Waters Corporation (WAT) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to Waters Corporation Third Quarter 2013 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.

Thank you. Well, good morning, and welcome to the Waters Corporation Third Quarter Financial Results Conference Call. [Audio Gap] Art Caputo, the President of the Waters Division; and Gene Cassis, Vice President of Investor Relations. As is our normal practice, I will start with an overview of the quarter's highlights, then John will follow with details of our financial results and provide you with our outlook for the fourth quarter. But before we get going, I'd like John to cover the cautionary language.

During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company, this time for Q4 2013. 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, 2012, in Part 1 under the caption Business Risk Factors, and the cautionary language included in this morning's press release and 8-K. We further caution you that the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results, except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings call and webcast is currently planned for January 2014. 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 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 items such as those outlined in our schedule entitled Quarterly Reconciliation of GAAP to Adjusted Non-GAAP Financials included in this morning's press release.

Thank you, John. Well, our constant currency sales growth rate in the third quarter was 4%, which was a slight improvement over the second quarter's performance, but clearly, moderately below our expectations. Earnings per diluted share were up 1%, again an improvement from our earnings picture in the second quarter, but still significantly lower than what we have typically delivered. That was due primarily to currency headwinds and somewhat slower organic growth. In comparison to our business in the second quarter, we saw a slowing of demand from our global pharmaceutical end market, in combination with the strengthening in chemical analysis segment. The stronger demand for industrial chemical applications was most apparent in the very strong sales growth that our TA Instruments division achieved in the quarter. In total, instrument system sales were up 2%, and our recurring revenues were up 6%. Turning now to analysis of our third quarter sales. Constant currency sales growth for the Waters Division was 2%. In comparison to the third quarter of 2012, instrument sales were flat, and recurring revenues were up mid-single digits. Product growth in pharmaceutical sales significantly offset a strong quarterly performance from chemical analysis and nonprofit end markets. Geographically, and for the Waters Division, sales growth in the U.S. was 3%, which included a double-digit decline in government and academic spending. Pharma sales were up low-single digits, a slight improvement over our second quarter results, but not as strong as we had hoped for. Industrial chemical spending was healthy in the quarter and up high-single digits. This is a continuation of the strength that we saw earlier in the year and indicative of continued but shallow economic recovery. Sales growth in Europe for the Waters Division moderated in the quarter in comparison to the first half of 2013 and was up low-single digits. As we saw earlier in the year for Europe, government and academic spending was fairly robust and grew at a high-single-digit rate in the quarter, while our pharmaceutical end market business decelerated from the first-half pace and finished slightly down. Pharmaceutical weakness in Europe is significantly related to budgetary delays associated with restructuring activities at certain key accounts. Waters Division constant currency sales in Japan were up nicely in the quarter, as the pickup in government and academic spending that began to materialize late in the second quarter continued through the third. Governmental supplemental stimulus programs are having a positive impact on our Japanese business. Sectors in Japan, which are not associated with governmental funding activities, remain under pressure, including industrial, chemical and pharmaceutical end markets. Our quarterly sales growth in China was at mid-single-digit rates and lagged our orders growth rate there. Through the first 3 quarters of 2013, orders growth in China has been at a mid-teens rate. We think the underlying demand for research-focused systems, especially mass spectrometry-based, is strong and should be reflected in accelerating shipment volume, as we close out 2013. Sales in India were up modestly in the quarter, and demand in that country seems to have stabilized, as the large generic-drug user base appears to be returning to a more normal buying pattern despite significant local currency unfavorable dynamics. Our sales in the Asian markets, outside of Japan, China and India, were generally in line with our expectations and grew at a mid-single-digit rate, an improvement from what we saw in the second quarter, but still slower than the typical double-digit growth that we have historically enjoyed in periods of stronger global economic conditions. Our TA Instruments division had a very strong quarter, with double-digit sales growth, primarily based upon strong demand for core thermal and radiology products. Strong sales in the U.S. were indicative of a continuation of economic recovery and of TA's strong market position. During the quarter, TA continued to augment its technological capabilities and materials characterization with the acquisition of a small, privately held German innovator in elastomer analysis. Through the first 3 quarters of 2013, TA's constant currency growth rate is in the high-single digits, and the third quarter's strong momentum suggests that a similar growth rate may be achievable in the fourth quarter. Now I'd like talk about the product line dynamics that we saw for the Waters Division in the quarter. Our recurring revenues, the combination of service and chromatography consumables, grew as expected in the third quarter, delivering mid-single-digit sales growth before currency effects. Column sales to pharmaceutical accounts was strong in the quarter with ACUITY columns, including our new line of CORTECS columns, growing at a double-digit rate within most regions. Looking at our Waters Division mass spec instrument system sales, we continued to see strong demand in the quarter for high-performance QTof technology systems, including Xevo and SYNAPT platform instruments. New SYNAPT G2-Si features, which we introduced at ASMS earlier this year, have been well received for large biomolecule applications, including proteomics and lipidomic workflows. Our tandem quadrupole system sales for clinical and applied market applications grew nicely in the quarter, while demand for high-end tandems, used in more classical, small-molecule drug development, slowed in the quarter, due to generally weaker Pharma spending and to delays associated with the valuation of new competitive products. Through 3 quarters of this year, our MS-based system business is tracking at a high-single-digit growth rate, and our prospects look encouraging as we close out the year. On the chromatography instrumentation front, instrument system sales growth improved from what we saw in the second quarter, but remained below our expectations. Capital spending delays, primarily from larger pharmaceutical customers, continued to adversely impact new system growth and classical small-molecule research applications. Looking toward the future, and I'll shortly be talking to you about a very recent product launch that we feel will begin to stimulate chromatography system demand in the fourth quarter and serve as a meaningful growth platform in 2014. In summarizing our third quarter results, overall instrument systems demand improved slightly from what we saw in the second quarter. However, a combination of factors, including weak public sector demand in the U.S., restructuring activities at some of our large accounts and shipment delays that we saw in China, all contributed to a less-than-hopeful quarterly performance. Through the first 3 quarters of 2013, we feel that our recurring revenues, our mass spectrometry growth and TA instrument performance were mostly in line with our expectations. And it has been our chromatography instrument systems, primarily for pharma research applications, which have been weaker-than-expected. On the topic of pharma research, earlier this month, we introduced a quadrupole-based detection technology that is specifically tailored to provide more qualitative information to chromatographers seeking higher levels of confidence in compound identification. This new detector is called the Waters QDa. And it's no coincidence that the name sounds pretty similar to PDA, or our Photodiode Array, the detection technology that is dominant today among chromatographers, especially those in drug research, requiring more qualitative information as part of a chromatography experiment. The key features of this new product include a small footprint, ease-of-use and a price that truly supports its positioning as an LC detector. Scientists using Waters LC, or UPLC instrumentation, can easily upgrade their existing systems by adding a QDa detector. In addition, customers in the market for a versatile and high-performance new complete ACUITY system can now purchase a superior instrument, which includes both PDA and QDa detection. The promise of LC/MS for a number of years has been on the notion that all chromatographers would one day be able to simply incorporate mass measurement into their existing workflows. However, even with all the improvements and sensitivity, versatility and reliability that were witnessed over the past 2 decades, the perception persists among chromatographers that mass spectrometry is too complex, big and expensive to be considered a practical LC detector module. We believe that the QDa goes a long way in changing that perception and will define a new high-end segment for ACQUITY UPLC. So at this point, we've already booked orders for the QDa and have begun customer shipments. I look forward to updating you with more information on this exciting product launch on the January call. But before turning it over to John, I'd like to say a few words about our nonoperational plans. On the M&A front, we will continue to seek smaller complimentary technology opportunities that fit our profitability and growth characteristics. As I mentioned earlier, our TA Instruments division completed a small acquisition. In addition, we also purchased a technology leader in software development for interpretation of ion mobility MS separations in the third quarter. Both acquisitions augment our technology portfolio and will accelerate new system introductions in coming years. Our strategy on the M&A front remains focused on seeking assets that enhance our technology and market-leading positions within the broadly-defined liquid chromatography, mass spectrometry and thermal analysis markets. As you've heard me say before, we remain focused on strong free cash flow generation. In the third quarter, we grew free cash flow at a rate higher than sales and operating income, and are on track to generate more than $400 million for the full year. The key deployment of our cash flow has been toward our share repurchase program, and this will likely continue into the future. In closing, I will reiterate that 2013 has been a challenging year for us. We believe that the slower growth in our business that we've seen in recent quarters can be largely attributed to factors that are external to the company and not related to the core business strategy that has driven our growth for nearly 2 decades. However, we also recognize the need to adapt to changes in market conditions by continuously refreshing our product offerings, by targeting market segments that offer superior growth characteristics and by judiciously managing our expenses to create business leverage. All of these key factors will be considered as we develop our operating plan for 2014. Now here's John for a review of our financials and an update on our outlook.

