Xylem Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2023

There are 12 speakers on the call.

Operator

Welcome to Xylem's Second Quarter 2023 Earnings Conference Call. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. I would now like to turn the call over to Andrea Vanderberg, Vice President of Investor Relations.

Speaker 1

Thank you, operator. Good morning, everyone, and welcome to Xylem's Q2 2023 earnings call. With me today are Chief Executive Officer, Patrick Decker Chief Financial Officer, Sandy Rowland and Chief Operating Officer, Matthew Pine. They will provide their perspectives on Xylem's Q2 2023 results and discuss the Q3 and full year outlook. Following our prepared remarks, We will address questions related to the information covered on the call.

Speaker 1

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 on the Investors section of our website, www.xylem.com. A replay of today's call will be available until midnight, August 9. Please note the replay number plus 1-eight hundred-eight thirty nine 1-three 20 or plus 1-four zero two-two two zero zero zero four eight eight. Additionally, the call will be available for playback via the Investors section of our website under the heading Investor Events.

Speaker 1

Please turn to slide 2. We will make some forward looking statements on 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 ks and in subsequent reports filed with the SEC. Please note that the company undertakes no obligation to update any forward looking statements publicly that reflect subsequent events or circumstances, and actual events or results could differ materially from those anticipated. Please turn to Slide 3.

Speaker 1

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 4, and I'll turn the call over to our CEO, Patrick Decker.

Speaker 2

Thanks, Andrea, and good morning, everyone. Today is a significant milestone for Xylem as we have the pleasure to present the performance An outlook is quite a different company than just a quarter ago as we describe our ability to make an impact on the world as society deals with growing water challenges. The combination of Xylem and Evoqua has already begun taking shape as an even stronger global platform that will have a profoundly positive impact on our customers and communities. We have a responsibility in front of us to help at exactly the moment when the world's water challenges are coming into more acute focus than ever. When we completed the acquisition in May, our capability to meet this moment expanded along with our opportunities for growth.

Speaker 2

Now 10 weeks into the integration of these 2 great enterprises, we are even more confident about the value we will create with our combined company. There are three things that underpin that confidence. First, the team is delivering impressive performance across both companies. I am so very proud of our teams for staying focused on serving our customers at a potentially distracting time. Each team, both legacy Xylem and Evoqua turned in a quarter significantly exceeding expectations and giving us brisk momentum for the future.

Speaker 2

2nd, our early progress on integration has increased our confidence and the cost synergies we previously laid out and the gross synergies ahead of us. We have moved well forward on both sources of value. And 3rd, as water challenges continue to intensify for our customers across many parts Of our economy and society, they are seeking simpler, more affordable ways to tackle them. But we are now Even more strongly positioned to solve those needs and capture that demand with increased exposure to attractive durable end markets. We'll come back to these bigger points in a few minutes, but I want to make sure we also give appropriate attention to the very strong quarter we disclosed.

Speaker 2

As we shared in our press release this morning, we significantly exceeded expectations on revenue growth, margin and earnings per share. Organic revenue growth was 15% with total reported revenue growth of 26%. EPS was up 32% and grew 28% excluding the impact of the acquisition. And we delivered EBITDA margin well above our guide at more than 19%. It was driven by strong demand and the team's continued focus on pricing as well as ongoing continuous improvement aimed at simplifying how we serve our customers.

Speaker 2

Organically, all segments contributed double digit revenue growth in all end markets. And each of our regions grew, led by notably strong pace in the U. S. And a solid recovery in China. Our legacy backlog was up 7% And then we added Evoqua's backlog of more than $1,000,000,000 and the 2 together bring our total backlog to $5,300,000,000 While we have a lot to do with the integration of these 2 great companies, we have strong commercial momentum, which gives us the confidence to raise our guidance for the year.

Speaker 2

And again, I want to thank every one of our team members around the world and our partners for what they are doing every day to deliver real impact to our customers and our communities. In a moment, we'll give more color on our outlook as well as detail on our end markets and regions. But first, I'm going to hand it over to Sandy to dig into the quarter's strong results.

Speaker 3

Thanks, Patrick. Please turn to Slide 5. Since this is the first time we are reporting as a combined company, I would like to walk you through how we will cover our performance. We now have 4 reporting segments. Evoqua's Applied Product Technologies business has been integrated into water infrastructure, immediately combining our 2 complementary treatment product businesses.

Speaker 3

Evoqua's Integrated Solutions and Services Business or ISS is reported as its own segment providing continued transparency on the segment's results. Our other two segments, Measurement and Control Solutions and Applied Water, are unchanged. Additionally, since this quarter includes about a month of Evoqua's results, we have laid out organic results compared to our previously shared expectations and broken out the impact of the acquisition. Unless otherwise stated, all growth rates shared are on an organic basis. And lastly, we have reported EPS on an adjusted basis that adds back non cash purchase accounting and tangible amortization from the Evoqua acquisition and Xylem's previous acquisitions.

Speaker 3

We will therefore recast 2022 announced for comparison purposes. And now let's turn to Slide 6 for our quarter's results. The team delivered strong performance beating our expectations for both growth and margin expansion. Total revenues grew 26%, while organic revenue growth of 15% was led by double digit growth in the U. S.

Speaker 3

And Western Europe and high single digit growth in emerging markets. Each business to price realization in both MNCS and Water Infrastructure. Industrial grew 11% on strong price realization and demand across all regions. And lastly, building solutions, which includes commercial and residential grew 15%. Overall, demand remains resilient as demonstrated by our $5,300,000,000 backlog, up 7% organically as Patrick highlighted and now includes Evoqua.

