Veralto - Q1 2024

Transcript

Operator (participant)

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 first quarter 2024 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. If you would like to ask a question during that time, simply press star, then the, then the number one on your telephone keypad.

If you would like to withdraw your question, please press star, then the number two on your telephone keypad. I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr. Taylor, you may begin your conference.

Ryan Taylor (VP of Investor Relations)

Good morning, everyone. Thanks for joining us on the call. With me today are Jennifer Honeycutt, our President and Chief Executive Officer, and Sameer Ralhan, our Senior Vice President and Chief Financial Officer. Today's call is simultaneously being webcast. A replay of the webcast will be available on the Investors section of our website later today under the heading Events and Presentations. A replay of this call will be available until May 8, 2024.

Before we begin, I'd like to point out that yesterday we issued our first quarter news release, earnings presentation, and supplemental materials, including information required by the SEC 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 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 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. With that, I'll turn the call over to Jennifer.

Jennifer Honeycutt (President and CEO)

Thank you, Ryan, and thank you all for joining our call today. The first quarter of 2024 marks our second consecutive quarter of solid operating execution as a standalone company. We are driving steady, profitable growth and continuous improvement through greater focus and accountability using VES fundamentals, basic blocking and tackling.

For Q1, we delivered 8% adjusted earnings growth year-over-year, driven by 2% core sales growth and 90 basis points of adjusted operating profit margin expansion, and we exceeded our guidance across the board. Our financial performance reflects our culture of continuous improvement and demonstrates our ability to deliver on commitments. From an end market perspective, we are seeing healthy trends across our key verticals.

In our Water Quality segment, we continue to see positive secular growth drivers across industrial markets, particularly in North America, along with steady demand at municipalities. In our Product Quality and Innovation segment, we are seeing modest signs of recovery in consumer packaged goods markets. Most notably, PQI's recurring revenue grew mid-single digits year-over-year for the third consecutive quarter.

Equipment bookings for Marking and Coding started to show signs of recovery late in the first quarter, and we continue to see encouraging trends at some of our large CPG customers led by food and beverage. Based on our first quarter results and improving market trends, we continue to expect our core sales growth rate to modestly improve sequentially throughout the year. Looking at our full year guidance, we are on pace to deliver low single digit core sales growth and are trending toward the high end of our adjusted operating margin range of 50-75 basis points of improvement over 2023.

As a result, we have modestly increased our full-year Adjusted EPS and free cash flow conversion guidance. Sameer will cover that in more detail a bit later in the call. Confidence in our ability to deliver on commitments is, in large part, grounded in the Veralto Enterprise System, our proven system for driving growth, operational improvements, and leadership development. A core tenet of VES is continuous improvement, or Kaizen. During March, we completed Veralto's first CEO Kaizen Week as a standalone company.

CEO Kaizen Week is a long-standing tradition of our enterprise system and personally one of my favorite weeks of the year. The purpose of this year's CEO Kaizen Week was to drive value-accretive growth. For one week, we immersed 12 cross-functional teams at Gemba, where the real work happens, across six businesses in five countries. The Veralto executive team worked alongside associates in our operating companies to solve some of the most complex challenges and yield high-impact results.

For example, this year's event included increasing customer engagement in North America and EMEA to drive incremental sales growth of Hach's consumables, improving the customer buying experience at Videojet to accelerate key growth initiatives, and using lean conversion tools for make-to-stock products at a Hach distribution facility in North America to optimize efficiency, improve on-time delivery, and meet increasing customer demand. The benefits of any Kaizen week include immediate solutions that are rapidly implemented and yield real-time results.

Success is proven by sustaining these results, which we track following the Kaizen event. From a big picture perspective, this year's CEO Kaizen Week fortified our ability to deliver on our commitments to key stakeholders and reinforce that at Veralto, we are all practitioners of continuous improvement. Turning now to our financial results for the quarter. Core sales grew 1.8% year-over-year, led by price increases across both segments and modest volume growth in our Water Quality segment, led by our industrial water treatment businesses.

Notably, both segments delivered recurring sales growth in the mid-single digits year-over-year, increasing our percentage of recurring sales to 61% of total sales in the quarter. As compared to our guidance, we exceeded core sales growth expectations due to strong commercial execution and better-than-expected volume at both segments, particularly within consumables. On the margin front, we delivered 90 basis points of adjusted operating profit margin expansion, primarily through price execution, productivity improvements, and cost optimization.

Adjusted EPS was $0.84 per share, up 8% year-over-year, and $0.06 above the high end of our guidance range. We generated over $100 million of free cash flow, further strengthening our financial position. Looking now at core sales growth by geography for the first quarter, sales in North America grew over 3% year-over-year, with sales in high-growth markets flat and sales in Western Europe down about 1%.

