Veralto Corporation (NYSE:VLTO) Q4 2023 Earnings Call Transcript

Veralto Corporation (NYSE:VLTO) Q4 2023 Earnings Call Transcript February 7, 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: 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 Fourth Quarter and Full Year 2023 Earnings Results 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 investor section of our website later today, under the heading Events and Presentations. A replay of the call will be available until February 21, 2024. Before we begin, I’d like to point out that yesterday we issued our fourth quarter news release, earnings presentation, and supplemental materials, including information required by the SEC Regulation G, relating to any adjusted or non-GAAP financial measures.

These materials are available in the investor section of our website, www.veralto.com, under the heading quarterly earnings. Reconciliations of adjusted figures and 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 most recent 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, Ryan. Good morning, everyone, and thank you for joining our call today. 2023 was a historic year for Veralto as we successfully executed our separation from Danaher and delivered a record level of sales, high single-digit earnings growth and strong free cash flow in a dynamic macro environment. From a segment perspective, our teams in Water Quality achieved a record level of sales and operating profit despite headwinds in China. And in Product Quality & Innovation, our teams held sales and profitability flat year-over-year despite headwinds from consumer packaged goods demand and the Argentine peso. I’m proud of our team for their resilient effort to grow and improve our business, while supporting our customers and helping to ensure the safety of water, food and medicine supply chains across the world.

We finished 2023 with a strong fourth quarter, delivering core sales growth in both segments, solid operating margin expansion, and robust free cash flow generation. From a segment perspective, we saw continued growth across industrial markets in Water Quality and early signs of stabilization in consumer packaged goods markets and product quality and innovation. As we begin 2024, we are in a strong financial position and are cautiously optimistic about the near-term trends in our end markets. Over the long term, we remain focused on compounding earnings and cash flow through steady core sales growth, continuous operating improvement, and value-accretive acquisitions that yield attractive returns. Our team is tremendously excited about the significant opportunities to create future value for shareholders, while also having an enduring positive impact on our world through our unifying purpose of safeguarding the world’s most vital resources.

We are unwavering in these commitments and confident in our ability to achieve them collectively. Looking at our full year 2023 results, sales grew 3.1% year-over-year to more than $5 billion, an all-time high. Core sales grew 2.6% following two consecutive years of 8% core growth and we delivered 50 basis points of adjusted operating margin expansion. Adjusted EPS grew 7% year-over-year and free cash flow generation remained strong with free cash flow conversion at 109%. We ended the year in a strong financial position with more than $760 million of cash on hand and net leverage of 1.5x. Overall, I’m pleased with the steady growth and improvement we delivered in 2023 despite headwinds from lower volumes in consumer packaged goods markets, a slower economy in China, and the devaluation of the Argentine peso.

In addition to delivering solid financial performance, during 2023 we bolstered our leadership talent, realigned our commercial teams, and continued to optimize our portfolio and launch several new technology solutions. Over the past year, we increased the rigor around our innovation process and have started to see early benefits. A great example to highlight is Videojet, our marketing and coding business which launched seven new products in 2023 to fortify and expand its leading technology position. These launches included differentiated technology in both our continuous inkjet and laser offerings. In inkjet, Videojet launched the new 1580 C, which prints pigmented color codes without increased maintenance, enabling superior uptime, while delivering crisp, high-quality contrast codes.

And in laser, Videojet launched its 3350, which features our new smart focus technology, allowing increased flexibility for seamless product changeovers with no manual intervention. These new products demonstrate our innovation focus on solving customer problems, and we are excited about their growth potential. Turning now to our financial results for Q4. We delivered 1.7% core sales growth year-over-year with 50 points of adjusted operating margin expansion and 9% adjusted EPS growth. Core growth of 1.7% exceeded the top end of our guidance due to strong execution by our teams in both segments and better than anticipated demand, particularly in food and beverage consumer packaged goods markets where volume started to turn positive. We are encouraged by the signs of stabilization we saw in the latter part of 2023.