Speaker 3

And while orders were down 2% on the quarter, book to bill continues to be above 1. EBITDA margin was 19.1%, up 2 50 basis points from the prior year on higher volumes, productivity savings and favorable price cost dynamics. Excluding the impact of Evoqua, EBITDA margin was 200 basis points exceeding our previous expectations. Our EPS in the quarter was $0.98 up 32% year over year and up MNCS revenue was up 21%, driven by improved chip supply as well as strong demand in pipeline assessment services. U.

Speaker 3

S. And Western Europe saw robust growth and we continue to see favorable momentum in emerging markets. Orders grew 6% with a book to bill ratio of 1.2 and our backlog of $2,400,000,000 is up 17% versus the prior year, demonstrating continued strong demand for our AMI offerings. EBITDA margin for the segment was up 5.90 basis points versus the prior year on strong incrementals. Volume conversion, price realization and productivity drove the expansion, more than offsetting inflation and unfavorable mix.

Speaker 3

And now let's turn to Slide 8 and I'll cover our Water Infrastructure business. Water Infrastructure, which now includes Evoqua's Applied Product Technologies segment grew 20% on a reported basis and 13% organically. Growth was robust across the portfolio with revenues up double digits in all end markets and applications. Developed markets saw particularly strong growth driven by OpEx demand, while emerging markets grew 7% driven by Latin America and Asia Pacific. Orders in the quarter were down 4% year over year, lapping prior year growth of over 20% and book to bill was above 1.

Speaker 3

EBITDA margin for the segment was roughly flat year over year and up 20 basis points when excluding the contribution of Evoqua. Please turn to Slide 9 for an overview of Applied Water. Applied Water revenues grew 12% on continued strong price realization and backlog execution. The U. S.

Speaker 3

And Emerging Markets grew double digits, while Western Europe grew mid single digits. Industrial demand was both resilient in both Western Europe and Emerging Markets, particularly due to recovery in China. And while orders were down 6% in the quarter, our backlog continues to be elevated versus historical levels and book to bill is 0.9. Segment EBITDA margin was up 2.90 basis points in the quarter with continued strong price realization coupled with productivity more than offsetting inflation. Please turn to Slide 10.

Speaker 3

I'm very pleased to introduce Integrated Solutions and Services as our newest reporting segment. ISS is a leading North American water treatment solution and services provider that brings access to a durable and highly recurring revenue stream as well as a diverse and attractive industrial verticals. With approximately 75% recurring revenue, ISS is known for dependability and bringing mission critical water treatment expertise to our customers. Although we only reported ISS after our May 24 close, full quarter revenue was up 12%, driven by strong price realization and backlog execution. And orders grew 4% with a book to bill ratio above 1 due to broad paced demand across industrials and utilities.

Speaker 3

Backlog of nearly $1,000,000,000 to end the quarter was up 15% year over year. And adjusted EBITDA margin post close was a solid 24%. And now let's turn to Slide 11 for an overview of cash flows and the company's financial position. After retiring over 6 $100,000,000 of debt in conjunction with the closing of Evoqua, our financial position remains robust as we exit the quarter with over $700,000,000 in cash and available liquidity of $1,600,000,000 Net debt to EBITDA leverage is 1.4 times. And in the Q2, we had solid adjusted free cash flow conversion of 86%.

Speaker 3

Please turn to Slide 12, and I'll hand it back over to Patrick.

Speaker 2

Thanks, Andy. Just a little more than 2 months post close, our excitement about the Evoqua acquisition is only grown. We've made great progress in 3 areas. First is our performance and outlook as the business stands today. We began the integration with an overarching principle and that was to deliver continuity for our customers, keep our commitments and not disrupt business performance.

Speaker 2

The results tell a clear story of focused near The combination of our team's disciplined execution and healthy underlying market demand has given us the confidence to raise our full year guide. But our current performance is, as you would expect, largely a reflection of our businesses as they are. What we're most excited about is our future potential and the opportunities ahead of us, which brings me to the 2nd dimension on which our confidence is only growing. When the transaction closed, we announced the combined leadership team. And frankly, I'm energized by the strong cultural fit The team has already been demonstrating and the early momentum we've created.

Speaker 2

We are well on track to deliver the cost synergies outlined when we announced the transaction. And as we progress through the integration, we have even more greater visibility of the operating efficiencies to be realized in coming quarters, along with the opportunity for significant further margin expansion. At the same time, the whole strategic rationale of this combination has always been about further accelerating our profitable growth. And that's the 3rd dimension I referred to in my opening comments. We are now even more strongly positioned in attractive, durable end markets with a significant component of recurring revenue streams.

Speaker 2

Now that we have deeper insight into the intersection of our businesses and customers, we see those opportunities even more clearly. So moving on to Slide 13. This is the right combination at the right time. Together, we have the strongest platform of capabilities address customers' critical water challenges. Those needs are increasing and we have the scale and reach now to deliver differentiated solutions globally.

Speaker 2

Our teams are already detailing how we will do that. 1st, in utilities, we will deepen our penetration, especially with the addition of Evoqua's applied product technologies to our water infrastructure offerings. In industrial, We'll use the power of our combined offering to scale our presence in attractive industrial end markets. And then we will

Speaker 1

Now as many of

Speaker 2

you know, this combination delivers on part of the strategy we laid out back in our 2021 Investor Day, and that was to expand our capability and our presence in industrial end markets. Increasing industrial exposure reinforces the durability of our overall business model and gains us greater access to attractive customer sets for even faster long term growth. The recurring revenues of ISS, which deliver consistent performance throughout economic cycles, it complements our MNCS and Water Infrastructure businesses, which also benefit from the resilience of utility spending. We've already taken the first steps in offering our combined portfolio to light And we're already targeting attractive industrial verticals such as life sciences and microelectronics. Both have strong long term outlooks that are driven by secular trends that align well with Xylem's existing business.

