Xylem Inc. (XYL) Earnings Call Transcript & Summary

Hello, everybody. I'm John Church with Morgan Stanley. Thank you for joining us here in the room today and remotely. Very delighted to have the senior executive team from Xylem with us today. Patrick Decker, Chief Executive Officer; Matthew Pine, Chief Operating Officer. Thank you both for joining us and for the opportunity to have this discussion. Thank you. Maybe we kick it off with just a quick overview of Xylem, its business, its markets.

Sure. I'll try to keep it brief. Policy is on our website at xylem.com, so I'll try not to bore you here. But we're on a pro forma basis, roughly $8 billion global water technology leader. We operate in more than 150 countries around the world. We predominantly play in 2 large markets, one being the utilities market around the world, both on the clean water side and the wastewater side. But we also have a large portion of our business, especially with the recent acquisition of Evoqua, a large presence now. And we try not to say industrial, although we use that word sometimes. It's really businesses and operators who rely on clean water to meet their needs from a business standpoint that could be microelectronics, could be pharmaceutical, oil, gas, food, beverage, hospitals. Again, it's the business community that relies on that consistent water supply. We have been consistently over the last few years here, growing at a very nice clip organically, have put a fair amount of capital to work with our recent acquisition of Evoqua and much more that we can talk about here in the next 30 minutes or so.

Terrific. Great. Thank you for that. So big news. Last week, significant leadership changes announced both the CEO and CFO level. Maybe, Patrick, you can just start off by walking us through why now in your view is the right time for that transition. In light of the recent deal as well?

Sure, absolutely. So for those that are may be relatively new to the Xylem story, Xylem was created about 12 years ago when about 1/3 of our current business was spun out of ITT Corporation, and they were predominantly pumping and treatment applications, a little bit of analytics work that was going on there. And I joined the company 2 years after the spin as the CEO of the company. And over the last nearly 10 years now, we've been on a journey of building out what we believe to be the leading water technology platform around the world. And over that time, we have, I believe, demonstrated tremendous growth. built a really solid portfolio, generated really strong financial returns. We have put a fair amount of money to work around M&A and building out this very unique position that we've got that really, again, helps address water challenges more comprehensively around the world. I'm coming up on my 10-year mark. It will be 10 years in March, this coming March as the CEO about a few years ago in Scottsdale at our Board meeting coming right out of COVID. I was speaking with the board at that point in time and they were asking me, "How are you doing, just mentally wise, health-wise coming out of COVID. Are you okay? A lot of people leaving, stressed," and I said, I'm doing fine. "are you getting phone calls?" Yes, I get phone calls, but I'm not looking to leave. "well, how long do you want to stay?" And I said, I'm not leaving tomorrow, but I'm not going to probably be here 5 years from now. And I said, if you meet in the middle, that would put me around the 10-year mark. And I said that matters to me because I believe, and many companies don't do this very well, that if between me and the Board, we cannot develop an internal successor, then we're not doing our job. Matthew had joined literally the first day of lockdown, March 16, and we were about a year on whenever I had that conversation with the Board. I then said to the Board that I said the only caveat there is that we've got a couple of large acquisition opportunities in the pipeline. Never certain two to tango, but if we were able to do any one of them, I'm not going to leave you in the lurch. I will be here for at least a year or more after those transactions to make sure that we have a smooth integration and transaction. So we named Matthew as Chief Operating Officer after he had served in leadership capacities across each one of our business units. We named him COO back in December, effective January 1. We then announced the Evoqua combination in January, this past January. He has been involved in the -- all of the initial assessment strategically of Evoqua. He was involved in all of the management presentations with the Evoqua team. He's been involved in all of the target setting, all the integration work from the very beginning. And has been in every board meeting for the last couple of years and certainly this year. So as I and the Board sat down at that time, we said, over what time frame do we think, John, that we need to have time to assess Matthew in that role. And we felt that it would be this year that we would know whether he has the right stuff. And so in the August board meeting, our annual strategy review, Matthew owned that strategy review and long-range plan target setting. And so we made the decision at that point in time that he was the right person for the role, and that we would make that change effective at the end of this year. I would stay on through March. I know some have asked will not stay on a little bit longer, Patrick. And we simply said, we want there -- I am here through March. I'm not going anywhere, but we wanted Matthew to have a clean cut of ownership, full ownership of 2024, including an Investor Day, which we've not yet set a date, but it's probably going to be sometime in May or certainly late in the first half of the year. And we wanted to make sure that Matthew had full complete ownership of that without me being in the shadow so that he clearly owns that, and he's not just puppeting Patrick's Investor Day. So that's the CEO transition. The CFO transition is a bit different in that when we came through the end of this past year and through the Evoqua combination, it was very clear that Sandy, our CFO, who's done a terrific job here over the last few years that for personal reasons, we have made the decision to move our headquarters to DC. That's where I'm located. That's where our new headquarters is located. And while not all of our executives are required to live there because they travel all over God's creation anyway, that's when we get together, that's where our headquarters look at it. And so Sandy has been making that travel on a regular basis. And it's a personal decision that it's been a lot of wear and tear in terms of that travel. And so once we got through the Evoqua closure regulatory approval in May, we then made the decision to go ahead and start a search for a new CFO. And Sandy was in full agreement that she knew that if Matthew was going to be the next CEO, he needs to have somebody that's going to be able to be with him by his side on a regular basis for some years to come. And so that was the reason we made that decision as it related to Sandy. Why announce both at the same time. We had landed on the agreement with our new CFO, Bill Grogan, who is outstanding, coming over from IDEX. Many of you may know Bill or know of him. Top Pedigree CFO. We knew that we needed to go ahead and announce that move. And so then the decision was, well, we know we've made the decision that Matthew is going to be CEO. We need to announce that at some point in time. And we simply did not want to split the 2 announcements and have a progress over the course of the balance of the year. So it's a very smooth transition. Sandy stays on until the end of March, and that really is to make sure that both she and I are here to provide support, be held accountable and make sure that we ensure a smooth integration of bone.