Thank you, Doug, and good morning. Third quarter sales grew by 4% before currency translation. Currency translation reduced sales growth by 2%, resulting in 2% overall sales growth. Non-GAAP earnings per fully diluted share were up 1% to $1.19 this quarter, compared to earnings of $1.18 last year. On a GAAP basis, our earnings were $1.14 this quarter versus $1.12 last year, and a reconciliation of our GAAP to non-GAAP earnings is attached to our press release issued this morning. As I just mentioned, before foreign currency translation, sales were up 4%. And looking at the sales growth geographically, and, again, before foreign exchange effects, sales within the U.S. were up 6%; Europe was down 1%; Japan was up 5%; and sales in Asia, outside of Japan, were up 6%. On the product front and in constant currency within the Waters Division, instrument system sales decreased by 1%, and recurring revenues grew by 5% this quarter. Within our TA Instruments division, total sales increased by 15% versus prior year. Now I would like to comment on our Q3 non-GAAP financial performance versus prior year. Like last quarter, gross margins continued to be negatively impacted by foreign currency translation, capitalized software amortization and a product shift in this quarter towards more QTof instruments versus tandem quadrupole systems. Operating expenses were up 3% this quarter. On the tax front, a modest shift in production levels and profits favored our tax-advantaged geographies. We brought our effective operating rate for the year to about 14%. Within the quarter, the effect of applying this rate to our year-to-date income added $0.03 to earnings. In the quarter, net interest expense was $6.4 million, and share count came in at 86.4 million shares, 2.1 million shares lower than Q3 last year, as a result of our continued share repurchase programs. On the balance sheet, cash and investments totaled $1,699,000,000, and debt totaled $1,294,000,000, bringing us to a net-cash position of about $405 million. As for Q3 share repurchases, we bought 541,000 shares of our common stock for $55 million. This leaves 423 million remaining on our authorized share repurchase program. We define free cash flow as cash from operations, less capital expenditures, plus any noncash tax benefit from stock-based compensation accounting, and excluding unusual nonrecurring items. For Q3, free cash flow came in at $88 million after funding $17 million of CapEx. Excluded from this CapEx amount is $14 million of spend associated with our new Manchester, U.K. mass spectrometry facility, which is expected to be ready for occupancy in 2014. Accounts receivable days sales outstanding stood at 74 days this quarter, up 1 day from Q3 last year. And in the quarter, and as is typical at this time in the year, inventories increased by $14 million. Now thinking about the remainder of 2013, we expect conditions will remain constrained for our LC systems business within the pharmaceutical accounts in the fourth quarter. We believe our recurring revenues will provide a foundation of stable mid- to high-single-digit growth in the fourth quarter, resulting in an overall growth rate of around 4%. Foreign currency translation at today's rates is expected to continue to depress sales by about 2% in the fourth quarter. Moving down to P&L. Gross margins in the fourth quarter are expected to be about 59.5%. Operating expenses are expected to be up between 2% and 3%. Net interest expense is expected to be approximately $6.5 million, and we expect our operating tax rate to be about 14%. Our average diluted share count is likely to be just under 86 million shares in the quarter. And rolling all of this together, our non-GAAP earnings per fully diluted share are expected to be in the range of $1.58 to $1.63. For the full-year then, our non-GAAP earnings per fully diluted share are expected to be in the range of $4.92 to $4.97. Doug?

