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.

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.

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…

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…

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

Hey, good morning everyone.

Good morning, Scott.

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?

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.

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.

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.

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.

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

That's 23 years of Danaher coming through, Scott. Thank you.

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

Thank you. Good morning, everyone.

Good morning, Dean.

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.

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.

I know there's a continuous review, but are most of those cleanups done at this point?

Yeah. I mean, the two minor strategic actions we took amounted to about $20 million in annual revenue. We look at the portfolio on an ongoing basis and I would say that there's nothing material that needs to be done from a transformation standpoint. But we will continue to sort of prune and invest as appropriate, where we see the growth opportunities and the required return on investment.

Great. And then just second question, but a bit related, you mentioned filtration. I'd be interested in hearing a bit about Aria Filtra. I mean, this was a fabulous brand within Danaher as Paul Water, one of the leaders in membrane filtration. Just give us a sense of where and how are you positioning this business in Veralto, either strategically, kind of what end markets and what opportunities for growth do you have?

Yeah, you bet. Well, as you cited there, the Aria Filtra business is the rebranded Paul Water business, and we've actually pivoted how we're investing in this business. We're seeing very strong demand, particularly in critical applications for drinking water and portable reuse. So when it comes to recycle reclaim, it's an essential technology, and certainly in the macro that's become a more important part of water conservation. But we have repositioned this product line to allocate resources to highest return opportunities with more focus in North America and additional investments in mobile water treatment.

Great. Thank you.

You bet.

And we'll take our next question from Andy Kaplowitz with Citigroup. Your line is open.

Good morning, everyone.

Good morning, Andy.

Jennifer, Sameer, can you give us more color into what you are seeing in product quality focused markets? I think you had guided to download and mixing the digits Q4 yet, as you said you came in over 1% core growth. And core growth accelerated relatively significantly versus Q3. We know comparisons are a bit easier, but you did mention the early signs of recovery, particularly with food and beverage packaging customers. So could you elaborate on what you're seeing? Have you seen continued recovery as we started Q1 here? And I know you suggested lessening the budget growth for the segment ‘24. Is it just a tough comparison that is leading you to guide to flatten down for Q1?

Yeah, so thank you for the question. You know, I think what we said here as we came out of Q3 that customer destocking had largely been completed. We are 75% direct-to-customers, short-cycle business, so we don't have a lot of inventory sitting in a lot of intermediary depots. But what we did see in Q4 is the sales of PQI consumables by way of ink solvents and spare parts growing mid-single digits year-over-year, and we're also hearing from customers in the market that some of the leading indicators have turned positive. Now, this is predominantly in certain sectors of the food and beverage markets. But as price and volume in consumer packaged goods and groceries and the like start to rebalance, those lines are coming back online, and we're starting to see some of that volume start to increase as that equation rebalances. So, we do think that we'll continue to see a steady sequential recovery over the course of the year, but I think we're being prudent and modestly optimistic about how to think about that.

And Andy, if I can just add a couple of comments as it relates to the guide. We expect steady recovery in the CPG market sequentially, but overall being cautious as we kind of look at the commentary from the CPG customers and also what we're seeing in the channel. So from an overall year perspective, we're modeling in low single-digit core growth for the business, but the volume is going to be a tale of two halves. Effectively at this point, from a guide perspective we're modeling in low single-digit decline in the volume side, and that essentially means accelerating into positive low single-digits in the second half on gradual market recovery. So that's how we're kind of modeling it in the guide.

Okay, very helpful. And then maybe a similar question on the Water Quality side. It was also there in your guide in Q4, but still has been slowing a bit year-over-year. Comps are getting a little easier. So are you still seeing some reticence on the part of U.S. municipal customers? I guess it's more focused on HARP there, but is it really China just slowing you down for HARP? What's going on in the U.S.? And do you have visibility toward Water Quality getting back over all the mid-single-digit levels of growth at some point in ‘24?

Yeah, I mean it's probably the comp challenge, right. I think in the first quarter here is the last of our really tough comps on a year-over-year comparative basis. But in North America, we saw nice growth and continue to see nice growth for demand of our UV Trojan systems, and this is particularly related to reuse treatment for potable water. We see demand for analytics steady on a year-over-year basis, and saw some increase sequentially from Q3 to Q4. Europe, we see steady demand there coming out of Q4. I do think China is still a little bit suppressed in terms of its demand, although we're seeing a sequentially stable demand throughout the third quarter here. Year-over-year demand was down in China just due to lower government funding relative to 2022, but we're cautiously optimistic about the sequential improvement over the course of the coming quarters in China. We don't think it's going to get any worse and we've had a positive start here in January right out of the gate. So it's a little bit variable across the geographies, but we see good demand for where investments are happening.

Yeah, and Andy, just one quick point I would add to that is, as you're going to think about Water Quality, in the Q1 it's a very tough comp, as Jennifer just mentioned. And also, most of our broad portfolio does not have any seasonality, but Water Quality is one where we do see a little bit. Q4 tends to be strong as the budgets are finishing up the municipalities and similar institutions kind of making decisions. Q1 at the beginning of the year, people are a little predescent to how they kind of think about spending on the budget. So there's a little bit of seasonal element into Water Quality, not a whole lot, but that's something to keep in mind as well, and that's kind of baked into the Q1 guide.

Appreciate the detail.

And we'll take our next question from Mike Halloran with Baird. Your line is open.

Hey. Good morning, everyone.

Good morning, Mike.

Maybe we could have a similar conversation. How you are thinking about the margins, given the separation and moving pieces around everything. How do you think about the jump-off point into ‘24 from a margin level? Is the fourth quarter, if you adjust for the deval, the right way to think about the two segments? And then how do you think about cadencing through the year in 2024? Should you just kind of follow that revenue pattern you were talking to or is there a different pattern to think about?

