Veralto Q3 2026 Earnings Call Transcript
Veralto (NYSE:VLTO) reported third-quarter financial results on Friday. The transcript from the company’s third-quarter earnings call has been provided below.
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View the webcast at https://event.on24.com/wcc/r/5523738/AEC50C1C84EB0B13B63A8E7221520CBD
Summary
Veralto Corporation reported a 7.5% year-over-year increase in total sales for Q3 2026, with adjusted EPS up 19.2% and free cash flow of $304 million.
The company expects Q4 core sales growth of 5.5% to 6.5% and total sales growth of 10% to 11%, raising full-year adjusted EPS guidance to $4.49 to $4.52.
Veralto has invested $1.65 billion in four strategic acquisitions and repurchased 2.4% of outstanding shares, highlighting the acquisition of Clean Water One.
The company noted strong demand across both water quality and product quality & innovation (PQI) segments, with emphasis on recurring revenue models.
Management expressed confidence in their strategic direction, focusing on innovation, disciplined M&A, and cost optimization programs, with early savings of $10-15 million expected in 2026.
Full Transcript
Erica (Operator)
My name is Erica and I will be your conference operator this morning. At this time I would like to welcome everyone to Veralto Corporation’s third quarter 2026 conference call. 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 the star 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. Please go ahead. Mr. Taylor, you may now begin.
Ryan Taylor (Vice President 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, Senior Vice President and Chief Financial Officer. Today’s call is simultaneously being webcast. A replay of the webcast will be available on the Investors section of our website later today under the heading Events and Presentations. A replay of this call will be available until November 9th. Yesterday we issued our third quarter 2026 earnings news release, earnings presentation, prepared remarks and supplemental materials including information required by the SEC relating to adjusted or non-GAAP financial measures. These materials are available at veralto.com under the heading Quarterly Earnings. Reconciliations of all non-GAAP measures are also provided in the appendix of the webcast slides. Unless otherwise noted, all references to variances are on a year over year basis.
During the call we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties including those set forth in our SEC filings. Actual results may differ materially from our forward-looking statements. These forward-looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward-looking statements except as required by law.
And with that I’ll turn the call over to Jennifer.
Jennifer Honeycutt (President and Chief Executive Officer)
Thanks Ryan. I want to start by thanking our 17,000 associates for delivering an outstanding third quarter. We continue to build on our track record of meeting or exceeding our financial commitments through rigorous execution in support of our customers. In Q3, total sales grew 7.5% year over year, adjusted EPS increased 19.2% and we generated robust free cash flow of $304 million. Core sales growth led by water quality at 6.4% with PQI at 3.2%. Both segments accelerated core sales growth sequentially from Q2 to Q3.
Broadly speaking, demand for our products and services remains healthy across both segments. Relative to the fourth quarter, we expect core sales growth of 5.5 to 6.5% and approximately 5% growth from acquisitions, resulting in total sales growth of approximately 10 to 11%. Based on our third quarter performance, fourth quarter outlook and early gains from our cost optimization program, we raised our full year adjusted EPS guidance to $4.49 to $4.52 per share, representing 15 to 16% growth over the prior year. Our 2026 guidance includes benefits from our disciplined capital deployment.
Year to date we’ve deployed more than $1.65 billion across four strategic bolt-on acquisitions and the repurchase of 2.4% of our outstanding shares. Our most recent acquisition of Clean Water One expands our capabilities in water treatment solutions and I’m excited to welcome the Clean Water One associates to Veralto. With our strong balance sheet and robust cash generation, we have ample flexibility to act decisively on attractive new opportunities.
This year’s performance and disciplined capital deployment reflect the stronger Veralto that we have been architecting since our spinoff in 2023. As we mark our third anniversary as an independent public company, I’m proud of how much we’ve accomplished and even more excited about our future. Over the course of the first three years we have simplified VES and bolstered our execution, accelerated innovation and strengthened our portfolio through disciplined M&A. These actions have accelerated our core sales growth, driven consistent margin expansion and double digit adjusted EPS growth. I’m incredibly proud of what our team has accomplished. With a stronger foundation, talented team and proven track record, we are excited about the opportunities ahead and confident in our ability to deliver sustainable long term value for shareholders.
That concludes my prepared remarks and at this time we will now take your questions.
Erica (Operator)
Thank you. As a reminder, if you would like to ask a question, it is the star and one on your touchtone telephone. If at any point you would like to remove yourself from the queue, please press star then the number two. We do ask that you limit yourself to one question and one follow up question, and we’ll pause momentarily for all questions to queue. We’ll take our first question from the line of Jeff Sprague with Vertical Research. Please go ahead.
