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Mettler-Toledo International, Inc. (NYSE:MTD)

Q1 2009 Earnings Call Transcript

April 30, 2009 5:00 pm ET

Executives

Mary Finnegan - Treasurer, IR

Olivier Filliol - President and CEO

Bill Donnelly - CFO

Analysts

Sung Ji - JPMorgan

Peter Lawson - Thomas Weisel Partners

Brandon Couillard - Bank of America

Peter McDonald - Wall Street Access

Jon Groberg - Macquarie

Richard Eastman - Robert W. Baird

Mike Hamilton - RBC

Greg Halter - Great Lakes Review

Chuck Murphy - Sidoti & Company

Operator

Welcome to our first quarter 2009 Mettler-Toledo International Earnings Call. (Operator Instructions).

I would now like to turn the call over to your hostess for today's call, Ms. Mary Finnegan.

Mary Finnegan

Thanks, Abigail. Good evening. I am Mary Finnegan, Treasurer and responsible for Investor Relations at Mettler-Toledo, and I am happy to welcome you to the call. I am joined by Olivier Filliol, our CEO; and Bill Donnelly, our CFO.

Now, for some 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 will refer to on today's call is also available on our website. Let me summarize the safe harbor language, which is outlined on page one of the presentation.

Statements in this presentation which are not historical facts constitute forward-looking statements within the meaning of the U.S. Securities Act of 1933 and the U.S. Securities Exchange Act of 1934. These statements involve risks, uncertainties and other factors that may cause our actual results, 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 the forward-looking statements are qualified in their entirety by reference to factors discussed under the captions "Factors affecting our future operating results" and in the "Business" and "Management's Discussion and Analysis of Financial Condition 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 measure is provided in the press release.

I will now turn the call over to Olivier.

Olivier Filliol

I want to start with highlights of the quarter, and then Bill will provide details on our financial results and our updated outlook for 2009. I will then continue with additional comments on the business and our expanded cost reduction program. As always, we will have time for a Q&A at the end.

The highlights of the quarter are summarized on page two of the presentation. Today's economic environment is very challenging, and market conditions have continued to deteriorate. Consequently, local currency sales declined 8% in the quarter. However, we exceeded our operating profit and EPS targets through strong execution on cost control measures, strict discipline on pricing and improved material costs.

Specifically, operating profit reached $52.3 million, while adjusted EPS amounted to $0.95. Finally, we also had strong cash flow generation in the quarter.

We expect the current difficult market condition to continue at least through 2009. Given this framework, we have expanded our cost reduction program to target $100 million in total annual cost savings. This is necessary to align our cost structure for market levels and our expectations that market conditions will not improve in the course of 2009.

We have spent the last several weeks working closely with the management teams around the world to diligently develop and initiate these plans to achieve desired the cost savings, but also to ensure that we do not sacrifice the strength of our franchise. I'm convinced we have struck the right balance. We continue to invest in R&D and sales and marketing programs where cutbacks are more moderate.

I will come back on these topics shortly, but let me first turn it over to Bill to comment on the financial results.

Bill Donnelly

Let me start with additional details and sales which are outlined on slide number three. Sales were $374.1 million in the quarter, a decrease of 8% in local currency. On a U.S. dollar basis, sales declined 15% in the quarter as a result of negative currency of approximately 7%.

Breaking down local currency sales by geographic destination, we had local currency sales decline in Europe of approximately 10% and an 11% decline in the Americas. In Asia/Rest of World, sales increased by 1%. By product area, laboratory sales declined by 9% in the quarter, industrial sales decreased by 8%, and food retailing declined by 4%.

Turning to slide number five, let me now cover the rest of the P&L. Gross margins were 50.2% in the quarter as compared to 50.4% in the prior year quarter. The impact of the drop in volumes was largely offset by the impact of the stronger U.S. dollar. We also enjoyed the benefits from our pricing initiatives and lower raw material costs.

R&D amounted to $21.6 million or 5.8% of sales. This represents a 6% decline in local currency. We saw the benefit of our cost control measures as SG&A was $114 million, a decrease of 11% in local currency. We benefited from our cost reduction program as well as lower variable compensation.

Adjusted operating income amounted to $52.3 million. This compares to $58.3 million last year. That's a 10% decline. On a constant currency basis, operating margins were down slightly in the quarter, a level we are pleased with, given the much lower sales volume.

Continuing down the P&L, amortization amounted to $2.7 million in the quarter and interest expense was $5.2 million. Fully diluted shares for the quarter were 34 million shares. At the end of the quarter, we were at 33.9 million. Our tax rate in the quarter increased from 26% to 27%. We expect it to remain at 27% this year. The increase is due to changes in our estimated profitability by country during 2009.

You will also notice that during the quarter we had two non-recurring items. We had a discrete tax item resulting in a benefit of $0.25 per share. This relates principally to the settlement of certain tax audits and the closing of certain tax years. In the quarter, we also incurred restructuring charges amounting to $0.18 per share, which I will comment on further shortly. We have excluded both of these items from adjusted EPS.

