Good morning. Welcome to the Waters Corporation third quarter 2017 financial results conference call. All participants will be able to listen only until the question-and-answer session of the conference. This conference is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. John Lynch, Vice President of Investor Relations. Sir, you may begin.
Thank you, operator, and good morning, everyone, and welcome to the Waters Corporation third quarter earnings conference call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company for the fourth quarter and full year 2017. 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 Form 10-K annual report for the fiscal year ended December 31, 2016, in part one under the caption "Risk Factors" and the cautionary language included in this morning's press release and Form 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 release call and webcast is currently planned for January 23, 2018. During today's call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is attached to the company's earnings release issued this morning. In our 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 titled Quarterly Reconciliation of GAAP to Adjusted Non-GAAP Financials included in this morning's press release.
Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal year 2016. In addition, unless we say otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis. Now, I'd like to turn the call over to Waters' Chief Executive Officer, Chris O'Connell. Chris?
Thanks, John. Good morning, everyone, and thank you for joining us today. Along with John Lynch, joining me on this morning's call is Sherry Buck, Waters' Chief Financial Officer. During today's call, I will provide an overview of our Q3 and year-to-date operating results, as well as some broader commentary on the business. Sherry will then review financial details for our reported results and provide an update on our Q4 and full-year 2017 financial outlook. We will then open up the lines for Q&A. In summary, we are very pleased with our third quarter results, where we delivered solid revenue growth from each of our major customer-defined end markets, as well as across all of our major product lines, well-balanced between Instruments and recurring revenue. Geographic strength continued in Asia and Europe, and importantly, we saw another quarter of sequential improvement in the United States.
Third quarter revenues in total were up 6% compared to the same period in 2016, which built nicely upon our consistent quarterly results in the previous two quarters of 2017. This Q3 performance led to year-to-date revenue growth of 6% and a very strong P&L featuring operating leverage and consistent double-digit earnings per share growth of 13% for the quarter and 13% year-to-date. Additionally, we delivered another quarter of strong free cash flow, bringing our year-to-date growth in free cash flow to 11%. Taking a closer look and starting with a review of our market categories at the corporate level, sales to our broadly defined pharmaceutical category grew 5% in the quarter, which is encouraging against a strong low-teen base of comparison in the prior year. Our pharmaceutical growth was led by strength in large molecule and biomedical research applications.
Geographic growth was balanced between our developed and emerging markets. We also absorbed some headwinds from the natural disasters in the Americas and meaningful timing delays in India caused by our customers' implementation of systems to accommodate the new goods and services tax protocols or GST. Year-to-date, overall sales to our pharmaceutical markets were up 6% against a strong prior-year performance. Our ongoing strategy work continues to emphasize the vast opportunities in our core pharmaceutical business, where we believe we are very well-positioned to benefit from rising global regulatory standards, increasing patient access to medical therapies, and growing volumes of biologic therapies that require more demanding analytical testing methods. Sales to our worldwide industrial category, which includes the materials characterization, food, environmental, and fine chemical markets, grew 5% in the quarter, led by strength in material characterization.
Overall, we have seen encouraging growth across applications within our industrial markets, where year-to-date sales are growing 7%. Looking at our governmental and academic category, we saw sales grow by 13% in Q3, with broad-based performance across all major geographies. In the quarter, we experienced strength in spending from academic institutions focused on biomedical and omics research. Now I will review product line dynamics within our Waters and TA brands. Waters-branded Instruments sales grew 4% in the third quarter and are growing 4% year-to-date. Within Instruments, I would like to particularly highlight our bench top LC tandem mass spec systems led by our higher-end Xevo TQ-XS, as well as the workhorse Xevo TQ-S micro. Mass spec continues overall to grow solidly in the quarter and consistently year-to-date.
As we have commented on in the past, we continue to see the expansion of mass spec technology into routine use quantification workflows, primarily in food safety and biopharmaceutical applications. The development of our tandem quad Xevo platform has enabled us to meet evolving demands for reproducible quantification capabilities for both small and large molecules. Waters-branded recurring revenues, the combination of service and precision chemistries, grew 8% in the quarter and now represent approximately 50% of our Waters business. Recurring revenues were driven by global strength of our service, HPLC and UPLC application kits, and our complete chemistry offerings. Year-to-date, our precision chemistries and service revenues have grown at 7%, indicative of high utilization rates for our installed base of Waters Instruments. Turning to our TA product line, sales grew by 9% in the quarter, bringing our year-to-date growth to 7%.
Instrument sales for TA grew 12% in the quarter and continue to be led by our new Discovery line of thermal analyzers introduced in 2016. This strong quarterly result also benefited from the growth of rheology and high-temperature thermal systems. We are well-positioned to capitalize on market trends of rising innovation in highly engineered, high-performance materials. Finally, I will review our performance by geography at the corporate level. Asia, our largest region in terms of revenue, grew by 8%, again led by China, which grew faster, as well as Japan. Our China operation saw solid growth from all of our core markets. Within the pharmaceutical category, growth drivers continued to include new regulatory requirements for China's Food and Drug Administration. In the industrial category, China experienced strong growth across our materials characterization, food testing, and environmental customers.