Jeff Sprague (Analyst)
Hey, thank you. Good morning everyone. Hey Jennifer, just kind of wondering. Hey, good morning. Hope you’re doing well. You know, you’re not inherently a project related business, but, you know, when I look at these kind of improving trends, industrial water, some of the digital workflow stuff, maybe, you know, some things going on the muni side, I was just wondering if you could, you know, kind of comment on maybe the level of level in 2027. So maybe cheating here a little bit and trying to get an early 2027 preview from you.
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, thanks for the question, Jeff. You know, I think the way to think about our exposure here is, you know, we have a balanced portfolio in our water business between muni sales and industrial. In fact, 50% of our sales in water quality are into industrial applications. Insofar as your question around municipal spending. As a reminder, you know, 60% of our revenue sits in recurring revenue. Given the razor blade business, we’re essential to the customer’s operations.
But when we do have equipment that gets sold as capex, it’s part of the normal operational CAPEX cycle. And that is to say that these tend to be facility upgrades or optimizations as opposed to infrastructure investments which are more prone to federal funding fluctuations. So we see strong demand really for our solutions here relative to both the operating side of the business, whether that’s, you know, our recurring revenue based model or project based business, simply on the, on the back of the secular drivers that we see, right, recycle, reclaim, severe weather events, you know, water scarcity and so on. So we feel pretty good about ongoing demand here and you know, we’ll keep you posted once we get to 2027.
Jeff Sprague (Analyst)
And maybe just one on PQI on that side of the equation. Is there some visibility on the, you know, on the CapEx side that’s come into view or not at this point?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I mean by and large the PQI side of the house is not a capex business. You know, these equipment purchases in terms of, you know, marking and coding or packaging and color tend to be, again, operational improvements to existing lines. Again for our marking and coding business, we’ve got 60% of that business is recurring revenue based and we’ve got a huge install base there for continuing to upgrade as there are technology changes relative to substrates, packaging sizes and so on.
We see good pull through in our digital workflow solutions and in packaging and color which, as you know, we’ve continued to invest there by virtue of M&A. So we see steady demand, feel confident about the future there.
Samir (Senior Vice President and Chief Financial Officer)
Yeah. And maybe, Jeff, I’ll add one more thing. As you look at the packaging and color business, on the digital workflow solution business that’s growing nicely, there we have pretty good visibility given those are SaaS contracts. As you know, we sign up the contracts and we’re recognizing revenue over time, so we have pretty good visibility on that side. And then the marking and coding, as Jennifer said, for us, the demand patterns have been pretty steady.
Jeff Sprague (Analyst)
Great, thanks over there.
Erica (Operator)
Thank you. Sorry. Thank you. And we’ll take our next question from William Griffin with Barclays. Please go ahead.
William Griffin (Analyst)
Great, thank you. Appreciate the opportunity here. My first question, you’re flagging some early progress on cost saves here in the third quarter. I guess on top of that small benefit here from tariffs, I was wondering if you could help us think about the margin cadence next year within that context. And I guess just maybe more specifically, just given the progress thus far on the cost saves, are you maybe seeing potentially more cost out opportunity than you had initially laid out?
Samir (Senior Vice President and Chief Financial Officer)
Hey, thanks Will. As you kind of look at the cost optimization program, at the beginning of the year we had said that roughly half the savings by 2027 and then full run rate in 2028. That plan is still one to follow. Look, we’ve had some early successes and a good start out of the gate. So we’re going to see 10 to 15 million dollars worth of savings in 2026. But for 2027 at this point, just model it the way we kind of guided earlier. Roughly have more specifics as part of the 2027 guide on where we stand.
Just keep in mind, right, that the savings are net of investments as well. So there’s always a little bit of a variation on the timing which we want to make sure that we properly dial in into the ’27 guide. So that’s how you should think about the cost optimization program at this point. On track with a nice early start in 2026 for us.
William Griffin (Analyst)
Great, thanks. And my follow up here, in the release last night you noted strong demand for municipals in Hach. Was wondering if you could provide a bit more color on drivers there, whether it be replacement cycle, new product introductions within that business or new customer wins. And maybe how are you thinking about demand trends exiting the year?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I mean I would say here on the muni side of water quality, we’re really kind of firing on all cylinders here. And this is on the back of a three year build relative to commercial architecture, VES discipline, new product development. And, you know, as a reminder here, really on the OPEX side of our customers’ operations as opposed to capex, it’s non-discretionary spend. Right. This is regulated testing. So customers, you know, use our equipment to make sure that they stay within compliance.
And I would say here throughout the last year or so our new product development flywheel has particularly taken hold and we see that across our analytics business as well as our water treatment businesses. So, you know, for municipalities, you know, Hach’s got a brand new flagship spectrophotometer, got new ammonia. And so we continue to see sort of great execution that’s been bolstered by this increasing cadence of new product development launches. So we feel good about our position here and we would expect that to continue.
