Veralto Corporation — 2024 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
My name is [ Shelby ], and I will be your conference operator this morning. At this time, I would like to welcome everyone to Veralto Corporation's First Quarter 2024 Conference Call [Operator Instructions] After the speaker's remarks, there will be a question-and-answer session.
Good morning, everyone. Thanks for joining us on the call. With me today are Jennifer Honeycutt, our President and Chief Executive Officer; and Sameer Ralhan, our Senior Vice President and Chief Financial Officer. Today's call is simultaneously being webcast. The replay of the webcast will be available on the Investors section of our website later today under the heading Events and Presentations. A replay of this call will be available until May 8, 2024.
Thank you all for joining our call today. The first quarter of 2024 marks our second consecutive quarter of solid operating execution as a stand-alone company. We are driving steady, profitable growth and continuous improvement through greater focus and accountability using VES fundamentals, basic blocking and tackling.
Good morning, everyone. I will begin with our consolidated results for the first quarter on Slide 7. First quarter net sales grew 1.8% on a year-over-year basis to about $1.25 billion. Currency was a modest benefit, offset by the divestiture of Salsnes product line. Salsnes was a small commodity filter product line in our Water Quality segment that was divested in January.
In summary, as a stand-alone company, we have increased focus, discipline and accountability across all levels of the enterprise, which has elevated our level of execution. We are driving continuous improvement and investing in future growth as our end market environment gradually improves. We are off to a positive start in 2024 with solid growth and strong margin expansion in the first quarter.
[Operator Instructions]
The 60% gross margin is a pretty incredible number when you really think about the mix of businesses you have. But should we think about this as kind of high watermark or would you think about it as more of a step up into a new level of entitlement? How do you guys think about it?
Maybe I'll take that one, Scott. Overall, as you got to look at margin perspective, some of it comes down deliver of a mix. I think it's still going to be in the 58% to 60% kind of ZIP code.
And just following on a little bit to a comment you made, Jennifer, on increasing accountability. I understanding has always been that the Danaher business system always drove a pretty high level of accountability. How have you tweaked it to even raise that to a different level? And what kind of changes have you made when you think about just tightening things up for the assets that you have here?
Yes. I mean I think it's always challenging to provide an equal level of focus across a very, very large enterprise like Danaher has I think a smaller, more nimble $5 billion business, obviously, allows us to focus exclusively on these businesses, whereas there were many more factors sort of previously with the life sciences and diagnostics side in Danaher.
Congrats on the quarter. Good luck this year.
And we'll take our next question from Andy Kaplowitz with Citigroup.
Jennifer and Sameer, how are you feeling about the PQI recovery at this point? I know you mentioned North America and Western Europe, you continue to see signs of recovery. You talked about equipment demand coming back late in the quarter. Maybe you could elaborate on that equipment trend. Have you seen follow through in that food and beverage recovery that started, I think, in Q4? And how are you factoring in China-related growth in that segment for the rest of the year?
Yes. We're really encouraged by the PQI performance here in Q1, particularly around our consumable revenue stream or recurring revenue. Is this the third sequential quarter that we've seen mid-single-digit growth there. And with regard to sort of how those markets, particularly in food and beverage, recover from a downturn, we will always see the consumable revenue stream ramp first.
Andy, only other thing I would add from a guide perspective, we're building equipment recovery more in the second half, while the owners, as Jennifer mentioned, in March, were very encouraging, good discussions with the customers that those business teams are having but we're still cautious and we are building into anything on the equipment side in the second half than in the second quarter at this point.
Very helpful. And then maybe a similar question on the Water Quality side, Obviously, you've talked about strengthening industrial business for a while now. Maybe talk about the resilience of that. Are you seeing North American municipalities on the Hach side spend anymore? Is there -- do you see any risk of higher rates, maybe impacting that side of the spend?
Yes. So the nice thing about our business, Andy, is it's largely an OpEx-focused set of businesses. So interest rates, CapEx approval cycles we are minimally impacted by. And because we operate at the high end of the value continuum in terms of being integral to operating municipal water plants. We see steady spend there.
We'll take our next question from Jeff Sprague with Vertical Research Partners.
Hey Jennifer, just first on just kind of the M&A side of the equation. Obviously, a couple of quarters out of the box here probably kind of a solid year. So to think about it given the time line of the spin. Just wonder how the pipeline is coming together. Do you see things that are actionable. And do they lean towards one segment or the other?
Yes. This is everyone's favorite topic, I think. We are 207 days post spin, I think, today. So it's still early days here. But I have to say, we have a very, very robust process and a strong pipeline of activity, both in the Water Quality side, the PQI side with a number of opportunities that we're considering.
And then maybe unrelated and for Sameer. Given that maybe kind of the consumables versus equipment mix doesn't really shift a whole lot until we get into the second half of the year. Why is it that margins would be down sequentially Q1 to Q2 on sequentially higher revenues?
