Xylem Inc. (NYSE:XYL) Q3 2023 Earnings Call Transcript

Xylem Inc. (NYSE:XYL) Q3 2023 Earnings Call Transcript October 31, 2023

Xylem Inc. misses on earnings expectations. Reported EPS is $0.00063 EPS, expectations were $0.89.

Operator: Welcome to Xylem’s Third Quarter 2023 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for questions following the presentation. [Operator Instructions]. I would like to now turn the call over to Andrea van der Berg, Vice President of Investor Relations. Please go ahead.

Andrea van der Berg: Thank you, operator. Good morning, everyone, and welcome to Xylem’s third quarter 2023 earnings conference. With me today are Chief Executive Officer, Patrick Decker; Chief Operating Officer, Matthew Pine; Senior Advisor and former Chief Financial Officer, Sandy Rowland; and Chief Financial Officer, Bill Grogan. They will provide their perspectives on Xylem’s third quarter 2023 results and discuss the fourth quarter and full year outlook. Following our prepared remarks, we will address questions related to the information covered on the call. I’ll ask that you please keep to one question and a follow-up, and then return to the queue. As a reminder, this call and our webcast are accompanied by a slide presentation available in the investor section of our website.

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A replay of today’s call will be available until midnight, November 7. Additionally, the call will be available for playback via the investor section of our website under the heading Investor Events. Please turn to slide two. We will make some forward-looking statements in today’s call, including references to future events or developments that we anticipate will or may occur in the future. These statements are subject to future risks and uncertainties, such as those factors described in Xylem’s most recent annual report on Form 10-K and in subsequent reports filed with SEC. Please note that the company undertakes no obligation to update any forward-looking statements publicly to reflect subsequent events or circumstances, and actual events or results could differ materially from those anticipated.

Please turn to slide three. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. For purposes of today’s call, all references will be on an organic and or adjusted basis unless otherwise indicated, and non-GAAP financials have been reconciled for you and are included in the appendix section of the presentation. Now, please turn to slide four, and I’ll turn the call over to our CEO, Patrick Decker.

Patrick Decker: Thanks, Andrea. Good morning, everyone, and thanks for joining us. By now you’ll have seen that our first full quarter as a combined company was Xylem and Evoqua together. The team delivered very strong performance across each of our segments. We significantly exceeded expectations on organic revenue growth, EBITDA margin and earnings per share, and revenue grew 10% organically. We expanded EBITDA margin well above prior year, and we delivered EPS of $0.99 to the quarter, which represents 14% growth year-over-year. Orders were up 3%, and more importantly, our backlogs continue to grow, especially in our M&CS and ISS segments. Total backlog is now $5.2 billion, and this sets us up for continued growth momentum and demonstrates the health of our key end markets.

So on the strength of this performance, we are raising our full year guidance. I want to personally give a big shout out to the team for their strong operational performance during a period of integrating two large enterprises. Instead of getting distracted, the team continued to focus on serving our customers and delivering on our commitments. The integration of Evoqua is well on track to deliver the cost synergies we promised. It’s those synergies that underwrote the transaction, but more importantly, it’s the growth synergies that excite us the most. And our customers have already begun to experience the advantages of our combined capabilities. Overall, the quarter’s strong result, it reflects our continued momentum. And that puts me in a very privileged position on my last earnings call as CEO of Xylem.

In September, we announced the planned succession of both me as CEO and Sandy as CFO. Matthew Pine is going to lead Xylem as CEO beginning January 1. I’ll remain on as an advisor through the end of March. I’d also like to formally welcome our new CFO, Bill Grogan who is on the call with us today. He’s alongside Sandy Rowland. Bill took on the role of CFO on October 1, and it’s been a real pleasure to welcome him to the team. Now as Sandy was in the Chair through the end of September, she’s going to cover the third quarter results, but that’s not going to happen before I take the opportunity to thank her for her many significant contributions as Xylem. She’s been a great partner and a great leader over the last few years with me and the team.

