Mettler-Toledo International, Inc.

Good afternoon. 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 third quarter 2022 earnings call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by 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 Ullman at Investor Relations. Please go ahead.

Thanks, Audra, and good evening, everyone. I'm Adam Ullman. I'm responsible for Investor Relations at Mettler Toledo, and I'm happy to welcome you all to this call. I'm joined with Patrick Kaltenbach, our CEO, and Sean Vidala, our CFO, and Mary Finnegan. Let me cover some administrative matters. This call is being webcast and available for replay on our website, 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 meeting of the U.S. Securities Act of 1993 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 from those expressed or implied by any forward-looking statements. For discussion of these risks and uncertainties, 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 to these non-GAAP financial measures to the most directly comparable GAAP measures is provided in the 8 and available on our website. Let me now turn the call over to Patrick.

Thanks, Adam, and good evening, everyone. We appreciate you joining our call. I am pleased to report another quarter of strong results as our sophisticated sales and marketing programs, our innovative product portfolio, and our supply chain agility continue to be strong competitive advantages. The highlights of our third quarter performance are detailed on page three of the presentation. Local currency sales in the quarter increased 10% as compared to the prior year, with particular strong results in the Americas and in China. We had very good growth in our laboratory and core industrial businesses. Our robust sales growth and effective execution of our margin initiatives resulted in very good growth in adjusted operating profit and adjusted earnings growth, despite significant foreign exchange headwinds. As we look towards the remainder of the year and on to 2023, forecasting remains challenging and we acknowledge there is greater uncertainty in the macroeconomic environment. These uncertainties will require us to remain agile and focus on factors we can control, namely leveraging our strong strategic programs to identify and target profitable growth opportunities. We continue to strengthen our market position and benefit from the strong execution of our growth initiatives, as well as favorable market trends such as automation and digitalization. Based on market conditions today, we believe we will generate good sales growth for the remainder of the year and in 2023. Continued execution of our margin and productivity initiatives will support strong financial results. Later, I will have some additional comments on our business, but let me now turn it to Sean to cover the financials and guidance. Sean?

