My name is Leo, and I will be your conference operator this morning. At this time, I would like to welcome everyone to Veralto Corporation's Second Quarter 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Ryan Taylor, Vice President of Investor Relations. Mr. Taylor, you may begin your conference.

Good morning, everyone, and thanks for joining us on the call. With me today are Jennifer Honeycutt, our President and Chief Executive Officer; and Sameer Ralhan, our Senior Vice President and Chief Financial Officer. Today's call is simultaneously being webcast. A replay of the webcast will be available on the Investors section of our website later today under the heading Events & Presentations. A replay of this call will be available until August 9. Before we begin, I'd like to highlight a few recent disclosures. On July 24, we issued our 2024 sustainability report. That report can be viewed on our main website under Sustainability or on our Investor website under Corporate Governance. Yesterday, we issued our second quarter news release, earnings presentation, and supplemental materials, including information required by the SEC relating to adjusted or non-GAAP financial measures. Additionally, our Form 10-Q was filed yesterday. These materials are available in the Investors section of our website under the heading Quarterly Earnings. Reconciliations of all non-GAAP measures are provided in the appendix of the webcast slides. Unless otherwise noted, all references to variances are on a year-over-year basis. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results may differ materially from forward-looking statements. These forward-looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward-looking statements, except as required by law. With that, I'll turn the call over to Jennifer.

Thank you, Ryan, and thank you all for joining our call today. I want to start this call by recognizing the engine behind our strong second quarter results, our more than 16,000 associates around the world. Their strong execution and support of our customers drove our growth and improved profitability during the quarter. Nine months into our journey as an independent company, we are hitting our stride and delivering winning outcomes for our stakeholders. A key catalyst has been increased rigor in deploying the Veralto Enterprise System. As I've shared before, VES is a key competitive advantage for Veralto. It drives continuous improvement, accelerates innovation, and enables us to win in our markets. Every day, at all levels of our enterprise, our teams leverage VES to solve problems rapidly and drive sustainable improvements. Our increased rigor in deploying VES has helped drive growth, expand margins, and ensure that we deliver on commitments. Our second quarter results demonstrate the benefit of this increased rigor, while also highlighting the durability of our businesses. We delivered core sales growth across both segments, led by better-than-expected positive volume and price increases in line with historical levels. We expanded margins at both segments through strong operating leverage, improved productivity, and cost optimization. Based on our strong execution in the second quarter and an incrementally more positive view of our end markets, we have raised our full year adjusted EPS guidance. From an end market perspective, we are capitalizing on secular growth drivers across our industrial and municipal markets in Water Quality. In water analytics, our commercial initiatives are accelerating volume growth and market penetration, particularly in consumables. And in water treatment, we continue to see strong growth, driven by our customers' water conservation, reclaim, and reuse initiatives. On that front, ChemTreat was recently recognized as…

Thanks, Jennifer, and good morning, everyone. I'll begin with our consolidated results for the second quarter on Slide 8. Net sales grew 2.8% on a year-over-year basis to about $1.29 billion. Core sales grew 3.8%. Currency was an 80 basis points headwind or approximately $10 million. And the small divestiture of Salsnes was a modest headwind. Our core growth in this quarter was balanced, with both volume and price increases driving our growth. Price contributed 2% growth in this quarter, in line with our expectations and historical levels. Volume grew 1.8%, with positive volume growth across both Water Quality and PQI. This marks the first quarter since the second quarter of 2022 in which volume grew across both segments. Our recurring revenue grew mid-single digits year-over-year and comprised 62% of our total sales. We expanded margins at both segments through strong operational leverage, improved productivity, and cost optimization. Gross profit increased 7% year-over-year to $774 million. Gross profit margin improved 230 basis points year-over-year to 60%, reflecting the benefits of pricing, as well as improved productivity and reduced material costs. Adjusted operating profit increased 5% year-over-year and adjusted operating profit margin expanded 70 basis points to 24%. We delivered strong margin expansion, while investing in our sales and marketing efforts to drive future growth. We also increased our R&D investments, with R&D as a percent of sales increasing 20 basis points over the prior-year period. These investments are aligned with our strategic growth plans and we expect to continue to fund ongoing growth investments. Looking at EPS for second quarter, adjusted earnings per share grew 6% year-over-year to $0.85. And free cash flow was $240 million, down from the prior year, primarily due to standalone public company costs and cash tax payments, which were not incurred in the prior-year period.…

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

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

Hey. Good morning, Jennifer, Sameer, and Ryan.

Good morning.

Good morning.

I've got to ask -- good morning. I got to ask about the gross margins just because they've been so incredible, strong. Is -- A, I guess, is 60% the new normal or is that just more of kind of a shorter-term impact? And second, maybe I heard the word price in the context of pricing power more on this quarter and last one, too, than we would have thought in the past. And are you finding there's just more pricing power in your markets maybe than you thought you had before and that's driving that 60% gross margin. Is that a fair takeaway?