Speaker 2

We look forward to keeping you up to date with our integration progress on a regular basis and anticipate providing a longer term growth outlook at an Investor Day likely to be scheduled in the 1st part of 2024. Now with that, I'm going to hand it over to Matthew to say a bit more about our end market outlook.

Speaker 4

Thank you, Patrick. Turning to Slide 14. Before I cover our end market outlook for the year, I want to thank the team and our partners for a great quarter. Our continued outperformance and momentum give us confidence to deliver in 2023 beyond. We have record backlogs and the value proposition of our differentiated portfolio in attractive end markets Puts us in a strong position even in a potentially dynamic macroeconomic environment.

Speaker 4

We continue to take a balanced approach in our outlook and are monitoring leading indicators watching for signs of moderation. That said, we expect resilient demand in utilities and continued steady growth in industrial water applications. And now I'll turn to our 2023 outlook by end market, which will be on an organic basis. Utilities, which is approximately 45% of our revenue, continue to be healthy. And we now expect growth of mid teens up from low teens.

Speaker 4

On the Clean Water side, we anticipate growth of low 20s up from high teens previously due to robust demand for our AMI solutions and backlog execution on improved chip supply. In addition, we are seeing great traction on solution selling with our digital platform and customers are increasingly interested in bundling offerings. On the wastewater side, we continue to expect high single digit growth, Resilient OpEx in developed markets as well as continued CapEx spend in emerging markets will underpin demand. Turning now to the industrial end market, which is 45% of our revenue. We expect steady global growth of mid single digits, but are keeping a close watch for signs of moderation.

Speaker 4

We expect any softness from developed markets to be somewhat offset by growth in emerging markets, including China, where industrial momentum has continued to outpace utilities. Lastly, in Building Solutions, which is about 10% of our revenue. We expect growth of mid single digits driven by steady replacement business and backlog execution. The overall demand outlook remains healthy. And although we are not including Evoqua in our organic outlook, We expect the contribution of mission critical solutions and services in attractive high growth verticals such as life sciences and microelectronics to further increase the durability of our business.

Speaker 4

That outlook combined with our operating discipline, commercial momentum and large backlogs gives us confidence for the rest of the year and beyond. Now I'll turn it over to Sandy to walk you through the detail of our raised guidance.

Speaker 3

Thank you, Matthew. Turning to Slide 15. We are increasing our full year guidance across revenue, EBITDA and EPS and also incorporating Evoqua. I want to take a moment to walk you through the puts and takes of how we now see the full year. We expect total revenues to be around $7,200,000,000 for the year, which includes approximately $1,100,000,000 from Evoqua and another increase in our organic revenue guidance.

Speaker 3

We now expect full year organic revenue growth of 9% to 10%, up from 8% to 9%. We are raising the low end of our EBITDA guidance to about 18%. And in addition, we are lifting full year adjusted EPS guidance to $3.50 to $3.70 up approximately $0.35 at the midpoint. This incorporates a $0.15 raise from our strong organic outlook and a $0.20 increase due to acquisition related adjustments. This includes a contribution from Evoqua of approximately $0.45 the add back of legacy purchase accounting intangible amortization of $0.30 and partially offset by incremental share dilution of about $0.55 As Patrick highlighted, we've made great progress on integration.

Speaker 3

We expect to be at $40,000,000 of run rate cost synergies by the end of the year and we remain on track to deliver $140,000,000 of run rate cost synergies within 3 years. Turning to Slide 16. For 2023, our organic revenue growth by segment breaks down as follows: Approximately 20% growth in M and CS, high single digits growth in Water Infrastructure and mid single digit growth in Applied Water. And we are still on track to achieve free cash flow conversion of at least 100% of net income. We've also provided you with a number of other full year assumptions in the appendix on Slide 21.

Speaker 3

And now drilling down on the Q3, we anticipate total company growth will be in the range of 40% to 45% on a reported basis and 4% to 6% organically. By segment, we expect revenue growth to be in the high teens in M&CS and mid single digits in Water Infrastructure and remain flat in Applied Water. We expect Q3 EBITDA margin to be approximately 18% driven by higher volumes, continued price realization and productivity gains. And with that, please turn to Slide 17, and I'll turn the call back over to Patrick for closing comments.

Speaker 2

Thanks, Sandy. We've covered a lot here, We look forward to your questions. But just before we do that, I want to reiterate a fundamental point. This is a transformational step forward for Xylem and we believe it is transformational for our customers and our communities. We are very excited about this strategic evolution, But the most important things about Xylem are not changing.

Speaker 2

Our investment thesis is one of those unchanging constants. We are creating significant economic and social value with a durable business model that addresses intensifying water challenges. And we're doing that with a differentiated portfolio of solutions and services in attractive and growing end markets. This gives us a multiyear runway of profitable growth with sustainable margin expansion on the foundations of a strong balance sheet and cash generation with capital deployment to further strengthen our portfolio. It has become increasingly apparent that the need for solutions to the world's water challenges is only growing and we are in a very privileged position to serve those needs.

Speaker 2

So now we look forward to taking your questions. So operator, let me turn the call back over to you for Q and A.