Thanks, Patrick, and good evening, everyone. Sales in the quarter were $985.8 million. which represented a local currency increase of 10%. On a U.S. dollar basis, sales increased 4% as currency reduced sales growth by 6%. We estimate that the impact of reduced sales in Russia due to the war was a headwind of about 1% to sales growth. On slide number four, we show sales growth by region. Local currency sales increased 11% in the Americas, 1% in Europe, and 15% in Asia, rest of the world. Local currency sales increased 15% in China in the quarter. Excluding Russia, our sales in Europe grew 5%. On slide number five, we show sales growth by region on a year-to-date basis. Local currency sales grew 11% for the first nine months, with 13% growth in the Americas, 5% growth in Europe, and 15% growth in Asia, rest of the world. Local currency sales increased 15% in China, on a year-to-date basis. Excluding Russia, our sales in Europe grew 7% on a year-to-date basis. On slide number six, we summarize local currency sales growth by product area. For the quarter, laboratory sales increased 10%, industrial increased 10%, with core industrial up 13%, and product inspection up 6%. Food retail grew 7% in the quarter. The next slide shows local currency sales growth by product area on a year-to-date basis. Laboratory sales increased 13%, industrial increased 10%, including 12% growth in core industrial, and product inspection up 7%. Food retail declined 2% on a year-to-date basis. Let me now move to the rest of the P&L, which is summarized on slide number eight. For the third quarter, gross margin was better than expected, at 59.3%, an increase of 90 basis points. We benefited from favorable pricing and volume growth, which was offset in part by higher material costs. R&D amounted to $44.1 million in the quarter, which is a 10% increase in local currency over the prior period, reflecting increased project activity. SG&A amounted to $233.4 million, a 3% increase in local currency over the prior year, and includes increased sales and marketing investments. Adjusted operating profit amounted to $307.2 million in the quarter, a 13% increase. Currency reduced operating profit growth by approximately 6%. Adjusted operating margin was 31.2%, which represents an increase of 250 basis points over the prior year. A couple of final comments on the P&L. Immortization amounted to $16.7 million in the quarter. Interest expense was $14.5 million in the quarter. Other income in the quarter amounted to $1.9 million, primarily reflecting non-service related pension income. Our effective tax rate was 19% in the quarter. This rate is before discrete items and adjusting for the timing of stock option exercises in the quarter. We expect to maintain this rate in Q4 and in 2023. Fully diluted shares amounted to 22.6 million in the quarter, which is a 3% decline from the prior year. Adjusted EPS for the quarter was $10.18, a 17% increase over the prior year, or a 24% increase excluding unfavorable foreign currency. On a reported basis in the quarter, EPS was $9.76 as compared to $8.71 in the prior year. Reported EPS includes $0.22 of purchased intangible amortization, $0.07 of restructuring, and a $0.13 headwind due to the difference between our quarterly and annual tax rate due to the timing of stock option exercises. We're very happy with our year-to-date results, which are summarized on the next slide. Local currency sales grew 11% for the nine-month period. Adjusted operating income increased 13%, or 17%, excluding unfavorable foreign currency, and our operating margin expanded 150 basis points. Adjusted EPS grew 17% on a year-to-date basis, or 22%, excluding unfavorable currency. That covers the P&L. Now let me cover cash flow. In the quarter, adjusted free cash flow amounted to $224.7 million. DSO was flat compared to prior year levels at 35 days, while ITO was 3.7 times. Let me now turn to guidance and begin with some overall considerations for our guidance for the remainder of this year and next year. First, forecasting remains very challenging. There is greater uncertainty in the macro environment, including the impacts to the global economy from higher interest rates, the war in Ukraine, and China's zero COVID policies. We recognize the importance of being agile and able to react quickly if market conditions change. We're basing our guidance for Q4 in 2023, assuming market conditions remain as they are today. Second, we feel very good about our business. In particular, we believe we have strategies in place to identify and pursue growth opportunities, and we have an innovative product portfolio that supports these growth initiatives. We also continue to benefit from a more favorable business mix, as well as global market trends in automation, digitalization, and investments in on and near shoring. We also believe we will continue to execute well on our margin initiatives. Third, Supply chain challenges remain, but are improving. Our team has done an outstanding job of overcoming the various dynamics of the supply chain over the last three years. We believe our ability to continue to meet customer demands is a competitive advantage, but acknowledge risks remain in the global supply chain. Finally, we have significantly greater headwinds with respect to currency as compared to the last time we spoke. In particular, As I know you are all aware, currency has moved dramatically since early September, creating significant headwind for Q4 and for 2023. To a lesser degree, higher interest rates are also a bit of a headwind. Fortunately, we have limited floating rate debt. However, the significant movement in rates has increased our expense. I thought it would be helpful to provide this guidance overview, and now let me cover the specifics. For the full year 2022, we now expect local currency sales growth to be approximately 10%. This compares to our previous guidance of 9% to 10%. We expect full year adjusted EPS to be in the range of $38.95 to $39.05, which represents a growth rate of about 15%. The midpoint of our adjusted EPS guidance is slightly higher than our previous guidance as stronger than expected Q3 performance has been largely offset by greater currency headwinds in the fourth quarter. Specifically, we expect currency to be a headwind to adjusted EPS growth in the fourth quarter of approximately 10% and 6% for the full year. At the time of our last earnings call, we had expected currency to be ahead when to fourth quarter adjusted EPS growth of approximately 6% and 4.5% for the full year. With respect to the fourth quarter, we would expect local currency sales growth to be approximately 7% and adjusted EPS to be in the range of $11.55 to $11.65. This represents a growth rate of 10% to 11%, and as I just mentioned, includes a currency headwind of approximately 10%. For the full year 2023, based on our assessment of market conditions today, we would expect local currency sales growth to be approximately 5% and adjusted EPS to be in a range of $42 to $42.40, which represents a growth rate of 8% to 9%. This includes an estimated currency headwind of approximately 4.5%. Some further comments on our 2023 guidance. We expect interest expense to be approximately $73 million. Total amortization including purchased intangible amortization to be $71 million. Purchased intangible amortization is excluded from adjusted EPS and is estimated at $24 million on a pre-tax basis or 83 cents per share. Other income, which is below operating profit and reflects non-service pension income, is forecast to be approximately $12 million. We expect our tax rate before discrete items will be 19% for both 2022 and 2023. Now let's turn to cash flow. For 2022, we now expect full-year free cash flow in the range of $780 million, which is below our previous guidance. While our supply chain team has done an exemplary job in overcoming challenges and meeting customer demand, it has required us to hold a higher inventory level than we had expected. We believe it has been necessary given the challenges in the global supply chain and expect we will return to more normal levels in 2023. I also want to remind you that our free cash flow in both 2020 and 2021 was excellent, exceeding 25% growth on a per-share basis in each year. For 2023, we expect free cash flow in the range of $900 million, which represents a growth rate of 19% on a per-share basis and a conversion rate of 97% of net income. We would expect to repurchase approximately 1 billion of shares in 2023, which would allow us to maintain a net debt to EBITDA ratio of approximately one and a half times. As we have done in the past, we will aim to repurchase our shares evenly throughout the year. We have also announced today that our board has authorized an additional two and a half billion dollars to the share repurchase program to be utilized over the next few years. which is in addition to the $1.2 billion remaining on our previous year repurchase authorization. Lastly, with respect to the impact of currency on sales growth, we expect currency to reduce our sales growth by 5.5% in 2022, including an 8.5% sales growth headwind in Q4. At today's foreign exchange rates, currency would reduce our sales growth by an additional 4% for the full year 2023. That is it from my side, and I'll turn it back to Patrick.

