Xylem Inc. (NYSE:XYL) Q4 2023 Earnings Call Transcript

Xylem Inc. (NYSE:XYL) Q4 2023 Earnings Call Transcript February 6, 2024

Xylem Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to Xylem’s Fourth Quarter 2023 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference 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 fourth quarter 2023 earnings conference. With me today are Chief Executive Officer, Matthew Pine; and Chief Financial Officer, Bill Grogan. They will provide their perspectives on Xylem’s fourth quarter and full-year 2023 results, and discuss our outlook and guidance for 2024. 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. A replay of today’s call will be available until midnight, February 13.

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, Matthew Pine.

Matthew Pine: Thanks, Andrea. Good morning, everyone, and thanks for joining us. It’s a pleasure to share the Xylem team’s exceptional performance in the fourth quarter of a transformational year for the enterprise. The team delivered both Q4 and full-year results exceeding expectations on revenue and earnings per share. Looking at the fourth quarter, strong demand drove organic revenue growth of 9%. With disciplined execution, delivering EBITDA margin expansion of 90 basis points that drove double-digit orders growth. And our backlog is now more than $5 billion. Our Q4 performance capped off a year in which the team over-delivered in every quarter. Full-year organic revenues were up 12%, with EBITDA margin expansion of 190 basis points, and adjusted earnings per share growth of 20%.

The team even delivered an Evoqua run-rate cost synergies in 2023, ahead of plan. Both the quarter and the full-year give us very strong momentum entering 2024. Despite a dynamic environment and the excitement of our combination with Evoqua, the team stayed focused on serving our customers. Joining forces with Evoqua has put the sector’s most advanced portfolio of capabilities in the hands of our customers, and open up new opportunities to address even more of their water challenges. In our last earnings call, we shared a bit about the synergy traction we’re seeing between the legacy Evoqua Services business and Xylem’s dewatering business. And since them, we’ve seen the momentum continue to build as the team wins in the marketplace with our combined offering.

On January 1, we made it even easier for our customers to access the full breadth of our capabilities with the creation of the Water Solutions and Services segment, effectively combining Xylem and Evoqua services offerings in a realigned segment structure. The move supports the continuing growth of our services business and expansion of recurring revenues. And it puts Xylem in an even stronger position to capture value by serving industrial water customers who are increasingly outsourcing water management as water stresses intensify. Looking forward, we are starting strong in 2024 with momentum from our outperformance in ’23 and continued healthy demand in our major end-markets, though we’re keeping a close eye on demand dynamics in China, and are taking a prudent view of end-markets for Applied Water, which is our most cyclical segment.

Our backlog across the business is a source of continuing strength, especially at M&CS. We also feel very confident in our ability to drive continuing margin expansion by focusing our energy on the parts of the business delivering the greatest value. Overall, we’re well-positioned for profitable and sustainable growth. We expect 2024 organic revenues to be up 3% to 5%, with solid EBITDA margin expansion, resulting in earnings per share between $4.00 and $4.20. I’ll now turn it over to Bill to walk through the quarter’s results and our outlook for 2024 in more detail.

Bill Grogan: Thanks, Matthew. Please turn to slide five. As Matthew mentioned, we are pleased with the strong finish to 2023. The team has stayed focused and consistently delivered throughout the year, exceeding on our expectations on revenue and earnings per share for Q4 and the full-year. We continue to see resilient demand and are supported by our $5.1 billion backlog, which grew 5% organically for the year. Organic orders grew 10% in the quarter, with book-to-bill approximately 1 for the quarter, and greater than 1 for the full-year. Total revenues grew 41%, while organic revenues rose 9%, exceeding our guidance of 4% to 5%. Outperformance was led by M&CS and Water Infrastructure. All regions grew led by double-digit growth in the U.S. EBITDA margin was 19.6%, up 90 basis points from the prior year, with productivity savings, price, and higher volume more than offsetting inflation.

