Mettler-Toledo International - Q4 2022

Transcript

Operator (participant)

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mettler-Toledo Fourth Quarter 2022 Earnings Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press the star key followed by one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the conference over to Adam Uhlman, Head of Investor Relations. Please go ahead.

Adam Uhlman (Head of Investor Relations)

Hey, thanks, Audra, and good morning, everyone. I'm happy to welcome you all to this call. I'm joined with Patrick Kaltenbach, our Chief Executive Officer, and Shawn Vadala, our Chief Financial Officer. Let me cover some administrative matters first. This call is being webcast and is available for replay on our website at mt.com. A copy of the press release and the presentation that we will refer to on today's call is also available on our website. This call will include forward-looking statements within the meaning of the U.S. Securities Act of 1933 and the U.S. Securities Exchange Act of 1934. These statements involve risks, uncertainties, and other factors that may cause our actual results, financial condition, performance, and achievements to be materially different than those expressed or implied by any forward-looking statements.

For a discussion of these risks and uncertainties, please see our recent annual report on Form 10-K and quarterly and current reports filed with the SEC. The company disclaims any obligation or undertaking to provide any updates or revisions to any forward-looking statement except as required by law. On today's call, we may use non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure is provided in the 8-K and is available on our website. Let me now turn the call over to Patrick.

Patrick Kaltenbach (President and CEO)

Thanks, Adam, and good morning, everyone. We appreciate you joining our call that we are doing from Switzerland. 2022 was another year where our company's unique strength and culture of execution led to strong performance and success in overcoming significant external challenges. Our team's resilience and agility to quickly react and adapt to the changing environment allowed us to meet customer demand, gain market share, and deliver robust financial results. We also finished the year with excellent sales growth in the fourth quarter and benefited from very good broad-based growth across geographic regions and product categories. The highlights of the fourth quarter performance are detailed on Page 3 of the presentation. Local currency sales in the quarter increased 9% as compared to the prior-year, with broad-based growth across all regions and most of our product portfolio.

Strong sales growth, combined with benefits from our margin initiatives and good cost control, contributed to excellent growth in adjusted operating profit and Adjusted EPS, offsetting very significant currency headwinds. As we look ahead to this year, we expect continued uncertainty regarding the global economy and face challenging multi-year sales growth comparisons. I am confident that the diligent execution of our growth and productivity initiatives will again position us very well to gain market share and deliver solid financial results. Later, I will have some additional comments on our business, let me now turn it to Shawn to cover financials and the guidance.

Shawn Vadala (CFO)

Thanks, Patrick. Good morning, everyone. Sales in the quarter were $1.058 billion, which represented a Local Currency increase of 9%. On a U.S. dollar basis, sales increased 2% as currency reduced sales growth by 7%. We estimate that the impact of not shipping to Russia was a headwind of about 1% to sales growth. On Slide 4, we show sales growth by region. We had broad-based sales growth in Q4 as Local Currency sales increased 8% in the Americas, 9% in Europe, and 9% in Asia/rest of the world. Local Currency sales increased 11% in China in the quarter. Excluding Russia, our sales in Europe grew 13%. On Slide 5, we show sales growth by region for the full-year 2022.

Local Currency sales grew 11% for the year, with 12% growth in the Americas, 6% in Europe, and 13% in Asia/rest of the world. Local Currency sales increased 14% in China in 2022. Excluding Russia, our sales in Europe grew 9% for the full-year. On Slide 6, we summarize Local Currency sales growth by product area. For the quarter, laboratory sales increased 10%, industrial increased 6%, with Core Industrial up 5% and Product Inspection up 9%. Food Retail grew 12% in the quarter. The next slide shows Local Currency sales growth by product area for the full-year. Laboratory sales increased 12%, industrial increased 9%, including 10% growth in Core Industrial and 7% growth in Product Inspection. Food Retail grew 1% in 2022.

Let me now move to the rest of the P&L, which is summarized on Slide 8. For the fourth quarter, gross margin was 59.8%, an increase of 130 basis points. We benefited from favorable pricing and volume growth, which was offset in part by higher costs. R&D amounted to $45.9 million in the quarter, which is a 7% increase in Local Currency over the prior period, reflecting increased project activity. SG&A amounted to $227.6 million, a 1% decrease in Local Currency over the prior-year, included lower variable compensation related to our strong prior-year results. Adjusted operating profit amounted to $358.6 million in the quarter, a 12% increase. Currency reduced operating profit growth by approximately 9%.

Adjusted operating margin was 33.9%, which represents an increase of 310 basis points over the prior-year. A couple final comments on the P&L. Amortization amounted to $16.5 million in the quarter. Interest expense was $16.8 million in the quarter. Other income in the quarter amounted to $1.5 million, primarily reflecting non-service related pension income. We reduced our effective tax rate from 19% to 18.5% in the quarter. This rate is before discrete items and adjusting for the timing of stock option exercises in the quarter. We are pleased with this reduction and expect to maintain an 18.5% rate in 2023.

Fully diluted shares amounted to 22.4 million in the quarter, which is a 3.5% decline from the prior-year. Adjusted EPS for the quarter was $12.10, a 15% increase over the prior-year, or a 24% increase excluding unfavorable foreign currency. On a reported basis in the quarter, EPS was $11.86 as compared to $9.94 in the prior-year. Reported EPS in the quarter includes $0.21 of purchased intangible amortization and $0.07 of restructuring and other costs. We also had two items impacting reported income taxes this quarter.