Thanks, Sean. Sean and I recently completed our annual global budget tour, meeting with our colleagues around the world for in-depth reviews of strategic frameworks and key initiatives of our operating units. Those of you that have followed us closely know this is an important element of our annual planning process as it allows us to spend considerable time with our colleagues to discuss and analyze the opportunities across our diverse business. Although uncertainty exists in the outlook for the global economy over the next year, I feel very good about the underlying strategies we have in place and believe we are well positioned to enhance our market position going forward. We are quite confident that we can continue to gain share and generate good earnings in 2022 and 2023. Let me share with you some comments on our operating results, as well as more details on our outlook for 2023. Starting with our lab business, I'm very pleased with the strong sales growth we have delivered this quarter and year to date, and we saw good results across most of our portfolio. We expect good sales performance continuing in the fourth quarter and next year. As we think about our lab business over the medium term, we expect investment by pharma and biopharma into new drug modalities will provide great opportunities for us to support them with our solutions. The trend of digitalization in labs has also accelerated, and our solutions helps customers realize productivity gains, and address growing compliance and data validation requirements. We also will look to target a significant growth occurring in hot segments like lithium ion batteries, semiconductors, green hydrogen, and sustainable polymers, to name a few. We leverage a highly agile approach to capture growth in these segments, applying a systematic voice of the customer approach on a segment and application level to identify attractive opportunities and ensure we have the correct strategies, product roadmaps, and marketing efforts in place to take advantage of them. Switching now to the industrial business, Core Industrial had very strong results in the third quarter and year to date. We see good demand, particularly for our automation solutions as our customers look to improve productivity and increase yields. We have also seen good interest from pharma and biopharma customers as they utilize our solutions to efficiently bring new drugs to production. Like our laboratory business, pot segments are important for our core industrial business as well, and we have seen very strong activity from customers serving lithium ion battery industry in China, Europe, and the Americas. While we are seeing good demand to date in core industrial and our business has shifted over the years to more resilient industries, our business is not immune to changes in the economy. High energy cost and softer economic activity may weigh on our customers in Europe and particularly in the chemical customers. Nevertheless, We expect to deliver solid growth in our core industrial business in the fourth quarter and next year. Over the long term, labor shortages and the trend of nearshoring and reshoring to establish more resilient supply chains is expected to benefit our core industrial business over the coming years. Additionally, new product development has been critical to our success in meeting customer needs for automation solutions and we provide equipment that is very easy to integrate into customers' control systems and also meets the most stringent data integrity and cybersecurity requirements. We are also optimistic about our product portfolio and exciting innovations we have brought to market and new products to come. For example, in addition to a strong growth we have seen with our compact automation offering, Our new line of hygienic bench and floor scales positions as well to win with pharma and food customers in the coming years. Turning now to product inspection business, we had good growth with strong demand in the Americas, which was offset in part by more cautious investment activity in Europe. Some of our packaged food manufacturing customers face a more challenging operating environment and are focused on mitigating margin pressures from inflation and supply chain disruptions. However, we would still expect overall growth in the fourth quarter and into 2023. While the pandemic, high input costs, and the war in the Ukraine have resulted in lower relative sales growth for product inspection in the recent years, we remain convinced that the long-term growth dynamics remain strong. We are not standing still and continue to seek out pockets of growth, including check weighing with industry, pharma, and confectionery customers, and we have expanded our mid-range or our mid-market coverage with new product offerings in x-ray and metal detection. I'd also want to remind you that service is very important to our product inspection customers, and we have new initiatives underway to support our customers' uptime while at the same time improving our service technician productivity. These include augmented reality for remote customer support and advanced remote diagnostics to identify and recommend quick repairs to keep our food manufacturing customers up and running. Lastly, our food retail business delivered strong results in the third quarter, with strength in the Americas offset by weakness in China due to pandemic-related lockdowns. Our team has built good momentum recently and has an attractive product pipeline for 2023, and we are optimistic that we can generate profitable growth over the next year. Let me make some comments by geography. We had very good performance in the Americas. Again, strong growth in last year's third quarter, with strong growth across product inspection, core industrial, and retail. We have a favorable outlook for the remainder of the year and in 2023. Switching to Europe, our sales grew about 5%, excluding the impact of Russia. The war in the Ukraine has led to sharply higher energy costs across the region and has weighed on some of our customers' investment appetite, particularly packaged food manufacturers and some chemical customers. We still see good investment levels from other customer segments, including biopharma and firms involved in the development and production of electric vehicles. We expect moderate growth in Q4 and next year. Finally, for Asia and the rest of the world, they had very strong growth in the third quarter as our team successfully navigated challenging operating conditions with the pandemic and COVID-19 lockdowns. and also executed very well on our strategic initiatives. Going forward, we look to continue to optimize our Salesforce guidance activities in China to pursue attractive opportunities, and we will also increase our focus on leveraging digital approaches to generate customer leads. Our lab and industrial business have performed very well this year, which we expect to persist for the rest of the year and in 2023. We remain optimistic about several key long-term market drivers in China, including the continued development of pharmaceutical, biotechnology, electrical vehicles, micro-electronic, and new material industries. We are very well positioned to take advantage of these growth opportunities and have continued to invest in our sales and marketing efforts to support our growth in China. While we remain optimistic about the long-term, We acknowledge there is uncertainty in the short term, and we know from the past that economic conditions can change very quickly in China, requiring us to remain agile. So that is a summary of our outlook for the fourth quarter and next year. As you think about the longer term, we very strongly believe that favorable market dynamics, our growth initiatives, and our improved business mix is supportive of our long-term growth algorithm of 6% plus local currency sales growth and mid-teens earnings growth. This will be accomplished by gaining additional market share through strong execution of Spinnaker, which includes optimizing our Salesforce guidance and cross-selling initiatives, increasing customer engagement with digital tools, and selling services at the point of sale. Our team will continue to pursue the most attractive, fast-growing, and resilient market segments. We will also continue to invest in new product innovations that will be the foundation of future growth. And I would note that our portfolio and go-to-market approach is uniquely positioned to deliver on customer requirements for automation and digitalization. Our strategies and initiatives are well developed and well ingrained throughout the organization and will continue to be critical in gaining market share and driving sales and operating margin growth. That concludes our prepared remarks and I now want to open the call for questions.