William Griffin (Analyst)
Great. All right, Jennifer, Samir, thank you. Appreciate the time.
Erica (Operator)
Thank you. We’ll take our next question from Mike Halloran with Baird, please go ahead.
Mike Halloran (Analyst)
Morning everyone.
Jennifer Honeycutt (President and Chief Executive Officer)
Morning, Mike.
Mike Halloran (Analyst)
Hey, thanks. So maybe just some thoughts on underlying trajectory in the short term here. You know, certainly heard the answer to Jeff’s question. Just curious. It sounds like most of the pieces of your portfolio are tracking sequentially the right way. Anything that you’re seeing That deviated from seasonality as you work through the quarter. But I guess the question is, are there any areas of your portfolio that you’re not seeing that positive trajectory, or maybe put differently, are there any very obvious flex points that you’re thinking about in the portfolio as we position for 4Q next year?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah. Thanks for the question, Mike. Broadly speaking, all of our businesses are trending well in terms of growth and sequential acceleration. I would say we’ve seen some timing differences relative to kind of project timing, and that’s affected pieces of our packaging and color hardware business, to a lesser extent on the water side. And I would say, you know, projects tend to move around a little bit, but they generally come through. So we haven’t seen any, you know, indefinite delays or project cancellations.
But timing sometimes is variable there. In the main, I would say by virtue of our large sort of recurring revenue business, things are pretty steady. Demand continues for the products and services that we have. We’ve got great secular drivers relative to data centers and feeder industries in power, semiconductor and mining. Recycle/reclaim is big on the muni side as water scarcity becomes a bigger issue. And I would say the Food Safety Modernization Act is driving product reformulation, packaging changes and so on.
So we see good demand there as well. So I think we feel pretty good about the outlook here in the fourth quarter and the fact that we believe that momentum will continue here into 2027.
Mike Halloran (Analyst)
Appreciate that. And then just on the capital deployment side, it’s been an aggressive year and balanced with buybacks and M&A. So maybe a twofold question: one, how are you thinking about the buyback intent in the short term? Obviously saw some of the ongoing repurchases in October, but then how do you think about the pipeline after having completed a fair number of acquisitions over the last 18 months or so?
Samir (Senior Vice President and Chief Financial Officer)
Yeah. Hey Mike, thanks for the question. As far as the buyback is concerned, look, if you add what we have done in October that we disclosed, we’ve effectively done $550 million of share repurchases out of the 750 program. Look, I mean as we always said, we’re going to be opportunistic and if there’s an opportunity in the marketplace where we think there’s a disconnect between the intrinsic value and the market value, you should fully expect us to be using the authorization.
So we’ll continue on that path. As far as overall the pipelines are concerned, look, the pipelines are pretty active on the M&A side both. So as you’re going to move forward, we expect to stay pretty balanced. There’s no change in the overall capital allocation strategy.
Mike Halloran (Analyst)
Appreciate it. Thank you.
Jennifer Honeycutt (President and Chief Executive Officer)
Thanks Mike.
Samir (Senior Vice President and Chief Financial Officer)
Thanks Mike.
Erica (Operator)
Thank you. And we’ll take our next question from Nathan Jones with Stifel. Please go ahead.
Adam Farley (Analyst)
Good morning, this is Adam Farley on for Nathan.
Jennifer Honeycutt (President and Chief Executive Officer)
Morning Adam.
Adam Farley (Analyst)
Good morning. Maybe on chemical treatment within Water Quality on the data center piece, what is Veralto’s overall exposure to data centers within Water Quality? Maybe where do you think that exposure can grow to over time? And where in the data center construction timeline does chemical treatment benefit?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah. So overall, as we’ve said previously, our total sales in the data centers today remains small. We will say that our data center growth continued to be very strong and in fact doubled in Q3. But that’s obviously off of a small base. And the draw here is from both our treatment and our analytics businesses. We are, by virtue of our ChemTreat business, engaged early in those project builds and get requested to participate in helping to consult on water train and water treatment design so that customers can optimize both water utilization and power consumption.
Those often are counterbalanced to one another, and so finding the balance between power-efficient and water-efficient design is something that every data center is working to solve for. So we are involved early in the process. We have good installed base relative to utility water and increasingly have offerings and are really in the liquid side of direct-to-chip cooling as well. So good exposure here. Small base of business growing double digits. Strong double digits. And we would expect that to continue for the foreseeable future.
Samir (Senior Vice President and Chief Financial Officer)
Yeah. I mean, Adam, as you think about the data center business for us, especially on the treatment side, it’s an annuity business for us. So yes, the build cycle, I get that question. But think of our business predominantly as more annuity business. So as these data centers come in and operate,
Adam Farley (Analyst)
That’s really helpful color and then just staying on Water Quality, could you provide an update on your expectations for growth regionally? Do you expect North America to continue to lead growth maybe through next year and then maybe what are you seeing out of China? Thank you.