We simply would not be where we are today without her many contributions. So now over to you Sandy.

Sandy Rowland: Thank you, Patrick. Before I go over the quarter’s performance, I would like to take a moment to congratulate Bill. In the short time since he stepped into the CFO role, I’ve been impressed with how quickly he has immersed himself in the business and taken on financial leadership of the company. Like Patrick, I will continue to stay on as an advisor through March to ensure a smooth transition, but the company will be in great hands with Bill working alongside Matthew next year and I couldn’t be more confident in Xylem’s future. And now, let’s look at the quarter. Please turn to slide five. As Patrick mentioned, the team has continued to deliver strong performance in Q3, exceeding expectations on growth, margin expansion, and earnings per share.

Each segment outperformed including Integrated Solutions & Services. As a reminder, since the combination with the Evoqua, we began including ISS as our fourth reporting segment. For Xylem overall, total revenues grew 50%, while organic revenue rose 10%, led by particularly robust double-digit growth in the U.S. Western Europe grew a healthy 6% and emerging markets was down largely due to China, despite strengths in other parts of Asia and also in Africa. From an end-market perspective, utilities grew 16%, mainly driven by robust demand and price realization in both M&CS and water infrastructure. Industrial grew 5%, driven by strong demand in the U.S. and healthy demand in Western Europe. Lastly, building solutions grew 3% with strength in developed markets, more than offsetting moderation in emerging markets.

Overall, demand remains resilient. Our backlog is now $5.2 billion, up 5% organically, and this includes a $1.3 billion contribution from Evoqua. Orders were up 3% in the quarter and book-to-bill for the company was approximately one. EBITDA margin was 19.8%, up 150 basis points from the prior year on higher volumes, productivity savings, and favorable price-cost dynamics. Our EPS in the quarter was $0.99, up 14% year-over-year. Please turn to slide six, and I’ll review each segment’s third quarter performance in a bit more detail. M&CS revenue was up 25%, driven primarily by improved chip supply and backlog execution, as well as strength in test and measurement. All regions saw double-digit growth, led by an impressive 31% in the U.S. Orders were down in the quarter due to the timing of metrology orders, while assessment services saw strong growth.

Year-to-date, book-to-bill remains above one for the segment. Our M&CS backlog of $2.3 billion is up 11% organically versus the prior year, a reflection of strong continuing demand for our AMI offerings and the accelerating trend towards digitization. EBITDA margin for the segment was up 190 basis points versus the prior year, driven by volume conversion, price realization, and productivity, more than offsetting inflation. And now let’s turn to slide seven, and I’ll cover our water infrastructure business. Water infrastructure outperformed due to stronger-than-expected price realization and backlog execution, with reported growth of 40% and organic growth of 7%. As a reminder, we have integrated Evoqua’s applied products technology business into the water infrastructure segment, further building out our treatment portfolio.

This business outperformed expectations driven by stronger backlog execution. For both, utilities and industrials, the U.S. saw robust growth, while Western Europe proved resilient, offsetting some weakness in emerging markets. Organic orders in the quarter were up 14% year-over-year, and each region saw double-digit growth with particular strength in developed markets. EBITDA margin for the segment was up 50 basis points and 80 basis points when excluding the contribution of Evoqua. Please turn to slide eight for an overview of Applied Water. Applied Water revenues grew 1% on continued backlog execution, modestly better than expectations of flat revenue growth. Growth in building solutions was driven by continued strength in commercial, particularly in the U.S. While industrial was down modestly, there was resilient growth in developed markets, offset by moderation in emerging markets.