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

Hi, thank you. This is Peter on for Derek. Just real quick, could you guys just maybe walk through your assumptions by segment for the fourth quarter and next year as well, and also by geography too?

Yeah. Hey, Peter, this is Sean. I'll take that one. So let me start with our lab business. So for the fourth quarter, we estimate high single-digit growth in Q4. which would be low double digit growth for the full year and mid to high single digit growth for 2023. For our core industrial business, we estimate mid single digit growth for Q4, which would be approximately 10% growth for the full year and low to mid single digit growth for 2023. For product inspection, we estimate low single digit growth for Q4, which would approximate mid-single digit growth for the full year and low to mid-single digit growth for 2023. And for food retailing, we estimate approximately 10% growth in Q4, which would be about low single digit growth for the full year and mid-single digit growth for 2023. And then if I kind of go through that by region, in the Americas, we estimate high single digit growth in Q4, which would be low double-digit growth for the full year and mid single-digit growth for next year. For Europe, we're estimating low to mid single-digit growth in Q4, which would be mid single-digit growth for the full year and low single-digit growth for 2023. And then for China, we're estimating approximately 10% growth in Q4, which would translate to double-digit growth for the full year and we estimate high single-digit growth in 2023.

Okay, thank you. And could you guys give us an update on pricing? I guess maybe commenting on what you did on the third quarter and, I guess, updated expectations for 22 and what's embedded for 23? Yeah, yeah.

So we were very pleased with our execution of the organization in the quarter. And, you know, we also continue to see how our value propositions really are valued in this environment, especially as customers seek more solutions towards automation and digitalization. At the beginning of the quarter, we were estimating about 5% price realization for Q3, and we actually came in at in the 6% kind of a range. As we kind of look forward, so we did better than expected, as we kind of look at Q4, we're kind of expecting a similar price realization, again, in the 6% kind of a range. And then as we look to 2023, we're estimating about something in the 4% kind of a range. But I would say it's important to think that we'll do a little bit better in the first half of the year because we'll get some benefits from some of our pricing actions that happened during 2022 than the second half of the year.

