Q2 2021 Xylem Inc Earnings Call
Welcome to the Xylem second quarter 2021 earnings conference call. At this time, all participants have been placed on listen only mode.
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I would now like to turn the conference over to Matt Latino Vice President of Investor Relations.
Thank you good morning, everyone and welcome to the Xylem second quarter earnings Conference call with me today are Chief Executive Officer, Patrick Decker, and Chief Financial Officer Sandy Rowland.
They will provide the perspective on xylem second quarter results and our outlook.
Following our prepared remarks, we will address the questions related to the information covered on the call I'll ask that you. Please keep to 1 question and a follow up and then return to the queue.
As a reminder of this call and our webcast are accompanied by a slide presentation available in the investors section of our website at Www Dot xylem Dot com.
A replay of today's call will be available until midnight on September 1st please.
Please note. The replay number is 805.858367 and the confirmation code is 870.74036 <unk>.
Additionally, the call will be available for playback via the investors section of our website under the heading investor of Us.
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 of.
All references will be on an organic or adjusted basis, unless otherwise indicated.
These statements are subject to future risks and uncertainties such as those factors described in bounds. Most recent annual report on form 10-K, and the subsequent reports filed with the SEC, including in our form 10-Q to report results for the period ending June 30th 2021.
Please note that the company undertakes no obligation to update forward looking statements publicly to reflect subsequent events or circumstances and actual events or results could differ materially from those anticipated.
In the appendix. We have also provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics for.
For purposes of today's call all references will be on an organic and adjusted basis unless otherwise indicated non.
Non-GAAP financials have been reconciled for you and are in the appendix of the presentation.
Now please turn to slide 3 and I'll turn the call over to our CEO Patrick Decker.
Yes.
Good morning, everyone and thank you for joining us the.
Call of starting a bit later in the morning unusual this quarter. So by now you will have seen the second quarter performance exceeded our expectations on all major metrics Inc.
Putting orders revenue margin and earnings per share.
I'm very proud of the operator, beating the healthy pace, we set in the first quarter and you're delivering a very strong first half of the year.
Underlying demand for our solutions with robust across all segments and in more of everybody. Please standby 1 moment did a great job converting that into better than expected performance and continuing to expand margin.
They delivered even more exceptional results on orders, which grew 29% on low ranging underlying demand across all regions.
In addition backlog is up 35% versus this point last year.
That broad expansion reflects commercial momentum that puts us in a strong position, both now and into the future as we continue to invest in sustainable growth.
At the end of the first quarter, we raised full year guidance on revenue and earnings.
The second quarters performance shows the continuing strong trajectory into the second half.
And we're reflecting that by further raising full year revenue guidance.
The top line benefits are likely to be moderated somewhat by inflation and a challenging supply chain environment.
But we've been proactive on price and are working with our supply chain partners to mitigate the impact of those headwinds.
So we are also raising the midpoint on earnings per share guidance for the full year.
In a moment I'll provide some additional color on what we're seeing globally.
But first let me hand, it over to sandy to provide more detail on our performance in the quarter.
Thank you Patrick the second quarter offered of strong story of continuing demand recovery as the revenue grew 11% organically compared to the prior year.
Also saw momentum across most end markets on a quarter of sequential basis.
Our largest end market was up 6% compared to the prior year driven by clean water applications and continued wastewater each all of the Opex demands.
Industrial was up 17% on broad based strength as economies reopen and activity continued to line.
Commercial grew 12% and also improve sequentially led by strength in the U S and western Europe, well of residential our smallest end market grew 29%.
Geographically Western Europe, and China were both up mid teens with increasing demand across all end markets.
And he also returned to growth with the site access restrictions even during the corner.
As Patrick mentioned the team delivered exceptional organic orders growth of 29% and strong underlying demand across all segments and regions with particular pace and N C. S, which grew order 70% of March water metrology contacts.
This is our fourth consecutive quarter of sequential order improvement and the reflects higher orders growth than in the same period 2019.
Importantly, we ended the quarter with overall backlog up 35 per cent.
That's what the key financial metrics margins were above our forecasted range, but the EBITDA margin coming in at $17.30 per cent.
The 200 basis points of the year over year EBITDA margin expansion came largely from productivity.
And favorable mix, partially offset by inflation and investments.
Earnings per share in the quarter was 66 cents, which is up 65 per phone.
Please turn to slide 5 and I'll review, our segment performance for the quarter.