This reflects 33% incremental on the legacy Xylem performance. We finished the year with EBITDA margin of 18.9%, up nearly 200 basis points over prior year. Our EPS in the quarter was $0.99, above the high end of our guide by $0.03. When excluding the impacts of Evoqua, EPS was $1.10, up 10% over prior year. Our financial position remains robust with over $1 billion in cash, and available liquidity of approximately $2 billion. We ended the year with adjusted free cash flow conversion of 122%, exceeding our expectations and significantly improved versus last year. Please turn to slide six. Before I highlight each segment’s fourth quarter performance, I want to touch on some changes you’ll see in our earnings materials going forward. In the spirit of 80/20, we have simplified our earnings materials to focus on what is most important for investors.

To assist with the transition this quarter, we have provided our historical presentation format in the Appendix. And now, on to the segment performance, measurement and Control Solutions saw robust orders growth of 14%, with strength across the portfolio led by metrology and assessment services. Backlog is $2.3 billion and book-to-bill is above 1, a reflection of the strong demand for our AMI solutions and other digital offerings. MCS revenue is up 21% driven by metrology backlog execution and strong demand. We finished the quarter with improved EBITDA margins of 17.3%, up 220 basis points versus the prior year, and up 160 basis points sequentially on productivity, price, and higher volumes. Water Infrastructure also saw orders growth of 9% for the quarter, with strength across the portfolio, led by robust treatment demand globally.

Revenue exceeded our expectations with total growth of 30% on organic growth of 9%, driven by robust OpEx demand across all regions. EBITDA margin for the segment was down 90 basis points driven by the impacts of legacy Evoqua. When excluding the impact of Evoqua, EBITDA margin was up 50 basis points primarily due to price, productivity, and volume more than offsetting inflation and unfavorable mix. In Applied Water, although orders grew, book-to-bill was 0.9 times as we continue to work down our backlog and we saw softer demand environment in the U.S., our largest geography. Revenues were flat, in line with our guide, with the decline developed markets offset slightly by growth in emerging markets. Segment EBITDA margin expanded 80 basis points, with productivity and price more than offsetting inflation and volume declines.

Integrated Solutions and Services, orders grew 5% on a pro forma basis, and book-to-bill was 1. Demand was driven by services. Pro forma revenue growth of 10% exceeded our expectations, as implied in our reported guidance, with healthy growth across the portfolio. Adjusted EBITDA margin was strong, at 21.1%, driven by price realization and volume. Please turn to slide seven, I will cover our segment outlook for the year. As Matthew mentioned, in December, we announced the creation of Water Solutions and Services segment. We are providing organic revenue guidance based on our previous reporting segments. Later this month, we will provide recast financial information aligned to the new segments. However, we expect the segment guidance outlook to largely be in line with the new segment structure, and will update as needed in our Q1 earnings call.

In M&CS, we expected growth of low teens. Demand and order momentum for our AMI solutions remain strong. We expect to see sequential revenue improvement throughout 2024 supported by our robust backlog. In Water Infrastructure, we expect growth of mid-single digits. We expect resilient OpEx demand due to mission critical nature of our applications, and a healthy CapEx demand. We are continuing to closely monitor its office in China, where the majority of our business is in the utility end-market. In Applied Water, we expect a modest decline of low single digits. We continue to see pockets of softness across our end-markets, particularly in developed markets which make up about 80% of our business. We also expect to see headwinds as we lap price increases and our backlog returns to more historic levels.

ISS growth is expected to be mid single digits with growth across both capital and services. We continue to see strong activity in our funnel, particularly in high-growth verticals such as food and beverage, energy, and life sciences. This segment is supported by $1 billion in backlog and a durable service business model. And as a reminder, the ISS growth outlook is on an organic basis. Now, let’s turn to slide eight for our 2024 and Q1 guidance. The growth outlook by segment translates to 2024 full revenue of $8.4 billion to $8.5 billion, resulting in total revenue growth of 14% to 15%, organic revenue growth of 3% to 5%. EBITDA margin is expected to be 19.4% to 19.9%. This represents 50 to 100 basis points of expansion versus the prior year, driven by higher volume, productivity, and price offsetting inflation.