Super helpful. Thank you so much.

Thank you. You're welcome.

We'll take our next question from Josh Waldman at Cleveland Research.

Hey, thanks for taking my questions. Sean, I appreciate you talking through the segment and geo-assumptions. I guess, though, at a high level, I'm assuming the 5% is more of a base, just given where we are to start the year. How much variance do you think there is to that 5% number, given you You expect 4% price next year, you know, I guess only a point of volume. It seems like that's fairly conservative.

Yeah, I mean, hey, I feel like we're doing very well. We feel, you know, continue to feel good about the things we can control. The teams are executing well. We feel like we are gaining market share. We think that there's a lot of good trends in the world that we talk about, like automation and digitalization and near shoring but of course yeah there's uncertainty in the world as well and I think more importantly we are coming off a period of really strong multi-year comparisons I mean if you look at like our three-year CAGR over the last three years I think it's about nine percent organically and so that's that's something that I think we also need to you know kind of keep in mind as well too so so overall we feel like this is a good guide at this point in time of course You know, we'll see how things play out as we kind of get into the year and update as we kind of go along. But otherwise, you know, there's been no change to our planning process and how we approach things from the past.

Got it. And then, Patrick, for the first time in a while, I didn't hear you talk about LabX. I wonder if you could provide an update there. You know, we hear it come up in the research quite often. But, you know, I wondered if you could talk through maybe the opportunities you see forthcoming Maybe talk around metrics that you kind of gauge against internally.

Very good. Thanks for the question, Josh. Yeah, so look, LabX, we are really happy how LabX is being rolled out to more customers around the world. It has a very strong reputation in the market for those who are not aware. We don't know the background on LabX. It's our instrument control software. for our lab products, for most of all lab products, actually not only controls the instrument, it also reflects the entire workflows. So it's a very strong software solution that helps our customers also on the compliance and data integrity side. It's definitely one of the strong selling points for us for pharma customers and larger customers who are under even more strict compliance restrictions. And as we increasingly connect more of our lab instruments to LabX, it's becoming a strong differentiator for us as well, positioning our products in the broader lab space. Again, we continue to roll this out, but only with key accounts. We have several accounts using our LabX software on a broader base, but we see a very strong success in the overall lab space. As I said, we continue to connect more instruments moving forward. Our goal is to have most of our instruments connected to LabX and helping our customers, as I said, to reflect the entire workflow with our instruments and having the software backbone to not only store the data but also reflect the workflows, et cetera. Really strong selling proposition for us and also against our competitors, as I said, who don't have similar solutions. So I'm really happy with where we are, and we continue to add features and connect more instruments moving forward.

Great. Appreciate it, guys. Thanks.

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

Hey, this is Jordan on for Vijay. Thanks for taking my question. I was wondering if you could talk about your margin assumptions for the remainder of the year and kind of what you're assuming as we go into fiscal year 23.

Yeah, hey, I'll take that one, Jordan. So, like I said before, we, you know, we were very pleased with our performance with pricing for Q3 and I already provided guidance for Q4 and for next year. And I think that's, you know, that's certainly a key lever in our margin assumption. If you kind of look at Q3, we expanded our gross margin by 90 basis points. As we kind of look to Q4, we're looking at about 150 basis points of gross margin expansion. We're looking at a similar amount in 2023 of about 150 basis points. And then if you kind of drop down to operating margin, we expanded our margin by about 250 basis points in Q3. As we kind of look to Q4, we're going to be just under 300 basis points, probably about 290 basis points. And as we look at next year, we're looking at about 160 basis points. And a key ingredient will be our price realization as we go forward. As we kind of look towards Q4, we still will see some elevated headwinds in terms of inflation on material costs. but maybe to a slightly lesser degree than what we saw in Q3.

Great. And if I have time for one quick follow-up, I was wondering if you could talk about what you're seeing across geographies. I know you touched upon it in your opening remarks, but maybe could you talk about what you're seeing from an order perspective in Europe, kind of some factors that you've seen in the quarter and your expectations moving forward?

Yeah, so in terms of orders, as you're probably familiar, we only typically have about a month and a half or so of backlog. So we typically don't comment on orders or backlog. But of course, we consider that in our guidance for the fourth quarter and for next year. In terms of Europe, I don't know if I'd add too much to what Patrick said in our opening remarks. I mean, one area that we have seen some Some slowdown to a certain degree is in packaged foods and particularly the impact on our product inspection businesses. Companies are delaying investments in CapEx in that area, and product inspection would fit into CapEx, which is not the typical part of our portfolio. Most of our sales are below $10,000, but product inspection is above that. And then as we kind of look at the energy crisis, I mean, we still hear good things from our organization, but we're also mindful of the overall situation and the potential impact on industries like the chemical industry.