Finally, adjusted EPS was $0.95 per share. That's a 6% decline to the prior year amount of $1.01. In addition to the discrete tax benefit, adjusted EPS also excludes the restructuring charge of $8.4 million or $0.18 per share.

Let's turn to cash flow. Free cash flow in the quarter was $28.9 million as compared to $13.5 million in the previous year. We are pleased with this strong level of free cash flow, which was driven by improvements in working capital. DSO improved by one day versus Q1 2008 to 49 days, while ITO remained constant at 5.1 times. Inventories were down $20 million versus a year ago in constant currencies.

That covers the quarter, and now I want to cover the expansion of our cost reduction program.

We are increasing the targeted cost savings from this program from the $40 million, which we communicated to you last time, to $100 million in total on an annual basis. The savings will come from workforce reductions and other expense cuts.

In the first wave of the program, we targeted a reduction in our workforce of 5% or about 600 people. We are now initiating additional reductions in the workforce of more than 400 people or about 4%. We expect approximately two-thirds of the total savings to benefit us in 2009, while the remainder will help to offset normal cost growth in 2010.

We also benefit in 2009 from reduced levels of variable compensation, which we expect to return to more normal levels in 2010. We will incur approximately $40 million of restructuring charges to complete the currently envisioned program. We recognized $8.4 million in Q1 and $6.4 million in Q4. The majority of the remaining amount should be recognized over the next several quarters.

I've kept my remarks brief here, as Olivier will provide some additional comments later on the call.

Now let's turn to guidance. Based on our current assessment of the market, we have updated our outlook for 2009. I mentioned this last quarter, but it's worth repeating that the current uncertainty in the global economy makes forecasting very difficult.

Based on the business environment that we've seen in March and April, we are now forecasting local currency revenue growth for the full year at between negative 8% and negative 12%. This would result in adjusted EPS in the range of $4.85 per share to $5.35 per share. This compares to previous guidance of $4.80 to $5.30.

Furthermore our current guidance assumes a 27% effective tax rate, while our previous guidance assumed 26%. Finally, just as a reminder, adjusted EPS excludes purchased intangible amortization, discrete tax items and restructuring charges.

With respect to Q2 guidance, we have a couple items to consider. First, as a reminder, the second quarter of last year was a strong quarter with local currency sales growth of 11%. This is a much tougher comp than what we faced in Q1. Second, we'll have two less working days or about 3% lower than the prior year.

Given these factors, we expect local currency sales growth to be in the range of negative 11% to negative 13% for the second quarter and adjusted EPS to be in the range of $1.05 to $1.15. I will also point out that the sales comparisons for Q3 are also tough, but the working days are comparable.

One final comment on guidance. We remain comfortable with our full year free cash flow of $140 million to $150 million that we communicated last quarter. However, we expect cash flow in Q2 to be below the prior year due to the timing of working capital movements.

That's it for my side, and I'll now turn it over to Olivier.

Olivier Filliol

Thanks, Bill. I will start with some comments on the first quarter business result and then update you on the cost reduction measures we are taking to manage in this environment.

Beginning with lab, lab was down in the quarter against strong sales growth one year ago. By product line, pipettes are holding up due to their much higher consumable stream. Automated chemistry are also holding up, as most of their revenue is from pharma, but we are also seeing the benefit of our significant investment in marketing programs in this business.

The weaknesses we are seeing is in balances and analytical instruments, some of which is due to tough comparisons, but also due to softened end markets.

Turning now to industrial, our core industrial business got weaker during the quarter as manufacturing output slowed significantly in the Americas and Europe and was down in Asia as well. Our transportation and logistics business is performing well. Although comparisons were less challenging for this business, demand is holding up as these solutions offer a quick and sizeable payback to customers. Product inspection was in line with expectations as food safety continues to be a positive growth factor.

In food retailing, business was steady in the U.S. and strong in China. We saw a decline in Europe, although we hope it will be temporary. Service, which accounted for 26% of sales, was clearly better than our own products business. We had growth in lab, while retail was relatively consistent with the prior year. Industrial service was down slightly, reflecting reduced capacity utilization and plant closures among our customer base.

Finally, let me also comment on the business by region. As expected, Europe and the Americas were down. Business was particularly challenging in Eastern Europe and Russia due to economic and currency declines. Furthermore, we saw significant declines in the south of Europe and the Benelux region.

Service was a bright spot in Europe during the quarter where we saw solid growth. In the Americas, the decline was similar to Europe and across lab, industrial and food retailing, with the exception of some product lines. Our service business in U.S., which is less contract-based than Europe, was flat in the quarter.

In Asia, our lab business continues to grow while core industrial products declined due to reduced manufacturing output. Product inspection showed nice growth as a result of the drive to better product quality.

