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spk06: Please stand by. Your program is about to begin. If you need assistance on today's conference, please press star zero. My name is Leo, and I will be your conference operator this morning. At this time, I would like to welcome everyone to Boralto Corporation's second 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. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star then the number two on your telephone keypad. I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr. Taylor, you may begin your conference.
spk01: Good morning, everyone. Thanks for joining us on the call. With 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.
spk05: 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 August 9th. Before we begin, I'd like to highlight a few recent disclosures. On July 24th, we issued our 2024 sustainability report. That report can be viewed on our main website under sustainability or on our investor website under corporate governance. Yesterday, we issued our second quarter news release, earnings presentation, and supplemental materials. including information required by the SEC relating to adjusted or non-GAAP financial measures. Additionally, our Form 10Q was filed yesterday. These materials are available in the Investor section of our website 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-over-year 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.
spk03: Actual results may differ materially from forward-looking statements.
spk05: 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. With that, I'll turn the call over to Jennifer.
spk00: Thank you, Ryan, and thank you all for joining our call today. I want to start this call by recognizing the engine behind our strong second quarter results are more than 16,000 associates around the world. Their strong execution in support of our customers drove our growth and improved profitability during the quarter. Nine months into our journey as an independent company, we are hitting our stride and delivering winning outcomes for our stakeholders. a key catalyst has been increased rigor in deploying the varalto enterprise system as i've shared before ves is a key competitive advantage for varalto it drives continuous improvement accelerates innovation and enables us to win in our markets every day at all levels of our enterprise Our teams leverage VES to solve problems rapidly and drive sustainable improvements. Our increased rigor in deploying VES has helped drive growth, expand margins, and ensure that we deliver on commitments. Our second quarter results demonstrate the benefits of this increased rigor while also highlighting the durability of our businesses. We delivered core sales growth across both segments, led by better than expected positive volume and price increases in line with historical levels. We expanded margins at both segments through strong operating leverage, improved productivity and cost optimization. Based on our strong execution in the second quarter and an incrementally more positive view of our end markets, we have raised our full year adjusted EPS guidance. From an end market perspective, we are capitalizing on secular growth drivers across our industrial and municipal markets in water quality. in water analytics our commercial initiatives are accelerating volume growth and market penetration particularly in consumables and in water treatment we continue to see strong growth driven by our customers water conservation reclaim and reuse initiatives on that front chemtree was recently recognized as industrial supplies and services supplier of the year by one of the largest global beverage companies Chemtreat is playing an integral role in helping this customer achieve its sustainability targets through wastewater projects that support the reclamation of hundreds of millions of gallons of water annually. In PQI, we are encouraged by ongoing recovery in consumer packaged goods markets and improved sentiment from brand owners and packaging converters. In our marketing and coding business, recurring revenue grew mid-single digits for the fourth consecutive quarter. Notably, sales of marketing and coding equipment accelerated during the quarter and grew on a year-over-year basis with good traction on new product launches. One of those new products is VideoJet's 2380 large character inkjet printer, which launched in early April and is off to an impressive start. This printer is designed for use on sustainable packaging materials such as corrugated cardboard and other porous materials. Second quarter sales of the 2380 printer exceeded our expectations and we continue to build momentum through a robust sales funnel. In our packaging and color business, second quarter bookings were strong, driven in part by the success of new software launches unveiled at recent trade shows and industry events. At the Drupa trade show, our ESCO, Pantone, and X-Rite teams jointly showcased their latest innovations and highlighted our seamless packaging workflow software and hardware solutions. At the event, ESCO unveiled its S2 platform, a multi-tenant, cloud-native platform that provides cloud computing, data sharing, and artificial intelligence. All ESCO applications connect to this platform, giving all key stakeholders in the value chain access to live data and identical information wherever they are in the world. This integrated ecosystem will empower customers to compress workflows, harness cloud technology, and artificial intelligence to accelerate speed to market with vital integrated color accuracy. This new technology helps our customers save time, reduce waste, and ensure brand fidelity. These workflow improvements help our customers minimize the environmental impact across their supply chains and achieve their sustainability objectives while providing safe foods and trusted essential goods to their customers. This is a great example of the alignment between our product innovation and our purpose. Our work at Peralta is inspired by our unifying purpose, safeguarding the world's most vital resources. We live in a world with big challenges, and Veralto plays a significant role in solving many of them. Helping customers ensure clean water, safe foods, and