It’s important to recognize that we are still in the early stages of recovery here. We are cautiously optimistic about the CPG markets at the outset of 2024 and remain prudent in our expectation of steady sequential improvement in demand as this year progresses. Q4 sales into China were also better than anticipated, down only 3% year-over-year and up 7% sequentially, a nice recovery from Q3 to Q4. Versus the prior year period, both segments delivered core sales growth through continued strong price execution and to a lesser extent volume growth in our water treatment solutions, particularly for industrial applications. Adjusted operating profit grew 5% and margins expanded 50 basis points to 23.8%. We delivered strong underlying margin expansion through price execution, cost optimization and improved operating performance driven by the Veralto Enterprise System.

Adjusted EPS was $0.87 per share in the fourth quarter, $0.03 above the high end of our guidance range. Adjusted EBITDA was $316 million or 24.5% of sales, and we generated $241 million of free cash flow at just over 120% conversion. Our Q4 financial performance reflects our ability to navigate a dynamic macro environment and is a testament to delivering results and meeting our commitments through the Veralto Enterprise System. Looking now at core sales growth by geography for the fourth quarter, we grew about 5% year-over-year in North America and over 2% in high growth markets, more than offsetting a 2% decline in Western Europe. In North America, we continue to see strong growth in Water Quality highlighted by our water treatment businesses.

ChemTreat grew sales in the high single digits with broad-based growth across industrial end markets and continued new customer wins. And at Trojan, we continue to see growth in North America, driven primarily by demand from municipal customers for our UV systems focused on wastewater discharge regulations and contaminant destruction in drinking water. Trojan also continued to see steady growth in its Aria Filtra product line serving industrial customers in North America. This is a great example of renewed strategy and strong execution driving value accretive growth. In PQI, core sales in North America were flat as modest growth in marketing and coding was offset by a decrease in sales of packaging and color hardware equipment. In Western Europe, we also saw moderate declines in sales of packaging and color hardware equipment.

Demand for water analytics and treatment was steady in Western Europe across both municipal and industrial customers. Fourth quarter sales into high growth markets were up 2% year-over-year as most single digit growth in Latin America and strong double digit growth in the Middle East and India offset a 3% decline in China. For the full year, we delivered growth across the three regions led by 4% growth in North America and 2.5% growth in Western Europe. These two regions represent more than two-thirds of our total sales. Sales in the high growth markets were up 1% in 2023 with strong growth in Latin America, the Middle East and India more than offsetting a high single digit decline in core sales year-over-year in China. That concludes my opening remarks, and at this time I’ll turn the call over to Sameer for a detailed review of our fourth quarter financial performance.

Sameer Ralhan: Thanks, Jennifer, and good morning everyone. I’ll begin with our consolidated results for the fourth quarter on slide eight. Fourth quarter net sales grew 3.3% on year-over-year basis to $1.29 billion. Our core sales were up 1.7% and currency contributed 1.6%. We continued to execute well on pricing, which contributed 3% to sales growth in the fourth quarter over the prior year period. You can see this benefit in our gross profit, which increased 5% on a year-over-year basis to $746 million. Gross margin was 57.9%, up 90 basis points from the prior year fourth quarter. Adjusted operating profit increased 5% year-over-year, and adjusted operating profit margin expanded 50 basis points to 23.8%. As Jennifer mentioned, further devaluation of the Argentine peso was a significant headwind that we offset in Q4.

Late in the fourth quarter, the Argentine peso declined by more than 50% relative to the US dollar. This reduced the value of our cash-on-hand in the region and led to a significant chart quarter in the PQI segment. On a year-over-year basis, the impact of the fourth quarter was $17 million or 130 basis points to our total adjusted operating profit margin. And for the full year, it was a $29 million headwind or 55 basis points headwind to the adjusted operating profit margin. We ended 2023 with approximately $15 million of cash and $5 million of accounts receivable in Argentina. We continue to evaluate options to mitigate the impact of further devaluation while serving the needs of our customers in the country. The net EPS impact from the Argentine peso devaluation was approximately $0.03 in the fourth quarter.