Operator

The floor is now open for questions. Our first question is coming from Deane Dray with RBC Capital Markets.

Speaker 2

Thank you. Good morning, everyone. Hey, good morning, Deane.

Speaker 5

Hey, just a comment to start and we really appreciate all the heavy lifting that went on, all these moving parts, Recasting financials, the re segmentation, the new end market mix and the move to cash EPS. And look, from our

Speaker 2

Hey, Deane, before your question, I just want to I do want to give a shout out to the entire Team here and around the world that have been a part of not just closing this transaction, but all the moving parts and pieces that you talked about In the midst of exciting momentum, a lot of work and we really appreciate that recognition.

Speaker 5

Yes, that's exactly what I was doing. And just the fact you did not skip Speed on the organic side of the business, cash conversion, order intake and so forth. So that was the comment part. And now I go to my question. On this, resegmentation, ISS is standalone, check the box, that's what we'd expect And then combining APT with water infrastructure that also makes sense because that's where there's some interesting overlap in terms Go to market customer, not so much on the technologies, but on the go to market side.

Speaker 5

So first question, because that is where Is on combining those businesses and anything about the cost or cost synergies and any conceptual thoughts on revenue

Speaker 2

Yes. Thanks, Dean. So I'm going to hand it to Matthew to comment on your specific question. I would say that The integration efforts are really off to a great start. And APT, that part of Evoqua is a clear and obvious Opportunity for us and I've been really pleased and impressed by the cultural assimilation of the teams.

Speaker 2

But with that, I'll let Matthew comment a bit more on why that integration, why now and what that kind of looks like for us.

Speaker 4

Thanks, Patrick. Hey, Dean. First of all, as Sandy mentioned a few minutes ago in her remarks, they're very complementary businesses, 1st and foremost. And there is immediate synergies both on the revenue and the cost side. So that's getting us out of the gate fast.

Speaker 4

The teams are making great progress as Patrick mentioned. And it allows us to quickly cross sell our products both in industrial and utilities. And an example of this would be in the utility space, being able to bundle our solutions And walk through the front door with a total solution across the whole treatment train, if you will, from beginning to end. We didn't have that capability before. Bringing the 2 companies together Enables us to bring that full offering to the table.

Speaker 4

Also something that maybe is not as intuitive is our technicians, what we call Aqua Pros, or out with our customers. Now they have a broader portfolio to solve customer pain points and we're already seeing that play out just organically with our recommending other recommending new products in the portfolio very quickly. So that may be something that's not as intuitive, but it's happening already. I'd say thirdly, I'd say the R and D synergies. There's obviously R and D synergies when we bring the treatment businesses together.

Speaker 4

And then lastly, Patrick mentioned leadership in the very beginning. We brought over 3 leaders to the senior leadership team from Evoqua. Herve Fage will lead the combined treatment business. He has tremendous experience here and bringing those two pieces together will be instrumental to our Out of the gate performance on cost and revenue.

Speaker 5

That's all really good to hear. And so second question is, the theme is digital. And first, just give us an update on the chip Does it continue to be a gradual supply improvement there and what's the outlook? And then related to that Patrick, there's been this digital path for Xylem, where you were targeting a 50 Percent of revenues by 2025. And I know it's still early and I'm not asking a real specific number here.

Speaker 5

But just conceptually, how And our view is Evoqua is significantly on the path of digital themselves. So now combined, That should help you towards this goal. So just chip supply and then conceptually where you on the path on Half of digital revenues by what time frame? Sure.

Speaker 2

I'll let Matthew start on where we are on chip supply and then he and I will tag Tim on where we are in Brazil.

Speaker 4

Great. Chip supply, Deane, as you mentioned, is continuing to the moderate improvement as we expected. Q3 will look a lot like Q2. We do expect to pick up in Q4 as we and also as we head into 2024, we do expect chip supply to improve, but So our redesigns will be coming online as we head into the really the end of 2023 into 2024. So that gives us confidence that we'll see that ramp Q4 and then into 2024.

Speaker 4

Maybe just a few comments on digital and then Patrick can wrap it up. We are making good progress towards the 50% of revenues digital goal. That was a legacy Xylem target. We can see it in the backlog. We have a lot of digital content that's trapped in the backlog.

Speaker 4

And that will start to release as we get better chip supply and we get better just in general electronic over the course of the next 6 to 12 months. The continued adoption of AMI, as you see in the backlog Increase this quarter with M and CS were up $300,000,000 So making significant progress on digital, especially buoyed by AMI. And then I'd say lastly, the partnership with Adriq is really important because it enables us to pull through more digital content. We're already starting to see that play out. So

Speaker 3

I'd say

Speaker 4

all in all, we're on a good trajectory and we're making good progress.

Speaker 2

Yes. And I'm just I would wrap that up, Deane, with First of all, great question, because it's a key underpinning of our overall story and differentiation in the marketplace, which is I know why you raised the question. So high confidence in both the heritage, kind of Xylem business. I would say what I'm most encouraged by there also is we continue to see really exciting adoption on AMI in the marketplace, which really is borne out by the print and our increased backlog and deal wins. With Evoqua, the opportunity there, it There really is more of a complementary strategy on digital.

Speaker 2

In the Evoqua business, we're really talking about the ISS business. The digital path that the team there has been on is really more about how do you use digital and connectivity to Actually improve the productivity of the services offering, making it easier for Aqua Pros to do their jobs. That leads to margin enhancement. That's a big opportunity within the ISS portfolio to improve our EBITDA margins by, Again, digitally enabling kind of what they do every day, making less truck rolls, less visits to serve the customer, give the customer more data insights, Predict where the issues are before they have to go out and find them. So there's a whole exciting area there that for those that are new to either the Xylem or the Evoqua story, We'll have more to share on that at our Investor Day going forward.

