Veralto Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

There are 7 speakers on the call.

Operator

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 Q3 2023 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr.

Operator

Taylor, you may begin your conference.

Speaker 1

Good morning, everyone. Thanks for joining us on the call. Me today are Jennifer Honeycutt, our President and Chief Executive Officer and Samir Rohan, our Senior Vice President and Chief Financial Officer. Today's call is simultaneously being webcast. A replay of the webcast will be available on the Investors section of our Web A replay of this call will be available until November 10, 2023.

Speaker 1

Before we begin, I'd like to point out that yesterday, We issued our Q3 news release, earnings presentation and supplemental materials, including information required by SEC Regulation G relating to any adjusted or non GAAP financial measures. These materials are available in the Investors section of our website, www.veralto.com under the heading Quarterly Earnings. As it relates to non GAAP measures, I want to highlight that we are presenting adjusted operating profit and adjusted EBITDA on a standalone basis, Reconciliations of adjusted figures and all non GAAP measures are provided in the appendix of the webcast slides. Unless otherwise noted, all financial metrics relate to the Q3 of 2023 and all references to variances These forward looking statements are subject to a number of risks and uncertainties, including those set forth in our most recent SEC filings. Speak only as of the date that they are made, and we do not assume any obligation to update any forward looking statements except as required by law.

Speaker 1

And with that, I'll turn the call over to Jennifer.

Speaker 2

Thank you, Ryan, and good morning, everyone. We appreciate you joining us for Peralta's first earnings call as an independent publicly traded company. The Q3 2023 marks a significant milestone for Veralto as we successfully completed our separation from Danaher. We accomplished this in just over 12 months from the time of announcement, a truly remarkable achievement. During the Q3, we filed our Form 10, issued our 2022 sustainability report and hosted our 1st investor event.

Speaker 2

Extraordinary effort related to the separation, while also driving solid operating execution In support of our customers. Through the 1st 9 months of this year, we delivered core sales growth of 3%, Expanded adjusted operating profit margin by 50 basis points and converted 105 percent of net income I'll open with a brief overview of Veralto for those who may be new to our story. Veralto is a global leader in Water and product quality, essential technology solutions and a proven track record of solving some of the most $5,000,000,000 and we are organized in 2 reporting segments: Water Quality and Product Quality and Innovation, or PQI QI for short. Our Water Quality segment represents about 60% of total sales and is positioned Our PQI segment represents about 40% of sales and is a leader in marking and coding technology as well as Packaging Design and Color Solutions. Across both segments, our key brands are leaders in their respective industries With long track records of innovation, commercial excellence and continuous improvement.

Speaker 2

Our global team is more than 16,000 strong and we serve over 225,000 customers By leveraging our scientific expertise and innovative technologies to help our customers solve complex challenges. Our technologies and services play an integral role in our customers' operations and are typically used Approximately 85% of our sales are tied to water, Food and medicine. We help our customers ensure drinking water is pure, foods and beverages are authentic macro environment as we continue to face headwinds from broad weakness in China and lower demand for consumer packaged goods. Pricing remained favorable but continues to moderate towards historical levels, both sequentially and year over In the Q3 this year, we delivered $1,250,000,000 in sales, of which 59% Core sales growth was 1% following 11% core growth Historical mid single digit growth rate. Adjusted operating profit margin, including incremental stand alone costs, Was 22.4 percent and adjusted EPS was $0.75 per share.

Speaker 2

Adjusted EBITDA was $290,000,000 or 23.1 percent of sales, And we generated over $230,000,000 of free cash flow or 113% of net income. This performance reflects our ability to navigate a dynamic macro environment and is a testament to Delivering results with the Veralto Enterprise System. Looking now at core sales by geography. On a combined basis, core sales grew 3.5% in North America and 2.5% in Western Europe. In high growth regions, core sales declined 5% due predominantly to weakness in China, Highlighted by strong growth across our water treatment businesses with modest growth in water analytics.

Speaker 2

In water treatment, Sales volumes at both ChemTreat and Trojan increased year over year. ChemTreat saw steady growth across End markets and continue to win new customers through technical expertise and strong commercial execution. At Trojan, we saw good penetration of our UV systems at municipalities, along with strong growth from our mobile rental program America declined 2.5% as modest growth in Marketing and Coating was more than offset by a decrease In sales of packaging hardware and color equipment. In Western Europe, Quality delivered 5.5 percent core sales growth with PQI flat. In Water, core sales growth was led by Hawk's analytical instruments and consumables with Germany and France contributing At PQI, marking and coating sales were flat and modest growth in packaging design software was offset by lower sales of color equipment.

