My name is Leo, and I will be your conference operator this morning. I would like to welcome everyone to Veralto Corporation's Second Quarter 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. 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, and 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. A replay of this call will be available until August 9. Before we begin, I'd like to highlight a few recent disclosures. On July 24, we issued our 2024 sustainability report. That report can be viewed on our main website under Sustainability or on our Investor website under Corporate Governance. Yesterday, we issued our second quarter news release, earnings presentation, and supplemental materials, including information required by the SEC relating to adjusted or non-GAAP financial measures. Additionally, our Form 10-Q was filed yesterday. These materials are available in the Investors section of our website under the heading Quarterly Earnings. Reconciliations of all non-GAAP measures are provided in the appendix of the webcast slides. Unless otherwise noted, all references to variances are on a year-over-year basis. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results may differ materially from 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. With that, I'll turn the call over to Jennifer.

Thank you, Ryan, and thank you all for joining our call today. I want to start this call by recognizing the engine behind our strong second quarter results, our more than 16,000 associates around the world. Their strong execution and support of our customers drove our growth and improved profitability during the quarter. Nine months into our journey as an independent company, we are hitting our stride and delivering winning outcomes for our stakeholders. A key catalyst has been increased rigor in deploying the Veralto Enterprise System. As I've shared before, VES is a key competitive advantage for Veralto. It drives continuous improvement, accelerates innovation, and enables us to win in our markets. Every day, at all levels of our enterprise, our teams leverage VES to solve problems rapidly and drive sustainable improvements. Our increased rigor in deploying VES has helped drive growth, expand margins, and ensure that we deliver on commitments. Our second quarter results demonstrate the benefit of this increased rigor, while also highlighting the durability of our businesses. We delivered core sales growth across both segments, led by better-than-expected positive volume and price increases in line with historical levels. We expanded margins at both segments through strong operating leverage, improved productivity, and cost optimization. Based on our strong execution in the second quarter and an incrementally more positive view of our end markets, we have raised our full year adjusted EPS guidance. From an end market perspective, we are capitalizing on secular growth drivers across our industrial and municipal markets in Water Quality. In water analytics, our commercial initiatives are accelerating volume growth and market penetration, particularly in consumables. And in water treatment, we continue to see strong growth, driven by our customers' water conservation, reclaim, and reuse initiatives. On that front, ChemTreat was recently recognized as the Industrial Supplies & Services Supplier of the Year by one of the largest global beverage companies. ChemTreat is playing an integral role in helping this customer achieve its sustainability targets through wastewater projects that support the reclamation of hundreds of millions of gallons of water annually. In PQI, we are encouraged by ongoing recovery in consumer packaged goods markets and improved sentiment from brand owners and packaging converters. In our marking and coding business, recurring revenue grew mid-single digits for the fourth consecutive quarter. Notably, sales of marking and coding equipment accelerated during the quarter and grew on a year-over-year basis, with good traction on new product launches. One of those new products is Videojet's 2380 large character inkjet printer, which launched in early April and is off to an impressive start. This printer is designed for use on sustainable packaging materials, such as corrugated cardboard and other porous materials. Second quarter sales of the 2380 printer exceeded our expectations and we continue to build momentum through a robust sales funnel. In our packaging and color business, second quarter bookings were strong, driven in part by the success of new software launches unveiled at recent trade shows and industry events. At the Drupa Trade Show, our Esko, Pantone, and X-Rite teams jointly showcased their latest innovations and highlighted our seamless packaging workflow software and hardware solutions. At the event, Esko unveiled its S2 platform, a multi-tenant cloud-native platform that provides cloud computing, data sharing, and artificial intelligence. All Esko applications connect to this platform, giving all key stakeholders in the value chain access to live data and identical information wherever they are in the world. This integrated ecosystem will empower customers to compress workflows, harness cloud technology and artificial intelligence to accelerate speed-to-market with vital integrated color accuracy. This new technology helps our customers save time, reduce waste, and ensure brand fidelity. These workflow improvements