Japan continued to benefit from strength in governmental and academic customers and steady growth from pharmaceutical customers. As mentioned previously, disruptions associated with customers' implementations of the new GST reporting system impacted our results in India in the quarter. We expect this situation to smooth out over the next couple of quarters with continued solid overall performance of our Indian business. Turning to the Americas, sales were flat in the quarter with our U.S. sales up 1%, despite headwinds from recent natural disasters in the broader region. Macroeconomic and governmental policy uncertainties that we talked about last quarter still persist, affecting general business activity in the United States. But we are seeing steady sequential improvement in line with our expectations. We are looking for continued improvement in the U.S. growth trends based on our strong product and market position.
Europe was a strong contributor to the third quarter, with sales growing 13%, highlighted by broad-based growth from our pharmaceutical customers across product categories and throughout the region. We saw strength in biopharma applications, where we are well-positioned with our targeted LC-MS and a biomolecule separation solution. We also saw strong service revenue from our large and growing base of installed systems. Commenting further on Europe, I was able to spend some time in the region this quarter with customers and employees. In addition to a deep dive into our high-potential Eastern European operations, a highlight of this trip was my visit to the Waters operation in Brașov, Romania. The Brașov team has grown steadily over the years into one of our top operational sites worldwide.
Recently, this site became Waters' Informatics Center of Excellence, supporting development of our Empower Chromatography Data System, UNIFI software technology, and NuGenesis lab management system, as well as the development of LC-MS and TA Instruments drivers. During my visit, we dedicated a modern new facility designed to enable collaboration and innovation. Our informatics offering is a key differentiator for Waters, and Brașov is a significant contributor to this strength. As we head into the home stretch of 2017, I am pleased with the consistent top-line and bottom-line results the company has delivered for the first three quarters of the year. We also remain steadfastly focused on our five-point value creation model. As I've consistently communicated, we aim to create shareholder value by, first, holding a unique and highly differentiated position in structurally attractive markets. Second, executing a clear growth strategy driven by organic innovation.
Third, seeking opportunity for continuous operational improvement. Fourth, being a disciplined capital allocator. And fifth, operating with a performance-oriented culture and management team. Finally, I'd like to comment on last week's announcement regarding the retirement of Doug Berthiaume as Chairman of the Board of Directors and my election as the new Chairman, effective January 1st, 2018. You all know Doug as a visionary leader who built the modern Waters and created significant value for shareholders. His achievements as Chairman and CEO have profoundly impacted our customers, employees, shareholders, and the broader community. During the past two years in his role as non-executive Chairman, Doug has been an invaluable mentor for me and orchestrated a smooth and productive transition. On a personal level, I am grateful for his example and his support and will continue to utilize him for advice and counsel.
More broadly, in my view, Waters has always been a model for good corporate governance with a rigorous cadence of board meetings, robust transparency practices, and a strong lead independent director. As part of this, I am pleased that Tom Salice will continue in his position as Lead Director, working very closely with me to sustain and continuously enhance our governance practices. Furthermore, I will continue our efforts underway to ensure the optimal mix of backgrounds and capabilities of our directors through our ongoing board development program. This initiative has already resulted in the recruitment of Dr. Flemming Ørnskov, CEO of Shire Pharmaceuticals, as a new Director of Waters. Flemming has now participated in two board meetings and has added valuable new insights to the board and management team. I look forward to continuing to develop our board to ensure the highest possible quality and effectiveness of our governance practices.
With that, I'd like to pass the call over to Sherry Buck for a deeper review of our third quarter financials. Sherry?
Thank you, Chris, and good morning, everyone. We recorded net sales in the third quarter of $566 million, an increase of about 6% before currency translation, which increased sales growth in the quarter by about 1% and resulted in 7% reported sales growth. In the quarter, pharmaceutical markets grew 5%, our industrial markets also grew 5%, and sales to academic and governmental customers were up 13%. Product line growth was strongest in our recurring revenue, with a combination of precision chemistries products and service revenue growing 7%, while instrument sales grew 5% in the quarter. Breaking that down further, sales relating to Waters' branded products and services were up 6%, while TA's grew 9%. Combined LC and LC-MS instrument platform sales increased by 4%, and TA's instrumentation system sales grew 12% as we continue to see the benefits of new product introductions.
Our total recurring revenues associated with both Waters and TA products grew by 7%. Looking at our growth rates in the third quarter geographically and before currency translation, sales in the Americas were flat, with sales in the U.S. increasing 1%. European sales were up 13%. Sales in Asia were up 8%, led by strong growth in China and Japan. I'd like to comment on our third quarter's non-GAAP financial performance versus the prior year. Gross margins for the quarter were steady, coming in at 58.3%. Positive mix dynamics and product manufacturing efficiencies were offset by approximately 30 basis points of currency headwinds from higher costs as a result of the U.K. pound and the euro. Moving down the third quarter's P&L, operating expenses were up 5% on a constant currency basis. Foreign currency translation increased operating expense growth by about 1% on a reported basis.