trusted essential goods for billions of people across the globe motivates all of us at Veralto each and every day. It inspires our associates who are drawn to Veralto because of the role our products and solutions play in helping preserve the planet how we care for and invest in our people and our efforts to minimize the environmental impact of our own operations and it's easy to be inspired by the work that we do at beralto in 2023 our team helped ensure 3.4 billion people around the world had access to clean water for daily use treat and recycle 13 trillion gallons of water save 81 billion gallons of water, and ensure product authenticity and safety by helping customers mark and code over 10 billion products every day. In addition to these positive and enduring contributions, I want to highlight two important commitments featured in this year's sustainability report. First, in support of our commitment to minimize the environmental impact of our own operations, We disclosed our 2023 Scope 1 and Scope 2 greenhouse gas emissions and committed to a 54.6% reduction goal by 2033. Second, in support of our commitment to drive a responsible supply chain, we set an initial target to have 40% of our supplier base certified through the EcoVadis program. ECOVADIS is one of the leading sustainability rating agencies and will help us measure, assess, and improve the impact of our supply chain on the world. The role our products play in preserving the planet and the targets we have committed to achieve embody the culture and are made possible by our people. Our people are the most important part of our strategy, and we invest heavily to recruit, develop, and retain the most talented and diverse team possible. Our 2024 sustainability report, published earlier this week, contains more details about our commitment and ability to deliver positive, enduring impact and drive sustainable outcomes for the benefit of humanity. Now turning to our Q2 financial results. Before getting into the details, it's important to highlight a key underlying strength of Veralto, and that is the durability of our businesses. Approximately 85% of our sales are related to water, food, and essential goods. These are large, attractive markets with steady growth driven by strong secular trends. Our customers in these markets have an essential need for our products and solutions to support critical aspects of their daily operations where the risk of failure is high. Our durability is further bolstered by a razor razor blade model, which drives a high level of recurring revenue further catalyzed by VES. The CEO Kaizen events we kicked off in Q1 are a strong proof point. These events, which focus on value accretive growth, have already had a positive impact on our 2024 performance, evident in our second quarter results. On a consolidated basis, we exceeded our guidance on all fronts with 3.8% core sales growth and 24% adjusted operating profit margin. Adjusted earnings per share was $0.85, up 6% year over year, and $0.05 above the high end of our guidance range. And we generated $240 million of free cash flow, further strengthening our financial position. Looking at core sales growth by geography in the second quarter, sales in the North America and high growth markets grew in the mid-single digits. and sales into Western Europe were essentially flat. In North America, core sales grew over 5% driven by both segments. In water quality, we continued to capitalize on strong demand for our water treatment solutions, which grew high single digits in North America. this growth was broad-based across most industrial verticals with the strongest growth in food and beverage mining and power generation we also continue to see strong growth for uv systems at municipalities in north america in water treatment we're partnering with customers to help them achieve their sustainability goals related to water conservation reclamation and reuse Our water treatment businesses are also well positioned in North America to support on-shoring or reshoring activity, including tech operations such as semiconductor fabs and data centers. Relative to North America, our PQI segment grew 3.5% in Q2. Packaging and color grew mid-single digits, with marking and coding up low single digits. In high growth markets, core sales grew by more than 4%. We continue to see strong growth in Latin America and India. And in China, core sales grew low single digits year over year. In Western Europe, core sales were essentially flat year over year, including 50 basis point headwind related to the strategic portfolio actions in our water quality segment that we mentioned on prior earnings calls. Excluding this headwind, core sales into Western Europe were up modestly. At this time, I'll turn the call over to Sameer to provide more details on our Q2 performance and our guidance.
spk05: Thanks, Jennifer, and good morning, everyone. I'll begin with our consolidated results for the second quarter on slide 8. Net sales grew 2.8% on year-over-year basis to about $1.29 billion. Core sales grew 3.8%. Currency was an 80 basis points headwind, or approximately $10 million. And the small divestiture of saltiness was a modest headwind. Our core growth in this quarter was balanced, with both volume and price increases driving our growth. price contributed two percent growth in this quarter in line with our expectations and historical levels volume grew 1.8 percent with positive volume growth across both water quality and pqi this marks the first quarter since the second quarter of 2022 in which volume grew across both segments our recurring revenue grew mid single digits year over year and comprised 62% of our total sales. We expanded margins at both segments through strong operational leverage, improved productivity, and cost optimization. Gross profit increased 7% year-over-year to $774 million. Gross profit margin improved 230 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 70 basis points to 24%. We delivered strong margin expansion while investing in our sales and marketing efforts to drive future growth. We also increased our R&D investments with R&D as percent of sales increasing 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 second quarter, adjusted earnings per share