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Executives

Mary T. Finnegan - Head of Investor Relations and Treasurer

Olivier A. Filliol - Chief Executive Officer, President and Director

William P. Donnelly - Chief Financial Officer, Principal Accounting Officer and Group Vice President

Analysts

Vijay Kumar - ISI Group Inc., Research Division

Jonathan P. Groberg - Macquarie Research

Isaac Ro - Goldman Sachs Group Inc., Research Division

Daniel Arias - UBS Investment Bank, Research Division

S. Brandon Couillard - Jefferies LLC, Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Derik De Bruin - BofA Merrill Lynch, Research Division

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Steve Willoughby - Cleveland Research Company

Mettler-Toledo International (MTD) Q2 2013 Earnings Call July 25, 2013 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to our Second Quarter 2013 Mettler-Toledo International Earnings Conference Call. My name is Victoria and I will be your audio coordinator for today.

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

Mary T. Finnegan

Thanks, Victoria, and good evening to everyone. I am Mary Finnegan, I'm the Treasurer and responsible for Investor Relations at Mettler-Toledo, and I'm happy to welcome you to the call tonight. I am joined here with Olivier Filliol, our CEO; and Bill Donnelly, our Chief Financial Officer.

I want to cover just a couple of administrative matters before we get started. 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 is also available on our website.

Let me summarize the Safe Harbor language, which is outlined on Page 1 of the presentation. Statements in this presentation which are not historical facts constitute forward-looking statements within the meaning of 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.

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 the factors discussed under the caption, Factors Affecting our Future Operating Results, in the Business and Management Discussion and Analysis of Financial Condition sections of our Form 10-K.

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

I will now turn the call over to Olivier.

Olivier A. Filliol

Thank you, Mary, and welcome to everyone on the call. I will start with a summary of the quarter, and then Bill will provide details on our financial results and our updated guidance for 2013. I will then comment on the current business conditions, as well as provide an update on our Service business. As always, we will have time for Q&A at the end.

The highlights for the quarter are on Page 2 of the presentation. Local currency sales increased 1% in the quarter, in line with the range we outlined on our last call. Both Europe and Americas did better than we expected, while market conditions in Asia, particularly China, were more challenging than expected. In particular, we saw the situation in China deteriorate in June.

We had another quarter of strong gross margin improvement, which combined with the benefit of our cost control initiatives, drove a solid increase in operating profit. I'm pleased with the 9% increase in earnings per share.

Despite modest conditions, which are less than ideal, we believe we will generate solid earnings per share growth in the second half of the year. We will have more to say on our outlook for 2013 in a few moments. But now, let me turn it to Bill to cover the financial results.

William P. Donnelly

Okay, thanks, Olivier, and hello, everybody. Let me start with additional details on sales which were $578.7 million in the quarter, an increase of 1% in local currency. On a U.S. dollar basis, sales also increased 1%, as we had no currency impact to sales this quarter.

Turning to Page 3 of the presentation, we outline sales by geography. In the quarter, local currency sales increased 5% in the Americas, increased 2% in Europe, while Asia/Rest of World decreased by 5%.

On Slide #4, we outline the results for the first half by geography. Sales increased by 3% in the Americas in the first 6 months, and declined by 1% in Europe, and declined by 3% in Asia/Rest of World. All these amounts are local currency and organic.

On Slide #5, we show sales by product line for the quarter. Laboratory Products increased by 3% in local currency, while Industrial declined 2% and Food Retailing increased by 5%.

In the 6-month period, which is shown on the next slide, Laboratory Products increased by 1%, while Industrial declined 1% and Food Retailing declined 2%.

Turning to Slide #7 of the presentation, we show the P&L. Let me walk you through the key items. We're pleased with our gross margins, which were 53.4% in the quarter, a 100-basis-point improvement over the prior year. We benefited from pricing, lower material cost and an overall favorable mix. R&D amounted to $29.0 million, a 4% increase in local currency versus the prior year. SG&A amounted to $173.4 million, a 2% increase in local currency as compared to the prior year quarter. We benefited from our cost control measures, which were partially offset by higher sales and marketing investments, as well as variable compensation.

Adjusted operating income amounted to $106.4 million, which represents a 5% increase over the prior year amount of $101.1 million. Operating margins were 18.4%, an increase of 70 basis points over the prior year. We are very pleased with our operating income growth, as well as the margin improvement in the quarter.

A couple of final items on the P&L. Amortization amounted to $5.8 million in the quarter, while interest expense was $5.5 million. Our effective tax rate is 24%, while fully diluted shares for the quarter were 30.8 million. Adjusted EPS was $2.35 per share, a 9% increase over the prior year amount of $2.15 per share.

On a reported basis, earnings per share were $2.24, as compared to $1.93 in the prior year. Reported EPS includes pretax restructuring charges of $3.2 million or $0.08 per share. This is primarily employee-related charges for cost measures announced in the second quarter of last year. Reported EPS also includes $0.03 of purchased intangible amortization.