This yields an EPS range of $4 to $4.20, up 8% at the midpoint over prior year. We are expecting approximately $100 million of exit run-rate cost synergies in 2024, which is embedded in our guide. Free cash flow conversion for the year is expected to be 115% of net income. Drilling down on the first quarter, we anticipate total revenue growth will be in the 36% to 38% range on a reported basis and 4% to 6% organically. We expect first quarter EBITDA margin to be approximately 18%, up 170 basis points, driven by higher volumes, continued price realization, and productivity gains. This yield first quarter EPS of $0.80 to $0.85. We are entering the year with momentum and from a position of strength. Our balanced outlook reflects our strong commercial position and the durability of our portfolio.

While we also continue to monitor broader market conditions particularly in China in Applied Water which is our shortest cycle business. In the case of larger than expected volume declines, we are ready to take additional cost actions as needed to ensure continued focus on margin expansion. Overall, our expectations for the year remain positive as we build on a strong momentum. With that, please turn to slide nine. And, I’ll turn the call back over to Matthew for closing comments.

Matthew Pine: Thanks, Bill. It’s been incredibly exciting to step up as CEO at a time of such great momentum and opportunity for Xylem. I began the year by spending time with customers and colleagues in India and the Middle East. Bill and I started off in India. And, the scale of ambition there to modernize infrastructure and tackle the big water challenges is frankly awe-inspiring. We have an outstanding team there doing great work to serve customers from our localized R&D in manufacturing platform that gives us a real competitive advantage. And both India and the Middle East provide great reminders of the fundamental interconnectedness of economic value and social value creation in our business. These markets present expansive commercial opportunity.

And in both markets every project improves lives and increases sustainability of communities. We took some time out with colleagues in India to visit a school in a rural area outside of Bangalore. We got hands-on building a small scale water treatment system that now provides clean drinking water for the students and their community. I’ll be honest. The experience of celebrating with those kids and their teachers as the clean water started to flow, well, it’s just hard to describe. And you also know that the impact on educational outcomes, health, and quality of life is likely to be profound. That experience drove home for me not just the importance of what Xylem does but it reinforced the focus we are bringing into 2024. Whether it’s a scale of a school or the scale of a megacity, we have to make it easier for customers and community to solve their big water challenges, reducing the complexity of water solutions that is our focus, simplifying water.

We have assembled the most advanced and most comprehensive portfolio of products, solutions, and services in the sector. The value creation opportunity in front of us is to make all that capability far easier for customers to access to empower them to solve their most critical water challenges and deliver great outcomes with far less complexity. We started the year with great pace with strong execution off the back of a great Q4 in 2023 across both legacy Xylem and legacy Evoqua businesses. And our integration is well on track to deliver on the full value creation opportunity of the combination. Our end markets are resilient. And as long as the long-term trends in waters continue to intensify, our team is energized to take all of our capabilities to deliver even greater impact for our customers.

Our investment thesis remains robust. And we continue to execute on the strategy that has positioned us so strongly for further economic and social value creation. We look forward to sharing further insights into our priorities and strategic direction at our upcoming Investor Day on May 30, in Washington, D.C., one I hope many of you will join us. Now, operator, I’ll turn the call back over to you for questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Deane Dray with RBC Capital Markets. Please go ahead.

Deane Dray: Thank you. Good morning, everyone.

Matthew Pine: Hey, good morning, Deane.

Deane Dray: Matthew, as we start the year, I’d love to hear what’s top-of-mind for you on your priorities? I know we’re going to get lot more specifics at the Analysts’ Day, but I think everyone would love to hear more about what you’re thinking the past and the opportunity for margin improvement broadly, and just some really thoughts on optimizing the portfolio potentially?