Great. Thank you.

We'll go next to Tim Daly at Wells Fargo.

Great, thanks. First question, wanted to touch on China here. So previously, you were expecting about 10% in the quarter, delivered 15. And I think previously, we're talking about low double digit for the year. And I think today, you said double digits. So just curious, what's been going on there? What drove the upside in the quarter? And how exactly has your outlook for the year changed, I guess?

Yeah, look, this is Patrick. I'd be very pleased if I were results in China. As you said, we had 15% in the quarter and we also forecast WG growth for the fourth quarter. So we are really happy how China is supporting for us. We have a very strong organization there and it's really performing extremely well. We have not been affected big time by the COVID lockdowns. Our manufacturing sites continue to manufacture under restrictions, but they have been operational. We see our sales team, as we said in the remarks, also really fully leveraging the Spinnaker tool set to really reach out to customers and capture the fast-growing segments in China as well. There's a lot of momentum behind, for example, electrical vehicles, the battery segment, the lithium-ion segment. But we're also seeing still very good growth in pharma and biopharma in China. So we are – actually, we continue to be very pleasantly surprised by the performance. Again, we have been optimistic. For Q3, it totally came in as expected or even better. And our outlook for China is still positive long-term, of course. It's anyway positive. Short-term, there are always risks in China. Of course, as we all acknowledge, there can be short-term lockdown impacts or others. But I think you should look at China from a long-term growth perspective. It is very promising. I think we will continue to see growth. We have an organization there that is very strong, both on the sales and marketing side, but also don't forget we have manufacturing and R&D there as well. And from that perspective, I think we have a really good understanding about what drives market momentum in China and can also quickly adopt to fast-growing segments and capture those.

All right, that's very helpful. Then a bit of a two-party here on margins. First on kind of price cost and inflation, and then the second is going to be on the FX impact. So on the price cost, just thank you for the outlook on the kind of four points of pricing next year, but should inflation come in higher or lower than currently forecast or currently embedded in the outlook? You know, how should we be thinking about that impact to the margin? You know, is it pretty much expected to be consistent if inflation comes in higher, upside, lower, downside, or general thoughts? And then on the FX side of things, you know, FX impact to the top line and the operating income line seem to be similar in the quarter. And on the outlook, I think that's consistent as well. So is that the best rule of thumb we can use, you know, kind of like-for-like impact on FX to the top line and to the bottom line?

Yeah, hey, good questions, Tim. Hey, so the first one, let me start with this, I'll kind of end with the second one. I'll start with the second one first. So I think the best way, I mean, I recognize what you're saying, the relationship between sales and EPS, but I would say probably the best way to think about it is to look at our major exposures. So our largest exposure would be the U.S. dollar to the RUM and B. And so for about every 1% change in the RUM and B to the US dollar, that would affect our operating profit of about $3.5 to $4 million. And then the second largest exposure would be our Swiss franc to the euro. So if you think about it, we are long in euro, but we're short in franc. And it kind of creates an inherent natural hedge within the company. And so we look at the cross rate. And so as the Swiss franc changes or the, you know, as that cross rate changes, um, every 1%, that's as effective about $2 million on our, on our operating profit. Um, and so I think that's, that's how I would probably look at it. And then I don't have a really good proxy for the dollar against the rest of the basket of currencies, but, but those are the two major impacts on our, on our, um, on our earnings. In terms of what was the first price cost? Okay, yeah. Yeah, in terms of price costs, I mean, I think you saw that we were able to respond very well to inflationary headwinds in 2022. You know, of course, it can take a quarter or two for us to be able to actually get the actions into the market. But if we were confronted with a similar situation next year, I think we would react exactly the same way. And I think that the market understands inflation. Our organization was able to do a great job articulating and explaining that to the market. And then I think most importantly, we're providing really strong value propositions to the market that they appreciate. And the ability to support them and provide these value propositions is highly appreciated and also supports our price realization going forward.

Great, thank you so much.

Thank you.

Our next question comes from Eliza Garcia at UBS.

Evening, guys. Thanks so much. So, you know, I guess to start off with, I just wanted to actually dig into a little bit with kind of, you've obviously talked a little bit about kind of supply chain and kind of the challenges that you've been able to kind of manage and how to think about the cadence. But if you could kind of help us understand kind of, you know, you've talked about electrical components previously and how that's improving, but kind of how to think about through the balance of 2023, kind of how to think about kind of maybe the impact to margins and the improvement there and what you're kind of expecting into the guidance.

