Veralto Corporation (NYSE:VLTO) Q1 2024 Earnings Call Transcript

Veralto Corporation (NYSE:VLTO) Q1 2024 Earnings Call Transcript April 24, 2024

Veralto Corporation isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Please standby. Your program is about to begin. [Operator Instructions] 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. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr. Taylor, you may begin your conference.

Ryan Taylor: 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. A 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. Before we begin, I'd like to point out that yesterday, we issued our first quarter news release, earnings presentation and supplemental materials, including information required by the SEC 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.

Reconciliations of all non-GAAP measures are provided in the appendix of the webcast slides. Unless otherwise noted, all references to variances are on a year [ph] basis. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results may differ materially from any forward-looking statements that we make today. These forward-looking statements 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.

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

Jennifer Honeycutt: 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 [ph] fundamentals, basic blocking and tackling. For Q1, we delivered 8% adjusted earnings growth year-over-year, driven by 2% core sales growth and 90 basis points of adjusted operating profit margin expansion and we exceeded our guidance across the board. Our financial performance reflects our culture of continuous improvement and demonstrates our ability to deliver on commitments. From an end market perspective, we are seeing healthy trends across our key verticals.

In our Water Quality segment, we continue to see positive secular growth drivers across industrial markets, particularly in North America, along with steady demand at municipalities. And in our Product Quality & Innovation segment, we are seeing modest signs of recovery in consumer packaged goods markets. Most notably, PQI's recurring revenue grew mid-single digits year-over-year for the third consecutive quarter. Equipment bookings for marking and coating started to show signs of recovery late in the first quarter and we continue to see encouraging trends at some of our large CPG customers led by food and beverage. Based on our first quarter results and improving market trends, we continue to expect our core sales growth rate to modestly improve sequentially throughout the year.

Looking at our full year guidance, we are on pace to deliver low single-digit core sales growth and are trending toward the high end of our adjusted operating margin range of 50 to 75 basis points of improvement over 2023. As a result, we have modestly increased our full year adjusted EPS and free cash flow conversion guidance. Sameer will cover that in more detail a bit later in the call. Confidence in our ability to deliver on commitments is, in large part, grounded in the Veralto enterprise system. Our proven system for driving growth, operational improvements and leadership development. A core tenet of the VES [ph] is continuous improvement or Kaizen. During March, we completed Veralto's first CEO Kaizen week as a stand-alone company. CEO Kaizen week is a long-standing tradition of our enterprise system and personally one of my favorite weeks of the year.

The purpose of this year's CEO Kaizen week was to drive value-accretive growth. For one week, we immersed 12 cross-functional teams at Gemba [ph] where the real work happens across 6 businesses in 5 countries. The Veralto executive team worked alongside associates in our operating companies to solve some of the most complex challenges and yield high-impact results. For example, this year's event included increasing customer engagement in North America and EMEA to drive incremental sales growth of Hach consumables. Improving the customer buying experience at Videojet to accelerate key growth initiatives and using lean conversion tools for make-to-stock products at a Hach distribution facility in North America to optimize efficiency, improve on-time delivery and meet increasing customer demand.

The benefits of any Kaizen week include immediate solutions that are rapidly implemented and yield real-time results. Success is proven by sustaining these results which we track following the Kaizen event. From a big picture perspective, this year's CEO Kaizen week, fortified our ability to deliver on our commitments to key stakeholders and reinforce that at Veralto, we are all practitioners of continuous improvement. Turning now to our financial results for the quarter. Core sales grew 1.8% year-over-year, led by price increases across both segments and modest volume growth in our Water Quality segment led by our industrial water treatment businesses. Notably, both segments delivered recurring sales growth in the mid-single digits year-over-year, increasing our percentage of recurring sales to 61% of total sales in the quarter.

As compared to our guidance, we exceeded core sales growth expectations due to strong commercial execution and better-than-expected volume at both segments, particularly within consumables. On the margin front, we delivered 90 basis points of adjusted operating profit margin expansion primarily through price execution, productivity improvements and cost optimization. Adjusted EPS was $0.84 per share up 8% year-over-year and $0.06 above the high end of our guidance range and we generated over $100 million of free cash flow, further strengthening our financial position. Looking now at core sales growth by geography for the first quarter. Sales in North America grew over 3% year-over-year with sales in high-growth markets flat and sales in Western Europe down about 1%.

In North America, we continue to see strong growth in our water treatment businesses across industrial verticals, including food and beverage, chemical processing, mining and power generation. We also continued to see strong demand for municipal customers for UV treatment systems. In Western Europe, core sales were down modestly year-over-year, primarily due to timing of UV system projects and the strategic portfolio actions in our Water Quality segment that we mentioned in our Q4 earnings call. Apart from these 2 items, core sales in Western Europe were steady year-over-year in both segments. In high-growth markets, core sales were essentially flat year-over-year as growth in Latin America and India was offset by low single-digit decline in China as anticipated.

Despite the year-over-year headwind in Q1, we believe our end market environment in China has stabilized. That concludes my opening remarks. And at this time, I'll turn the call over to Sameer for a detailed review of our first quarter financial performance.

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Sameer Ralhan: 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 softness product line. Softness was a small commodity filter product line in our Water Quality segment that was divested in January. Store sales growth in Q1 was 1.8%. Price contributed approximately 2% growth in this quarter, in line with expectations. This aggregate price increase is also in line with historical levels. Volume was down a modest 40 basis points year-over-year. This was better than we expected, primarily due to higher sales volumes of consumables and both segments during the quarter.

