Mettler-Toledo International Inc (MTD) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to our second quarter 2010 Mettler-Toledo International earnings conference call. I will be your audio coordinator for today. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session

(Operator Instructions)

I would now like to turn our presentation over to your hostess for today, Ms. Mary Finnegan. Please proceed.

Thanks. Good afternoon, everyone.

I am Mary Finnegan, Treasurer and responsible for investor relations at Mettler-Toledo. I'm happy to welcome you to the call. I'm joined by Olivier Filliol, our CEO, and Bill Donnelly, our CFO.

I would like to cover a couple of administrative matters. This call is being webcast and is available for replay on our website at www.mt.com. A copy of the press release and the presentation that we refer to on today's call is also available on the website.

Let me summarize the Safe Harbor language, which is outlined on page 1 of the presentation. Statements in this presentation which are not historical facts constitute forward-looking statements within the meaning of U.S. Securities Acts of 1933 and the U.S. Securities and Exchange Act of 1934. These statements involve risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by any forward-looking statements. For a discussion of these risks and uncertainties, please see the discussion in our recent Form 8-K. All of these forward-looking statements are qualified in their entirety, by referenced to the factors discussed under the caption, "Factors acting our future operating results," and in the "Business and management discussion analysis of financial conditions" and "Results of operations" sections of our form 10-K.

One other item, on today's call, we may use non-GAAP financial measures. More detailed information with respect to the use of, and differences between, the non-GAAP financial measures and the most directly comparable GAAP measures is provided in the 8-K.

I will now turn the call over to Olivier.

Thank you. Good evening, and welcome to the call. I will start with a summary of the quarter, and then Bill will provide details on our financial results and our increased guidance for the year. I will then continue with additional comments on the business. As always, we will have time for Q&A at the end.

I'm very pleased with our strong performance in the second quarter. Highlights of the quarter are presented on page 2 of the presentation. While comparisons were relatively easy, local currency sales growth of 16% exceeded our expectations. Business momentum improved in the quarter, and we had strong growth in almost all product lines and regions. Strong operating leverage drove a 200 basis point increase in gross margins, which led to a 30% increase in operating profit and a 32% increase in adjusted EPS.

With these strong results, we are raising our full-year guidance. Bill will provide details on our guidance, as well as our financial results for the quarter. Bill?

Thanks, Olivier, and hello, everybody.

Let me start with additional details on sales, which were $468.5 million in the quarter, an increase of 6% in local currency. We estimate that acquisitions contributed between 1% and 2% of this growth. On a U.S. dollar basis, sales increased 15%, which included a negative 1% impact for negative currency. For the six months local currency sales increased 11%, with approximately 1% coming from acquisitions. As a reminder, the sales growth compares to a negative 11% from the same period last year.

Now, turning to page three of the presentation, we outline sales by geography. In the quarter, local currency sales increased 15% in the Americas, 10% in Europe and 27% in Asia and the rest of the world. On a six-month basis, which outlined on the following slide, sales increased 13% in the Americas, 4% in Europe, and 21% in Asia and the rest of the world.

On slide number five, we outline sales by product area for the quarter. Laboratory sales increased by 17% in the quarter, industrial sales increased by 16%, and food retailing was up 13%. The next slide provides six-month sales results. For the six months, lab was up 13%, industrial was up 12%, and retail was up 5%.

Turning now to slide number seven, we show the full P&L. Let me walk you through the key items. Gross margin was at 52.6% in the quarter, a 200-basis point improvement over the prior year. We benefited from operating leverage and pricing. We did start to see the impact of higher raw material costs during the quarter. R&D amounted to $23.1 million, an increase of 5% in local currency. SG&A amounted to $143.6 million, an increase of 18% in local currency. Higher variable compensation due to much stronger results contributed to approximately half of this increase. Acquisitions, incremental sales and marketing programs, and investments in emerging also contributed to the growth. Adjusted operating income amounted to $79.9 million, which represents a 30% increase over the prior-year period of -- over the prior year amount of $61.7 million. We are very pleased with the 200-basis point improvement in operating margin, which 17.1% in the quarter.

A couple of final comments on the P&L. Amortization amounted to $3.6 million, interest expense was $4.7 million, and fully diluted shares in the quarter were $34.4 million. Our tax rate remained at 26% in the quarter, and we continue to believe that this is an appropriate rate for the full year. Finally, adjusted earnings per share was $1.55, which is a 32% increase over the prior year amount of $1.17. On the following slide, that is slide eight, our year to date P&L is presented. For the six months, local currency sales increased by 11%, which drove a 23% increase in operating profit and a 26% increase in adjusted earnings per share.

