Veralto Corporation (VLTO) Earnings Call Transcript & Summary

My name is Erica, and I will be your conference operator this morning. At this time, I would like to welcome everyone to Veralto Corporation's Third Quarter 2026 Conference Call. [Operator Instructions] I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Please go ahead, Mr. Taylor. You may now begin.

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 November 9. Yesterday, we issued our third quarter 2026 earnings news release, earnings presentation, prepared remarks and supplemental materials, including information required by the SEC relating to adjusted or non-GAAP financial measures. These materials are available in the Investors section of our website, veralto.com, under the heading Quarterly Earnings. Reconciliations of all non-GAAP measures are also 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. Actual results may differ materially from our forward-looking statements. 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.

Thanks, Ryan. I want to start by thanking our 17,000 associates for delivering an outstanding third quarter. We continue to build on our track record of meeting or exceeding our financial commitments through rigorous execution in support of our customers. In Q3, Total sales grew 7.5% year-over-year. Adjusted EPS increased 19.2%, and we generated robust free cash flow of $304 million. We delivered 5.1% core sales growth led by water quality at 6.4%, with PQI at 3.2%. Both segments accelerated core sales growth sequentially from Q2 to Q3. Broadly speaking, demand for our products and services remains healthy across both segments. Relative to the fourth quarter, we expect core sales growth of 5.5% to 6.5% and approximately 5% growth from acquisitions resulting in total sales growth of approximately 10%. Based on our third quarter performance, fourth quarter outlook and early gains from our cost optimization program we raised our full year adjusted EPS guidance to $4.49 to $4.52 per share, representing 15% to 16% growth over the prior year. Our 2026 guidance includes benefits from our disciplined capital deployment. Year-to-date, we've deployed more than $1.65 billion across 4 strategic bolt-on acquisitions and the repurchase of 2.4% of our outstanding shares. Our most recent acquisition of Clean Water One expands our capabilities in water treatment solutions, and I'm excited to welcome the Clean Water One Associates to Veralto. With our strong balance sheet and robust cash generation, we have ample flexibility to act decisively on attractive new opportunities. This year's performance and disciplined capital deployment reflects the stronger Veralto that we have been architecting since our spin-off in 2023. As we mark our third anniversary as an independent public company, I'm proud of how much we've accomplished and even more excited about our future. Over the course of the first 3 years, we have simplified VES and bolstered our execution, accelerated innovation and strengthened our portfolio through disciplined M&A. These actions have accelerated our core sales growth, driven consistent margin expansion and double-digit adjusted EPS growth. I'm incredibly proud of what our team has accomplished. With a stronger foundation, talented team and proven track record, we are excited about the opportunities ahead and confident in our ability to deliver sustainable long-term value for shareholders. That concludes my prepared remarks. And at this time, we will now take your questions.

[Operator Instructions] And we'll take our first question from the line of Jeffrey Sprague with Vertical Research.

Thank you. Good morning, everyone. Jennifer, -- just kind of wonder -- you're not inherently a project-related business, but when I look at these kind of improving trends in industrial water, some of the digital workflow stuff, maybe some things going on in the muni side. I was just wondering if you could kind of comment on maybe the level of visibility or sort of confidence level in 2027. So maybe cheating here a little bit and trying to get an early 2027 preview from you.

Yes. Thanks for the question, Jeff. I think the way to think about our exposure here is -- we have a balanced portfolio in our water business between Muni sales and industrial sales. In fact, 50% of our sales in water quality are into industrial applications. Insofar as your question around municipal spending, as a reminder, 60% of our revenue sits in recurring revenue given the razor blade business were essential to the customers' operations. But when we do have equipment that gets sold as CapEx, it's part of the normal operational CapEx cycle. And that is to say that these tend to be facility upgrades or optimizations as opposed to infrastructure investments, which are more prone to federal funding fluctuations. So we see strong demand really for our solutions here relative to both the operating side of the business, whether that's our recurring revenue-based model or project-based business simply on the back of the secular drivers that we see, right? Recycle reclaim severe weather events, water scarcity and so on. So we feel pretty good about ongoing demand here, and we'll keep you posted once we get to 2027.