In North America, we continued to see strong growth in our water treatment businesses across industrial verticals, including food and beverage, chemical processing, mining, and power generation. We also continued to see strong demand from municipal customers for UV treatment systems. In Western Europe, core sales were down modestly year-over-year, primarily due to timing of UV system projects and the strategic portfolio actions in our Water Quality segment that we mentioned in our Q4 earnings call.

Apart from these two items, core sales in Western Europe were steady year-over-year in both segments. In high-growth markets, core sales were essentially flat year-over-year, as growth in Latin America and India was offset by low single-digit decline in China, as anticipated. Despite the year-over-year headwind in Q1, we believe our end market environment in China has stabilized. That concludes my opening remarks, and at this time, I'll turn the call over to Sameer for a detailed review of our first quarter financial performance.

Sameer Ralhan (SVP and CFO)

Thanks, Jennifer, and good morning, everyone. I will begin with our consolidated results for the first quarter on slide seven. First quarter net sales grew 1.8% on a year-over-year basis to about $1.25 billion. Currency was a modest benefit, offset by the divestiture of Salsnes product line. Salsnes was a small commodity filter product line in a Water Quality segment that was divested in January. Core sales growth in Q1 was 1.8%. Price contributed approximately 2% growth in this quarter, in line with expectations. This aggregate price increase is also in line with historical levels.

Volume was down a modest 40 basis points year-over-year. This was better than we expected, primarily due to higher sales volumes of consumables at both segments during the quarter. Gross profit increased 6% year-over-year to $747 million. Gross profit margin increased 220 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 90 basis points to 24.5%....

We delivered strong margin expansion while investing in our sales and marketing efforts to drive future growth. We also increased our R&D investment to 4.8% of sales, up 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 Q1, adjusted earnings per share grew 8% year-over-year to $0.84, and free cash flow was $102 million, down from the prior year. This decline is primarily due to cash interest payments that we did not incur last year prior to our spin-off.

Moving on, I will cover the segment highlights, starting with Water Quality on slide nine. Our Water Quality segment delivered $749 million of sales, up 2.7% on a year-over-year basis. Currency was neutral, and the divestiture of Salsnes had 10 basis points impact on sales this quarter versus the prior year period. In addition to this divestiture, we strategically exited small product lines in our Water Quality segment in the fourth quarter of 2023.

As we previously mentioned on the earnings call in February, exiting these product lines resulted in approximately 60 basis points headwind to core growth for the segment in this quarter. Despite this headwind, core sales grew 2.8% year-over-year, as compared to 11% core sales growth in the prior year period, bringing the two-year core sales growth stack for Water Quality segment to about 7%. Pricing contributed 2.6% to core sales growth, and volume was up 30 basis points year-over-year. This is the first quarter of volume growth for Water Quality since Q1 2023.

Our volume growth in this year's first quarter was driven by strong demand for our water treatment solutions in industrial end markets and UV treatment systems in municipal end markets. Recurring sales across the segment grew mid-single digits, highlighted by increased sales of reagents and chemistries used in our analytical instruments at municipalities in North America. Adjusted operating profit increased 9%, or $16 million year-over-year to $186 million. Adjusted operating profit margin increased 150 basis points to 24.8%.

The increase in profitability reflects solid pricing execution and improved productivity. Moving to the next page, our PQI segment delivered sales of $497 million in the first quarter, up modestly versus the prior year period. Core sales were essentially flat on a year-over-year basis, as price increases of 1.5% were largely offset by 1.3% declines in volumes. Recurring sales grew mid-single digits, with growth across the portfolio, increasing the mix of recurring sales for PQI to 63% in Q1.

In Packaging and Color, sales were up low single digits year-over-year, highlighted by growth in recurring software and subscription revenue. In contrast, Marking and Coding sales declined modestly, reflecting lower demand from CPG customers as compared to Q1 2023. This decline, however, was less than what we had anticipated in our guidance. As Jennifer mentioned, we continue to see modest signs of recovery in CPG markets, with consumable sales up mid-single digits year-over-year for the third consecutive quarter, and equipment bookings showing pockets of improvement.

We remain cautiously optimistic that CPG volumes will improve sequentially as the year progresses. PQI's adjusted operating profit was $139 million in the first quarter, resulting in adjusted operating profit margin of 28%. This was a strong margin performance for PQI and demonstrates the earnings power of these businesses. Turning now to our balance sheet and cash flow. In Q1, we generated $115 million of cash from operations and invested $13 million in capital expenditures. Free cash flow was $102 million in the quarter.

Note, this included about $57 million of cash interest payments, which we did not incur in Q1 2023, prior to our spin-off. At the end of the quarter, gross debt was $2.6 billion, and cash on hand was $827 million. Net debt was $1.8 billion, resulting in net leverage of 1.5 times. In summary, we further strengthened our financial position during the quarter and have ample liquidity. This gives us flexibility in how we deploy capital to create long-term shareholder value with a bias towards M&A. Turning now to our guidance for 2024, beginning with our updated expectations for the full year.

