Earnings Call Transcript - MTD Q4 2022

Operator, Operator

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 speakers’ 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 the number 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

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, 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’m 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, but let me now turn it to Shawn to cover financials and the guidance.

Shawn Vadala, CFO

Thanks, Patrick, and 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 No. 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 No. 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 No. 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 No. 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 and 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 are 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 3.6 times. 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 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 to $43.95, representing a growth rate of about 10% to 11% or approximately 11% to 12% excluding unfavorable foreign currency. This compares to our previous guidance of adjusted EPS in the range of $42 to $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 to EBITDA ratio of approximately 1.5 times. That is it for my side, and I’ll now turn it back to Patrick.

Patrick Kaltenbach, 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 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 lithium batteries and others, and expect favorable results in 2023. Turning now to our industrial business, where 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, with project activities in the Americas and Europe offset in part by a significant sales decline in China due to disruptions from the pandemic. Now 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, but 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. Also, 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, preventative maintenance, spare parts and repair services. Over 50% of our service 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 stand-up 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, and 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 penetration 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 concepts 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 the 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 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 under a 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 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 so we can continue to gain share and deliver solid results. That concludes our prepared remarks, and I now want to open the call for questions.

Operator, Operator

Thank you. We’ll take our first question from Josh Waldman at Cleveland Research.

Josh Waldman, Analyst

Thanks for taking my questions. I have one for Patrick and one for Shawn, if I may. Patrick, Europe came in 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 and 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, CEO

We are very proud of our fourth quarter results. The team performed exceptionally well across different regions and product lines. What you've seen is Mettler in action, showing our ability to seize market opportunities as they arise. There has been market momentum that exceeded our predictions, and we have effectively capitalized on available opportunities. Europe showed strong performance, as Shawn mentioned earlier. We noticed good opportunities despite the challenges of not shipping products to Russia. Excluding Russia, Europe grew by 13% compared to the previous quarter, driven by our capability to capture existing opportunities. Market conditions remain consistent with what we observed last year. In Europe, we have noticed some caution among customers, particularly in the PI business, where spending is more conservative, and project timelines have extended. Nevertheless, we managed to convert all available orders into sales. Our supply chain team performed excellently, overcoming remaining supply chain issues. We achieved very short shipment times, which significantly contributed to our strong Q4 performance.

Josh Waldman, Analyst

Got it, good to hear. Then 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. This setup obviously implies a bit of a decel in the latter three quarters despite an easing comp. Just curious if it’s something in the order book. Was there push-outs from the fourth quarter that hit in the first, or is it just Mettler being prudent?

Shawn Vadala, CFO

No, I think if you look at it, of course there’s an element of caution, just given that we have these difficult multi-year comparisons that we referred to, and there is uncertainty. But I think there’s a couple dynamics that are important to reflect on, too. The first is that when we look at pricing in terms of the cadence of pricing, we’re going to have better higher pricing in the first half of the year than the second half, but we’ll probably have better volume growth in the second half of the year versus the first half, so that’s one topic. Then another is we’ll probably do a little bit better on the retail business in the first quarter. Maybe this is a good time, I’ll just kind of walk through the different pieces of the business and you’d 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, and then here we get to retail, we’re looking at high teens, so we’re going to benefit from strong project activity in Q1. Now keep in mind, retail is still only about 5% of our business, but you get a sense for it. But then for the full year, we’re still thinking in the mid to high single digit range for retail. Then 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, so that’s us being maybe a little bit cautious on Europe and also acknowledging multi-year comparisons, especially if you exclude Russia - I think we grew 13% in the fourth quarter of this past year.

Josh Waldman, Analyst

Got it, really helpful. Appreciate all the detail.

Shawn Vadala, CFO

Yes, thank you.

Dan Arias, Analyst

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 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 would just love to get your two cents.