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

[Operator Instructions] Our first question comes from Ross Muken from ISI Group.

I guess, if you sort of tried to tease out the pharma weakness in terms of some of the different buckets -- whether it's generic, zeros, emerging pharma, traditional pharma, where were you sort of most surprised about the trend that you're seeing? Is it a product-cycle issue? Is it a budgeting issue? Is it a timing issue? We're just trying to get a sense for where you feel like that incremental delta versus your expected sort of come from?

Ross, I'd say the disappointments that we see in generics has been there for a while, largely driven off India and the struggle with the Indian generic accounts. Outside of India and maybe the issues with the large Israel generic manufacturer, which has also been slow, the rest of the generic world has been okay. In the ethical pharmaceutical world, I would say the large dynamic -- most significant dynamic that we're seeing is -- can probably be characterized as restructuring. And the layoffs that are going on, many of which are focused in R&D, that's certainly where we're seeing kind of the most delays and issues in programs that we had identified through our marketing and sales efforts earlier in the year. They're not lost; they keep just being pushed back. We don't see big programs there going to competitors, so we don't think it's a market share issue. We think it's just one of continued delays, as they struggle with kind of dealing with their own economic issues. I'd say that's the main things we see going on in pharma.

And maybe on China, it's interesting commentary. I mean, you're sort of suggesting order rates there continue to be strong, but you're not seeing the pull-through. Is that a distributor issue? Is it a channel issue? Is it a timing issue? Again, I'm just trying to get a sense for -- back in 2, we saw this with another one of your players -- another one of your peers earlier in the year, and obviously, there's been a lot of noise in that channel overall. I'm just trying to get a sense for, particularly on the pharma side, what sort of you the think culprit is in terms of the slow conversion.

Yes. I think the China issue, we really do believe it's more of a short-term issue than a long-term issue. We've seen symptoms like this on the fringe before. But this quarter, it was a more significant issue really with delays in importation and tax paperwork. These orders can come through in significant amounts, but -- and so they indicate the real demand, and the customer is settled on you and has tendered the order. But in most cases, you can't ship it until there's a valid tax certificate, so that the government lab doesn't have to pay a tax or an import tax on that. For the first time, we saw a number of those kind of issues push out from the third quarter. And to the best we can determine, it was somewhat serendipitous. It wasn't indicative of a government edict coming down. And in fact, we've seen some of those ship early in the fourth quarter. So we don't believe -- we're watching it very closely. We still have reasonably high expectations for the China business. We don't think there's anything fundamental on the demand side of the equation, but it was a pretty significant surprise to us that those multimillion dollars of shipments that we thought we were going to come got pushed from the third quarter into the fourth.

Our next question comes from Dan Leonard from Leerink Swann.

The weakness you're seeing in pharma, how much of it, do you think, represents the secular shifts where Pharma is spending money, perhaps the shift from small molecule research to large molecule? How much is that, perhaps, accelerating versus to something temporary restructuring?