The next slide highlights our results for the first half. Let me touch briefly on the key items. Local currency sales were flat in the first half as compared to the year earlier period. Gross margins have increased by 120 basis points, while operating profit increased by 5%. Adjusted earnings per share increased by 10% from the same period. Given the challenging economic environment we faced so far this year, we're pleased with earnings growth in the first half.

Now turning to cash flow. Free cash flow for the quarter amounted to $78.2 million, a 13% increase over the prior year amount of $69.3 million. On a per share basis, this represents an increase of 17%. For the first 6 months, our cash flow per share is up 24% over the prior year period. We remain on track for our full year cash flow target in the $270 million range.

In terms of working capital, I'm pleased with the continued improvement in ITO, which reached 5.2x this quarter as compared to 4.5x 1 year ago. We continue to gain additional transparency on our supply chain with the new Blue Ocean system, which is helping to increase inventory turns.

Finally, our DSO was 45 days. This is 4 days slower than last year. Similar to what we saw in the first quarter, this increase is related to China and is impacted by their reduced level of project activity, where we benefit from advanced payments and by the overall liquidity situation there.

Let me spend a few minutes on the situation in China and what we think it means to our business. We continue to see liquidity issues in our Chinese customer base, which is impacting demand. We do not see short-term improvement to the situation, and we expect it to continue to impact growth in China. Our sales decline in China in the second quarter was more than expected, with June orders being particularly weak. The quarter got off to a solid start as reflected in the April results. May was okay, but June was weaker than anticipated. The tightening credit situation, which we spoke of, with the spike in CHIBOR rates in June as a symptom, was more of a factor than we anticipated. The government's attempts to rein in lax credit practices is clearly impacting their economy more than we had anticipated the last time we spoke. We continue to be bullish about China in the medium to longer term and believe that as their economy moves more towards a consumer-driven economy, our Lab and Product Inspection businesses will grow faster and our core Industrial business will be reduced as a percentage of our total sales.

One final comment. We have long believed that the growth in China will not be a smooth line, rather, we'll face these ups and downs, more so than in the developed world. We're seeing some of that right now.

Let me cover guidance. Although sales in the first half of the year were modestly below our expectations, we expect to see improvements as the year progresses. However, we see dynamics differently by region. Our businesses in the Americas are solid, while Europe is stable but below historical levels. I've already mentioned China, but clearly, economic framework is more uncertain in emerging markets than in the developed world. At this stage, we expect China to be down mid- to high-single digits in the third quarter and to be flattish in the fourth quarter.

Now for specifics. For the full year, we believe our sales in local currency will be between 1% and 2%, that is narrowing our range slightly from 1% to 3%, which we had previously communicated. This reduces the midpoint of sales growth by 50 basis points, and reflects the slower start to the year, as well as our current outlook for the second half.

Although we're narrowing the top line, we are slightly increasing our adjusted EPS guidance to the range of $10.45 per share to $10.60 per share or a growth rate of 8% to 10%. This compares to our previous guidance of $10.40 to $10.60 per share.

For the third quarter, we would expect local currency sales growth to be in the range of 1% to 3%. With our guidance of 1% to 2% sales growth for the full year, this implies about 3% sales growth as an estimate for the fourth quarter at this stage.

With our sales growth assumptions for Q3, we expect earnings per share on an adjusted basis of between $2.55 per share and $2.60 per share, or a growth of 6% to 8%.

A couple of additional points to cover with guidance. First, currency. We would expect currency to have no impact on sales growth in the third quarter and reduce sales by about 1% in the fourth quarter. For the full year, currency will be neutral to sales growth.

Now looking at the impact of currency on earnings for the remainder of the year, we continue to face a little bit of a headwind in 2013. In terms of the Swiss franc versus the euro, we're relatively neutral given the hedges we have in place. However, we're getting hurt with the Japanese yen and some of our other smaller currency exposures. In total, we expect currencies will reduce EPS growth by 3% in the third quarter and 2% in the fourth quarter.

A couple of additional points. We have continued to assume an effective tax rate of 24% for this year, and we continued to assume that all our free cash flow will be used for the share repurchase plan.

One additional item related cash flow. Today, the board increased our authorization under the share repurchase program by $750 million. We have used up our previous -- we would have used up our previous availability over the next 12 months, and this increase will allow us to continue for the next several years. We do not anticipate a change in our repurchase strategy, that is, we'll continue to target repurchases equal to our free cash flow plus option proceeds. For 2013, this amounts to approximately $290 million.

That covers my comments on guidance, and I want to now turn it back to Olivier.

Olivier A. Filliol

Thanks, Bill. Let me start with summary comments on business conditions. Lab increased 3% in the quarter, with good growth in the Americas and Europe and a slight decline in Asia/Rest of the World.

In terms of product areas, Analytical Instruments had very good growth, while AutoChem and Balances had good growth.