We had a $0.20 headwind due to the difference between our quarterly and annual tax rate due to the timing of stock option exercises, and we also had a $0.16 benefit from adjusting our tax rate to 18.5% for the first three quarters of the year. The next slide summarizes our full-year 2022 financial results, which we're very proud of, considering the unexpected challenges our team faced over the last year. Local Currency sales grew 11% for the year. Adjusted operating income increased 13% or 18%, excluding unfavorable foreign currency, and our operating margin expanded 190 basis points. Adjusted EPS grew 17% for the full-year or 23% excluding unfavorable currency. That covers the P&L, and let me now comment on cash flow.

In the quarter, adjusted free cash flow amounted to $272.9 million, and DSO was 37 days, while ITO was 3.6x. Let me now turn to guidance. To start off, forecasting remains challenging and market conditions remain dynamic. We are basing our guidance for the first quarter and the full-year, assuming market conditions remain as they are today. While some factors impacting our outlook have improved, like foreign exchange rates, we still face uncertainty, including the risk of recession in certain countries. We also face difficult multi-year sales growth comparisons. Regardless, we remain focused on the factors we can control and believe our unique sales and marketing strategies and innovative product portfolio will support market share gains and profitable growth this year.

For the full-year 2023, we have left our Local Currency sales growth guidance of approximately 5% unchanged. We expect full-year Adjusted EPS to be in the range of $43.55-$43.95, representing a growth rate of about 10%-11% or approximately 11%-12% excluding unfavorable foreign currency. This compares to our previous guidance of Adjusted EPS in the range of $42.00-$42.40 and reflects the impact of three items. First, foreign exchange based on today's rates is expected to be a 1% headwind to profit growth, down from our previous guidance of a 4.5% headwind due to the strengthening of the renminbi, among other currencies.

Secondly, we now expect our effective tax rate for 2023 to be approximately 18.5%, down slightly from our prior estimate and a modest benefit to EPS. Lastly, somewhat offsetting these benefits to Adjusted EPS is an increase in interest rates and related interest expense, as well as a decrease in forecast pension income. Specifically, we now expect interest expense to be approximately $78 million. Other income, which is below operating profit and largely reflects non-service pension income, is forecast to be approximately $1 million. Total amortization, including purchased intangible amortization, is forecast to be $73 million. Purchased intangible amortization is excluded from Adjusted EPS and is estimated at $27 million on a pre-tax basis or $0.97 per share. Now let's turn to cash flow.

For 2023, we continue to expect free cash flow in the range of $900 million, and we still expect to repurchase approximately $1 billion of our shares this year. This would allow us to maintain a net debt EBITDA ratio of approximately 1.5x. That is it for my side, and I'll now turn it back to Patrick.

Patrick Kaltenbach (President and CEO)

Thanks, Shawn. Let me start with some comments on our operating businesses, starting with Lab, which had strong sales growth in the quarter, with strong growth across most of our product portfolio, especially in the Analytical Instruments and Process Analytics, while our pipette business was down due to a decline in pipette tips. Overall, we continue to see growth with pharma and biopharma customers, as well as the faster-growing segments such as the lithium batteries and others, and expect favorable results in 2023. Turning now to our Industrial business, where our Core Industrial had solid growth in each region and continues to benefit from market trends towards automation and digitalization. Our outlook for this year is positive, although I'd note this business is not immune to potential changes in the economy and will require us to remain agile to identify and target growth opportunities.

Product Inspection sales were stronger than expected this quarter, with very strong sales in the Americas. Europe had modest growth as we saw better customer activity compared to the last quarter. Overall, we expect to have a positive start in 2023 in Product Inspection with good growth in the Americas. However, we remain cautious in Europe with softer conditions in packaged foods. Finally, Food Retail delivered very strong growth with project activities in the Americas and Europe, offset in part by a significant sales decline in China due to disruptions from the pandemic. Let me make some additional comments by geography. Sales in Europe increased 9% in the quarter, better than we had expected and inclusive of a 4% headwind from stopping our shipments to Russia. We saw good growth across most product categories in Europe, particularly in Process Analytics and retail.

The potential energy crisis and related impact on customer demand has also been better than expected, we of course still need to get through the rest of the winter. Sales in the Americas was again strong, with especially good growth across Product Inspection and Food Retail. Finally, Asia and the rest of the world had another quarter of good growth led by our lab business. China grew 11% with particularly strong growth in lab. Switching now to our service business, we continue to see excellent momentum, and service sales grew 11% in the quarter and 12% for the year. Service remains an important contributor to our profits and a key advantage versus our competition. Customers that use our service are more likely to buy instruments from us again in the future.

Given the importance of our service business, I'd like to share with you more details on our strategy and initiatives. To start off, as a reminder, service represents 20% of our revenues and is a key part of our solution offering. Our service offering is comprehensive and includes installation, qualification, calibration, preventive maintenance, spare parts, and repair services. Over 50% of our service revenues represent service contracts that support our customers' ability to maintain uptime, improve productivity, and comply with regulatory requirements. An important piece of our business is calibration services, and our comprehensive and audit-proof electronic calibration certificates are fully traceable and available on demand from a secure database. This makes it very easy for our customers to comply with regulatory requirements. We have very strong competitive advantages with our service business and excellent opportunities to accelerate our growth.

We believe we have the largest installed base of weighing instruments in the world and the largest service network across our direct competitors with over 3,000 service technicians around the world. We have a standard global service offering with dedicated service sales experts. This global coverage is increasingly important as customers look for consistent service around the world. Our ability to serve customers during the pandemic has proven to be a strong competitive advantage, and our service offering was especially important to customers in regulated environments. The introduction of new service levels, 24/7 support, and remote diagnostics have been helpful in supporting customers. We have seen continued improvement in our Net Promoter Scores in recent years and throughout 2022, which measure customer satisfaction after a service event.