Yeah, hey, Liza. So you can imagine there's a lot of moving parts in terms of our gross margin assumption and our different material categories. There are going to be some benefits next year where we've seen things like electronic components. We have seen or expect to see some benefits next year. But of course, there's other categories like where we've had to do broker buys this year going out several months where we're going to have to carry additional costs into next year as two simple examples. I think the best way to think about the impact on margin next year is that overall we're expecting 150 basis point improvement in our gross margin. About 170 basis points of that will come from our pricing assumption. And then it will be offset by a wide range of other categories in this inflation basket. And as you kind of think about material cost assumptions for next year, I think right now we're planning on something more modest, probably in the low single-digit kind of a range.

Okay, great. And I know PendaTech is at this point part of the organic number, but it would be great to kind of just kind of get a contextual update on performance in the quarter and how the company is maybe performing relative to kind of expectations?

Yeah, absolutely. I'll take that look. We are very happy with how PendoTech is performing. It has been probably one of the best acquisitions in terms of overall growth. Not in total volume, but overall growth. It's really exceeding our expectations. We are very happy. We are still seeing strong demand from our end customers. And We continue to build out the organization. We started, as you know, mainly with pressure sensors. In the future, we will look into additional single-use sensors as well. It's now, in the meantime, really well-connected and ingrained in the overall process business. So we are very optimistic on the outlook for the business moving forward.

Great. Thanks so much.

We'll move next to Patrick Donnelly at Citi. Hi. This is Lizzy on for Patrick. Thanks for taking my question. I was wondering if you could delve a little bit into what you're seeing in Europe. You said that maybe there's a little weakness on product inspection. Is that a particular country? Is it the entire region? Just any more color there would be helpful. Thank you. And I have one more.

Thank you. I'll take the question. Look, in Europe and product inspection, you know, a lot of them are large international, multinational companies. And what we are seeing is that they are not cancelling projects, but they are delaying projects. I think overall they have become a bit more cautious with their projects and how they are spending their money, at least in this quarter and probably also in Q4. So they are postponing projects and they have, I would say, a better line of sight of how things develop in Europe. It's not specific to any particular country in Europe, so I would say you see this from several customers, but it's not linked to one country at all.

Great. Thank you. And then in terms of the investor day coming up, anything you're willing to share, what we can expect for that? That's it for me. Thanks.

Yeah, hey, I think you'll see an update on our business and our different initiatives. We'll walk you through that, and then we'll kind of also talk about some of our exciting opportunities to continue to expand our margins through supply chain and pricing. And then it's going to be – the Investor Day is going to be based – actually, we're here right now in Massachusetts at our process analytics business, and so – We're going to feature that business and showcase that business in a lot more detail and then also show you how we serve the value stream of a typical biopharma customer.

Great. Thank you.

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

Hey, thanks for taking my questions. Maybe the first question, Patrick or Sean, just as you look into 23, there's obviously risks out there, whether it's inflation or supply chain or Europe weakness, and I'm sure you've baked them into the guidance you've presented. If one of those were to improve, meaning not become a risk, is there a certain one of those three or others that could really change kind of the dynamic of One, how you think about the progression of the year, but also the dynamics of the business and the growth in certain areas.

I can take this. We're flipping a coin. As we said, of course, there are still ongoing multiple risks. And it's not only Europe. Again, in China, we're talking potentially about continued lockdowns related to COVID-19. but there's not yet clarity of how that will evolve. Let's talk maybe for a minute about Europe. I mean, the war in Europe with the related energy crisis, et cetera, just throws quite some uncertainty in the outlook of 2023. Of course, if that would be resolved, we would see upside to our current projection. But who knows? I mean, there's no short-term resolution inside, and there's actually also not really clear about how big those impacts will be, right? How many of the chemical customers will be affected? Will there be rolling energy outages? What does this mean for the entire strategy? We took, of course, that all into consideration and tried to make a very reasonable forecast for 2023, but we cannot neglect these risks, right? And they are now

our forecast if that those would go away and of course it would be upside right yeah exactly and you know but how much is really hard to quantify yeah so again how our customers will respond to this crisis and i think the key is like you kind of go back josh kind of asked about an upside downside at the beginning and in the end it is going to be a lot to do with the macro like you know there are a lot of big topics out there in the world and if they go away you know any one of them could be a good upside for us. And if they worsen, I mean, it could be a downside. And those are things out of our control. And as an organization, we just try to stay agile. We continue to try to monitor these situations very closely and make sure we can react quickly.