As we go from Q1 to Q2, Jeff, this is -- really ends up -- the first thing is the second quarter ends up being a seasonally heavier trade show activity quarter for us. So the operating expenses do go up seasonally just for us in Q2 and Q1. And that's kind of -- I would say, applies to both the segments. The other fact that is just some of the corporate spending. As we said at the beginning of the year in February, right, we just want to be very cautious and judicious as you bring in the corporate expenses, from a stand-alone company perspective.
Does it bias towards one segment or the other?
No, it's pretty universal across the board.
We'll take our next question from Mike Halloran from Baird.
So following up on Jeffrey's question, as you became a stand-alone company, did you have to change processes lean in any way from an organizational perspective with incremental resources, whatever, to essentially build the muscle on the M&A side, obviously, a little bit less prioritized at Danaher?
So clearly, standing up -- a stand-alone company does require a corporate organization to support it. Previously, tax and treasury and all of those functions were taken care of for us. But with respect to sort of the M&A trajectory, we were very deliberate in bringing in top talent in our strategy and sustainability function and our corporate development function. Both of those individuals that sit on my staff have long-standing histories within Danaher building strategy and executing on M&A. Insofar as the muscle building within the operating companies themselves.
And the second one is just kind of putting the commentary together on the Water Quality and the PQI side as far as starting to see some green shoots in specific areas or recovery in specific areas. How much of that is embedded from here from a guidance perspective? Are we talking relatively normal sequentials, or is there an assumption for an improved backdrop as we get through the year and just had some context?
Hey Mike, yes, I'll take this one. Essentially, it's pretty kind of a gradual sequentially improving quarter-by-quarter that you just built into the guide at this point. As I said earlier, really what we're building is this point for -- in the near term is really more on the consumables side, still that trend slowly kind of building equipment side, it's really more in the second half of the year.
We'll take our next question from Deane Dray with RBC Capital Markets.
I appreciate all the color and specifics in the slides in your prepared remarks. I'd like to get a very specific question in Water Quality, if I could. So the new EPA regulations on PFAS, the 4 parts per trillion is really -- as that pushes the testing technology limits. And right now, it's still you have to use a prohibitively expensive mass spec, no utility really can afford that.
Yes. Great question, Deane. We knew that the EPA was headed towards a 4 parts per trillion limit of detection here. So that's not fundamentally new news for us. What is new news there is the time line for compliance with [ Salsnes ] in 2027, but you are right that this is a phenomenally difficult and complex problem to solve in a fit-for-purpose way. Right now, the way to solve for this is water sample set to centralized lab, run through GC mass spec, answers come back, a couple of weeks later.
That's really helpful. And I fully appreciate that time line that you've suggested that's everything that we've heard as well. There's a question between wanting something and there's a demand -- industry demand versus the practicality given the complexity of the molecules. But I really appreciate the color. And I'm so glad to hear you mention destruction as well because that's an opportunity.
Yes. I mean I think you're right, Deane. We do and will use distribution for our analytics businesses in certain countries. They tend to be areas where we don't have critical mass in terms of staffing up the full capability of selling direct. We think it's actually a good thing to sell direct. And it's part of what I would consider to be the secret sauce because we have that long-standing technological applications knowledge.
We'll take our next question from Andrew Krill with Deutsche Bank.
I wanted to ask on -- going back to price and price costs more specifically. Just can you give us an update on what you're assuming there? I think we've heard from several companies like transportation, labor, certain raws all continue to be pretty inflationary.
Andrew, I'll take that one. Essentially, from a price, from a guide perspective and the future look perspective, we're modeling in price in line with historical norms. So it's 100 to 200 basis points. This quarter, of course, as things are rolling off, we came in a little bit towards the high end of that range. But I think from an outlook perspective on the guide perspective, 100 to 200 basis points is a good way to model.
And then for a follow-up on free cash flow conversion, it's nice to see the conversion boosted for the year from 100% to 110%. Just any more insight into like what changed to give you cost through 1 quarter? And looking ahead, should we be maybe thinking of like 100% conversion as kind of a lower like legacy Danaher was very consistently over 100%.
Yes. Andrew, if you look at free cash flow conversion, right, just as a reminder, we do give the conversion on the basis of the GAAP metrics, right, not on any kind of adjusted metrics. So essentially, when you look at that, just add the amortization and the share compensation or the stock-based compensation, I think based on all that stuff, we should be a little bit on the 100%, a little over 100% but really going towards 100% to 110% range this quarter for the full year for us. That guidance is really driven by getting more conviction on the margin side.
And we'll take our next question from Nathan Jones with Stifel.
I'm going to follow up on Deane's question on distribution, but I'm going to come at it from the PQI side because I would have thought there might actually be some more opportunities to leverage the distribution model and maybe reduce the cost to serve on the PQI side than on the water side, potentially maybe in lasers where there's not the same kind of consumable revenue or some of the smaller customers that maybe don't need thatkind of super high level of service from you guys. So any commentary you could make on maybe the potential from that side of the business to leverage distribution a bit more?