grew 6% year-over-year to $0.85, and free cash flow was $240 million down from the prior year primarily due to standalone public company costs and cash tax payments, which were not incurred in the prior year period. Moving on, I'll cover the segment highlights, starting with water quality on slide nine. Our water quality segment delivered $777 million of sales, up 2.8% on a year-over-year basis. Currency was an 80 basis points headband And the divestiture of saltiness had 40 basis points impact versus the prior year period. In addition to this divestiture, small product lines that were strategically exited in the fourth quarter of 2023 resulted in approximately 80 basis points headwind to core growth for the water quality segment in the second quarter. Despite this headwind, core sales grew 4% year over year. Pricing contributed 2.4% and volume growth contributed 1.6% to year-over-year core sales growth. Our volume growth was driven by strong demand for water treatment solutions in our industrial end markets and UV treatment systems in municipal end markets. We also saw growth in sales of lab instrumentation, reagents, and chemistries to municipalities. Recurring sales across the water quality segment grew mid-single digits. Adjusted operating profit increased 5.5% year-over-year to $192 million. And adjusted operating profit margin increased 70 basis points to 24.7%. An increase in profitability and margin reflects strong pricing execution, leverage and volume growth, and improved productivity. To a lesser extent, our adjusted operating profit margin also benefited from a favorable sales mix this quarter. Moving to the next page, our PQI segment delivered sales of $511 million in the second quarter, up 2.7% year over year. Currency was a 70 basis points headwind. Core sales grew 3.4%. Positive volume contributed 2% growth, and price increases contributed 1.4% to the year-over-year core sales growth. PQI's recurring sales grew mid-single digits year-over-year for the fourth consecutive quarter, with growth across the portfolio. Recurring revenue increased to 63% of PQI sales next in the second quarter of this year. Breaking this down by business, core sales growth in a marketing and coding business was in line with the segment, driven by growth in both consumables and equipment. This growth was driven by both CPG and industrial end markets. In a packaging and color business, core sales grew about 3% year-over-year, led by growth in recurring software and subscription revenue. PQI's adjusted operating profit was $141 million in the second quarter, resulting in adjusted operating profit margin of 27.6%. That represents 100 basis points improvement in adjusted operating profit margin over the prior year period. This was another quarter of margin improvement for PQI. driven by the strong operating leverage, particularly on the recurring revenue growth and productivity improvements. Turning now to a balance sheet and cash flow. In the second quarter, we generated $251 million of cash from operations and invested $11 million in capital expenditures. Pre-cash flow was $240 million in the quarter, 118% conversion of GAAP net income. As of June 28, gross debt was $2.6 billion, and cash on hand was just over $1 billion. Net debt was $1.6 billion, resulting in net leverage of 1.3 times. In summary, our financial position is strong, We have 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. We increased our full year guidance to reflect our strong second quarter execution and incrementally positive view of our end markets. For core sales growth, our target remains low single digits, However, we are trending towards the high end of low single digits. Through the first half of 2024, core sales growth was 2.8%. For the second half, we are targeting core sales growth in the low to mid single digits range, similar to what we achieved in the second quarter. Looking at adjusted operating profit margin for the full year, we now expect to deliver approximately 75 basis points margin expansion year-over-year, which would put our full-year adjusted operating profit margin at about 24%. This implies an incremental margin or fall-through of around 50%. For adjusted EPS, we raised our full-year guidance range to $3.37 to $3.45 per share. At the midpoint, this represents 7% growth year-over-year and is 11 cents or about 3.5% higher than a previous guidance. And a guidance for free cash flow conversion remains in the range of 100% to 110% of GAAP net income. Looking at a guidance for Q3, We are targeting core sales growth in the low to mid single digits on a year-over-year basis. At the midpoint of our Q3 guidance, we are modeling a core growth rate similar to second quarter. We expect adjusted operating profit margin of approximately 23.5% in the third quarter. This represents 100 basis points of improvement in adjusted operating profit margin on a year-over-year basis. And our Q3 2024 guidance for adjusted EPS is 82 to 86 cents per share. At the midpoint, that represents double-digit year-over-year growth. With that, I'll hand the call back to Jennifer for closing remarks.
spk00: Thanks, Samir. In summary, we are executing well across the company with greater focus and rigor using VES. and we are capitalizing on the secular growth drivers in our key end markets. We delivered a strong second quarter across the board, with core sales growth approaching mid-single digits, continued margin expansion, and strong cash generation. Based on the strength of our execution and positive view of our end markets, we raised our full year 2024 adjusted EPS guidance. As we look longer term, we remain committed to creating value through steady, durable sales growth, continuous improvement, and disciplined capital allocation. That concludes our prepared remarks, and at this time, we are happy to take your questions.
spk06: At this time, if you would like to ask a question, please press star 1 now on your telephone keypad. To withdraw yourself from the queue, you may press star 2. Please limit yourself to one question and one follow-up. Thank you. We'll take our first question from Scott Davis of Milius Research.
spk05: Scott Davis of Milius Research Hey, good morning, Jennifer, Samir, and Ryan.
spk03: Good morning, Scott.