Excellent. Matthew, congratulations on the new appointment. As the next CEO, maybe you could just spend a moment a quick overview on your background and perhaps also an early day view on your sort of key priorities here in this immediate next chapter.

Yes. Thank you. As Patrick said, I've had the opportunity to be at Xylem for 3.5 years and be in different parts of the business over that time frame, most recently, the COO role, which I think for me, it's very difficult at least in my mind, I think a lot of people's mind and move from a segment president role to a CEO role. It's a big jump. It's like moving from high school sports to professional. And having this opportunity the Board put together with Patrick to be in the COO role for the year, really gave me momentum heading into 2024, gave me confidence. And it gave me some experiences that you just can't get until you're a little bit into the chair. So that's been very powerful. So that momentum has been good. Prior to coming to Xylem, I've worked in 3 different industries. I've had -- I've had the fortune of somewhat architecting my career to get multiple experiences both in -- I've been in sales, I've been in marketing, product development, engineering, digital, general management. And so I think that serves me well in being able to process information pretty quickly because I've been able to -- I have a lot of empathy for people in the organization because I've been in a lot of their shoes. And I think that's really important.

Very.

As far as what I'm focused on, I'm not the CEO yet. We're sitting here in September. So we need to deliver on our promises, our commitments. We've made commitments publicly. We need to deliver on this year in 2023. Patrick talked about the Evoqua acquisition and integration. That's first and foremost, my focus as we move from planning now into execution and making sure we deliver on that. And more importantly, just making sure we're also following up on what we said publicly in 2021 at our Investor Day in September of that year, and we're on that trajectory through 2025. So that's the immediate focus. Obviously, Patrick said, I had time this year to put together the strategic plan, which we'll get into a lot more detail probably in May of next year and be able to give a lot more color around what that looks like over the next 3 years. But it's not a major departure from where we've been. It's nuance. There'll be some changes, but largely building on the platform that Patrick has built over the past decade. 70% of the company didn't exist 5 or 6 years ago. And we're in a really good place with a strong platform to execute from. Excellent.

We're going to get into Evoqua and the combination in just a second. But maybe since we have this audience here, it's coming up next week, just a little bit more on Bill and his background and maybe why you were so convinced he was the right candidate.