Jennifer Honeycutt (President and Chief Executive Officer)
Just to clarify, the last point was what do we expect out of China?
Adam Farley (Analyst)
Yeah. In Water Quality.
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, okay. Water Quality. Yeah. So, you know, China continues to be lower in its muni spend, kind of still bumping along the bottom there. We’re not accounting for or expecting any significant change there. But as a reminder, China represents about 6% of our sales. In Latin America, water was down modestly year over year, but higher sequentially throughout the quarters here. Underlying demand is strong, but timing of some of these projects has been delayed and that’s largely on the back of waiting for election results and so on.
I would say given the completion of the election here in Brazil, that uncertainty should clear here and we should start to see, you know, that demand start to increase. So, you know, we continue to watch our high growth markets here. They have been relatively lower than their name would suggest, with good growth in the western markets of Europe and North America. But we continue to have good opportunities in Latin America, I would say as well in India, parts of Southeast Asia. But China is definitely still not investing.
Adam Farley (Analyst)
Thank you for taking my questions.
Erica (Operator)
Thank you. And we’ll take our next question from Andy Kapowicz with Citigroup. Please go ahead.
Andy Kapowicz (Analyst at Citigroup)
Hello, can you hear me?
Erica (Operator)
Yes, go ahead. Yes, Andy, we can hear you.
Andy Kapowicz (Analyst at Citigroup)
Hey, good morning guys. So maybe we could just double click into the reacceleration in organic growth you’re seeing in PQI. Jennifer, you mentioned some project delays, but obviously your growth has been picking up and you’ve continued to talk about acceleration in digital workflow solutions. So what are your core customers telling you? And, you know, given that the economic environment is sort of mixed out there.
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I mean, I think what we see here is, you know, strong demand and bookings of our digital workflow solutions. You know, this is on the back of, you know, the TraceGains, GlobalVision acquisitions being integrated into the Esko Digital backbone. And as you know, we book revenue over the life of the contracts, which gives us good visibility and confidence in the sequential core growth acceleration. We continue to see steady demand in marking and coding.
Right. There are some category changes within consumer product goods, but effectively, you know, we see strong continued, you know, performance and uptake from our mid-market customers. That’s going to continue to result in sequential core sales growth. And then I would say the other element here is Q4’s got a relatively easy comp in our marking and coding side of the business. So that’s an element as well. And then finally say that our sales recovery of our color measurement equipment in packaging and color, we would expect that to come back.
And, you know, we see good commercial execution, good funnels. We exited Q3 with stronger service growth and that gives us confidence here as we head into Q4.
Andy Kapowicz (Analyst at Citigroup)
Very helpful, Jennifer. And then Samir, can you give more color into what you’re seeing maybe in price versus cost? I think you’re modeling adjusted operating margin to be down a bit in Q4 versus Q3, even excluding the tariff benefit in Q3. So just maybe the puts and takes on sort of how you’re thinking about margin in Q4.
Samir (Senior Vice President and Chief Financial Officer)
Yeah. And as you look maybe at this for the margin first, if you look at the margin for Q4, yes, sequentially, you know, most of the impact that you see is really driven by the Clean Water One acquisition. Overall for Q4 margins you should fully expect the flow-through to be 30–35%. So that’s roughly 30 bps of a margin expansion on a year-over-year basis. Cost optimization program, if you look at the guide that we’ve given for the full year, that adds another roughly 40 basis points to the OMX for Q4.
So that’s at 70, and that 70 is mostly offset by the Clean Water One acquisition. That’s how we kind of modeled it in. But as you know, in Q4 we do tend to make some investments to help support ’27 strategic initiatives. So we’ve built in a fairly healthy amount of investment in Q4 tied to that. To the extent that those things come in light, of course there’ll be upside to the guidance.
Andy Kapowicz (Analyst at Citigroup)
Appreciate all the color.
Samir (Senior Vice President and Chief Financial Officer)
Thanks Andy.
Erica (Operator)
Thank you. And we’ll take our next question from Jacob Levinson with Melius Research. Please go ahead.
Jacob Levinson (Analyst)
Hi, good morning everyone.
Jennifer Honeycutt (President and Chief Executive Officer)
Good morning, Jake.
Jacob Levinson (Analyst)
Just to go back to Mike’s question for a second on the M&A side of things. I know you folks have been pretty active here with a number of bolt-on deals, but can you just give us a sense of what that funnel looks like from here? Is it a lot of these smaller assets that are out there, or are there also some larger deals that you might be interested in as well?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I would say, Jake, that it’s a mix. Both funnels on both sides of the house are healthy and full. Lots of cultivation work underway. You know, I think what you’ve seen us do here in the first three years is, you know, build out our position in treatment in the environmental business and digital workflow solutions, all of which are expansions of our current positions, but squarely within our wheelhouse. So we feel good about the funnels. There are all kinds of assets in those funnels.