Yeah Mike, I'll take that one. As you're going to look at the margin profile, we had a pretty strong finish to Q4. But as you kind of move from Q4 into 2024, for the full year we expect to deliver 50 to 75 basis points. There's going to be sort of a sequential improvement through the year. In Q1, as you can imagine, we're going to probably see the biggest impact, the run rate of the stand-up and the corporate costs. So that's going to have a tough compare in Q1 on a year-over-year basis. You're also making some select investments in both Water Quality side and PQI side, more oriented towards growth in the sales and marketing kind of initiatives, which are going to impact Q1. But overall, as you're going to think about for the full year, we expect to deliver 50 to 75 basis points of margin expansion. And that includes roughly $40 million of headwinds that's going to come from run rate corporate expenses and the stand-up company costs. So 50 to 75 with a margin, or with a fall-through of roughly 40 basis points is how we're going to think about it.

Okay. And I might have missed this, and I appreciate that. What's the interest expense expected to be this year?

Yeah, interest expense, you should think of Mike, roughly $140 million on a run rate basis for us. That includes a little bit of a benefit from the interest income, but overall $140 is a good assumption for modeling purposes.

Great. I appreciate it. Thank you, everyone.

Thanks Mike.

And we'll take our next question from Nathan Jones with Stifel. Your line is open.

Good morning, everyone.

Good morning.

Question first on PQI. I think it makes sense that you would say the recovery in consumables first. Can you talk a little bit about what would be a typical lag time before you start to see improvement on the equipment side from that improvement in consumables?

Yeah, I think it's typically a couple of quarters. It certainly depends upon the individual company and customer, but generally I would say that it's around two quarters.

Okay. And then I wanted to follow-up on Deane's question about Aria Filtration. A couple of the comments that you made there, sort of lead me to questions about the strategy there. Are we looking at some kind of outsourced water model, water as a service model, where you are kind of able to leverage the footprint you have in testing to build that kind of a business up? Is that the kind of thing that we're talking about with the changing strategy of that business?

Yeah, I mean certainly every business will take a look at its portfolio and position it to be – to fully meet the needs of the customers and certainly align with where the opportunities are. That is not currently in our purview, but remains to be something that could conceivably be considered in the course of sort of moving the strategy along.

Yeah, the strategy point Nathan is more around really focusing around geography product combination, so this is not a complete wholesale change in strategy. Just want to highlight that.

And just the last one on price-cost, you said 100 to 200 basis points in 2024. Are you assuming that that's neutral to margins or slightly accretive to margins?

No, I think overall maybe slightly positive, Nathan. I think when you look at the overall contribution to the margin, I think it's helpful to just have a look at holistic basis. On a holistic basis it'll be 50 to 75 basis improvement of the margin. It's going to come through a combination of price and volume, and frankly, some of the cost optimization initiatives just as far as continuous improvement are going to bake into that as well. So that will result in a pretty healthy fall through of 40%.

Awesome. Thanks very much for taking my questions.

Thank you.

You bet.

[Operator Instructions]. We'll take our next question from Andrew Krill with Deutsche Bank. Your line is open.

Hey, thanks. Good morning, everyone. I wanted to go back to the 1Q margin guide of 23% to 23.5%. It just seems like a pretty big step down sequentially versus the around 25% in 4Q if we add back the Argentina number. I know I mentioned this is in a very seasonal business and there's a little bit more corporate cost, but just anything else going on sequentially and maybe any help by segment on margins? Thanks.

Yeah, Andrew, maybe I'll take that one. As you're going to look at the sequential margin specific to Q1, there are really three things at play. The first one is the ramp up of the standalone company cost and the corporate cost. As you know it's going to have the toughest year where you're comparing in Q1 for us. That's going to be an impact. Even in Q4, we were pretty judicious in how we're going to bring in some of the costs related to the standalone company costs. So Q1 is where we're going to start seeing the full run rate. And as I said earlier, the second one is going to be on the select investments that we are making. I think as we kind of look at the opportunity landscape in both Water Quality and PQI, there are some select growth investments we want to make that will impact Q1, and the benefit of those investments should start flowing through the P&L in the second half of the year. Lastly I would say, just at the beginning of the year, water is slower to start given that Q4 is much stronger, and that's always going to have a margin decrement, right. So a combination of those three things is really driving it. There are no major in materials otherwise impacting the margin. Overall, if you kind of again step back and look at the full year, we expect to deliver 50 to 75 basis points. We feel pretty good about delivering that. So I think in the margin, sometimes quarter-to-quarter there can be some variance, but it's good to step back and look at the full year.

Great. Then just a quick follow-up. I know in the intro comments, I think there's a lot of discussion on the innovation, new products for this year. Is there any way you can quantify how much of a benefit that might be in 2024? And is it more focused on one segment versus the other? Thanks.

I think across the board, we generally see about 4% to 5% of sales spent on R&D and innovation. That has been the case throughout history, and we're carrying that forward as part of the model as well. I do think what we have as an independent standalone company, a more acute focus on where those dollars go in terms of really driving to investments that are high return and strategically compelling from the standpoint of solving customer problems. So you can think about that average as being spread pretty evenly across both Water Quality and PQI.

Thank you.

[Operator Instructions]. And it appears that we have no further questions at this time. I will now turn the program back over to our presenters for any additional or closing remarks.

Thanks, Shelby. This is Ryan Taylor. I just want to thank everybody for joining us on our fourth quarter and full year earnings call today. We appreciate your engagement and your support, and we look forward to talking to you next time. Thank you.

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