Year-to-date, sales have grown about 1% faster than operating expenses. On the tax front, our effective operating tax rate before the effects of the new stock compensation rule for the quarter was about 14%. This is the result of the mix of our legal entity profits in the quarter. Including a three-cent benefit from new stock option accounting rules, the non-GAAP effective operating tax rate was about 12%. In the quarter, net interest expense was $5 million, down about $1 million from prior year. Our average share count came in at 80.5 million shares, or approximately 900,000 shares lower than in the third quarter last year. This is a net effect of our ongoing share repurchase program. During the third quarter, we bought 437,500 shares of our common stock for $79 million.
Our non-GAAP earnings per diluted share in the third quarter were up 13% to $1.77 in comparison to earnings of $1.57 last year. On a GAAP basis, our earnings were $1.69 versus $1.53 last year. Both our non-GAAP and GAAP earnings include a benefit of three cents resulting from the new stock compensation accounting rules. The impact of foreign currency translation in the quarter on earnings per share was a positive one cent, keeping the year-to-date impact about neutral. A reconciliation of our GAAP to non-GAAP earnings is attached to our press release issued this morning. Turning to the balance sheet, cash and short-term investments totaled $3.3 billion, and debt totaled $2 billion, bringing us to a net cash position of $1.3 billion. We define free cash flow as cash from operations, less capital expenditures, and excluding special items.
In the third quarter of 2017, cash flow was strong and came in at $134 million after funding $20 million of capital expenditures. Modest improvements in working capital efficiency and disciplined capital spending contributed to our cash generation. This represents both a strong quarterly performance and year-to-date growth of approximately 11%. Accounts receivable days sales outstanding stood at 73 days this quarter, which is down 2 days from the second quarter of this year and 3 days compared to Q3 of last year. In the quarter, inventories were approximately $298 million compared to $303 million in the third quarter of the prior year, which was in line with our expectations. As we look forward to the balance of the year, I'd like to share our full year and fourth quarter 2017 guidance.
Our outlook generally assumes continued global growth and demand from our end markets and consistent growth in our recurring revenue. Bringing this all together, we continue to expect constant currency sales to increase 5%-6% for the full year. At current rates, currency translation is assumed to be neutral for the full year. Our outlook for gross margins for the year is consistent with our previous guidance in the range of 58.5%-59%. Higher volume and manufacturing efficiency gains are expected to continue to be offset by negative effects from foreign currency translation. Our plan for the year is to continue managing operating expense growth at a rate that is less than our sales growth. Moving below the operating income line, net interest expense is expected to be approximately $22 million.
We estimate our full-year tax rate, including an expected benefit to earnings per share of approximately $0.19 due to new stock option accounting rules, to be about 12%. This is comprised of approximately $0.17 benefit realized year-to-date, plus an assumed amount of $0.02 in the fourth quarter of this year. Quarter-to-quarter variation will reflect the timing of actual stock option exercises and our stock price. We continue to provide a reconciliation of this item for the remainder of 2017. Our guidance regarding capital allocation assumes continuation of our share repurchase program for 2017 at a rate that will result in average diluted share count of about 80 million shares outstanding. Rolling all this together and on a non-GAAP basis, full-year 2017 earnings per fully diluted share are projected to be within a range of $7.38-$7.48.
At current rates, the foreign currency impact on full-year earnings per share growth is expected to be about neutral. Looking at the fourth quarter of 2017, we expect constant currency sales growth in the range of 3%-5% against a very strong base of comparison, as well as another quarter of likely impacts from hurricane-affected areas. At today's rates, currency translation is expected to positively impact fourth quarter sales growth by about 2%-3%. Combining these top-line factors with our moderate increase in expenses and assumed $0.02 of tax benefit due to the new accounting standard, we estimate fourth quarter earnings per diluted share in the range of $2.38-$2.48. Now I'd like to turn the call back to Chris. Chris?
Great. Thank you, Sherry. As we move into the fourth quarter, we will continue to emphasize execution in our core businesses and delivering on our operating performance objectives. As we have stated, we will seek to balance growth, operating leverage, and investment in the business. With that, we will now open the phone lines for Q&A. We are rarely able to get to everyone's questions, so please limit yourself to one question and one follow-up. If you have additional questions after the call, please contact our investor relations team. Operator, may we have the first question, please?
Thank you. Our first question or comment comes from Tim Evans from Wells Fargo. Your line is open.
Hi. Thank you. Can you perhaps give us a sense for how big the hurricane impact and the India GST impact was in the quarter, and maybe also how big you're expecting it to be for Q4?
Sure, Tim. Thanks for the question. We estimate that these one-timers that we referred to in the call hit our top-line growth rate by about 1%, and that was roughly equally split between the natural disasters in the Americas region and the India GST. As we commented, those factors will look a little bit different in the fourth quarter. We think that the India GST situation is working through as we speak, and while we may not be completely out of the woods, we expect to recover that business steadily over the coming two or three quarters. That is really simply a delay in orders and shipments. From a natural disaster standpoint, it was really the U.S. that took the majority of the hit in the third quarter, where some of that risk shifts to Latin America for the fourth quarter.
Hopefully the impact will be somewhat less in Q4 than we saw in Q3.
Okay, I'll leave it there. Thank you.
Thank you. Our next question or comment is from Tycho Peterson from JP Morgan. Your line is open.