You heard from Bill that gross margins are holding up fairly well. In addition to our cost reduction efforts, pricing is helping, which reflects the efforts that we have placed in this area over the last 18 months. It is still early in the year, but we are optimistic that pricing will continue to hold. Material costs are also providing some benefit for us, and costs are down approximately 250 basis points year-to-date.

Obviously, the sales environment is very tough and there are limited actions we can take against it. However, we are pleased with the progress with our cost control measures. We remain well on track with our cost reduction program, even ahead of schedule for the initial phase. Given our outlook for our end markets, we have now expanded this program.

Let me provide some additional details. We're initiating additional workforce reductions of approximately 400 people or 4% of the total. This is incremental to what we announced to you last quarter, which Bill detailed earlier. Where and how these reductions are made is a key management topic.

We have diligently reviewed all the plans. We expect the majority of the reductions will take place among manufacturing and related personnel, including temporary, contract workers and supervisory positions and administrative personnel. In addition, we plan to consolidate some management positions.

We are convinced that this next phase of reductions, similar to the first wave, will be executed well. We will remain a strong, but even more efficient company when this phase is completed. These reductions are significant for us, but are necessary to align our cost structure for the environment, which will reflect lower volumes.

We have been very diligent throughout the process to ensure that the long-term strength of the company is not compromised through these actions. The reductions have not been made across the board. Rather, we have been very conscious of which businesses and which functions are targeted.

Management teams from around the world have worked diligently to strike the right balance, the need for immediate cost savings with the flexibility to capture the growth that will come at a later point. This careful consideration by unit gives us confidence that we have implemented the right measures for the long-term.

Workforce reductions are not easy for the people directly impacted and those remaining in the organization. I'm very pleased with our management team around the world and the diligence and thoroughness in which they are performing this very difficult task.

In addition to the workforce reduction, we will also implement additional cost control measures. Salary increases are only being implemented where legally required. We have cut down on discretionary spending. We are working with suppliers to reduce the prices to us. In some circumstances, we are reducing work hours of our employees.

We are targeting annual cost savings with this expanded program of approximately $100 million on an annual basis. Of this amount, we expect about two-thirds to benefit us in 2009, with the remainder benefiting 2010. We will take restructuring charges consisting principally of severance of approximately $40 million. We expect to have a large portion of this action completed during the next several quarters.

While our cost reduction program is critical in this environment, we continue to invest in the business to win forth our market position. In R&D, our product pipeline remains robust. Let me highlight a few of our new product launches.

Our revolutionary powder dosing system, QUANTOS, has added an integrated automated sampler to its offering. For many pharmaceutical customers who fill hundreds of capsules a day, the sample would further expand the value of our offering, because it dramatically increases the speed at which these capsules can be filled. Aside from the efficiency and accuracy, a strong case can be made for the safety of that solution.

In product inspection, we recently introduced a sterilization checkweigher for the pharmaceutical industry. This solution combines the checkweigher, marking and vision control into one compact solution. By marking all components, pharma companies can have 100% traceability for all points in the supply chain. This is increasingly important as they try to reduce and eliminate incidents of counterfeit drugs.

Also, in that product inspection, we recently expanded our metal detection offering in Asia to target the mid-range of the market. As food safety becomes increasingly important in this region, we wanted to provide a more comprehensive offering.

Finally, in food retailing, we are in the process of introducing a new entry-level solution with full touch screen capability and the modern interface capability targeted to cost conscious customers here in the United States. We are pursuing several large opportunities in retail where this new product can be a powerful tool in securing the business. These are only a few examples, but gives you a sense of how we continue to spend and succeed in new product development.

Sales and marketing continues to be an investment area for us as well. We are emphasizing short-term campaigns and redirecting recourses to lead nurturing and lead conversion to help offset the natural slowing of the order to sales cycles that happens during economic downturns.

We also continue to target pockets of growth that exist even in this environment. We address this through sales boost programs. We have the resources and flexibility to go after these opportunities, something some of our competitors don't necessarily have. This covers the topics for today.

In closing, clearly the current economic environment is very challenging, the most challenging that most of us have experienced in our career. We are working diligently to maneuver through the storm and at same time being careful that we don't damage the boat, as we want to be in a strong position once the seas become smooth again. We are confident that we will emerge in better shape than many of our competitors. Why do we say this?

We are operating from a leadership position, which provides us with a very strong foundation in which to navigate. We also continue to invest and have made limited cuts to R&D and sales and marketing. We have a solid team in place throughout the world and can leverage our core strength in execution during this tough period. We have a very solid capital structure which provides added flexibility for this environment. We are confident we will emerge a stronger company with better market position versus our direct competitors.

That concludes our prepared remarks, and I would now like to ask the operator to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Tycho Peterson with JPMorgan.

Sung Ji - JPMorgan

Hi. This is Sung Ji in for Tycho today. Thanks for taking the questions. I appreciate the details on the cost reduction initiative. I just had a question. Would you be able to quantify the impacts for your major geographies?

Olivier Filliol

Okay. Actually this is a level of detail that we are not actually detailing and sharing, because many of the implementations still also need to be pursued within the organization. What I can tell you is to give maybe a flavor that the lab business versus, for example, the industrial business is less impacted.