As Jennifer mentioned, we are on track to deliver our target of low single-digit core sales growth at the enterprise level and in both segments. We're targeting 100-200 basis points of price, consistent with historical pre-pandemic levels. From a sequential perspective, our guidance assumes that year-over-year core sales growth increases modestly quarter-to-quarter through 2024. Looking at adjusted operating profit margin, our target remains 50-75 basis points of improvement this year. Based on our Q1 performance, we are trending towards the high end of this range.

Given our Q1 results and current view on margin improvement for the year, we have increased our full year adjusted EPS guidance to a range of $3.25-$3.34 per share, up from our prior guidance range of $3.20-$3.30 per share. In addition, we increased our free cash flow conversion guidance to a range of 100%-110%. Looking at our guidance for Q2, we are targeting core sales growth in low single digits on a year-over-year basis, with adjusted operating margin of approximately 23%. Our Q2 2024 guidance on adjusted EPS is $0.75-$0.80 per share.

That concludes my prepared remarks. At this time, I'll turn the call back to Jennifer for closing remarks before we open up the call for questions.

Jennifer Honeycutt (President and CEO)

Thanks, Sameer. In summary, as a standalone company, we have increased focus, discipline, and accountability across all levels of the enterprise, which has elevated our level of execution. We are driving continuous improvement and investing in future growth as our end market environment gradually improves. We are off to a positive start in 2024, with solid growth and strong margin expansion in the first quarter. Our financial position remains strong, and we continue to take a disciplined approach to capital deployment, with our primary focus on strategic acquisitions with attractive returns.

Looking ahead, we remain focused on driving commercial excellence, continuous improvement, and disciplined capital allocation to create shareholder value while safeguarding the world's most vital resources. That concludes our prepared remarks. I want to thank you all again for joining our call, and at this time, we're happy to take your questions.

Operator (participant)

At this time, if you would like to ask a question, please press the star and one on your telephone keypad. Please limit yourself to one question and one follow-up. You may remove yourself from the queue at any time by pressing star two. Once again, that is star and one to ask a question. We will pause for a moment to allow questions to queue. We'll take our first question from Scott Davis with Melius Research. Your line is open.

Scott Davis (Chairman, CEO, and Lead Research Analyst)

Good morning-

Jennifer Honeycutt (President and CEO)

Good morning, Scott.

Scott Davis (Chairman, CEO, and Lead Research Analyst)

Jennifer and Ryan. Good morning. The 60% gross margin is a pretty incredible number, when you really think about the mix of businesses you have. But should we think about this as kind of high-water mark or would you think about it as more of a step up into a new level of entitlement? How do you guys think about it?

Sameer Ralhan (SVP and CFO)

So maybe I take that one, Scott. Overall, as you got to look at our margin perspective, you know, some of it comes down to deliverable mix. I think it's still gonna be in the 58%-60% kind of zip code. As Jennifer mentioned on the call earlier, you know, we saw good sort of a rebound in the consumables in both sides. That really helps us on the margin side, both in the Water Quality and PQI side. But as kind of equipment kind of starts coming back in the rest of the year, the second half of the year, we should be in that 58%-60% kind of zip code.

Scott Davis (Chairman, CEO, and Lead Research Analyst)

Okay, fair, fair enough. And just following on a little bit to a comment you made, Jennifer, on increasing accountability. You know, understanding has always been that the Danaher Business System always drove a pretty high level of accountability. How have you tweaked it to even raise that to a different level? And what kind of changes have you made, when you think about just tightening things up for the assets that you have here?

Jennifer Honeycutt (President and CEO)

Yeah, I mean, I think it's always challenged, challenging to provide an equal level of focus across a very, very large enterprise like Danaher has. I think a smaller, more nimble, $5 billion business obviously allows us to focus exclusively on these businesses, whereas there were many more factors sort of previously with the life sciences and diagnostics side in Danaher. And so some of the things that we've done here is, you know, we've just, we've raised the level of not only expectation, but visibility to how we're operating, the tools that we're using by way of VES, and we're really focusing on the critical few.

Every business is a little bit different. Their evolutionary maturity is a little bit different, and as a result, we focus on using fit-for-purpose tools in our VES Toolbox to make sure that we're elevating the level of performance of each of those businesses.

Scott Davis (Chairman, CEO, and Lead Research Analyst)

Okay, fair enough. Congrats on the quarter. Good luck this year. Thank you.

Jennifer Honeycutt (President and CEO)

Thank you.

Sameer Ralhan (SVP and CFO)

Thanks, Scott.

Operator (participant)

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

Andy Kaplowitz (Managing Director and Senior Analyst)

Good morning, everyone.

Jennifer Honeycutt (President and CEO)

Good morning, Andy.

Andy Kaplowitz (Managing Director and Senior Analyst)

... Jennifer, Sameer, how are you feeling about the PQI recovery at this point? I know you mentioned North America and Western Europe, you continue to see signs of recovery. You talked about equipment demand coming back late in the quarter. Maybe you could elaborate on that equipment trend. Have you seen follow-through in that food and beverage recovery that started, I think, in Q4? And how are you factoring in China-related growth in that segment for the rest of the year?