help our customers minimize the environmental impact across their supply chains and achieve their sustainability objectives, while providing safe foods and trusted essential goods to their customers. This is a great example of the alignment between our product innovation and our purpose. Our work at Veralto is inspired by our unifying purpose, Safeguarding the World's Most Vital Resources. We live in a world with big challenges and Veralto plays a significant role in solving many of them. Helping customers ensure clean water, safe foods, and trusted essential goods for billions of people across the globe motivates all of us at Veralto each and every day. It inspires our associates who are drawn to Veralto because of the role our products and solutions play in helping preserve the planet, how we care for and invest in our people, and our efforts to minimize the environmental impact of our own operations. And it's easy to be inspired by the work that we do at Veralto. In 2023, our team helped ensure 3.4 billion people around the world had access to clean water for daily use, treated and recycled 13 trillion gallons of water, saved 81 billion gallons of water, and ensured product authenticity and safety by helping customers mark and code over 10 billion products every day. In addition to these positive and enduring contributions, I want to highlight two important commitments featured in this year's Sustainability Report. First, in support of our commitment to minimize the environmental impact of our own operations, we disclosed our 2023 Scope 1 and Scope 2 greenhouse gas emissions and committed to a 54.6% reduction goal by 2033. Second, in support of our commitment to drive a responsible supply chain, we set an initial target to have 40% of our supplier base certified through the EcoVadis program. EcoVadis is one of the leading sustainability rating agencies and will help us measure, assess, and improve the impact of our supply chain on the world. The role our products play in preserving the planet and the targets we have committed to achieve embody the culture and are made possible by our people. Our people are the most important part of our strategy and we invest heavily to recruit, develop, and retain the most talented and diverse team possible. Our 2024 Sustainability Report published earlier this week contains more details about our commitment and ability to deliver positive, enduring impact, and drive sustainable outcomes for the benefit of humanity. Now turning to our Q2 financial results. Before getting into the details, it's important to highlight a key underlying strength of Veralto, and that is the durability of our businesses. Approximately 85% of our sales are related to water, food, and essential goods. These are large attractive markets with steady growth, driven by strong secular trends. Our customers in these markets have an essential need for our products and solutions to support critical aspects of their daily operations where the risk of failure is high. Our durability is further bolstered by a razor-razorblade model, which drives a high level of recurring revenue, further catalyzed by VES. The CEO kaizen events we kicked off in Q1 are a strong proof point. These events, which focused on value-accretive growth, have already had a positive impact on our 2024 performance, evident in our second quarter results. On a consolidated basis, we exceeded our guidance on all fronts, with 3.8% core sales growth and 24% adjusted operating profit margin. Adjusted earnings per share was $0.85, up 6% year-over-year and $0.05 above the high end of our guidance range. And we generated $240 million of free cash flow, further strengthening our financial position. Looking at core sales growth by geography in the second quarter, sales in North America and high-growth markets grew in the mid-single digits and sales into Western Europe were essentially flat. In North America, core sales grew over 5%, driven by both segments. In Water Quality, we continued to capitalize on strong demand for our water treatment solutions, which grew high-single digits in North America. This growth was broad-based across most industrial verticals, with the strongest growth in food and beverage, mining and power generation. We also continue to see strong growth for UV systems at municipalities in North America. In Water Treatment, we're partnering with customers to help them achieve their sustainability goals related to water conservation, reclamation, and reuse. Our water treatment businesses are also well positioned in North America to support onshoring or reshoring activity, including tech operations, such as semiconductor fabs and data centers. Relative to North America, our PQI segment grew 3.5% in Q2. Packaging and color grew mid-single digits, with marking and coding up low-single digits. In high-growth markets, core sales grew by more than 4%. We continue to see strong growth in Latin America and India. And in China, core sales grew low-single digits year-over-year. In Western Europe, core sales were essentially flat year-over-year, including a 50 basis point headwind related to the strategic portfolio actions in our Water Quality segment that we mentioned on prior earnings calls. Excluding this headwind, core sales into Western Europe were up modestly. At this time, I'll turn the call over to Sameer to provide more details on our Q2 performance and our guidance.