Of course, we are, when we look from a geographic standpoint, taking bigger measures in North America where we have also been more severely impacted than, for example, in Asia. We are clearly also doing these cost measures with a long-term view, and we certainly expect that the emerging markets, Asian markets, have a better growth perspective in the long term. So, we want to be more careful there.

So, without going into the details, you can expect us taking bigger measures in North America and Europe than in Asia.

Sung Ji - JPMorgan

As far as your sales and marketing strategy, I think you had previously mentioned that your exposure to NIH-funded customers is in the couple percentage of total sales. Given the stimulus, the U.S. stimulus as well as stimuluses around the world, do you have any opportunities to potentially expand into academic markets?

Olivier Filliol

This is why the NIH stimulus has limited impact on us, but what we clearly see is that there a lot of government funding going in other areas. In general, in academia, we see a benefit from that. This is not just in the U.S., but clearly also in Europe and very much also in Asia, and I would highlight also China. This is something we are tracking all the opportunities and diligently following up. We have specific programs that are following up on stimulus package opportunities.

Operator

Your next question comes from the line of Peter Lawson with Thomas Weisel Partners.

Peter Lawson - Thomas Weisel Partners

Olivier, at what point did the end markets get worse for you during the quarter?

Olivier Filliol

January was really the turning point for us. What we saw is the sharp decline in January continued on throughout the full quarter. So, clearly January was the turning point for us.

Bill Donnelly

Yes, sir. What we clearly saw was that at the time we made our last announcement, we saw things deteriorating. That was the basis for the guidance. We didn't really see any improvement in February either, probably marginally worse. March, of course, looked pretty good, but I think everybody is aware that there were certainly some working day advantages in the month of March.

Now seeing March and April together, we feel more confident probably in making our forecast at this time about Q2 than maybe we felt at the same point three months ago, making forecasts about Q1. I think the visibility in a sense is a little bit better even if it's not clear whether there could be another shoe dropping or other things later.

Peter Lawson - Thomas Weisel Partners

Which end markets did you see that visibility increase in?

Bill Donnelly

I would say it's less a specific end market. As you know, we serve many markets, Peter. I would say maybe confidence in terms of forecasting, the pipelines are stabilizing more and we just feel much less uncertainty in our own organization in terms of the sales and service personnel, but as well just in general with the customer base.

I'd say that applies to food, pharma. Maybe chemical probably would still be a pretty less stable market than most that we serve. Geographically, I think in emerging markets, you see, particularly in China, more positive things than you felt, let's say, two months ago.

Olivier Filliol

Many of our customers experienced also a very difficult January. So on the customer side, there was also a lot of uncertainty when we entered February and March. I think for many of our customers, there is now also a little bit a clearer picture of how the rest of the year will go. So it becomes more predictable for us too.

Peter Lawson - Thomas Weisel Partners

Just on the cost savings plan, how is it going to pan out during the year? It is going to be immediately and sharply affected?

Olivier Filliol

The plans will be fine, and we are very much now in implementation mode. Affected employees are going to be informed, communicated in the next few days, weeks. That depends a little bit by country. This is something that we are taking very rapid actions. Like you have seen us executing on wave one, we're going to execute on this wave two in a very diligent and urgent way.

Peter Lawson - Thomas Weisel Partners

So we should think about it as 2Q and 3Q, the bulk of that effect for 2009.

Bill Donnelly

We think by the end of Q2, we'll have 75%, maybe a little bit more, implemented. Now, we won't have the full effect in Q2, but Q3 will be a little bit more. By the end of Q3, it will be largely implemented.

Peter Lawson - Thomas Weisel Partners

I am wondering if you could just do a housekeeping thing, just break-out of revenues by the business lines, please.

Bill Donnelly

Sure. This is now for the quarter. Lab was 45% of total sales, industrial 43%, and retail was 12%.

Operator

Your next question comes from the line of Jon Wood with Bank of America-Merrill Lynch.

Brandon Couillard - Bank of America

It's actually Brandon Couillard in for John. Any thoughts to reinitiating the buyback program, given the stable cash flow outlook?

Olivier Filliol

Yes. We always said that we initiated the share buyback when the financial markets got more stabilized and that we see that our own financial performance has stabilized. I think for both, it takes a little bit more time. The financial markets have still a lot of volatility and (inaudible) security. We would certainly also want to see that our own performance stabilizes and gets stronger.

Brandon Couillard - Bank of America

Okay. Would you care to update specifically on the product lines between lab, industrial and food? You gave us some guidance on those line items on a full year basis. Would you care to update that given your revised outlook?

Bill Donnelly

Sure. It's mostly kind of tweaking as compared to what we talked about before, but I guess you could expect our lab business to be in line with what you saw in Q1. I think that if you break out the industrial piece between the product inspection business and then our core industrial, I would expect that the PI business is probably going to be flattish for the year, while the core industrial business could be a little bit weaker in the latter quarters than it was in the first quarter, particularly Q2 and Q3.

