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 Third Quarter 2023 Earnings Results Conference Call. [Operator Instructions] I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr. Taylor, you may begin your conference.

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 & Presentations and will remain available until our next quarterly call. A replay of this call will be available until November 10, 2023. Before we begin, I'd like to point out that yesterday we issued our third quarter news release, earnings presentation and supplemental materials, including information required by SEC Regulation G relating to any adjusted or non-GAAP financial measures. These materials are available in the Investors section of our website, www.veralto.com, under the heading Quarterly Earnings. As it relates to non-GAAP measures, I want to highlight that we are presenting adjusted operating profit and adjusted EBITDA on a standalone basis, including incremental standalone costs as estimated by management for all periods. We are also presenting adjusted diluted earnings per share, including incremental standalone costs and interest expense related to our new capital structure. Reconciliations of adjusted figures and all non-GAAP measures are provided in the appendix of the webcast slides. Unless otherwise noted, all financial metrics relate to the third quarter of 2023, and all references to variances are on a year-over-year basis. During the call, we'll 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're 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.

Thank you, Ryan, and good morning, everyone. We appreciate you joining us for Veralto's first earnings call as an independent publicly traded company. The third quarter 2023 marks a significant milestone for Veralto as we successfully completed our separation from Danaher. We accomplished this in just over 12 months from the time of announcement, a truly remarkable achievement. During the third quarter, we filed our Form-10, issued our 2022 Sustainability Report and hosted our first investor event. At that event, we described key attributes that differentiate Veralto, along with our framework to create long-term shareholder value and our disciplined approach to strategic capital allocation. I'm proud of our team for their extraordinary effort related to the separation, while also driving solid operating execution in support of our customers. Through the first 9 months of this year, we delivered core sales growth of 3%, expanded adjusted operating profit margin by 50 basis points and converted 105% of that income into free cash flow. We ended the third quarter in a strong financial position with over $425 million of cash on hand and net leverage below 2x. Given our financial position and strong free cash flow profile, I'm pleased to share with you that we expect to announce a quarterly dividend of $0.09 per share in Q4 2023. We are off to a great start as a public company, and there is positive energy throughout Veralto. Our team is tremendously excited about the significant opportunities in front of us to create value for shareholders. Before we dive into the results of the quarter, I'll open with a brief overview of Veralto for those who may be new to our story. Veralto is a global leader in water and product quality with essential technology solutions, and a proven track record of solving some…

Thanks, Jennifer, and good morning, everyone. I'll begin with our consolidated results on Slide 8. Third quarter net sales grew 3% on a year-over-year basis to $1.25 billion. Our core sales were up 1%. Currency contributed 1.5%, and acquisitions contributed 0.5 point to overall sales growth. We continue to execute well on pricing to mitigate inflationary pressures. Pricing contributed 3.5% to sales growth in the third quarter over the prior year period. You can see this benefit in our gross profit, which increased 4% on a year-over-year basis to $723 million. Gross margin was 57.6%, up 70 basis points from the prior year third quarter. Adjusted operating profit was flat year-over-year. Note that on an adjusted basis, both quarters presented here include incremental standalone costs. Adjusted operating profit margin was 22.4%, down 60 basis points year-over-year, primarily due to higher SG&A related to growth investments and labor cost inflation. We generated $232 million of free cash flow, representing 113% conversion of GAAP net earnings. Moving to the next chart. I'll cover the business segment highlights, starting with Water Quality. Our Water Quality segment delivered $772 million of sales, up 4% on a year-over-year basis. Currency was a 1% benefit. Core sales grew 3% year-over-year as compared to 16.5% growth in the prior year period, bringing the 2-year core growth stack for Water Quality to about 10%. Pricing contributed 5% to core sales growth in the period, offsetting the impact of lower overall volume. On a positive note, we drove increased volume in water treatment across ChemTreat and Trojan businesses, which was more than offset by lower sales volume in water analytics businesses, weakness in China across both municipal and industrial customers, representing the biggest impact. Adjusted operating profit increased 3% year-over-year with margins down modestly due to an increase in…

Thanks, Sameer. In summary, we successfully executed our spin-off from Danaher and are off to a good start as a public company. Through 9 months this year, we have delivered 3% core sales growth, 50 points of adjusted operating profit margin expansion and 105% free cash flow conversion, solid operating results amid a dynamic macro backdrop. And yesterday, we announced our expectation to pay a quarterly dividend of $0.09 per share. Going forward, we are focused on delivering our commitments, driving continuous improvement and executing disciplined strategic capital allocation that create sustainable long-term value for shareholders. In closing, I want to reiterate our long-term value creation framework. Over the long term, we expect to deliver mid-single-digit core sales growth with incremental margin fall-through in the 30% to 35% range, and we expect 100% free cash flow conversion annually. We intend to complement core growth with disciplined strategic acquisitions. We are confident that the durability of our business, the essential need for our technology solutions and the strong secular growth drivers of our end markets will provide steady growth consistent with our historical track record. The combination of our leading brands, proven value creation playbook powered by the Veralto Enterprise System and the strength of our balance sheet differentiates Veralto, and positions us to deliver sustainable long-term shareholder value. And as we look to build our future, we are unified and inspired by our shared purpose: 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're happy to take your questions.

[Operator Instructions] And we'll take our first question from Mike Halloran with Baird.

Congrats on a good public -- first quarter as a public company. So let's start on the margin side here. Maybe you can give some context on why the healthy sequential uptick from the third quarter to the fourth quarter on the margin line. Any help you could give us by segment would be great. And then is this the right jumping-off point, adjusting for seasonality and revenue levels and all that? But is this the right jumping-off point as we think about 2024?