Despite the headwind, we delivered adjusted earnings per share of $0.87 in the fourth quarter, up 9% year-over-year and $0.03 above the high end of our adjusted EPS guidance range. We also delivered strong cash conversion in the quarter. We generated $241 million of free cash flow, representing free cash flow conversion of 121%. Moving to the next chart, I’ll cover the segment highlights, starting with Water Quality. Our Water Quality segment delivered $782 million of sales, up 3.4% on a year-over-year basis. Currency was a 1.3% benefit. Core sales grew just over 2% year-over-year as compared to 9.5% core growth in the prior year period, bringing the two-year core growth stack for Water Quality to about 6%. Pricing contributed 4.2% to core sales growth in Q4, 2023.

We continue to see strong demand for our water treatment solutions, with steady growth across industrial markets at ChemTreat and high demand for Trojan’s UV systems in both municipal markets and in the semiconductor industry, where manufacturing of chips requires ultra-pure water. And in water analytics, as expected, we experienced lower year-over-year demand in China, where municipal budgets continue to be impacted by reductions in government funding. On a positive note, sequential sales for water analytics in China have been consistent now for three consecutive quarters. Adjusted operating profit increased 9% year-over-year, with margins up 150 basis points to 26%. The increase in profitability was across all key businesses in the Water Quality segment and primarily reflects strong pricing execution and improved operating productivity.

For the full year, Water Quality delivered steady, profitable growth, with core sales up 5% and adjusted operating profit margin up 80 basis points to 24.5%. As Jennifer mentioned, 2023 marked a record year for Water Quality, with sales over $3 billion and adjusted operating profit of $746 million, both all times high levels on an annual basis. Moving to the next page, our PQI segment delivered sales of $506 million in the fourth quarter, up 2.9% versus the prior year period. Currency was a 1.8% benefit. Core sales grew 1.1%, as 1.8% benefit from pricing more than offset modest volume declines from the prior year quarter, primarily related to CPG markets. While still down year-over-year, demand from CPG customers steadily improved during the quarter and came in better than our guidance assumptions.

Additionally, sales into China came in better than anticipated, up 1% over the prior year quarter. From a product perspective, core sales in both marketing and coding solutions and packaging and color solutions grew in line with the segment at about 1% year-over-year. PQIs recurring sales grew mid-single digits year-over-year, with growth across every major product line, an encouraging sign. We continue to see signs of sequential stabilization across PQIs and markets, led by increased demand from our food and beverage customers. That said, we are still in the early stages of recovery here and are cautiously optimistic about CPG volumes as we begin 2024. PQIs adjusted operating profit was $123 million in the fourth quarter, resulting in adjusted operating profit margin of 24.3%.

These results include the unfavorable impact from the devaluation of the Argentine peso. That impact resulted in 330 basis points of headwind to adjusted operating profit margin on a year-over-year basis for the fourth quarter, and 145 basis points headwind to the full year. Excluding the impact from the Argentine peso devaluation, for the fourth quarter PQIs underlying operating profit grew low double digits year-over-year, and adjusted operating profit margin expanded to about 28%. And for the full year, PQIs underlying profit grew in the high single digits on flat sales, and adjusted operating profit margin expanded to about 27%. Strong pricing execution and benefits from cost optimization actions were the primary drivers of improved underlying profit and margin performance.

For the full year, PQIs sales and profitability were essentially flat year-over-year, a great result considering the significant headwinds from destocking and lower volumes at consumer packaged goods customers, a challenging economy in China, and the currency devaluation in Argentina. The teams within the PQI segment were able to withstand these headwinds to turn in a great result for 2023, with positive momentum building as we enter 2024. Turning now to our balance sheet and cash flow. During the quarter we generated $263 million of cash from operations, and invested $22 million in capital expenditures. Pre-cash flow was $241 million in the quarter, resulting in free cash flow conversion of 121%. This quarter again demonstrates the strong free cash flow generation capabilities of our businesses.