Thanks, Jennifer, and good morning, everyone. I'll begin with our consolidated results for the second quarter on Slide 8. Net sales grew 2.8% on a year-over-year basis to about $1.29 billion. Core sales grew 3.8%. Currency was an 80 basis points headwind or approximately $10 million. And the small divestiture of Salsnes was a modest headwind. Our core growth in this quarter was balanced, with both volume and price increases driving our growth. Price contributed 2% growth in this quarter, in line with our expectations and historical levels. Volume grew 1.8%, with positive volume growth across both Water Quality and PQI. This marks the first quarter since the second quarter of 2022 in which volume grew across both segments. Our recurring revenue grew mid-single digits year-over-year and comprised 62% of our total sales. We expanded margins at both segments through strong operational leverage, improved productivity, and cost optimization. Gross profit increased 7% year-over-year to $774 million. Gross profit margin improved 230 basis points year-over-year to 60%, reflecting the benefits of pricing, as well as improved productivity and reduced material costs. Adjusted operating profit increased 5% year-over-year and adjusted operating profit margin expanded 70 basis points to 24%. We delivered strong margin expansion while investing in our sales and marketing efforts to drive future growth. We also increased our R&D investments, with R&D as a percent of sales increasing 20 basis points over the prior-year period. These investments are aligned with our strategic growth plans and we expect to continue to fund ongoing growth investments. Looking at EPS for second quarter, adjusted earnings per share grew 6% year-over-year to $0.85. And free cash flow was $240 million, down from the prior year, primarily due to standalone public company costs and cash tax payments, which were not incurred in the prior-year period. Moving on, I'll cover the segment highlights, starting with Water Quality on Slide 9. Our Water Quality segment delivered $777 million of sales, up 2.8% on a year-over-year basis. Currency was an 80 basis points headwind and the divestiture of Salsnes had 40 basis points impact versus the prior-year period. In addition to this divestiture, small product lines that were strategically exited in the fourth quarter of 2023 resulted in approximately 80 basis points headwind to core growth for the Water Quality segment in the second quarter. Despite this headwind, core sales grew 4% year-over-year. Pricing contributed 2.4% and volume growth contributed 1.6% to year-over-year core sales growth. Our volume growth was driven by strong demand for water treatment solutions in our industrial end markets and UV treatment systems in municipal end markets. We also saw growth in sales of lab instrumentation, reagents, and chemistries to municipalities. Recurring sales across the Water Quality segment grew mid-single digits. Adjusted operating profit increased 5.5% year-over-year to $192 million, and adjusted operating profit margin increased 70 basis points to 24.7%. The increase in profitability and margin reflects strong pricing execution, leverage on volume growth, and improved productivity. To a lesser extent, our adjusted operating profit margin also benefited from a favorable sales mix this quarter. Moving to the next page, our PQI segment delivered sales of $511 million in the second quarter, up 2.7% year-over-year. Currency was a 70 basis point headwind. Core sales grew 3.4%. Positive volume contributed 2% growth and price increases contributed 1.4% to the year-over-year core sales growth. PQI's recurring sales grew mid-single digits year-over-year for the fourth consecutive quarter with growth across the portfolio. Recurring revenue increased to 63% of PQI sales mix in the second quarter of this year. Breaking this down by business, core sales growth in our marking and coding business was in line with the segment, driven by growth in both consumables and equipment. This growth was driven by both CPG and industrial end markets. In our packaging and color business, core sales grew about 3% year-over-year, led by growth in recurring software and subscription revenue. PQI's adjusted operating profit was $141 million in the second quarter, resulting in an adjusted operating profit margin of 27.6%. That represents a 100 basis points improvement in adjusted operating profit margin over the prior-year period. This was another quarter of margin improvement for PQI, driven by strong operating leverage, particularly on the recurring revenue growth and productivity improvements. Turning now to our balance sheet and cash flow. In the second quarter, we generated $251 million of cash from operations and invested $11 million in capital expenditures. Free cash flow was $240 million in the quarter, or 118% conversion of GAAP net income. As of June 28, gross debt was $2.6 billion and cash on hand was just over $1 billion. Net debt was $1.6 billion, resulting in net leverage of 1.3 times. In summary, our financial position is strong. We have flexibility in how we deploy capital to create long-term shareholder value with a bias towards M&A. Turning now to our guidance for 2024, beginning with our updated expectations for the full year. We increased our full year guidance to reflect our strong second quarter execution and incrementally positive view of our end markets. For core sales growth, our target remains low-single digits; however, we are trending towards the high end of low-single digits. Through the first half of 2024, core sales growth was 2.8%. For the second half, we are targeting core sales growth in the low to mid-single digits range, similar to what we achieved in the second quarter. Looking at adjusted operating profit margin for the full year, we now expect to deliver approximately 75 basis points margin expansion year-over-year, which would put our full year adjusted operating profit margin at about 24%. This implies an incremental margin or fall-through of around 50%. For adjusted EPS, we raised our full year guidance range to $3.37 to $3.45 per share. At the midpoint, this represents 7% growth year-over-year and is $0.11 or about 3.5% higher than our previous guidance. And our guidance for free cash flow conversion remains in the range of 100% to 110% of GAAP net income. Looking at our guidance for Q3, we are targeting core sales growth in the low-to-mid single digits on a year-over-year basis. At the midpoint of our Q3 guidance, we are modeling a core growth rate similar to the second quarter. We expect adjusted operating profit margin of approximately 23.5% in the third quarter. This represents 100 basis points of improvement in adjusted operating profit margin on a year-over-year basis. And our Q3 2024 guidance for adjusted EPS is $0.82 to $0.86 per share. At the midpoint, that represents double-digit year-over-year growth. With that, I'll hand the call back to Jennifer for closing remarks.