We are focused on accelerating our service growth given these competitive advantages and strong customer satisfaction. Over the medium term, would expect our service sales to outpace our product sales. To achieve this, there are two important elements of our growth strategy besides continuously upgrading our offering: penetrating our large installed base of instruments and selling service contracts at the point of product sale. Starting first with penetrating our installed base. We have a large installed base of instruments we have sold over many years, the majority of which is not serviced by us today. To further penetrate this installed base, we use the same concept and similar approaches with advanced big data analytics that we use when selling products, but with more specific data about history, needs, current penetration, and potential of a customer.

Our service telesales teams can leverage this data to run marketing campaigns based on the age, warranty, service history, and projected service intervals of our instruments to generate a service lead when an instrument is most likely to require service. Additionally, we use sophisticated data analytics for sales force guidance to identify carefully selected high-potential accounts for our field service sales team. Selling services contracts at the point of sales is another high-priority focus for us. Over the past year, we revamped our sales trainings and product quoting process to automatically provide a quote for a service contract at the point of sale. Productizing service has also been beneficial in providing and communicating the value of a service contract to a customer in an easy way. Providing service on the service contract is a win-win for us and the customer.

It ensures high reliability and accuracy of measurement for our customers and also helps prevent costly failed experiments, poor production quality, or unplanned downtime from devices that are not properly maintained or calibrated. Our technicians are able to build deeper relationships with customers and become trusted advisors. Service contracts are also a benefit for our service team as they are able to more efficiently schedule service calls weeks in advance, leveraging our territory and route planning and analytics to optimize the productivity of the team. Additionally, customer satisfaction is higher for customers with service contracts, and as I said, those customers are more likely to purchase our instruments again. Overall, I feel very good with our service growth strategies that they will position us well to grow this very important and very profitable portion of our business over the coming years.

As we look ahead through 2023, we expect to face continued uncertainty in the global economy and challenging multi-year sales growth comparisons. Our ability to demonstrate resilience and agility during difficult times is an important signature of our culture. I am confident we will be able to react quickly to the new challenges and opportunities that arise, we can continue to gain share and deliver solid results. That concludes our prepared remarks, I now want to open the call for questions.

Operator (participant)

Thank you. At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. We'll take our first question from Josh Waldman at Cleveland Research.

Josh Waldman (Senior Equity Research Analyst)

Thanks for taking my questions. I have one for Patrick and one for Shawn, if I may. Patrick, your opinion solidly above the low to mid-single target for the fourth quarter. Just curious, any other color you can provide on what drove the upside? How durable do you think this is? Do you think it was something Mettler is doing different or just a stronger market outlook?

Patrick Kaltenbach (President and CEO)

Yeah, look, I mean, we are very proud of our fourth quarter result, of course. I mean, the team performed extremely well across the regions and across the product portfolio. I would say what you have seen is, again, Mettler in action. We have demonstrated that we can go after the market opportunities as they arise. There has been, I would say, not much better market momentum than we predicted, but we have been really capable to act on the opportunities as they're out there. Europe has performed stronger, as Shawn already indicated in his remarks. We have seen good opportunities despite the headwind we have seen from, you know, not shipping products to Russia. Europe re-grew, excluding Russia, 13% on a best compare against the prior quarter.

Again, that is also given by the fact that we really were capable to capture opportunities out there. I would say the market conditions have not changed compared to what we have seen last year. We have seen some reluctance in Europe, for example, in the PI business. Customers are more cautious spending dollars right now. They extend time of some of the projects. We were able really to get everything that was out there and turning all the orders in sales. Our supply chain team executed very well getting over some of the remaining issues we had seen in the supply chain. We had really shorter shipment times, it all helped us to really perform extremely well in Q4.

Josh Waldman (Senior Equity Research Analyst)

Got it. Got it. Good to hear. Shawn, was wondering if you could walk us through the thought process on the 6% Local Currency guide for the quarter, but reiterating the 5% for the full-year. The setup obviously implies a bit of a detail in the latter three quarters despite an easing comp. Just curious if it's something in the order book. Was there, like, pushouts from the 4th quarter that hit in the 1st or is it just Mettler-Toledo being prudent?

Shawn Vadala (CFO)

No, I mean, hey, I think if you look at it, you know, we, you know, of course, there's an element of caution just given that we have these difficult multi-year comparisons that we refer to, and there is uncertainty. I think, you know, there's a couple dynamics that's important to reflect on too. The first is that, you know, when we look at pricing in terms of the cadence of pricing, we're gonna have better, higher pricing in the first half of the year than the second half. We'll probably have better volume growth in the second half of the year versus the first half. That's one topic. Another is, we'll probably do a little bit better on the retail business in the first quarter.

You know, maybe this is a good time. I'll just kind of walk through the different pieces of the business, and you'll kind of see that retail will have a little bit of a benefit here in Q1. As we're thinking about the first quarter, we're thinking about mid-single digit % growth in Lab, and we're thinking mid to high single digit % growth for the full-year. For Core Industrial, we're thinking mid-single digit % growth for Q1, and we're also thinking low to mid-single digit % growth for the full-year. We're thinking Product Inspection mid-single digit % growth for Q1 and low to mid-single digit % growth for the full-year. Then here we get to the retail. We're looking at high teens %, so we're gonna benefit from some strong project activity in Q1.

Keep in mind, retail is still only about 5% of our business, but you get a sense for it. For the full-year, we're still thinking, in the, like, mid to high single digit range for retail. From a geographic perspective, we're looking at mid-single digit for Q1 and for the full-year for Americas. For Europe, we're looking at mid-single digit for Q1 and low single digit for the full-year. That's us being maybe a little bit cautious on Europe and also acknowledging, you know, multi-year comparisons, especially if you exclude Russia. I think we grew 13% in the fourth quarter of this past year. For China, we're looking at mid-single digit growth for Q1 and high single digit growth for the full-year.