Speaker 2

When we look at high growth markets, Modest growth in Latin America, India and Eastern Europe was more than offset by the Sharp decline of sales into China. In China, core sales for water quality were down high teens With PQI core sales down more than 20% year over year. These declines reflect broad weakness We remain confident in the attractive secular growth drivers for both water quality and PQI and our ability to grow core sales In the mid single digits over the long term. At this point, I'll turn the call over to Samir for a detailed review of our Q3 financial performance.

Speaker 3

Thanks, Jennifer, and good morning, everyone. I'll begin with our consolidated results on Slide 8. 3rd quarter net sales grew 3% on a year over year basis to 1.25 $1,000,000,000 Our core sales were up 1%. Currency contributed 1.5% and acquisitions contributed We continue to execute well on pricing to mitigate inflationary pressures. Pricing contributed 3.5% to sales growth in the Q3 over the prior year period.

Speaker 3

You can see this benefit in our gross profit, which increased 4% on a year over year basis to $723,000,000 Gross margin was 57.6%, Up 70 basis points from the prior year Q3. Adjusted operating profit was flat year over year. Note that on an adjusted basis, both quarters presented here include incremental stand alone costs. Year primarily due to higher SG and A related to growth investments and labor cost inflation. We generated 230 $2,000,000 of free cash flow, representing 113% conversion of GAAP net earnings.

Speaker 3

Moving to the next chart, I'll cover the business segment highlights, starting with Water Quality. Our Water Quality segment delivered $772,000,000 of sales, up 4% as compared to 16.5% growth in the prior year period, bringing the 2 year core growth Weakness in China across both municipal and industrial customers representing the biggest impact. Adjusted operating profit increased 3% year over year, with margins down modestly due to an increase in growth investments and higher labor Note that adjusted operating profit for both periods presented here includes an allocation of margin up 60 basis points, a strong 9 month performance. Moving to the next page. Our PQI segment delivered sales of $483,000,000 in the 3rd quarter, up 1% versus the prior year period.

Speaker 3

Currency was a 2.5% benefit and acquisitions contributed 1% to the year over year growth. Pricing was a 2% benefit in the quarter, partially offsetting the impact of volume declines Whereas core sales of Packaging and Color Solutions were down 7% on a year over year basis. Again, on a positive note, recurring sales for our Marketing and Coating business were up about 5% year over year and 1% Sequentially. Based on the customer insights, we believe destocking of consumables has largely run its course, and we're beginning to see signs of stabilization And China to persist through the balance of the year. Over time, we are confident that we will return that includes incremental stand alone costs for the 3rd quarter was $110,000,000 and adjusted operating profit margin was 22.8%, down 18 basis points on a year over year basis.

Speaker 3

Improved pricing Benefits from cost optimization actions were offset by lower core sales volume and higher SG and A related primarily to growth investments PQI's adjusted operating profit and margin. Excluding this discrete currency impact, PQI's adjusted operating profit margin operating profit margin up 60 basis points. Turning now to our financial position on the next page. During the quarter, we generated $243,000,000 of cash from operations, and we invested $11,000,000 And capital expenditures. As a result, free cash flow was $232,000,000 in the quarter, our 100 13% conversion of GAAP net earnings.

Speaker 3

This quarter again demonstrates the strong free cash flow generation capabilities of Note that we did not have any cash payments related to interest costs in Q3. Going forward, we'll have semiannual interest payments in the 1st and third quarter of the year. As of September 29, Gross debt was $2,600,000,000 and cash on hand was $426,000,000 Net debt was just under 2 our Investor Day, we discussed our financial policy and capital allocation framework. Conceptually, our framework is grounded in driving Compounded earnings growth while maintaining an investment grade balance sheet. Our bias is to drive compounding growth in earnings and Cash flow through investments in high ROIC organic growth opportunities aligned with secular growth drivers in both of our businesses And strategic acquisitions that drive long term value creation.