That's clearly happening, Dan. They're changing many of their programs from small to large. So we do think we're in somewhat of a shift -- a technological shift. Long-term, that should help us, because those large molecules are more intensely invested in our type of technologies, particularly high-end mass spectrometry. But it's still at the early phase. There's still -- I believe longing out the replacement cycle and a lot of this small-molecule areas, we clearly see somewhat of an aging of workforce systems in the mainstream QC areas. And so whether they're ramping up significantly in the bio area, we've seen a lot of programs, a lot of interest in early-stage programs. But I can't say that we've seen the release of orders that offsets the dynamics that we're seeing in small molecules.

Okay. And then my follow-up. Have you seen any opportunities pop up as a result of the healthy capital rates environment in biotech? And if not, why not?

I think we've seen some of that, and that's helped to offset some weak conditions in big pharma. But I think a lot of that in those small bio, it's still early phase, and they are still not fully investing at the pace of a big pharmaceutical company. We're seeing good results from that segment of the market in our high-end mass spectrometry, SYNAPT and QTof, and we had a good quarter in the high end in that segment of the marketplace. But you don't see quite the same large volume of QC systems that flow into that segment of the pharma market.

Our next question comes from Daniel Brennan from Morgan Stanley.

Maybe just one quick one on kind of acquisitions and backlog in the quarter. I think you ended the quarter with double the rate of backlog you typically have. Can you just give us an update on the backlog contribute this quarter? And were there any acquisition impact in the quarter on the top line?

Yes. There wasn't anything meaningful on the acquisition impact that rounded this one way or the other. And from a backlog perspective, we were able to take down some of the backlog that we had planned in the Waters side of the business. On the TA side, though, we ended up not quite getting as far as we thought we would. But as you saw in the strength that we had in that business, we ended up with a very good result anyway, and we think there's probably a little more opportunity in the TA side in Q4. Perhaps not so much with the Waters Division as a result of pulling some of that down in Q3. But overall, it wasn't quite as meaningful as we had originally thought as a result of some technical issues that were resolved very late on the TA side. I'd say the only dynamic there, Dan, might be as it relates to China. And we were a bit surprised at some of the lags there and getting those certificates that Doug mentioned. And we're hopeful in the fourth quarter that, that growth can accelerate, and we don't see it -- we might not get back everything that we've put in the backlog in the quarter, but I don't think we're going to add to it in the fourth.

Okay, John, and then maybe just one on LC. So, Doug, can you just comment on kind of the penetration of UPLC today? I think you mentioned in the last questions, the answer to the last question regarding some delays at pharma right now from maybe -- upgrading from older equipment. But can you just give us an update on kind of where you are with the penetration of UPLC? Is that one of the key issues that's been a drag in your LC growth, such that you're just not seeing the uptake of UPLC penetration right now as pharma struggles with some tighter budgets?

Dan, I think it's a very -- it's a hypo question. The ACUITY penetration in early-stage R&D and even middle-stage R&D in pharma continues to be very strong. We see no -- very clear that our belief is that UPLC takes over that market long-term as it continues to be strongly indicative by the facts. The stick-up of UPLC in downstream applications continues to be disappointing, I'd say. I think that's also a function of this reluctance to move processes and kinds of change in restructuring in that industry. Things tend to -- the decision-making tends to slow down. And it's very clear that we've had trouble penetrating into the downstream applications with ACQUITY. So I think that's been a factor in this. I think that -- it's been as much, though, a factor of the whole issue of how pharma have used their investments in the various segments of the market, particularly in a period when most of the major pharmas are going through some period of restructuring. So I think what's -- we clearly continued to see very strong results coming out of our consumables business. No sign that that's slackening off. So overall, we're still very happy with the UPLC, but we're still struggling. We're trying to get the downstream penetration.

Our next question comes from Paul Knight with Janney Capital Market.

When do you think that the diagnostics market and the funding occurring there and the technology breakthroughs in that area will start to increase the growth rate of your business?

Well, clearly, the clinical applications, if you look over a 5-year period, have been amongst the strongest growth applications for us. Unfortunately, it's still a relatively small piece of our overall revenue base, something a little less than 10% of our revenue base. I think the encouraging thing is that there are many applications that are being worked on in the field, as well as with us, that offer a great deal of optimism long term. But it's -- they're not ready to break as we speak. We clearly see much penetration in neonatal screening, in any rejection -- a rejection in immunosuppressant drugs. We continue to see a lot of interest and activity in pain monitoring and in drugs of abuse testing. Probably even more so -- probably see in drug testing more opportunity to move GC applications into broader-base LC/MS applications. So, I mean, the level of activity grows significantly quarter-by-quarter, but I can't point to you one specific application that I think is going to dramatically multiply the business in the short term. There's some promising things, but, I think, right now, we'd be happy with saying, we continue to see good double-digit-type of annual growth opportunities. But it'll still take a while for that to make a dent into our traditional analytical laboratory business.

Our next question comes from Doug Schenkel from Cowen and Company.