Turning now to Industrial, which was down 2% in the quarter, with Product Inspection basically flat and core Industrial down 2%. The declines were driven by Asia, particularly China. We had good growth in core Industrial in the Americas. Retail was up 5% in the quarter, driven by project activity in the Americas and growth in Asia.

Now let me make some additional comments by geography. Europe was up 2% in the quarter. Better than we expected, as Lab had strong growth and Industrial was up slightly. The U.K., Benelux region and Eastern Europe were particularly strong.

Americas was up 5% in the quarter, better than we expected and the economic environment has proven strong. Finally, Asia/Rest of World was down 5% in the quarter, and Bill already commented on China and I'm sure we will discuss more during our Q&A.

That covers my comments on the current market conditions. I want to now spend a few minutes updating you on our Service business, which represents approximately 23% of total sales, with operating margins above the company average.

We have a wide range of services that provides clear value to our customers in terms of avoiding downtime, optimizing performance of their instruments, ensuring compliance with customer's standard operating procedures, as well as helping our customers increase their knowledge of applications and related processes.

We have made important investments in our service organization over the last few years, which we believe will drive further growth.

Two key focus areas are globalizing our service offering and increasing the percentage of our installed base that we service, thereby increasing the amount of service revenue under contract.

Let me provide some details of the initiatives that are driving these strategies. In conjunction with our Blue Ocean program, we have invested in the cleansing, enhancing and standardizing of data about our installed base. With millions of installed instruments, this is a significant project and we are still working through it in many of our units.

However, with better data on our installed base, our I base, as we refer to it internally, we can design more targeted and effective service marketing campaigns tailored to the product life cycle of the instrument. Furthermore, with this data, we can also target sales campaigns for instruments that are nearing the end of their useful life.

In 2013 alone, we have plans for more than 500 campaigns to our installed base. At the same time that we are gathering more clarity on our installed base, we are also working to harmonize and standardize our service offering around the world. With our decentralized organization, our service offering has been local in nature. While that has been effective, we recognize that we will have greater leverage with a globally harmonized service offering and related operational model. What this means is that we have a common scope of work, a detailed description of service delivered, regardless of where in the world the service is performed. The harmonization process allows us to productize our services. This leads to the ability to market our services more effectively and more easily sell it at the point-of-sale.

Our Blue Ocean program is a key enabler of this globalization of our service offering and the benefits are multifold. First, a standardized global service offering is an important competitive advantage, as our competitors are often local small service organizations.

Second, we can standardize and globalize marketing campaign and leverage internal global marketing resources to target additional service revenue.

Third, we can enhance productivity as a standardized service offering, which will allow us to create standard workflows. Finally, this approach will allow us to shift our pricing strategy to value-based pricing rather than hourly-based pricing. We're still in the early stages of this transformation, as we just went live with our pilot service organization in Blue Ocean earlier this year.

We think the potential in terms of service revenue growth and service margin is meaningful. We have complemented these investments in data and IT infrastructure with new equipment and automation tools for our technicians, including handheld devices, automated signature capture pads and device service management dashboards.

New uniforms and signatures on our vehicles have also reinforced the professionalism and strength of our Service business. Our Service business provides us significant competitive advantage as it keeps us in close contact with customers and provides invaluable insight into our customers' instrument needs. I'm confident that the investments we are making will lead to solid growth in our service sales and profitability over the medium term.

That concludes our prepared remarks. While market conditions are uncertain, we expect to see improvements as the year progresses. Although the dynamics will be different by region, we recognized the uncertainty in our markets, particularly in China, and we'll monitor closely. We believe our cost structure is in good shape and believe that despite the more challenging market environment, we are strongly positioned to capture growth opportunities and market share.

I will now ask the operator to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Ross Muken with ISI.

Vijay Kumar - ISI Group Inc., Research Division

This is Vijay in for Ross, and Olivier, I just wanted to dig in on the China. Sir, can you maybe parse out sort of what's behind your assumptions in mid- to high singles decline in third quarter? And I know that last quarter, you mentioned an order revenue mismatch and that was driven by tightening credit conditions. Is this a continuation of the same or is it the CHIBOR spike in last Q? Was that sort of an additional concern that China worsened? What are you seeing in China?

Olivier A. Filliol

Let me maybe have Bill cover it because he was actually the very close contact, also with the Chinese team over the last few days, on these kind of topics and he can give you -- certainly, he has more details.