Sure. I'll go first, and Matthew was in the process all along the way. So we used Spencer Stuart as the firm, and we had a really, really strong, attractive pipeline of fitting public company CFOs. It's a very tough competitive environment. It's hard to get CFOs to cross borders on companies these days with all that's going on in the world. But we had a lot of success there, and I think it really comes down to -- before I talk about Bill, the candidates and certainly, Bill will be able to answer these questions for you. The attractive aspect of Xylem is, one, the purpose of the company. And it's not just about water. We've done a lot around culture and climate and employee engagement and what we do in our communities. We talk about customers and communities first. That's been a lot of work in my tenure over the last 10 years. We've got a lot of stuff we got to keep working on. But I think he really got the spear to core of that. Two, great portfolio of growth. I mean the capital personal that we have, the way we structure the Evoqua transaction, the cash power of generation, both companies, an all-stock deal, we're going to have several billion dollars of balance sheet capacity over the next few years to continue to put to work. That's always exciting for, I think, a CFO coming in, give them latitude. The chemistry, obviously, with not just myself, but even more so with Matthew was critically important. And it's a slightly bigger opportunity. I mean, IDEX is an incredibly successful company. I think many of you know them. And -- but he sees opportunity here that I think he can have a long run here at the company. What we like to about Bill, love the pedigree, particularly in IDEX. He'll bring a lot of good operating discipline and principles and tools with him. I always say to leaders, don't focus on bringing a playbook because every circumstance is different, but bring your toolkit. And he's got great tools in the toolkit to come in. And it's part of the reason why Matthew was putting the role he's in is I acknowledge that I think what I focused the last several years on the last decade was building out -- I mean water was not even considered to be an investable asset class. And so I think building out a portfolio, building out an awareness, thought leadership, a portfolio, a culture, but there's still a lot of opportunity here to drive efficiency, to drive margin expansion, and we have a lot of good processing in place. We're not starting from scratch here. Matthew has been around for 3.5 years, but Bill's got a unique skill set there coming from IDEX that I think just takes us at the next level.

That's great. Great. But let's go deeper on Evoqua and the combination, your months into it. The integration is underway. Can we dive deeper, just remind us around the original rationale. How is it playing out? Any additional risks on the table, any additional opportunities that you see there?

I'll start. I'll keep brief and Matthew can talk about exactly where we are because he's been here from the beginning of this strategically, we did our value mapping work when I first got here that kind of laid out all the subsectors of the water challenges around the world, which ones where do we want to play and how do we want to win? And where are we not going to play. Not every piece of water is profitable or growing. And so you got to be purposeful around what you go after. We had done a lot of work over the first 7 or so years on -- we started off as a wastewater utility company for the most part. We did some work in kind of the industrial space, mainly around pumps. And the first move we made was we went out -- we acquired a company called Sensus Metrology. And that's been a terrific acquisition for us. That got us into the clean water side of the utility. So now we had our hands wrapped around the utility space, which is half of the spending in the world around water. And it's a great, stable, steady, mid-single-digit growth if not higher, depending upon the cycle. But what we were missing, John, was we had no point of entry and to the other big part of water spending, and that are all the businesses and members of the community that need access to it, so-called the Industrial Services side. And so we looked at a number of opportunities. We had looked at Evoqua a number of years ago. It didn't make sense at the time. We had stayed close to them over the course of the last few years. And finally, when value disconnects for a lot of reasons, came into play. We moved quickly at that point in time, but it's been something we've looked at for quite a while because the customers that we serve now there, the value of money to those customers is not the price per liter or a gallon of water. It's when their businesses are disrupted. So you take a pharmaceutical company. they don't care so much about the price per gallon or liter of water, what they care about is that they're in water stressed environments which they are increasingly are. Microelectronics, we didn't list, when their operations are disrupted, they lose revenue and they lose profits. And it's exponentially more than the price of a gallon of water. Two, they have reputational risk, whether it be discharge, whether it be branding for the food and beverage companies about being water neutral. So it's a very attractive market, set of markets in terms of long-term growth. And we've got unique skill sets there in terms of managing a skill that is not core to their operations. That's not what they're best at doing and so they let us do that. In terms of integration, I'll let you...