If we look at food retailing, I think probably it will be a little bit weaker than what we saw in the first quarter. These aren't full year numbers. What you can imagine is that Q2 and Q3, because they were double-digit growth rates in last year, that we're assuming those are a little bit more difficult. Then in Q4, we expect to show certainly better numbers in terms of topline growth than we have seen so far.

Brandon Couillard - Bank of America

Okay. Thanks. Then on the gross margin line, we saw a pretty significant benefit from the cost savings, procurement benefits in the first quarter. Should we expect that similar type of impact through the year or do you expect to be able to hold the gross margins perhaps flat on a year-over-year basis for the full year?

Bill Donnelly

I think if exchange rates stay about where they're at today. That's probably a pretty reasonable assumption. I think that on the one nuance to what you said is that "comparisons on raw material costs will get tougher come Q4." We started seeing raw material costs coming down in Q4 of last year, but I am thinking along similar lines to what you stated.

Operator

Your next question comes from the line of Peter McDonald with Wall Street Access. Your line is open.

Peter McDonald - Wall Street Access

Thanks a lot. First, how large is the surface business now?

Olivier Filliol

26% in Q1.

Bill Donnelly

That's always the biggest quarter, so it will be a little bit less than that for the full year.

Peter McDonald - Wall Street Access

Okay. Could you just expand a little bit on the trends? Are you seeing any increase in quote activity as customers kind of delay capital equipment upgrades and things of that nature?

Olivier Filliol

Actually, quote activity is strong in general. That's not what holds us back. I think what you ought to see is the people or customers don't get approval from the purchasing and finance department. So that what's more our focus is to get closing on quotes.

Peter McDonald - Wall Street Access

Now, you have to start arguing ROI and things like that with the processing people?

Olivier Filliol

Yes, that's exactly what we are focusing on. We are emphasizing our value stories that we have, providing ROI tools to our customers, so that they can get certifications, all those things, yes, absolutely. I was referring in me prepared notes to the sales booster programs. These are kind of things that we are doing to help our sales.

Peter McDonald - Wall Street Access

In terms of price increases, was there an average that you pushed through across the board?

Olivier Filliol

We expect also for the full year that 150 basis points is a realistic number what will stick for us. We have executed actually different pricing rounds last year, and then we had a major one from January 1. Now, what's also important is it wasn't just executing on the price increase itself, but it was very thorough training and coaching of our sales force around the world to really make sure that this price increase is big, particularly in the current environment.

Peter McDonald - Wall Street Access

How has the customer response been so far? Have they pushed back?

Olivier Filliol

In general, a good understanding for it and no particular pushback, but obviously, it's something that we monitor also closely. That's why I said before the coaching is an important part, because we don't want to lose deals just because we are off on pricing.

Peter McDonald - Wall Street Access

Okay. Then finally, what are your thoughts around FX for the second quarter, just if we could get those?

Olivier Filliol

Bill, you want to take that?

Bill Donnelly

Sure. Of course, the year-on-year comparison is that the dollar will be much stronger. I think if you estimated something like 9%, that's probably reasonable assumption.

Peter McDonald - Wall Street Access

Okay. Thanks a lot for taking my questions and good execution in a tough market.

Operator

Our next question comes from the line of Jon Groberg with Macquarie. Your line is open.

Jon Groberg - Macquarie

Congratulations on some good execution. I think what surprised a lot of people with a lot of the more instrument manufacturers is given the steep decline in sales how well gross margins have kind of held up. Can you maybe detail a little bit more how you did that?

In general, I would think as you get fewer products being manufactured and that works its way through inventories, you're going to have less utilization, higher costs. At some point, that's going to hit gross margins. I think that's just surprising a lot of people. Can you maybe describe what's going on there at that line?

Olivier Filliol

We had the impacts on the gross margin. One, we had the currency benefit on gross margin. The second one was the price increases that I mentioned before. The third one was we had material cost savings. So, that all helps. Now, of course, we had also modest offset by having a volume decline, but that hasn't been that significant.

Bill Donnelly

Basically, if you break it up into pieces, we had about 100 basis point benefit due to foreign exchange. That's purely, Jon, if you assume that the gross profit dollars stay about the same and the headwind we had in terms of the first quarter was in the range of 7% or so. So, if your gross margin was 50 on a 100 of sales, it's now 50 on 93 of sales. Of course, I am using example numbers there.

Jon Groberg - Macquarie

On the currency front, didn't the Swiss franc move against the euro?

Bill Donnelly

Yes, so that cosmetic impact was 100 basis points benefit, and netted in that are two, let's call it, operating effects. One is that the Swiss franc/euro hurt us, but on the other side, we did benefit from the British pound because of our metal detection manufacturing is largely located there.

So, roughly, the volume was a little bit more than 100 basis points. The currency was about 100 basis points. Then we picked up some benefit due to pricing and material costs, as Olivier mentioned, and then the mix was maybe a negative number partly offsetting that overall.