Jennifer Honeycutt (President and CEO)

Yeah, we're really encouraged by the PQI performance here in Q1, particularly around our consumable revenue stream or recurring revenue. This is the third sequential quarter that we've seen mid-single-digit growth there. With regard to sort of how those markets, particularly in food and beverage, recover from a downturn, we will always see the consumable revenue stream ramp first. That's as a result of CPG customers coming back online that were previously mothballed. They're, you know, getting those lines running, they're refurbishing equipment, and so we always see that leading our equipment growth.

Now, on the equipment side, we did see some nice pockets of growth relative to orders late in the first quarter. This is sequentially encouraging and very closely maps to the pattern of what we would have seen with consumables recovery first, followed by equipment recovery.

Sameer Ralhan (SVP and CFO)

Yes, and the only other thing I would add from a guide perspective, we're building equipment recovery more in the second half. While the orders, as Jennifer mentioned in the March, were very encouraging, the good discussions with the customers that the business teams are having. But we're still cautious, and we are building into anything on the equipment side more in the second half than in the second quarter at this point.

Andy Kaplowitz (Managing Director and Senior Analyst)

Very helpful. And then maybe a similar question on the Water Quality side. You know, obviously, you've talked about strengthening industrial businesses for a while now. Maybe talk about the resilience of that. Are you seeing North American municipalities on the Hach side spend any more? Is there any risk of higher rates, you know, maybe impacting that side of spend?

Jennifer Honeycutt (President and CEO)

Yeah. So the nice thing about our business, Andy, is it's largely an OpEx-focused set of businesses. So interest rates, CapEx approval cycles, we are minimally impacted by. And because we operate at the high end of the value continuum in terms of being integral to operating municipal water plants, we see steady spends there. And you know, following the pandemic, when municipalities were kind of in lockdown relative to their levels of investment, they are starting to execute on their project backlog.

And that means that as they execute on that activity, there will be more you know, analytics and testing required for refurbishing plants and getting going on those improvements. So we continue to see good demand here that's continuing to recover in municipalities. We also have a variety of opportunities here in water reuse and recycling, reclaim activities as well. So, we're encouraged by the emerging markets that are starting to recover and look forward to continued execution there.

Operator (participant)

Thank you. And we'll take our next question from Jeff Sprague with Vertical Research Partners. Your line is open.

Jeff Sprague (Founder and Managing Partner)

Thank you. Good morning, everyone. Hey, Jennifer, just first on, just kind of the M&A side of the equation. Obviously, a couple of quarters out of the box here, probably kind of a solid year or so to think about it, given the timeline of the spin. Just wonder how, you know, the pipeline is coming together. Do you see things that are actionable? And, you know, do they lean, you know, towards one segment or the other?

Jennifer Honeycutt (President and CEO)

Thanks for the question, Jeff. Yeah, this is everyone's favorite topic, I think. We are 207 days post-spin, I think today. So it's still early days here, but I have to say, we have a very, very robust process and a strong pipeline of activity, both in the Water Quality side, the PQI side, with a number of opportunities that we're considering. We are gonna stay disciplined here, consistent with our heritage, and focus on making sure that we're going after the right markets, strong companies within those markets, and making sure that they come at the right valuation.

We continue to like businesses that have similar operating model, durability, and financial profile to those that we have in the portfolio today. Businesses that can drive VES, or that can utilize VES for continued improvements in gross and margin. And certainly, you know, our bias towards M&A is an important catalyst here going forward. But we will continue to maintain the rigor and the discipline that we have inherited from our history. And as always, M&A is a little bit episodic. We do see more opportunities opening up relative to actionability as the year progresses, and so we are encouraged by that.

Jeff Sprague (Founder and Managing Partner)

Great. Then, maybe unrelated and for Sameer. You know, given that, maybe kind of the consumables versus equipment mix doesn't really shift a whole lot until we get into the second half of the year, why is it that margins would be down sequentially, Q1 to Q2, on sequentially higher revenues?

Sameer Ralhan (SVP and CFO)

Yeah, thanks, Jeff, for that. As we go from Q1 to Q2, Jeff, this is really ends up, the first thing is the second quarter ends up being a seasonally heavier trade show activity quarter for us. So the operating expenses do go up, seasonally just, for us in Q2 and Q1. And that's, kind of, I would say, applies to both the segments. The other factor is just some of the corporate spending. As we said in the beginning of the year in February, right, we just want to be very cautious and judicious as we bring in the corporate expenses, from a standalone company perspective.

So some of that is just how we're kind of pacing in and slowly in, in second quarter, some of that is going to ramp up. And lastly, I would say, as Jennifer mentioned, we are investing on SG&A side, and in Q1, we did make investments. We're going to start seeing more run rate impact as we kind of move into the second quarter. So it's really a combination of those three things that's driving the sequential decline.