So my first question is, over the years, you've developed a well-earned reputation of strong operators. That said, operating income has declined now, I believe, in 5 of the 7 last quarters, as organic revenue lags peers. And it does seem like you may be starting to find ways to cut operating spend below levels you've already cut. Your R&D spend, as a percentage of sales, is below the typical levels of your peer group. Is there any reason we shouldn't be concerned that a focus on cutting operating spend has maybe started to catch up with you in the form of share loss and potentially inability to maintain price?

I think the -- that the market facts, Doug, don't take the LC marketplace. I don't -- we track in certainly annual context, which, I think, is probably the only relevant one because quarterly dynamics swing around quite a bit. There's no indication of loss market share. I would say, there's more evidence of gradual accretion in market share in our LC business. So it certainly is a notion that all of us who service the pharmaceutical industry and have suffered through swings in the industrial market have faced the same dynamics, and I don't think we're doing worse. I think the evidence suggests we're doing better. It's doing better in a tough market, I agree. And certainly, in the thermal analysis marketplace, I think the evidence is strong that we continue to gain share. So that brings us to the mass spectrometry piece of the market, and I think that clearly is a tougher call, and that's subject to quarterly swings that can move one way, one quarter, and another way, another quarter. We're clearly -- with our QDa, I think that we're moving things on the analytical benchtop level of the marketplace. We think we have a good strong offering on the high-end. The area that's challenged right now is that pharmacokinetics drug metabolism segment of the pharma market that competitors have launched some new products, I think that's introduced some level of reevaluation in that customer segment. Now to be fair, we haven't been the strongest players in that segment of the market. Our triple quads have been more targeted at the applied marketplace and the food and beverage segment of the market where we continue to do well. So I think, on balance, I think that's a pretty good picture. I think that the marketplace has suffered, and we continued to look to try to manage our resources and our expenses as prudently as we can. Absolutely, when your growth rates are in the low single-digits, that's tougher to do than when they're approaching double digits. But we feel that we have an obligation to manage the business as well as we can. We don't think that we're cutting into the muscle and sinew of our R&D operations. We've always had a very productive R&D organization. And if you go back 20 years, you'll see that we've spent less as a percentage of sales on R&D than almost everybody in our industry, and we're not spending markedly less as a percentage of sales today than we were then. So we think we're rightsized, but we continue to look at all of our projects, and we will not be constrained to spend on a major project that we think pays off long term.

Okay. Well that's really helpful, and it's a good segue to my second question. Over the years, you guys have always talked about Waters being a mid single-digit to high single-digit revenue growth company. And we're going -- you're going through a second tough year of -- coming up a little bit light of that. With that said, as we look ahead to 2014, the comparisons will be, again, favorable. You'll have a new product that could accelerate demand in LC. So recognizing some positive dynamics, but also the recent trends, how should we be thinking about 2014, at least at this point? Is it fair to think of it as a mid single-digit growth top line year with same type of 1 or 2 points of operating leverage at the operating line and with typical buybacks below the line that give you a few more points? I mean, is that reasonable, given recent...

That's certainly our thinking at this point in the process, Doug. I think you summarized it pretty well. We do firmly believe that this pent-up replacement demand in our biggest customer segments. Now I thought we'd begin to see some of that work its way through. We think 2014 sets up well with that. We have a great new product that I've talked about here, that's not the only set of new products that we'll be talking about as we move into 2014. And you're right, you hate to say a low base prepares you well for the future but that is the fact. I think cautious optimism about next year is a fair picture.

Our next question comes from Tony Butler of Barclays Capital.

Doug, on QDa, does that actually substitute potentially for a higher cost instrument? In other words, on an instrument to instrument basis, are you actually achieving less profit? And then the second question, maybe more for John, who I think answered this but I didn't hear. In Q2, there was a roughly $20 million backlog. Did that all get converted in this quarter? Is there still some left or will it not convert?

Do you want to answer part 2?

Yes. On the backlog side, Tony, we did convert the piece that we thought we would in the Water side of the business. We didn't on the TA side as a result of a late fix to some of the acquired technologies that were in the works. There was a piece remaining that will come out in the fourth quarter per plan. So in sum total, there wasn't a big difference in expectation versus where we landed, though on the TA side, like I said, there'll be a little bit more coming in Q4 than we originally thought.

And in terms of the benchtop quadrupole market, Tony, there -- we and others have sold a single quadrupole mass spectrometer for a number of years. If you go back and look at when we acquired Micromass in 1997, and there are still a few of us left here who were part of that deal. Certainly, Art and I would've said that a major part of the strategic benefit to that would be driving mass spectrometry into the benchtop chromatographer marketplace. And early on, we had some success in that, possibly because of its novelty. But that quickly wore off and really carved out a niche in the purification segment of the marketplace, but never really established a position in the workhorse day-to-day chromatography marketplace. So if you look at our single quadrupole sales over the last several years, they've been de minimis. They have been not a significant part of our market, and they're sold into a specialty segment of the analytical marketplace. So as we launch this QDa, and it's launched at a price point lower than the traditional single quadrupoles, so it is attractive to that analytical marketplace. We expect to get a little cannibalization, if you will, of the existing single quad, but not a lot. It largely is aimed at a new marketplace. We might see a little bit of cannibalization of the high-end traditional optical detector marketplace. But we think, for the most part, this is an incremental revenue source, with margins that are right in line with our traditional margins. So -- and with a price point that's higher than the high-end optical system sale but lower than any comparable benchtop mass spectrometer sale. Does that cover all the bases, Tony? Operator, are you still there?