And maybe just 1 on PI. On that side of the equation, is there some visibility on the CapEx side that's coming to view or not at this point?

Yes. I mean, by and large, the PQI side of the house is not a CapEx business. these equipment purchases in terms of marking and coding or packaging and color tend to be, again, operational improvements to existing lines Again, for our marketing and coding business, we've got 60% of that business is recurring revenue based and we've got a huge installed base there for continuing to upgrade as there are technology changes relative to substrates, packaging sizes and so on. we see good pull-through in our digital workflow solutions in packaging and color which, as you know, we've continued to invest there by virtue of M&A. So we see steady demand, and we feel confident about the future there.

Yes. And maybe, Jeff, I'll add 1 more thing is as you look at the Packaging color business on the digital workflow solutions business, that's growing nicely. There, we have pretty good visibility, given those are SaaS contracts. So as you know, we sign up the contracts and be recognizing revenue at time. So we have pretty good visibility on that side and then the market coding as Jennifer said, for us, the manned patents have been pretty steady.

We'll take our next question from William Grippin with Barclays.

Great. Appreciate the opportunity here. My first question, you're flagging some early progress on cost saves here in the third quarter. I guess on top of that, small benefit here from tariffs. I was wondering if you could help us think about the margin cadence next year within that context. And I guess just maybe more specifically, just given the progress thus far on the cost saves, are you maybe seeing potentially more cost out opportunity than you had initially laid out?

As you kind of look at the cost optimization program, at the beginning of the year, we had said that roughly half the savings by 2027 and then full run rate in 2 -- that plan is still 1 to follow. Look, we've had some early successes and a good start out of the gate. So we're going to see $10 million to $15 million worth of savings in 2026, but for r 2027 at this point, just model it the way we kind of guided earlier, roughly half the savings. Will be more specific as part of the 2027 guide on where we stand. Just keep in mind, right, that the savings are net of investments as well. So there's always a little bit of a variation on the timing which we want to make sure that we properly dial in into the 2017 guide. So that's how you should think about the cost optimization program at this point on track with a nice early start in 2026 for us.

Great. And my follow-up here. In the release last night, you noted strong demand for municipals in Hawk. I was wondering if you could provide a bit more color on drivers there, whether it be replacement cycle, new product introductions within that business or new customer wins? And maybe how are you thinking about demand trends exiting the year?

Yes. I mean I would say here on the muni side of water quality, we're really kind of firing on all cylinders here, and this is on the back of a 3-year build relative to commercial architecture, VES discipline new product development. And as a reminder here, we're really on the OpEx side of our customers' operations as opposed to CapEx. It's nondiscretionary spend, right? This is regulated testing. So customers are -- use our equipment to make sure that they stay within compliance, and I would say here throughout the last year or so, our new product development flywheel has particularly taken hold, and we see that across our analytics business as well as our water treatment businesses. So for municipalities, Hach's got a brand-new flagship spectratometer, got new ammonia and phosphate analyzers. And so we continue to see sort of great execution that's been bolstered by this increasing cadence of new product development launches. So we feel good about our position here, and we would expect that to continue.

We'll take our next question from Mike Halloran with Baird.

So maybe just some thoughts on underlying trajectory in the short term here. You certainly heard the answer to Jeff's question. Just curious, it sounds like most of the pieces of your portfolio are tracking sequentially the right way. Anything that you're seeing that deviated from seasonality as you work through the quarter. But I guess the question, is there any areas of your portfolio that you're not seeing that positive trajectory? Or maybe put differently, are there any very obvious flex points that you're thinking about in the portfolio as we position for 4Q next year?