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

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

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

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

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

Thanks, Scott.

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

Thank you. Good morning, everyone.

Good morning, Deane.

Good morning. Hey, I'll echo…

Good morning.

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

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

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

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

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

That's real helpful. Thank you.

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

Hey, good morning, everyone.

Good morning, Andy.

Good morning, Andy.

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

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

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

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

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

Appreciate the color, guys.

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

Yeah. Thanks for taking my question. Maybe one on the free cash flow side. Obviously, a really strong quarter for you there and hitting kind of conversion levels that are above what you're certainly looking for the year. I guess, can you help us to think about what drove that? And if that -- if we see more things that you can kind of wring out from, whether it's a working capital side to kind of keep that level elevated for the next couple of quarters, how should we be thinking about that?

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

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

Yeah. I think it's -- let's take it in two buckets, right? One is -- first, on the business side, as we kind of told you, right, at the beginning of the year, we will be we -- are investing in the sales and marketing side to really drive the growth of the business, and you've seen that kind of really coming through or flowing through the numbers in the first quarter and second quarter. John, inflation is there a little bit, I think, just like everybody else. There's nothing outsized. But it's -- these are really heads that are added more on the sales and marketing side to drive the growth, and you started seeing a little bit of the impact and more in the 2025 that you're going to see. So I would say, on the business side, we are more or less in a normalized state, so to speak, and SG&A as a percent of revenues. On the corporate side, we were very judicious in how we bring the cost in. So what you're going to see is more of a run rate view of the corporate expenses in the second half of the year. So there's going to be a little uptick in the second half versus the first year that you're going to see on the corporate side, but that should normalize in the second half. So, nothing extraordinary on that front.

Great. Thanks very much for the color.

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

Hey, good morning, everyone.

Good morning, Mike.

Good morning, Mike.

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

Yeah. I think, Mike, what you've seen us do here is just pruning around the edges, right, and this is actually part of standard work that we do day-in and day-out in managing the portfolio of the businesses. It's not an -- it's not something that we look at on an episodic basis. We're looking at this all the time. So, I would say, when we see opportunities for continued portfolio evolution to get us a stronger portfolio, focused in the higher areas of growth with higher margin and recurring revenue, anything that falls materially far away from that profile is something that we'll take action on. So we feel good about the portfolio we have today. We'll continue to prune around the edges as and when we see that it's appropriate to do so.

Makes sense. And then just to follow up on, I think, Andy's question earlier, when you think about the greater confidence going into the back half of the year, has anything actually changed, or is this just about starting to see the momentum into this year, first quarter, and is actually having to materialize that gives you extra confidence? In other words, has there any -- been really any change in your thinking about how these end markets are going to progress?

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

Appreciate it. Thank you.

Thanks, Mike.

Our next question is from Brian Lee of Goldman Sachs.

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

Good morning, Brian.

The first one on -- hey, Sameer, good morning. Sameer or maybe Jennifer, you mentioned during your prepared remarks some favorable mix, I think, in the Water Quality segment that might have helped margins. Can you elaborate any -- on that, and is that something that either you can quantify or, as you think about the next few quarters, is that expected to persist.

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

All right. Fair enough. That's helpful. And then I know you're talking about improving end markets kind of across the board. Jennifer made some comments around the strong backlog trends in Water Quality. Can you maybe talk a bit more specifically around -- I think you had comments in the release about strong bookings in packaging and color. Our understanding is that that's more of a short cycle business. So, where is the visibility? Are those the areas where you're seeing trends improving as well? Just kind of any commentary on the short cycle side of your business? Thank you, guys.

Yeah. Relative to packaging and color, as we mentioned, we've just concluded our Drupa Trade Show. That's a trade show that runs once every four years. And given the pandemic, this is the first time that show has been conducted in eight years. So there were some really good kind of pent-up demand that we saw there. But I think our solutions and, particularly those around innovation that we're providing in the S2 cloud-native digital integration of the workflow has got the attention of a lot of brand owners, because they are under pressure to compress their development cycles and ensure the integrity of the information that they're working with, which gives every user of that system access to the same information. So we had a great showing there. The teams -- all three teams in terms of Esko, Pantone, and X-Rite really did a great job there. And I think the -- outside of the enthusiasm generated in Drupa, the recovery of the CPG markets will lend itself to new product releases and new product innovations from brand owners. So they are getting ready. They have a number of projects that they're considering in terms of new product releases and so on and so forth. And so, this is the front end of that. And I think we're well positioned to be able to help them with their solutions.

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

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

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

Good morning, Brad.