So, with a company with as many product lines and geographies as we participate in, there is always a lot of pieces moving around. I kind of think of the volume and the currency kind of offsetting each other, and then pushing through the price increases and good raw material costs were partly offset by some mix considerations.

Jon Groberg - Macquarie

You addressed this a little bit, but to make sure I'm clear, there isn't anything that was happening in the first quarter where some of your manufacturing costs, kind of lower volumes, worked their way through the P&L that your gross margins are going to be hurt more? You would be able to sustain the gross margin, all else being equal on the FX front that you did in the first quarter?

Bill Donnelly

To say it differently, we would continue to think that our gross margins would be at about prior year levels throughout the year.

Jon Groberg - Macquarie

Okay. Did you explain why the tax rate was going up 100 basis points?

Bill Donnelly

I didn't in detail. It's on the way up. As our profits increase, we tend to earn most profits in lower tax cost countries, China and Switzerland in particular. To a certain extent, on the way down, it's the same. I'd like to thing be that, we will return to the 26% rate next year, but I think 27% is probably a realistic expectation for this year.

Jon Groberg - Macquarie

Okay. Then last question, Olivier, for you. We hear a lot of every company saying that they want to take advantage of the current challenges and come out stronger. I am just curious if you have any specific targets or goals internally that you can share with us of defining that. What do you mean in terms of being a stronger player? What specifically can you do to take advantage of some of the weakness of your competitors?

Olivier Filliol

I think it's about our market share strategy that we have. We always pursued that in the past. I think in this current economic environment, we clearly have that opportunity to even further accelerate this market share gain. This conscious investment in the sales booster program, marketing programs, but also continues very detailed attention to this [Pinnacle] implementation across the world, even after we implement this cost containment program will help us to gain market share.

I am convinced that we can do so without playing with pricing. If we navigate this downturn through this cost containment programs, we will be in a very, very good position when the economy restabilizes.

Jon Groberg - Macquarie

Is M&A at all in your plans there in terms of taking advantage of this?

Olivier Filliol

It is part of it. Our M&A strategy has not changed from the past. We want to pursue strategic acquisitions. They need to be bolt-on acquisitions. I think the current environment offers better valuation. That was our hurdle in the past. So that's the good news, but it probably also takes a little bit more time until tentative sellers are fully calibrated on this new valuation levels.

To be honest, I also don't mind if it takes a few more months, because that gives us time to really focus on doing our homework, but very open to acquisitions. We're going to pursue them if opportunities come up.

Operator

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

Unidentified Analyst

Hi, this is Dan in for Derik. I'm just wondering if you guys could just quantify the overall decline in the one-third of your business that would be consumables and services and then geographically whether you could break out the growth in China in particular?

Bill Donnelly

Okay. In terms of service and consumables, we had about 2% or so growth, 2% to 3%. I would highlight that if you broke that down, we probably did better on the lab-oriented and a little worse on industrial-oriented.

In terms of China, China was up 1% in the quarter. We think that that will be a little bit worse next quarter largely due to the industrial side. As you maybe sense from us, with having more visibility on the government plans in China, we're starting to feel better about what that would mean for the latter part of the year.

Unidentified Analyst

As we look at the food safety markets, which have been particularly strong for several quarters in a row, are you still taking on new customers here? As we anniversary these strong quarters, are we basically going to see the comps become very difficult in terms of growth anyways?

Olivier Filliol

The comps will get more difficult in Q2 in particular, very true. On the other hand, we clearly see continued interest in this topic of food safety. That certainly is an area where I expect us to further gain market share.

Bill Donnelly

In particular, we see the X-ray technology, which is a new and emerging technology, having good growth dynamics as people look at the benefits of that technology.

Olivier Filliol

We have seen good growth in Asia for our product inspection business in Q1, and I would certainly expect that's going on also in the next quarter.

Unidentified Analyst

On the cost cutting, I know that part of the movement in manufacturing to China was something that you were looking at for cost savings. Was this migration mostly baked into the initial phase of the program or is this something that you had accelerated as part of the additional $60 million?

Olivier Filliol

The move to China is a very ongoing effort. This is not something we can implement on such a short-time base. So, yes, we continue to move product lines to China, but this is an ongoing journey. So, it's not a significant part of this whole cost containment program.

Unidentified Analyst

Okay. This is probably a difficult question, but given that $100 million is a large cut, do you have a sense for how close you may be to running about as lean as you want to be going forward in, say, 2010's time?

Olivier Filliol

We definitely designed the program with a long-term view and definitely designed it also in anticipation of how the year will further evolve, but also what we expect for 2010. We have in 2010 a situation where if sales are stabilizing and we even would experience some sales growth next year, I would hope to bring bonus payments to normal levels.

We might expect some salary increases next year if the economy stabilizes or gets better. We wanted to have here a cost management program, cost containment program that would also address this additional cost that we have next year. That's also one of the reasons why we defined this $100 million of annual savings, so clearly with a longer term view rather than just a Q2 or Q3 view.