Thanks, Sameer. In summary, we are executing well across the company with greater focus and rigor using VES, and we are capitalizing on the secular growth drivers in our key end markets. We delivered a strong second quarter across the board, with core sales growth approaching mid-single digits, continued margin expansion, and strong cash generation. Based on the strength of our execution and positive view of our end markets, we raised our full year 2024 adjusted EPS guidance. As we look longer term, we remain committed to creating value through steady, durable sales growth, continuous improvement, and disciplined capital allocation. That concludes our prepared remarks. And at this time, we are happy to take your questions.

Thank you. We'll take our first question from Scott Davis of Melius Research.

Good morning, Jennifer, Sameer, and Ryan. I need to ask about the gross margins because they have been remarkably strong. Is 60% the new normal, or is it more of a temporary situation? Also, I've noticed more mention of pricing power in this quarter and the last one than we anticipated. Are you finding that there is greater pricing power in your markets than you previously thought, which is contributing to that 60% gross margin? Is that a reasonable conclusion?

Yeah. Scott, let me just touch on the margin and then I'll have Jennifer just talk about the price. On the gross margin side, it's really been due to the increased rigor on VES, really driving the execution side. Frankly, it's been lots of singles and doubles that are driving the margin here. And also, as you see, we are benefiting a little bit from the recurring revenue here, right? The mix is more towards consumables to the spares, which is impacting and helping us on the margin. The packaging and color business, as you know, tends to be on the software side with a little higher margin. So, that's helping us. So, those things are helping us. I would say, you should expect the gross margins to come in a little bit as the growth rate equilibrates between the equipment and consumables over time. But we feel really good about 60%, but I think once the transition happens, we'll be more in the high-50% or 59% growth range.

Yeah. And I think, Scott, what you're seeing relative to price is our ability to sort of hold the value of our products in terms of commercial excellence related to VES. So the teams commercially are executing well around the world, but we have seen prices normalize to historical levels, which we believe fit in the range of 100 basis points to 200 basis points.

Okay. Fair enough. And just I feel obligated to ask about M&A. I know these things are lumpy and it's hard to kind of talk about it, but any update on maybe your pipeline and your enthusiasm about the assets that are out there?

Yeah. We remain pretty convicted about our M&A approach. We've got really robust funnels for both PQI and Water Quality. We're looking at a lot of assets and we're actively engaged in our market activity here. But consistent with what we've said on prior calls, we're really going to stay close to our heritage and the disciplined capital allocation around market, company, and valuation. So we obviously like businesses that have similar operating models and secular durability, financial profiles that look like us, and certainly businesses where we think VES can add value. So we're active here. We're excited about the space. We're working hard kind of on both sides of the fence, and more to come.

Yeah. Best of luck. Congrats on the first two quarters here of the year.

We'll take our next question from Deane Dray of RBC Capital Markets.

Thank you. Good morning, everyone.

Good morning, Deane.

Good morning.

Hey, I'll echo… Scott's comments, that's a clean quarter, kind of hard to find anything to quibble about. So maybe I'll start with product quality. Your primary competitor had some similar results yesterday in terms of strong aftermarket, but it looks like your printer sales are stronger. I know the 2380 sounds like that was a boost. Just can you comment on the mix and the go-forward, especially with the recovery expected in the consumer packaging goods?

Yeah. Thanks for the question, Deane. Our PQI businesses in the main are performing well. I think you see that both in terms of our marking and coding businesses. You also see it on our color and packaging side. We're not going to comment really on competitors' activity, but what we can say is, our marking and coding businesses are performing well and I think in line with the recovery of the consumer packaged goods market. So we see this fourth consecutive quarter of mid-single digit recurring revenue growth. And we also see, as you rightly point out, Q2 marking the return of growth in equipment sales. And so, this follows a nominal recovery that we see when we're coming out of a down cycle where consumables and, by way of inks and solvents and spare parts and so on, recover before equipment does. We're excited about the funnel that we have for equipment. And certainly, as we talk to our CPG customers, their sentiment is more positive in terms of the future outlook. From a packaging and color standpoint, we've just finished the Drupa Trade Show, where we got a lot of positive response in terms of the products being launched there, mostly around our S2 native-cloud, digital integrated solutions. This really helps reduce time-to-market for the brands. It also helps mistake-proof relative to the information that they're passing around between their functional departments. So, funnels are healthy on both sides. The market recovery in terms of CPG itself is a little bit lumpy. We do see mixed results across various CPG categories. But certainly, we're encouraged by the market indicators and I think our teams are executing well with recent product launches, and our new product innovations really are gaining momentum.