Note that we did not have any cash payments related to interest costs in Q4, 2023. Beginning in 2024, we will have interest payments in the first and third quarter. At year end, gross debt was $2.6 billion and cash on hand was $762 million. Net debt was $1.9 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. Our bias as you know, is to drive compounding growth in earnings and cash flow, through investment 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.

Within our framework, we also maintain flexibility to return capital to shareholders. In line with the capital allocation framework, we declared a cash dividend of $0.09 per share for the fourth quarter. Turning now to our guidance for 2024. Beginning with an expectation for the full year, we expect core sales to grow low single digit on a year-over-year basis. This assumes low single digit growth across both of our segments. We are targeting 100 to 200 basis points of price, consistent with historical pre-pandemic levels. Our guidance assumes corporate and other expenses of about $100 million, reflecting the full annual run rate of standalone costs. Looking at adjusted operating profit margin, we are targeting 50 to 75 basis points of improvement this year.

This assumes 65 to 90 basis points of operating profit margin improvement across the businesses and approximately 25 basis points benefit from lower exposure to the Argentine peso. These benefits more than offset a 40 point headwind from the full run rate level of corporate and standalone company expenses. Our adjusted EPS guidance for the full year 2024 is in the range of $3.20 per share to $3.30 per share. This assumes an effective tax rate around 25%. From a sequential perspective, our guidance assumes that year-over-year core sales growth steadily improves quarter-to-quarter through 2024, with core sales growth in the first half of the year relatively flat, and core sales growth in the second half up low to mid-single digits. Looking now at Q1, 2024, we expect core sales to be approximately flat year-over-year.

At segment level, we expect core sales and Water Quality to be flat to modestly positive, and core sales in PQI to be flat to modestly negative. As a reminder, Water Quality core sales growth was 11% in Q1, 2023, resulting in a tough year-over-year comparison. Additionally, turning of the portfolio, which resulted in the shutdown of small product lines in Water Quality, represents 60 basis points headwind to core sales growth for the segment and the quarter. We anticipate adjusted operating profit margin in the range of 23% to 23.5%, and our Q1, 2024 guidance for adjusted EPS is $0.73 to $0.78 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 : Thanks, Sameer. In summary, we successfully executed our spinoff from Danaher and are off to a great start as a public company. In 2023 we delivered 2.6% core sales growth, 50 points of adjusted operating profit margin expansion, and 109% free cash flow conversion. Solid operating results amid a dynamic macro backdrop and against a tough comparison relative to 2022. Going forward, we are focused on delivering our commitments, driving continuous improvement, and executing disciplined strategic capital allocation that creates long-term value for shareholders. As an independent company, we are benefiting from increased operational focus with 100% of our capital available for strategic growth and value creation.

We are confident that the durability of our businesses, 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 VES, 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, safeguarding the world’s most vital resources. Our talented diverse team is excited about the bright future ahead and the opportunities to drive value creation for shareholders by helping customers solve some of the world’s biggest challenges while having a positive enduring impact on our environment.

That concludes our prepared remarks. I want to thank you again for joining our call, and at this time, we are happy to take your questions.

Operator: [Operator Instructions] And we’ll take our first question from Scott Davis with Melius Research. Your line is open.

Scott Davis : Hey, good morning everyone.

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Q&A Session

Jennifer Honeycutt: Good morning, Scott.

Scott Davis : Looks like China is still a little bit sloppy for you guys. It has been for everybody else too, so not a big surprise. But any color, what your folks there are telling you. Any sense of if we’re closing in on a bottom here or what you think in the next couple quarters on a sequential ramp?