1 of the infrastructure delivered strong results during the quarter.
1 is were flat, but up 22%, excluding the large prior year deal and talented Telangana India.
The intake was robust and treatment globally.
Revenues were up 6% organically.
We used 1 of utilities remained resilient and we are now seeing recovery in the industrial end market.
Geographically emerging markets delivered mid teens growth from industrial recovery driven in part by increasing mining demand in Latin America, and Africa, while Western Europe delivered double digit growth from continued strong each of the opex activity.
In the U S health of utilities, the Opex demand reflected in strong orders growth was offset by the lapping of prior year of treatment project deliveries.
EBITDA margin was in line with the prior year of strong productivity savings and volume effects offset inflation and investments.
Now please turn to slide 6.
The applied water segment had a very strong quarter, driven by continuing market because of rate across all regions and end markets orders were up 40%, 43% organically in the quarter with particular strength in the U S and Western Europe.
Revenue grew 18% in the quarter with double digit industrial demand driven by reopening of activity and especially in marine and food and beverage applications.
Residential growth continues to be robust and strong market demand.
Geographically the U S was up double digits, while yet western Europe contributed 27% growth on increasing industrial demand.
Emerging markets were up 24% due in part to broad industrial recovery and momentum in China.
Segment, EBITDA margin grew 200 basis points compared to the prior year. The expansion came from strong volume leverage and productivity more than offsetting material and freight inflation.
Now please turn to slide 7 and I'll cover our measurement and control solutions.
And then yeah delivered a strong quarter as large project deployments began to ramp.
Also realized gains in our industrial water quality testing business.
Orders for the segment were up 17% organically on strong demand.
Our backlog now stands at $1.5 billion, which is an historic high and almost 50% higher than at this time last year.
We have secured more than $400 million and Mark Patrick and the last 18 months that reflect the number of major projects, which increasingly equally a broader digital solutions in combination with the core metrology applications.
Revenue was up 11% led by 17% growth in water applications, driven by large project appointments and double digit growth in water quality applications.
And as the energy applications were down modestly due to project timing and supply chain constraints.
And packing of the results by geography emerging markets in Western Europe were up 20, and 25% respectively. The.
The U S was up mid single digits on the strong demand for quality water quality applications and assessment services.
As a reminder for this segment in particular growth rates can be uneven due to the impact of project timing.
Segment EBITDA margin in the quarter was up 460 basis points compared to the prior year.
Productivity savings from prior year restructuring actions favorable mix and volume leverage more than offset inflation of investment.
Now, let's turn to slide 8 for an overview of the cash flows and the company's financial position.
Our balance sheet continues to be very strong we closed the quarter with $1.8 billion in cash and cash equivalents.
In the third quarter 600 million of senior notes will mature to be paid with cash.
Free cash flow conversion was 172 per cent in the quarter in line with our expectations and historical seasonality patterns.
Net debt to EBITDA leverage was 1.3 times at the end of the quarter. Please.
Please turn to slide 9 and I'll turn the call back over to Patrick.
Thanks, Andy.
Want to touch on 3 areas briefly.
Our operating discipline, our growth platforms and sustainability.
On operating discipline. The team did an excellent job on margins in the quarter, delivering 200 basis points of EBITDA margin expansion year on year. In addition to quarter sequential improvement.
We do anticipate some inflation and component supply challenges in the second half, but we're confident in our ability to manage through them and to mitigate their impact.
Earlier I noted are extremely healthy backlogs.
As we work through these volumes the team is doing a great job, making sure we manage the pressure on working capital this can create.
In fact, despite serving spiking demand, we've improved working capital both year over year and quarter sequentially.
Sandy just mentioned that performance puts us firmly on track to deliver our commitment on attractive free cash flow conversion.
We clearly have significant capacity for capital deployment.
On top of strong organic growth investment options, we have an attractive and active pipeline of M&A opportunities.
Our growth platforms are an area will be delving into at our Investor day in September.
So I'm going to refrain from too much detail here today.
I do want to draw attention to 2 things however.
Last quarter, we highlighted the pace of growth in emerging markets.
This quarter that papers continued despite india's hard deceleration through the quarter due to COVID-19 impact there.
I'm very proud of the entire xylem team's discipline and compassionate response in all countries affected by Covid.
In terms of our own operations and also how we've leaned in to support customers and help serve our communities.
I also want to take a moment to draw of connecting the line between our portfolio and some of the dramatic water centric of events, we've been seeing recently around the world.