It's all very helpful. And just a geographic question. Just for both businesses, what was the sense of demand in China and the outlook? The expectation is that you all have a very defensive type of mix there, but will you feel any of the ongoing pressures in the economy over the next couple of quarters?

Yeah. I think, Deane, our view of China hasn't materially changed from quarter to quarter. I think we believe that China has stabilized related to the end markets, but we don't expect to see any meaningful recovery in China this year. I think for state-owned or state-sponsored municipalities, funding is still extraordinarily tight. So we're not seeing much money flow there. I think long-term, China is anticipated to improve. It's got a large and aging population. Those folks are going to require clean water, safe food, and trusted medicines. But our China team has stepped up to the challenge here in the slower growth macro and we continue to ensure that we have a China business that's creating incremental value for Veralto.

And then, Deane, from a guide perspective, effectively, you assume China will be sequentially flat, right? So, as you know, we were down quite a bit in the Q3 and Q4. So you're going to see a little bit of an uptake on a year-over-year basis as we kind of get into the second half, but sequentially, it's effectively flat.

That's real helpful. Thank you.

We'll take our next question from Andrew Kaplowitz of Citigroup.

Hey, good morning, everyone.

Good morning, Andy.

Good morning, Andy.

Jennifer, you raised your revenue guidance by $100 million for '24, I think, versus last quarter's forecast. So, maybe just give us a little more color into what markets are better than you expected. I know you just talked about Videojet equipment starting to accelerate. What are you baking in now for the second half of that improvement? And then in Water Quality, is it more that water treatment is driving continued strong momentum, or are you seeing more improvement in water analytics?

Yeah. I mean, I think we see strength across the board, really. We benefit, I think, from a couple of areas here. One is just the markets that we're in and the quality of the products we bring to market being part of the essential nature of customer operations. I think the deployment of VES and the increased focus that we have as a standalone company continues to help us execute well commercially. From a macro standpoint, on where the demand is occurring, water and municipalities, particularly in US and Europe, continue to execute on project backlog in terms of improvements to their respective plants and their run rate business is steady. We do see some nice pockets of growth coming for our water treatment businesses and see some tailwind and some benefit from things like the CHIPS Act in terms of building out their data centers, which are requiring an extensive amount of water in their cooling towers. And those kind of two markets really benefit our ChemTreat and our Trojan businesses, respectively. So we're seeing good sort of solid, steady, robust demand really for both water treatment and Water Quality.

Very helpful. And then Jennifer, just going back to M&A, like, I know timing is always difficult, but would you expect to get something done this year? And then under what conditions would you do a larger deal where you may potentially raise equity?

Yeah. I think you are right that M&A is clearly episodic. We can't guarantee the intersection of when we will see market, company, and valuation come together. As we've mentioned in the past, we're going to stay disciplined to that approach. We have to like the market, right? It's got to be adjacent or near-adjacent to where we play. The company has got to be a strong company that has secular drivers that we value under the umbrella of Safeguarding the World's Most Vital Resources, and we got to be able to get at the right price. I think right now, valuations are still a little bit inflated. So we're looking at the intersection here, but we've got to fundamentally get to all three of those variables. And all I can say is, we're working hard in this area.

And Andy, just going to look, think about the equity side, it's just one of the components of how we think about funding any transaction. The main thing is value creation, right? Anything that can ultimately help us create long-term value, we'll look at all forms of funding, as we have talked about in the past. The main thing for us is that we're going to think of any kind of funding is maintaining investment-grade balance sheets. That's sacrosanct for us.

Appreciate the color, guys.

We'll take our next question from John McNulty of BMO Capital Markets.

Thank you for addressing my question. I'd like to focus on the free cash flow aspect. You've reported a very strong quarter, exceeding your expected conversion levels for the year. Could you explain what contributed to this performance? Additionally, are there opportunities to improve working capital that could help maintain this elevated level in the upcoming quarters? How should we approach this?

Yeah, John. Thanks for that. As you kind of look at the free cash flow conversion, quarter-to-quarter, it can vary. As you know, we have the bond payments that come in the first quarter and the third quarter. So that gets impacts timing of the cash payments. So I would say, when you look at the free cash flow conversion, really look at it on a full year basis. Overall, given the strength that we're seeing in the business, the execution, we feel pretty good about delivering 100% to 110% free cash flow conversion, that's off GAAP net income.

Got it. Fair enough. And then just a question on SG&A. It took a reasonable jump up, somewhere in the 7.5% kind of range. I guess, can you help us to think about how much of that is just general labor, inflationary type trends versus the corporate side, where now you're a public company versus investment for growth? I guess, how should we be thinking about the various buckets there?