spk05: I've got to ask about gross margins just because they've been so incredibly strong. A, I guess, is 60 the new normal, or is that just more of kind of a shorter-term impact? And second, maybe I heard the word price in the context of pricing power more on this quarter and last one, too, than we would have thought in the past. And are you finding there's just more pricing power in your markets maybe than you thought you had before, and that's driving that 60% gross margin? Is that a fair takeaway? Yeah. Yeah, Scott, let me just touch on the margin, and then I'll have Jennifer just talk about the price. On the gross margin side, it's really been really increased rigor on VES really driving the execution side. Frankly, it's been lots of singles and doubles that are driving the margin here. And also, as you see, you know, we are benefiting a little bit from the recurring revenue here, right? The mixed is more towards consumables to the spares, which is impacting and helping us on the margin. The packaging and color business, as you know, that tends to be on the software side with a little higher margin. So that's helping us. So those things are helping us. I would say, you know, you should expect the gross margins to come in a little bit as a growth rate. uh you know uh it equilibrates between the equipment and consumables over time um but you know we feel really good about 60 but i think once the transition happens we'll be more in the you know high 50 50 or 59 range yeah and i think scott what you're seeing relative to price
spk00: is our ability to sort of hold the value of our products in terms of commercial excellence related to VES. So the teams commercially are executing well around the world, but we have seen price normalized to historical levels, which we believe fit in the range of 100 to 200 pips.
spk05: Okay, fair enough. I feel obligated to ask about M&A. I know these things are lumpy and it's hard to kind of talk about it, but Any update on maybe your pipeline, your enthusiasm about the assets that are out there?
spk00: Yeah, we remain pretty convicted about our M&A approach. We've got really robust funnels for both PQI and water quality. We're looking at a lot of assets, and we're actively engaged in our market activity here. But consistent with what we've said on prior calls, we're really going to stay close to our heritage and the disciplined capital allocation around market company and valuation. We obviously like businesses that have similar operating models and secular durability, financial profiles that look like us, and certainly businesses where we think the ES can add value. So we're active here. We're excited about the space. We're working hard, kind of on both sides of the fence, and more to come.
spk05: That's a lot. Congrats on the first two quarters here of the year.
spk00: Thanks, Scott.
spk05: take our next question from dean dre of rbc capital markets good morning everyone good morning yeah i'll echo god's comments that's a clean quarter kind of hard to find anything to quibble about so um maybe i'll start with uh product quality your primary competitor had some similar results yesterday in terms of strong aftermarket but looks like your printer sales are stronger I know that 2380 sounds like that was a boost just can you comment on the mix and the go forward especially with the recovery expected in the consumer packaging goods yeah thanks for the question Dean
spk00: You know, our PQI businesses in the main are performing well. I think you see that both in terms of our marketing and coding businesses. You also see it on our color and packaging side. We're not going to comment really on competitors' activity, but what we can say is, You know, our marketing and coding businesses are performing well, and I think in line with the recovery of the consumer packaged goods market. So we see, you know, this fourth consecutive quarter of mid-single-digit recurring revenue growth, and we also see, as you rightly point out, know q2 marking the return of growth in equipment sales and so this follows the nominal recovery that we see when we're coming out of a down cycle where consumables and and by way of of of inks and solvents and spare parts and so on recover before equipment does we're excited about the funnel that we have for equipment and certainly As we talk to our CPG customers, their sentiment is more positive in terms of the future outlook. From a packaging and color standpoint, we've just finished the Drupal trade show where we got a lot of positive response in terms of the products being launched there, mostly around our S2 products. native cloud digital integrated solutions. This really helps reduce time to market for the brands. mistake proof relative the information that they're passing around between their functional departments. So funnels are healthy on both sides. The market recovery in terms of CPG itself is a little bit lumpy. We do see mixed results across various CPG categories, but certainly we're encouraged by the market indicators and I think our teams are executing well with recent product launches and our new product innovations really are gaining momentum.
spk05: It's all very helpful. And just a geographic question for both businesses. What was the sense of demand in China and the outlook? The expectation is that you all have a very defensive type of mix there. But will you feel any of the ongoing pressures in the economy over the next couple of quarters?
spk00: yeah i think dean our view of china hasn't materially changed from quarter to quarter i think you know we believe that china is stabilized related to the end markets but we don't expect to see any meaningful recovery in china this year i think for state-owned or state-sponsored municipalities funding is still extraordinarily tight so we're not seeing much money flow there I think long-term, you know, China is anticipated to improve. They've got a large and aging population. Those folks are going to require clean water, safe food, and trusted medicines. But, you know, our China team has stepped up to the challenge here in this slower growth macro. And, you know, we continue to ensure that we have a China business that's creating incremental value for Veralto.
spk05: And then, Dean, from a guide perspective, effectively, I assume China will be sequentially flat. right so as you know we were down quite a bit in the q3 and q4 so you're going to see a little bit of an uptake on year-over-year basis as we kind of get into the second half but sequentially it's just effectively flat that's real helpful thank you we'll take our next question from andy kaplowitz of citigroup hey good morning everyone good morning andy
spk01: Jennifer, Samir, you raised your revenue guidance by $100 million for 24, I think, versus last quarter's forecast. So maybe just give us a little more color into what markets are better than you expected. I know you just talked about video jet equipment starting to accelerate. What are you baking now for the second half of that improvement? And then in water quality, is it more that water treatment is driving continuing strong momentum, or are you seeing more improvement in water analytics?