Operator

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

Richard Eastman - Robert W. Baird

Good afternoon. Bill, do you have a sense of how much cost benefit realization you received in the first quarter from plan A, the plan you introduced in the fourth quarter? Do you know what the savings number might be there?

Bill Donnelly

When I think of our expense structure, I think of our SG&A, our R&D as well as our fixed overheads in the plant and our service costs, that number was down around 8% or so in the quarter, including all those components. About half of that decline came as a result of us taking out costs and about half was due to what I would call the variable comp kind of topics or one-off items.

Now, I would say, though, that as compared to the prior year, that 4%, but of course we also built up costs through the first three quarters of last year. So, we were also taking off the cost increases as they relate to Q2 and Q3. So, the headcount we added or the salary increases we implemented. Does that kind of answer your question, then, Rick?

Richard Eastman - Robert W. Baird

What I was trying to go with this is we talk about two-thirds of the savings, two-thirds of the $100 million being realized this year. So, let's call it $67 million would be realized. The cost is $40 million for the entire $100 million program. At about 6.5 we took in the fourth quarter, leaving the cost, I assume all of the $34 million will be absorbed this year, correct?

Bill Donnelly

Yes, let me say it this way. We of course built that into the 100. There were a few things within the 40 that weren't going to come, but it was 90% we've got to come this year.

Richard Eastman - Robert W. Baird

So, again, if we're trying to match up costs and savings here, we're looking at maybe a net number of something like $30 million would be the net savings number this year. And then the balance of the savings next year, were you suggesting that some of that may be absorbed into inflationary increases or for heading into 2010?

Bill Donnelly

If you just look at our SG&A level and our R&D level and constant currency, just to pick the two visible elements of our fixed cost structure, as we take up those costs by some inflationary factors, maybe returning bonuses not to where they were in 2008, but let's say to a budgeted level, that will naturally increase the SG&A line, for example. Some of these cost cuts that we're making now won't be fully realized in 2009 and will have some carryover benefit that should work to offset or eliminate the cost increases we get from salaries and other things next year.

Richard Eastman - Robert W. Baird

Olivier, with this revised local currency sales guidance for the year, just geographically how much you lay that out? My curiosity is particularly in the Rest of World/Asia-Pac. Is that still expected to be flattish or some growth or would that decline as well?

Olivier Filliol

Actually, we will have very difficult comparisons also in Q2, Q3. So that we need to consider. But I would expect that we see some return of good momentum in industrial business, particularly in China. I think the stimulus package could help us here. So, while Q2, Q3 will be difficult, remain difficult for the Asia region, we would hope that Q4 will look more reasonable for us. So, this flattish expectation is actually what we build in our planning.

Richard Eastman - Robert W. Baird

Then obviously to wait these out, you have both the Americas and Europe down roughly 15% or something like that?

Bill Donnelly

A little bit less than that, yes.

Richard Eastman - Robert W. Baird

Okay. And then just the last question that I have, within the lab segment of the business, can you just talk a little bit about pharma spending trends? Could you differentiate anything there in the first quarter and how it may trail into the second quarter?

Olivier Filliol

Pharma, in particular big pharma, is obviously quite challenging, and this is true for the western markets, Europe as well as U.S. I would expect that to continue like that. I think the whole cost pressure that these companies have will continue to impact us. What seems to go well and we expect to continue to go well is pharma, and I would say life science in general in Asia and that should clearly help us to offset what we see in the west markets.

Richard Eastman - Robert W. Baird

Yes. And of the lab business, was it about 40% or so, is it pharma life sciences oriented?

Olivier Filliol

Yes.

Operator

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

Mike Hamilton - RBC

Could you give a picture, given what we've seen this economic cycle of areas that have surprised you or that you're responding to differently from what you've seen in past cycles? In other words, what are your conclusions of what's different this time and what you're trying to orient to for the future?

Olivier Filliol

I think what's certainly unique and we would have never expected and never planned for that, is how broad-based the decline was. We have seen a decline across all the geographies. We have seen a decline across all the businesses and we have even seen quite a challenge in pieces of our service business. I think that is unique.

We have also addressed it in our assessment of the different industry segments over the last few weeks, months. I think when we entered into this year, we had so-called industry heat maps, where we tried to assess which industry would still be solid and strong, which one we expected to be really weak. We had to adjust some of them over the last few weeks because you see a little bit of other dynamics than what you expected. So that certainly is unprecedented and has surprised us.

Bill Donnelly

I would maybe add a little bit to what Olivier said, in the past, part of our job as managers always when we take these programs is we're taking down costs, but where they go back in later on will be different, because part of this reallocation of resources processes. And we always did that to an extent in the past and it was very much driven on which businesses we had a focus on.

As Olivier alluded to earlier, this idea of emerging markets is so much more prevalent in our strategy going forward and what we see, and I think that the dynamics and investment considerations around that part of the world are probably a little different than we thought in the past. Then I think one thing that we always tried to protect in the past and did again now, is our resources around and investments around R&D and technology.

