Xylem Inc. — 2024 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Welcome to Xylem's First Quarter 2024 Results Conference Call. [Operator Instructions]. Please note, this event is being recorded.
Thank you, operator. Good morning, everyone, and welcome to Xylem's First Quarter 2024 Earnings Call. With me today are Chief Executive Officer, Matthew Pine; and Chief Financial Officer, Bill Grogan. They will provide their perspective on Xylem's first quarter 2024 results and discuss the second quarter and full year outlook.
Thanks, Andrea. Good morning, everyone, and thank you for joining us today. The Xylem team delivered a very strong first quarter, outperforming expectations on all metrics. The team drove high single-digit organic revenue growth, reflecting a healthy balance of both volume and price. And the team also expanded adjusted EBITDA margin almost 300 basis points. And without outperformance, we delivered EPS growth of 14%.
Thanks, Matthew. Please turn to Slide 5. Q1 was an excellent start to the year, exceeding expectations across revenue, margin and earnings per share. I want to echo Matthew's thanks to all of our teams for remaining focused and turning in an outstanding quarter. We continue to see resilient demand with our backlog increasing 4% to $5.3 billion. Organic orders grew 3% in the quarter with book-to-bill above 1, supported by strength across developed markets, particularly in WSS.
Thanks, Bill. Two things I want to mention before we close. First, it's been such a privilege in my first 100 days as CEO to spend time with so many Xylem colleagues around the world. You can see they're doing fantastic work, and it's evident in today's results. And our integration progress is a great indicator of how smoothly the Xylem and Evoqua teams have come together. As a combined company, there is so much potential for growth and impact, especially as we pivot to even stronger execution of our strategy.
[Operator Instructions] The first question comes from Deane Dray with RBC Capital Markets.
Maybe we can start with the Evoqua integration and just lots of focus here on the potential revenue synergies, the rollout of the European business. Just any color there in terms of what the potential is on some new outsourcing contracts? And then also, can you just -- any color on that large outsourced contract. That would be helpful too.
Yes, I can start us off, Deane. I'll have Bill cover the big win that we had in our newest WSS segment on the long-term build, own, operate contract. But maybe just broadly on Evoqua integration update, it's really hard to believe that we closed about a year ago. We -- just to remind everybody, we closed that in what I call record time, announced in January, closed in May of last year. And I would characterize this as great momentum. Obviously, we've got an Investor Day coming up in about 4 weeks. And we're going to have some real tangible proof points to the progress that the teams are making.
Yes. And Deane, maybe just to that project. I mean, great win by the team. It's a $100-plus million 20-year outsourced water project to support a large hydrogen plant investment with 1 of our key customers. Obviously, there's an upfront revenue recognition over the first 18 months, and it's about 1/3 of it and the balance will be recognized over the next 20 years.
That's all really good to hear. And just as a second question, and I'm not asking to front run anything about the analyst meeting that's coming up. But just there's an expectation that there's portfolio optimization coming, there's margin improvement that will be targeted. And I would just want to get a sense of -- I know that's going to be very inward looking at the 4 walls of the company. But what about the growth algorithm. Just during this period, are you still focused on M&A? Are you looking at new opportunities? And I just don't want to miss any of that growth upside during this period of kind of portfolio optimization?
No, it's a great question, and you pretty much hit on 3 of my key messages that I'll be taking up in the Investor Day with me. Look, we're extremely focused on executing on the platform that's been built over the past decade, especially over the past year with the acquisition of Evoqua to drive above-market growth. I mean that's our mantra. This is our #1 execution priority in our goal deployment process this year, and it will be in the future years. And it's really obviously bolstered by the Evoqua synergies.
The next question comes from Mike Halloran with Baird.
So a couple here. First, maybe just taking a step back here, you've been [indiscernible] year-to-date 100-plus days, Bill, you've been there, what, 6, 7 months now. What are the initial impressions as far as the momentum you're seeing, how the messaging you 2 are pushing through are starting to sink into the culture, sink in to the people? And what kind of impressions do you have so far?