Hey, thanks. Chris, I want to ask a little bit about the bifurcation growth you're seeing out of Europe versus the U.S. The particular subsegments in Europe that are driving 13% growth this quarter, that certainly stands out. And conversely, here in the U.S., I noticed industrial slowed a little bit sequentially versus an easier comp. Is that kind of dragging down the U.S. market?
Sure. Thanks, Tycho, for the question. There is definitely a bifurcation, as you point out, between the U.S. and Europe. I will first make a comment more on the pharmaceutical business. As you know, the pharma business is a very global business, and clearly in our experience here in the short term, we are seeing the larger multinational pharma companies favoring the more friendly operating environment in Europe right now. That is obviously driven by a more certain environment on tax and regulation and trade. The U.S. does feel like it has been in a little bit of a wait-and-see mode, but like we have said on the call, we definitely saw a sequential improvement in that tone in the U.S. Certainly Q2 was better than Q1, and Q3 was better than Q2, so hopefully we are stepping out of that.
As you know, sometimes these companies have cycled their purchasing activity between the U.S. and Europe, and that is what we think we are seeing right now. In the Industrial sector, we actually saw growth in both the U.S. and in Europe, which was encouraging. Our industrial performance is pretty broad-based right now. In Academic and Government, we also saw growth in both the U.S. and in Europe. Really, the U.S. versus Europe question is really trading off pharma demand. But like we said, we are very encouraged with pharma demand overall. We think pharma demand is healthy despite the near-term U.S. shift. The pharma growth that we saw in the quarter was obviously on tough comps as well as absorbing some of those one-timers that we just spoke about a few minutes ago.
Okay. Just for the follow-up, I know on biopharm, if you could just comment a little bit on where you are feeling better or worse. I know you like to talk about the increasingly broad customer base there, and I know you highlighted large molecule, but we get a lot of questions on the generic side given some of the headlines there. So I am wondering if you can comment on what you are hearing from those customers as well.
Yeah. I think a lot of the themes we saw in the quarter, Tycho, were pretty similar to what we have been seeing all year and what I have been seeing over the past couple of years. The demand in generics is good. There is obviously some headlines with some bigger companies out there, but again, keeping in mind that even in some of the larger generics companies that have had some difficulty, our business is much more a function of volume and production than it is about, say, new initiatives. But the generics market is very broad-based. Certainly, the Indian business has been consistently strong despite the short-term dislocations with system implementation on GST. The U.S. continues to see new investment in generic categories from startup companies and mid-size companies. As I alluded to in the call, the biopharm market has been really solid.
Again, we continue to see the majority of the innovator companies focusing their investments on new analytical techniques for biopharma. As you heard at our Analyst Day and in subsequent investor conversations, we continue to highlight our strategy to win in that environment.
Okay. Thank you.
Thank you. Our next question or comment is from Dan Leonard from Deutsche Bank. Your line is open.
Thank you. Chris, how are you thinking about the opportunity on the margin side as you head into 2018?
Sure. Margin is, as I pointed out in the call on the value creation model, our margin philosophy and approach is to look for continuous improvement. We operate at strong margins. As I've said before, I think our margin profile is a unique reflection of our business model, and the concentration we have in highly attractive end markets and technologies, and is not a reflection of being optimized in any way. We have a strong operational improvement initiative underway where we think we can achieve modest ongoing operational improvements. If you look at our P&L year-to-date, we've delivered operating leverage in the quarter and year-to-date on both a reported basis and a constant currency basis. I think that mentality is going to continue into 2018. We're not giving guidance on 2018 yet, and we'll certainly do that in the January call.
We will be looking at another solid year of revenue and looking to drive some modest operating improvements while continuing to invest in future growth, particularly in R&D. Maybe I'll take a moment while you raise that just to comment, but one of the things I like most about our P&L, both quarter-to-date and year-to-date, is that we've achieved really nice leverage on the SG&A line while investing in R&D. Our year-to-date R&D investment on a constant currency basis is up about 10%, and that's really a reflection of our strong desire to continue to lead the industry in organic innovation.
Appreciate all that color. Thank you.
Thank you. Our next question or comment is from Derik De Bruin from Bank of America. Your line is open.
Hi, good morning. Hey, a couple of questions. The first one, Sherry, just a question. You are doing a $0.19 tailwind from the stock-based comp this year. I guess, can you talk about how you are looking at what that would translate over into 2018? Obviously, the follow-up question, obviously, if there is tax reform, you are going to be able to repatriate some cash. Can you talk about what cash is overseas and what your initial thoughts would be? I assume you would use some of that to buy back shares, help offset this. Love to sort of walk through the dynamics on the pushes and pulls.
Sure. That is a really good question on the stock compensation impact for next year. I would say it is a little bit too early, as Chris talked about, for our guidance for 2018. Probably the best commentary I can provide is really think about our operating tax rate. We would expect that to remain consistent in the mid-teens, as you have seen this year. Then switching to your next question on tax reform. As we have shared, we have had a team internally looking at the tax reform, and we have an ad hoc finance committee meeting that is helping us also in this arena. I would say for us, we have a lot of optionality. We obviously would look to continue our share repurchase program, but it will free up quite a bit of cash on our balance sheet.
As we think about deploying that, looking to invest in the business is important to us, looking at our debt profile as well as return to shareholders. We think we have a lot of options, and we are going to watch closely with the details as the tax reform emerges and put a fine point on it when we have some more details. I know, Chris, if you would like to add anything else.