spk00: Yeah, I mean, I think we see strength across the board, really. We benefit, I think, from a couple of areas here. One is just the markets that we're in and the quality of the products we bring to market being part of the essential nature of customer operations. I think the deployment of VES and the increased focus that we have as a standalone company continues to help us execute well commercially. From a macro standpoint on where the demand is occurring, you know, water municipalities, particularly in the U.S. and Europe, continue to execute on project backlog in terms of improvements to their respective plants and their run rate business is steady. We do see some nice pockets of growth coming for our water treatment businesses and see some tailwind and some benefits from things like chipsacks in terms of build-out there, data centers, which are acquiring an extensive amount of water in their cooling towers. And those kind of two markets really benefit our chemtreat and our Trojan businesses, respectively. So we're seeing good sort of solid, steady, robust demand really for both water treatment and water quality.
spk01: Very helpful. And then, Jennifer, just going back to M&A, like I know timing is always difficult, but would you expect to get something done this year? And then under what conditions would you do a larger deal where you may potentially raise equity?
spk00: Yeah. I think you are right that MNA is clearly episodic. You know, we can't guarantee you know the intersection of when we will see market company and valuation come together as we've mentioned in the past we're going to stay disciplined to that approach we have to like the the market right it's got to be adjacent or near adjacent to where we play the company's got to be you know a strong company that has secular drivers that that we value under the umbrella of safeguarding the world's most vital resources and we got to be able to get at the right price I think right now valuations are still a little bit inflated. So, you know, we're looking at at the intersection here. But we've got to we've got to fundamentally get to all three of those variables. And all I can say is we're we're working hard in this area.
spk05: And it's going to take away the equity side. It is just one of the components of how we think about funding any transaction. You know, the main thing is value creation. Right. Anything that's can ultimately help us create long-term value. We'll look at all forms of funding, as we kind of talked in the past. The main thing for us, as we're going to think of any kind of funding, is maintaining investment-grade balance sheets. That's the second thing for us.
spk01: Appreciate the call, guys.
spk06: We'll take our next question from John McNulty of BMO Capital Markets.
spk05: Yeah, thanks for taking my question. Maybe one on the free cash flow side. Obviously, a really strong quarter for you there and hitting kind of conversion levels that are above what you're certainly looking for for the year, I guess. Can you help us to think about what drove that? And if that, you know, if we see more things that you can kind of wring out from whether it's a working capital side to kind of keep that level elevated for the next couple of quarters, how should we be thinking about that? Yeah, John, thanks for that. As you're going to look at the free cash flow conversion, quarter to quarter it can vary. As you know, we have the bond payments that come in the first and the third quarter, so that impacts timing of the cash payments. So I would say when you look at the free cash flow conversion, really look at it on a full-year basis. Overall, given the strength that we're seeing in the business, the execution, we feel pretty good about delivering 100% to 110% free cash flow conversion. That's off gap net income. Got it. Fair enough. And then just a question on SG&A took a reasonable jump up somewhere in the seven and a half percent kind of range. I guess, can you help us to think about how much of that is just general labor inflationary type trends versus the corporate side where now you're a public company versus investment for growth? I guess, how should we be thinking about the various buckets there? Yeah, I think it's let's take it into buckets, right? One is first on the business side, as we kind of told you right at the beginning of the year, we will be we are investing in the sales and marketing side to really drive the growth of the business. And you've seen that kind of really coming through or pulling through the numbers in the first and second quarter. John, you know, inflation is there a little bit. I think just like everybody else, there's nothing outsized. But these are really heads that are added more on the sales and marketing side to drive the growth. And you started seeing a little bit of impact and more in the 2025 that you're going to see. So I would say on the business side, we are more or less in a normalized state, so to speak, and SCNA is a percent of revenues. On the corporate side, we were very judicious in how we bring the cost in. So what you're going to see is more of a run rate. uh view of the corporate expenses in the second half of the year so there's going to be a little uptake in the second half versus the first year uh that you're going to see on the corporate side but that but that should normalize in the second half so nothing nothing uh extraordinary on that front great thanks very much for the caller we'll take our next question from mike halloran of baird hey morning everyone
spk03: So just some thoughts on the product rationalization side of things, some of the issues you're doing there. You know, maybe just how far along do you think you are in that journey in general? Have most of the areas been identified already, or do you think that there's more to come on that side of things?