There are large deals, there are small deals, there’s technology deals, there’s geographic expansion deals. And so, you know, we have a track record here of going after these strategic bolt-ons. I think we’re well served by that. But again, we’ve got a variety of different types of assets in our funnel that we’ll continue to work and, you know, bring those in under the very disciplined approach that we’ve taken thus far to increase long-term shareholder value.
Jacob Levinson (Analyst)
Okay. And in your slide deck, on slide four that I’m not sure I’ve seen before, around modernized technology and upgraded facilities. I know you’ve done some work on the footprint given everything with tariffs, but maybe you can just elaborate on what that really means.
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I don’t think it’s, you know, unreasonable to think that some of our technologies might have atrophied in prior times, being a smaller portion of Danaher. And so this is just part and parcel to continuing to mine the shop here at Veralto and make sure that we have modernized tech stacks for all of our data systems to ensure that we are continuing to invest in technology. You know, one example would be robotic automation of our ChemKey lines at Hach, right.
We will continue to modernize and upgrade these, you know, our ability to utilize data in ways that are AI friendly. And so this is just part and parcel to making sure that we are staying fit operationally, as we would say, and to make sure that we’ve got access to the latest and greatest tools to continue to be able to run the business well. And Jake, for those of you who’ve been to our Hachock manufacturing facility in the last 12 to 18 months, and any other tours, you’ve seen all the automation that we have done over there on the board manufacturing site. So those are the kind of examples where we are really upgrading our manufacturing footprint to be able to serve the customers more recently and more effectively over the U.S.
Jacob Levinson (Analyst)
Great. Appreciate the color. I’ll pass it on. Thank you.
Jennifer Honeycutt (President and Chief Executive Officer)
Thanks, Jake.
Erica (Operator)
Thank you. And we’ll take our next question from John McNulty with BMO Capital Markets.
John McNulty (Analyst)
Yeah, good morning. Thanks for taking my question and congrats on some really solid results. So wanted to dig into the water side and in particular water treatment and the UV treatment, just where you saw the double-digit growth. I guess can you help us to think about at least high level how much price there was there? I think some of the players in the industry put out some blanketed type pricing and it looks like it was around mid-single-digit.
I know you’re a little more surgical, so maybe a little more detail or color around the pricing environment would be helpful.
Samir (Senior Vice President and Chief Financial Officer)
Yeah, John, thanks for the question. Look, the pricing over there is pretty much in line with what you’re seeing overall, John. We want to make sure that we are covering the inflation in the chemicals that’s coming in the chemical treatment side. But those are very selective discussions with the customers to make sure that we are serving them well and making sure we’re getting paid for the service that we are delivering. So there is nothing out of the normal overall.
What you know from our perspective, pricing is an important lever. At the same time, installed base and having those contracts in place for the longer term is really key. As you know, as you kind of think about the water treatment part on the ChemTreat side, installed base really drives recurring revenue over the longer term. So we are always very mindful of that, how we think about the price in the instruments versus the services versus consumables.
John McNulty (Analyst)
Got it. Okay. No, that’s helpful. And then also in the water side you’ve made a couple of transactions, some very recent, some you’ve had a little duration on, I guess. Can you speak to the growth that you’re seeing in those businesses? Are they seeing any incremental synergy benefits on the revenue side yet or not, and how you’re thinking about that going forward?
Samir (Senior Vice President and Chief Financial Officer)
Yeah, maybe, John, I’ll start with that water side. The first one was In-Situ at the beginning of the year. Really solid start. You’ve seen us the expansion in the water side if you look at the M&A contribution line in the water quality, like very solidly contributing. That’s where you see the impact of In-Situ. Overall, I would say on the synergy side of the commercial, we are well ahead of the plan actually that we used to underwrite the acquisition.
So feeling really solid about the In-Situ, and you’re going to start seeing that in the organic growth as you move into next year. I would say the Aquafeedis acquisition that we did in Europe on the UV treatment side, again really solid execution and contribution that we’re seeing over there. Alpha UV and Clean Water, just early days, right? Alpha UV, they’ve been there only less than a month. Clean Water has been there for less than a month with us.
So more to come on Alpha UV and Clean Water as you move into the year. And when we talk about the guide overall, really pleased with the execution and the synergy, especially the synergy part on both In-Situ as well as Aquafetis.
Jennifer Honeycutt (President and Chief Executive Officer)
Well, the way to think about this is, all of those assets that Samir just mentioned are high single-digit, low double-digit growers, and it’s by virtue of where they sit in the water treatment process. In-Situ, certainly in the groundwater hydrology side of things, as municipalities look for intelligence around what water is coming into their plant as influent. Alpha UV, our UV business at Trojan has been a high single-digit, low double-digit grower.