Orders were up 2% in the quarter on strength in the U.S. And segment EBITDA margin expanded 20 basis points with continued strong price-cost dynamics and productivity, more than offsetting volume declines. Please turn to slide nine. Last quarter, we introduced Integrated Solutions & Services as our fourth segment. ISS brings a durable recurring revenue base from businesses including outsourced water, which provide outcome-based treatment services to customers. In its first full quarter with Xylem, ISS revenue exceeded our expectations as implied in our reported guidance. On a pro forma basis, ISS revenue grew 10% year-over-year, driven by strong price realization and backlog execution. Orders grew on a pro forma basis by 12% year-over-year with broad-based demand across industrials and utilities.

Book-to-bill was greater than one, and backlog exceeded $1 billion to end the quarter up 14% year-over-year on a pro forma basis. Adjusted EBITDA margin was strong at 22.6%, driven by price realization and productivity. And now let’s turn to slide 10 for an overview of cash flows and the company’s financial position. Our position remains robust as we exit the quarter with over $700 million in cash and available liquidity of $1.7 billion. Net debt to EBITDA leverage is 1.2x. And year-to-date we have adjusted free cash flow conversion of 94%. Please turn to slide 11, and I’ll hand it back over to Patrick.

Patrick Decker: Thanks, Sandy. Today is the 12th Anniversary of Xylem’s listing on the Newark Stock Exchange. And I think it’s pretty fair to say that 12 years ago, water wasn’t very widely recognized as an investable thesis. But since then, intensifying secular trends have made absolutely clear, the value of a platform of solutions to meet the global water challenges. In that time, Xylem has evolved in our composition, our scale, and our impact. But our investment thesis has remained constant. It’s one that’s focused on a multi-year runway of attractive organic growth with sustainable margin expansion and strong free cash flow conversion. And it’s that financial strength and confidence that allows us to effectively deploy capital as we continue building a differentiated market-leading water solutions platform.

Under that thesis, we built a very durable business model. And Xylem colleagues and partners around the world are creating significant economic and social value as we serve our customers and communities around the world. I am both proud of what we built so far, but also excited to see what Xylem is capable of becoming under Matthew’s leadership. Matthew and I have worked side by side for the three and a half years. So this handover is progressing very smoothly. And I have total confidence he will lead this team to realize the full promise of our strategy and create an even greater impact and value in the years to come. So now, over to you Matthew.

Matthew Pine: Thank you, Patrick. I am grateful and energized at the prospect of building on Xylem’s momentum and creating our next phase of growth and impact. I’m also deeply grateful for Patrick’s passionate, visionary leadership. His legacy is Xylem’s bright future, having put Xylem firmly on a path of continuing profitable growth. The strength of our partnership is making it easy to deliver the continuity essential to all stakeholders in this handover as we approach the turn of the year. And as Patrick said, our thesis is constant, our strategy is sound, and we are committed to our long-range plan. Our team is solving customers’ greatest water challenges with the most advanced platform of solutions in the world. In a fragmented, complex market, that integrated offering is a distinctive, competitive advantage.

The opportunity ahead of us is to make it easier for even more customers to access the full range of capabilities they need to solve their most critical water challenges. In the process, we’ll grow our penetration, our profitability, our durability, and our impact. The team and I look forward to sharing more color about the next phase of our growth at an Investor Day in May next year. We’ll provide a further update on our combined company opportunity and long-range plan then. In the meantime, I’m pleased to share our nearer-term outlook. I’ll provide a brief update on our Evoqua integration, and then a picture of what we expect in our end markets over the next period. And then finally, I’ll ask Bill to provide guidance for the remainder of the year.

Moving to slide 12, as you can see, the integration of Evoqua has gained quick momentum, and the team has come together remarkably fast. There’s great collaboration, and we have the benefit of bringing two highly complemented cultures with a similarly strong sense of purpose together. We committed $140 million of cost synergies within three years, as well as exiting 2023 with a $40 million run rate. And as Patrick mentioned, that’s well on track. But the rationale for the combination has always been about growth, the opportunity to create more value serving customers with our combined capabilities. In utilities, we’ll deepen our penetration, especially with the addition of Evoqua’s applied product technology offerings through our water infrastructure segment.