spk00: Yeah, I think, Mike, what you've seen us do here is just pruning around the edges, right? And This is actually part of standard work that we do day in and day out in managing the portfolio of the businesses. It's not something that we look at on an episodic basis. We're looking at this all the time. So I would say when we see opportunities for continued portfolio evolution to get us a stronger portfolio focused in the higher areas of growth with higher margin and recurring revenue, um you know anything that that falls materially far away from that profile is something that we'll take action on so we feel good about the portfolio we have today we'll continue to prune around the edges as and when we see uh that it's appropriate to do so it makes sense and then just to follow up on i think andy's question earlier
spk03: When you think about the greater confidence going into the back half of the year, has anything actually changed? Or is this just about starting to see momentum into this year, first quarter, and is actually having to materialize that gives you extra confidence? In other words, has there been any change in your thinking about how these end markets are going to progress?
spk00: Well, I think we've come out of a pretty tumultuous several years following the impact of the pandemic, Mike. And we saw a lot of whiplash, right, in terms of price and volume and demand cycles and consumer spending and what they were spending on and so on. I would say that our confidence is built more as a function of an enduring steady state for our water quality businesses, driven by the secular drivers that we've talked about, and an incrementally improving macro here for consumer products goods markets. Eighty-five percent of our revenue goes into water, food, and pharmaceuticals. And provided that those markets are steady or improving, we're going to see that benefit.
spk03: Michael Heaney, Appreciate it. Thank you.
spk00: Thanks, Mike.
spk06: Our next question is from Brian Lee of Goldman Sachs. Brian Lee of Goldman Sachs Hey, everyone.
spk02: Good morning. Thanks for taking the questions. Samir, good morning. Samir, or maybe Jennifer, you mentioned during your prepared remarks some favorable mix, I think, in the water quality segment that might have helped margins. Can you elaborate any on that, and is that something that you can quantify, or as you think about the next few quarters, is that expected to persist?
spk05: Hey, Brian. Yeah, I'll take that one. The mixed comment is really around consumables. We've seen a good amount of consumable uptake that's driving it. As you've seen, our recurring revenue is almost at 62% right now, and that is predominantly mixed and a little bit of spares from the SaaS software side, but predominantly consumables. you know if you recall and go back in the history when things are more normalized that tends to be in the high 50s right so that kind of helps you dimensionalize now the transition as the uh volume comes back on the printer side in in pqi instrumentation side uh on on the water quality side it's going to be a multi-quarter journey as we're going to move so you're not going to see a big variation uh quarter to quarter but that's really you know 62 versus high 50s as a way to dimensionalize the change over time
spk02: All right. Fair enough. That's helpful. And then I know you're talking about improving end markets kind of across the board. Jennifer made some comments around the strong backlog trends in water quality. Can you maybe talk a bit more specifically around, I think you had comments in the release about strong bookings and packaging and color. Our understanding is that that's more of a short-cycle business. So where's the visibility? Are those the areas where you're seeing trends improving as well? Just kind of any commentary on the short-cycle side of your business. Thank you, guys.
spk00: Yeah, relative to packaging and color, you know, as we mentioned, we've just concluded our Drupal trade show. That's a trade show that runs once every four years. And given the pandemic, this is the first time that show has been conducted in eight years. So there were some really good kind of pent up demand that we saw there. But I think, you know, our solutions and particularly those around innovation that we're providing and the S2 cloud native digital integration of the workflow, has got the attention of a lot of brand owners because they are under pressure to compress their development cycles and ensure the integrity of the information that they're working with, which gives every user of that system access to the same information. So we had a great showing there. You know, the teams, all three teams in terms of ESCO, Pantone, and X-Rite really did a great job there. And I think outside of the enthusiasm generated in Drupa, the recovery of the CPG markets, um will lend itself to new product releases and new product innovations from brand owners so they are getting ready um they have a number of projects that they're considering in terms of new product releases and so on and so forth and so this is the front end of of that uh and i think we're well positioned to be able to help them with their solutions okay i appreciate the call i'll pass it off
spk06: We'll move next to Brad Hewitt of Wolf Research. Brad Hewitt of Wolf Research Hey, good morning, guys.
spk04: Thanks for taking my question. Brad Hewitt of Wolf Research Good morning, Brad. Brad Hewitt of Wolf Research So, I guess I wanted to start on the margin side of things. Your guidance implies about a 50 basis points step down in margins in Q3 versus Q2, despite the fact that revenue, I think, should be flat to slightly up sequentially, and then also your trade show expenses should step down
spk05: quarter over quarter so just curious if you can talk about kind of the drivers of the sequential margin pressure there yeah brian the severe um effectively really two things here the first one is is the mixed comment that we made earlier you know our mix is pretty rich in consumables and recurring revenue right now we have started seeing uh some good encouraging signs on the equipment side we said in the second quarter you know we finally see uh saw positive um you know revenue growth on the equipment side to be modeled in uh sort of a decent equipment growth in this in the q3 and second half of the year so mixed impact is what's kind of flowing through here and the other one i would say is uh really on the on the corporate side as we kind of get into the second half of the year we are going to be getting more towards the run rate expenses on the corporate uh corporate expenses so that's impacting the margin side as well so it's really those two things that are impacting the margin okay
spk04: That's helpful. And then I guess going back to the long-term incremental margin framework of 30% to 35%, I know that includes kind of some reinvestment in the business, but just given the strong execution on VES since the spend, as well as the implied 50% incremental margins this year, despite volume growth kind of in the 1% to 2% zone, does that give you confidence in perhaps something more like 40% plus incrementals going forward over the medium term?