Now turning to cash flow, which came in pretty much as expected at $69.6 million or $2.02 per share, our working capital initiative continued to yield strong results, as DSO declined by three days as compared to the prior year, and now stands at 40 days. Our ITO remained constant at 5.1.

During the quarter, we spent $43.6 million to repurchase 378,000 shares at an price of $1.15.40. Year-to-date we've purchased 663,000 shares at an average price of $1.09.8 or $72.8 million in total.

Now let me turn to guidance. We're increasing our full-year local currency sales growth guidance to the 8% to 9% range. Of this amount, approximately 1% to 2% will be from acquisitions. This compares to our previous guidance for the full year of 6% to 7%. Adjusted EPS is now expected to be in the range of $6.35 to $6.45 per share, or a growth rate of between 14% and 16%. For the third quarter, we expect local currency sales growth to be in the range of 8% to 10%, and adjusted earnings per share to be in the range of $1.52 to $1.57 per share.

Let me make some additional comments on the implied sales growth for Q4, as well as on our foreign currency assumptions that we've built into the guidance. As always, we will provide guidance for fourth quarter sales growth after our -- after we announce our third quarter results. However, you can back into an implied Q4 growth rate of 4% to 5% based on the full-year numbers we've provided today.

We have two factors impacting our thoughts on Q4. First, the comparisons in Q4 will get tougher, specifically Q3 2009 was a 12% decline, while Q4 2009 was a 5% decline. Second, we're cautious on the global economy. Recent ripples in Southern Europe and a potential slowing in China could impact sales. Although our business is quite solid right now and we see no signs of slowing, given this uncertainty, we wanted to build some conservatism into our full-year growth assumptions.

Now for the impact of foreign exchange. We've spoken about the impact of Forex on our results many times to you. Those of you who know us well understand that our primary currency exposure is the Swiss Frank versus the euro. As a reminder, we have a net cost position in Swiss Franks, because a large part of our product development, manufacturing and headquarter costs are based in Switzerland. We have a large net revenue position in the euro, given our significant European sales base, with only limited manufacturing in those countries.

If you turn to page nine of the presentation, we've provided some historical data on the Swiss Frank versus euro exchange rate. You can see from the period of 1999 through 2008, it typically traded in a relatively narrow band in the $1.50 to $1.60 range. Since the end of 2008, we've had more volatility in this cross rate. Specifically in 2009, the euro weakened against the Swiss Frank by approximately 5%. During the first six months of 2010, it also weakened by 5% as compared to the prior year. Current rates would imply an 11% weakening of the euro versus the Swiss Frank for the remainder of the year.

So what does this mean for us? Using the current exchange rate environment, we estimate the impact of foreign exchange would reduce earnings per share by approximately $0.06 in Q3 and $0.12 in Q4 as compared to the prior year. This reduces our earnings per share growth by approximately 4% in Q3 and approximately 6% in Q4.

Now let's put this into perspective. Probably the most important factor is we view this as a temporary situation until the comparisons become annualized. Assuming Forex rates remain at current levels, the impact would be about $0.05 into Q1 next year, and slightly less than $0.05 in Q2, and no effect thereafter. Some of this would be partly offset if the Chinese renminbi appreciates versus the dollar in that period.

In summary, the Forex headwind, and specifically it's impact on incremental margins, is not a long-term issue. The fundamentals of our financial/operating model remain intact.

Okay, that's it for my side. Now I want to turn it back to Olivier.

Thank you, Bill.

I want to start with some comments on the business, both by product area and geography, for the quarter. In laboratory, we had very strong growth in almost all product lines and in all regions. Our product inspection business continues to have very strong results, especially in the United States and Asia. Core industrial also had strong growth, despite transportation and logistics being down. China was very strong in industrial, while Americas and Europe was also very solid. Food and retailing came in better than expected, with good activity in Europe and Asia.

Finally, let me also comment on sales by region. We were pleased by solid growth in Europe. Looking at Europe by region, we had good growth in Germany and UK, while France also had growth. Eastern Europe was very strong. Countries in Southern Europe, which are receiving most of the media attention, were relatively flat in the quarter. Turning to Asia and the rest of the world, we had strong growth in most product lines and most regions. Finally, in the Americas, we had good growth in most product lines and regions.

I want to make some additional comments on Brazil, where we see significant growth opportunities. We have had a very small direct presence in Brazil, and largely used indirect channels to markets. As a result, we have limited success in the markets. The exception was our process analytics business, where we had our own operations for many years. Using our process analytics business as a base, we began to expand our presence about two years ago. We currently sell balances, analytical instruments and automated chemistry offerings directly into this market. Later this year, we will also launch pipettes, and our entry-level products to provide a full laboratory offering. Our product portfolio stands up well against the offering of local competition, as well as our traditional competitors.