Yes, Mike. This is Sameer. I'll jump in on that one. As you kind of look at the sequential margin improvement, that's primarily driven by some of the cost optimization things that we've been doing, especially in PQI and also the impact of the Argentine peso devaluation in Q3. We have not assumed that in Q4. It's a one-off item in Q3. So majority of the uptick that you see on a sequential basis going from Q3 to Q4 will be in the PQI segment.

Got it. And then -- but is that the right thought process then for next year? I mean, is the fourth quarter more representative run rate as you think about things relative to the third quarter?

Yes. If you're going to look at some of the costs, things like standalone costs, we are ramping from Q2, Q3. They're going to be on a more run rate basis in Q4. So, they're going to start reflecting. But overall impact from the demand of sales, [ we aim to be ] ultimately close to the margin as well. We'll give that guide, view as we are going to get the guide early next year for '24.

Makes sense. And then on the PQI side, some comments about certainly softness in China. I don't think that's a surprise to anybody, but you also commented on the destocking side of things on the consumable side. So, a couple of things. One, could you just give us some thoughts on how you think this demand picture plays out as we look on a forward basis? But also in the fourth quarter, is the thought process that sell-in and sell-out are a little bit more balanced from a portfolio perspective? Or is there a little bit more to come?

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

That makes sense. And last one, if I may, on the Water Quality side of things. It certainly seems like if you exclude the China part of the business, where there's just broader-based weakness that there's a lot of stability across the portfolio here. Maybe just talk about how you think about the economic sensitivity of that segment, excluding the China piece? It certainly seems like that's built to be a little bit more resilient here.

Yes. I mean, certainly, our biggest downdraft in volume in water was attributed to our China business. I think what we see here is we see some relatively good growth on the treatment side. Certainly, Trojan benefiting from the CHIPS Act. We've got ChemTreat that's seeing good positive momentum in sectors such as energy, agriculture and metals. On the muni, demand side for municipalities is a little bit softer. Municipalities are really focused on making sure that they are focused on regulatory compliance, and so their order patterns are consistent with that. But they're still holding off a little bit in terms of plant upgrades and investments related to optimization. So process optimization is still a little bit lackluster, but solid demand still in the municipal regulatory compliance side.

[Operator Instructions] We'll take our next question from Andy Kaplowitz with Citigroup.

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

Yes, Andy. Thanks for the question. Look, I think overall for the PQI side, overall, yes, in general, the volumes are low. You're going to see some impact on the absorption side. But overall, the biggest impact actually was a currency one. So, that's why I highlighted that in my prepared remarks. And just to frame that for you, essentially, the impact if the Argentina peso devaluation impact you remove, actually PQI would have been up by almost 60 basis points. So that gives you just a sense of how big the impact was going from 22.8% to almost 24.2%. So, that is one of the biggest impact. And that, of course, is a one-off and we don't expect that to occur in Q4. And also, we did some cost optimization actions. As you know, we don't take those costs out, adjust those costs out. So the benefit of that, you're going to start seeing in Q4 itself. That's why I earlier said that you're going to start seeing a sequential improvement in Q4 in PQI, and that's driving big chunk of the overall company sequential improvement that we laid out in the guidance.

That's great, Sameer. And Jennifer, just -- I want to follow up on your comments on municipalities sort of holding back, I guess, at Hach. Seems like that's happening in North America. We know you have tough comps versus last year. But sort of what gets them to sort of accelerate to get back to, I would assume that you still think Hach could grow mid-single digits across the cycle. So what do you need to see to sort of get that to happen?

Yes. I mean, I think some of these supply and demand nuances will start to level out. There is good funding available with the Infrastructure Bill here in North America. We're seeing a robust growth here for our municipal business in Europe. So it's really more of a matter, I think, of sort of the global economic environment and sort of a steady recovery of industrial markets. But we hold to the mid-single-digit performance for Water Quality going forward. These are essential solutions for people around the world. So, we think the underlying macro is a little bit choppy right now, but the secular drivers remain strong.

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

Yes. Thanks for the question, Andy. Our pipeline across both Water Quality and PQI is strong for M&A, and we've got a number of opportunities that are currently being considered. We do not anticipate that we will require a lengthy ramp time as a public company. We have executed the spin with a remarkable level of discipline and focus on the back of the learnings that Danaher had from its prior spends, and we feel pretty good about where we are positioned. That said, we are going to take a very disciplined approach to M&A, just as we would expect from our heritage at Danaher. We're going to make sure that it's a market that we like with companies that have similar operating model durability and financial profiles where VES can drive growth and margin expansion. And we've got to be able to get at the right valuation. So we believe, obviously, this is going to be an important catalyst for value creation over time, but we will maintain similar rigor and discipline as we've seen amongst these businesses as part of Danaher in the past. So, timing is always difficult to predict. M&A is episodic, but we are in the market and working a number of opportunities.

[Operator Instructions] We'll take our next question from Joe Giordano with TD Cowen.

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

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

And Joe (sic) [ Michael ], maybe if I can add a little bit is as we talked at the Investor Day, right, we are lot more tied to the operating budgets to the -- of our customers rather than capital side, so that kind of helps us as well as you're going to move forward.

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

Thanks, Shelby. This concludes our third quarter earnings call. We thank you very much for joining us. I'll be available over the next several days for follow-ups should you have any additional questions. Thank you once again, and that concludes our call.

That concludes today's teleconference. Thank you for your participation. You may now disconnect.