No, that's a great question. I did mention that in my opening remarks about the first 100 days. We -- not this me, but we as a team feel good about where we are. And we believe we've got -- we had good momentum coming into 2024. We believe now we're continuing to build on that momentum that you've seen in Q1. We're executing on a great platform, which I just teed up with Deane here. I'd say we did not have a cold start, right? We didn't start this January 1 and figure out how to start turning the crank.
And then kind of a broad question on underlying dynamics in orders. One, kind of twofold here. One, can you give the pro forma organic overall orders for the company or give some sort of proxy for it? And then second, if I listen to the messaging here, it feels like not a lot has changed in terms of what you're seeing from an end market perspective across the various segments. I'd like to just understand if there are any notable puts and takes that have either inflected more so or less so than you thought in the quarter or from a trend line perspective?
Maybe I'll let Bill open up on your orders question, I'll give us some commentary and color on the markets.
Yes. So obviously, organic was reported at 3%. The pro forma organic was 7%, so more than 2x that.
Yes. So good momentum on orders in Q1. The book-to-bill was greater than 1 and backlog up 4%. And not a lot has changed. Demand remains healthy, Mike, in the majority of our end markets. And it's supported by a lot of the favorable drivers that we've been talking about around the secular trends. Government funding is trickling in globally across different parts of our coverage still a lot of resiliency in municipalities or utilities, OpEx and CapEx for that matter. I know that there's been questions about with rates, especially in the U.S. and in Europe with that slowdown, we're not seeing any slowdown. And you've seen with our results in the WSS segment this quarter, the durability of that business model. And I'm really proud of the M&CS team with their backlog conversion. We continue to win orders, though, and our orders are up year-over-year, and we've got good momentum there.
The next question comes from Scott Davis with Melius Research.
Congrats on the -- getting through the first 100 days and having a good quarter here. Big picture, Matthew, when you see a synergy target after a deal like yours, I have to wonder, is it input or output, meaning are you trying to find $100 million in synergies? Or is it a natural output of the actions that are taken integration-wise, that's a little theoretical, but I guess somewhat kind of the -- the second derivative of the question is, is that if those synergies track above the [ 100 ] , will you likely be more likely to invest that back into the business or show it on the margin line?
Yes. If you're referring to the cost synergies as a part of the Evoqua transaction?
Yes.
Yes. So look, we did announce $140 million when we did the deal. So it is a little bit more than $100 million. Look, we're running to a target much higher than 140. And we're going to land the plane for sure at 140, and we're going to make sure that we put that upside probably somewhat to the bottom line, but also somewhat investing in growth. It's probably a mixed bag of whatever the overage would be -- would kind of fall half to the bottom line and half the top line growth. It's easy when you do these deals to look at cost synergies and they're on paper and they look like, okay, they're easy to do, they're procurement, back office, they're lift and shift factories. It looks pretty straightforward, but there's a lot of work that goes into this and a lot of tracking. And I'm really impressed, Scott, of the capability that we have built through this transaction. And that's only going to help us as we go forward and deploy more capital in the future.
That makes sense. And the second question, I'd probably only get an opportunity to ask this once when you get a newer CEO. But when you think about the buckets of where Xylem is historically perhaps over invested or under invested or over loved or under loved, what stands out to you as areas of perhaps improvement that you'd like to see. I mean, you mentioned the cultural changes and some of the operational rigor. But if you could be more specific around -- around maybe some areas where you feel like you guys could use a little bit more love or the [indiscernible]?
Yes. I think you hit the first one. It's culturally, and I think we're making good progress there. But you've heard me talk about simplify water. I think that's what it boils down to. Over the years as we've built this incredible platform, we have had some complexity conspired against us to some extent. And you can see a little bit of that in our margin profile. So it's not that we're going to be like super inwardly focused, but we do have to focus inwards so we can better serve our customers and our colleagues. And that's where we're focused. It's just making it simple to do business internally at Xylem as well as for our customers, so customer-backed mentality. 80/20 is one tool to do that. There's other tools that we're leveraging.