William P. Donnelly

Sure. So first of all, I think CHIBOR, what happened to it, more as a symptom, right? We do see tightening of credit. So for example, I -- we see it in the customer base, that we have more guys on credit hold. We actually have -- I mentioned on the last call, and can see pretty significant reduction now in inventory in some of our lab dealer channels, for example, who would carry make-to-stock type of products. We see reduced big project activity and our feeling is that we still have a little bit of time yet for the overall situation to get to a little bit easier comp and that growth rates returned to, maybe not where they were 2, 3 years ago, but still to a nicer growth rate more in line with their GDP or a little bit better. The areas that we see that we're, let's say, most see the biggest weaknesses in the medium term, or the next couple of quarters, I should say, relate to the Industrial business. I think with regard to the Lab business and the Product Inspection, we feel a little bit better about that. I think particularly if you adjust for maybe the reduced inventory in the channel and some of the credit holds that are in place. Yes, I think that you guys have read a lot about it in the paper and heard news reports about these credit topics, liquidity topics, in China. I think we're seeing some of that manifest in our business. There's still a lot of good things going on, even in the short term. And I guess, nothing has changed in our minds about China for the medium to long term. We continue to be very excited about our growth prospects there. Maybe I can let Olivier comment a little more there.

Olivier A. Filliol

We, definitely, as Bill said, we recognize that the short-term outlook, we also feel a little bit worse than the last call. But when it comes to the midterm, long term, the factors that I mentioned on last call are still very valid. I feel really in that sense comfortable that the key drivers like the overall manufacturing GDP growth will remain healthy and will be driving our growth. The increasing GDP per capita is, for example, one that is very relevant for us because that will mean more packaged food consumption, helping our food inspection, but also the pharmaceutical industry will benefit from that indirectly. We benefit with our instruments. There is government efforts that are really going on to move into more value-add industries that will drive also the number of scientists in the workforce. Again, the fact that, that helps us very much. And I continue to see that there is good investments in automation and quality topics, and we will certainly continue to benefit from that one. So all in all, these macro factors are very favorable. They will be particularly favorable for the Laboratory business and the Product Inspection business. We would recognize that these businesses have the better growth prospect than the Industrial business. And we have been talking for quite a while that we would foresee that our Chinese business, who is currently skewed toward industrial, will rebalance more to a global average than we experienced.

Vijay Kumar - ISI Group Inc., Research Division

Maybe Olivier, I just want to sort of, you know what you mentioned in your prepared comments on service offering. Can you -- now how should we think about sizing that service opportunity in the longer term, I guess, given some of the initiatives that you rolled out and any color would be helpful.

Olivier A. Filliol

Yes, so currently, about 23% of our global sales, we would clearly see that this ratio is higher in the West than in emerging markets. And however, I see good, good progress in emerging markets on the topic and I would foresee that they have actually good growth momentum for many more years on that topic. So we're going to benefit from that effect. Then we're going to benefit from all these initiatives that I just mentioned. Over an economic cycle, I definitely expect service to grow more than products. And with that, I do expect that this share will grow up, but we are talking about every year a few points. I'm not suggesting here that this is a radical shift; it's a journey and there is a long way to go here. But every year, a little but will help us to shift the mix. I like it so much, because of course, the Service business is more resilient, more repetitive and service has above-group-average profitability. So it's a good trend for us.

Operator

Your next question is from Jon Groberg with Macquarie.

Jonathan P. Groberg - Macquarie Research

So just maybe put a little more teeth around it, if you wouldn't mind. What did China grow or decline by in the quarter and maybe can you talk about by division, put some numbers around it? I think last quarter, too, you mentioned it was mainly small customers. I'm just curious if it's still small or if it's widening, and that's kind of one of the reasons why it got worse in June.

William P. Donnelly

Okay. So in terms of by division, we had a decline in the Laboratory business of, let's call it 7% or so, and about 15% or so in the Industrial business, and Retail business was actually up. If I'd look and you drill down a little bit on the Lab numbers, it was AutoChem, for example, which is not a big piece of that business, but it was down 90% in part because there was some big orders in the quarter the year before. And then our Balance business was down in China, and that's a largely reflection of us reducing inventory in the channel. In terms of your comments regarding, maybe it getting a little bit more broad-based, I think that, that is the case. It is the case, too, that maybe there were more orders we declined, if you know what I mean, in the second quarter, where we just felt this, the margin and the prospects for payment on this one, maybe were not as good as they should be for us to accept the work. In that case, most of those relate to some infrastructure-related projects maybe out in some of the second and third tier cities. Those are more government-related and that will be an example of a relatively bigger entity. But yes, I would maybe also say that there's always some impact if on a general customer base because they're all seeing their small customers spending less and that has some impact on them, too.

Jonathan P. Groberg - Macquarie Research

Okay, that's helpful. So all in, maybe down 10%, and I'm curious, I think before in the first half, you thought your orders would be a little bit better than your revenues. In this quarter, did that happen or no?

William P. Donnelly

Orders were a little bit better, Jon. But I think it's fair to say, and I think we would have -- we were, entered the quarter and came out of April thinking we ought to be able to put up a mid-single digit positive number and actually, while orders were better than sales, they were actually down around 5% or so in China. And that was mostly incurred in the month of June. We were actually, I think, positive, April, May combined.