I think that is well said, Sherry.
Okay. Follow-up question. I just wanted to walk through the EPS bridge for the full year. It looks like by my math, you were about a - 2% FX headwind before. Now you are talking about an additional one set of benefits. That is like a $0.14 increase by my math. Then, obviously, the increase for the full year is not as high as we would have thought, sort of based upon that math. I guess, what is going on with the underlying business? It looks like it is a little bit lower. Can you just walk through the EPS bridge?
Yeah. As we are looking at the EPS bridge, basically as we look at our guidance, we are flowing through our Q3 beat and just a little bit of the FX. As Chris mentioned earlier, we are taking some of the FX upside and investing in the business through R&D. The R&D year-to-date, up about 10% on a constant currency basis. So really trying to balance the benefit of some of the operating leverage and investing in the business.
Great. Thank you.
Thank you. Our next question or comment is from Doug Schenkel from Cowen. Your line is open.
Good morning. What was core revenue growth by each sub-segment within the food, environmental, and core industrial category? Could you provide any relevant details on trends within each sub-segment by geography?
Doug, I think we are not going to go break out those details at that level of granularity. I point you back to some of our general commentary. Our industrial business was quite well-balanced, actually, across many of those different categories in food and materials characterization, and environmental. It was really well-balanced across our major geographies. U.S., Europe, and China were all in positive territory on industrial. India was slightly negative, in part due to the GST tax implementation, but is a much smaller number in industrial, as you know, with the bigger pharma business. I would just look at both the quarter results, but also on industrial, the year-to-date results and last 12-month results, all in positive territory in the U.S., China, and in Europe.
Okay. Just flipping back to biopharma. You have had a good year, but your biopharma revenue growth for the year has lagged the broader tools group, at least the last couple of quarters. This may simply be a function of your concentration on certain product classes and company-specific comparisons. That said, Chris, how comfortable are you that competitive share shifts are not also a factor?
Yeah. I guess as you sort of allude to, Doug, the basic comparison in the last two quarters of low teens growth in prior year has to be taken into consideration when looking at our pharma growth rate. We have been really rock solid at 6% pharma growth, both year-to-date as well as last 12 months and over almost any rolling period. I am confident that we are doing well from a share standpoint in the pharma business. If you compare our results over almost any rolling period to competition, I think you will see that. We obviously do the best we can to look at market share data from different sources like SDi and the ALDA survey. All of those surveys tend to reinforce the same point. As you know, share can be very sticky in these markets.
We have done a good job innovating and holding onto share. Certainly, there are some categories where we've seen some pressure, like high-resolution mass spectrometry in recent years. We also are continuing to invest in new technology that will turn that in the other direction. In the heart of the LC-MS world, we've done very well from a share standpoint, we believe, especially with the broadening of our Xevo product line that I talked about earlier in tandem mass spec. As those two technologies continue to grow together in utilization, we think we're well positioned for share gains in the future. In our core LC business, we've got a very strong base of share that's really headlined by not just our multiple technology categories of HPLC and UPLC, but also our Empower Chromatography Data System.
Keep in mind, we own about two-thirds of the market for CDS, which gives us great visibility into what's happening with Instruments in the market, and is a major competitive advantage that only continues to be enhanced. We do try to study the share question as much as we can, but feel good about where we are.
Okay. That's really helpful color. Thank you.
Thank you.
Thank you. Our next question or comment is from Jack Meehan from Barclays. Your line is open.
Thanks. Good morning, guys. Chris, I was wondering, could you elaborate on the industrial trends in the quarter? Obviously, a great result from TA. As you think about the fourth quarter, you have a little bit of a tougher comp there. If you could talk about the setup, that would be great.
Sure. As you point out, the industrial has been a good story all year long. Just to reiterate, our industrial growth year-to-date has been 7% and actually the last 12 months has been 9% because, as you allude to, we did have a strong fourth quarter in industrial last year. I would say that the balance in our industrial performance is really good between TA and those Waters categories. TA has really come on strong this year. TA's had a year, as you've seen, that's developed well over the course of the year. This quarter, we saw double-digit instrument growth out of TA. That's really a reflection of this, we believe, is really a winning product strategy around the Discovery line of thermal analyzers, which as you know, has been rolling out steadily since mid-2016.
We're still in the process of maturing that overall portfolio of tiered Instruments for all the different thermal applications. I think we're also encouraged by the performance of some of the more recent acquisitions of TA. As you know, TA has a bit of a drumbeat of small tuck-in product line acquisitions, like the ElectroForce Group and Rubotherm, and things we've talked about in the past. A lot of those are also beginning to scale a little bit and give us strength and even a broader footprint in some of these industrial markets. Obviously, we watch this closely. When we came into the year, we were setting out to have good balanced growth between pharma and industrial, and I think that's what's played out over the course of the year, and I think one of the more satisfying aspects of the year-to-date so far.
Great. Then just one for Sherry. You mentioned on gross margins, FX was about a 30 basis points headwind. That would imply about flat year-over-year otherwise. Could you just talk about some of the mix impacts in the quarter, whether it is product- or end-market-driven , that got to that result?