I mean, what I want to say is, looking back at just the last crisis, as we know, went into COVID-19. I mean, our organization has really demonstrated incredible agility to adjust to the market conditions. And we will apply similar or same measures as moving forward if any new crisis comes up. I think we are very well trained and very agile and have demonstrated actually how we can react to changing market conditions and the flexibility of our organizations and the tools we have in place, as I said, also in my remarks in the beginning. We have these tools in place where we can very quickly identify the pockets of growth in the market and send our sales team to those and capture those opportunities as they come up.

Got it. Well, thanks for indulging me in that question. I appreciate the color. And just a second question, a quick follow-up. As you look at food retail, it's obviously a smaller part of your business. It's been fairly volatile, and I think comps are obviously impacting that. As you look at that mid-single-digit growth for next year, should we expect a decrease maybe in the volatility of revenue for that business? Are there things that you've done there to better manage that or help to manage that? Or is that mid-single-digit sort of an average of the volatility that we might see continue into 2023?

Well, look, as you rightfully said, it's a smaller part of our business. It's about 5% of the total business. We have seen really good projects over the last couple of months where we have been really successful. We're also looking at a rollout of an upgraded portfolio of products. So we are optimistic with the product we have. But in terms of the overall volatility in the market, we don't see any short-term changes. Again, I mentioned also the remarks that we have. In China, we're currently facing issue with the lockdown which affects a lot of the retail customers there and we don't know exactly how long that will continue if it eases up there is probably some upside um but overall volatility i don't expect a total uh significant change in 2023 what we what we do want to say is that we have again a pretty strong portfolio and also the the number of projects we have one over the last couple of months, also gives us confidence in the portfolio.

Great. Thank you very much.

And our next question comes from Rachel Vestal at JP Morgan.

Hi, this is Nolan for Rachel. Thanks for taking the question. First, could you give us some color or some additional color on inventory? You know, last quarter you had updated us on customer inventory levels. noting they had come down a bit on pipette tips after customers had stockpiled during the heights of the pandemic. You talked today a bit about how your inventory levels in relation to free cash flow had changed. So could you provide us some more color here on both customer inventories, like how are they looking? Are they looking the same by product? And then kind of some of the key products there, like have you noticed any material change here in your inventory levels?

Hey, maybe I'll take it. And if Patrick wants to add something from the customer perspective, let me start with our internal. So the first comment I would say is we're extremely happy with our global supply chain organization. Really tremendous, just really great job in terms of supporting customers for the last few years during the pandemic. And it's been a competitive advantage. It really has. Patrick and I were just traveling around the world, visiting our different businesses, and we just heard several antidotes from around the world about how we're able, our delivery times, they might be a little longer than they were in the past, but they're significantly better than competition. And that's allowed us to gain share in different cases. And so we feel really good about that. Now, of course, the other side of that is we've carried higher inventory levels, higher safety stocks in different categories to be able to make sure that we could do that. I don't think it's necessary to get into any particular detail with one category or another. There's different types of components that are key to a wide range of our portfolio. We have 130,000 SKUs, so you can imagine it's pretty complex. I think Blue Ocean has allowed us to have the visibility through the supply chain to manage that complexity and know where we had to increased safety stocks. But, you know, now as we kind of look to 2023, you know, and with shipping times, especially coming from China to the US, dramatically shortening just recently, we feel like we are in a position also to reduce those levels in 2023, which was included, of course, in our outlook and our guidance for 2023. From a customer perspective, probably the one area that we have heard some noise is in the area of pipette tips. Difficult to quantify exactly how much that is in our business. Overall, we're very pleased with our overall pipette tip business. The instrument sales are actually continuing to grow very well with really good demand in biopharma research. But, you know, as you say, on the consumable side, we were down in the third quarter. And then, you know, it's hard to have visibility through our customers and that, but it's also not a significant impact to our overall business.

Yeah, I would say not significant also because we didn't serve the majority of the COVID testing labs, right? Our majority, Sean, as you said, have been biopharma research labs, et cetera. which didn't overstock to the same extent as a lot of testing customers did.

Awesome. That's super helpful. And then just one more. You had noticed previously that there had been some rumblings of potential government stimulus in different regions, particularly China, that could probably benefit the region. Have you noticed any sort of updates on that? Have you heard any updates on that? And that's it. Thank you so much.

Actually, good question, but no, we have not heard any significant impact or changes driven by any government issues at the moment.

Awesome. Thanks.

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