To capitalize on the many opportunities in this market, we are making meaningful investments in (inaudible)-related sales and marketing programs, and resources to expand our regional sales coverage. We have established a marketing team with permanent dedicated telemarketing resources, and are building an elite (inaudible) engine for this market. We're also working to improve and refine our web tools, e-mail campaigns, e-newsletters and webinars, to expand our customer base and gain new business. Finally, we are developing and refining our service offering, which is now a small part of our business, but with good expansion potential. With the investments we are making, and the dynamics in the market, we expect to achieve excellent growth and build a presence, as we have done in other emerging markets. That covers our business by product and geography.

Turning to page ten of the presentation, let me now provide some additional comments on our process analytics business, which has an excellent track record for technology innovation and sophisticated marketing. The business has achieved above market growth from numerous years, and also benefits from a high percentage of revenue from consumables. Furthermore, our product innovation and expansion strategy is reinforcing the consumable portion of the revenue.

Let me provide you with some additional background on this business. Process analytics provides industries such as pharma, biotech and chemical companies, solutions for monitoring and optimizing their production. While the total market is large, we have market-leading positions in industrial applications, such as ultra pure water, PH and dissolved oxygen. Our solution combines sensor technologies with transmitters to measure specific analytical parameters. The system must be calibrated, maintained and replaced on a timely basis. A sensor malfunction can cause and entire batch to be lost, which for a pharmaceutical company can be very costly. For example, in biopharma production, a typical batch is in the $1 million to $2 million range, and can be as high as $10 million. Consumables would present approximately 30% of this business, with service an additional 10%.

We're well regarded as the technology leader in this market. Our sensors, which we refer to as ISM or intelligence sensor management, are based on digital communications, and are easy to install and operate. Most important, they contain predictive diagnostics to ensure on-time replacement and avoid any unplanned downtime.

We have now taken our technology further with the leapfrog innovation of new digital sensors provided to pharmaceutical customers for ultra pure water applications. Ultra pure water analysis helps ensure the integrity of the manufacturing process, and is critical to companies in regulated environments, such as pharmaceutical. Our new sensor, known as [UNICOM], incorporates technology directly into the sensor that used to be housed in the transmitter. This means that cables no longer influence the measurements, giving the sensor a high level of accuracy. A single sensor can now also provide a broader measurement range. The customer has a tangible pay back in terms of better water quality and higher process reliability, which drives improved yields. Initial customer reception has been very strong.

To complement our offering for water purity, later this year we'll introduce new digital sensor technology to POC, targeted to the entry-level ultra pure water market. The solution is easier to use, and leverages our Chinese transmitter manufacturing. We see significant opportunities for POC in emerging markets, particularly in China, whose pharma [PR] regulations are similar to that of the US. Finally, we soon launch a new-generation transmitter which can detect multiple parameters. It's easy to use and install, and has an intuitive touch screen and enhanced real-time diagnostics. Customers obtain a payback in lower cost per measurement point. Internally, it also represents a milestone in our initiative to move our transmitter manufacturing to China. This was started a few years ago, and by the end of the next year, almost all of our transmitters will be produced in China at considerable cost savings. These are a just few examples of our strong product pipeline. Our technology innovation also helps to reinforce our consumables stream, as our intelligence sensor has a greater level of real-time diagnostics and electronics, which makes substitution by competitors more difficult.

It is not just our new product launches that are driving above market growth rate, but our sophisticated sales and marketing programs. Process analytics was the incubator for projects (inaudible) several years ago, and they continue to refine and further enhance the marketing programs. The lead generation activities remain robust, and are increasingly developing integrated marketing campaigns, so the entire process from telemarketing to identifying leads, to sending a salesperson for the most qualified leads, is streamlined and focused. Process analytics is a good example of using strong execution, combined with innovative product launches and well-evolved marketing programs to gain market share.

That's all I wanted to comment on the business. Bill has one additional topic before we conclude and open Q&A. Bill?

Thanks, Olivier.

We have some additional comments on return on invested capital, as we know that's a focus area for many of you. On page 11 of the presentation, we present how we evaluate return on invested capital internally, with a KPI called return on controllable assets. The definition is tax-adjusted operating profit divided by net working capital and fixed assets; that is, the assets that our managers can control. We believe that this is a more relevant definition to our general managers, as it excludes the impact of intangibles such as the goodwill from our original buyout, which is largely outside their control. Our steady improvement and operating profit, combined with strong control on working capital and low fixed asset requirements, has produced very strong returns, as highlighted in the chart. We know that capital returns are important to you as shareholders. We want to assure you that it is important to us as well. We're happy with the progress to date, and believe we can continue to drive improvements in the business going forward.