spk05: Yeah, no, thanks for that. Look, I mean, it's first of all, really kudos to all our teams, all our 16,000 people that are really helping drive this kind of fall through that you're seeing, right? Really proud of what we've been able to achieve this year. But, you know, as you're going to think about 30 to 35 percent is really on the longer term. We do want to incorporate in that long-term value creation algorithm a healthy investment mix from the sales side, from R&D side. So I think from a long-term value framework perspective, I think still 35% is the right way to look at it. And in the near term, really good performance and execution of the teams is driving a fall through close to 50%. Great.
spk04: Thanks, Samir.
spk06: We'll take our next question from Nathan Jones of Stifel.
spk05: Good morning, everyone. Morning, Nathan. I guess I'll follow up on that last question. You guys have made it pretty clear that you intend to continue to invest in growth here. Can you talk about what you think the growth rates will be in kind of investment in commercial resources, investment in sales, investment in R&D? kind of over the next several years rather than just any one year to the next? No, I think as you're going to think about long term, Nathan, these investments should be supportive of the mid single digit growth framework. right and you know and that is four to six percent uh kind of a range as we have kind of talked about so as when we think about uh that mid single digital growth framework we do reflect the incremental contribution coming from these investments on the sales and marketing side as well as on the r d side right this is a technology heavy business as you're going to think about in the commercial execution business so those are investments are key as we kind of think about long-term sustainable value creation So you would be looking at kind of that kind of mid-figure growth in those investments as revenue? Yeah. Yeah. Yeah. Okay. Now, look, the other question kind of depends, right, just to make sure, Nathan, right, on average, right, this is a cumulative thing that we're looking at. Of course, the new investment should be incrementally driving higher growth from their side, but some things fall out of the portfolio, too. Got it. The other question I wanted to ask was on the recycle, reuse, reclaim market driver. I think that is likely to be a pretty considerable driver of investment from industrial water users. So I'm hoping you could talk a little bit more about where Veralto plays, kind of how much of your revenue that makes up, where you think it could go to over the next five to 10 year kind of timeframe. long-term growth rate you're expecting out of that, just because I think that's going to be a pretty good draw for incremental demand.
spk00: Yeah, thanks for the question, Nathan. We do see great demand here in recycle, reclaim, and reuse. The businesses most impacted by that certainly is our Trojan business, who is well-positioned there to help customers with their sustainability initiatives in this space chemtree also has a play here and certainly if you're going to be moving water around you're going to have to test it as well so it does create some opportunity for our analytics businesses but the primary beneficiary really of this opportunity would be our trojan business and frankly we see this space growing probably mid to high single digits for the foreseeable future. Lots of industries are under pressure to achieve their sustainability targets, and we're well positioned with solutions to help them.
spk05: Great. Thanks for taking my questions.
spk06: Our next question is from Andrew Krill of Deutsche Bank.
spk00: Good morning, Andrew.
spk04: Thanks. Good morning, everyone. I want to circle back on margins again from a little bit more of the medium-term perspective. I know there's been a lot of discussion just that the company has meaningfully more opportunities to improve margins than might be appreciated by investors.
spk05: Just can you update us on any of the findings you've had since the spin on that and whether you would consider explicitly quantifying those at any point? And then would you also say is there more opportunity in one segment versus the other, or do you think it's kind of similar? Yeah, Andrew, thanks for that. You know, if you're going to look at, you know, the opportunities on the margin expansion, right, you know, The work that the teams have been doing on the procurement side really are folks on the front lines and the shop floor, on the factory optimization. So these are lots of singles and doubles. As I said earlier on the call, it's not one or two factors that are driving this margin expansion. And that, frankly, really is the beauty of the Kaizen culture, right? That's what you're going to see. the margin contribution coming in. Those efforts really that the teams have been doing and execution that is happening is giving us the confidence to really up the bar on the margin expansion for the full year. Instead of 50 to 75 basis points, what we've said, raised the guidance to is 75 basis point margin expansion for the full year this year. So that should get the full year pretty much close to 24% on the operating earnings margins. Okay, great. Very helpful. And then can you give us an update on the situation in Argentina and maybe just how much contingency, if you will, you have left in your guidance for the full year?
spk00: And then I guess depending on how that shakes out the rest of the year, how that could help or hurt PQI margins in the back half? Thanks.