Patrick Kaltenbach (President and CEO)

Got it. Really helpful. Appreciate all the detail.

Shawn Vadala (CFO)

Yep. Thank you.

Operator (participant)

We'll move next to Dan Arias at Stifel.

Dan Arias (Managing Director of Life Sciences and Diagnostics)

Morning, guys. Thanks for the questions. Shawn, maybe just on your last point there on China, can you just talk a little bit about the transition from, you know, first half of the year headwinds from COVID to something that looks like presumably a step up in the back half of the year? I'd be particularly interested in your thoughts around stimulus dollars in China. Some of our companies have just been more emphatic about the impact there that you might see than others, so I would just love to get your two cents.

Shawn Vadala (CFO)

Yeah. Yeah. Hey, thanks, Dan. You know, maybe a few comments. You know, one, we're very pleased with the quarter we're coming off, you know, 11% growth in China. You know, when we look at China for 2023, we feel very good. We're, you know, we're coming off two very strong years. We grew 14% in 2022, but we grew 25% in 2021. That's kind of always on our mind, and I'd like to remind everybody that. As we look at the cadence for this year, you know, very pleased with how the team was able to manage through different dynamics with COVID. We've always said that things can change quickly in China, and this is another example with the reopening.

You know, we had quite a bit of the organization infected with COVID around the holidays, but we've been back up in terms of full capacity now for a few weeks, I'd say, and things are back to normal. Of course, they just also came off the Chinese New Year as well. We're actually looking at it quite favorably in terms of the reopening. There could be some short-term uncertainty in terms of what it could mean to certain customer segments. As we kind of look to the second half of the year, certainly there could be, you know, we're looking at higher growth in the second half of the year than we're looking at for the first half.

In terms of stimulus, I think we're all looking forward to what comes out here over the next month, you know, in terms of the magnitude of stimulus. Our expectations certainly are that stimulus dollars will be most likely directed towards a lot of the programs under the Five-Year Plan. Then I'm sure some of these strategic industries within the country will also benefit as well too. We continue to see really good momentum in a lot of these hot segments like lithium batteries, like semiconductor, and then just these overall arching trends towards automation and digitalization continue to play out well. We continue to feel like we're very well positioned for China for the medium to long term.

Of course, in the short term, always a little bit more difficult to call. yeah, I'd say that's it. Patrick, any other comments from your side?

Patrick Kaltenbach (President and CEO)

No, I think you covered really well. Again, we have a strong team in China, long history in China. Team has executed very well using the same go-to-market strategies and tools that we use in the rest of the world very efficiently. As you said, yeah, I'm very confident about the mid and long-term performance in China. Who knows what's coming out of, you know, of any stimulus might be a bit more biased towards the real estate market. We don't know yet, but I think it will also cover a good part of their Five-Year Plan. Which means investing into health, investing into important technologies where we all play well.

Dan Arias (Managing Director of Life Sciences and Diagnostics)

Yeah. Okay. Thank you for that. Just maybe on pricing. Shawn, I don't know if I missed it, but did you give the refreshed price realization assumption that you're making for the year? As you're dialing in your pricing expectations for 23, I'm just curious if there are business segments or geographies that maybe we should think of as being more or less than the company average when it comes to realization. Do you think that everyone being kind of just moves up in sort of the same range?

Shawn Vadala (CFO)

Yeah. I mean, our guidance for the full-year is unchanged at 4%. I would say we actually finished the year a little bit better than what we were expecting. We had a very strong finish in Q4 with something in more in like the 7% kind of a range. I expect to get off to a good start here in Q1 with something more in the maybe the 6% kinda range, but then we'll kinda moderate into the second half of the year as we kinda start lapping a lot of these pricing actions that we did to combat inflation during the course of 2022. In terms of differentiation, I'd say, you know, lab always does.

I have nothing significant to point out, but I'd say lab tends to do a little bit better than the rest of the portfolio, and then we tend to do maybe a little bit better in the developed countries than we do in the emerging countries.

Dan Arias (Managing Director of Life Sciences and Diagnostics)

Okay. Very good. Thank you, guys.

Shawn Vadala (CFO)

Okay.

Operator (participant)

Our next question comes from Jack Meehan at Nephron Research. Mr. Meehan, your line is open. You may be muted.

Jack Meehan (Equity Research Analyst)

Sorry, I was muted. Morning. Wanted to ask about the Product Inspection business. 9% core, you know, nice beat versus the guide, and I think the CAGR accelerated into year-end too. you know, the service piece is usually pretty steady. I was just curious if you could talk about the trends there, what you're seeing on service versus the product side. Was there any acceleration?

Patrick Kaltenbach (President and CEO)

I can cover this. Good morning, Jack. Look, as you said, we are really, really happy with the performance of Product Inspection in the fourth quarter. We gained momentum. Again, we were a bit more cautious getting into the quarter, but we saw especially good momentum in the U.S. and a bit better performance than expected in Europe. We are still cautious, as I said before, about Europe. Of course, increasing our install base on products will continue to drive also more service business. Service is a really important part of that, and our service coverage, especially in the U.S., is exceptional compared to many of our competitors and gives us a clear advantage in Product Inspection.

We continue to build out our service offering in terms of, you know, the level of services we can provide also for this product portfolio. Again, as we also launch new products, including now also more mid-range products, addressing more of the mid-market needs of products, we are also going after more market share of instrumentation, which will afterwards continue to drive more services. The area, the region where we had probably more, still more happen was also in China, given COVID-19. Again, there was not a lot of momentum in PI in the fourth quarter. While we saw some good adoption of the new product that we launched for mid-range, overall the market there was still suffering from the pandemic.

Also there, I would say moving forward, we see opportunity, of course, of building more market momentum in that domain as well. The U.S. is for us, by far the biggest and most important market and, very well covered by several service business there, of course. Europe is the second biggest part, and then continuing to build out also, China and Asia Pacific.