I'll turn it back to you, Olivier.

One final comment, before I make some closing remarks and open the line for questions. I'm happy to report that CI-Vision, the vision inspection business that we acquired at the end of last year received its largest order ever. It's a pharmaceutical-based application, with a total order value of approximately $3 million. Demand for in-line vision inspection is increasing, as customers such as pharma have heightened sensitivity to even the smallest product defect. We are pleased with this order, which reinforces why this was an attractive market for us to enter. It also reinforces why we are a good home for this type of technology. We hope to eventually go global with this technology.

I want to conclude the prepared remarks by stating that we are very pleased with the continued momentum in our business. While we are benefiting from the rebounding economy, we also continue to realize the benefits from the investments we made over the last years. We remain cautious of certain markets, as uncertainty still exists. We continue to believe we will further strengthen our market position as the global economy continues its recovery.

I want to now ask the Operator to open the line for questions.

(Operator Instructions)

Your first question comes from the line of Jon Groberg with Macquarie Capital. Your line is now open.

Hi. Thanks a million for taking the questions, and congratulations on a very impressive quarter.

Thanks.

Thank you, Tom.

Can yoy -- maybe just Bill, if I can tell you for a second, when you talk about currency here, if you look at the first half of 2010, you had a 5% headwind, and you're saying kind of a current rate that goes to 11%. What kind of earnings impact did that have in the first half of the year?

In the first half of the year, you had some other currencies going the other way, and I think it was around $1 million positive in Q2 for us; and if you take the rates as they sit today, we would not have the positive effect in some of these other currencies. I would highlight that if you actually go back some period of time and look at kind of how various rates interact, it's a little unusual that some of these currencies haven't moved in concert to kind of offset this. There's usually some offsetting of the Swiss Frank/euro, particularly in what I would describe as the energy or commodity currencies, like the Canadian dollar or Australian dollar, and a few of these tend to offset it. But the facts are that sitting here today, they're just not.

Okay. So if you look toward some of those currencies, and if they were to strengthen, you know commodities around a little bit, then that would potentially be a bit of an offset?

Yes. And particularly I would say the biggest one would be if the Chinese let the renminbi appreciate. We've now moved into a net revenue position in the renminbi. I think last year was 30 million. I guess it would grow somewhere between 40 million and 50 million for the full year this year.

And then, if you look at -- obviously in these forecasts, as we think out -- and I appreciate you're trying to be conservative, given that you have no idea what's going to happen, as most of the rest of us don't as we move into the end of this year and into 2011, but if you just kind of think about how your business is currently performing. And kind of what you're hearing from the field, is it just -- a lot of this just a large make up from the slowdown in 2009? Does it feel as though kind of a restocking or a make up, or does it feel as though you kind of hit this bottom? There's a little bit of a rebound, but it's a healthy kind of rebound? I know it's a bit of a qualitative question, but I'm just trying to get a feel for how you're thinking about the business?

What we have seen, actually, from the beginning of the year that we have a very good momentum overall, a good environment, and Q2 actually came in from the beginning very good, and got even stronger at the end. We don't have signs that things are cooling down. We feel good, but we remain cautious and as highlighted in the prepared notes, comparisons start to change. We have, in Q3, still weak comparisons; but then in Q4, the comparison becomes improved. And in that sense, I think that's why we have this guidance out as we just stated. But it's not that we see any early signs of things weakening versus what we have experienced earlier in the year.

And maybe to add a little bit to Olivier's comment, I think that we entered the quarter with good backlog, leads are good, et cetera, et cetera. I think what we see a little bit, maybe to comment you were making, Jon, is in the western world, we see kind of a rebound moving back toward our 2008 levels in the Western world, where we believe our customers, you know, cut back on their spending with us in kind of an unsustainable way. It's not really destocking in that sense, because our customers don't really stock our products or our consumables very much. But certainly somehow they were holding back on a basis that wasn't really sustainable. I would say that's mostly a Western world economy. Clearly, the growth in emerging markets is more fundamental.

Okay. Thanks. I guess restocking probably wasn't the right word, but a reinvestment as you said. And I guess -- and one last question, and then I'll hop in the queue. Can you maybe -- I know it's hard when you're growing those stats, and you're coming off the comparisons you're coming off. But a few companies have given some numbers in terms of like they're doing in product inspection and other areas. Can you maybe talk about some specific areas where you grew, and your comments around what you think is happening with share?