Jeff Sprague (Founder and Managing Partner)

Does it bias towards one segment or the other?

Sameer Ralhan (SVP and CFO)

No, it's pretty, pretty universal across the board.

Operator (participant)

Thank you. We'll take our next question from Mike Halloran from Baird. Your line is open.

Mike Halloran (Senior Research Analyst)

Good morning, everyone.

Sameer Ralhan (SVP and CFO)

Morning, Mike.

Mike Halloran (Senior Research Analyst)

Following up, so following up on Jeff's question, you know, as you became a standalone company, did you have to change processes in any way from an organizational perspective with incremental resources, whatever, to you know, essentially build the muscle on the M&A side? Obviously, a little bit less prioritized at Danaher. So is there anything that you've had to do to kind of build that up more than what you had when you came in here, and centralization of resources? And then I guess the second part is, how integrated is that with the R&D functionality as you sit here today?

Jennifer Honeycutt (President and CEO)

So, you know, clearly, standing up a standalone company does require a corporate organization to support it. You know, previously, tax and treasury and all of those functions were taken care of for us. But with respect to sort of the M&A trajectory, we were very deliberate in bringing in top talent in our sustainability, our strategy and sustainability function and our corporate development function. Both of those individuals that sit on my staff have long-standing histories within Danaher building strategy and executing on M&A.

Insofar as the muscle building within the operating companies themselves, we have upskilled the capability for our leadership within the operating companies to be able to perform strong due diligence, look at effective ways of integrating, and so on. We spent actually quite a bit of time here in both the ramp up to the spin and following the spin itself.

Mike Halloran (Senior Research Analyst)

And then thanks for that. The second one is just kind of putting the commentary together on the Water Quality and the PQI side as far as starting to see some green shoots in specific areas or recovery in specific areas. How much of that is embedded from here from a guidance perspective? Are we talking relatively normal sequentials, or is there an assumption for an improved backdrop as we get through the year? And just add some context.

Sameer Ralhan (SVP and CFO)

Hey, Mike. Yeah, this is Sameer. I'll take this one. Essentially, it's pretty kind of a gradual, sequentially improving quarter by quarter that I think that's kind of built into the guide at this point. As I said earlier, really what we're building is this point for, in the near term, is really more of the consumable side. Still, that trend slowly kind of building. Equipment side, it's really more the second half of the year. So there's a little bit of a macro backdrop kind of helping us, some of the equipment side coming back, but it's going to be pretty moderate sequentially kind of going up.

But on the year-over-year basis, as you can imagine from the Q3, Q4, it'll, it'll be better. That's how the math works.

Operator (participant)

Thank you. We'll take our next question from Deane Dray with RBC Capital Markets. Your line is open.

Deane Dray (Managing Director and Senior Equity Analyst)

Thank you. Good morning, everyone.

Jennifer Honeycutt (President and CEO)

Good morning, Deane.

Deane Dray (Managing Director and Senior Equity Analyst)

Hey, appreciate all the color and specifics in the slides and your prepared remarks. I'd like to get a very specific question in Water Quality, if I could. So the new EPA regulations on PFAS, the 4 parts per trillion, is really that pushes the testing technology limits, and right now it's still you have to use a prohibitively expensive mass spec. No utility really can afford that. So is the industry any closer, are you all any closer to what might be a more economical test? Because all this is going to be seeing incredible demand over, yep, as of now, as of two weeks ago.

Jennifer Honeycutt (President and CEO)

Yeah, great question, Deane. You know, we knew that the EPA was headed towards a 4 parts per trillion limit of detection here, so that's not fundamentally new news for us. What is new news there is the timeline for compliance with MCLs in 2027. But you are right that this is a phenomenally difficult and complex problem to solve in a fit-for-purpose way. Right now, the way to solve for this is water samples sent to a centralized lab, run through, you know, GC mass spec, answers come back, you know, a couple of weeks later.

In the meantime, you know, the municipality has discharged tens, if not hundreds of thousands of gallons of water. We are investing in this area. We do believe we have a right to play here. Hach, in and of itself, has over a 70-year history of innovating in the analytics space. We've got a broad portfolio there, and certainly on the water treatment side, particularly in UV applications, we've got great expertise there as well. But I would say this is a long game here, with solutions that are not imminent.

But we're probably still a couple of years out here in terms of identifying and developing fit-for-purpose technology that addresses both detection and destruction. We think that winning is going to require both, and right now, the analytical test options, as you say, are not fit for purpose in terms of being at plant. And frankly, destruction technology is not readily available either.

There are products out there, granular activated carbon being one of them, that can capture PFAS. But what happens when you refresh those resin beds? You're just moving the PFAS to some other place, like a landfill. So it's gonna be a long journey here, but we are investing in a number of organic activities and are open to inorganic options as well.