Alpha gets us really good position in India with good sales into industrial applications, and Clean Water One has a leading set of technologies that really help in the disinfection, odor control, and solids management side. So again, these are all technologies and product lines that sit in high-value areas that are structurally faster growing than some other portions of the portfolio.
John McNulty (Analyst)
Got it. Thanks very much for the color.
Erica (Operator)
Thank you. And we’ll take our next question from Robert Davies with Wolfe Research.
Robert Davies (Analyst at Wolfe Research)
Morning. Thanks for taking my question. I had two. One was just on the cost optimization program. You’d obviously fleshed out some early gains there, 10 to 15 million. But could you provide us a little bit more color, exactly what you’re doing, where the kind of main areas of focus are for that program? Thank you. And then the second question was just around the sort of non-recurring part of your business, sort of the 40% I guess of water quality.
What’s going on there? Do you see any sort of slowdown, any kind of impact from higher interest rates? Any more caution or down-trading? That’d be great. Thank you.
Samir (Senior Vice President and Chief Financial Officer)
Thanks, Robert. I’ll start with the cost optimization first. The cost optimization program is really focused around three activities. The first is a simplification of the business processes, and second is the functional transformations to optimize the cost, and then really looking at the investments that we can do to improve the competitive positioning from the technology perspective or the process improvement perspective. So that’s how the activities in the cost optimization program are focused.
We’ve had a pretty nice start to the program early on. And as you look at making the investments overall, we are still on plan to deliver roughly half of the savings by the end of ’27 and the full run rate in 2028. So that’s how you should think about the cost optimization program.
Jennifer Honeycutt (President and Chief Executive Officer)
And relative to your question around the 40% of water quality that is hardware or instrument based, bear in mind that we’ve got hundreds of thousands of instruments from water quality sitting out in our installed base, and those will have a seven-year life on average. So ongoing sort of reoccurring hardware move to modern technologies. As there are changes in the knowledge base of folks that sit in water treatment plants, there is a trend towards deskilling of the labor, and we’ve made a concerted effort here to collapse workflows, simplify the technologies that are deployed.
And so we feel good about the ongoing demand for new technology purchases and upgrading the existing installed base that’s out there.
Robert Davies (Analyst at Wolfe Research)
Thank you very much.
Erica (Operator)
Thank you. And our next question comes from Andrew Buscalia with BNP Paribas. Please go ahead.
Andrew Buscalia (Analyst)
Good morning everyone. I’m just wondering if you can kind of set us up into ’27 on margins here. And I know you want to probably give guidance for next year, but I think your margins are really starting to accelerate. It’s a stark contrast to kind of what else we’re seeing this earnings season where costs and inflationary pressures are starting to sting some companies, but you guys have navigated that quite well. But before we, you know, just looking out to ’27, are you cautious on costs creeping in in any sort of business?
Are you seeing any challenges on the horizon or that have crept up in the last three months? Yeah. And kind of what’s your view on just price/costs and the ability to continue this margin acceleration into ’27?
Samir (Senior Vice President and Chief Financial Officer)
Yeah, Andrew, thanks for the question. Let’s start with the raw material costs and the price side first. As you kind of look at this year, look, we are seeing inflation. We are seeing the inflation in some of the materials that are tied to, or which are oil derivatives. You’ve got to start looking at some of the transportation costs, memory prices. Of course, we are an instrumentation company so we do have some exposure over there. So we are seeing those price increases, but a really, really solid VES-driven execution and the partnership between our procurement teams and the business teams to help offset that.
So at this point, as the results demonstrate both in Q3 and also as you look at the guide for Q4, we believe we are well positioned at least in 2026 to make sure we offset that and drive the margins. Now as we move into 2027, look, Andrew, we’ll talk in more detail in February, but overall I think it’s fair to expect that we will have 30% to 35% of a fall-through and that’s close to 30-ish bps on the margin side. Cost optimization, of course, if you do the run rate, roughly $35 million cost saves. Now we look at 15 already this year. So that’s going to be a little bit of an upside on the cost optimization side on the margin side. But we are going to have a couple of headwinds as well on the margin side as we move into 2027. We got a little bit of benefit from tariffs, so that’s not going to be there next year, and then some of the dilution from the Clean Water One acquisition.
So there are lots of puts and takes; more details to come in February.