The combination allows us to provide even more comprehensive treatment solutions in both clean water and wastewater. In industrial, we will scale our presence in attractive verticals with services offerings of ISS. We see long-term market expansion in growing verticals such as microelectronics, power, life sciences, and food and beverage. And geographically, we will scale Evoqua’s products and solutions internationally, including the services business, by leveraging Xylem’s global distribution platform. Both Xylem and Evoqua were market leaders on their own, but together, we’re in even a stronger position. We are already seeing the benefits of scale, reach and integrated offerings, and a robust pipeline of global opportunities, as well as the combined wins both teams are posting.

And as we integrate our two businesses even more deeply, we’ll take advantage of the opportunity to optimize our portfolio for growth. That will include structuring our offerings in ways that are matched to how our end markets address water management. The job is to make it even simpler for them to access solutions they need, and we’re already hearing how customers appreciate having fewer vendors to coordinate across multiple domains. Now, let’s turn to slide 13, and I’ll cover the outlook for our end markets. Our outperformance in the first three quarters of the year provides great momentum to build on. I especially want to echo Patrick’s shout out to all of our teams for delivering such a standout performance this year, and in the third quarter.

It’s that kind of commitment and discipline that demonstrates the team’s ability to execute through a dynamic macroeconomic environment. That said, we continue to take a balanced outlook and are monitoring signs of softness on a regional level, particularly in China, and some end markets addressed by our Applied Water Segment. As a reminder, our 2023 outlook is expressed on an organic basis. At a high level, we anticipate that utilities demand will continue to be resilient, and industrial demand will provide steady growth. Utilities compromise approximately 45% of revenue. They continue to show healthy demand, and we continue to expect growth of mid-teens. On the clean water side, we continue to see robust demand for our AMI solutions. On top of that, we’re driving backlog execution on improved chip supply, and we’re seeing even more traction on solution selling with our digital platform as customers increasingly value bundled offerings.

We now anticipate growth of mid-20s up from low-20s previously. On the wastewater side, OpEx is expected to remain resilient in developed markets, alongside steady CapEx spend across regions, underpinning demand. We expect to see high single-digit growth in wastewater overall. Turning to industrial end market, which is about 45% of our revenue, we now expect global growth of high single digits up from mid-single digits. Developed markets continue to be resilient, although there are pockets of moderation in emerging markets. Lastly, in building solutions, which is about 10% of our revenue, we continue to expect growth of mid-single digits, driven by steady replacement business, particularly in commercial applications. Overall, the demand outlook continues to be positive despite some variability in macro indicators.

While the organic view does not include Evoqua, the demand profile in ISS is resilient on a foundation of recurring revenues, further increasing the durability of our business. Now, I have the pleasure of turning the call over to Bill for the first time to walk through our Q4 guidance.

Bill Grogan: Thanks, Matthew, and thanks Patrick and Sandy for your kind words. I’m incredibly grateful to Sandy for being so generous with her insight about the business during this handover. She has built a strong team and culture, and I wish her well in her new endeavors. I want to start by saying how excited I am to join the Xylem team. I have long admired the company, both because of its rise to sector leadership and also because of its distinctive commitment to both social and economic value creation. And now, a month in, I’m even more compelled by the opportunities ahead of us. It is a privilege to be part of the team that will take Xylem forward, building on this extraordinary platform and performance. As Patrick mentioned, we are increasing our full-year revenue EBITDA margin and EPS guidance.

Full-year revenue will now be approximately $7.3 billion. This translates to total revenue growth of about 32% and organic revenue growth of about 11%, up from 9% to 10% previously. We are raising EBITDA margin to approximately 19%, up from 18%, driven by higher volume, stronger price realization, and productivity initiatives. This reflects about 200 basis points of margin expansion versus the prior year. In addition, we are lifting full-year adjusted EPS guidance to $3.71 to $3.73, up from $3.60 at the midpoint. The revised guidance breaks down by segment as follows: Low 20s growth in M&CS, up from approximately 20% previously, high single-digit growth in water infrastructure, and mid-single digit growth in Applied Water. And we remain committed to achieving free cash flow conversion of above 100% of net income.