Jonathan P. Groberg - Macquarie Research

Okay, and then maybe one quick one, just switching to Europe, which has been tougher. Do you get the sense that, that's just a bottoming out? Given some of the macro trends there, do you get a sense that things might actually start to improve a little bit? There's been a lot of pent up, maybe, demand for some products that might get released?

Olivier A. Filliol

Yes, I would characterize Europe as bouncing along the bottom. Market conditions remain still uncertain, but they are definitely not getting worse from what we are seeing. In contrary, I would say when talking to the team, they really express good outlooks and optimism. You might recall that I shared that also the last time we talked on the call, that the team were feeling things were better than what we could read in the newspaper. And it translated actually in the numbers, and I feel still that, that's the case now.

One explanation for that is certainly that comparisons. And we now start to benefit from easier comparisons. So that's a little bit the reason why I say we bounce along the bottom. Certainly too early to see here good momentum in the economy. And it depends, also, by the different geographies. But there were a few countries that I highlighted also in the prepared remarks that had good momentum. And so I feel that's probably a fair characterization of how we see Europe at this stage.

Operator

Your next question is from Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

I think we covered most of China pretty well and Europe, as well. I wanted to maybe switch back to United States. And if you could offer any comments on how you feel about capital spending visibility to the back half of the year. We're still easing into the sequester process, I know it's a limited piece of your end markets. But just the general capital spending environment in the back half would be helpful.

William P. Donnelly

Okay. I think our view is that, first of all, we had a solid quarter in the Americas. Order growth and sales growth were both pretty good. And our retail did well, but actually our core product categories all had good periods. So it was a good profit period as well. And they built a little bit of backlog. And so we were feeling pretty good about that. In terms of the back half of the year, I think you're going to see, let's call it, mid-single digit, maybe the lower end of mid-single digit, but in -- for that in the Americas. And I think we'll see all product categories probably doing pretty good, I think. The only product area I could think of right now that we -- maybe some of our kind of core Industrial product categories weren't particularly strong, but actually, the vehicle piece was good. And then maybe the Rainin business, which has exposure to academia, wasn't particularly strong, but not terrible either.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Got it. If I could just ask one follow-up on China. It occurred to me to ask, are there any particular parts of the end market dynamic, whether it be industrial or academic or otherwise, that were particularly volatile? Meaning, did they kind of decelerate into the end of the quarter? I think Olivier said in the prepared comments that there was, I think, deceleration into June. So I'm just wondering if there's any one area that really stood out.

Olivier A. Filliol

Just on China, I would say the liquidity topic that Bill mentioned certainly impacts, in a different way, end-user industries. Everything that is infrastructure-related is very much impacted by that, and then we have smaller private companies that are also impacted by it. They're -- but at the same time, I want to also stress that there are market segments in China that remain, actually, very attractive and where we see, also, good activities. I would, for example, mention everything there is, testing labs, environmental market, and so on. We have not huge exposure to them, but they are healthy markets. And for example, food processing market, food safety topics and so on, remained good. And what we are really working on is to make sure that we are shifting resources and our attention to these growth opportunities, and not getting hang up on the segments that will probably suffer also for quite a while. The liquidity thing is a short-term thing, but we will also have impact from the overall economy that slowed down.

Operator

Your next question is from Dan Arias with UBS.

Daniel Arias - UBS Investment Bank, Research Division

Olivier or Bill, I'm not sure if you guys touched on this during your first response, but what is the timeframe that you think of in terms of the business mix in China moving more in line with the corporate average?

Olivier A. Filliol

Well, we are talking about years. This is not a short thing, it takes years. And I would say the way it's going to happen is by having the Lab business and Product Inspection business having better growth in China than Industrial. So it's not that I expect here that we have continuous declines on Industrial or Retail, it's much more that the Lab business will -- and Product Inspection will have strong growth. So -- but to rebalance, we talk here about multiple years.

Daniel Arias - UBS Investment Bank, Research Division

Got it, okay. And then maybe on Blue Ocean. I think better price realization is a part of the plan there. So do you have a feel for how much incremental prices come out of just having a better model versus maybe what you're able to do because of pricing power in the market?

Olivier A. Filliol

The way we should look at Blue Ocean. Blue Ocean is an enabler for us to continue all these programs that we have in place, for operational excellence and in particular, around Spinnaker and pricing when we talk about the front end. So I'm not looking to Blue Ocean, let's say, "Okay, we have this country going live with Blue Ocean, and thanks to that, we will have an extra 2% price increase the following year." I rather see that Blue Ocean is a complete enabler for us to get more data transparency, get better pricing execution on all these topics, and will help us to maintain these ongoing price increases that we have every year and getting even more sophisticated. But it's a continuous journey and a continuous program.

Daniel Arias - UBS Investment Bank, Research Division

Okay. So it's sort of a part of the overall price realization process, not sort of necessarily something explicit?

Olivier A. Filliol

Yes. I understand, again...

William P. Donnelly

An enabler.