Yes. Thanks for the question, Mike. Broadly speaking, all of our businesses are trending well in terms of growth and sequential acceleration. I would say we've seen some timing differences relative to kind of project timing and that's affected pieces of our packaging and color hardware business. to a lesser extent on the water side. And I would say projects tend to move around a little bit, but they generally come through. So we haven't seen any indefinite delays or project cancellations but timing sometimes is variable there. In the main, I would say, by virtue of our large sort of recurring revenue business, things are pretty steady. Demand continues for the products and services that we have. We've got great secular drivers relative to data centers and feeder industries in power semiconductor and mining, recycled reclaim is big on the muni side as water scarcity becomes a bigger issue. And I would say in the Food Safety Modernization Act, it's driving a lot of need for product reformulation, packaging changes and so on. So we see good demand there as well. So I think we feel pretty good about the outlook here in the fourth quarter and the fact that we believe that momentum will continue here into 2027.

I appreciate that. And then just on the capital deployment side, it's been an aggressive year and balanced with buybacks and M&A. So maybe a twofold question. One, how are you thinking about the buyback intent in the short term? Obviously, you saw some of the ongoing repurchases in October. But then how do you think about the pipeline after having completed a fair number of acquisitions over the last 18 months or so?

Yes. Mike, thanks for the question. As far as the buyback is concerned, look, if you add what we have done in October that we disclosed, we effectively done with $550 million of share repurchases out of the $750 program. Look, I mean, we -- as we always said, we're going to be opportunistic. And if there's an opportunity in the marketplace where we think there's a disconnect between the intrinsic value of the market value, you should fully expect us to be using the authorization. So we'll continue on that path. As far as overall, the pipelines are concerned, look, the pipelines are pretty active on the M&A side, both. So as we kind of move forward, we expect to stay pretty balanced. So there's no change in the overall capital allocation strategy.

And we'll take our next question from Nathan Jones with Stifel.

This is Adam Farley on for Nathan. Maybe on chemical treatment within water quality on the data center piece, what is Veralto's overall exposure to data centers within water quality maybe where do you think that exposure can grow to over time? And where in the data center construction time line does chemical treatment benefit.

Yes. So overall, as we've said previously, our total sales in the data centers today remains small. We will say that our data center growth continued to be very strong and, in fact, doubled in Q3, but that's obviously off of a small base. And the draw here is from both our treatment and our analytics businesses. we are, by virtue of our ChemTreat business engaged early in those project bills and get requested to participate in helping to consult on water train and water treatment design so that customers can optimize both water utilization, power consumption. Those often are counterbalanced to one another. And so finding the balance between power-efficient and water-efficient design is something that every data center is working to solve for. So we are involved early in the process. We have a good installed base relative to utility water and increasingly have offerings and are really in the liquid side of direct-to-ship cooling as well. So good exposure here, small base of business, growing double digits, strong double digits and we would expect that to continue for the foreseeable future.

Yes. I mean, Adam, as you're going to think about the data center business for us, especially on the treatment side, it's an annuity business for us. So yes, the bill cycle I get that question, but think of our business predominantly as more annuity business. So as these data centers come in and then operate.

That's really helpful color. And then just staying on all quality. Can you provide an update on your expectations for growth regionally? Do you expect North America to continue to lead growth maybe through next year and then maybe what are you seeing out of China?

Just to clarify, the last point was what do we expect out of China?

Yes, in water quality.

Okay. water quality. Yes. So China continues to be lower in its muni spend, kind of still bumping along the bottom there. We're not accounting for or expecting any significant change there. But as a reminder, China represents about 6% of our sales. In Latin America, water was down modestly year-over-year, but higher sequentially throughout the quarter here. Underlying demand is strong, the timing of some of these projects has been delayed, and that's largely on the back of waiting for election results and so on. I would say, given the completion of the election here in Brazil, that uncertainty should clear here, and we should start to see that demand start to increase. So we continue to watch our high-growth markets here -- they have been relatively lower than their name would suggest with good growth in the western markets of Europe and North America, but we continue to have good opportunities in Latin America, I would say as well in India, parts of Southeast Asia, but China is definitely still not investing.

And we'll take our next question from Andy Kaplowitz with Citigroup.