Shawn Vadala (CFO)

In terms of trends, we saw improvement both in the service and the product business, Jack, kinda going from Q3 to Q4, but service has been growing faster than product this year.

Jack Meehan (Equity Research Analyst)

Got it.

Shawn Vadala (CFO)

Yeah.

Jack Meehan (Equity Research Analyst)

Then, just one, probably minor point on the 2023 outlook by segment in Lab. I think previously you were talking about mid-to-high single-digit % growth, now mid-single-digit %. Was there anything that softened a little bit or just anything you would call out there?

Shawn Vadala (CFO)

For lab, if I said it incorrectly, I apologize. We expect to grow mid to high single digit for the full-year—

Jack Meehan (Equity Research Analyst)

Oh, okay.

Shawn Vadala (CFO)

Which is consistent with what we said before. For Q1, we're at mid-single digit, and Q1's gonna be a little bit impacted by, you know, some of the topics with like pipette tips and customer stocking, so.

Jack Meehan (Equity Research Analyst)

Sorry, I may have misheard. Thank you.

Operator (participant)

We'll go next to Vijay Kumar at Evercore ISI.

Vijay Kumar (Senior Managing Director)

Hey, guys. Congrats on a strong finish here, thanks for taking my question. I guess, my first question is here on the Q1 guidance. Did I hear you correctly, Shawn, that pricing is 6 points in Q1 and the guidance is 6%? That implies zero volume. Seems a little conservative. Maybe talk about the Q1 assumptions.

Shawn Vadala (CFO)

I mean, I think, you know, we If you look at it, we've always been concerned a bit by multi-year comparisons and, you know, uncertainty in the macro, and I don't think it's really that different than what we've been saying, you know, about the full-year results. You know, I think right now, it's a new year. We're very early in the year. I think we, you know, we need to see how the next couple of months play out, and then we'll be able to have a lot more, you know, insight in terms of, you know, how the, not only the first quarter went, but like how the year starts to have, what kind of momentum we have kinda going into Q2 into the rest of the year.

Vijay Kumar (Senior Managing Director)

Understood. Then one, on free cash flows here. It looks like free cash flows, came in below your guidance for fiscal 2022. I'm curious, was that just, a timing element? I'm looking at your, guidance here for, fiscal 2022 $900 million. Is that benefiting from some timing elements here or, any cadence on free cash flows?

Shawn Vadala (CFO)

Yeah. Good question. Our free cash flow, you might not remember, but we updated our guidance for that last quarter. We actually came in line with our revised guidance from last quarter, and we revised down 2022 primarily because of we carried more inventory in 2022, giving more safety stocks just to kind of mitigate some of the challenges in the global supply chain. As we kind of look towards 2023, we expect to, you know, benefit and reduce a lot of those inventory levels. You'll see from a you know, one-year growth perspective, you'll see a, you know, pretty significant growth, but a lot of it has to do with timing of working capital.

Vijay Kumar (Senior Managing Director)

Okay, sir. Thanks, guys.

Shawn Vadala (CFO)

Yep.

Operator (participant)

Our next question comes from Timothy Daley at Wells Fargo.

Timothy Daley (VP)

Great. Thanks. Appreciate the detail on the service side, but just wanna dig a bit in consumables. What was the consumable growth in the quarter and the year? Can you help quantify the size and the timing of the two major one-off headwinds Mettler is facing in 2023 around the pipette tip business, particularly the roll-off DoD contract and then that inventory stock dynamic?

Shawn Vadala (CFO)

Our consumables business, in terms of total mix on the business is about, it was about 10% in the quarter, for the full-year is about 12% of our business. Consumables, as a reminder for everybody, about half of that's probably pipette tips, and then the other half is a combination of Process Analytics sensors as well as other consumables for other categories. As a total group, consumables were down about 5% in the quarter. For the full-year, they were up 5%. If you kinda dug into the details, of course, the one area where we saw a decline was pipette tips, which would have been down over 20% in the quarter.

That's a top, you know, that's a topic related to customer stocking that you've, you know, you've heard about from other companies. Fortunately for us, it's not a, it's not a significant impact to our overall results, and we will probably continue to see that trend play out here in the first quarter and maybe even in the Q2.

Timothy Daley (VP)

All right. Appreciate that. My second one on margins. I think the guidance implies about 120-ish basis points from operating margin expansion. Can you help us understand, you know, how we should think about the pieces of growth versus SG&A, R&D? Just additional help here would be great.

Shawn Vadala (CFO)

Yeah, sure. If we look at our, you know, maybe, you know, rather than going through each line, maybe I'll give you a little bit of flavor in terms of gross profit. Then, you know, of course, there's a lot of other ingredients in terms of like R&D and SG&A. Like, in terms of the first quarter, we're looking at gross margin expansion of about 140 basis points. For the full-year, we're looking at about 100 basis points. That number is a little bit lower than the last time we spoke, and the reason is it purely, you know, almost entirely related to just currency translation. On a currency neutral basis, it's pretty consistent with our, with our previous guidance.

For the full-year, our operating margin's up, 190 basis points. For the full-year, we're estimating about 130 basis points.

Timothy Daley (VP)

Great. Thank you.

Shawn Vadala (CFO)

Yep, you're welcome.

Operator (participant)

We'll go next to Matt Sykes at Goldman Sachs.

Matt Sykes (Research Analyst and Managing Director)

Thank you. Morning, and thanks for taking my questions. Patrick, maybe, just on the services business that you talked about on the call. Just reflecting back from the Investor Day, you talked about that services mix being about 50/50 contract versus value-added services. Could you just maybe talk about the importance of that mix shift as you move forward and where you see that mix over sort of the medium term developing into?