By which I mean, the flooding in Europe, China, and Central Asia, and the drought and the American West.
These events reflect the trend as the effects of climate change become more and more apparent.
And that trend requires an affordable response to keep the humidity safe resilient and water secure.
So we continue to invest in specific technologies in our portfolio that respond to these challenges.
As an example, automated wastewater network optimization is amongst our most advanced digital solutions.
Its job is to manage overflows and prevent flooding.
And our customer deployments are already preventing 1.4 billion cubic meters of water from flooding communities.
Similarly, we also continue to innovate in the technologies that make communities more resilient to drought.
Technologies like leak detection, smart metering, and especially water reuse.
Already 1 trillion gallons of water are being recycled using xylem technologies.
Which brings me to the topic of sustainability more broadly.
The numbers I just quoted come from our annual sustainability report, which we published in June.
And I think they bear out what we've said for some time.
Our sustainability strategy is fundamental to our business strategy.
We were pleased to report for example that almost half of our major facilities are now operating on 100% renewable energy.
Helping reduce our greenhouse gas emissions intensity by more than 7% year over year.
Beyond our own footprint, our solutions have enabled our customers to reduce their carbon emissions by 700000 metric tons last year.
The report details progress on all of our signature sustainability goals and shows how sustainability is deeply embedded in who we are as a company.
Now with that I'll hand, it back over to Sandy to provide commentary on our end markets and guidance for the remainder of the year.
Thanks, Patrick our full year of outlet for our end markets remains largely consistent with our view from last quarter with some positive evolution as a few end markets are showing even faster recovery.
And the utility demand continues to be strong at the wastewater and clean water affirming our anticipate anticipated growth of mid to high single digits.
On the wastewater side, we have seen steady demand in western Europe, and North America as operators continue to focus on mission critical applications. While also investing in larger scale upgrades on affordable funding from capital markets.
Bid activity and long term capital spending outlook in the emerging markets remained solid, though some COVID-19 concerns linger in certain markets.
On the clean water side demand for smart water solutions and digital offerings continues to be robust as utilities increasingly turned their focus to more resilient infrastructure and affordable water delivery.
Consistent with other technology companies the connected nature of our solutions raises some risk in the second half given prolonged supply chain constraints for electronic components are.
Our teams are working closely with our suppliers and manufacturing partners to optimize deliveries.
Please turn to slide 11.
Looking at the industrial end market, where we had expected mid single digit growth for the year. We are now anticipated growing in the high single digits.
The growth was broad based with the rebounding industrial activity across all segments and regions.
We're seeing upticks in demand, particularly in our industrial dewatering business in emerging markets.
We're also seeing higher demand in marine and food and beverage driven by recovery in outdoor recreation and the hospitality sector.
We are increasing our outlook in the commercial end market as well the U S.
The replacement business is growing at a brisk pace.
New commercial building is expected to lag the recovery somewhat but key leading indicators reflect optimism for late 2021 recovery in the institutional sector.
But the growth in Western Europe, and China sustained through the second half along with modest share gains and supply chain resiliency, we now.
I expect the commercial end markets the up mid to high single digits up from the low single digits previously.
In the residential we now anticipate low teens growth for the full year up modestly from our previous expectations of high single digit to low double digit growth.
We do expect growth will moderate through the second half due largely to a more difficult year over year of comparison.
And now, let's turn to slide 12, and I'll walk you through our updated guidance.
As you can see we are further raising our previous annual guidance for xylem overall, we now see full year organic revenue growth in the range of 6% to 8% up from our previous guidance range of 5% to 7%.
This confidence is based on clear demand recovery combined with the pricing actions, we are taking to offset inflation.
This revenue guidance breaks down by segment as follows for water infrastructure, we expect mid single digit growth from our previous expectation of mid to high single digits.
We expect low.
Low double digit growth in applied water up from mid to high single digits and in measurement and control solutions, we expect mid single digit growth.
I also expect EBITDA margin in the range of 17, 2 to $17.7 per cent.
This guidance represents full year margin expansion of 120 basis points at the midpoint.
That's grounded in the strong first half performance with 300 basis points of expansion from restructuring savings on actions. We took late last year as well as volume leverage from the top line growth.
The third quarter was more challenging primarily driven by the timing of inflation and price realization.
However, price realization will increase into the fourth quarter as we work through the large backlog built over the last several quarters.
Overall, we expect strong second half margins compared to the first half of the year.
