the Indian market that's related to generic drug manufacturers. So that's -- and this time of year, Art Caputo, I, John, spend a lot of our time looking at the assumption of our individual areas and probing what are the current discussions with the customers in those individual areas say. Have their budgets been booked, what are they being promised, how have they reacted in past crises? So it's a lot of specific information, I'd say, rather than a lot of macro information that we're tracking. And right now we're in the middle of that. We're in no way culminated in it. And yes, we're a little bit concerned about the US, but I'd say not to an extent that makes us significantly concerned about our current run rates.

Just as a follow-up, what do you think the lag time is relative to previous cycles between when we started to hear about general weakness amongst your more economically-sensitive customers or those who typically are larger purchases of the instrument side of your business, what's typically the lag between when we've seen that in the press or heard rumblings of it and when it started to reflect in your growth and your P&L? And then as a follow up to that -- and that'll be my final question -- where do you think liquid chromatography ranks in the hierarchy of preference for your core purchasing group? So even if there is on the traditional life science biopharma piece of business any contraction where do you think it fits in terms of importance relative to other instrument classes, because obviously, chromatography's the most prevalent technique in the lab?

Yes, I think it -- pretty clearly,HPLC and now more and more UPLC is the number one analytical technique in these laboratories. Certainly not true in some inorganic labs, but in all the labs that we're talking about we're the most important technology, and certainly MS, as it's connected to HPLC, is certainly closely related to that. So I think we have a privileged position. Again, the economic downturns -- half of our worldwide business or more is related to pharmaceutical accounts, either large pharma or generics or biotech, and what have you. It's much more important what's affecting that class of customers than general economic conditions and very often what affects those accounts can be anticyclical to what's happening in the overall economy, so you look at that half of the business. And another cut of the science what we emphasizing our recurring business because all of these installed instruments have to be kept up. And through good times and bad we've seen the continuing rolling on of our recurring revenues regardless of the economic conditions that are out there.

So I know I'm not answering your question. I can't give you a simple, if a recession hits tomorrow, then a year and a half later we see our economically-sensitive customers turn down. There's no question that all of us in the long run will be somewhat affected by general economic conditions. If inflation gets higher our customers will get more sensitive to what they have available to spend. I think generally we're not as economically sensitive as many custom -- many companies are out there. The piece of our business that is economically sensitive in the context that you're asking is probably less than 30%, 25% of our business, I'd say. So that's probably the best I can do with that question.

Thanks, Doug. That was actually very helpful and congrats on solid execution in what's a very challenging market.

Thank you. And, operator, I think maybe we can take one more and let these kind people get back to their day jobs.

Our last question then comes from Marshall Urist from Morgan Stanley. Your line is open.

Hey, guys, thanks for sneaking me in at the end here. I had a question on the legal entity reorganization. Is that a one-time benefit or does that change how you generate cash from a geographic perspective within the business, and is there any tax implications of that going forward?

Yes, it is a one-time impact, if you will. Certainly we look at reorganizing our business on a frequent ba -- on a common basis going forward based on conditions that change, but this is not something that's going to have an impact on the current distribution of legal entity profits and thus have an impact, for example, on the tax rate or any -- or where cash is generated from this point forward. So from that perspective you've seen the full impact, if you will, this quarter on the tax line from this specific reorganization.

And as you look at where that stands right now are there any other potential opportunities like this within the current structure?

Certainly nothing of this magnitude that exists. We have smaller opportunities that we take advantage of to bring cash back on a regular basis. The IRS has extended the duration of intercompany loans at this stage, whereby companies like Waters can loan monies from overseas subsidiaries for up to a 180-day or so period, I understand, so we'll look at that. There's some discussion, perhaps, that those loans might premanentized in some fashion, maybe similar to the HACA as time goes forward, so we'll stay on top of that. But from a specific Waters strategy legal entity perspective there's nothing of the magnitude that you just saw that's in the cards in the short term.

Okay, thanks. And then last question, can you just comment specifically on guidance for the fourth quarter on how much typical pharma year-end budget relief do you anticipate in that number, or is it the same mixed bag, some will have more or some will have less and it's a neutral total impact?

I'd say that's basically our assumption right now that it's not a material blast out of budget money at the end of the year.

Okay, great. Thanks, guys.

You're welcome. And thank you all for being with us. These are interesting times, as our Chinese friends say, and we'll look forward to talking to you again after the fourth quarter. Thanks again.