Deane Dray (Managing Director and Senior Equity Analyst)

All right. That's really helpful, and I fully appreciate that timeline that you've suggested. That's everything that we've heard as well. You know, it's—there's a question between wanting something, and there's a demand, industry demand versus the practicality, given the complexity of the molecules. But I really appreciate the color, and I, and I'm so glad to hear you mention destruction as well, because that's an opportunity.

All right, and then just for a follow-up question, and I'll echo Scott's comments about that 60% threshold on gross margin and how big a deal that is, and I remember when Danaher hit that level as well. And just what are the ways that you might be able to boost that further?

I know your business model is a direct-to-customer on the overall, and especially on the Hach consumables, where you just would think there'd be more of a distribution angle to this, which would lower that cost of getting the reagents to the customers. Just where does that stand? Is that a non-starter, or is that something you've explored? I know in some countries you will use distributors, which just because it's not practical to have direct, but just where does that stand?

Jennifer Honeycutt (President and CEO)

Yeah, I mean, I think, I think you're right, Deane. We, we do, and will use distribution, for our analytics businesses in certain countries. They tend to be areas where we don't have critical mass, in terms of staffing up the full capability of selling direct. We think it's actually a good thing to sell direct, and it's part of what I would consider to be the secret sauce, because we have that long-standing technological applications knowledge.

It's that customer intimacy and the insight to their processes, their process control, their analytics needs, their unmet, you know, the problems that have yet to be solved, that give us great insight and creates the flywheel of a feedback loop from our sales and service organization to our new product development organizations, that help us continue to innovate and evolve the product portfolio to solve unmet customer needs. So we are not inclined to sort of steer away, if you will, from our direct sales model, just from a margin benefit standpoint.

We think there's lots of opportunity by virtue of applying VES, and, you know, working on mix. The teams are doing a great job here in delivering margin as a result of just good operating execution, right? Where the factories are running a better, you know, procurement teams are pushing back on inflationary pressures, and we're doing far fewer spot buys. So we got a number of other levers that we can pull relative to margin without compromising the secret sauce of customer intimacy.

Operator (participant)

Thank you. We'll take our next question from Andrew Krill with Deutsche Bank. Your line is open.

Andrew Krill (VP and Equity Analyst)

Hi, thanks. Good morning, everyone. Wanted to ask on the market price and price costs, more specifically. Just can you give us an update on what you're assuming there? I think we've heard from several companies, you know, like transportation, labor, certain raws, all continue to be pretty inflationary. So you know, the guide, assuming you can stay price cost positive, like, on a margin basis or just dollars, and anything there would be really helpful. If there's any big difference by segment. Thanks.

Sameer Ralhan (SVP and CFO)

Hey, Andrew, I'll take that one. Essentially from a price, from a guide perspective and the future look perspective, we're modeling in, price in line with historical norms, so it's, 100-200 basis points. This quarter, of course, as you kind of-- things are rolling off, you know, we came in a little bit towards the high end of that range. But I think from a, a outlook perspective and a guide perspective, 100-200 basis points is a good way to, to model.

On the raw, on the raw materials and the materials side, look, I think it's a pretty broad mix of kind of things that we buy, all the way from semiconductors and the circuit board stuff, to stuff in plastics and things of those nature, which are kind of tied to commodities. I would say the operating discipline and the VES really helping us kind of manage that, I think, has been a big differentiator, and that's kind of really reflected at the Q, in Q1. The question that, you know, Scott and Deane had as well on the gross margin side, we saw a big uplift from that side as well.

I think, really going forward, having the operating discipline, making sure we are doing less of a spot buy. I would say inflationary pressures are there. We are managing them really well, but it's also about the operating discipline to make sure we are minimizing any kind of spot buy, buys, which can really have a big impact on the margin side. So I would say pricing, we're doing the value-in-use pricing, and it's showing up in the margin side. But the bright side, there's a lot of discipline that all starts all the way from operating the system.

Andrew Krill (VP and Equity Analyst)

Okay, great, very helpful. Then for a follow-up on free cash flow conversion, it's, like, nice to see the conversion boosted for the year from 100% to 110%. Just any more insight into, like, what changed, you know, to give you confidence through one quarter and, you know, looking ahead, should we maybe thinking of, like, a hundred percent conversion as kind of a floor? Yeah, just, you know, like legacy Danaher was very consistently over 100%. Thanks.

Sameer Ralhan (SVP and CFO)

Yeah, Andrew, if you look at free cash flow conversion, right? Just as a reminder, we do give the conversion on the basis of the GAAP metrics, right? Not on any kind of adjusted metrics. So essentially, when you look at that, you know, just add the amortization and the share compensation or the stock-based compensation. I think based on all that stuff, we should be a little bit on the, on the 100, a little over 100%. But really, we're going towards 100-110% range this quarter, for the full year. For us, that guidance is really driven by getting more conviction on the margin side.