I think -- I'm kind of looking at Olivier, probably we don't feel like we have share issues in any product line at this point in time. We really feel like we did well in the downturn in 2009, as well as this early part of the year. I think we were able to invest more effectively in marketing programs as well as product development. It feels really good competitively right now.

If you were to think about our lab businesses, our lab product lines all did quite well. I would highlight in particular processing analytics and pipettes did very well. Balances had solid growth, analytical instruments as well. In the industrial side, in the Western world, we had strong growth in product inspection, and in the base industrial the growth more came from emerging markets.

Okay. Great. Thanks, William.

Your next question comes from the line of John Wood with Jefferies. Your line is now open.

Hey, thanks a lot. Bill, can you -- can you kind of go over -- I think you did this last quarter, the major buckets in gross margins, you know, just the major contributors to the expansion there?

Sure. We had about 50 basis points of the expansion is due to pricing, and that -- you know, just in the math, that means we had a net realized price increase of about 110 basis points in the quarter, and then we had -- the next big impact was sales leverage, the sales leverage on the product side was around 120 basis points in the business, and then that accounts for the majority of it, and the rest is miscellaneous.

Okay. Thanks a lot. And Olivier, if you look at the fourth quarter, so just, you know, you gave kind of implicit guidance of 4% to 5% local currency growth, can you kind of just go down the major geographic region expectations built into that? And then comment on just the specific actions in Europe that you've seen and how -- you know, how you think about that impacting your European business? I guess it would be a 2011 phenomenon at this point? Thank you.

Yes. Okay. Specific to Q4, I think what you're going to see is having a relative performance to what we had last year. Last year we were minus 5%, and that's not -- we had different results by geography; but when I just look at the momentum that I see in the market and how our team are performing against that, I would certainly expect Asia and the emerging markets in general to perform very well, continue to perform very well. We had this -- China grew 30% in the quarter. Are we going to be keeping that up at this level? Here I'm more cautious, but I certainly expect a very good growth of China and the emerging markets in general.

Europe, I expect actually good growth in Q3. How it will continue into Q4, I want to be a bit more cautious here. I think it's certainly the market where there are the most question marks in terms of the general economy, about the mood in the market. Our teams still feel good. We have good lead activity. We have good requests for quotes, and so from that standpoint, I feel very comfortable; but we don't have enough visibility into Q4 to really have a good forecast there. When it comes to the Americas, I see, actually, that this should have a good Q3, and that momentum should stay on into Q4, and I wouldn't have the same worries that I've been having about Europe.

I think that gets you pretty much kind of how I sense it, about -- I think you asked more specifically about Europe, what's going on and how this could impact us. Right now, there is nothing in particular that I'm worried about. We talked about some of the PIGS countries, in particular Southern Europe, that have some relevance for us, there I need to put it in perspective. Europe for us, in total, is 37% of revenue. The PIGS countries would represent about 5% of our total revenue. So we are not so much impacted, and so far some of the countries, like Italy, still perform well for us. Spain was kind of flattish, but still had some growth, and, yes, I have modest expectations from these countries, but I wouldn't expect that there would certain and big drops for us.

Okay, that was great. Thanks a lot. And one quick one for Bill. On CapEx, any change to the outlook there?

No. I think we can probably expect some similar numbers. We talked at the Board meeting that we'll start spending some money on some plant expansions in China next year, but they're still not going to materially move the overall CapEx number.

All right. Thanks a lot.

Your next question comes from the line of Paul Knight from CLSA. Your line is now open.

Hi, guys. Great to be back on a Mettler call.

Nice to have you back, Paul.

A couple of questions. When I look at this 29% organic Asia emerging market, stated was like 34%. What are the currencies we need to watch in that spread? The RMB, is that it? Or the rupee? What are the major --

RMB is about half of that number, and then you would have the Brazil, the Eastern European countries, which is probably part of the improvement, some of the Eastern European currencies did better, Eastern European currencies, and then the small numbers include kind of like the Middle East countries, some African countries.

Okay. And then another angle on Jon's earlier question, and that is do you have and assumed GDP growth rate on Europe that you look at or believe in for Q4 and the future?

No. And we certainly think that it's going to be a modest number, and that it will probably likely be something less than the US number. But specific to Q4, we didn't really tie it to a GDP number, and as you know we're a bit of a laggard to GDP in particular, I would say, manufacturing GDP. So we did look at, among other things, Paul, kind of like two-year growth rates and stuff, and maybe just have some caution in and around some of the -- let's call it economic uncertainty with all that Europe is in the news today.

All right. Thank you.

Sure.