Speaker 2

It's very exciting.

Speaker 5

Thank you and best of luck.

Speaker 2

Thank you, Damian. And

Operator

we'll take our next question from Mike Halloran with Baird.

Speaker 6

Hey, good morning, everyone.

Speaker 2

Hey, good morning, Mike.

Speaker 3

Hey, Mike.

Speaker 6

So the first question, I think, is a relatively straightforward question, but I just I just want to level set everything given how many moving pieces here that there are. So it sounds like guidance was raised both organically as well as your expectations that have moved higher on the Evoqua piece if we compare this to call it 2, 3 months ago whenever you last gave an update. Can you just talk through the pieces of why that those expectations have moved higher? I know some of it's the 2nd quarter outlook, But it feels like that's it's a little broader than that. So can you just maybe line out those moving pieces for us?

Speaker 3

Yes. Let me take a crack at that, Mike. If you rewind back to February, we If you look at where compared to our initial guide, organically, we're now forecasting about $300,000,000 higher revenue. We did raise our guidance the last time we spoke and this quarter we raised it by another $75,000,000 So in MNCS, we started the year thinking that the business would grow somewhere in the low teens. We now are expecting 20% growth in that segment.

Speaker 3

And we're seeing very good strong incremental margins come from that business. No, it's a combination of metrology. It's also a combination of the other businesses that we wrap around metrology and M and CS that's giving us good upside. And then the other two businesses, they've been performing really well. They've gotten ahead of the curve from a price cost perspective.

Speaker 3

We sustained that momentum. But I think what's also encouraging is we're seeing significant we're seeing more increases on the volume side as well. And so it's really all parts of our portfolio that are contributing to the beat and raise. When I look at the Evoqua side of the house, we talked about them Contributing about $1,100,000,000 this year. This past quarter, we brought in $175,000,000 of revenue from Evoqua.

Speaker 3

Margins there are developing really nicely. And if you look at our implied outlook for the rest of the year, there The margins for both companies are really right on top of each other. So, it's really good to see strong momentum from both sides of the house. And I think it goes back to to the deal operating principles where we've kept both teams really focused on delivering on the organic plan.

Speaker 6

Great. No, that's exactly what I was looking for. I appreciate that. And then second question, maybe you could just talk a little bit about the momentum you're seeing on the utility side as we work through next year. Book to bill seems pretty good on the utility pieces.

Speaker 6

Obviously, MCS, it's healthy. I think the infrastructure piece is healthy, though, obviously, you got some industrial in there. Backlogs very high on the MCS side. Maybe just talk about the visibility you have on those pieces in the next year, wrapping I assess into that a little bit as well and talk about how you're looking at the contribution from some of these Regulatory drivers coming up, some of the funding that might or may not get released here.

Speaker 2

Yes. So I'll start, Mike, and then I'll hand it over to Matthew. Just to your question zooming out around utilities, we remain, I would say, more confident than ever Around where utilities again, this is a global statement, where utilities are in the cycle. 1, we see here in the U. S.

Speaker 2

That while we're still early in the adoption of AMI, We continue to see an increased excitement around that and that shows up in our bidding pipeline. It shows up in our deal wins. It Shows up in our backlog, and I think the numbers speak for themselves there on where AMI adoption is going and our ability to Successfully compete and win in that space of the market. Secondly, the underlying fundamentals of The largest part of utility spend, as you well know, is OpEx. It's repair and replace.

Speaker 2

And given the age of infrastructure around the world, most notably here in North America, but also in Europe. We see continued increases in that demand and outlook, That's going to continue as a long term trend. I think in terms of other demand Profiles beyond that, as we think about whether it be the Inflation Reduction Act, other infrastructure legislation here in the U. S, We get a lot of questions around PFAS and obviously with our Evoqua capabilities coming in, that's obviously a very exciting area for us. But as we've said before, and I know Ron, the CEO of Evoqua in the past has said, that's a dimmer switch.

Speaker 2

It's not like all of a sudden one day It's going to show up. It's going to be adoption over time. And it just reinforces the positive tailwind that we believe we have in the areas that we're focusing on as Xylem. So that's my commentary around utilities. I don't know, Matthew, if you want to add Anything to

Speaker 4

add? I think the only thing I would add to that, we have really close relationship with our customers, especially our utility customers. And based on conversations that we've had with them over the past few months, we don't see a reason that there's going to be any slowdown. The draft muni budgets for the next year Some of our well weather utilities are showing growth year over year. So I'd say kind of that's kind of customer back the feedback we're getting.

Speaker 4

Obviously, we play very globally not only in the U. S, but half of our revenue is outside the U. S. And to Patrick's point, there's a lot of public funding globally, both in the UK with the AMP cycle, in China, the EU and then obviously in the

Operator

And we'll take our next question from Joe Giordano with TD Cowen.

Speaker 7

Can you talk through like kind of how the quarter went in Western Europe and China? I mean, that's where the data has been kind of squishy and maybe getting worse there a little bit. And just curious on your thoughts on potential for Chinese stimulus and where that might get directed if it has impact to you guys?

Speaker 4

Yes. Hey, Joe, it's Matthew. Just maybe just some comments on Europe. It continues to be resilient, Especially in utilities, which is over 50% of our revenue in Europe, with the majority of that being in OpEx, as Patrick just mentioned earlier. We were up low teens in orders in Europe and utilities.