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

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

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

Yeah. No. Thanks for that. Look, I mean, it's first of all, really kudos to all our teams, all our 16,000 people that are really helping drive this kind of fall-through that you're seeing, right? Really proud of what we've been able to achieve this year. But as you kind of think about 30% to 35% is really on the -- over the longer term, right? We do want to incorporate in that long-term value creation algorithm, a healthy investment mix from the sales side, from R&D side. So I think from a long-term value framework perspective, I think still 30% to 35% is the right way to look at it. But I think -- and in the near term, really good performance and execution of the teams is driving a fall-through close to 50%.

Great. Thanks, Sameer.

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

Good morning, everyone.

Good morning, Nathan.

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

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

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

Yeah.

Now, look, the other question I had…

It kind of depends, right -- just to make sure, Nathan, right, it -- on average, right, this is a cumulative thing that we're looking at. Of course, the new investment should be incrementally driving higher growth from their side, but some things fall out of the portfolio, too.

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

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

Great. Thanks for taking my questions.

Our next question is from Andrew Krill of Deutsche Bank.

Good morning, Andrew.

Thanks. Good morning, everyone. I wanted to circle back on margins again from a little bit more of the medium-term perspective. I know there's been a lot of discussion just that the company has meaningfully more opportunities to improve margins than might be improved -- appreciated by investors. Just can you update us any of, like, the findings you've had since the spin on that and whether you would consider explicitly quantifying those at any point? And then would you also say, is there more opportunity in one segment versus the other or do you think it's kind of similar? Thanks.

Yeah. Andrew, thanks for that. As you kind of look at the opportunities on the margin expansion, right, this is -- the work that the teams have been doing on the procurement side, really our folks on the front lines and the shop floor, on the factory optimization, so these are lots of singles and doubles. As I said earlier in the call, it's not one or two factors that are driving this margin expansion. And that, frankly, really is the beauty of the kaizen culture, right? That's where you're going to see the margin contribution coming in. Those efforts really that the teams have been doing and execution that is happening is giving us the confidence to really up the bar on the margin expansion for the full year or we have -- instead of 50 basis points to 75 basis points, what we've said -- raised the guidance to is 75 basis point margin expansion for the full year this year. So that should get the full year pretty much close to 24% on the operating earnings margin.

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

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

Okay. Great. Thank you.

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

Good morning, Andrew.

Hey, good morning, everyone.

Good morning.

I'm just looking at your guidance and trying to map out the ranges. And looking at the high end, I'm wondering kind of what's contemplating or what informs the high end of your guidance? Because it's difficult to get there. So, you either need sales to accelerate for some reason or maybe you have some extra margin expansion in your back pocket. I guess, of those two or what -- what's behind that high end is my question.

Yeah. No, thanks for that. It really comes down to how you're going to think about the CPG markets, right? CPG markets are evolving, incrementally becoming positive, but it's a pretty fast-changing views that we are seeing. So I think, as you kind of look at the guidance range, one of the big drivers is how we kind of think about the CPG markets and the impact they will have on the on the PQI topline. I would say -- if there's one thing I can say, that's one of the key things. And then on the margin side, right, I mean, there's always the raw material price versus raw material contribution we always look at. We believe we have baked in a pretty prudent view here. So, any benefit from that will be more enduring towards the high end of the range.

Okay. That's helpful. And yeah, I wanted to ask, any update on the PFAS regulation opportunity in terms of whether anything new around your discussions with customers or -- I know you guys are talking about product development. Just what's the latest there?

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

Okay. All right. Thank you.

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

Hey, guys.

Good morning, Joe.

Good morning. Thanks for taking my questions. I was interested in the industrial growth commentary. It's just we're not hearing that in a lot of places, right? Industrial data is pretty bad and most companies, we're seeing orders decline. So it was interesting and good to see that there. Can you kind of -- what's driving that? Is it new project ramps? Is it -- like, is it optimization at existing facilities? Like, what's the nature of this kind of growth there? Because it does seem somewhat unique.

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

And then just last for me on the margins. So, we touched on this a bunch, but with gross margins at 60%, it's excellent. If I look at the spread between gross margins and EBITDA, 30% in SG&A seems a little high, like you're a newer company. Like, long term, what's like a real -- realistic level that that should normalize out at?

Yeah. Joe, I'll take that one. It's really the sales and marketing, right? If you -- just to take you back, effectively, when you look at the P&L, it really aligns with how we create value in the business. It's more driven by investments in R&D, it's a technology-driven business, and then on the commercial side, right? The secret sauce, what we believe and our competitive strength, is a direct business model that effectively does result in the sales and marketing that you -- impact that you see on -- in the numbers. Overall, we feel really good about our business model that is more direct, and it really drives a competitive advantage in the marketplace.

Thanks, guys.

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

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

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