Our next question comes from Isaac Ro from Goldman Sachs.

I wanted to touch on the pharma dynamic you mentioned specifically with regards to QA/QC portion of the business. Can you put some color there regarding how much of the slowdown there was a function of capital equipment spending and budget delays versus just overall volumes on the consumables front? And the reason I ask is just as we look towards next year, I would assume there should be some positive correlation on QA/QC work as it relates to tell volumes, assuming health care reform actually takes hold. So I'm just wondering kind of what happened this quarter, and what your expectations are going to look like over the next 12 to 18 months as volumes potentially pick up?

Sure, Isaac. Actually, the QA/QC segment of the business was okay. It was much more of the research side of the marketplace that was slow, and that was certainly true in the consumables side of the business, where samples, overall, may be a little bit less in India because of the issues facing the generics. But overall, the chemistry business can continue to crank along. So I would say, while we're seeing -- we're not seeing the kind of pickup in QA/QC moving UPLC in there, the more traditional hardware is doing fine.

And then can you maybe comment on the forward view for the next -- whether it's the next 12 months or 24. But just schematically, what kind of a view you have regarding the potential benefit to QA/QC volumes as healthcare reform goes in the system at least in the U.S.?

Well, I think a segment of the QA/QC market that is likely to pick up is India, where most of that business is QA/QC. It's not research-oriented. And we know that there's pent-up replacement demand in India. So they still have to work their way through the rupee. They still have to make their way through some regulatory issues, but we're finally beginning to see some of the near-term interest pick up in India that says, "You've got to get back to investing for that marketplace." I think in the U.S., I don't think that the dynamics are as noticeable as we look at it today. I'd say what we're expecting is kind of more of the same as we move through the next 2 or 3 quarters.

Okay, fair enough. And if I can sneak in just one more. Any update on the CEO transition process there?

An update on the CEO transition process, I think you've read the announcement -- the Board has very active committee that's meeting very regularly, but we're at the front-end of the process with senior management kind of committed to seeing this process through to a very favorable conclusion. I suspect that we won't have a whole lot to talk about maybe for the next 6 months anyway, Isaac, so absent any unusual events, that's what I'd lead you to think about.

Our next question comes from Peter Lawson with Mizuho Securities.

Doug, just on the pent-up demand in the pharma replacement. How long can accounts delay purchase? And then -- or is that just a structural change that just doesn't return?

I think it's not a finite answer, Peter. I've seen big pharma over my lifetime here at Waters go from a very formal 8, 9, 10-year replacement -- stated replacement cycle on HPLCs to 6-year replacement cycles that was either driven by a perception that technology changed or service costs crossed the productivity timeline. It took you too much to keep an existing system operating versus replacing it. I think what we're seeing now is kind of situational as various companies struggle with kind of what they want to be when they grow up, and you see some companies announcing thousands of people being laid off. In times like that, I think decision-making changes and common processes begin to be talked one way or another. I'd say we clearly have aging systems in the pharma marketplace that are aged greater than they were 3 or 4 years ago. And I just think physics demands that those things build up to a point and then have to be replaced, because the technology other than moving towards UPLC, you're not going to change the process of chromatography as your continued workhorse technology here. So I'm betting, and certainly our plans call for that to kick in. And it's a matter of how much and when, but we're pretty certain that it's a dynamic that's going to kick in.

Do you think biotech is just naturally less capital intensive versus pharma? Essentially, are they more efficient, so as pharma consolidates biotech, does that lead to a step-down in investment?

I don't think so. I think, to some extent, at different phases of their development, biotech invests in different technologies. That's clearly true on the process side where fermentation technologies prevail versus typical small molecule synthesis technologies. I think the downstream applications as -- particularly when you move into things like biosimilars, really works in the favor of our type of instrumentation, where you have to do much greater characterization of molecules as they come off QC to prove that you've got the right molecule synthesized. So I don't think long term that we see the investment being significantly lower. We do clearly see it as being more mass spec-centric in the biotech world. But then again, all mass specs require a very strong HPLC or UPLC on the front end. So I think it's a very beneficial segment of the marketplace, but probably takes a little bit longer to develop from the beginning stages through the full production stages.

Our next question comes from Amit Bhalla from Citigroup.

John, you mentioned in the -- in your comments about potential trialing of competitor products in the high-end tandem quad market. I mean, I was wondering if maybe you and Doug could elaborate on that, why you don't think that, that's competitive share loss and just competitive trialing?