Your next question comes from the line of Derik De Bruin with UBS. Your line is now open.

Hi. Good afternoon.

Hi, Derek.

With the changes in the Chinese currency, you know, I've got a lot of questions from investors kind of asking about the competitive landscape, and more local players -- will more customers in China buy local manufacturers and local products. I mean, have you seen any of this? You certainly seem to be very well -- you certainly seem to be very competitive even with the local Chinese markets. Have you seen any changes in buying patterns since that announcement was made?

No, but remember, we are -- we have our own presence there. We have our own manufacturing capabilities, so we are competing with them on and equal base when it comes to currency. There are a few products that we are importing from the West. But that's typically products where we compete with all the Western competitors, with global competitors. When we compete with local players, these are typically the product categories where we produce also locally with our own capabilities.

I would even say, too, maybe we're -- because we've been there so long, it may be a little bit of the nature of the way we're set up there, and the town we're set up in, we're in some ways viewed as Chinese. We're in close relationships with local governments and things because we've been there so long, and I think frankly we're kind of competing in product categories that are not the ones that are receiving high political attention.

Got you. The food retail business was stronger than I thought. Is that just easier comps or just -- or is there something specific going on?

It was easier comps, but it nevertheless exceeded our expectations. This is a business where we always depend on large projects, and there's some lumpiness in it, and it exceeded our expectations versus that forecast that we had.

And I guess in the wake of some of the problems some of the pharma companies have had, the Genzyme and the J&J issues, I mean, are people actively upgrading their process analytics stuff, and are you seeing a lot more demand for -- you know, are people really starting to get more seriously about inspection than they might have been before? I know there's been good demand there. I know you said you've had your biggest order ever. But I am just wondering, you know, are you seeing this just from more the people who are in trouble, or is it the entire industry who is getting more aggressive like this, more so than they were before?

I would say it's the entire industry; but of course, whenever there is such news coming from individual companies, it alerts the whole industry, and in that sense it accelerates and drives the demand. If it's a situation where a company doesn't pass the audits, that typically alerts everybody. But if you have a product recall, that also drives very much the [allotments] in the industry. So yes, I would phrase it that way. It's not in a particular one customer that gets in an issue and has a big demand for new instruments.

Right. And just one final question. Are there any unusual costs [after] that back to SG&A from the -- you know, you cut out a last year. You've been adding things back. Have you done most of the add-backs? Is the second half a lot cleaner in terms of what you think you need to do to get back to where you were? Sorry, that was kind of convoluted. I was just wondering if --

Let me just try to answer it, Derik, and ask me to clarify if I wasn't getting the point. I think, in terms of this quarter, about half of the increase in SG&A relates to higher cash incentives.

Right.

And pretty much for the whole period last year we, you know, paid bonuses, you know, well below budget levels, closer to zero than to budget. This year we're paying that not just at budgeted levels, but based on where we are now, we're expecting to exceed our budgeted targets, and our current guidance reflects that, which would mean cash incentives higher than budgeted levels. So that's quite, let's say, an impact year on year, and driving a lot of the SG&A growth.

If I look -- if I pull out the impact of acquisitions and cash incentives together, I think that year to date, our SG&A is up maybe 3% or something like that, 4%, and so we feel comfortable about, you know, where we are. And I think one thing we feel very comfortable about is kind of where the costs -- you know, to the extent now that we are making investments in SG&A, R&D for that matter, it's -- it came out in certain places, and it's going back in in other places that we think bode well for the long-term returns.

Great. Thank you very much. You got my point exactly.

Your next question comes from the line of Richard Eastman with Robert W. Baird. Your line is now open.

Yes, thank you. Bill, just on the cost currency impact that you lay out, primarily, you know, in the slide, you talk a little bit about the EBIT or EPS impact. Does that hit the P&L mainly at the cost of sales line? In other words, will the optics of this be that your gross margin would come in, given that it's basically a manufacturing cost issue?

Actually, it's probably -- I'd have to run the model a little bit, but actually, I think it's more SG&A and R&D than it is in the cost of sales. I think you'll still see a cost of sale -- a gross margin expansion next quarter. And part two, Rick, as you know, will have more of a currency headwind next quarter, okay, on the top line, and that naturally leads to health, the cosmetic health in gross profit margin.

Okay. All right. And then, just from a -- just kind of a bottoms-up approach here, our new guidance is about $0.09 higher than our old guidance, adjusted. We beat by $0.20 here in the quarter, adjusted; so again, the Delta is about a dime. But then you're suggesting that this cross currency issue will take about $0.18 out of the second half. So I guess, if I'm processing this right, you're essentially raising the second half EPS adjusted guidance by about a dime. Is that right?