Talk about a few words on integration. We've used 4 principles in the integration, which I think are really important. I'll cover them really briefly. Number one is there's a lot of value that's created by both organizations, the legacy businesses meeting their 23 plants. That's going to create a tremendous amount of value. So keeping people focused. We use the word integration tourism. We don't want people jumping in the new [ bright ] shining object, which is Evoqua coming in. And so people -- keeping people focused is really important. That's the first principle. Second, is the value capture, making sure we're delivering on the cost synergies, which fund the deal. But more importantly, why we did the deal was to get after the revenue synergies. So that's been a critical focus. We're gaining momentum since we closed in May of this year. That's progressing nicely. And I'll give some examples of that in a moment. The third is talent. In a lot of these deals, a lot of times, the acquirer, it's, "hey, we know best. We got the best people." That's not the mentality we walked in with. We walked in with, we want to put the best talent on the field and when you look at our announcements that have come out, both at the senior leadership team level and 2 or 3 levels down the organization, 25% of the talent has come from Evoqua. So that's -- getting the best talent on the field has been really important. And fourth is to take the best of both cultures. We've spent a lot of time kind of on the soft side of the integration, which is the culture work and making sure that we're representing both cultures as they come together. So that's been progressing nicely. I'd say there's 3 areas that are primary focus out of the gate. One is on the municipal side, which has been the legacy Xylem focus, and it's pulling through products from Evoqua into the municipal space. Not a lot of money, OpEx, CapEx due to do that, leveraging the portfolios and pulling them through. Another opportunity is on the industrial side, which is where Evoqua now can pull through the legacy Xylem business into those opportunities. And an example of that would be, I was recently, 2 weeks ago in Florida, at a large customer site for legacy of Evoqua business. And obviously, Evoqua did only treatment on that site. It was a mining site for phosphate, which makes fertilizer. And in that process, if you will, in addition to treatment, well, you need to transport the water, you need to have conduit, piping to move the water, and then you need analytics to tell you what's going on with the water. We do all those things at the legacy Xylem business, but we weren't on the site. And so we have real opportunity very quickly to walk into customers and package a solution and have one belly button that's responsible for an outcome. And so that's starting to really gain a lot of traction. The second example I would give you is in the services part of our business, about 3 weeks ago, there was a large fire to refinery in Baton Rouge, Louisiana. And had we not had the combination, it would have been multiple billions of dollars worth of problems. And within 24 hours, we had both legacy businesses on site managing not only the treatment but helping put the fire out through our dewatering business, leveraging our pumping solutions. We laid 2.5 miles of pipe in 24 hours, put the fire out and then treated that water. We couldn't do that 6 months ago, and we saved the business from a catastrophe. So those are some real examples on the ground of what's going on. Thirdly, there's a real opportunity for international expansion in that business. It was mainly a U.S.-focused business. And our business, we're in 150 countries. We have legal entity structure. We have back-office support and looking at more longer term, scaling the services businesses outside of North America, where customers, large customers want the same experience in other parts of the world. So that's something we're also very keenly focused on.

I would just punctuate on that, John, that the sort of give some specific examples. So Coca-Cola, Procter & Gamble and Intel, they need the same quality of water everywhere around the world. It needs to taste the same. It needs to be pure water for chips. And they have been asking the Evoqua team for a number of years to help follow them around the world. And it wasn't that Evoqua didn't want to. They literally did not have beachheads. They didn't have legal entity. They didn't have service center footprint. They didn't have any of that. They didn't have the leadership talent that had the bandwidth to be able to do that. And that's where our global scale of Xylem is really going to present a very powerful opportunity.

Innovation technology. It's always been a big part of your history. Any changes there as you think about the combined opportunity?

Yes, absolutely. Sivan Zamir is here. He's based out of Los Angeles. He leads our innovation labs. And we put a tremendous amount of effort over the past, let's say, 2 or 3 years on making sure that as a proxy through R&D is going out and investing in venture capital, doing helping with start-ups, helping with -- partnering with universities for technology. That's been a huge focus of ours to really accelerate a space that's moving very quickly. There's a lot of regulation. There's a lot of compliance. There's a big need for kind of step-change technology advancements, and that's been a big focus area for us that we've invested to be able to move faster to solve a lot of the critical water challenges out there today.

In some of the specific areas, I mean, I know many investors ask about things like PFAS. Obviously, Evoqua has a leading position and the deconstruction of PFAS, obviously, the big challenge now facing the world and the new EPA mandates coming out are going to be the actual capture and destruction. So you have to move it across state lines, et cetera. So there was work that Evoqua was doing in that area in terms of early-stage innovation. We were doing the same thing through Sivan's group. We're joining forces on that now. It's easier for academics and start-ups to work with one company in that regard. This is one example. And there's a lot we're doing on the digital front in terms of leveraging what we were already doing in terms of digital platform over to help the services side of Evoqua. So I don't want to speak for Matthew, but innovation and technology is really -- it's been one of our top 5 kind of stall works since I got here, and I think he's committed to me and the board that would not change. Part of our identity.