Super helpful. Thank you, Matthew. We'll see you all in a few weeks.
The next question comes from Andy Kaplowitz with Citigroup.
Matt, I know you mentioned you continue to watch Applied Water. I think you did say that you won a couple of larger projects there that led to book-to-bill over 1 time. So maybe what does that say about the market? Is it like you thought, better than you thought, worse than you thought? How would you sort of characterize what's going on there?
Yes. I'd say it's largely what we thought. If you look at the prior Q1s, we're up 10% in each 1 of those. So it's a tough compare. But it's our most cyclical segment, we do continue to expect low single-digit decline this year. It's kind of in line with what we planned. We did, to your point, have good Q1 orders performance. There were a few larger projects in that, that are a little bit out in the future. So it's not something that's book and ship. It's more of future projects. But we do continue to see soft markets, especially in Europe and emerging markets is where our orders were down. Obviously, we're watching developed markets as well, but obviously, Europe plays into that. But our really weakness in Q1 was emerging markets and in Europe for Applied Water.
Helpful. And then obviously, it was expected, but can you talk a little bit more about how the new EPA rules regarding PFAS affect Xylem. Did they change the time line at all when PFAS may be impactful? Or is it just kind of slow and steady wins the race for how to think about your impact?
Yes, it's the latter. It's slow, steady race. Look, we're glad to see the rule be final. Now we have some clarity on the rules of the road, the time line. Look, I'm really proud of our teams in providing clarity just 24 hours after the final rule on LinkedIn Live that really shows that we're customer-centric, we're focused. We're being a leader in the space to educate our customers. But again, to your point, this is a long journey. It will take time for the impacted utilities to comply. They've had 3 years for testing, 5 for PFAS removal, and that's a little bit longer than we initially anticipated in terms of when they need to be compliant. And we're really well positioned today and ready to partner with utilities on PFAS and other emerging contaminants for that matter.
The next question comes from Bryan Blair with Oppenheimer.
Great to drill down on M&CS margin performance, kind of eye-catching step up in profitability there. Maybe offer some finer points on the drivers, seem kind of broad-based in terms of productivity, volume price mix in the quarter? And whether there's anything that we should consider one-time-ish that benefited results? And then lastly on that front, is it still the expectation that margin will improve sequentially throughout the year.
Yes. No, Bryan, I'll take that one. I'd say [indiscernible] team delivered an outstanding quarter. Obviously, EBITDA margin is up 550 basis points with almost 50% incrementals. That team has been on a journey over the last few quarters, dealing with some pretty significant external challenges relative to the supply chain. And then internal challenges to ramp up production levels that they haven't been able to realize historically to deliver for their customers to make up for that past due backlog. They drove significant labor and material productivity to drive efficiencies to increase our output. They went out with incremental pricing, price cost negative for a while. They're back to price material cost positive. It took restructuring actions to address some underperforming parts of the business just to build a stronger financial foundation that they're now leveraging extremely well with this incremental volume.
Okay. Very helpful detail and encouraging trends. Matthew, you mentioned that government money is starting to trickle in. And you touched on the outlook for PFAS and your team's positioning there. It would be great to hear just updated perspective on [ IIJA ] related growth opportunities overall. You've been pretty consistent in tempering expectations to date, understandably so, given the phasing of the rollout, but we have seen some acceleration in obligations and outlays, front-end reads are certainly very encouraging. And looking at the categories of funding and ultimate spend, I would have to assume that your team is going to participate in just about everything.
Yes. I wish I could turn and stick on that hose nozzle and make it go a little faster, but look, it's -- I've been pretty consistent about this, whether it's in the U.S. or other markets, U.K., in Europe, with their funding. It's just going to be a slow drift and it's going to drip in and really help support our market growth over the next 3 to 5 years. And so that's how we continue to look at it. We don't have a big jump in our long-range plan in terms of incentives or subsidies that are coming in. So it's just going to trickle in and be kind of a layer on top of the market growth. And that's how we look at it.