Shawn Vadala, CFO

Thank you, Dan. I want to share a few thoughts. First, we are very pleased with the recent quarter, noting an 11% growth in China. Looking ahead to 2023, we feel optimistic, though we are coming off two strong years with 14% growth in 2022 and 25% in 2021, which is something we keep in mind. This year, we are pleased with how our team has navigated various dynamics related to COVID. We know that circumstances in China can change quickly, and that's evident with the reopening. Many in our organization were affected by COVID around the holidays, but we have been operating at full capacity for a few weeks now, and things have returned to normal. Additionally, we have just come off the Chinese New Year, which we are viewing positively in relation to the reopening. There may be some short-term uncertainties affecting certain customer segments, but we anticipate higher growth in the second half of the year compared to the first half. Regarding stimulus measures, we eagerly await the upcoming announcements and expect that the funding will primarily support various programs under the five-year plan and benefit certain strategic industries. We continue to see strong momentum in key sectors like lithium batteries and semiconductors, alongside ongoing trends toward automation and digitalization. We believe we are well positioned for China in the medium to long term, even if the short term is a bit more challenging to predict. That's all from me. Patrick, do you have any additional comments?

Patrick Kaltenbach, CEO

No, I think you covered it really well. Again, we have a strong team in China, a long history in China. The team has executed very well using the same go-to-market strategies and tools that we used in the rest of the world very efficiently. As you said, I’m very confident about the mid to long-term performance in China, and who knows what’s coming out of any stimulus. It 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 the five-year plan, which means investing into health, investing into important technologies where we all play well.

Dan Arias, Analyst

Yes, okay. Thank you for that. Then 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, and then 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, or do you think that everyone kind of just moves up in sort of the same range?

Shawn Vadala, CFO

Our guidance for the full year remains at 4%. We actually concluded the year slightly better than anticipated, with a strong finish in Q4 at around 7%. I expect a good start in Q1, likely around 6%, but we will see some moderation in the second half as we start to compare against the pricing actions taken to address inflation in 2022. Regarding differentiation, lab performance tends to be slightly better than the overall portfolio, and we generally perform a bit better in developed countries compared to emerging ones.

Dan Arias, Analyst

Okay, very good. Thank you guys.

Operator, Operator

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

Jack Meehan, Analyst

Sorry, I was muted. Good morning. I wanted to ask about the product inspection business, so 9% core, nice beat versus the guide, and I think the CAGR accelerated in the year end too. 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, CEO

Yes, 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. I think 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, but we are still cautious, as I said before, about Europe. Of course, increasing our installed 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 the level of services we can provide also for this product portfolio, and 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 with instrumentation which will afterwards continue to drive more services. The area, the region where we had probably still more happen was also in China. Given COVID-19, 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. But also there, I would say moving forward, we see opportunity of course of building more market momentum in that domain as well, but the U.S. is by far the biggest and most important market and very well covered by our service business there, of course. Europe is the second biggest part and continuing to build out also China and Asia-Pacific.

Shawn Vadala, CFO

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

Jack Meehan, Analyst

Got it. 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, we expect to grow mid to high single digits for the full year, which is consistent with our previous statements. In Q1, we anticipate mid single digit growth, though Q1 will be slightly impacted by factors such as pipette tips and customer stocking.

Jack Meehan, Analyst

Sorry, I may have misheard. Thank you.

Operator, Operator

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

Vijay Kumar, Analyst

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

Shawn Vadala, CFO

Yes, we've always had some concerns about multi-year comparisons and macroeconomic uncertainty, and this situation isn't much different from our previous commentary on the full year results. Currently, we are at the beginning of a new year, and it’s important to see how the next couple of months develop. After that, we will have better insight into not only the performance of the first quarter but also the momentum we might carry into the second quarter and the rest of the year.

Vijay Kumar, Analyst

Understood. Then one on cash flows here, it looks like free cash flows came in below your guidance for fiscal ’22. I’m curious, was that just a timing element, and I’m looking at your guidance here for fiscal ’23 - $900 million, is that benefiting from some timing elements here, or any cadence on free cash flows?

Shawn Vadala, CFO

Yes, that's a good question. Our free cash flow guidance was updated last quarter, and we aligned with that revised guidance. We lowered our expectations for 2022 mainly because we had higher inventory levels to maintain safety stocks, addressing some of the global supply chain challenges. Looking ahead to 2023, we anticipate reducing a lot of that inventory, which should lead to significant growth from a year-over-year perspective, largely influenced by the timing of our working capital.

Vijay Kumar, Analyst

Understood, thanks guys.