Sure. So any quarter, we have a lot of pushes and pulls on the gross margin. So, some positive mix dynamics and manufacturing variances were a help. Some of the pushes on it, we had a pretty strong service quarter, and so, as you know, that is a kind of a headwind to our gross margin, but it helps us on the operating margin. Our U.S. performance, with it being, it has been improved, but not as big a part of the total. That is also a little bit of a headwind on the gross margin. So you put all those things together, and with the FX, that gets us to our gross margins for the quarter.
Makes sense. Thanks.
Thank you. Our next question or comment comes from Steve Beuchaw from Morgan Stanley. Your line is open.
Hi, thanks. First, just a couple of housekeeping items for Sherry, and then I have one for Chris. Sherry, there are some new revenue recognition rules coming into play for next year. Have you had a chance to take a look at those, and to see if you have any sense whether they will impact, particularly on service, any of the rev rec accounting? Also for Sherry, it seems like currency for next year is probably going to be, I do not know, maybe 3%-4% positive to the bottom line. Is that anywhere close to what you are thinking? Again, I have one for Chris.
Sure. On the revenue recognition, our team has been doing quite a bit of work on that globally just to understand the impacts of it. While we are not totally complete with everything, our current assessment would be that it would not have a material impact on our revenue line or the service contracts at this point in time. Your other housekeeping question about FX for next year. It is a little too early to be giving guidance for 2018. We will do that in January. I would say, looking at today's FX rates, it would be just a slight positive tailwind. I would not be thinking as high as 3%- 4% based upon today's rates, but too early to call, obviously, since we are not in 2018 yet.
Okay. Thanks, Sherry. Chris, look, we have covered a lot of details here in the Q&A. I would love to just open it up to you and ask a real simple question. It is like, over the next, I do not know, quarter or year, you can pick the time horizon. If you want investors thinking about one thing that you are really excited about that is a driver of the top-line growth for Waters that you think people might underappreciate, what is that? I will let others jump in here. Thanks.
Sure. Thanks for the question, Steve. It is a good time to think about those things. We have just completed our second annual strategic planning process. We had a great discussion with our board of directors last week in New York. One of the things that I have gained a deeper appreciation for, I guess, I have been on the job a little more than two years now, is just the opportunity out there. I think there is more opportunity in this business than I even appreciated when I first came in. That really is a function of the inexorable desire of the world to gain even deeper insights into the molecular structure of material of all type, whether it is drugs, food, or materials.
I think as we look at our long-range plans and we look at our technology roadmap, making our technology more accessible to more users to really open up that opportunity, not just in pharma, but in our other categories, is a big opportunity. I'd say at the very top of our list is something that I've mentioned in some previous settings, including your conference, which is just the rise in analytical rigor around biomolecules, and the opportunity to move LC plus mass spec workflows into routine regulated applications. We've talked a little bit about our BioTOF program, and there's a lot behind that as well. But I think there's some things out there that could lay the foundation for sustainable growth for a long period of time.
As we put more specificity around workflows and applications and informatics for the other vertical markets, we think that this is a great market development opportunity overall. I think what I'm most excited about is we really hold all the cards in this deck. We have a very strong position, as you know, in chemical separations, in mass spectrometry, particularly the integrated use of mass spectrometry. Of course, precision chemistries and the informatics that makes it all work together and comply with regulation and compliance needs. I know that's a bit of a long answer, but that's the opportunity that's on my mind. It's up to us as the management team to be very disciplined on how we continue to deliver strong results and growth, but also balance that margin expansion with the investment in the business to get after these opportunities.
Really appreciate that. Thanks so much.
Thank you. Our next question or comment is from Dan Arias from Citigroup. Your line is open.
Yeah, good morning. Thank you. Chris, within mass spec, can you just put some color to your comments there? You came back to the expansion of the application base in MS. At this point, are you seeing higher growth from routine testing, or is it more the discovery research segment? Just curious how the split looks by usage, if there is, in fact, a difference.
Yeah. It's a good question, Dan, and actually, as I highlighted in the note, we've been encouraged by our mass spec performance this year. We've had a really solid mass spec year, both in the quarter and year-to-date, and that strength is broad-based. We are seeing, I think, the beginnings of what I alluded to there in the prior question about the movement of mass spec into the heart of product development and even working its way even further downstream into QA/QC. But discovery's been robust, but it's also been robust in the applied markets. Our tandem quad portfolio, in particular with Xevo, TQ-XS, and TQ-S micro is showing its strength in the food and some of the chemical application areas as well. Again, somewhat of an outside-in view coming into the company.
I really do see mass spec over time playing out as a much more broadly utilized tool in more simple formats that go well beyond some of the research applications that it's traditionally been known for.
Okay, helpful. If I just maybe could ask one more question on the setup within the customer classes. If I just look at the coming quarter, the comp for biopharma is 6%, I believe, which is less than what it was this quarter. If you just look ahead at 4Q, do you think you could finish the year a couple of points higher in biopharma? Or is 5%-6% in line with what you've done year-to-date still the way to think about it?