This yields an adjusted EPS guidance range of $2.55 to $2.70.
The increased confidence in our ability to lift the bottom end of the range, while still managing through inflation and supply chain challenges.
That range now reflects the 28% increase in EPS guidance at the midpoint over last year.
We continue to expect full year 2021 free cash flow conversion of 80% to 90% as previously guided putting our 3 year average right around 130 per cent.
We have provided you with a number of other full year assumptions to supplement your models.
The assumptions are largely unchanged from our original guidance.
However, 1 item worth noting is our updated assumption on foreign exchange for the second half of the year.
As of the recent dip in the euro and the disproportionate effect. It has on our results we've updated our euro to dollar conversion rate assumption for the second half from 1 point to 2 to 1.18.
This change along with some other currency movements has the <unk> negative impact on our second half outlook.
As you know foreign exchange can be volatile sort of included our typical foreign exchange sensitivity table in the appendix.
Also we are making an adjustment to of restructuring and realignment guidance from $50 million to $60 million to now $30 million to $40 million, while still expecting to realize similar restructuring savings due to high natural attrition and the timing of actions.
And now before wrapping up let me share some thoughts on our third quarter outlook.
Anticipate total company organic revenues will grow in the range of 5% to 7%. This includes mid single digit growth in water infrastructure high single digit growth in applied water and low single digit growth in the Mcs we.
The third quarter adjusted EBITDA margin to be in the range of $16.7 to 17, 2% largely in line with our strong second quarter.
While inflation in component supplier of likely to present some headwinds in the third quarter, we are addressing them with the pricing and supply chain actions previously mentioned.
And with that please turn to slide 13, and I'll turn the call back over to Patrick for some closing comments.
Thanks, Andy.
The teams have been doing an outstanding job capturing market demand, giving us exception of orders and backlog growth.
We expect to continue capitalizing on the underlying demand.
And the team will manage through the near term supply chain environment with the same spirit and discipline they've demonstrated through the many external challenges of the past year.
Looking forward trends toward new investment in infrastructure and particularly in the modernization of infrastructure are accelerating hand in hand with demand to make community is more resilient to climate change and the do it in a more affordable way.
Those trends only reinforced the strength of our investment thesis.
That our differentiated portfolio of leading technologies addressing scarcity resilience and affordability will drive increased revenue growth and margins and sustainable growth with strong cash flow generation and increase the opportunity for capital deployment.
This puts us in a privileged position to create both economic and social value for our stakeholders now and over the medium and long term.
We are genuinely excited about providing an update on our strategy and long term plans at our upcoming Investor day, which is scheduled for September 30th.
It'll be the first opportunity for many of you to meet all of our business leaders and our entire senior leadership team, especially those who've joined us over the past year.
So it's a great chance to provide a full of strategic update including our long term financial targets and a deep dive into our vision of how digital solutions are transforming outcomes for our customers, including discussions with the few of those customers who have deployed some of our most advanced technologies.
Matt and the team will follow up with invitations and logistical details in the coming days.
Now, let's turn the call over to you and are happy to take any questions. You may have the opposite.
If you would like to ask a question. Please press star 1 on your telephone keypad again, the star 1 to ask an audio question.
Your first question comes from the line of Michael Halloran with Baird.
Hey, good morning, everyone.
Hey, Mike Hey, Inc.
I'm all good. Thank you. So 2 questions on Mcs here first maybe just a little deeper dive on how you see that backlog conversion playing out obviously, a really nice sequential moving orders really good commentary from an underlying perspective on what the underlying cadence demand et cetera looks like.
But you also have the supply chain challenges and shortages things like that.
How do you see that playing out right now in terms of site access in terms of availability in terms of when that next ramp of rollout really can start accelerating again.
Yes, sure Thanks, Mike Great question.
The backlog growth in MMC, specifically it was about 49%.
And this past quarter, so a really good uptick.
Really encouraged by a number of not just the large deal wins that the team has achieved there but also of the base business.
The day to day business grew quite nicely in the quarter and we seek amendment good momentum there.
We feel that the site access issues have certainly eased.
Say, they're completely resolved, but there is certainly trending in the right direction.
We're really seeing and really be the primary challenge out there right now, which the team is all over I'm working hard to mitigate that is some of the component shortages and that's not limited to us that really is not just across our sector of as you all well know broader broader sectors as well.
The team is all over we're doing everything we can whether it be kind of paying up for some components, making sure we lock in.