Yes, I think that was me who commented on it. We clearly have seen competitive introductions of new tandem quadrupole instruments in the past several months. And we've seen competitors report that they had a pretty good quarter in that segment of the market that they traditionally have the highest market share. So we're not -- I don't think we're terribly surprised by that. As it relates to market shares, though, that's been a marketplace that we haven't penetrated to a large extent. That's kind of been the province of one of our competitors. So when they're coming off several years of slower growth and they introduce a new instrument, I'm not terribly surprised that they do a pretty good quarter of penetrating in the first quarters of their introduction. I think over the next several quarters, you'll see that modulate, very unusual to see fundamental market shares change on the basis of 1 quarter's dynamic. You got to look at market shares over a longer term period, and when the face of a brand new introduction, like somebody has a strong presence in that segment of the market, that's not surprising. Come back and talk to me in 1.5 years and see if it continues to grow at a double-digit rate in those applications, and I think you'll be on firmer ground saying that fundamental market shares have changed. But I don't think that's likely to happen.

Okay. I'll definitely try to track you down in 1.5 years if you're still around there.

As I've disclosed, I think I'll still be here.

Second question is for John, and it's around the gross margin. Last quarter, the gross margin was weak and you talked about a shift from LC to MS, and now you're talking about a shift within the MS in the gross margin, missed our estimate there again. Can you get into a little more detail, maybe peel apart the margin to help us with the underlying dynamics?

Sure. Within the quarter, FX is still the biggest play on the margin front. The impact of the yen that we've been talking about, that's throughout the year that remains in place. Euro got a little stronger in the quarter, but still at the end of the day when you add up the currency FX versus prior year in the quarter, there's still about 70 bps of margin deterioration versus prior year, which wasn't much different than what we had anticipated. The software amortization costs that are in this quarter on a relatively low sales base as we ramped that product introduction up, cost somewhere around 30 bps in the quarter overall. And then we had a shift of product shipments in Q3 towards Tof, away from triples. There's a meaningful margin differential between the 2, and that added about another 30 bps, which was beyond what we had anticipated at the start of the quarter, so that explains the -- about 130-ish bps in margin deterioration. And again, that's probably the only difference versus guide our expectation would've been that Tof versus triples piece.

And that product shipment dynamic into the fourth quarter, is that not being taken into account like that -- how is the fourth...

No. That is being taken into account. So as I look at the fourth quarter now, I'm assuming that we're going to have stronger Tof business and a somewhat weaker triples business. As Doug had said during the quarter of introduction of new products like we saw in Q3, with a couple of introductions on that front, there's no doubt that people are doing demos, people who are, perhaps, still likely to buy our tandem quadrupole or at least got to look to see what else is out there. So I am accounting for the fact that even in the fourth quarter, we'll continue to see some of that dynamic and we're likely to see better growth in Tofs and triples.

Our next question comes from Dan Arias of UBS.

I just wanted to ask one of the follow-up on the molecule mix question from earlier. Doug, when you look back at the expectations for sort of the mix of large molecules and the drug classes that you thought would drive the business, is that generally in line with what you're seeing now? Or has the protein drug world sort of evolved in a way that's been different from what you envisioned earlier in the quarter?

I'd say in its broadest terms, Dan, it's moving in the direction that we anticipated. All big pharma accounts have talked about moving their development towards large molecules and away from small molecules and have been for many years now. So we're clearly -- have had fair warning about the direction of their development. Certainly, the small pharma startups have been almost all into the field of biotech. I would say the movement of those into therapies has been maybe slower than they and we believed -- and I think the movement into actual production has somewhat slowed the uptake of downstream technologies. So these things have stayed in development longer than people believed. And the movement to biosimilars, which, I think, also is something that's fundamentally attractive to us, has been a little slower than -- a lot slower in the U.S. but slower overall than the industry anticipated. I'd say around the corners and the fringes of the strategy, we've seeing some changes. But in general, this movement, the large molecules, I think, is pretty clearly as described.

Okay. That's helpful. And then just maybe on the strategy side, specifically within the clinical market, how important is partnering there for you guys when you think about how you can be most effective?

I think it depends. In terms of the way we approach the clinical market on kind of an application-by-application basis, we've been pretty successful in developing the applications and things like Vitamin D and things like pain monitoring, where we have largely done those kinds of things on our own. Now we partner in the neonatal business, largely because of the proprietary chemistry capabilities that we didn't have, and we saw it as appropriate to access that marketplace. We're -- there are some interesting things that could emerge on the clinical market that I'm kind of not ready to talk specifically about that might well offer big mainstream applications that if we develop it to a point, we might well think of a broader partnering with somebody who's more intense in the clinical or medical device marketplace. I think that's the topic, probably, for some time next year. But in the applications that we think will build into our 2014 kind of budget, those are things that we think we can largely develop on our own.

Our next question comes from Tycho Peterson of JPMC. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: I want to go back to actually one of the earlier questions Doug Schenkel kind of asked about, the competitive dynamics. And Doug, you made a comment that you're taking share, but I think as Doug Schenkel highlighted, you're growing below some of the peers. So can you maybe just talk specifically about where you are taking share in? Also maybe overlay that with some comments on your pricing strategy. In other words, in a world with more budget constraints, do you have to get a little bit more aggressive on price going forward?