Speaker 4

And so that was really good news. The softness that we're seeing is more on the building solution side, which is Partially offset by industrial. All in all, Western Europe is up low single digits in orders. So I'd say all in all faring pretty well there from when you take the balance there in account. China, which makes up around 6% of our revenues.

Speaker 4

We saw positive momentum both in orders and revenue in Q2. We were up 20% plus, Which although it was an easier compare, it was really great work done by Shu Ping Lu, who leads our team there and the entire team in China. Just incredible resolve and just really in China for China, localizing products and shifting where some of the slowness It's happening and getting into more of the high growth areas. Industrial has led the way in China for us and we're starting to see a little bit of momentum in the utility space. And obviously in the commercial building space in China, that's where the weakness is, but it's not a big part of our business in China.

Speaker 4

75% of our business in China is more utility centric. So all in all, we're very confident in China and we in the long term outlook, Given really the critical nature and focus on water in country there.

Speaker 2

And Joe, you know this already, but for the rest of the listeners, I've been a long term bull on China, just because of The underlying demands and needs from a water and environmental standpoint there continues to be a top policy mandate of the government. You couple that with the strength of our team and our portfolio of offerings, we've weathered A couple of cycles in China over the time that I've been here. But when you go back and look over the last 7 or so years, it's like a double digit CAGR of growth. And we continue to see that potential going forward. So I'm very proud of the team and optimistic about China for us.

Speaker 7

That's good color. Thank you, guys. And then just I wanted to follow-up on ENDRECA. Just where is that in terms of like What needs to happen for that to become kind of like a core kind of beachhead for you and digitalization on a scale basis? And then Sandy, I just had one clarification for you.

Speaker 7

APT within water infrastructure, just curious how that looked organically on like a full quarter basis for revenue and orders? Thank you.

Speaker 3

Yes, let me knock that out of the way and then Matthew can take Adrika. When you look at the performance of the full quarter of Evoqua, The business grew 9% organically, and the APT piece of Evoqua grew 4%.

Speaker 4

Great. Yes, in terms of EDRECA, just for folks that are on the phone that may not know what EDRECA is, it's we have an Commercial partnership worldwide with Eudrica, which is headquartered in Valencia, Spain. They were born out of a utility operator. And the digital platform that they have that we're partnered with addresses really the biggest pain point we hear from utilities need for a singular platform to seamlessly integrate all of their applications and data. And I would say, we have built really good momentum over the past 4 to 5 months, we've engaged over 200 plus utilities globally and it's got really global reach.

Speaker 4

It's fairly balanced across the globe And it built a solid funnel with really significant synergy wins through bundling our solutions. So I would say it is Becoming the beachhead, it will become the beachhead. And earlier in Dean's question is going to help us pull through and drive more digital content, and also reoccurring revenue, which is really important. Just one example I'll give you, in the U. S.

Speaker 4

Recently where we leveraged this Digital platform, we're calling the Xylem View, which is the Adreka platform. We pulled through a large AMI order. Now you're seeing in the backlog. You saw the backlog grow by $300,000,000 One of those big synergy wins was due to the digital platform that we enabled and pulled through this synergy order. So it's going to help us with recurring revenue, but it's also going to pull through content, which is really strong.

Operator

And we'll take our next question from Nathan Jones with Stifel.

Speaker 8

Good morning, everyone.

Speaker 2

Good morning, Nate.

Speaker 8

I'm going to start on the cost synergy side. Pretty good run rate to be at $40,000,000 by the end of the year, like 30% of the targeted cost synergy number. So maybe you could just start off by talking about Where that's coming from to hit that kind of run rate that quickly in this kind of deal, the major buckets for the 140,000,000 If you can give us any color on how we should think about those layering in, in 2024, 2025, 2026?

Speaker 3

Yes, sure, Nate. Let me kick that off. I think the cost synergy buckets that we outlined when we announced the transaction have not So, the first category was to go after public company costs, overlapping public company costs as well as And so that is making up the lion's share of the savings that we're going to realize in 2023. And so the other two categories of savings, which are going to come from procurement savings, as well as Some site consolidations and manufacturing footprint overlap, we expect the procurement savings to start to kick in later in 2024 and The manufacturing site consolidations, that's going to happen over time. We have those phased, because we want to make We're purposely taking care of our customers.

Speaker 3

So about $40,000,000 exit rate in Q4. As I look into 2024, We'll be more than double that when we exit 24. So I think all signs, we're very confident about the 140.

Speaker 8

Thanks for that. And I did want to ask a couple of questions or one probably long question about revenue synergies. It's obviously a big motivating factor for this deal to get done in the 1st place. Not looking for exact numbers. I We might get some more of those in early 2024.

Speaker 8

But if you can just talk conceptually about areas where you see potential for revenue synergies And kind of the phasing of those, I mean, there's obviously the APT and water infrastructure combination, I think certainly signals that there's revenue synergies there and you talked about them before. But maybe talking about things like expanding Evoqua's Service based business model internationally may be leveraging their footprint in the U. S. To develop some more service based business models with Xylem's legacy products and then any other channels you'd be willing to talk about to help us understand the opportunity here?

Speaker 2

Sure. Suneet, this is Patrick. So I go back to the 3 overarching kind of areas that we're focused on. And what I would offer is we've also got special incentives in place for our teams to go Sure. The revenue synergy because we want people to be highly motivated to go do these things beyond their day job.