I think we can look at this in two parts. First, on the business side, as we mentioned earlier this year, we are investing in sales and marketing to drive growth. You can see that reflected in our numbers from the first and second quarters. Regarding inflation, we are experiencing some effects like everyone else, but they are not significant. The new hires are primarily focused on sales and marketing to support growth, and you will start to notice the impact of these investments more in 2025. Overall, we are operating in a relatively normal state when it comes to business and SG&A as a percentage of revenues. On the corporate side, we are being careful with our costs. You will notice a slight increase in corporate expenses in the second half of the year compared to the first half, but that should stabilize later on. There is nothing unusual in that area.

Great. Thanks very much for the color.

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

Hey, good morning, everyone.

Good morning, Mike.

Good morning, Mike.

So, just some thoughts on the product rationalization side of things, some of the initiatives you're doing there. Maybe just how far along do you think you are in that journey in general? Have most of the areas been identified already, or do you think that there's more to come on that side of things?

I think, Mike, what you've seen us do is just refining our approach, and this is actually part of our regular work in managing our business portfolio. It's not something we address occasionally; we focus on this continuously. When we identify opportunities for enhancing our portfolio to make it stronger, concentrating on higher growth areas with better margins and recurring revenue, we will take action on anything that significantly deviates from that. We are confident in our current portfolio and will keep refining it as necessary when the time is right.

Makes sense. To follow up on Andy's earlier question, when you consider the increased confidence going into the latter half of the year, has anything really changed, or is it simply a matter of beginning to see the momentum from this year’s first quarter that boosts your confidence? In other words, has there been any change in your outlook regarding how these end markets will develop?

Well, I think we've come out of a pretty tumultuous several years following the impact of the pandemic, Mike. And we saw a lot of whiplash, right, in terms of price and volume and demand cycles and consumer spending and what they were spending on and so on. I would say that our confidence is built more as a function of an enduring steady state for our Water Quality businesses, driven by the secular drivers that we've talked about and an incrementally improving macro here for consumer products, goods markets. 85% of our revenue goes into water, food, and pharmaceuticals, and provided that those markets are steady or improving, we're going to see that benefit.

Appreciate it. Thank you.

Thanks, Mike.

Our next question is from Brian Lee of Goldman Sachs.

Hey, everyone. Good morning. Thanks for taking the questions. I guess…

Good morning, Brian.

Good morning, Brian.

Good morning, Sameer. You mentioned in your prepared remarks some favorable mix in the Water Quality segment that may have contributed to the margins. Could you provide more details on that and whether you can quantify it? Also, do you expect this trend to continue in the upcoming quarters?

Hey, Brian. Yeah. I'll take that one. The mix comment is really around consumables. We've seen a good amount of consumable uptick that's driving it. As you've seen, our recurring revenue is almost at 62% right now and that is predominantly mix and a little bit of spares and some of the SaaS software side, but predominantly consumables. If you recall and go back into the history, when things are more normalized, that tends to be in the high-50s, right. So that kind of helps you dimensionalize now the transition as the volume comes back on the printer side, in PQI, instrumentation side, on the Water Quality side, it's going to be a multi-quarter journey as we kind of move. So, you're not going to see a big variation quarter-to-quarter, but that sort of 62% versus high-50s is the way to dimensionalize the change over time.

That's helpful. I know you're discussing improvements in end markets overall. Jennifer mentioned strong backlog trends in Water Quality. Could you elaborate on the strong bookings in packaging and color? Our understanding is that this is more of a short cycle business. What kind of visibility do you have? Are those areas also showing improving trends? Any insights on the short cycle aspect of your business would be appreciated. Thank you.

We recently wrapped up the Drupa Trade Show, which occurs once every four years. This was the first time it took place in eight years due to the pandemic, leading to significant pent-up demand. Our innovative solutions, especially those related to the S2 cloud-native digital integration workflow, gained a lot of attention from brand owners. They are under pressure to shorten their development cycles and maintain information integrity, allowing everyone who uses the system to access the same data. We made a strong impression at the show, and the teams from Esko, Pantone, and X-Rite performed exceptionally well. Beyond the excitement from Drupa, the recovery in the consumer packaged goods markets is likely to drive new product launches and innovations from brand owners who are preparing multiple projects for new releases. We believe we are well positioned to support them with our solutions.

Okay. I appreciate the color. I'll pass it on.

We'll move next to Brad Hewitt of Wolfe Research.

Hey, good morning, guys. Thanks for taking my questions.

Good morning, Brad.

So, I guess, I wanted to start on the margin side of things. Your guidance implies about a 50 basis point step-down in margins in Q3 versus Q2 despite the fact that revenue, I think, should be flat to slightly up sequentially. And then also your trade show expenses should step down quarter-over-quarter. So, just curious if you can talk about kind of the drivers of the sequential margin pressure there.