I think, actually, no, your calculation was a little bit off, because I think you built in a little bit the kind of double count of the impact of the Q2 beat. I think the comp actually comes out pretty close. I think it's down to a couple of pennies one way or the other how much -- what the full year went up is basically the beat minus some foreign exchange effect, and you can throw away a couple pennies I think that's left over.

Okay.

So maybe we can walk you through it offline, Rick, but I think that's basically how it works.

So then your core expectation for the second half is essentially the same? Excluding currency?

Yes.

On a slightly higher local currency sales assumption?

Yes. I think maybe marginally on Q3. I think Q4, not sure, I think we weren't so precise between the quarters, but yes -- and maybe there's a little bit there, but not that much.

Okay. And, Olivier, you talked a little bit about Brazil and laid out the opportunity there, but can you give us a general sense of how large that business is, what the base is we can grow off of?

Yes, yes. Let me phrase it that way. Without giving you exact numbers, we saw -- it was the process analytics business down there, and now -- which is -- it's one of the smaller divisions. So we feel strong about the base; and then we added our laboratory business more recently, and we have not yet the full portfolio. We're going to have the full laboratory the end of this year, when we're going to add pipettes and the low-end balance business. So while we have a solid base with a solid team, I wouldn't suggest here that this is already a big business, that we'll just start and grow. What I tried to explain here is we want to leverage a base, and make Brazil like we have with other emerging countries. Bill, do you have paper to give us a little bit of flavor of the current sales in Q2?

Yes. I guess Brazil -- yes. I guess Brazil would be in the area of maybe a $30 million business for us.

Okay. And then just lastly, when we talk about Europe being up 10% in LC for the quarter, you know, just by segment, lab, industrial and maybe food, how did those three segments fare against that 10% LC growth rate in Europe?

Say that again, Rick. I didn't quite catch it.

Just the three segments, lab, industrial and food, how did those three segments do relative to the 10% local currency growth rate overall?

The lab business was quite strong. You know, kind of mid-teens kind of level, or mid single digits for industrial and, you know, a double-digit number for retail.

And the question was kind of asked earlier, but in the food retail business, I know it's lumpy. It also tends to be kind of project-driven. Is there some momentum in that business to carry us well into the second half, food retail?

I think you'll see a positive number, but --

Yes, we should remain cautious. Q2 had reasonable growth, but against the previous year.

Minus 26 in the prior year.

So no, you shouldn't read into -- that this is already coming back and has particular good momentum.

I want to remind ourselves of something I mentioned on previous occasions. We want to remain very selective in which projects we're going to compete on. This is a business that has below average profitability. It's a very competitive business, and this big project often ends up in a tender, and we want to be really selective. We want to remain profitable in all of these projects, and so we will be selective. So I expect the food retail business to clearly grow below the group average, and it might well be that we will have one or the other quarters where we might even have some sales declines depending on how these projects come in.

All right. Very good. Thank you.

Thank you.

(Operator Instructions)

Your next question comes from the line of Mike Hamilton with RBC. Your line is now open.

Hello, Mike.

You commented in your prepared remarks about the -- starting to see some higher costs run through on raw materials. Wondering if you can just kind of give a picture of what you're seeing and thinking as you look out at the balance of the year?

Okay. I'll give you first a picture on the second quarter. So about 8% of our total raw material spend -- let me say that differently, our purchase material spend is raw steel. We're buying steel, we're bending it, we're doing something, it relates to the business as well as some of the equipment we sell in the product inspection business. That 8% spend is up over 20% in the quarter, and that's due to largely China, you know, or prices, things like that. You can kind of see what's happening there.

If I look at the rest of the business, Mike, the other 92% of sales, I believe, is down almost 2%. And the -- so I think that we'll continue to see maybe some trends on the raw material piece, which is relatively small, and something that we do try to address in a relatively short cycle on pricing. The decline in the non-raw material stuff, though, I think we probably are going to see some increases in electrical component costs, which is actually a relatively large spend category for us. You probably have read some of the stuff and maybe heard -- I listened to a couple of other industrial companies' calls, there's certainly shortages for many electrical components on the market today, meaning surcharges and other things that I think we'll start to see in terms of coming into costs. I don't want to be, you know, overdramatic there. I think you may not see some of the same gross margin expansions in the third and fourth quarter that you saw these first two quarters, but I still think you'll see expansion.

Thanks, Bill.

Your next question comes from the line of Tycho Petersen with JPMorgan. Your line is now open.

Hey, good afternoon.

Hi, Tycho.