Daniel Arias - UBS Investment Bank, Research Division

Got it. Okay. Maybe just one more. You'd said last quarter that order cancellations were not expected to be anything of a real concern. Just wanted to see whether that was still the case -- was it still the case in 2Q and is still the case for the coming quarters.

William P. Donnelly

We didn't have any order cancellations. I think I mentioned there were -- when we were talking to the Chinese team, they did tell us they walked away from more, what they felt were too low a margin, vis-a-vis the risk, from a credit perspective, with some customers, but it was never orders they expected, but more orders they ultimately declined to accept. And -- but in terms of actually us having received orders and then customers contacting us to cancel them, I am not aware of. I mean, I'm sure there are a few out there, but nothing material such that I would have noticed a backlog adjustment or something.

Olivier A. Filliol

I think what's happening regularly is that we work on promising projects, and teams can work along with they have in their sales pipeline. And then it doesn't materialize or we decide not to pursue it, but that wouldn't be in our -- wouldn't be booked as orders in our systems.

Operator

Your next question is from Brandon Couillard with Jefferies.

S. Brandon Couillard - Jefferies LLC, Research Division

Olivier, coming back to Europe, we're seeing some nice sequential improvements in the PMI figures there. Just curious how demand paced through the second quarter? And if you could give us a sense of how orders shaped up versus revenue, that'd be helpful.

Olivier A. Filliol

Okay. So we -- in Q2, overall, we had good momentum, and this relates also to order entry. And I would, in that sense, also expect that we'd get a benefit for the rest of the year. So rest of the year will be stronger than year-to-date numbers.

William P. Donnelly

Yes, and orders were good in the quarter -- a little better than sales.

S. Brandon Couillard - Jefferies LLC, Research Division

And then, Bill, could you walk us through the major puts and takes in the gross margin line? I'm a little bit surprised in just the overall profitability strength, given the uptick in food retail. But anything you could share with us in terms of FX, material cost, pricing and mix would be helpful.

William P. Donnelly

Sure. So we had -- and now these are quarterly numbers. So overall, we had 100 basis points improvement in gross margin. We had a 2.3% price increase in the quarter, net realized. And so you can kind of -- the impact on gross profit margin from that was 110 basis points. Then we had about a 60 basis points benefit from material costs reductions, which were material costs were down 2.4% in the quarter. And then kind of, let's call it, mix and other, but a lot of the other is the low volume and what happened with overheads was minus 70 bps. And that's how you got to the 100 basis points.

Operator

Your next question is from Tycho Peterson with JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

I actually just want to follow up on Brandon's first question there, about just trends, sequentially, in the quarter. Can you make -- can you help us quantify the drop-off in June? And any color you're willing to give on how things trended in July?

William P. Donnelly

Sure. In terms of, let's say -- and there are different pieces, but in terms of June, in China, our orders were down, it was the worst month in the quarter. I think they were down in the order of 10% or so. If you look at a multiyear basis, it's probably -- that sounds a little bit worse, because that was the toughest comp as well in the 3 months of last year's quarter. If I go to Europe, we had kind of a positive trend coming out of June. Orders were a good bit above the prior year and above the sales level. To give you a feeling, our backlog is up a good bit. Actually, I think it's the first time we've had a year-on-year backlog increase since the beginning of 2012. If I pull out China, which is usually -- accounts for a lot of our backlog as a company, it's actually quite a big increase, which I think, maybe to your point, Tycho, we see pretty good trends coming out in the Western world, maybe a little bit offset with what we're seeing in China.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then from a kind of cost perspective, it sounds like you're going to kind of hold the line with the initiatives you talked about at this point, right? Assuming that things don't deteriorate further?

Olivier A. Filliol

Yes, that's -- absolutely. We feel that we have the right balance of things going on. Of course, we continuously optimize our cost structure that's -- at the same time which we invest. But if I look big picture, I feel actually comfortable that we have the right cost structure going forward. There are things that we feel are adapting. For example, also, in China, we do selective moves here because we definitely recognize that we need to do some resource shift and we need also to maintain our productivity gains that we always pursue. But all in all, no major new initiatives that are being launched here.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

And then, I guess, as we kind of step back and think about kind of the bigger picture here, giving your commentary on China, just the macro situation. If we think about kind of the intermediate to longer term, for the next, call it, 12 to 18 months, should we be thinking about kind of low-to-mid single-digit organic growth and high 20% incremental margins? Is that the right way to think about it if we're starting to think a little bit longer term?

William P. Donnelly

Hey, Tycho, I apologize. You broke up a little bit. I got the incremental margin number, but I didn't get the...

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

I mean, I'm just trying to kind of think about -- as we think about the revenue growth, should we be thinking about kind of low-to-mid single-digit growth? I mean, I know it's early to be talking about '14, but that's essentially the heart of my question. How should we be thinking about things beyond the next quarter or 2?