I would also say that we feel that we've progressed a lot as a company from a marketing point of view, and that we have been probably more protective of marketing resources and marketing investments than we had in the past, a lot because sales booster programs and the related segment marketing approaches is something we really believe in and we think we're spending wisely in those areas and it's going to help us gain share as we emerge from this downturn.

Mike Hamilton - RBC

Is what you're saying here changing your thinking at all in terms of priorities of where you want to go in focus with bolt-on acquisitions?

Olivier Filliol

We always look at acquisition opportunities in the areas where we have high margins and that's something we would continue. I think in that sense that hasn't changed.

Mike Hamilton - RBC

Thanks. Then last, if you could speak tactically, Bill, what you're trying to accomplish on debt financing this year, if there's anything worth noting?

Bill Donnelly

Just a reminder, we're really happy we have that bank facility in place, $950 million, LIBOR plus 70, so we have a real asset there. We are evaluating what to do in terms of we have a bond that's due in the latter part of next year.

I would like to, of course, think about how we are going to replace that, and you guys have probably seen that credit spreads have made bond pricing certainly more attractive than they were three months ago, and so we would like to stagger more variability of our tenure, and in terms of our debt structure. I think that that is an important element to us entering back into our share repurchase program.

So, Olivier talked a bit about the stability in markets and financial situations and I think may be Urs showing up a couple more things on the financing side would really put us in a good position for the share repurchase program and these bolt-on acquisitions that Olivier referred to.

Operator

Your next question comes from the line of Greg Halter with Great Lakes Review. Your line is open.

Greg Halter - Great Lakes Review

I wonder if you could comment on your receivable quality. I know the dollars are down, but if you could comment on the quality.

Bill Donnelly

Actually, we've been really sticking our nose into the whole receivable portfolio since October. I mean, we always did it but maybe an additional level of detail. I can tell you that we, for example, look at it in various pools and terms of the aging. I am happy to report actually that in terms of the current receivables, they are actually increasing as a percentage of the total as compared to a year ago and certainly as compared to the end of the year.

The less than 30 days past due, that position is improving as well. We saw some increase in some of the outlying related primarily to China, and these are mostly state-owned companies and they have been maybe sometimes famous for keeping that last 5% on us for a little bit longer than they would have to, but if I look at the overall picture, Greg, in terms of receivables, I am really frankly quite pleased with how the aging looks right now.

Greg Halter - Great Lakes Review

Okay. That is very encouraging. Also, I noticed that your debt was up about $23 million sequentially. Any comment there? Is there currency involved or what is going on behind that?

Bill Donnelly

No, purely, this may be going to some of our conservatism; we are holding higher cash balances. I think the cash balances are up $50 million or so.

Greg Halter - Great Lakes Review

Right. Okay. What would you expect to spend on capital expenditures this year?

Bill Donnelly

About $50 million.

Greg Halter - Great Lakes Review

$50 million, okay. One last one for you; on the SG&A side, $114 million that you recorded in the first quarter, is that a peak dollar number that you would expect to see for the year or would that really vary around how things go?

Bill Donnelly

With the sales force and aging commissions, and things like that, there is a variability element and the first quarter is always the lowest quarter sales wise and so you would actually expect our SG&A to grow in most of the quarters throughout the rest of the year, a little bit less maybe in the third quarter with summer holiday period, particularly in Europe, but I think you can assume Q2 and Q4 would be higher numbers and that is even with the cost savings and that is because of just variability in the compensation structure and the aging commissions due to sales volumes.

Operator

(Operator Instructions). Your next question comes from the line of Chuck Murphy with Sidoti & Company. Your line is open.

Chuck Murphy - Sidoti & Company

Most of my questions have been answered, so I just had one. I think in the last conference call you said you expected the SG&A to be down about 6% to 8% on a local currency basis. I was wondering if you could kind of give an update there.

Bill Donnelly

You are talking about for the full year just to be clear, Chuck?

Chuck Murphy - Sidoti & Company

Yes.

Bill Donnelly

I think it will be down in the 12% to 13% kind of range.

Chuck Murphy - Sidoti & Company

On local currency basis?

Bill Donnelly

On a local currency basis.

Chuck Murphy - Sidoti & Company

That's all I have. Thanks.

Operator

As there are no more questions, I will now turn the call back over to management for concluding remarks.

Olivier Filliol

We thank you for joining us this evening. We know how busy you are and appreciate taking the time with us. Today's environment is extremely challenging, but we are determined to take the necessary steps to align our cost structure and to firmly position ourselves for the long term.

We have a very strong foundation from which to operate from and are convinced that we will emerge a stronger company. We will speak to you again at the end of the second quarter. So, thanks again and good luck.

Operator

This concludes your conference call for today. You may now disconnect.

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Source: Mettler-Toledo International, Inc. Q1 2009 Earnings Call Transcript
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