So maybe we could just double click into the reacceleration of organic growth you're seeing in PI. You Jennifer, you mentioned some project delays, but obviously, your growth has been picking up and you've continued to talk about acceleration in digital workflow solutions. So what are the core customers telling you? And given that the economic environment is sort of mixed out there?

Yes. I mean, I think what we see here is strong demand and bookings of our digital workflow solutions. This is on the back of the TraceGains Global Vision acquisitions being integrated into the Esko digital backbone and as you know, we book revenue over the life of the contracts, which gives us good visibility and confidence in the sequential core growth acceleration. We continue to see steady demand in marking and coating, right? There are some category changes within consumer product goods. But effectively, we see strong continued performance and uptake from our mid-market customers. That's going to continue to result in sequential core sales growth. And then I would say the other element here is Q4 has got a relatively easy comp in our marking and coating side of the business. So that's an element as well. And then finally, say that our sales recovery of our color measurement equipment and packaging and color, we would expect that to come back. And we see good commercial execution, good funnels. We exited Q3 with stronger service growth, and that gives us confidence here as we head into Q4.

Very helpful, Jennifer. And then Sameer, can you give more color into what you're seeing maybe in price versus cost, I think you're modeling adjusted operating margin to be down a bit in Q4 versus Q3, even excluding the tariff benefit in Q3. So just maybe the puts and takes on sort of how you're thinking about margin in Q4?

Yes. as you look maybe just sort of the margin first. If you look at the margin for Q4, yes, sequentially, most of the impact that you see is really driven by the Cleanwater1 acquisition. -- overall, for our Q4 margins, you should fully expect the fall-through to be 30% to 35%. So that's roughly 30 bps of a margin expansion on a year-over-year basis. Cost optimization program, if you look at the guide that we've given for the full year, that adds another roughly 40 basis points to the OMX for Q4. So that's a 70 and that 70 is mostly offset by Clean Water One acquisition. Is that how we're going to model in -- but as you know, in Q4, we do tend to make some investments to help support '27 strategic initiatives. So we've built in a fairly healthy amount of investment in Q4 tied to that. To the extent that those things come in light, of course, there will be upside to the guidance.

And we'll take our next question from Jacob Levinson with Melius Research.

Just to go back to Mike's question for a second on the M&A side of things. I know you folks have been pretty active here with a number of bolt-on deals. But can you just give us a sense of what that funnel looks like from here? Is a lot of these smaller assets that are out there? Or are there also some larger deals that you might be interested in as well?

Yes. I would say, Jake, that it's a mix. Both funnel or funnels on both sides of the house are healthy and full lots of cultivation work underway. I think what you've seen us do here in the first 3 years is build out our position in treatment in the environmental business and digital workflow solutions, all of which are expansions of our current positions, but squarely within our wheelhouse. So we feel good about the funnels -- there are all kinds of assets in those funnels. There are large deals, they're small deals, there's technology deals. There's geographic expansion deals. And so we have a track record here of going after these strategic bolt-ons. I think we're well served by that. But again, we've got a variety of different types of assets in our funnel that will continue to work and bring those in under the very disciplined approach that we've taken thus far to increase long-term shareholder value.

Okay. That's helpful. You made a comment in your slide deck on Slide 4 that I'm not sure it seemed before around not graded facilities. I know you've done some work on the footprint, given everything with tariffs, but maybe you can just elaborate on what that really means.

Yes. I don't think it's unreasonable to think that some of our technologies might have atrophied in prior times. -- being a smaller portion of Danaher. And so this is just part and parcel to continuing to mine the shop here at Veralto and make sure that we are have modernized tech stack for all of our data systems to ensure that we are continuing to invest in technology. One example would be robotic automation of our Chemkey lines at Hach, right? We will continue to modernize and upgrade manufacturing facilities, our ability to utilize data in ways that are AI friendly. And so this is just part and parcel to making sure that we are staying fit operationally as we would say. And to make sure that we've got access to the latest and greatest tools to continue to be able to run the business well.