Andrew Buscalia (Analyst)
Okay, yeah, thanks for that. Yeah. And I wanted to ask on Clean Water One. I think this deal looked interesting to me as it’s kind of a perfect fit with Trojan and there seem to be some real near-term synergies where you might even get some accretion in ’27. It sounds like, bottom line, was that the impetus to do this deal, where it’s like kind of a cost savings margin ramp type deal, or is it a missing link to your kind of technology portfolio that you think you had to have?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I think we’re most attracted to the leading technologies that are brought with the acquisition. This bolsters our technology portfolio relative to treatment and it expands our penetration into higher-growth water treatment applications. They’ve got a terrific 25,000 instrument installed base there—equipment installed base—with deep applications expertise. We do see commercial synergies with Trojan and their UV treatment solutions. I think the first order of business obviously is don’t break what we bought.
So we will bring them in in the customary way relative to other acquisitions and focus on making sure that they’re firing on all cylinders as we look for those opportunities to bring synergies together with Trojan.
Samir (Senior Vice President and Chief Financial Officer)
Yeah, Andrew, to your point regarding the accretion, the point that I made earlier is on the margin it might be a little dilutive, but from the EPS perspective, we expect it to be flat to slightly accretive, as you said.
Andrew Buscalia (Analyst)
Nice. Yeah. All right, thank you, guys.
Jennifer Honeycutt (President and Chief Executive Officer)
Thanks, Andrew.
Erica (Operator)
Thank you. And we’ll take our next question from Jeff Reeve with RBC Capital Markets. Please go ahead.
Jeff Reeve (Analyst)
Thank you. Good morning everyone. My first question is on growth. Markets there grew 4.7% with strength in China and Latin America. I think that’s a notable reversal from the declines earlier this year. Maybe what changed and is this recovery broad-based or concentrated in specific products?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I think one of the things that we see here with our high-growth market exposure in PQI is, you know, we see good growth in China as manufacturing has come online and industrial output increases there, particularly relative to our coding and marking business. You know, anywhere in the world we see a growing middle class, that leads to more consumption. We see that in India, see it in parts of Southeast Asia, and we’ve seen relatively good uptake as well in Latin America for our products and services.
So I think the secular drivers that are around industrial manufacturing and a growing middle class, in terms of consumption for products that you’d see in our packaging and color side, you know, in terms of brand development as well as coding and marking, is something that we continue to see as well. So good position here in high-growth markets, and we would expect that to just continue.
Jeff Reeve (Analyst)
Got it. Okay. And maybe just to double click on PQI in the fourth quarter, you said you expect a meaningful acceleration in the digital workflow solutions. Can you just help us calibrate what meaningful means? Is this driven by bookings and ACV already in hand or is there an element of pipeline conversion that needs to occur, or is this an easy comp?
Samir (Senior Vice President and Chief Financial Officer)
Yeah, Jeff, thanks. When we say it’s meaningful, really, when you look at the guidance, PQI will be closer to the high end of the range off of our Q4 guide. Now what’s driving it? You said earlier on the call, the digital workflow solution is going to be the biggest piece there. We have the bookings and we are recognizing revenue over time. So when you look at a three-month period, we have pretty solid visibility on that. The PQI on the marking and coding side is going to be steady demand, so we have a little bit of comp helps for us. And last, the element that’s giving us the confidence on the guide in Q4 is really the recovery in the color and measurement instruments. As you know, that business has been down for almost four quarters. We saw some recovery in Q3, and as we exited Q3 the order books look good. Good commercial execution is giving us confidence. So really it’s not dependent on one factor or the other.
It’s a combination of those three factors which is giving us the confidence as we think about the core growth for PQI in Q4.
Jeff Reeve (Analyst)
Great, appreciate it.
Erica (Operator)
Thank you. And we’ll take our next question from Steve Volkman with Jefferies. Please go ahead.
James (Analyst)
Good morning, this is James from Steve. Thanks for taking questions here. I guess I wanted to touch on water quality here a bit. Data center obviously is still small, but that has doubled. And you kind of talked about chemical processing, food and bev, power and mining all growing kind of double digits here. So are these kind of new site wins driven that are going to build an annuity going forward, or are those more so kind of recurring OPEX work?
And how should we think about sizing of this fast-growing market exposure? I know data centers is small, but if we have to combine everything, how big are those?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, so we don’t disclose our sales by vertical market segment. Rest assured, when these are of size that require us to declare, you’ll see it in print. But the way to think about our play in data centers is very much, you know, driven by the recurring revenue side of things. So for our ChemTreat business, obviously there is a consultative opportunity early on when the plant is being designed, but the reality is where we really gain traction and start to accelerate is when those data centers come online.
So there’s greenfields, there’s brownfields, there’s expansion of existing data centers. The technology within a data center will be upgraded every five to six years. So over the life of a 30-year data center you’ve got five to six opportunities really to play a role in how they upgrade and optimize. But the reality is we’ve got a play in utility water. And then certainly when those data centers come online, they’re operating 24/7. And that’s an opportunity for us to continue to have good penetration of our chemical solutions and services that go into everything from utility water to direct-to-chip cooling as well. So I think that the drivers here are pretty durable in terms of how we think about this going forward, with every data center that comes online an increasing opportunity for us to gain market share.
