Conference Transcript - XYL 2026-11-10

Gregory Giametti, Head of Investor Relations

And we're pleased to welcome the Zyland Management team with us today, Matthew Pine, CEO, Andrea Vandenberg, CFO, Greg Giametti, IR. We've got a full slate here today. We're going to dive right into Q&A. If you've got any questions, please raise your hand or send me an email. Cards in front of you have the address. I'll be happy to integrate those questions into the conversation here. But thanks for coming. Thank you. Appreciate it.

Matthew Pine, CEO

Appreciate it. Good to be here.

Gregory Giametti, Head of Investor Relations

Yeah, it's great. So a lot of moving pieces right now. You know, you've got Some demand variances happening, some strong orders, but project conversion timing. Maybe you could just level set us and talk to the changes that are coming through the organization concurrent with this. So we'll talk maybe the organizational changes as you see them and what you're driving, and then we'll transition into the kind of demand pieces just to make sure everyone's on the same page.

Matthew Pine, CEO

Okay, so from the four-to-three perspective?

Gregory Giametti, Head of Investor Relations

Yeah, maybe just talk about all of that transition, what you're happening on the portfolio side, and then while you're simultaneously doing 80-20, there's just a lot going on, so let's take it piece by piece.

Matthew Pine, CEO

Yeah, there's a lot going on. I think we continue to run our playbook that we laid out back in 2024, Investor Day in May, and it's really about the operational transformation of the company, And that's really our kind of operational transformation, leveraging the simplicity we create to focus on organic growth and then rotating our portfolio. So we're making good progress in that journey. You know, some of the proof points I laid out in our recent earnings call in terms of our safety performance up, you know, improved 34 percent. Our on-time performance to customers up 700 basis points. You know, really good days of inventory, outstanding reduction of 20 days, $275 million of improved cash flow. So, all the operational things are going well, and we're making good progress there. And a lot of that is due to 80-20. Some of that is also, you know, in terms of our EBITDA contribution is the integration of OCOA over the past couple of years. So, that's tracking well. Now we want to leverage that simplicity to focus on growth, and that's really around speeding up the innovation flywheel and really addressing commercial excellence and focusing on what we call these high-growth verticals around, you know, data centers, semiconductor, chip fabrication, food and beverage, life sciences, and power and mining. So those are areas that we're leaning in from an organic perspective. A lot of that comes from the legacy of vocal business that we're ramping up and got that kind of acquired industrial treatment and services business. And then continue to rotate the portfolio. And we've done 14 divestitures in the past couple of years. Think about it as half a billion out, and we've done about half a billion in. We just announced the closure of Cornell Roper yesterday, and the half a billion out is roughly negative growth and high single-digit margins, and the half a billion in is mid-single-digit growth and way above our kind of current margin expectations for the year. So things are tracking well. In terms of maybe this setup for next year, the first thing, obviously, we announced two more divestitures to the tune of about 9% of our revenue and about less than 5% of our EBITDA. So it's going to help us to continue to elevate growth and elevate our margin expansion over time, rotating those assets out. At the same time, we announced a further evolution of our structure. Back when we did our Investor Day, we were a highly matrixed organization. And didn't always have a lot of accountability, a lot of discipline, because we had people responsible for lots of different things. And so moving to a kind of a four-segment, 16-division structure enabled us to have much more focus, rigor, integrate a VOCWA. And now this is really the next evolution of that journey. It's moving to three segments around flow technologies, which is aligning all of our pumping assets in one segment. It's aligning all of our treatment. Both our integration capability that we got from Avoqua and our treatment products in one segment, and then measurement analytics, which largely doesn't change. I think there's tremendous further synergy opportunities by aligning that way, especially as we rotate the portfolio into more industrial focus, both organically and inorganically. And so that's gone well. On the demand front is maybe the last part of your question, on the demand front as we exit this year, we're exiting with momentum, and I would say three out of our four segments in the four-segment structure that we have today. Really, the challenge is MNCS, and we've talked about that, which is our metering business. And in Q3, we had some challenges around slowdown of book and ship, largely due to affordability of, you know, the inflation impacts on utilities and their ability to have to defer their monies into mission-critical assets. So that's really, for next year, we see three of the four segments. Getting into the four to six framework, two of them, water infrastructure and WSS more towards the low end of that framework, and then applied water. Which we have really good visibility to that backlog and our growing presence in data centers will be at the high end of that long-term framework. With MNCS, we talked in the last earnings call about the step down into Q4 and kind of that run rate over the first half of next year. And with our strong orders growth in Q3, hoping to see that materialize and come to fruition in the second half of next year.