spk05: Yeah, very brief, right? Andrew, as you're going to look at Argentina, as we said at the Q1 call, we did the blue chip swap to really insulate any impact on the historical cash that really drove the impact last year. But as you're going to move into this year, effectively, our exposure is much smaller, and that's reflected in the guide.
spk00: Okay. Great. Thank you.
spk06: We'll take our next question from Andrew Viscoglia of BNP.
spk05: morning andrew hey good morning good morning everyone um morning you know i'm just looking at your guidance um and trying to map out you know the ranges and looking at the high end i'm wondering kind of what's contemplating or what informs the high end of your guidance because it's difficult to get there so you either need cells to accelerate you know for some reason or maybe you have some extra margin expansion you know in your back pocket i guess of those two or you know what What's behind that high end is my question. Yeah, thanks for that. It really comes down to how you're going to think about the CPG markets, right? CPG markets are evolving, incrementally becoming positive, but it's a pretty fast-changing view that we are seeing. So I think as you're going to look at the guidance range, one of the big drivers is how you're going to think about the CPG markets and the impact they'll have on the on the PQI top line. I would say if there's one thing I can say that that's one of the key things. And then on the margin side, right, I mean, there's always, you know, raw material, price versus raw material contribution we always look at. You know, I believe we have baked in, you know, pretty prudent view here. So any benefit from that will be more inuring towards the high end of the range. Okay. That's helpful. And, yeah, I wanted to ask, Any update on, you know, the PFAS regulation opportunity, you know, in terms of whether, you know, anything new around your discussions with customers or, you know, I know you're talking about product development. Just what's the latest there?
spk00: Yeah, we continue to be interested in the space, but as you know, this is an incredibly difficult and complex problem to solve. We believe that we're well positioned given our 70-year history at Hock for democratizing tests and analytics and our long track record at Trojan for developing treatment solutions. So we continue to invest in this space and stay focused there. But, you know, real fit-for-purpose solutions that are focused on you know, at site or in line testing and at site, uh, uh, real time destruction of PFAS are going to be re remaining difficult problems to solve. Uh, but we're focused on creating winning outcomes for our customers that have fit for purpose solution. So still a few years away here, but we are, uh, we are interested in the space as we are with sort of all of the micro contaminants that come into the regulation, uh, frame.
spk06: Okay. All right. Thank you. We'll take our next question from Joe Giordano of TD Cowen.
spk00: Good morning, guys. Good morning.
spk05: Thanks for taking my question. You know, I was interested in the industrial growth commentary. It's just we're not hearing that in a lot of places, right? Industrial data is pretty bad, and most companies were seeing orders decline. So it was interesting and good to see that there. Can you kind of What's driving that? Is it new project ramps? Is it, like, is it optimization at existing facilities? Like, what's the nature of this kind of growth there? It does seem somewhat unique.
spk00: Yeah, I think what you're seeing here is that there's really three things that differentiate us from other industrials. We play in the end markets with really attractive and kind of non-optional secular growth drivers, right? So when you've got a business that's 85% of our sales into food, water, and pharma, these are not elective businesses. you know, areas of testing, right? So these are really durable markets. And as a consequence, the way our businesses have been built are durable in turn. 60% of our recurring revenue or 60% of our revenue is kind of in this recurring revenue space. It's a razor razor blade business model with high margin consumables. And these products and services that are deployed for our customers are are essential parts of their operation. So if they choose not to use our products or they choose not to treat and measure and monitor and so on, the cost of failure to them is high because we're really tied to sort of product quality and public health. So the last thing I would say is, you know, VES provides a competitive advantage for us really in terms of differentiating us relative to talent growth and continuous improvement.
spk05: And then just last for me on the margins. I always touch on this a bunch, but with gross margins at 60, it's excellent. You know, if I look at the spread between gross margins and EBITDA, you know, 30% in SG&A seems a little high. Like your newer company, like long-term, what's like a realistic level that that should normalize out at? Yeah, I'll take that one. It's really the sales and marketing, right? You know, just to take you back, effectively, you know, when you look at a P&L, it really aligns with how we create value in the business. It's more driven by investments in R&D. It's a technology-driven business, and then on the commercial side. The secret sauce, what we believe, and our competitive strength is a direct business model that effectively does result in the sales and marketing impact that you see in the numbers. Overall, we feel really good about our business model that is more direct, and it really drives a competitive advantage in the marketplace.
spk01: Thanks, guys.
spk06: And this does conclude our question and answer session. I'd be happy to return the conference to Ryan Taylor for closing comments.
spk01: Thank you, Leo, and thanks for everybody that joined us on the call today. We really appreciate your engagement and the discussion. Feel free to reach out to me if you have any more follow-ups. Thanks again for joining us, and we'll talk to you next quarter.
spk06: This does conclude today's conference. You may now disconnect your lines, and everyone, have a great day.
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