William P. Donnelly

I think that, that's reasonable. I -- of course, we're going to have some easier comps next year. We're probably feeling -- we're certainly not going to have negative numbers coming out of China for the full year, next year. So I think we would probably say, sitting here today, the lower part of mid-single digit to mid-single digits would probably seem realistic. We'll give you precise guidance when we -- in 3 months or so. And with regard to the incremental margins, I think your -- I think, if I heard you right, you were kind of staying high 20s, maybe low 30s, and I think that's probably realistic.

Operator

Your next question is from Derik De Bruin with Bank of America.

Derik De Bruin - BofA Merrill Lynch, Research Division

Well, Tycho and Brandon got most of my question. So, I guess, on the Lab Products business, the -- is there anything -- I mean, in terms of new product introductions or anything that's coming out, I guess, because you talk about what the R&D is yielding. I mean the R&D, you're still keeping it at 5% range. What's new in the pipeline? What can we expect over the next couple of years?

Olivier A. Filliol

So that's -- I would almost say, I come up here with a standard answer. We definitely continue with our R&D commitments and investments. We have not been cutting back on that one, even in the more difficult economic times. And the pipeline is a continuous one. We -- every quarter, we are launching a few new products, and it is definitely also true here for the coming months. And there's some good things coming out in the titration area. We have things that we are leveraging in the pH area. Actually, I could name it. I just realized, of course, Balance, we have also something in the pipeline for the next 3 months. The usual things, nothing that I would particularly highlight and would say, "Oh, this is going to make a big impact." But it's very important to our story here that we come out regularly with products -- new product generations to drive the product replacement cycle in the market and to expand our competitive advantage that we have in all the different Lab segments. So, yes, feel comfortable and good stuff coming, believe me.

Derik De Bruin - BofA Merrill Lynch, Research Division

So I guess if you think about the customer -- the situation in China right now, I mean, are the customers going to some of the -- or they can go to some of the local suppliers? The question then being is there some chance that it's not just like business getting put on hold, but there is potential for some lost business. I mean, maybe you're not willing to extend terms, but -- or do this, but maybe some of the local suppliers are?

Olivier A. Filliol

I don't -- I would see that when we walk away from deals. If we walk away from projects because of terms and conditions, the likelihood that it might go to another company is high. That's a calculated risk that we are willing to take because we feel that the right way and the sustainable way to do the business. But when -- absent of that one, I do not feel that customers are looking for lower-cost suppliers, that's not what I observe at all.

William P. Donnelly

I might even say that our -- you probably heard us talk in the past, Derik, that, from a competitive landscape point of view, China is by far the most fragmented of the markets we compete in, and that can't last forever. And maybe we're going to have a little bit of natural consolidation because our competitors are -- many of our Chinese competitors are actually the ones who are most hard hit by what's happening right now. So they're having their own access to capital issues, as well as maybe some of their customer base, on average, let's call it, they're not getting paid in 5 days from Nestle and 12 days from Pepsi. So they have bigger things probably to deal with in that regard.

Olivier A. Filliol

And on top of that, they have been operating with big margins for quite a while. So they are entering this economic situation with a much more difficult context.

Operator

Your next question is from Sung Ji Nam with Cantor.

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

So I was wondering about maybe some of the other important emerging markets for you guys like Brazil, India and Russia, and how things are looking in those areas?

Olivier A. Filliol

Okay. Actually Russia had good growth and that's against easier comparisons. And we had -- India, actually, I'm really happy how India performs. The growth in the quarter, if I recall well, was more modest, but we had growth. And I think it's a good accomplishment compared to what's happening in the market. And I really feel -- well with that market. And then we have some modest markets, like Eastern Europe, that performed really well, and I continue to be happy, especially considering that they have a European context that could be challenging. But actually, the team performs very well.

William P. Donnelly

Actually the -- as you saw, we had worse results in China in the second quarter. But actually, the rest of emerging markets did better than they did in the first quarter.

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Okay. Great. And then I guess one more question about China. Just was wondering, you guys talked about shifting resources there, kind of maybe potentially near term. Do you think that's sufficient? As you look towards your longer-term goals of either rebalancing your customer mix, do you think you have the right resources there in order to achieve that? Or is this -- is that going to require further investment in the near term?

Olivier A. Filliol

We -- in general, I would say the capacity that we have, the facilities that we have are absolutely sufficient also for the long term. There's one exception that I would mention here is that we are building a new plant in the western part of China, but that's actually to serve that region. We want to be closer to the customers there. And this is mainly for the heavy industrial equipments, for example, vehicle scales, where you need a certain proximity to have a good penetration in the market. So I would say that's an investment in market development. And we take the opportunity, also, since we built a new manufacturing plant for the vehicle business there, we also are leveraging that new site for our market organization. But otherwise, I wouldn't foresee big investments here to expand capacity, even for a couple of years here.

Operator

Your next question is from Richard Eastman with Robert Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Olivier, could you just speak to -- I know when you covered Europe, we kind of blasted through there. I know we have -- we had the 2% local currency growth. Did Industrial grow? You had mentioned Lab was up strong, but did the Industrial business grow as well?