As Jennifer mentioned, our margin will be towards the high end, on the 50-75 basis points. That kind of flows down. That gave us a little more conviction. And also there's a non-cash charge in there as well, right, this quarter, that's going to the GAAP net income, but just tied to the sale, softness of et cetera. So that's kind of just from a math perspective, and adds up onto the cash flow conversion as well. But overall-

Andrew Krill (VP and Equity Analyst)

Great, thank you.

Sameer Ralhan (SVP and CFO)

Better operating performance.

Andrew Krill (VP and Equity Analyst)

Thank you.

Operator (participant)

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

Nathan Jones (Managing Director)

Good morning, everyone.

Jennifer Honeycutt (President and CEO)

Good morning, Nathan.

Nathan Jones (Managing Director)

I'm gonna, I'm gonna follow up on Deane's question on distribution, but I'm gonna come at it from the PQI side, because I would've thought, there might actually be some more opportunities to leverage a distribution model and maybe reduce the costs to serve on the PQI side than on the water side. You know, potentially, maybe in, you know, lasers, where there's not the same kind of consumable revenue or some of the smaller customers that maybe don't need that kind of super high level of, of service from you guys.

So if there's any commentary you could make on maybe the potential from that side of the business to leverage distribution a bit more?

Jennifer Honeycutt (President and CEO)

Yeah, I mean, I think it's probably the same answer as for water. I mean, we do have distribution, and we do consider use of distribution, depending upon where we're selling in the world and what types of products are in the portfolio. This is something that we always consider in terms of when we decide to make investments and which product lines actually require a more significant level of applications, knowledge, and insight.

But I will tell you that, like in water, there are pretty significant insights to be gained from understanding customer problems in a direct way for any kind of customer who's on the Packaging and Color side or on the Marking and Coding side. And it actually spurs a great deal of our innovation. You, you will recall from our fourth quarter call that Videojet launched seven new products last year. They additionally launched another two in the first quarter, and these are on the back of innovations for direct customer feedback.

So, I, I continue to be a little bit biased here towards our direct model because I do think it creates a customer intimacy required to have those untapped insights relative to some of the problems that they face. But we do use distribution, and we selectively consider that in the course of every strategic planning cycle.

Nathan Jones (Managing Director)

Thanks. I wanted to ask a follow-up on recycle and reuse in industrial markets, which is a market I think has significant growth potential over, you know, the next five, 10, 20 years, and would certainly be a market that's right in the bull's eye for, for a lot of your Water Quality business. So maybe some commentary on, trends in industrial recycle and reuse markets, what you're seeing going on there, and what the opportunities are for Veralto to play in those markets?

Jennifer Honeycutt (President and CEO)

Yeah, this is a great question, and, absolutely, we see a great deal of activity, interest, and growth potential in both recycle, and reuse, and it's one that is, pan-operating company, I would say, across our Water Quality businesses. So the intersection of ChemTreat, Trojan, and Hach, can all play in that space, and in fact, do have, conversations amongst themselves and amongst the sales folks, in the field relative to solving of those kinds of applications.

But increasingly, by virtue of the importance of ESG amongst our customers, we do have them coming to us saying, you know, look, my company has just said I've got to use, you know, 25% less water, and of the water that's not used in the process, you know, I've got to recycle 50% of it, right? So can you help me with both reduction and recycling? And those are, those are great. Those are sweet spots for us. We've got a great product portfolio that, that can be deployed to these applications, and so we continue to be excited about the space.

Nathan Jones (Managing Director)

Sounds like a good opportunity to me. Thanks very much for taking my questions.

Jennifer Honeycutt (President and CEO)

You bet.

Operator (participant)

Thank you. We'll take our next question from Andrew Buscaglia with BNP Paribas. Your line is open.

Andrew Buscaglia (Senior Analyst for U.S. Industrial Technology)

Hey, good morning, everyone.

Jennifer Honeycutt (President and CEO)

Good morning, Andrew.

Andrew Buscaglia (Senior Analyst for U.S. Industrial Technology)

So I just wanted to check on, you know, on the Water Quality side, you're talking about really strong industrial demand, and you did much better than your guidance. I'm wondering what changed, let's say, you know, from December, January to what transpires throughout the quarter, and then just the sustainability around that. What, you know, you know, what's driving that, really?

Jennifer Honeycutt (President and CEO)

Yeah, I mean, I think we still see, you know, pretty strong industrial output here, particularly in North America. I think, you know, as we mentioned in our prepared remarks, we do see food and beverage coming back, which across the portfolio is the largest contiguous industrial segment that we play in. But likewise, chemical processing, mining, and power generation all continue to be strong. You know, we do see opportunities around the reshoring activity as well as, as the world becomes a little bit more fractured relative to its trade relationships.

And so that's, you know, providing, you know, great opportunity, particularly with respect to microelectronics and, you know, the CHIPS Act and so on. So we do see a good macro environment here, particularly in North America, for our industrial sector.