Gregory Giametti, Head of Investor Relations

Great segue, and I appreciate this thought process. So why don't we start first on the demand side of things and what you're seeing. So maybe let's take some of the muning side of things. What is exactly happening on the metrology piece, both in terms of the book and ship, as well as in terms of the longer cycle? So why is there an air pocket here? What do you think is happening in the marketplace to create what is a short-term dislocation amidst what is still a very attractive long-term growth opportunity?

Matthew Pine, CEO

Yeah, so maybe just real quick, there's two pieces. One is energy, which we talked about in Q2 this year. And that's largely, I would say, that's a much more concentrated customer base for us. And I would say that was largely a political issue around affordability due to the ever-growing presence of data centers and the energy that it takes to, whether it's increasing transmission capacity or more energy production, is driving up consumers' energy bills. So, moratoriums in lots of states on raising rates on consumers there. So, that obviously put a little bit of a demand challenge on us on the energy side. As we got into Q3 on the waterfront, no pun intended, that I would say it was more inflationary than it was. Political. There was some pockets of political issues around raising rates, but it was more about inflation. It was tariffs from last year still hanging around. It was the Iran war and some of the challenges. And then pockets of our utilities are impacted maybe at the micro level or local level from the EIA build out, and that's creating inflation in those local markets, having trouble getting access to labor. And things of that nature. So what's happening on the water side is it's the inflation is creating an affordability issue. Their budgets are not shrinking. They just have less to work with. And metering becomes a deferrable investment or deferrable spend, if you will. And they need to focus their assets into mission-critical applications, which we have a lot of, like wastewater pumping and treatment. So that's, in essence, what's going on. I think in the short term, over the next 12 months, we'll see this continue to play out, hence our Our kind of guide in the last call about MNCS through the first half of next year, but I think the long-term setup is very strong. Half of utilities have AMI. The other half need it. So there's definitely a huge demand for it going forward. It's got tremendous return on investment with labor, with efficiency, just helping them be more effective with capital deployment. So I think the long-term setup is still sound. It's just we're in a little bit of an air pocket due to some of this affordability.

Gregory Giametti, Head of Investor Relations

So it's not about access to funding because funding is there, right? This is more of a discussion of if I have a dollar of spend. I can't buy what I used to be able to buy, and maybe the ability to go out and push more rates to fund that isn't really there, and the budgets aren't really changing, right? And so, you know, so then if I think about the growth thought process in the next year specifically for that segment, that feels more like a flat, maybe even slight decline based on what you're saying, because I think what you're saying is you're going to assume no real change in that book and ship business to start out with. Correct. And then the projects that, you had a good 3Q orders, maybe a little softer going into 4Q. Those are more late next year, maybe early 28, right? That's right. And so is that a fair way to characterize the growth process for the next year? Yeah, I think that's right. Okay, okay.

Andrea van der Berg, CFO

Which would imply MCS would be flattish to potentially deal with other segments would be in the framework of mid-single digits, potentially at the low end and applied water at the high end.

Gregory Giametti, Head of Investor Relations

That makes a lot of sense. That makes a lot of sense. And then the value proposition, though, hasn't really changed for the metering side at that level. Maybe talk to some of the savings or why, when you're still having these conversations with municipalities, that they are excited about the conversion opportunity on a forward basis.

Matthew Pine, CEO

Yeah, I mean, lots of utilities, if they have walk-by, drive-by, or they don't have anything at all, moving to a full AMI system creates a lot of value for them. It's got a strong return on investment. Just think about the amount of truck rolls and labor that you have to go out to read a meter, either walking up to the house or driving by it. So significant savings in terms of their operating expenses. And so the payback's very, very strong. Also, you get, you know, I call it turn the lights on when you put a smart meter and you start to get data. And through that data, you can build a digital twin. You can start to really think about capital deployment in a much more effective way versus just thinking about deploying capital like a shotgun and going out into districts of your city and doing kind of, you know, upgrades versus being very pinpointed and targeted. So it affords you not only to reduce OPEX expenditure, but it also gives you more visibility so you can be smarter with capital deployment.