James (Analyst)
Awesome. Thanks for the color. I guess following up on that, you kind of talked about increasingly offering into the liquid side of direct-to-chip cooling here, and that kind of sounds like a different role from utility water chemistry. So what are you actually selling there? Is it like fluid chemistry, monitoring, filtration, and is the content per site kind of richer than the traditional cooling water site?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, there it’s going to be, look, it’s going to be fluids and the services that tie to it. You’ve seen us announce a partnership with Dow as well, on the glycol side. So it’s a combination of things around that and the services that go along with it.
James (Analyst)
All right, thanks for taking questions here.
Erica (Operator)
Thank you. And we’ll take our next question from Josh Spector with UBS. Please go ahead.
James Cannon (Analyst at UBS)
Yep. Hey guys, this is James Cannon on for Josh. I just wanted to dig into the regional trends in PQI again. To me the Europe numbers seem to lag a bit versus, to us it seemed like the end consumer trends seem a bit more stable region to region. Can you just unpack what you’re seeing there and how you expect that to trend going forward?
Jennifer Honeycutt (President and Chief Executive Officer)
So yeah, the low single-digit growth in packaging and color in Western Europe: what we see there is marking and coding flat. We do see solid growth in consumables but modestly lower sales in equipment, and that’s largely on the back of some timing around customer spend. We do see solid growth in Western Europe for marking and coding during the first half of the year, and we do expect certainly to see some growth here in the fourth quarter.
James Cannon (Analyst at UBS)
Great, thank you very much.
Erica (Operator)
Thank you. And we’ll take our final question from Joe Giordano from TD Cowen. Please go ahead.
Joe Giordano (Analyst)
Yes, thanks for taking my question. So the acceleration at PQI here into 4Q, I just wanted to kind of understand how representative of that, of the true underlying conditions as we go into next year. Like is that a good exit rate to be building? I know you don’t want to give guidance here, but just is there anything in that kind of six and a half that’s a little bit one-time, a little bit comps, or should we kind of think about that as truly the pace of growth across that portfolio?
Samir (Senior Vice President and Chief Financial Officer)
Yeah, thanks Joe for the question. Yeah, but look, I won’t draw a straight line from that needless to say in 2027, February. But if you’re going to look at the build-up to the core growth in Q4 for PQI, marking and coding is kind of steady. So that should kind of flow into 2027 at this point based on everything that we know. On the digital workflow solution side, that is driven by the underlying demand in the TraceGains, GlobalVision, and Esko product lines. We would expect that will grow. But on the color measurement side, comp is helping. Right. If you recall, we started seeing the weakness in the second half of last year, so Q3, Q4 were pretty weak in the color measurement side. So that will normalize over time. But you know, we’ll talk about more in detail in February, Joe.
But there are some elements which are kind of helping from a comp perspective here too.
Joe Giordano (Analyst)
Yeah. Okay. And then just on the water quality broadly, I’d say as we’ve gone through earnings season, most of the commentary across water has been utilities kind of a little bit constrained on spend and project delays. And I fully appreciate the nature of your business is not into these projects and you’re not doing water meters and stuff like that. But ultimately, if these utilities are facing kind of budgetary constraints, to some extent does that ultimately roll over to you guys on some sort of lag to a lesser extent?
Like how should we think about the issues as they’re seeing in one part of their spend ultimately impacting the totality of the spend?
Jennifer Honeycutt (President and Chief Executive Officer)
Yeah, I mean, you know, obviously, the vast majority of our sales in water are OPEX instead of capex. Where they are capex, they tend to be on the operating side of technology upgrades or facility improvements as opposed to infrastructure where government funding and federal funding is more material. But look, you know, we represent a low relative cost of the entire operating environment where critical workflows are essential. The cost of failure to the customer is high, and they’re not going to take a chance on choosing not to fund water treatment operations.
So our sales here are really durable. Sixty percent recurring revenue. The other forty percent is really around upgrades and reoccurring revenue relative to equipment that needs to be replaced over time. So again, we see this as being pretty durable on an ongoing basis. And we are very minimally exposed to federal funding fluctuations. So we like where we sit, and we continue to have good momentum here.
Joe Giordano (Analyst)
Thank you guys.
Ryan Taylor (Vice President of Investor Relations)
Thanks, Joe. This is Ryan Taylor with Veralto. We just wanted to thank everybody for joining the call. That ends the question and answer portion of the call, and we really appreciate the engagement. We wish everyone well, and we will talk to you next quarter.
Erica (Operator)
Would like to thank everybody for their participation. Please feel free to disconnect at any time.
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