Jennifer Honeycutt: Yeah, I mean I think in the fourth quarter China came in a little bit better than how we were anticipating. We saw some nice growth in our Trojan UV systems, really related to semiconductor chip manufacturing. We did anticipate municipal markets to be down, and as expected, they were year-over-year, but we have seen now three quarters of consecutive stability in that market. I think going forward in 2024, I think we’re pretty much near the bottom, and we anticipate steady sequential performance improvement stability for the second half of 2024. So a little bit more of the same. We’ll see year-on-year sales decline during the first half, which we expect to improve throughout the balance of the year.

Sameer Ralhan: Yeah Scott, maybe I can just add from the guide perspective, the way we model China is effectively, as Jennifer said, sequential improvement, but for the first half of the year, that’s going to be a little bit of a headwind for us. And in the second half, we’re going to start stabilizing and be a little positive. So that’s how we’re going to think about China in terms of a guide.

Scott Davis : Okay, helpful. And then just changing gears, I know I don’t want to over read this, but Sameer, in your prepared remarks, you just mentioned something about returning – potential for returning capital. Still I would imagine the focus is on around M&A. So perhaps just an update on what you’re thinking on an M&A pipeline and likelihood or potential of transactions in 2024, and how you guys are feeling about that part of the equation. Thanks.

Jennifer Honeycutt: Yeah, I think the return to capital to shareholders, obviously we have an ongoing continued bias towards M&A. We did announce in the fourth quarter a $0.09 dividend, but our pipeline for M&A and both Water Quality and PQI remain strong with a number of opportunities being considered. So we’re going to maintain as we said before, a disciplined approach that we’ve inherited from Danaher in terms of it’s got to be the right market, the right company at the right price. In terms of valuation, we do have a whole variety of different kinds of assets that we’re looking at, but we do like targets that have a similar operating profile in terms of the durability of the business model. And we like businesses that we can improve in terms of margin expansion through the use of VES. So yeah, we are fully committed to long term shareholder value through the capital deployment.

Scott Davis: Well, Freudian slip. Best of luck in ’24 and congrats on the start, CEO. Thank you.

Jennifer Honeycutt: That’s 23 years of Danaher coming through, Scott. Thank you.

Operator: And we’ll take our next question from Deane Dray with RBC Capital Markets. Your line is open.

Deane Dray : Thank you. Good morning, everyone.

Jennifer Honeycutt: Good morning, Dean.

Deane Dray : Maybe we’ll start with more of a housekeeping question just in terms of Veralto still being a new company. Can you characterize and frame some of the frictional costs that might still be running through the P&L like transitional services? And I know you did some portfolio line shutdown of that European filtration separation business. It really was an outlier in the portfolio. But just kind of frame for us what might be those frictional costs that are there now and what the timing might be.

Sameer Ralhan: Yeah Dean, let me just start with the frictional costs. I think as we kind of said in the guide, starting Q1, we should pretty much start seeing the run rate costs on the standalone company basis, that’s a little of the corporate function. So $100 million in the corporate number that you have in the guide kind of really represents the run rate. So beyond that, there’s no sort of a major frictional cost, although one-time costs are pretty much done as well. On the TSA side, Deane, as you said earlier, this was a very clean separation from a TSA perspective. So there’s very minimal in terms of dollars, like it’s a nominee matter. So I wouldn’t think about any kind of remaining frictional costs per se. On the portfolio side – then on the portfolio side it’s roughly 60 basis points, in fact as we said on the Water Quality side.

So again, you can do the math. It comes down to $15million, $20 million-ish kind of headwind, kind of actions that we took. Really cleaning up some of the product lines as we inherited some of the filtration assets from Danaher. We are as good stewards of capital just sitting back saying, hey, every product line has to earn its place in the portfolio, and some of the product lines and geography combinations just did not meet that hurdle, so we took some actions. But that is a minor sort of a regular portfolio cleanup frankly.