William P. Donnelly

So the Industrial business was up in -- up modestly 1%, roughly.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. And did that all come out of Product Inspection?

William P. Donnelly

Yes. Product Inspection, yes. It was actually slightly down in core Industrial, up a little bit in Product Inspection.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then can I ask -- when you give -- you shaved in your core growth guidance for the year, for '13 as 1% to 2%, so we're not obviously talking about a great deal of growth. But I'm curious, as you look out to that 1% to 2% for the full year, does the distribution look something like -- is lab plus 3% to 4% and Industrial and Food flat? Or -- I'm just curious if Lab's growth rate kind of exceeds that 2% number.

William P. Donnelly

Well, if you pick the midpoint of the range, it does, yes.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. Midpoint of the 1%, so 1.5%. Okay. So Lab is a faster grower. And so, again, I guess that gives you a bit of an upward bias on the gross margin line, given mix. And then also, is the price -- you commented about a couple points of price in the quarter, presumably, that's all coming in Lab? Or are you able to capture something in Product Inspection?

William P. Donnelly

Lab is the biggest contributor, but Product Inspection does well, overall. And it would kind of go, in order, Lab, Product Inspection, Industrial and then Retail, I think, was actually negative.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

So there is some volume growth in Lab outside -- or is it pretty much all price?

William P. Donnelly

Well, volume can be a little -- I mean, volume might be a little bit misleading, of course, because it's not standard units and the price points are so different. But if your point is, if you pull out the impact of pricing out of the Lab growth, is it, overall, more flattish? Yes, I think that would be the answer.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

That's how it plays out. All right. And then also, did you give an overall order growth rate for Mettler in the second quarter? Or could you?

William P. Donnelly

It was better than the sales growth number by, I think, 2 or 3 percentage points.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. All right. And then just last, Olivier, you spent a lot of time on the service piece of the business. And just 2 questions, actually, how did that grow, year-over-year, in the second quarter? And then also, when you see the kind of slump that we're in on the product side, do you tend to see an acceleration in the growth rate in service? Do people tend to extend the service policy? Or any correlation there?

Olivier A. Filliol

Yes. Let me cover the second question before I get the data for the first question. I was just looking it up. But -- so on the second part, actually, often, we see the opposite. We actually -- when the economic times is weak, people would cut also maintenance budgets. They would, on the one hand, try to keep the products lower, and so maybe there is a bigger risk that the product might fail and therefore more repair. But when it comes to maintenance contracts, it's more challenging. And what we would also see is that customers would try to do the service more themselves in difficult economic times. And then the third point I would stress is the Service business depends, particularly the Industrial business, depends also on capacity utilization of our customers' plants. Now what we are experiencing here that service is doing well for us, I think it's really a reflection of all the initiatives that we were talking about before. We have been working on improving our service growth rates for quite a while. And we start to really see the fruits. And if I look at the number, actually it was 6% and definitely reflecting that this was strong. But I would explain it was our own initiative and not an economic phenomenon.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. Okay. And as you go forward over the next, say, 3 years, do you target the same growth rate in service that you target for overall Mettler? Presumably, service would be a little bit higher than products, but maybe not?

Olivier A. Filliol

Yes. I think that's a fair statement. I would expect service to do better. Not necessarily every quarter. What you would see is if product sales has a strong quarter, it's going to be difficult for service to match that. In essence, service will be certainly more steady, but if I take it over a certain time period, I would definitely expect service to be above product growth.

Operator

[Operator Instructions] Your next question comes from Steve Willoughby with Cleveland Research.

Steve Willoughby - Cleveland Research Company

You've seen good gross margin growth in the first half, just was wondering, what's your thoughts are on gross margin expansion in the back half of the year? And then secondly, the impact from currency, are you still expecting about a $0.10 headwind in total this year?

William P. Donnelly

I know the percentage is here, but...

Mary T. Finnegan

Steve, it's a little bit higher. You're talking about currency and EPS, it's probably closer to 16 -- $0.15 now.

William P. Donnelly

In terms of gross profit margin expansion, we expect it to narrow in the second half of the year. The reason we're expecting it to narrow a little bit is that, as a reminder, in the middle of last year, we put through a midyear price increase. And so we have, at least for the first half of this year, kind of 2 price increases, the midyear of last year, as well as the January 1. So it's not that prices will decline, but just the year-on-year impact will be less. As a reminder, we had about 100 basis points gross margin expansion in the second half of last year versus the second half of '11. And so I expect, now, numbers more in the 30, 40, 50 bps range in the second half of the year.

Operator

There are currently no further phone questions.

Mary T. Finnegan

Thank you, Victoria. And hey, thanks, everyone, for joining the call. As always, if you have any questions, hey, please don't hesitate to call us. Thanks and good night.

Operator

Thank you for your participation in today's conference call. This concludes today's conference. You may now disconnect.

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