Speaker 2

Deepen our utility penetration, and that really is around, again, the combination of our treatment product The portfolio of the 2 companies, they really do complement each other very, very well and leveraging what Xylem's Really market leading utility position is around the world. These are not North America comments alone, they're around the world, It's a big opportunity. Secondly, scaling our offering to industrial customers, Again, we call them industrial, and there's a number of customers that are in that area that we think there are big opportunities. We don't We see big opportunities to really go solve their needs. So if you think about Well, the third is expanding the ISS offering internationally.

Speaker 2

And 23 have a lot in common, because as part of our diligence when we looked at Evoqua, they have a really, really impressive roster All customers, market leading customers that cut across areas of whether it be Power, whether it be food and beverage, whether it be life sciences, whether again, whether it be microelectronics that have needed even more of Evoqua's capability than Evoqua has been able to provide in the past, especially international. And that's where we as Xylem have the footprint and we have the scale and the resources to be able to drive that adoption.

Speaker 8

Great. Thanks very much for taking my questions.

Speaker 2

Thank you.

Operator

Thank you. And we'll take our next question from Joe Giordano with Jefferies.

Speaker 1

Operator, I think we've heard from you.

Operator

We'll take our next question from Saree Boroditsky with Jefferies.

Speaker 9

Hi. Thanks for taking my question. Maybe digging into Building Solutions a little bit. Commercial demand has continued to be strong. I think this is one area that you're anticipating a slowdown previously.

Speaker 9

So maybe just an update on what you're seeing there?

Speaker 3

Yes. I mean I'm sorry, sorry, it was a little bit choppy. You asked about commercial. Yes. So our commercial business Has been pretty resilient this year.

Speaker 3

We've seen continue to see strong revenue growth. And Our outlook for the back of the year is we still are going in with an elevated backlog. So nothing has changed materially there.

Speaker 2

3, was your you were a bit choppy in the break. I want to make sure we clarify your question in terms of which segment?

Speaker 9

Yes. I think you were anticipating a slowdown previously. I think Citi and maybe ABI, so just trying to get an update there on Building Solutions. And then maybe just on just following that up on residential, obviously small market for you guys, but How did that trend through the quarter? And are you seeing any positive signs there?

Speaker 9

Thank you.

Speaker 3

Yes, Saree. I mean, I think when you look across The portfolio, we're seeing really good orders momentum and strong book to bill. The one soft spot in our portfolio is residential. And before the acquisition that made up about 5% of our revenue base. Now it's even lower than that.

Speaker 3

It's 2% or 3% of our revenue base. So Yes, that is the weakest part of our portfolio. You're seeing a slower growth outlook in AWS for the second half of the year, offset by the other businesses that have more resilient end markets such as utilities.

Speaker 9

Thanks. Appreciate the color. I'll pass it on.

Operator

And we'll take our next question from Andy Kaplowitz with Citigroup.

Speaker 10

Good morning, everyone. Hey,

Speaker 2

good morning, Andy. Good morning, Andy.

Speaker 10

So Patrick, dewatering has obviously remained strong for you Guys, we've talked about it in the past being a little more cyclical, but it seems like it's sort of holding up well. So maybe you can talk about sort of what you See going forward, maybe even into 2024 in that business?

Speaker 2

Yes. Dewatering had historically, for those that may be relatively new to the story of Xylem, had historically been one of our more cyclical businesses. And because it's such a high margin business, it would tend to capture spotlight even with a little bit of movement in terms of downturn. And there have been a number of moves that we've made over the past handful of years to diversify the end market exposure of that. I'll hand it over to Matthew to kind of give his take on kind of where we are positioned right now.

Speaker 2

But I'm certainly proud of the work the team's done. And there's been a lot of work done on Synergy commercial integration even before the acquisition of Voqua, and it only gets stronger now.

Speaker 4

Yes. No, it's great, Patrick. We've put a lot of time and effort into dewatering over the past couple of years, Andy. And I would say maybe a couple of things. One is we invested in both in Europe and in the U.

Speaker 4

S, which has really helped us capture more wins. Number 2, really coming out of 2019, we needed to diversify our segments in dewatering, we were too oil and gas dependent. And we've done a nice job of mixing into light construction as well as into mini bypass and some different areas that are A bit more steady and less cyclical. So those are a couple of key drivers, I would say, that's really helped us. And the last thing I would say, In the U.

Speaker 4

S, where it's predominantly our revenue is, we've done a good job of driving the businesses together and driving synergies With our service organizations passing leads back and forth to one another with our pipeline assessment service businesses, Our valve maintenance business and whatnot, so really good on the synergy side that's helped drive growth as well.

Speaker 2

I would just wrap up that answer by saying, I think in this business like the entire business, but certainly this area, it's about leadership. We've got a strong leadership team in that area that are working together. They're leveraging the portfolio. They're focusing on what happens at a slight Kind of local service level, this just like our ISS business coming in, it's a people very people driven business. It's an emergency room kind of operation.

Speaker 2

It's what happens every day 20 fourseven. And so the hearts and minds of the people really, really They do everywhere, but they really matter here in terms of what customers experience in the moment. And Again, I just give I give an applause to the leadership team for what they've done.

Speaker 10

Very helpful guys. And I apologize, I joined the call a little late, so if this has been asked, but like on price versus cost, maybe talk about sort of You already talked about supply chain getting better, I think, but sort of what you're seeing on the pricing side versus that sort of improving supply chain? And then maybe And looking at Evoqua too, any sort of differences in markets as you're thinking about price versus cost as you go to the second half of this year and into 2024?