Patrick Kaltenbach (President and CEO)

Thanks, Matt. Really good question. As I pointed out at the Investor Day, it is important for us to continue to drive that mix more towards services on the contract. The team is working hard on that. We have telesales team including the sales team, of course, working on continuously also bringing new our new service story to our customers, including the new service offerings that we have, ensuring that our sales team and our customers understand the benefits of being under contract, what it means to them in terms of, you know, preventive maintenance, of uptime, response time of the service, 24/7 availability, et cetera. I see actually a good momentum.

I think we have made good progress over the last two years or three years in moving more of our services under contracts. It starts always at the point of sales, making sure that when we sell a product, a salesperson can have an educated discussion with the customer of the benefits of being on a contract. At the same time, we have increased the portfolio of services that we offer, as I mentioned before, from basic to comprehensive services. That makes it then also easier and more attractive to our customers to select the service contract. I see the shift ongoing. We are working on that because in the end, again, it's a win-win for both the customers and ourselves. As I said. We have the data analytics behind it.

We know that customers on the service contract are more likely to buy from us again because they have seen the full benefit of our offering. For us, it also helps us, of course, to drive more efficiency in services. It helps us to, you know, be more effective in scheduling services, making sure we optimize the coverage of a service and the timing when we can do services, and make sure the service technicians that we have are working most efficient. Expect a continued increase there in terms of service coverage. It's again, beneficial both for us as a company, but also a strong win for the customer.

Matt Sykes (Research Analyst and Managing Director)

Got it. Just maybe a follow-up, just staying on services. Patrick, you mentioned that the majority of instruments are not serviced by Mettler. Maybe if you could give us a little bit more color on what that percentage is and where you think it can go to. Shawn, just given that services, and you commented that it's gonna be growing faster than group, and I'm assuming it's higher margin, could you talk about the medium-term impact on margins from a larger services business over the next few years?

Shawn Vadala (CFO)

Yeah, sure. Hey, maybe I'll go first, I'll let Patrick go second. I'd say, you know, I don't have it quantified in terms of precision, but you're right. We expect our service business to grow faster than our product business over the medium to long term, and our service business has operating margins that are higher than our corporate average.

Patrick Kaltenbach (President and CEO)

Yeah. Back to your question regarding the service opportunity overall, of course, we have billions of instruments in our database, and that is a very competitive advantage for us to have that visibility. Our, let's say, served market for service is over 3 billion, so we have significant opportunity to expand our market share in there as well. If you look at the total share of instruments of the install base, of course, you never know which we know to good extent about which instruments are still on the operation, and then make also based on lifetime expectations of the database we have for instruments, we make some assumptions in terms of how many instruments otherwise would be still operational.

we think that it's probably more than 60% of the instruments out there are not yet on the full service coverage from us.

Matt Sykes (Research Analyst and Managing Director)

Great. Thank you very much.

Operator (participant)

Our next question comes from Brandon Couillard at Jefferies.

Brandon Couillard (SVP)

Hey, thanks. Good morning. Just a couple for you, Shawn. Could you just split out lab versus industrial in China in the quarter, and then those two subsegments, what you're anticipating for the year? Any bifurcation between those two markets?

Shawn Vadala (CFO)

Yeah, sure. Sure, Brandon. For Q4, lab was up over—I'm sorry, I'm looking at the wrong year here, but still good results. Lab was up about 20% in the fourth quarter, industrial was up low single digit. As we kinda like look for towards 2023, we're expecting double digit growth in lab for the first quarter and the full-year, and we're expecting industrial to be more flattish. You know, you can imagine more impacted by, you know, some of the disruptions over the last few months. For the full-year, we're a little bit more conservative there with low to mid-single digit growth. Obviously expecting more growth in the second half of the year.

Brandon Couillard (SVP)

Got it. On the lab business globally, are you able to quantify the impact of the pipette declines on that segment in the quarter? I imagine most of them, maybe at least a point. Patrick, you mentioned lithium batteries. Just help us understand like what areas of the portfolio are serving that market.

Shawn Vadala (CFO)

For the quarter, Brandon, you know, if you kinda like play out the math that, you know, the data points that I kinda mentioned earlier, that's probably, you know, in the, you know, 1% or so to the group. It probably would have been in the 2% or more to the lab division and probably looking at, you know, similar type trends here in the first quarter. Then, you know, at some point it will, you know, we expect it to stabilize it during the second quarter.

Patrick Kaltenbach (President and CEO)

Yeah. If I may add there, Shawn. On the pipette business itself, we have seen good growth on pipette instruments also in Q3 and throughout 2022. We see continuing good growth in service pipette business. It's really the pipette tip business that have been suffering.

Brandon Couillard (SVP)

Yeah.

Patrick Kaltenbach (President and CEO)

That's of course, also due to, you know, the ramp down of testing, et cetera, out there. With the increased number of instruments that we sell, single-use pipettes, et cetera, and the increased service business, I think we are quite confident that, as we see the demand for pipettes, that also the demand for pipette tips will continue to go up.

Brandon Couillard (SVP)

Yeah. Yeah, excellent.

Operator (participant)

We'll go next to Catherine Schulte at Baird.

Catherine Schulte (Senior Research Analyst and Director)

Hey, guys. Thanks for the questions. I guess first I wanted to go back to the services business. You talked on the penetration side with Matt's question, on the other area of opportunity you mentioned of selling contracts at the point of sale, can you just elaborate on what your attach rate is today and where you'd like to see that go over the next few years and longer term?