Operator, Operator

Our next question comes from Tim Daley at Wells Fargo.

Tim Daley, Analyst

Great, thanks. Appreciate the detail on the service side, but just want to dig a bit into consumables. What was the consumable growth in the quarter and the year, and then can you help quantify the size and the timing of the two major one-off headwinds Mettler is facing in ’23 around the pipette tip business, particularly the roll-off of the DoD contract and then that inventory stock dynamic?

Shawn Vadala, CFO

Yes, so our consumables business, in terms of total mix on the business, is about 10% in the quarter. For the full year, it was about 12% of our business. Consumables, as a reminder for everybody, about half of that is probably pipette tips and then the other half is a combination of process analytic sensors, as well as other consumables for other categories. As a total group, consumables were down about 5% in the quarter, and for the full year they were up 5%. But if you kind of 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, and that’s topic related to customer stocking that you’ve heard about from other companies. Fortunately for us, it’s not a significant impact to our overall results, and we’ll probably continue to see that trend play out here in the first quarter and maybe even in Q2.

Tim Daley, Analyst

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

Shawn Vadala, CFO

Yes, sure. Instead of going through each line, I'll provide some insights on gross profit. In the first quarter, we expect gross margin expansion of about 140 basis points, and for the full year, we anticipate around 100 basis points. This figure is slightly lower than what we previously mentioned, primarily due to currency translation effects. On a currency-neutral basis, it aligns well with our earlier guidance. For the full year, our operating margin has increased by 190 basis points, and we estimate around 130 basis points for the entire year.

Tim Daley, Analyst

Great, thank you.

Shawn Vadala, CFO

Yes, you’re welcome.

Operator, Operator

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

Matt Sykes, Analyst

Hi, good morning. 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 develop into?

Patrick Kaltenbach, CEO

Thank you, Matt, for the question. As I mentioned at the investor day, it’s crucial for us to shift our mix more towards contract services. Our telesales and sales teams are diligently working on this, continuously communicating our new service offerings to customers. We aim to illustrate the advantages of being under contract, such as preventative maintenance, uptime, and 24/7 service availability. I see positive momentum in this area, as we have made significant progress over the last few years in increasing the number of services under contract. This begins at the point of sale, ensuring our salespeople can educate customers on the benefits of contract services. Additionally, we have expanded our service portfolio from basic offerings to more comprehensive solutions, making it easier and more appealing for customers to choose a service contract. This ongoing transition is beneficial for both our customers and us. Our data analytics show that customers with service contracts are more likely to make repeat purchases, as they recognize the full value of our offerings. This not only increases efficiency in service delivery but also optimizes the scheduling and coverage of services, ensuring our technicians work effectively. We expect to see continued growth in service coverage, which will benefit both the company and our customers.

Matt Sykes, Analyst

Got it, and just a follow-up on services. Patrick, you mentioned that most instruments are not serviced by Mettler. Could you provide more details on what that percentage is and your thoughts on potential growth? Shawn, you indicated that services will be growing faster than the group, and I'm assuming it's a higher margin. Can you discuss the medium-term impact on margins from an expanded services business over the next few years?

Shawn Vadala, CFO

Yes, sure. Maybe I’ll go first, then I’ll let Patrick go second. I’d say 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, CEO

Yes, regarding the overall service opportunity, we have millions of instruments in our database, which gives us a competitive advantage through that visibility. Our market for services exceeds $3 billion, providing us with a significant chance to increase our market share. While we cannot know for certain, we estimate that more than 60% of the instruments currently operational are not yet fully covered by our services.

Brandon Couillard, Analyst

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 sub-segments, what you’re anticipating for the year? Any bifurcation between those two markets?

Shawn Vadala, CFO

Yes, of course, Brandon. In the fourth quarter, lab revenue increased by about 20%, while industrial revenue grew in the low single digits. Looking ahead to 2023, we anticipate double-digit growth in the lab sector for both the first quarter and the entire year, whereas we expect industrial growth to be relatively flat due to recent disruptions. For the full year, we are adopting a more conservative outlook for industrial, forecasting low to mid single-digit growth, with the expectation of stronger growth in the latter half of the year.