Speaker 3

Within our framework, we also maintain flexibility Turning now to our guidance for the Q4 and full year. For the Q4, on a consolidated basis, we In our Water Quality segment, we expect core sales to be flat year over year with another tough comp given 10% growth in Q4 Last year, in our PQI segment, we expect core sales to be down low to mid single digits. This decline is expected due to the ongoing weakness in consumer packaged goods and markets on a year over year basis. We anticipate adjusted operating profit margin in the range of 23.5% to 24.5%. That's about assumes Q4 tax rate of approximately 25% and reflects diluted shares outstanding of approximately 2 And our adjusted EPS guidance for the full year 2023 is in the range of $3.11 It includes incremental standalone costs and annual pretax interest expense of approximately 140,000,000 Despite the dynamic macro environment that Jennifer outlined earlier on the call, our teams remain focused on controlling what we can control

Speaker 2

In summary, we successfully executed our spin off from Danaher and are off to a good start as a public company. For 9 months this year, we have delivered 3% core sales growth, 50 points of adjusted operating profit margin expansion And 105 percent free cash flow conversion, solid operating results amid a dynamic macro backdrop. And yesterday, we announced our expectation to pay a quarterly dividend of $0.09 per share. Going forward, we are focused on delivering our commitments, driving continuous improvement and executing disciplined In closing, I want to reiterate our long term value creation framework. Over the long term, we Expect to deliver mid single digit core sales growth with incremental margin fall through in the 30% to 35% range.

Speaker 2

And we expect 100% free cash flow conversion annually. We intend to complement core growth with disciplined strategic acquisitions. We are confident that the durability of our The essential need for our technology solutions and the strong secular growth drivers of our end markets will provide steady growth consistent With our historical track record, the combination of our leading brands, proven value creation playbook powered by the Veralto Enterprise System and the strength of our balance sheet differentiates Veralto and positions us to deliver sustainable long term shareholder value. And as we look to build our future, we are unified and inspired by our shared purpose, That concludes our prepared remarks. I want to

Operator

And we'll take our first question from Mike Halloran with Baird. Your line is open.

Speaker 4

Good morning, everyone, and congrats on a good public first quarter as a public company. So let's start on the Thanks. So let's start on the margin side here. Maybe give us some context on why the healthy

Operator

.:]

Speaker 4

Quenchal uptick from the Q3 to the Q4 on the margin line. Any help you could give us by segment would be great. And then is this the right Jumping off point adjusting for seasonality and revenue levels and all that, but is this the right jumping off point as we think about 2024?

Speaker 3

Yes, Mike. This is Veer. I'll jump in on that one. As you can look at the sequential margin improvement, that's primarily driven by Some of the cost optimization things that we've been done especially in PQI and also the impact of the Argentine So in evaluation in Q3, we have not assumed that in Q4 is a one off item in Q3. So majority of the update As you see on a sequential basis going from Q3 to Q4, we'll be in the PQI segment.

Speaker 4

Got it. And then but is that the right thought process then for next year? I mean is the Q4 a more representative run rate as you think about things relative to the Q3?

Speaker 3

Yes. If you're going to look at some of the costs, things like standalone costs, we are ramping through Q3, We'll give that guide view as we're going to get the guide early next year for 2024.

Speaker 4

That makes sense. And then on the PQI side, Some comments about certainly softness in China. I don't think that's a surprise to anybody. But you also commented on the destocking side of things on the consumable side. So couple of things.

Speaker 4

One, could you just give some thoughts on how you think this demand picture plays out as we look on a forward basis? But also In the Q4, is the thought process that sell in and sell out are a little bit more balanced from a portfolio perspective? Or is there a little bit more to come?

Speaker 2

Yes. Thanks for the question, Mike. Relative to PQI, I think what we're seeing is There's signs of sequential stabilization. And again, in the prepared comments, this is really focused on sort of The improving consumable sales, we believe this is attributed to customer destocking being largely complete And resuming order rates more in line with run rate ordering, albeit at lower overall volumes. That said, as we think about the 4th quarter, consumer packaged goods volumes, we still expect to be net negative on a year over year basis, Changes in consumer behavior relative to inflationary pricing means that these folks on the customer side are going And that said, we still have a pretty variable and highly uncertain environment in China as well.

Speaker 4

No, that makes sense. And last one if I may on the water quality side of things. It certainly seems like if you exclude the China The business where there's just broader based weakness that there's a lot of stability across the portfolio here. Maybe just talk about how you think about the economic sensitivity of that segment excluding the China piece, it certainly seems like that's built to be a little bit more resilient here.

Speaker 2

Yes. I mean, certainly, our biggest downdraft in volume in water was attributed to our China business. I think What we see here is we see some relatively good growth on the treatment side. Certainly, Trojan benefiting from the CHIPS Act. We've got Chemtree that's seeing good Positive momentum in sectors such as energy, agriculture and metals.

Speaker 2

On the muni demand side for municipalities, it's a little bit softer. Municipalities are really focused on making sure that they are Focus on regulatory compliance, and so their order patterns are consistent with that. But they're still holding off a little bit in terms of Plant upgrades and investments related to optimization. So process optimization, still a little bit lackluster, but solid demand Still in the municipal regulatory compliance side.