Gregory Giametti, Head of Investor Relations

So how is this conversation then impacting the other parts of your municipal portfolio, you know, the pump assets, the treatment assets? How would you talk about the dynamic on that side?

Matthew Pine, CEO

Yeah, I would say those are more mission critical, and they're, you know, I'd say largely been very resilient. Over the course of this year, I think the area that I would point to is our treatment business, where we've been very intentional to walk away from revenue and do some divestitures, small divestitures. That was a part of our portfolio, the division that had not so great margins. We think it's relevant to keep, and it's very critical going forward. And so, you know, instead of taking a shotgun approach, being very targeted on what jobs we're going to go after, where we can make margin, and so that is a more longer cycle business. And so while we're kind of through 80-20, the margins are coming up. It does take a little bit of time to build the pipeline. We will exit Q4 with momentum and orders and treatment, you know, up mid-single digits, exiting the year, and we expect that we'll continue to improve through the first half of next year.

Gregory Giametti, Head of Investor Relations

And so, you know, a couple final points in MCS before we transition to WSS. The electric meter side, when do you start cycling some of the tougher comps on that side? First half of next year. First half of next year?

Matthew Pine, CEO

Yeah, after the first half we get through the tough.

Gregory Giametti, Head of Investor Relations

The reacceleration there is probably more about affordability all is equal. And then how should I think about the margin impact associated with the moving pieces within that MCS segment? Because obviously you have the international metrology sale that's a tailwind of the margins, but there's some deleverage impacts, some mixed impacts. So maybe talk to those moving pieces and how I should think about the margin levels.

Andrea van der Berg, CFO

Yeah, there's a few impacts on margin with MCS being a lower growth, flattish growth environment, or down potentially. We get the benefit from the international metrology divestory, and you would have seen that in our Q3 margin expansion, and that will continue to support us next year. We're also lapping a diluted gas, a large gas contract, so that will also help us for MCS margin. But then from a volume leverage standpoint, especially with water meters being flat growth or tempered on the growth side, those have very strong incrementals, and the fixed cost leverage will be one of the headwinds that we have on our overall Xylem profitability standpoint.

Gregory Giametti, Head of Investor Relations

So I think about fourth quarter, it was somewhere around 21% and change was the thought process implied in guidance. Is that the right thought process to use as a lever point in the next year?

Andrea van der Berg, CFO

Yeah, I would say approximately at that same type of run rate where you are in Q3 and Q4. We do take a step down from Q3 to Q4, so you're getting lower volume on the margin side, and then you can think about that on a go-forward basis. And if I step... Back, thinking about overall Zyland profitability, I would frame it in three ways. One is just we'll continue to have productivity from 80-20 actions. It just won't be at the same magnitude that we've had in past years. We've taken a significant step change with structural cost actions, where our margin is at the levels that we committed by the end of 27. When we did Investor Day in 2024, so we're at 23.2% our guide. We said we would hit that level again at the end of 2027, So we've taken a step change. We'll still have some productivity benefits going into next year, but that will help offset some of the mixed headwinds we have, as well as we won't have some of the volume leverage deceleration, especially from MCS. The second portion is on price cost. We've been price material cost positive this year from margin benefit, given we've gone out with pretty strong price actions to mitigate tariff impacts, as well taking specific actions on holding inventory buffer stock to mitigate inflationary issues that we've had this year. Going into next year, we'd expect price material costs to be neutral from a margin perspective, so that won't be as much of a tailwind as we've had this year. And then the third factor impacting our profitability is we'll have really great benefit from an inorganic perspective with the addition of Cornell Roper into the portfolio. That's 30% EBITDA margin. However, from an EPS standpoint, that's offset by higher interest expense, at least in the first year, that will mute our EPS growth going into next year. So those are a couple of the puts and takes from a margin.