Andrew Buscaglia (Senior Analyst for U.S. Industrial Technology)

Yeah. It's a lot of little things, it sounds like. Yeah, you know, you got a lot of questions on M&A. You know, obviously that's where a lot of interest lies. I'm wondering if you can comment on, you know, your margins, especially in Water Quality, are quite high. You know, how are you thinking about margins as you add M&A to your portfolio? Is there enough out there where you could see some accretion, or generally long term, is this not really should we not expect those margins to stay where they are if you're adding deals?

Sameer Ralhan (SVP and CFO)

Yeah, Andrew, since as you considered in the past, and when it comes down to M&A, truly, you know, we follow a very disciplined and rigorous approach around markets, companies, and valuation. With respect to the financial metrics, it really is a combination of multiple factors, right? We look at ROIC, we look at margin, what are the things that we can add to the portfolio that can drive overall core growth, and create synergies? How do we apply VES into the acquired businesses to really create that differentiated value?

So it really comes down to the value creation potential, and comes down and ultimately, that's based on a combination of all these different financial factors that we kind of look at as part of our rigorous process. So I wouldn't really focus on one metric versus the other. It really comes down to the combination of all to see how they'll create long-term value.

Andrew Buscaglia (Senior Analyst for U.S. Industrial Technology)

Yeah. Okay. All right. Thank you, everyone.

Operator (participant)

Thank you. We'll take our next question from Brian Lee with Goldman Sachs. Your line is open.

Brian Lee (Managing Director and Senior Analyst for Clean Energy and Renewables)

Hey, good morning, everyone. Thanks for taking the questions. You know, a lot's been covered on the call, so maybe just-

Jennifer Honeycutt (President and CEO)

Good morning.

Brian Lee (Managing Director and Senior Analyst for Clean Energy and Renewables)

Just a few follow-ups, I guess, on PQI. Can you remind us how far out, you know, does your visibility extend on the equipment backlog and then the recent strength you're seeing in bookings? And then also maybe remind us, what are the mixed implications? You kind of alluded to them, but, mixed implications for margins in PQI as you move through the year, and it does sound, you know, like equipment will grow, relative to consumables. How should we think about that in the context of margins?

Jennifer Honeycutt (President and CEO)

Yeah, I mean, I think what we see here is, you know, visibility for equipment in the 60-to-90-day time frame, right? This is a short cycle business. So, a lot of our confidence around, you know, equipment here in the second half is a product of history, right? When we see cycles of food and beverage and consumer packaged goods sort of decline in recovery, we see typical patterns, which is pretty intuitive of, you know, the inks and solvents, spare parts, consumables recovering first as these lines are brought back online.

And then equipment following when funds are available to do line expansions, you know, equipment upgrades and so on and so forth. You know, you do see in the guide that we've projected a rebalancing of kind of consumables and equipment here in the back half of the year, and so we've accounted for that.

Brian Lee (Managing Director and Senior Analyst for Clean Energy and Renewables)

Okay, great. That's helpful. And then, you know, just one on Water Quality. You know, I think a couple questions ago, you were talking, Jennifer, about the demand in water reuse, water recycling, somewhat from an ESG footprint, from a growing subset of your customers. I think there's also, you know, a growing subset of customers and industries here levered to, you know, power gen growth. We're seeing load growth on the grid in the U.S. especially. First time in a while, really, really seeing some positive inflection.

So can you kind of give us a sense of, from your vantage point, the different technologies, product sets you have into the microelectronics sector? How much of, you know, the mix it is? And then it seems like there's just incremental volume growth opportunities there. Maybe if you could just speak to that a little bit. Thank you.

Jennifer Honeycutt (President and CEO)

So the business that benefits most from the CHIPS Act and microelectronics is Trojan that sells UV treatment systems in for high purity, ultrahigh purity water. That water has to be exceedingly pure, given the manufacturing requirements for semiconductor wafer fab. But there are, you know, pockets of other equipment and, you know, analytics and so on, that get sold into that space. But, you know, we've really seen some nice growth in our UV treatment business as a result of sort of the onshoring or reshoring of fabs here in North America, as well as the ones that continue to be built in China.

Sameer Ralhan (SVP and CFO)

Brian, the only other thing I would add is, to that, as we kind of look at the bid activity that our teams are seeing, you know, we've seen a pretty frequent bid activity that's kind of tied to the reuse point that earlier Nathan had as well, on the municipal side and then on the semi side for the UV treatment system. So the bid activity is actually pretty good on both sides. That kind of ties back into the Trojan business.

Operator (participant)

Thank you. It appears that we have no further questions at this time. I will now turn the call back over to Ryan Taylor for any additional or closing remarks.

Ryan Taylor (VP of Investor Relations)

Thanks, Shelby. And thanks everybody for joining us today. We really appreciate your time and engagement. As normal, I'll be available for follow-ups today and throughout the next coming days and weeks. Should you want to talk, please reach out to me. And at this time, we'll conclude our call. Thank you so much again, and we'll join you next time.

Operator (participant)

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