5 segments, lots of integration you described. Do you expect or anticipate any point conducting a portfolio review as you prioritize capital and businesses and resources over time to just measure where the capital wants to go and which businesses are indeed priority?

Yes. I mean absolutely. I mean it's something that we do ongoing. Patrick mentioned earlier, we're in the process of doing another kind of wave of value mapping as the world is changing. Patrick and the team back in 2014, '15, did an incredible job of laying out what are the opportunity sets to go after to build the company, and we've largely executed on those. That was digital, getting after and growing emerging markets, where those are growing at 2x the developed markets. Big focus area as well as industrial services and solutions. And you've seen through the inorganic side, us build this platform. And so we're getting after the next set of value mapping exercises. It's not that the telescope is broken. It just needs a little tweaking, Things are moving very quickly out there. So we're in that process right now. And like I said, we're always assessing the portfolio once a year. We'll continue to do that, and we've -- over the past few years, we've continued to prune the portfolio, and we'll continue to look at those things.

I think one of the other things, John, not just because the capital allocation is not that you're suggesting it is. It's not just about businesses staying or going. It's also product lines. It's 80/20. And Matthew and the team have done a lot of great work on that and teeing that up. still brings a lot of skill sets on that from IDEX. It's been part of their [ kit of ] success is you can't feed everything in the organization. So I'm very encouraged around that work the team is going to be doing.

You've got a very conservatively levered balance sheet because of the way you structured the deal. Talk a little bit about growth markets. You've mentioned some, but others that might be important.

Yes, absolutely. I mean the key is to focus on Evoqua right now and get that integrated. And Patrick mentioned, we've got a very strong balance sheet to go deploy capital, be very strategic. Obviously, we continue to build on what's happened over the past 6 or 7 years in terms of the emerging markets is a huge focus for us. We've built a lot of momentum there. We're going to continue to double down in that space. We just did a deal in April of this year with a company called Idrica, which is a digital platform based out of Valencia, Spain. It was born out of a utility operator where they understand how utilities operate. And it's basically like an iPhone, you're laying a platform in for utility to aggregate all their data. So we're moving kind of beyond kind of applications of digital that can help and point solutions. And we believe in the utility space, we can come in and be the aggregator of all data. And so that's an area that we've doubled down. We'll continue to focus on. A lot of that data when you get into utility, it's siloed, people can't access it, they can't make decisions off of it. And so that's where we've been really focused, especially with the Idrica joint venture, and that's an area we'll continue to focus as well. And we've also been committed after the deal to continue to do a lot of the tuck-in acquisitions that Evoqua was doing prior to the combination. And that's an area that we're going to continue to focus to on the services front.

So I would say, John, in the discussion we have with the Board in the August strategy meeting that Matthew had led was certainly we'll continue to stay with our general financial policies, at least for some time, and that would be we've got a lot of organic growth opportunities. It's not a capital-intensive business. We have low CapEx, generally speaking. But we'll continue to fund that fund innovation. Certainly, we will grow dividends in line with our earnings growth. And I think over time, you're right. I mean this is such an opportunity to have. There are other assets of size and scale that are out there at the right time. We expect to be a part of those conversations at the right time. In the meantime, we'll -- I'm sure he'll continue to go after those things that are strategic within the businesses themselves and then the opportunity there to determine with what's left, what the whole return to shareholders approach looks like. So it's a great situation to be in and exciting future.

It's been a few years since you've been in front of investors at an Investor Day format, any plans that we can think about here? You've got something coming up early next year?

Yes. We're going to do an Investor Day probably likely in May of next year. Give Bill a chance to come on board here in October, give myself some time January 1 as well I'll be taking over the CEO role, get that stabilized, and we'll come out to the investor community probably in May of '24 as the timing.

And our Investor Day tend to be a lot of show and tell to showcase the technology, the solutions, customers will make it very interactive.

Yes. Okay. Looks like we're up against the bell here. Patrick, congratulations on all your accomplishments Again, Matthew, congratulations on the appointment, and we look forward to great things from the company. Thank you.

Thanks for your interest. Appreciate it.