Brandon Couillard, Analyst

Got it, and then on the lab business globally, are you able to quantify the impact of the pipette declines on that segment in the quarter? I imagine it must have been maybe at least a point. Then Patrick, you mentioned lithium batteries, just help us understand what areas of the portfolio are serving that market.

Shawn Vadala, CFO

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

Patrick Kaltenbach, CEO

Yes, let me add there, Shawn. On the pipette business itself, we have seen good growth on pipette instruments also in Q3 and throughout 2022, and also we see continued good growth in service pipette business, so it’s really the pipette tip business that has been suffering, and that’s of course also due to the ramp down of testing, etc. out there. With the increased number of instruments that we sell, single-use pipettes, etc., 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.

Catherine Schulte, Analyst

Hey guys, thanks for the question. I guess first, I wanted to go back to the services business. You talked on the penetration side in Matt’s question, but 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, CEO

What we are focusing on is the continued increase of the attach rate. Last year, we overhauled the entire quoting process. In the past, our sales representatives had to manually quote services and refer to a catalog for available services and products. Now, it's an automatic part of the quoting process. If a salesperson is unable to sell services, they must provide justification, which helps us improve our marketing materials for services and enhances our ability to communicate the value of these services. We are committed to ensuring our customers recognize the benefits of service contracts. The current attach rate is difficult to specify, and I will need to verify that number and provide an update in a future call. However, the key takeaway is that we are witnessing a consistent increase.

Catherine Schulte, Analyst

All right, great. Then 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 factor 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, CEO

I believe there are several factors at play. The packaged food sector is certainly one of them, as it involves significant capital investment and is among the few categories that require a high level of capital expenditure. Additionally, we have observed that some of our customers are becoming more hesitant, a trend we noted in Q4, which is continuing into Q1. They are all assessing the current market situation and are awaiting clarity on how it will unfold. Thankfully, the potential impact of an energy shortage in Europe has not yet materialized, and we hope to get through the winter without major problems, which could bolster overall market confidence. In Europe, we have been quite successful over the past few years and performed well in Q4, but we anticipate that the second half of the year will present tougher comparisons for us. Therefore, we are currently projecting low single-digit growth for Europe in 2023.

Michael Ryskin, Analyst

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

Shawn Vadala, CFO

Yes, I’d say we’re coming off a period of a lot of growth in that business, Mike. 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 special chemicals for us. This business also benefits from some of these hot segments that we talk about, like lithium battery, and then just these trends in automation and digitalization, which we continue to see really holding up during a deteriorating macro environment over the last few months. Historically, it is the business that’s most susceptible to the macro, so we still keep an eye on it. We were really pleased in the fourth quarter that we saw good growth in each region, which I think is good. It’s important to see each region of the world growing, but we’re certainly a little bit more cautious as we kind of look to 2023 - it’s early in the year. China is a big part of this business, so I think it will be important for us to 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, Analyst

Okay, that’s fair. Maybe just a follow-up, tying up 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

Yes, so it’s at least a two-year dynamic. 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 kind of communicate anything, but it could be something in the 1% to 2% kind of range. But we’ll obviously know a lot more towards the end of this year and when we provide guidance for next year. Yes, thank you.

Patrick Kaltenbach, CEO

Thank you.

Operator, Operator

We’ll go next to Liza Garcia at UBS.

Liza Garcia, Analyst

Good morning, everyone. I appreciate you fitting me in. I have a question regarding operating expenses and how to consider the investment strategy. R&D has increased by 7% in local currency this quarter, which has been balanced by a decline in SG&A. As we evaluate your investment strategy, how should we approach modeling the R&D expenditures?

Patrick Kaltenbach, 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, and the success of our business really also relies on driving innovation to market. This year we brought a lot of great products to the market, helping our customers in the domain of automation, digitalization, compliance, etc., both on the hardware and software portfolio that we launched. We actually launched internally a program that we call our accelerator program, where we look at our pipeline of R&D projects that we have across the company and selected a number of really high potential projects that we are accelerated with additional funding, and that’s part of the increase that you also see there on the R&D line. Again for us, on the leadership team, we’ve made a very conscious decision, saying using the success that we have as a company to accelerate products and bringing even more horsepower to the street and making sure that we get stuff to our customers which we know will help them to drive more productivity, help them to drive better insights into the research they are doing, and I’m actually really excited and really proud that we could do that.