The next question comes from Nathan Jones with Stifel.
I wanted to pick up on 1 of Bill's comments and something I know I've talked to Matthew about before, which was the anticipation that in the future price will offset inflation. Several years ago, it had been Xylem's target for price plus productivity to offset inflation. So there's a significant change there. So just looking for some color on how you look to go about implementing that and what you think will give to Xylem the entitlement to be, I guess, a little more aggressive with price versus inflation than it has been historically?
Yes. I think, obviously, price capture has been a focus with rising inflation. We're going to talk more about that at the end of the month, just a new approach to strategic pricing. I mean, I think for us, it's really -- we're looking to offset our material inflation with price and then let productivity handle the balance of indirect and SG&A inflation and fund our investments. I think the teams have got the operational productivity down, and now it's for us just to continue to refine and our process relative to value capture for the products that we offer to our customers.
I guess my follow-up question for Matthew. You talked about government funding kind of trickling in. There's I think, an increased focus in Europe on non-revenue water, big increases in the focus for that in the next [ half ] cycle and parts of Western Europe and Southern Europe after the 2022 drought. Can you talk about if there's any material opportunities from that increased focus on non-revenue water for Xylem's business over the next several years?
Yes, I do. I think first with our Idrica platform is a great entree into that. There's a lot of opportunities to leverage the Idrica platform to help visualize that data through AMI systems. So that's a big focus area that we're working with utilities on across Europe and across the globe, but especially Europe. And you're right, there's a lot of funding in Europe and in the U.K. with the AMP cycle in the U.K. on non-revenue water. And also, there's a lot of focus on analytical instrumentation, especially out in the environment where they're holding polluters liable for contaminated water. So we see a great opportunity on smart metering and analytical instrumentation in that region with an overlay of our Idrica partnership and platform.
The next question comes from Joe Giordano with TD Cowen.
So on PFAS, I know we talked a lot about it, but can you maybe just talk us through exactly where you're exposed on that? And if there's capabilities that you don't currently have maybe like sampling or destruction that you're currently exploring either internally or maybe through acquisition?
Yes. So -- we're -- obviously, we have the technology to capture through our acquisition with Evoqua coming together at Xylem. And we have over 80 PFAS installations to date. Actually, we just had 1 written up in Newsweek, I believe it was Newsweek a month or so ago up in Maine, where we were capturing PFAS from a well that they had dug to serve the increasing population. So we've got proven technology on the capture side. Where the innovation needs to happen and get to commercial liabilities on destruction. And then sensing, we can sense and bring it to a lab and get the sensing part of PFAS, but need to get sensors that can be in real-time flow. So those are the areas on destruction and real-time sensing whether it's innovation needed and our teams are working on that through our innovation labs. And with the 2 teams coming together from a legacy of Xylem and Evoqua, we believe that we can move faster and obviously spend less money getting there.
And then the last question, I guess, is 1 I never really thought I'd be talking to you guys about, but we're getting questions about Xylem is like a data center play now on the water side. So can you maybe explain the opportunity set in front of you, either on the power side as we have to ramp up generation capabilities to support a huge buildout or we're like in the buildings themselves on the data center side, how that opportunity kind of scales for you?
Yes. I mean, look, on the power side, we're excited. It's one of our high-growth verticals. You heard Bill talk about the big win, $130 million build on operate win in hydrogen. And so we see that energy mix shift driving lots of opportunity for us. Specific to data centers, I do think it is a growth opportunity. We're starting to see it. Actually, one of our examples. I won't steal the thunder here at Investor Day coming up in a few weeks is about the data center, where we have synergy win there. But it's currently a small part of our revenue, probably less than $50 million.
This concludes our question-and-answer session. I would like to turn the conference back over to Matthew Pine for any closing remarks.
Well, we'll wrap it up there. Thank you for your questions, and thanks to everyone who joined today. We hope to see many of you either in person or online at Xylem's Investor Day on May 30. And we look forward to sharing further insights into our priorities and strategic direction then. Until then, all the best.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.