Yeah, Brad. This is Sameer. Effectively, really two things here. The first one is the mix comment that you made earlier. Our mix is pretty rich in consumables and recurring revenue right now. We have started seeing some good, encouraging signs on the equipment side. We said in the second quarter, we finally saw a positive revenue growth on the equipment side. So we've modeled in kind of a decent equipment growth in the Q3 and second half of the year. So mix impact is what's kind of flowing through here. And the other one I would say is really on the corporate side. As we kind of get into the second half of the year, we are going to be getting more towards the run rate expenses on the corporate expenses. So that's impacting the margin side as well. So it's really those two things that are impacting the margin.

Okay. That's helpful. And then, I guess, going back to the long-term incremental margin framework of 30% to 35%, I know that includes kind of some reinvestment in the business. But just given the strong execution on VES since the spin, as well as the implied 50% incremental margins this year despite volume growth kind of in the 1% to 2% zone, does that give you confidence on perhaps something more like 40%-plus incrementals going forward over the medium term?

Thank you for that. I want to give a shoutout to all our teams, all 16,000 people, for driving the results you're seeing. I'm really proud of what we've accomplished this year. Looking at the long term, I believe a target of 30% to 35% remains appropriate. This should include a balanced investment strategy on both the sales and R&D sides. In the short term, however, the teams' excellent performance is leading to a fall-through rate close to 50%.

We'll take our next question from Nathan Jones of Stifel.

Good morning, everyone.

Good morning, Nathan.

I guess, I'll follow up on that last question. You guys have made it pretty clear that you intend to continue to invest in growth here. Can you talk about what you think the growth rates will be in kind of investment in commercial resources, investment in sales, investment in R&D kind of over the next several years rather than just any one year to the next?

No. I think as you kind of think about long term, these investments should be supportive of the mid-single digit growth framework, right? And that is 4% to 6% kind of a range, as we have kind of talked about. So as when we think about that mid-single digit growth framework, we do reflect the incremental contribution coming from these investments on the sales and marketing side, as well as on the R&D side, right? This is a technology-heavy business as you kind of think about in the commercial execution business. So those investments are key as we kind of think about long-term sustainable value creation.

So, you would be looking at kind of that kind of mid-single digit growth in those investments as revenue?

Yeah.

Now, look, the other question I had…

It depends. To clarify, this is a cumulative aspect we are considering. The new investment should contribute to higher growth from their side, but there are also factors that may exit the portfolio.

Got it. The other question I wanted to ask is on the recycle, reuse, reclaim market driver. I think that is likely to be a pretty considerable driver of investment from industrial water users. So I'm hoping you could talk a little bit more about where Veralto plays, kind of how much of your revenue that makes up where you think it could go to over the next five-year to 10-year kind of timeframe, long-term growth rate you're expecting out of that, just because I think that's going to be a pretty good driver of incremental demand.

Yeah. Thanks for the question, Nathan. We do see great demand here in recycle, reclaim, and reuse. The businesses most impacted by that certainly is our Trojan business, which is well-positioned there to help customers with their sustainability initiatives in this space. ChemTreat also has a play here. And certainly, if you're going to be moving water around, you're going to have to test it as well. So it does create some opportunity for our analytics businesses. But the primary beneficiary really of this opportunity would be our Trojan business. And frankly, we see this space growing probably mid-to-high single digits for the foreseeable future. Lots of industries are under pressure to achieve their sustainability targets, and we're well positioned with solutions to help them.

Great. Thanks for taking my questions.

Our next question is from Andrew Krill of Deutsche Bank.

Good morning, Andrew.

Thanks. Good morning, everyone. I wanted to revisit the topic of margins from a medium-term perspective. There's been considerable discussion regarding the company's considerable opportunities to enhance margins, which may not be fully recognized by investors. Could you provide any updates on your findings since the spin-off and whether you might consider quantifying those insights in the future? Also, would you say there is more potential in one segment compared to another, or are the opportunities largely similar? Thanks.

Thank you, Andrew. When we consider the potential for margin expansion, it's clear that the work being done by our teams in procurement, along with the efforts on the shop floor and factory optimization, is yielding consistent results. As I mentioned earlier, this margin expansion is not driven by just a couple of factors. This illustrates the strength of our kaizen culture, where we expect to see significant contributions to margins. The execution of these initiatives has given us the confidence to raise our margin expansion forecast for the year from 50 to 75 basis points. This adjustment positions us to achieve approximately a 24% operating earnings margin for the full year.