Liza Garcia, Analyst

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 me the update on the M&A environment and what you’re seeing in the market, maybe in terms of incremental opportunities to enhance the portfolio?

Patrick Kaltenbach, CEO

Yes, that's a great question, Liza. Regarding mergers and acquisitions, our strategy remains unchanged. We are focused on tuck-in acquisitions and bolt-on acquisitions that enhance our capabilities, whether through technology that we currently do not possess but believe is crucial for our portfolio, or by providing market access in areas where we have not previously operated. An example of this was PendoTECH, where we aimed to expand into downstream bioprocessing and offer suitable solutions to our customers. Last year, we also made a strategic acquisition in the software sector with Scale-up Systems, which strengthens our autochem business and supports customers in scaling from research and development to manufacturing. This gives us a unique value proposition. Towards the end of the year, we acquired a smaller lab business in Germany with $10 million in revenues, which includes products essential for our portfolio, and I anticipate continuing in this direction. We are always on the lookout for the right opportunities. Given our strong business position, we can be very selective about the companies we choose to acquire. I believe Mettler stands as a leader with an exceptional platform for companies seeking global market access or requiring our supply chain strength to accelerate their market entry, but it must be something that complements our portfolio. We do not need to pursue M&A for growth as we have a robust organic growth engine. Nonetheless, I am quite interested in opportunities that can propel us into fast-growing market segments, such as biopharma, which was a major factor in our acquisition of PendoTECH.

Rachel Vatnsdal, Analyst

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 the pipette inventory stocking as well. You flagged that consumables were down 5% during 4Q due to that pipette dynamic, so can you just walk us through your expectations for consumables growth in the first quarter and then for the full year? Then kind of within that, what’s embedded for that consumables growth between pricing versus volume?

Shawn Vadala, CFO

Yes, hey Rachel. I don’t have the specific breakout for the full year. I would say I’d probably expect to see a similar result in Q1 as we saw here in Q4 overall for consumables, then I would certainly expect to see some growth in the second half of the year. But I don’t have anything specific in mind in terms of exactly what that would be, but definitely would expect us to return to growth in the second half of the year.

Patrick Kaltenbach, CEO

Yes, absolutely Shawn, and think again, as I said before, some good indicators for us is the demand for our pipette itself, for the instruments. It should give us continued growth. We are playing very well in the biopharma research space with our product portfolio, so the COVID tailwinds, I think will hopefully not be any topic for us as we go into the second half of the year. The rest of the portfolio that we have in consumables, the sensors that go into biopharma, some of their probe sensors or even some of the lab products, have consumables. They are still doing quite well.

Shawn Vadala, CFO

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 specific into our guidance.

Operator, Operator

We’ll take our final question from Patrick Donnelly at Citi.

Patrick Donnelly, Analyst

Hey guys, thanks for fitting me in. Maybe just one, obviously a lot of ground covered here. Shawn, maybe on the supply chain in general, you talked about inventory, obviously you ran a little high in ’22 because of some of the stocking impacts. Can you just talk about expectations to kind of wind that down? Are you seeing normalization in the supply chain? Some thoughts on how you’re thinking about that piece.

Shawn Vadala, CFO

Yes, thank you, Patrick. I'll begin and then Patrick can add a few comments as well. We've definitely noticed significant improvement in the supply chain, especially in transportation. The time it takes to move goods from one country to another is nearly back to normal, which is fantastic. Regarding component availability, there are still occasional issues, but overall, the level of disruption is much lower than what we experienced six months ago.

Patrick Kaltenbach, CEO

Yes, I can confirm that the semiconductor issues we discussed last year are mostly behind us, with only a few exceptions. The team has also been quite flexible in altering some of the instrument designs, reducing our dependence on certain uncommon components. Overall, our supply chain is nearly back to normal regarding transportation times and material availability, which should not hinder our business success in 2023.

Shawn Vadala, CFO

Maybe just one final comment on that one is we’re really proud of our team. 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. I think it, frankly, helped us gain some share along the way and enhance our brand.

Patrick Kaltenbach, CEO

Absolutely.

Operator, Operator

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