Patrick Kaltenbach (President and CEO)

What we are working on, Catherine, what we are working on is, again, continued increase of the attach rate. I mean, what we changed last year is the entire quoting process. Before, meaning that our salespeople basically had to actively quote services and have to look up in a catalog for what services we could offer, what dedicated products. Now it's an automatic part of the quoting process. If a salesperson wouldn't be able to sell services, they also have to give us some justification why they couldn't. That also helps us then to improve again the marketing collateral behind service and making sure that we make a better job of selling the value of services.

We are continuing to really make sure that we pull all levers to make sure our customers understand the benefit of service contracts. The overall attach rate, I think is in the range of. Actually, I have to look up that number and get back to you probably on one of the next calls. For me, the most important measure is really that we continue to see an increase.

Catherine Schulte (Senior Research Analyst and Director)

All right, great. On Europe, you mentioned there's maybe some conservatism in your low single-digit guide for the year. What do you view as the swing factors there? Is it mostly on the packaged food side or are there other areas where you're trying to be a bit more prudent as you start that initial guide?

Patrick Kaltenbach (President and CEO)

I think it's multiple factors there. I mean, packaged food is definitely one of it, clearly. I mean, again, because this is high CapEx investment and it's one of the few pro-product categories where it's really more on the high CapEx side. We also have seen, you know, some of our customers being more reluctant. We have seen this in Q4, and we see this continue into Q1. They all are looking at the, you know, at the market situation right now, and they all want to see how it plays out. Fortunately, as I said, the impact of the potential energy shortage in Europe has not yet played out. Hopefully, we'll get through the window with some major issues, and that will then hopefully also increase all the overall market confidence.

I would say otherwise in the European market, for us, it's also look at the we have been very successful over the last couple of years. We also have been quite successful in Q4, so in the second half will also be a tougher compare for us. That's why we are thinking currently about for Europe more in the low, low single digit for 2023.

Catherine Schulte (Senior Research Analyst and Director)

Very great. Thank you.

Operator (participant)

We'll move next to Michael Ryskin at Bank of America.

Michael Ryskin (Managing Director)

Great. Thanks for taking the question. This is Michael Ryskin on for Derik De Bruin. Sorry if I missed this earlier, I wanna drill a little bit into Core Industrial. I know you kind of anticipated a little bit of a step down in the fourth quarter, it still seems like a sequential decline from the first three quarters of the year where you had really strong 10% growth. Looking at your guide for low to mid-single for 2023, anything in particular you wanna call out how that's trending? Is that, you know, mostly a reflection of macro or is it, you know, how much conservatism is built into that? Are you seeing any change in order patterns with those customers? If there's anything by geo you could call out there? Thanks.

Shawn Vadala (CFO)

I'd say we're coming off of a period of a lot of growth in that business, Mike. You know, we still feel really good, though. The business is well-positioned. It's a better mix of business than it used to be. Like we've talked a lot about over the past year, a lot more in what we would call the more attractive segments of the market, like more anchored towards pharma, food manufacturing, and chemical, which is primarily specialty chemical for us. This business also benefits from some of these hot segments that we talk about, like lithium battery.

Just these trends in automation and digitalization, which we continue to see, you know, really holding up during, you know, a deteriorating macro environment over the last, you know, few months. You know, historically, it is the business that's most susceptible to the macro, so we, you know, we still keep an eye on it. We were really pleased in the Q4 that we saw good growth in each region, which I think is good. You know, it's important to see, you know, each region of the world growing. You know, we're certainly a little bit more cautious as we kinda look to 2023. It's early in the year.

China's a big part of this business, so I think it will be important for us to kind of get through the first quarter, see how things look, and then we'll have maybe some better visibility into the rest of the year.

Michael Ryskin (Managing Director)

Okay. That's fair. Maybe, just a follow-up tying off a loose end on modeling. The 18.5% tax rate, is that a one-year dynamic for 2023, or is it safe for us to assume that going forward beyond?

Shawn Vadala (CFO)

Yeah. I mean, it's at least a two-year dynamic. You know, we took it down for 2022. We feel comfortable we can hold it for 2023. As we look to 2024, I think there could be some upward pressure on the rate. It's still a little early for us to kinda communicate anything, but, you know, it could be something in the 1%-2% kinda range. We'll obviously know a lot more towards the end of this year and, you know, when we provide guidance for next year.

Michael Ryskin (Managing Director)

Great. Thanks so much. Congrats on the quarter again.

Shawn Vadala (CFO)

Yeah, thank you.

Patrick Kaltenbach (President and CEO)

Thank you.

Operator (participant)

We'll go next to Liza Garcia at UBS.

Liza Garcia (Director)

Hey, good morning, guys. Thanks for squeezing me in. Kind of an OpEx question and kind of how to think about maybe diving in there a little bit. R&D up 7% in Local Currency in the quarter. Obviously, you offset that with SG&A decline. As we think about kind of broader your investment strategy, how should we think about the R&D line and kind of modeling that out?

Patrick Kaltenbach (President and CEO)

I'll get started on this. Look, actually, I'm very proud that we really have a lot of opportunities in our business to drive more products to the market. The success of our business really also relies on, you know, driving innovation to market. This year, we brought a lot of great products to the market, helping our customers in the demand of automation, digitalization, compliance, et cetera, both on the hardware and software portfolio that we launched. We actually launched internally a program that we call also Accelerator Programs, where we looked at our pipeline of R&D projects that we have across the company and selected a number of really high potential projects that we accelerated with additional funding. That's part of the increase that you also see there on the R&D line.

It's again, for us, it's on the, on the leadership team, we made a very conscious decision saying we're using the success that we have as a company to accelerate products and bring even more horsepower to the street and making sure that we get the stuff to our customers of which we know it will help them to drive more productivity, help them, you know, to drive better insights in the research they are doing. I'm actually really excited, and I'm really proud that we could do that.