I want to just dive into some of the dynamics you're seeing for the lab business. Can you comment a little bit about pharma, biotech and academic respectively, whether those segments grew for you, and what your outlook is into the back half of the year for each of those customers?

Yes. Okay. Let me split it in big pharma, other life science and academia. I would say big pharma, we still have a relatively challenging environment. We clearly see that many of these big pharma companies are planning or preparing restructurings, and this has some impact on their investment commitments, and we have different ones that are holding back. However, we also see that there is good opportunities for us surrounding that. All of these big pharma companies are looking for productivity gains, and we have really good solutions that are going to help them. I say that particularly in the context of automated chemistry, which helps really to get very significant productivity gains. Now, in that era in particular we also see there's commitments to our instruments, but they are not yet willing to really release the money and make the purchases.

In that area in particular, we also see that there is interest, there is commitment to our instruments, but they are not yet willing to really release the money, and make the purchases. But I don't want to [give] here too bad of a picture, because in reality we still see good momentum, we have seen for example for the balance business, for the analytical chemistry business still good demand. Maybe more in emerging markets, we see often big pharma making good investments there than in the West.

When I talk about other life science, biotech, CROs and so on, I would say the environment is more healthy this year than last year, and again in particular in emerging markets, good demand.

Academia was very good for us last year, I would say, because of the general environment, a lot of government funding helping also the academia, stimulus packages. I see that actually still going very well for us. Here what's also helping is we started last year with a dedicated effort to better penetrate the academia sector, and that continues to pay off. We're working on many different campaigns for that segment, and actually more than just was launched on -- kind of reinforced in the last few weeks that will continue to pay off. So all in all, actually, a good picture.

That's helpful. What is your appetite right now for M&A, and are you seeing more interesting things come across your radar screen given the macro landscape?

I will tell you, it remains as it was earlier in the year, when we talked about it last time. We have more attention to the topic of M&A. We have more resources on the topic. We are screening many different opportunities. You have seen us doing two acquisitions, bolt-on acquisitions, early on in the year. I think these types of acquisitions continue to be attractive to us, and we continue to pursue them. So hopefully, yes, we can materialize one or the other, and as always, we're working on a relatively broad pipeline, and some will work out, and some will not. But it's all bolt-on acquisitions, kind of in the size that we had earlier in the year.

Okay. And then maybe one last one for Bill. I think, in your comments before on kind of OpEx you talked about, as you go to re-add head count and costs in some areas, you know, you're potentially shifting, you know, from areas that you've pulled from. Can you comment on that a little bit more? Is this both on R&D and SG&A? Are you shifting more to emerging markets? How are you reprioritizing as you look to rebuild?

You just hit the examples, clearly it's emerging markets, clearly it's product lines like our process analytics business, our pipette business that we enjoy excellent margins and good growth prospects. So yes, those would be the typical kind of examples, product inspection being another.

Okay. Thank you very much.

Your next question comes from the line of Chuck Murphy with Sidoti & Company. Your line is now open.

Hi, guys.

Hello, Chuck.

I apologize if I missed this. I got on the call a little late. Did you say what product inspection is these days as a percentage of sales?

I didn't say, but it's around 15% of sales or so.

Okay. Can you say what it was, like, a year or two ago? Has it changed much?

It's grown faster. I mean, maybe it's from 12%, but it's --

Okay.

It's grown faster than corporate average.

It's increased, because it grew above average, and remember, we did one of the acquisitions, the CI-Vision, that was added to the business; and of course, in that sense, it's growing in percentage of the total business, and that's actually very much welcome. You heard us talk about, that we are allocating resources more to -- more profitable businesses. Our product inspection business is also in this category, and we feel it's good end user market momentum and good demand, for example, food safety, but also in the pharma sector, as the example that I gave you about CI-Vision, that's got the biggest order. So it's a good market, and it grew in importance, and it will continue to grow in importance in the group.

Got you. What do you think the level of penetration is for the various types of inspection technologies? I mean, would you say that most of your customers use it already? Some of them, or a few of them?

I would say in the [regular] market, it becomes more and more standard, but not necessarily for all the different inspection technologies. So for example, while [metal] action is a relatively mature market and well used technology, the x-ray technology is still in an [adoption] rate, and we have by far not penetrated the market for that in the West, but certainly not also globally. And so that's also one of the reasons why the x-ray business for us should clearly grow above the average of the product inspection.

Got you. All right. That's all I had. Thanks.

Thank you.

There are no further questions at this time. I would like to turn the conference back over to our presenters.

Thank you, Louisa. Thank you for joining us today. If you have any questions, please don't hesitate to call, and have a nice night.

Thank you, bye.

This now concludes today's conference call. You may now disconnect.