Gregory Giametti, Head of Investor Relations

And super helpful. And just to clarify, because I have gotten this question, and I know it's something we've talked about, the interest expense and income is embedded in the fourth quarter guidance associated with the debt offering that you guys did in conjunction with this. But Cornell Roper is not in the fourth quarter, guys, in terms of revenue. It doesn't matter, really, from an earnings perspective. And then that will be part of what you referenced as far as a stepping point into next year, right?

Andrea van der Berg, CFO

Agreed, because we were focused on our net interest expense. So until we closed the deal, we were benefiting from the interest income that we would get by doing the bond issuance earlier. There was a modest negative carry, but once we acquired Cornell and used those proceeds, it's EPS neutral. At least until the end of the first year, but we'll have the benefit of revenue that was in the Q4 guide.

Gregory Giametti, Head of Investor Relations

And then on the WSS side of things, how should we think about the moving pieces there? The dewatering side seems pretty healthy. The orders for the WSS side and the more legacy of VOCA side seem pretty healthy, but you're also seeing some project timing variability, which somebody covered VOCA for a long time before you all acquired them. That was always part of the quarter-to-quarter movement here.

Andrea van der Berg, CFO

Yeah.

Gregory Giametti, Head of Investor Relations

So maybe talk to those moving pieces and how should we think about that going into next year?

Andrea van der Berg, CFO

Yeah, so stepping back in Q3, We saw great momentum from a demand perspective with WSS. That's where a majority of our sequential backlog growth came from was in WSS. We had 6% orders growth. So we see strong momentum on capital projects, but those tend to be lumpier. It's about when those orders convert to revenue based on some of the projects, what's happening on the project site, for example, if there's other contractors that are readily available, or if that from the funnel to order conversion, whether they're We're ready to move to an order, or in that case, we could always do a mobile site. It just doesn't have the same chunkiness of revenue versus just a service portion until the customer decides to move forward with the larger capital project. So overall, we expect it to be in the mid-single-digit growth framework, likely on the lower end of that framework, as we're monitoring the lumpiness of some of these capital projects.

Gregory Giametti, Head of Investor Relations

You know, spring, summer is when you expect it to start normalizing a little bit. So one of the questions we just got was, Essentially, software meter demand driven by utilities focusing on these mission-critical applications. Maybe talk about why you think there's different commentary from some of the public peers, and what might be the difference between what you're seeing and what some of the others might be saying.

Matthew Pine, CEO

In terms of just overall metering business specific hypothesis. Got it. Yeah, I can't speak for others, but I would just say that... We get market share data. We look at the data. The market's down. The market's down in dollars. The market's down in units. We're holding an actually growing share in the market, specifically to water. And so I can't speak to commentary in the marketplace other than what we see and what we get from third-party reporting, which we report into. It could also be timing of projects. Projects can be lumpy. Maybe some peers have projects ahead of us or behind us, and so there could be some noise in just terms of project timing, but there's no doubt that the market's been challenged.

Andrea van der Berg, CFO

In Q3, our biggest impact was from electric metering being down as well. Water was modestly down. And then going forward, we're just trying to be pragmatic and transparent on how we see some of the softer water metering and electric metering impacting us going forward. And we will continue to provide transparency on the orders composition of our metering orders and backlog. So you can point to what would be the inflection to get us back to growth in MCS.

Gregory Giametti, Head of Investor Relations

Yeah. And then another one here, just how does the technology, including AI, impact services and sales on the evoco side of the WSS business? Does this help you competitively drive more efficiencies or does this make it maybe a little more level for competitors?

Matthew Pine, CEO

What was the first part that you said, AI?

Gregory Giametti, Head of Investor Relations

How does technology, including AI and other things you're rolling out, impact the services and sales of the Evoqua business?

Andrea van der Berg, CFO

So it's kind of like the Water One.

Gregory Giametti, Head of Investor Relations

Yeah.

Matthew Pine, CEO

Yeah, I think we're leveraging our view platform with WaterOne to help us. It's more about our internal efficiency and servicing those assets in a more efficient way. Sending technicians when we need to send technicians versus just having technicians on site. So I don't know if that's so much AI driven and it is more disconnected assets and being able to use that data to be efficient with our assets. That's definitely something that we've leveraged with Evoco coming in, our VIEW platform that we put together three years ago. And so, again, it's helping us really drive productivity more than anything.