Yes. Sure, Tycho. I think -- although I think I laid it out pretty explicitly. I think the growing more slowly than some of our peers, you have to see chapter and verse. I'm aware of one mass spec vendor who after 3 years of below average growth has talked about 1 quarter of good mass spec growth. So if you consider that a massive share change, then, I guess I've got to give you that. In the LC area, we track -- we have information from the industry. We have industry from almost everybody in the world, who imports LCs, and we have very clear indication that not only are we not losing share in the LC marketplace. Again, over a multi-year period, we're in a difficult market, grant you. We're probably gaining share. So -- and I think TA Instruments, although a smaller part of our business, has very clear indications of the same. Now having a good share position in a very tough marketplace can be -- it's not the strongest place we want to be, but I think those are the facts. A lot of -- almost everybody else in our world is doing significant acquisitions that sometimes muddy the field of what organic growth is and versus acquired growth. So obviously, I can't necessarily see my way through all of those dynamics but I try to look at the core data that I can get through other sources. And I'm frankly just not convinced that any of these share moves are fundamental. So if you've got better data than that, I'd be delighted to look at it, but I have trouble getting my hands on it, Tycho. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: And then just how about thoughts on the pricing strategy then? Do you need to be a little bit more flexible on price in a budget-constrained environment?

The question about -- I guess, should we lower price is the question. I think that's a terrible idea. I think between Art and I, over 30 years in this industry with regularity, both internally and externally. People have suggested that we should cut our prices to gain market share. We've successfully fought off that strategic initiative for 30 years, and I think the long-term evolution of this marketplace is, I think, the same as it was 10, 15 years ago. The customers want performance, they want productivity, they want service, they want reliability and they continue to tell us that price is very low on their list, assuming that they can get everything else. I think we'll stick with the strategy that we've employed. I don't see anything out there that suggests this time is different. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Okay. And then for John, just 2 very quick ones. As we think about '14, I know you kind of gave some preliminary color on the top line. Any thoughts on the cost side, I mean, given your experience in '13, should we think about a consistent approach to cost management? Or will you bake in a little extra cushion? And then longer term, one of the uncertainties is tax rate, how do you think about your tax rate in Singapore over time? Any preliminary discussions on where that could go?

Yes, I think from an operating leverage perspective, Tycho, we would be continuing to look to provide some level of operating leverage, even if we continue to live in a mid single-digit type world. Yes, it's tough to do that, but as Doug said, it's our obligation to find ways to do that, so we'll be able to create operating leverage at that top line rate. We will be able to continue with the share repurchase programs being the fundamental use of cash. And then on the tax rate side, I mean, outside of the R&D tax credit that kind of doubled up this year, I don't see any reason that our tax rate is going to go up or down for mixed reasons as I think about '14. As we think about beyond '15, we do have to consider that we do have a treaty with Singapore that expires, that we will be looking to see how we manage that. That will be an activity that will take place probably mid next year to get ready for that in early '16. So it's a little early to say what -- how much success we'll have on that front. But to the extent that we don't, there's probably a point or 2 of overall impact that could be negative as we think about the rate all the way up to '16. But certainly for '14, I would say, on the side of it, of not doubling up on the U.S. tax credit piece, there shouldn't be a meaningful change in the tax side.

Operator, we've hung on here for a while, past our normal closing date to kind of be sensitive to people's morning schedules. Maybe we could take one more question and then call it a morning.

Brandon Couillard from Jefferies, your line is open.

Doug or John, if you could just elaborate on the dynamics you saw within the industrial end market between, both the applied categories and the more cyclical chemical industrial accounts? How is it pacing to the third quarter especially within that segment?

I would say that we saw stronger performance in the applied segment of the marketplace. We're seeing a great deal of interest in some of our new technologies, including our new ROI system from the main line chemical industrial players. But it's early on as they think about switching segments of their marketplace. John, in TA...

TA had a good quarter actually right across the 3 months, and they had a somewhat strong product line. They had, across the quarter, as we said, a backlog that helped a little bit, not to the extent that we thought, but I would say, right across their end markets. They saw reasonably good demand. They didn't have as much of a government impact in the U.S. as we might have thought. So I would say that as we look at TA's business right across their various segments, there isn't one that stood out as being meaningfully weak. It was across the board.

John, on the buyback front, looks like a little bit slower activity here over the past few quarters than is traditional. Would you still expect to do 100% of free cash flow in the share repurchase this year?

There's no doubt that we did have a situation with the window being closed a bit longer in the third quarter, so the buying opportunity was a bit limited. So we will pick that pace up in the fourth quarter to get that closer to the targeted level of about $300 million or so in repurchases. So I'd say there's -- nothing's changed in our strategy, with the announcement that went out late August, we kept the window closed just to be safe.

Okay. Operator, I think we'll close it off at that point. I want to thank everybody for their attendance and we'll look forward to talking to you again in January. Thank you.

This concludes today's conference. Thank you for participating. You may disconnect at this time.