We have also provided you with a number of full-year assumptions in the appendix on slide 19. And now, drilling down on the fourth quarter. We anticipate total revenue growth will be in the 35% to 36% range on a reported basis, and 4% to 5% organically. By segment, we expect revenue growth to be mid-teens in M&CS, low single digits in water infrastructure, and remain flat in Applied Water. We expect fourth quarter EBITDA margin to be approximately 19.5%, driven by higher volumes, continued price realization, and productivity gains. This yields fourth quarter EPS of $0.94 to $0.96. Our operational discipline, commercial momentum, and backlog strength give us confidence to the remainder of the year in delivering our long-term plan. With that, please turn to slide 15, and I’ll turn the call back over to Patrick for closing comments.

Patrick Decker: Thanks, Bill, and thank you Matthew and Sandy. This is a bittersweet moment for me. I’m wrapping up my last earnings call with Xylem. Leading and helping build this enterprise has been absolutely the greatest privilege of my career. I’m so proud of what the team has achieved in the past 10 years. Of the work that we’ve done alongside our partners, serving our customers and communities, and of the value we’ve created together. That said, it’s clear to me personally, we are only just beginning to realize our full potential. Xylem is strongly positioned, our momentum is accelerating, and there has never been a greater need for solutions to the world’s water challenges. It’s incredibly gratifying to know that me, that my more than 22,000 Xylem colleagues and our partners are going to take the work of solving water forward under an exceptionally strong leadership team.

We are poised to have an even greater impact and to create even more value in the many years to come. On a final personal note to the many of you whose jobs include closely tracking and analyzing our business, I’ve come to know you quite well as you followed Xylem’s growth. I admire and respect the work that you do. All the very best to each of you, and simply go keep making a difference. Now, we’re going to take your questions, and so operator, let’s open it up for Q&A.

Operator: The floor is now open for questions. [Operator Instructions]. We’ll take our first question from Deane Dray with RBC Capital Markets.

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Q&A Session

Deane Dray: Thank you. Good morning, everyone.

Sandy Rowland: Morning, Dean.

Patrick Decker : Good morning.

Deane Dray: You’ll have to indulge me. I need to start with some important congratulations, so let me just rattle through them here. So Sandy, thank you for all your help and wish you all the best. Matthew, you and I have already connected twice in person since the announcement, but in my view, you’ve got the right skill set and leadership to lead Xylem from here, so congrats. And Bill, Bill, welcome. And I don’t want to put too much pressure on you, but we are expecting the same sort of elite CFO contributions that we saw for years at IDEX, so congrats and welcome to you.

Bill Grogan : Appreciate it, Deane.

Deane Dray: All right, so, and Patrick, no tissues here, but you’ve had a fabulous 10-year run. You’re handing off the reins truly in it from a position of strength, and I just remember when you joined Xylem, it was a company that thought of itself as a pump company. I mean, that’s what they said. And the entire portfolio has evolved to where, I love how you phrase it, you’re solving water. So just, you should feel really proud about how you developed the company and the portfolio and the leadership team, so congrats.

Patrick Decker : Thank you, Deane, and that means a lot coming from you. You’ve been here from the beginning.

Deane Dray: Yes sir, yes sir. All right, so let’s just talk about the quarter if we could, and maybe start with Evoqua and how the business – Matthew referenced some new wins. Just how have the revenue synergy started, conversations with customers, what’ll be the first opportunities maybe to take Evoqua’s business with existing customers to Europe? So any color there would be helpful. Thanks.