Gregory Giametti, Head of Investor Relations

Got it. So maybe the Cornell Roper deal, maybe talk to why that was the right fit from a portfolio perspective and what it brings to the table organizationally that you didn't have before.

Matthew Pine, CEO

Yeah, I mean, it was a really good deal. First of all, it's a great asset. It, you know, grows at high single digits or high mid single digit business. It's got really, you know, 30% EBITDA plus margins. And so that's over a long period of time, they've been able to demonstrate that kind of growth and margin expansion. So it fits well, you know, as we as we move the portfolio to line up around flow, treatment, and measurement analytics, it really fits nicely. Obviously, there's a lot of synergy between the flight pump and the Cornell Roper pumps, especially at Cornell. Which is the largest piece of the asset, where we can take technology and bring flight technology in, and then actually Cornell technology into flight. And so it's going to help us be more, you know, I think more effective in our sales value proposition. There's also lots of opportunity kind of on the insourcing side to a lot of the castings today in Cornell are outsourced. We make all of our castings in-house today in the flight business. There's an opportunity for Applied Water, Remain Co., kind of North America as well, where we can do more insourcing, leverage our economies of scale, and so that makes a lot of sense. Strategically, it gets us more aligned to industrial water applications, especially mining, and also enables us to expand our municipal presence and some very niche applications that we just can't get to with our flight pumps.

Gregory Giametti, Head of Investor Relations

Makes sense. A backlog question here. I had a few investors ask this. So if you look at the shippable backlog going in this year, I think the Q said it was like 20%. Last year it was 30%. Maybe talk to what this means for the fourth quarter, confidence in your fourth quarter numbers, sort of change in composition of expecting more book and shift versus project activity. Any thoughts on that side would be appreciated.

Andrea van der Berg, CFO

Yeah, I'd say, I mean, that's intended to be a pretty high level metric in terms of how much of the backlog is really going to ship near term. You know, if you think about the, you know, large WSS contract we had early in the year, driving up, you know, backlog meaningfully in a long, you know, long term period, you know, it kind of flips us on the round a bit, because we kind of rounded to 20 or 30%. And so it's really just intended to be kind of a high level metric. When you think about specifically applying that as a backlog coverage metric, it, you know, It could skew a bit. If we think about what we have from a fourth quarter perspective, the backlog is pretty in line with historical periods in terms of a backlog coverage.

Gregory Giametti, Head of Investor Relations

So don't over-index the backlog levels in this commentary about what that means for the fourth quarter.

Andrea van der Berg, CFO

Yeah, I'd say we're pretty in line from where we see the fourth quarter projection to what we've had from a backlog coverage over the last several years.

Andrea van der Berg, CFO

It's a strongly rounded number.

Gregory Giametti, Head of Investor Relations

It's a strongly rounded number. I like that. So maybe just tie together 27 all SQL. It feels like you're talking to a low single digit type growth outlook all SQL with some modest margin expansion and then puts and takes between the interest expense Cornell Roper all SQL. And anything else we should be thinking about as far as the moving pieces for next year? Or correct me if I'm not characterizing those pieces correctly.

Andrea van der Berg, CFO

No, that's correct. I think you're framing it really well. I think going forward, we've highlighted we had strong orders growth in Q3. Q4, MCS is having challenge. They will have a difficult compare from an orders perspective, but we're confident about our position and our value proposition of AMI. And then going into 2028, we're strongly positioned with the planned divestitures that are below our framework. So that will support us as we rotate to stronger growth and stronger profitability, especially with the addition of Cornell as well.

Gregory Giametti, Head of Investor Relations

Yeah, because, you know, while there might be some nuances in the shorter term here, it doesn't feel like your thought process for growth as we move into next year has really changed. And so not next year, the following year into 28 and longer term. That growth profile from your perspective really hasn't changed. If anything, it's getting better because of what the moves you're making are from a portfolio perspective.

Andrea van der Berg, CFO

Yeah, we're positioning the portfolio stronger for profitable growth. That will be ahead, position stronger than our previous framework by taking out that 9% of revenue that was growing below our framework, as well as continuing to see strength on MCS orders. It's just that it's being deferred longer, and we wouldn't necessarily see the benefit of that until 2028. And again, we've had 80-20, and our operating discipline has been embedded in our operating model, which will continue to benefit us going longer term.