Liza Garcia (Director)

Great. I know obviously the Mettler story has been predominantly organic, but you've definitely made some notable tuck-ins like PendoTECH, Biotix. Can you just provide maybe an update on kind of the M&A environment and what you're seeing in the market, maybe in terms of incremental opportunities to enhance the portfolio?

Patrick Kaltenbach (President and CEO)

Yeah. Very good question, Liza. On M&A, I mean, we didn't change our strategy at all. We are still looking at, you know, tuck-in acquisitions, bolt-on acquisitions that complement us both either on the technology sides, technology that we do not own today, but think are important for us to complement our portfolio or giving us market access in areas where we don't play. PendoTECH was an example of that, where we said we wanna go more into downstream bio processing and have the right solutions for our customers. We also made last year strategic acquisition in the area of software complementing our AutoChem business with Scale-up Systems, which is a very important software capability for us to help customers scaling up from R&D to manufacturing. It gives us really also unique value proposition there.

End of the year, we acquired also a small lab business called Hörle in Germany, $10 million revenues, but also with products that we think really we should have in the portfolio. That's the way I envision to continue this. We really look for the right opportunities. Given the strength we have as a business, we can be very selective in what companies we want to acquire. I think Mettler-Toledo is an outstanding platform for these companies who look for, you know, either global access to market, which we have, or also the strength that we have in terms of supply chain to help them to really accelerate their go-to market. It needs to be really something that is missing in our portfolio. We don't have to beg M&A to grow.

We have a strong organic engine. I'm very interested in, of course, on opportunities to get us into the fast-growing market segments like we have in biopharma, for example. This was one of the reasons why we acquired PendoTECH.

Liza Garcia (Director)

Great. Thanks so much.

Shawn Vadala (CFO)

We'll move next to Rachel Vatnsdal at J.P. Morgan.

Rachel Vatnsdal (Executive Director of Equity Research)

Great. Thanks for taking my questions, guys, and congrats on the quarter. I wanted to follow up about some of the earlier questions around the consumables dynamic and some of this pipette inventory stocking as well. To flag, the consumables were down 5% during Q4 due to that pipette dynamic. Can you just walk us through your expectations for consumables growth in the first quarter and then for the full-year? Kind of within that, what's embedded for that consumables growth between pricing versus volume?

Shawn Vadala (CFO)

Yeah. Hey, Rachel. Hey, I don't have the specific breakout for the full-year. I would say, you know, I'd probably expect to see a similar result in Q1, you know, as we saw here in Q4 overall for consumables. You know, I would certainly expect this to see growth in the second half of the year. You know, I don't have anything specific in mind in terms of exactly what that would be. Definitely would expect us to return to growth in the second half of the year.

Patrick Kaltenbach (President and CEO)

Yeah. Absolutely. Thanks, Shawn. I think, again, as I said before, some good indicators for us is the demand for our pipettes itself for the instruments.

Shawn Vadala (CFO)

Exactly.

Patrick Kaltenbach (President and CEO)

It should go, give us continued growth also. I mean, we are playing very well in the biopharma research space with our product portfolio. The COVID tailwinds, I think, will hopefully not be any topic for us, as we go to the second half of the year. The, the rest of the portfolio that we have in consumables, the sensors that go into, you know, into biopharma, some of the probe sensors or even some of the lab products have consumables, they are still doing quite well.

Rachel Vatnsdal (Executive Director of Equity Research)

Great. Then maybe a quick one here just on onshoring. You guys have talked about the onshoring and nearshoring dynamic being a tailwind for Mettler. Can you just talk about your latest expectations on where you could see that impact the portfolio? Obviously, there's some debate going on around the U.S. budget here locally. How are you kind of embedding that into expectations in the near and medium term as well? Thank you.

Shawn Vadala (CFO)

Yeah, we still see that as a really good opportunity for the company in the medium to long term. But in terms of 2023, we didn't really build anything, you know, specific into our guidance. We'll take our final question from Patrick Donnelly at Citi.

Patrick Donnelly (Managing Director)

Hey, guys. Thanks for, thanks for fitting me in. Maybe just one. Obviously, a lot of ground covered here. You know, Shawn Vadala, maybe on the supply chain in general, you know, you talked about inventory. Obviously, you ran a little high in 2022 with some of the stocking impacts. Can you just talk about expectations to kind of wind that down? Are you seeing normalization in the supply chains? You know, some thoughts on kind of how you're, how you're thinking about that piece.

Shawn Vadala (CFO)

Yeah, thanks, Patrick. I'll start, and I'll let Patrick maybe add a few comments as well too here. Yes, we definitely have seen a lot of improvement in the supply chain, in particular on the transportation side. You know, just the time to go from, you know, one country to another is the lead times are, I think, pretty close to back to normal at this point in time. That's been great. In terms of, like, availability of components, there's still, you know, there's still a topic here or there, but I'd say the noise level is significantly lower than what we were seeing, you know, six months ago.

Patrick Kaltenbach (President and CEO)

Absolutely. I only can confirm that semiconductor issues that we talked about last year are mostly behind us with very few exceptions. The team has been also very agile to change some of the designs of the instruments, so we are not so dependent on some of the exotic components there. Clearly, I mean, our supply chain is, I would say it's almost back to normal in terms of transportation times, availability of materials, and that should not be, you know, get into our way to make successful business in 2023.

Shawn Vadala (CFO)

Yeah. Maybe, hey, just one final comment on that one is, you know, we're really proud of our team. You know, the supply chain, I think, really has been a competitive advantage for us over the last few years and just the collaboration around the global organization and the culture has just been really amazing to observe from the inside and it's, I think, frankly, helped us gain some share along the way and enhance our brand.

Patrick Kaltenbach (President and CEO)

Absolutely.

Operator (participant)

That does conclude the question and answer session and today's conference call. Thank you for your participation. You may now disconnect.