Dan, I guess I'd just comment that what we always typically say, which is we look at the long-term historical growth rate of the markets, which we've very much been tracking on sort of a rolling basis, as we've said. We continue to strive for that and strive to overachieve it where we can. Obviously, year-end dynamics will play into that. I think we're continued to look at the business as a global business. We're cautious in the U.S. at this point, but cautiously optimistic, we think. We're not assuming everything goes right in terms of our guidance, so we'll continue to take step by step. But the main point is that we think the pharma market is healthy overall, is a very attractive and increasingly attractive market looking forward.
We'll just continue to stay laser-focused on it and getting as much as we can.
Okay. Thanks much.
Thank you. Our next question or comment comes from Amanda Murphy from William Blair. Your line is open.
Hi. Good morning. I actually had a similar question to Dan, just in terms of the LC side of the business. Obviously, you've talked about, or just talked about growth in generics and how that's been a continued driver as well as strength in biologics. I just was wondering if you could help us understand how the mix looks like in the install base at this point, so between the Alliance platform, and then some of the UPLC products, what does that look like and how has it changed? How do you expect it to change, and what's the contribution to growth from both sides at this point?
Sure. Yeah, on the LC business, Amanda, that's a good question. We continue to see pretty good balance actually between our HPLC and UPLC platforms. At this point in time, Alliance and HPLC is still bigger in terms of units than UPLC. Also don't forget the ACQUITY Arc system, which is a hybrid system that can bridge those methods. So we have a pretty robust portfolio, and we continue to develop enhancements to that platform alongside our informatics platform because it's really LC plus optical detection plus Empower Chromatography Data System as an overall system solution that is really the offering in the marketplace that serves particularly that generic customer as well as a wide variety of other types of molecules.
It's not just the LC component, but it's actually the system, and that's why you hear us talking so much about more of a systems orientation and systems engineering and transformational engineering and the things we can do uniquely by pulling all those things together.
Got it. Okay, then I just also had another question on China. So one of the other areas that you've talked about in the past as being a driver of growth is traditional medicine. I just was curious if you had any context around how big that market could be for you. If you think about China, it's obviously growing quite well, but how much of that market is driving the growth at this point? Again, thinking going forward.
Yeah. That's a good question. TCM is definitely a unique aspect of the China market. It's hard to predict, I think, or even get our arms around how big that could be, but it's an important market. The data point that I always love to hear and see is that the Chinese population takes prescriptions in equal amounts for TCM-type products as well as traditional medical therapies. Yet the labeling requirements and the testing methods around TCMs are small but growing quickly. So there does seem to be a genuine interest on the part of the Chinese regulators to continue to enhance the labeling requirements and the testing requirements for TCMs, and we think that's a long-term tailwind. Those are pretty niche applications now.
But we definitely see TCM, and I'd also throw in food and food testing alongside TCM, as categories that are seeing increasing regulation within China. China has been a great story for the company. We've had a very strong year-to-date in the last 12 months and quarter itself in China. The thing that continues to impress me about China is the balance and the breadth of that growth. China's actually less concentrated in pharma than a lot of other markets. It's more concentrated in food and materials than other markets, and even within pharma, has a lot of diversity in terms of generics, innovator drugs, and TCMs.
Okay, thanks very much.
Thanks.
Thank you. Our next question or comment is from Patrick Donnelly from Goldman Sachs. Your line is open.
Great, thanks. Chris, I know you guys aren't the best proxy for government academic market given your relatively small exposure, but certainly saw some notable growth there. Can you maybe just talk through where you saw particular areas of strength and then maybe just the focus on the U.S., which you saw with the lab budgets here?
Sure. No, actually, Patrick, you're exactly right. You said it well, which is we're not a great proxy for that market. It's roughly 10% of our revenue. It was definitely a good quarter overall, and that built on the 5% we grew in the prior quarter. Year-to-date, though, if you look at more of the rolling period of year-to-date or last 12 months, we're in that low to mid-single digit type range, which is, again, I think, more characteristic of that market overall. As we've pointed out before, the academic and government market is small for us and somewhat lumpy, so we do get quarter-to-quarter variation, and we'll continue to emphasize that because, if the market goes down a bit or up a bit, we don't get overly exercised because we see a pretty steady drumbeat of that business over the rolling period.
But in particular, there just continues, I think, to be a very healthy appetite for investment in biomedical research and in the omics. We're particularly pleased with our position in a lot of the metabolomics-type work and assays and have particular strength there, and we have seen greater and greater interest from the research community on metabolomics and better understanding the microbiome and some of the related areas of biomedical research.
Okay. Makes sense. Maybe just one more on pharma, obviously, a few questions on that. But when you look at the last couple of quarters at 4% or 5% growth, when you look forward, do you see pockets of growth opportunities that you feel can re-accelerate this market towards the high single-digit growth? I know you've talked about the longer-term growth rate of 6%. Do you feel like we're in the cycle where we're going to hang around there for a little while here?
I don't exactly know. I think we feel good about the overall market right now, as we've said, and we never get too far ahead of our ski tips, if you will, in terms of forecasting accelerated growth over historical trends. But as you know, we do get that from time to time, from quarter to quarter, and we've had some years like that. We do think that the underlying trends in pharma give us that possibility of continuing to see better growth from time to time, and to fairly safely rely on that sort of the long-term historical rates. So it's pretty hard to predict when that happens, but it has happened and ought to continue to happen from time to time, that we get some acceleration.