Gross profit increased 6% year-over-year to $747 million. Gross profit margin increased 220 basis points year-over-year to 60%, reflecting the benefits of pricing as well as improved productivity and reduced material costs. Adjusted operating profit increased 5% year-over-year and adjusted operating profit margin expanded 90 basis points to 24.5%. We delivered strong margin expansion while investing in our sales and marketing efforts to drive future growth. We also increased our R&D investment to 4.8% of sales, up 20 basis points over the prior year period. These investments are aligned with our strategic growth plans and we expect to continue to fund ongoing growth investments. Looking at EPS for Q1. Adjusted earnings per share grew 8% year-over-year to $0.84 and free cash flow was $102 million, down from the prior year.

This decline is primarily due to cash interest payments that we did not incur last year prior to our spin-off. Moving on, I will cover the segment highlights, starting with water quality on Slide 9. Our Water Quality segment delivered $749 million of sales, up 2.7% on a year-over-year basis. Currency was neutral and the divestiture of softness had 10 basis point impact on sales this quarter versus the prior year period. In addition to this divestiture, we strategically exited small product lines in our motor quality segment in the fourth quarter of 2023. As we previously mentioned on the earnings call in February, Exiting these product lines resulted in approximately 60 basis points headwind to core growth for the segment in this quarter. Despite this headwind, core sales grew 2.8% year-over-year as compared to 11% core sales growth in the prior year period, bringing the 2-year core sales growth stack for Water Quality segment to about 7%.

Pricing contributed 2.6% to core sales growth and volume was up 30 basis points year-over-year. This is the first quarter of volume growth for water quality since Q1 2023. Our volume growth in this year's first quarter was driven by strong demand for our water treatment solutions in industrial end markets and UV treatment systems in municipal end markets. Recurring sales across the segment grew mid-single digits, highlighted by increased sales of reagents and chemistries used in our analytical instruments at municipalities in North America. Adjusted operating profit increased 9% or $16 million year-over-year to $186 million. Adjusted operating profit margin increased 150 basis points RECONNECT to 24.8%. The increase in profitability reflects solid pricing execution and improved productivity.

Moving to the next page. Our PQI segment delivered sales of $497 million in the first quarter, up modestly versus the prior year period. Core sales were essentially flat on a year-over-year basis as price increases of 1.5% were largely offset by 1.3% decline in volumes. Recurring sales grew mid-single digits with growth across the portfolio increasing the mix of recurring sales for PQI to 63% in Q1. In Packaging and color, sales were up low single digits year-over-year highlighted by growth in recurring software and subscription revenue. In contrast, marketing and coating sales declined modestly, reflecting lower demand from CPG customers as compared to Q1 2023. This decline, however, was less than what we had anticipated in our guidance. As Jennifer mentioned, we continue to see modest signs of recovery in CPG markets with consumable sales up mid-single digits year-over-year for the third consecutive quarter and equipment bookings showing pockets of improvement.

We remain cautiously optimistic that CPG volumes will improve sequentially as the year progresses. PQI adjusted operating profit was $139 million in the first quarter resulting in adjusted operating profit margin of 28%. This was a strong margin performance for PQI and demonstrates the earnings power of these businesses. Turning now to our balance sheet and cash flow. In Q1, we generated $115 million of cash from operations and invested $13 million in capital expenditures. Free cash flow was $102 million in the quarter. Note, this included about $57 million of cash interest payments which we did not incur in Q1 2023 prior to our spin-off. At the end of the quarter, gross debt was $2.6 billion and cash on hand was $827 million. Net debt was $1.8 billion resulting in net leverage of 1.5x.

In summary, we further strengthened our financial position during the quarter and have ample liquidity. This gives us flexibility in how we deploy capital to create long-term shareholder value with a bias towards M&A. Turning now to our guidance for 2024. Beginning with our updated expectations for the full year. As Jennifer mentioned, we are on track to deliver our target of low single-digit core sales growth at the enterprise level and in both segments. We're targeting 100 to 200 basis points of price, consistent with historical pre-pandemic levels. From a sequential perspective, our guidance assumes that year-over-year core sales growth increases modestly quarter-to-quarter through 2024. Looking at adjusted operating profit margin, our target remains 50 to 75 basis points of improvement this year.

Based on our Q1 performance, we are trending towards the high end of this range. Given our Q1 results and current view on margin improvement for the year, we have increased our full year adjusted EPS guidance to a range of $3.25 to $3.34 per share, up from our prior guidance range of $3.20 to $3.30 per share. In addition, we increased our free cash flow conversion guidance to a range of 100% to 110%. Looking at our guidance for Q2, we are targeting core sales growth in low single digits on a year-over-year basis, with adjusted operating margin of approximately 23% and our Q2 2024 guidance for adjusted EPS is $0.75 to $0.80 per share. That concludes my prepared remarks. At this time, I'll turn the call back to Jennifer for closing remarks before we open up the call for questions.

Jennifer Honeycutt: 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. Our financial position remains strong and we continue to take a disciplined approach to capital deployment with our primary focus on strategic acquisitions with attractive returns. Looking ahead, we remain focused on driving commercial excellence, continuous improvement and disciplined capital allocation to create shareholder value while safeguarding the world's most vital resources. That concludes our prepared remarks. I want to thank you all again for joining our call. And at this time, we're happy to take your questions.

Operator: [Operator Instructions] And we'll take our first question from Scott Davis with Melius Research.

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