Speaker 3

Yes. Thanks for the question, Andy. We've seen really nice developments on the price cost side and it The way we've managed it, it's now been a tailwind for us from a margin perspective. We are starting to anniversary Some of the price increases that we took when inflation was peaking and so you're not going to see as much of a tailwind from price in the back half of the year That you saw in the front half. The positive thing is that this is actually the Q1 that we've seen inflation start to moderate and come through our results.

Speaker 3

And we would expect to see a little more of that as well in the back half of the year. So, really great work by the commercial teams to make that happen over the past year.

Speaker 10

Appreciate all the color.

Operator

We'll take our next question from Brian Lee with Goldman Sachs.

Speaker 11

Hey, good morning, everyone. Thanks for taking the questions. Good morning, Brian. Question on the MNCS margins, kudos on super solid execution there. I don't think we've seen Margins at these levels since, I think right after you bought Sensus, so it's been a while.

Speaker 11

So just trying to Get a better sense of what drove that, how sustainable it is and then what we maybe should be thinking of run rates through year end. And If you think this is a good sort of jumping off point for potentially getting back to a double digit margin on a full year basis Next year, is that a reasonable sort of target to have at this point?

Speaker 4

Yes. Thanks for the question. I'll start us out and then turn over to Sandy. But we've spent Lot of time in the past 6 to 12 months, really the past 12 months on M and CS margins. And I'd say there's probably 2 or 3 things I would point to.

Speaker 4

Number 1, obviously, We were hampered by chip supply not being able to unlock the backlog. And so being able to unlock the backlog has really helped with absorption in our factories And helping cover fixed costs. So that's probably number 1. Number 2 is we're getting back to productivity in that business. We had to redeploy Resources to go after, redesigned our products for chips.

Speaker 4

And so productivity has increased this year year over year and we'll continue to drive that in the business. And then thirdly, I would just say, in general, price cost has been a very good positive over the past 2 to 3 quarters And M and CS, which has helped buoy margins as well. So we'll continue that pace going forward and expect margin improvement sequentially going forward. And Brian, this is Patrick. I'll just offer up some historical perspective here for those that may be early on in the story here.

Speaker 4

MNCS is not a turnaround.

Speaker 2

We I mean, this has been an issue in terms of being able to Deliver on what has been an impressively growing backlog over the course of the past few years. And we've had margin read through on what that backlog is for a long time. We've made commitments in the past as to when we reach certain levels of revenue, what the margins would be. That's exactly what you're seeing right now. So again, I give a shout out to the entire team that drives, especially the metrology part of our business because they've been executing on this Ever since we did the acquisition, it's just it's always been something along the way.

Speaker 2

And now we're seeing that the clouds have kind of moved off the horizon And you're now seeing what the full potential or at least the next stage of potential is for this part of our business.

Speaker 11

Okay, that's great. I appreciate that color. And then maybe just a second question around with the acquisition of Evoqua, Clearly, much bigger scale, but much more diversification across the business model. It seems like it'd be a lot less cyclical Going forward, in the past, I know Evoqua has sort of broken out what their sort of their recurring revenue exposure is as a part of their portfolio or sales mix. Now on the combined entity, any sense you can give us as to how you think about the recurring Revenue nature of the different segments where you have exposure there and kind of how that compares to Xylem standalone?

Speaker 11

Thanks

Speaker 2

guys. Yes, yes. No, certainly, great question, Brian. I mean, it was certainly not the reason for the acquisition, but certainly one of the big benefits Is that recurring revenue component? The Evoqua business, we have tremendous line of sight going into any given year based upon contractual commitments as to what that looks like.

Speaker 2

And so you're talking about the largest portion of their revenue is predictable and repeatable going into the year. And so and that really is ISS, which is Obviously, the largest part of what we got from Evoqua. If you look at the other parts of our business, historically, Our M and CS business, which is metrology, also has a lot of revenue under contract. And so a majority of revenue there It's visible going into the year, but not even 1 year. It's looking at it over the course of a 10 to 12 year timeframe given AMI deals that are there.

Speaker 2

Water infrastructure would be the next one, given the fact that we've got such a large installed base of our Submersible wastewater pumps, but also our treatment products that we do that are typically long term kind of projects that we're operating under. And it's just a very stable repair replacement environment. We feel very good about that. The area, the business that's Always been shortest cycle for us is our applied water business. But even there, we would say upwards of a third to 40% of our revenue, While it's not under contract, it's a replacement model.

Speaker 2

And once you expect your pumps into a commercial building or an industrial application. The likelihood of a customer changing out to a new supplier is very low. It's very sticky and we have market leading positions there. So even though it's not contractual, we can kind of have that visibility going into the year. So We will in the future, we'll give you specific numbers in the aggregate.

Speaker 2

I don't want to over commit to that right now, But we feel very good about the durability and nature of recurring revenue of this business, much more now than we did a quarter ago because of bringing in Evoqua.

Speaker 11

All right. That's great. I appreciate the color.

Operator

This concludes the Q and A portion of today's call. I would now like to turn the floor over to Patrick Decker for closing remarks.

Speaker 2

Well, again, I mean, thanks to all of you for your time this morning and for your ongoing support. Look forward to seeing many of you over the coming And just a reminder, lastly, again, really excited today about the power of the combination of 2 companies coming together that were strong on their own and performing well. And now is the time. It's the right time in this world for these Because there are so many great water challenges out there to be dealt with and we feel that we are in a position to really be a meaningful part of that. So thank you all very much.

Operator

Thank you. This concludes today's Xylem Second Quarter 2023 Earnings Conference Call. Please disconnect your line at this time and have a wonderful day.

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Earnings Conference Call
Xylem Q2 2023
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