Speaker 4

Great. Really appreciate all the color. Thank you.

Operator

We'll take our next question from Andy Kaplowitz with Citigroup. Your line is open.

Speaker 5

Good morning, everyone. Congrats on the launch.

Speaker 2

Thanks, Andy.

Speaker 5

Jennifer, Sameer, maybe just a little more color on PQI margin in Q3 and really the trend over the last several quarters. I know you mentioned the concierge in the quarter. You also talked I think in the press in the presentation around growth investments, labor inflation, but Is there just inefficiency in a region such as China that's holding you back? Or would you expect to see margin recovery As China gets better maybe next year.

Speaker 3

Yes, Andy, thanks for the question. Look, I think overall for the So that's why I highlighted that in my prepared remarks. Just to just frame that and sort of for Essentially, the impact if the Argentina peso devaluation impact you remove, actually PQI would have been up by almost 60 basis So that gives you just a sense of how big the impact was going from 22.8% to almost 24 point percent. So that is one of the biggest impact. And that, of course, is one off and we don't expect that to occur in Q4.

Speaker 3

And also, we did some cost optimization actions. As you know, we don't take those costs out, adjust those costs out. So the benefit of that, you're going to start seeing in Q4 itself. That's why I earlier said that you're going to start seeing the sequential improvement in Q4 in PQI and that's driving big

Speaker 5

Palliative sort of holding back, I guess, at Hock. It seems like that's happening in North America. We know you have tough comps versus last year, but sort of what gets them To sort of accelerate, to get back to, I would assume that you still think HOT could grow mid single digits across the cycle. So what do you need to see

Speaker 2

Yes. I mean, I think some of these supply and demand nuances will start To level out, there is good funding available with So it's really more of a matter, I think, of sort of the global economic environment and sort of a steady recovery of industrial markets. But We hold to the mid single digit performance for water quality going forward. These are essential solutions for People around the world. So we think the underlying macro is a little bit choppy right now, but the secular drivers remain strong.

Speaker 5

Got it. One more question, if I could. Like how are you thinking about the M and A pipeline and the potential timeline of your first deal as a public company? Do you need A bit of transition time to execute as a public company before you consummate a bigger deal or could we expect M and A to ramp up sooner versus later? And maybe are there any particular areas of interest As you sort of come out on M and A.

Speaker 2

Yes. Thanks for the question, Andy. Our pipeline across both water quality and PQI is strong for M and A, and we've got a number of opportunities that are currently being considered. We do not Anticipate that we will require a lengthy ramp time as a public company. We have executed the Ben, with a remarkable level of discipline and focus on the back of the learnings that Danahertz had from its 2 prior spends, and We feel pretty good about where we are positioned.

Speaker 2

That said, we are going to take a very disciplined approach to M and A, just as we would expect from our heritage at Danaher, we're going to make sure that it's a market that we like And we've got to be able to get it at the right valuation. So we believe, obviously, this is going to be an important catalyst for value creation over time, But we will maintain similar rigor and discipline as we've seen amongst these businesses as part of Danaher in the past. So Timing is always difficult to predict. M and A is episodic, but we are in the market and working a number of opportunities.

Speaker 5

Appreciate the

Operator

We'll take our next question from Joe Giordano with TD Cowen. Your line is open.

Speaker 6

Good morning, everyone. This is Michael on for Joe.

Speaker 2

Good morning, Michael.

Speaker 6

Yes. I was just curious as you look towards the Q4, what customers might be telling you around the potential for a budget flush? What does the guidance kind of assume versus historical patterns?

Speaker 2

Yes. I think that remains variable based on what industries, markets we're talking about. We do see Some of our customer segments that are use it or lose it kinds of budgets. And we would expect that We will see some of that here in the Q4, albeit at probably lower rates than we have seen sort of historically in the pre pandemic era.

Speaker 3

Joe, maybe if I can add a little bit as we're going to talk during the Investor Day, right, we are a lot more tied to the operating budget of our Customers rather than the capital side, so that kind of helps us as well as you're going to move forward.

Speaker 6

Great. Thank you.

Operator

And it appears that we have no further questions At this time, I will now turn the program back over to Ryan Taylor for any additional or closing remarks.

Speaker 1

Thanks, Shelby. This concludes our Q3 earnings call. We thank you very much for joining us. I'll be available over the next several days for follow

Remove Ads
Powered by Quartr
Earnings Conference Call
Veralto Q3 2023
00:00 / 00:00
Remove Ads