Yes. I mean I think it's probably the same answer as for water. I mean we do have distribution and we do consider use of distribution depending upon where we're selling in the world and what types of products are in the portfolio. This is something that we always consider in terms of when we when we decide to make investments and which product lines actually require a more significant level of applications, knowledge and insight.
I wanted to ask a follow-up on recycle and reuse in industrial markets, which is a market, I think, has significant growth potential over the next 5, 10, 20 years and would certainly be a market that's right in the bull's eye for a lot of your water quality business. So maybe some commentary on trends in industrial recycle and reuse markets, what you're seeing going on there and what the opportunities are for Veralto to play in those markets?
This is a great question, and absolutely. We see a great deal of activity, interest and growth potential in both recycle and reuse. And it's one that is pan-operating company, I would say, across our water quality businesses. So the intersection of ChemTreat, Trojan and Hach, can all play in that space. And in fact, do have conversations amongst themselves and amongst the sales folks in the field relative to solving those kinds of applications.
And we'll take our next question from Andrew Buscaglia with BNP Perles.
So I just wanted to check on the Water Quality side, you're talking about really strong industrial demand in your guide -- you did much better than your guidance. I'm wondering what changed, I'd say, from December, January to what transpired throughout the quarter? And then just the sustainability around that? What's driving that really?
Yes. I mean I think we still see pretty strong industrial output here, particularly in North America. I think as we mentioned in our prepared remarks, we do see food and beverage coming back, which across the portfolio is the largest continuous industrial segment that we play in. But likewise, chemical processing, mining and power generation all continue to be strong.
A lot of little things it sounds like. Yes, yes. And you got a lot of questions on M&A. Obviously, that's where a lot of interest lies. I'm wondering if you can comment on your margins, especially in Water Quality are quite high. How are you thinking about margins as you add M&A to your portfolio? Is there enough out there where you could see some accretion or generally long term, is this not really -- should we not expect those margins to stay where they are if you're adding deals?
Yes, Andrew, as we've kind of stated in the past, and when it comes down to M&A, it really -- we follow a very disciplined and rigorous approach around markets, companies and valuation with respect to the financial metrics, it really is a combination of multiple factors, right? We look at ROIC, we look at margin, what's are the things that we can add to the portfolio that can drive overall core growth and create synergies, how do we apply VES into the acquired businesses to really create the differentiated value.
We'll take our next question from Brian Lee with Goldman Sachs.
Lots has been covered on the call. So maybe just a few follow-ups, I guess, on PQI. Can you remind us how far out does your visibility extend on the equipment backlog and then the recent strength you're seeing in bookings? And then also maybe remind us what are the mix implications? You kind of alluded to them, but mix implications for margins in PQI as you move through the year. And it does sound like equipment will grow relative to consumables, how should we think about that in the context of margins?
Yes. I mean, I think what we see here is visibility for equipment in the 60- to 90-day time frame, right? This is the short-cycle business. So a lot of our confidence around equipment here in the second half is a product of history, right, where we see cycles of food and beverage and consumer packaged goods sort of decline in recovery. We see typical patterns, which is pretty intuitive of the inks and solvents, spare parts, consumables recovering first as these lines are brought back online and then equipment following when funds are available to do line expansions, equipment upgrades and so on and so forth.
And then just one on Water Quality. I think a couple of questions ago, you were talking, Jennifer, about the demand in water reuse, water recycling somewhat from an ESG footprint from a growing subset of your customers. I think there's also a growing subset of customers and industries here levered to power gen growth. We're seeing low growth on the grid in the U.S. especially. First time in a while really seeing some positive inflection.
So the business that is -- benefits most from the CHIPS Act and microelectronics is Trojan that sells UV treatment systems in for high-purity -- ultra-high-purity water. That water has to be exceedingly pure given the manufacturing requirements for semiconductor wafer fab. But there are pockets of other equipment and analytics and so on that get sold into that space. But we've really seen some nice growth in our UV treatment business as a result of sort of the onshoring or reshoring of fabs here in North America as well as the ones that continue to be built in China.
And Brian, the only other thing I would add to that is as you're going to look at the bid activity that our teams are seeing, we're seeing a pretty healthy bid activity that's kind of tied to the reuse point that earlier Nathan had as well on the municipal side and then on the semi side on the -- for the UV treatment system. So the bid activity is actually pretty good on both sides. That kind of tie back into the Trojan business.
And it appears that we have no further questions at this time. I will now turn the call back over to Ryan Taylor for any additional or closing remarks.
Thanks, Shelby, and thanks, everybody, for joining us today. We really appreciate your time and engagement. As normal, I'll be available for follow-ups today and throughout the next coming days and weeks, should you want to talk, please reach out to me. And at this time, we'll conclude our call. Thank you so much again, and we'll join you next time.
That concludes today's teleconference. Thank you for your participation. You may now disconnect.