Veralto (VLTO) Q3 2025: Recurring Revenue Hits 62% of Sales as Data Center Demand Accelerates
Secular demand for water quality and product integrity solutions powered Veralto’s fifth straight quarter of mid-single-digit core sales growth, with recurring revenue now comprising nearly two-thirds of total sales. Robust free cash flow and disciplined capital allocation set the stage for increased M&A activity, while margin headwinds from tariffs and investment are being actively managed through pricing and operational agility. Management’s tone signals confidence in long-term secular growth, especially as data center and digitalization tailwinds intensify across key end markets.
Summary
- Recurring Revenue Momentum: High single-digit growth in recurring revenue underscores business durability and visibility.
- Tariff Mitigation Playbook: Strategic pricing, supply chain shifts, and local production are offsetting cost headwinds and supporting margin stability.
- Data Center Opportunity: Double-digit growth in water treatment for data centers and AI-linked verticals signals a long runway for expansion.
Performance Analysis
Veralto delivered consolidated sales growth of 6.9% year-over-year, with core sales up 5.1% and both segments—Water Quality and Product Quality & Innovation (PQI)—contributing to broad-based growth. Volume and price each drove roughly half of the core sales increase, reflecting both resilient end-market demand and successful pass-through of tariff-related costs. Recurring revenue, defined as consumables, services, and software contracts tied to installed equipment, rose at a high single-digit rate and now accounts for 62% of total sales, providing a stable earnings foundation.
Gross margin expanded 50 basis points to 60.1%, with Water Quality segment margin up 150 basis points, offsetting acquisition dilution and tariff mitigation costs in PQI. Free cash flow conversion exceeded 100% of net income, and net leverage fell to 0.7x as cash accumulated on the balance sheet. North America (50% of sales) led regional performance, with PQI core sales up 9.2% and Water Quality up 6%. High-growth regions like India and the Middle East also delivered double-digit increases, while China returned to positive growth in both segments.
- Recurring Revenue Growth: Outpaced equipment sales, driven by consumables, software, and increasing instrument placements.
- PQI Margin Compression: Tariff mitigation and strategic investments weighed on PQI margins, but price actions and operational shifts are expected to restore expansion in 2026.
- Water Quality Margin Outperformance: VES-driven execution and robust industrial demand, especially from data centers, supported outsized margin gains.
Overall, Veralto’s financial profile continues to strengthen, with disciplined execution balancing growth investments and risk management in a volatile macro environment.
Executive Commentary
"Our steady growth and improvement this year is a testament to our durable business model and the critical role our technologies and services play in supporting the daily operations of our customers ... The essential need for our technology solutions, our durable business model, and the secular growth drivers across our end markets fortified by the Veralto Enterprise System enable us to deliver long-term sustainable growth."
Jennifer Honeycutt, President and Chief Executive Officer
"Recurring revenue grew high single digits year over year and comprised 62% of our total sales ... Gross profit margin expanded 50 basis points to 60.1%, reflecting the benefit of our strategic pricing actions and strong procurement and supply chain efforts related to the tariff environment."
Sameer Rohan, Senior Vice President and Chief Financial Officer
Strategic Positioning
1. Recurring Revenue Model Drives Resilience
With 62% of sales now recurring, Veralto’s business model is increasingly insulated from macro volatility. Recurring revenue includes consumables, service contracts, and SaaS solutions such as TraceGains, digital compliance and workflow software, and ESCO, packaging workflow software. This shift enhances cash flow predictability and customer stickiness, especially as software integration deepens in both Water Quality and PQI.
2. Data Center and AI Infrastructure as Secular Growth Engines
Water treatment solutions for data centers and AI-related industries are growing at double-digit rates, with Veralto’s expertise in energy and water efficiency positioning it at the heart of this infrastructure buildout. The company’s role spans pre-construction consulting through ongoing operations, touching not just data centers but also semiconductor, power generation, and mining verticals that supply the AI value chain.
3. Tariff Mitigation and Localization
Veralto’s three-pronged tariff mitigation—strategic pricing, supply chain and procurement shifts, and localized production—has helped maintain volume and margin in the face of policy headwinds. Notably, PQI’s North American strength reflects both pricing actions and new product traction, with VideoJet, marking and coding technology, driving share gains as customers adapt to regulatory demands like the Food Safety Act.