Okay. Great. Very helpful. And then can you give us an update on the situation in Argentina and maybe just how much contingency, if you will, you have left in your guidance for the full year? And then, I guess, depending on how that shakes out the rest of the year, how that could help or hurt PQI margins in the back half? Thanks.

Yeah. Very brief, right, Andrew, as you kind of look at Argentina, as we said at the Q1 call, we did the Blue Chip Swap to really insulate any impact on the historical cash that really drove the impact last year. But as you kind of move into this year, effectively, our exposure is much smaller, and that's reflected in the guide.

Okay. Great. Thank you.

We'll take our next question from Andrew Buscaglia of BNP.

Hey, good morning, everyone.

Good morning.

Good morning.

I'm examining your guidance and trying to understand the ranges. Regarding the high end, I'm curious about what considerations contribute to that figure, as it seems challenging to reach. Does this imply a need for sales to suddenly increase, or might you have additional margin growth anticipated? Essentially, I would like to know what factors are influencing that high end.

Thank you for that. It really depends on our perspective on the CPG markets. The CPG markets are evolving and gradually becoming more positive, but our view is changing rapidly. As you consider the guidance range, a major factor is how we perceive the CPG markets and their impact on the PQI topline. I would highlight that as one of the key considerations. On the margin side, we always evaluate the balance between raw material prices and their contribution. We believe we've taken a cautious approach here, so any advantages we see will likely be more sustainable towards the high end of the range.

Okay, that's helpful. I wanted to ask if there are any updates on the PFAS regulation opportunity regarding your discussions with customers or your product development efforts. What’s the latest on that?

Yeah. We continue to be interested in this space. But as you know, this is an incredibly difficult and complex problem to solve. We believe that we're well positioned, given our 70-year history at Hach for democratizing tests and analytics and our long track record at Trojan for developing treatment solutions. So we continue to invest in this space and stay focused there, but real fit-for-purpose solutions that are focused on at-site or in-line testing and at-site real-time destruction of PFAS are going to remain a difficult problem to solve. But we're focused on creating winning outcomes for our customers that have fit-for-purpose solutions. So, still a few years away here, but we are interested in the space, as we are with sort of all of the micro-contaminants that come into the regulation frame.

Okay. All right. Thank you.

We'll take our next question from Joe Giordano of TD Cowen.

Hey, guys.

Good morning, Joe.

Good morning. I appreciate the opportunity to ask my questions. I'm curious about the commentary on industrial growth because we aren't seeing that trend widely. The industrial data appears quite poor, and many companies are experiencing a decline in orders. It was intriguing and positive to hear about growth in that area. Could you elaborate on what is driving this growth? Is it due to ramping up new projects or optimizing existing facilities? What specifically is contributing to this growth, as it seems somewhat unusual?

Yeah. I think what you're seeing here is that there's really three things that differentiate us from other industrials. We play in the end markets with really attractive and kind of non-optional secular growth drivers, right? So, when you've got a business that's 85% of our sales into food, water, and pharma, these are not elective areas of testing, right? So these are really durable markets. And as a consequence, the way our businesses have been built are durable in turn. 60% of our recurring revenue or 60% of our revenue is kind of in this recurring revenue space. It's a razor-razorblade business model with high-margin consumables. And these products and services that are deployed for our customers are essential parts of their operation. So, if they choose not to use our products or they choose not to treat and measure and monitor and so on, the cost of failure to them is high, because we're really tied to sort of product quality and public health. So the last thing I would say is, VES provides a competitive advantage for us really in terms of differentiating us relative to talent growth and continuous improvement. So, we feel good about our ability to continue to grow in these sectors, particularly in the recovering industrial markets.

Regarding margins, we've discussed this quite a bit, but with gross margins at 60%, that's impressive. However, the difference between gross margins and EBITDA shows that 30% in SG&A seems somewhat elevated for a newer company. Looking ahead, what do you consider a realistic level for that to normalize?

Sure, I’ll address that. It really comes down to sales and marketing. When you examine the profit and loss statement, it aligns with our value creation strategy. Our focus is largely on research and development because it’s a technology-driven business. On the commercial side, we believe our unique strength lies in our direct business model, which effectively influences the sales and marketing results reflected in our numbers. Overall, we are confident in our direct business model, as it provides us with a competitive edge in the market.

Thanks, guys.

And this does conclude our question-and-answer session. I'd be happy to return the conference to Ryan Taylor for closing comments.

Thank you, Leo, and thanks for everybody that joined us on the call today. We really appreciate your engagement and the discussion. Feel free to reach out to me if you have any more follow-ups. Thanks again for joining us, and we'll talk to you next quarter.

This does conclude today's conference. You may now disconnect your lines, and everyone, have a great day.