Helpful. Thank you.
Thank you. Our next question or comment is from Puneet Souda from Leerink Partners. Your line is open.
Hi, Chris. Thanks for taking my question. A quick clarification on the GST. I assume India is still 7%-8% of the mix. So if you look at the GST categories and changes from a tax perspective and the GST tax buckets, once they are accounted for, is it a benefit to the customer, or is it a negative for them? Is that market still continuing to be largely Alliance, and are some of them shifting to UPLC on the generic end?
Yeah, thanks for the question. Just to clarify a couple of quick things. India is more in the 6%-7% range of our mix versus 7%-8%, but that is a pretty small difference. Yeah, GST is actually a really important thing, and as just an observer of India and a bull on India and the economy and the government of India, I applaud the implementation of GST as well as measures like demonetization. I think what India is doing right now is putting in some changes to their economy that could pave the way for more stability going forward. The delay in orders and shipments is purely related to systems implementations for our customers to be compliant with the new laws, and then our systems have to match up to their systems.
As we work through that, which we are working through real time, and our customers are working through, that will provide certainly a very stable base of transactional capability going forward. I do not see it as any kind of an ongoing headwind, or in particular, an acute tailwind other than the catch-up that we will see. But really, I think it is another example of more of a long-term foundational attribute of the Indian economy that will benefit the country over time.
Okay. Thanks for that. Quickly on the hurricane impact as well. Just wanted to understand, are you expecting or are you accounting for any of the uptake in instrument replacement as some of these mass specs and LCs are largely sitting idle? I ask that because some of us who have been in mass specs, essentially detectors, will go bad over time if they are sitting without vacuum. Just trying to understand if there is any replacement tailwind coming from that in your guidance and expectations.
I think we are actually pretty conservative on that. We are not assuming any kind of accelerated replacement or tailwind there. We are really focused on the needs of our employees and our customers. Obviously, we have employees in some of these ravaged areas, Puerto Rico, and beyond. Our focus is really purely on getting people back up and running, and helping our customers work through this. If that results in some additional opportunity down the road, great. But we are not thinking opportunistically about it in that way. We are thinking more operationally about it and doing the best we can to serve our customers. I think we have time for one or two quick ones here, John. Maybe two more, please, operator.
Thank you. Our next question or comment is from Brandon Couillard from Jefferies. Your line is open.
Thanks. One quick one for Sherry. A couple housekeeping items . What was the revenue contribution from M&A in the third quarter? Then just to confirm, you do have an extra day in the fourth quarter, correct?
Yes. Just a very small contribution from M&A coming through TA, as Chris mentioned in his earlier comments. Then, there is an extra day in the fourth quarter, and we've fully factored that into our outlook and guidance.
Good. Thank you.
Thank you. Our next question or comment comes from Steve Willoughby from Cleveland Research. Your line is open.
Thanks for squeezing me in here. Just a quick one for Sherry and then another question for Chris. Sherry, just when I'm looking, just want to make sure I have all the math right here on your third-quarter results. I believe your guidance was for a 4%-5% headwind from FX, and then FX was a penny positive. Do I have that right? So it's kind of somewhere in a $0.07-$0.09 positive swing for FX in the quarter?
Yes, that's correct.
Chris, just wondering if you could comment at all about your product vitality in terms of what products you're driving your growth these days, whether it's new products, older products, how the QDa fits into that. Any comments on your overall new product pipeline?
Sure. I will not give too precise of an answer on that, because it does move around quarter to quarter. But the word balance really comes to my mind. I am impressed by the contribution of very old products, if you will, like Alliance HPLC Systems Empower Chromatography Data System. That continues to chug along and be a very reliable source of growth. We continue to see good uptake on what I will call medium in-the-market products like UPLC and ACQUITY Arc as well. Like I said, mass spec has been really solid, and that has been a combination of some technology that has been in the market for a few years, like TQ-S micro, QDa, but also Xevo TQ-XS, which is about a year old. So we have a lot of balance.
We do have a pretty strong product cycle, we believe, coming up in 2018 and beyond, and we will continue to try to leverage all aspects of this. One thing I do think about a lot is not just the launch of new technology, but really how that technology grabs hold and gets traction in the marketplace. Sometimes the biggest impact you actually see in a lot of these products and technology categories is actually in year two, three, and four, as some of those technologies work their way into more standards of measurements. Anyway, we think we have a pretty vibrant product offering and a good product position. As I have said today and many times, R&D investment is our number one priority for growth for the future. Anyway, with that, maybe we will finish with the questions.
I just want to say thank you for the great questions from all of you. In conclusion, we are pleased with our results through the first three quarters of 2017, headlined by our ability to deliver consistently strong organic revenue growth, combined with disciplined P&L management to deliver double-digit earnings per share growth. As we close out 2017, we remain focused on execution and feel that market conditions, combined with our strong competitive position, support continued success. So on behalf of our entire management team, I would like to thank you for your support and interest in Waters. We look forward to updating you on our progress during our Q4 2017 call, which we currently anticipate holding on January 23rd, 2018. Thanks, and have a great day.
Thank you. That concludes today's conference call. Thank you for your participation. You may disconnect at this time.