Matthew Pine: Yeah, thanks Deane for the question. Maybe I’ll just start at a very high level and just talk about the guiding principles that Patrick really stated when we did the deal, which I think were really important to our execution. The first was, we said we have to deliver on our ‘23 plans, and as you can see from Q3, really strong performance. As most of you know, that was the legacy Evoqua’s business Q4 in this past fiscal calendar Q3. So great execution by the team, and I couldn’t be happier. The second, we need to make sure we deliver on the value capture of the cost and revenue synergies. And on what I would call the softer side, which is equally as important when you bring two companies together, is to make sure we get the right talent on the field or the pitch, if you will, and make sure we retain top talent.

We’ve done a really nice job there. And then lastly, bringing the best to both cultures together. So obviously the work’s not done, but we’re off to a good start, and those guiding principles have helped really get momentum in the business. Just quickly on cost synergies, we’re tracking at the $40 million exit rate that we talked about, and those three buckets of corporate costs, procurement, and footprint. But more so on the revenue synergies, which you’re getting at Deane, the momentum is strong. We’ve just completed the APT integration into water infrastructure, which is really a milestone for us. We’ve appointed regional synergy leads in each one of the regions to drive the value capture. The incentives are in place, and the training’s ongoing, both for the sales team as well as the services organization.

The short term, as you talk about, really the short term we’re focused on cross-selling our products into industrial and back into municipal. I think the services, which I’ll touch on in a minute, has been the biggest surprise so far. Midterm, we’re going to leverage the Xylem footprint in Europe to bring capital products to customers, to the Evoqua products that are international, and bringing those folks from the U.S. to international. And then lastly, long term we’re moving our services internationally. But I wanted to give you an example of an early synergy win. We have a power customer, it’s an oil and gas – well, actually it’s an oil and gas customer, where we do the process water for them. It’s a build-on operate. We do not do the wastewater and they had their wastewater system go down and it was crippling their operations.

So within really 48 hours, we were able to bring the legacy businesses together, both on the treatment side, as well as the pumping and transport of wastewater in that facility and keep them up and running, and also keep them away from having fines. We’ve had several examples like that where we can bring a full solution to the customer with one phone call, and I think that’s really important. So off to a great start. There’s many examples like that, but we’ll be able to give a lot more context as we roll into 2024.

Deane Dray : That’s all really good to hear. And if I could have a follow-up on M&CS, just your update on the chip supply. It looks like we continue to see gradual improvement there. And any comments about the orders in the third quarter and just kind of what the funnel looks like? Thanks.

Matthew Pine: Yeah, I’ll start with orders and I’ll come back to chip supply. Although we were down 11%, backlog is up 11%, $2.3 billion in M&CS, book-to-bill ratio greater than one. Deane, the bid activity remains really strong in M&CS, especially metrology. Really the reason for the decline in orders in the quarter was more of a timing of the backlog conversion to orders. As you know, a lot of the larger AMI deals, they sit in backlog for a period of time, anywhere from three to 12 months, while the utility is getting ready for the deployment. And when we receive the PO is when we book it as an order. So it’s more of a timing issue, and that can be a little bit lumpy. But in general, we’re really bullish on AMI adoption, and it’s still fairly early innings.

On the chip supply, the original guide this year for the business was low teens. Now we’re in the low 20s. So we’ve seen continual gradual chip improvement quarter-over-quarter. I think this quarter it came in a little faster than we had thought, and it can be lumpy. But really chip supply in Q3 was strong. We see that continued momentum into Q4, especially with our product redesigns. And then obviously we’ve got — with the backlog, we have a lot of potential in ‘24 in M&CS.

Patrick Decker: Deane, this is Patrick. Just to punctuate what Matthew had said, in that segment again, orders are only a function of when POs are placed. The key metric there is what’s happening with backlog. And again, the backlog is very healthy, the deal pipeline is very healthy, and the win rate, especially in North America, is very impressive for AMI.

Deane Dray : Great. That all sounds good, and congrats again to everyone.

Matthew Pine: Thank you, Deane.

Patrick Decker : Thanks, Deane.