4. Capital Allocation Bias for M&A
With net leverage at 0.7x and $1.8 billion in cash, Veralto is positioned for disciplined M&A, particularly in water quality and digital workflow adjacencies. Recent integration success at TraceGains (20%+ growth) and partnership with Emerald Ventures, early-stage water tech investment, highlight a proactive approach to pipeline development and innovation sourcing.
5. VES-Driven Operational Discipline
The Veralto Enterprise System (VES), a proprietary continuous improvement toolkit, underpins margin expansion, working capital efficiency, and rapid response to market disruptions. This operational backbone enables quick product line shifts and supply chain resilience, supporting both growth and risk mitigation.
Key Considerations
Veralto’s Q3 results reflect a business balancing secular tailwinds with disciplined risk management. Investors should weigh the following considerations as the company enters 2026:
Key Considerations:
- Scaling Digital and Software Revenue: Integration of TraceGains and ESCO is building a digital layer that could unlock higher-margin, recurring revenue streams in CPG and packaging markets.
- Data Center and AI Buildout Exposure: Double-digit growth in these segments is still a small percentage of total sales, but offers substantial runway as hyperscale infrastructure expands globally.
- Tariff and Supply Chain Agility: Localized production and nimble supply chain management are strengthening competitive positioning, especially in North America and high-growth markets.
- Capital Deployment Optionality: Ample cash and low leverage create flexibility for bolt-on M&A, but management remains disciplined, prioritizing long-term value creation over deal volume.
- High-Growth Market Acceleration: India, Middle East, and Latin America are contributing outsized growth, with secular drivers in water scarcity and infrastructure buildout.
Risks
Tariff volatility and ongoing geopolitical shifts could pressure input costs and supply chains, especially in PQI. While pricing actions have offset much of the impact, sustained cost inflation or new trade barriers could compress margins further. Currency fluctuations remain a secondary risk, as does the pace of digital adoption in legacy customer bases. Finally, the company’s growing reliance on M&A to drive incremental growth introduces integration and execution risk, particularly as the deal pipeline expands.
Forward Outlook
For Q4 2025, Veralto guided to:
- Mid-single-digit total sales growth year-over-year
- Core sales growth in the low-single digits (impacted by three fewer shipping days, representing a 2.5% headwind)
- Approximately 30 basis points of margin expansion year-over-year
- Adjusted EPS of $0.95 to $0.98
For full-year 2025, management raised guidance:
- Adjusted EPS of $3.82 to $3.85 (high single-digit growth)
- Free cash flow conversion at approximately 100% of GAAP net income
Management highlighted continued secular demand in water quality, robust commercial execution in PQI, and a strong M&A pipeline as key drivers for 2026 and beyond. Margin expansion is expected to resume in PQI as tariff headwinds lap by mid-2026, while water quality margins remain on a sustainable growth trajectory.
Takeaways
Veralto’s Q3 showcased the durability of its recurring revenue model and the strategic leverage of secular trends in water and product integrity.
- Margin Resilience: Pricing, supply chain agility, and VES execution are offsetting tariff and input cost headwinds, especially in PQI.
- Growth Engines: Data center and AI infrastructure demand are emerging as high-growth verticals, with water quality solutions at the core.
- Capital Allocation Discipline: Ample balance sheet capacity is poised for M&A, but management remains focused on value-creating targets in core and adjacent markets.
Conclusion
Veralto exits Q3 2025 with a strengthened recurring revenue base, robust free cash flow, and clear strategic focus on digital and infrastructure growth markets. Investors should monitor the pace of margin recovery in PQI and the scaling of digital solutions as key levers into 2026.
Industry Read-Through
Veralto’s performance signals sustained demand for mission-critical water quality and product integrity solutions, with secular tailwinds from data center and AI infrastructure spend benefitting the broader industrial technology sector. The company’s success in recurring revenue expansion and digital workflow integration offers a template for peers seeking resilience through business model evolution. Tariff mitigation strategies and localized production are likely to become industry standards in the face of persistent trade volatility. Finally, the accelerating growth in high-potential regions like India and the Middle East underscores the importance of global diversification for industrials navigating uneven macro conditions.