Matthew Pine: Great, thanks, Deane. First, I want to just acknowledge the team’s Q4 and full-year performance during really a transformational year for Xylem. We had the Evoqua combination, we announced that in January, followed by the Idrica partnership. And then obviously we had a leadership change, all that while dealing with a lot of macro challenges out there around the globe. So, the team’s done an incredible job staying focused. I’m really humbled and excited to lead Xylem into the next chapter. We’ve built, as I’ve said before, an incredible platform over the past decade. If you look back six or seven years ago, half the company did not even exist, so a lot of really good momentum there. And from my perspective, we’re in a very unique position with our platform leadership of this 10-year journey, to have visibility across the water value chain.

And this really enables us to provide holistic kind of optimized solutions to our customers. And moving forward, we’re going to continue to build on that platform. As COO last year, I did lead the strategic planning process at Xylem. So, we have, I’d say, really strong strategic continuity as we transition this year. And I’ve talked about three strategic execution priorities that we’re focused on. Number one, we have to deliver the Evoqua value capture, that’s first and foremost. That’s the transformational deal that we did last year. Number two, is — and you hit on it, is we’ve got to get after margin expansion acceleration. And we’re going to do that through productivity and continuing to drive operational excellence through the business.

And then lastly, scaling our services business enabled by digital, which we’ll talk probably later in the call about the WSS segment for 2024 and its ability to help us do that. One thing I’d mention that we don’t talk a lot, it’s kind of the soft side, and that’s on culture. As we bring two large companies together, culture is really important. And we’ve put a lot of focus in that area. We call it high-impact culture. And there’s behaviors to drive alignment around our culture. And those behaviors are, first of all, to have our people be inspired to innovate. We don’t want people to feel a fear of failure. We want them to innovate, and that’s going to drive the next cash flows and top line growth in the company. The second is we want them to be empowered to lead, and empowered in the business.

And then thirdly, and most importantly, we want them to be accountable to deliver. And so, those are things we’re really pushing the organization on get around that’ll, I think, help us going forward. Maybe the last comment I would make is we have a call to action in the company that we’ve been working on over the past few months, and that’s we want to simplify water. And what that means is really bridging our aspiration, which is Let’s Solve Water, which everybody knows our tagline, to our strategic execution priorities, which is really the what we’re going to focus on. So, that’s really the rallying cry in the organization, and that’s what we’re going to be focused in 2024.

Deane Dray: Appreciate all that color. And just as a follow-up for Bill, would love to get an update on the rollout of 80/20 besides the check-the-box, say, successful recast of the slides, which I really like. And then, could you also lead in on the update on the revenue synergy plans on Evoqua specifically? I know there is a plan to rollout existing North America customers who have asked to have similar facility outsourcing in Europe, so an update there, please?

Bill Grogan: Sure. So, maybe I’ll start with the first part of the question. And first off, 80/20 is a multiyear journey. As it gets weaved into the fabric of the culture, Matthew just highlighted, we are on a cultural evolution incorporate some new tools and behaviors into the organization. And you have to remember, 80/20 is kind of about systematic complexity reduction, and that takes time. It’s not just a quick math exercise, and you’re done. It’s really about focused resource allocation methodology, aligning the teams around the things that matter most in the business. Obviously, there’s a tremendous margin opportunity that comes with the toolset, but longer term, it’s really a tool to drive better organic growth performance by over-serving your best customers and innovating around your best ideas.

We’ve kicked off two pilots late in Q4 within Applied Water North America and North American Metrology within M&CS. It takes some time to do the analytics. And I look to see some benefits starting to evolve within six to 12 months. Obviously, as we get to Investor Day, we’ll be able to put some more specific numbers around that. But I really think it’s going to be a transformational tool for the organization as we roll it out, and be a big part of our longer term margin improvement story.