Gregory Giametti, Head of Investor Relations

Thank you. Maybe talk about the push-pull in the short term between buybacks and how aggressive you want to be, and then what the strategic opportunity is on the M&A side from a funnel as well as actionability perspective.

Matthew Pine, CEO

Yeah, I think we've done a good job of, like I was talking earlier about, you know, divestitures, acquisitions. We bought back $1.5 billion worth of shares this year so far, and so we'll continue that balance. We definitely want to remain flexible in terms of being able to deploy capital towards M&A, so we'll balance that throughout the year next year. So we'll look at both. If things aren't actionable or things aren't affordable, we'll continue to buy back shares. And if we can, you know, our goal is to bring in a billion dollars or deploy a billion dollars towards M&A, we'll do it. If it's not actionable and it doesn't create value, then we'll do share buyback. So we've got good optionality, especially given where the stock is today.

Gregory Giametti, Head of Investor Relations

Do you think that? The pipeline is particularly actionable right now?

Matthew Pine, CEO

Yeah. I mean, I would say the pipeline is healthy. Variable actionability, though? I would say that there's decent actionability to get to the billion dollars of capital deployment.

Gregory Giametti, Head of Investor Relations

And then maybe where we are in that 80-20 journey, right now we're in essentially a pivot to growth part of that. What is that growth headwind, all else equal into next year? And then maybe provide some examples of where you can say, these are the examples for what we are doing that is going to drive better growth and where you're focused on all else equal to help that growth profile.

Matthew Pine, CEO

Yeah. So, I mean, the headwind next year we've talked about on the earnings calls between 50 and 100 basis points. Largely, that's going to show up in our treatment business because it's a bit more long cycle and takes some time to kind of work through and then a little bit in MNCS. In terms of our focus, I mean, obviously, 80-20 sets you up for growth. It's just not about driving leverage and driving margin expansion. Yes, that happens first, but it's about simplifying the company so we can focus on our eight customers. You know, if you pull out MNCS, which is obviously a dislocation this year in the market, we're growing our eight customers at 2x the rate of the rest of our customers. So that's, you know, I think that's a positive proof point. One of the areas, a couple of areas we're focused on is enterprise selling. We didn't really have an enterprise account. 80% of our customers buy from one segment, 20% buy from multiple, and maybe they don't know, but there are a subset of customers. For us, right now, it's about 60 customers, probably will scale up to around 80, that need to be treated as enterprise. We're really starting to grow that very quickly. We built that enterprise solutions team, and I think that's got a lot of momentum going into next year. The second area I would talk about is innovation. I think getting our structure even further dialed in, you know, making sure we're making investments in innovation so we can keep our formidable positions in each one of our segments. We have market-leading and channel-leading partners in every one of our businesses. And so making sure that we're investing in those products to continue to have the leadership role and the leadership position that we have is obviously a huge focus as well.

Gregory Giametti, Head of Investor Relations

Because if I think about the 80-20 journey for you, it's not like the innovation ever really changed, right? You were still putting a lot of capital dollars forward. But what changed, I suppose, is just the focus around where the capital dollars were being deployed.

Matthew Pine, CEO

That's right. So you're killing the long tail of things that are sometimes science projects and maybe not as value creative and really getting focused on the critical few and moving faster and kind of getting speed for innovation.

Gregory Giametti, Head of Investor Relations

And then last one here, maybe just talk a little bit about the applied growth opportunity on the data center and the industrial pump side.

Matthew Pine, CEO

Yeah, I mean, that's been a bright spot. Probably last year, you know, starting to build momentum. This year, obviously, the last two quarters up 200% on data center orders within the applied water business that make pumps for chilled water systems, chillers, and CDUs. And so we've seen a big lift in that business, continued momentum. We are in the process of exiting this year by doubling our capacity for heat exchangers and pumps. And not getting too far ahead of the orders, but making sure we can keep up with the orders that we've seen. And that's going to be a really nice tailwind as we exit this year into 27.

Gregory Giametti, Head of Investor Relations

Great.

Matthew Pine, CEO

Well, please join me in thanking the Xylem team for their time today.

Gregory Giametti, Head of Investor Relations

Thank you.