It's around that so.
We're very we feel very good about the momentum it really does feel like.
That part of our business is turning the corner in terms of converting things into backlog.
We look at the margin.
Backlog, especially as we go into 2022.
And feel very good about that not just what they've achieved already this year again challenging the side in the second half around component shortages of nodes are real theyre not theyre not insignificant, but we're confident we can work through that.
And it's shaping up very nice for up for 'twenty, 2 and beyond.
So some of you touched it a little bit on it in the answer but just to dig a little deeper could you just talk about the mix of the backlog, how that's tracking versus some of the more digitally oriented the newer solutions or putting in the marketplace.
Broader approach there versus more traditional and also thoughts on how you think the backlog margin is tracking out as well and comfort level given all of the moving pieces share.
Yeah, and I think I think on the Martin Let me take the second 1 first the.
The margin on the backlog, we're confident about as we go into 'twenty 2 and beyond again, we've got this near term challenge, where we can do in Q3 and Q4 on on component shortages et cetera, but again.
We're holding our own there.
As it relates to the.
The mix.
Continue to see a real adoption of even.
Even in these large metrology deals.
Of that we're doing there is an ever growing increase component of that that is digital.
And so we're very encouraged by that and we continue to see.
Really impressive wins on the branding that we called Xylem view, which is the purely digital kind of data driven diagnostic capabilities and so we're very encouraged in that area as well, but there is definitely a shifting mix towards.
The digital component.
Great. Thank you for the time line.
Mike.
We will share on that at our upcoming Investor day, the kind of unpack in a bundle of after you all.
It makes a lot of sense I appreciate it.
Thank you.
Your next question comes from the line of Deane Dray with RBC capital markets.
Thank you and good morning, everyone.
Good morning day, and how you doing good morning, how are you doing real well. Thanks, I'm just like the pick up where we left off there on the supply chain and it looks like you are managing through this based upon your margin success.
We were expecting you to get some price increases in the second quarter, how did that play out and then what's the expectation for second half on a price cost for the total company.
Yeah. Thanks, Thanks for the question being you know I think that well.
We're very happy with how we've managed to the inflation dynamics through the first half of the year.
And we were able to realize some incremental price in Q2.
We do expect that that will continue to ramp throughout the year just as a reminder, we're now up on our third price increase for the year, we got out of the gate early with a price increase in the first quarter.
Because of the.
Continuous rise in the commodity prices. We've then taken the decision to take care of additional price increases.
No I think there is 1 unique dynamic that we're working through the backlogs are a little higher than we typically find in any given in any given period of time and so.
The realizations theres, a little bit of a timing issue.
Net net I think.
We're doing a good a good job here and it will continue to ramp, particularly in the fourth quarter. Yes, obviously the offer that so yeah as Sandy said the most challenging timeframe. We can say for now is really in Q3.
Because we didn't have the speed bump in backlog and so that's we're shipping that out there is price realization in there, but as you know commodities, especially have moved so quickly that.
We've gone out now will go out again with further price increases, but would we as we look at the exit.
Actually in Q4.
That really all comes back into complete equilibrium.
And we are net positive at that point once again.
Great just a quick clarification of Patrick I don't know if you were anticipating what was going to ask this question until you gave the partial answer earlier is in the orders, especially M. C. N S. The digital component can you put a number or just broadly.
Have to be that precise but how much of these orders have a digital component and and you can include census.
They're smart.
Peter share part of that as well, yes, absolutely and I think dean.
I'll give you an answer of Indiana.
This is absolutely what we want to delve in a bit more at Investor day, we really kind of want to lay out that base line in that framework as to how we think of about digital and what that kind of trend line is in 1 of our metrics and incentives tied to that are so much more to come at Investor day, but just to put it in perspective I mean, we've had.
In the last 18 months, we've had $400 million roughly and large deal wins.
And that has had a significant digital component to it.
And so that just gives you 1 sense of kind of a proof point.
And then.
There are a number of again really interesting.
And deals that we've won within what we call. The xylem view, which is again purely the diagnostic kind of consultative side of the business that we will be highlighting at investor day. So.
What kind of more of that.
On September 30 of them, but hopefully that gives you a bit of a flavor of that theres, a real meaningful adoption here on the digital side that we want to give the appropriate color too we're very very excited about it.
Of course, I'm happy to to wait until then for those specifics and just last 1 for me on water infrastructure, just tempering the guidance on the top line going to the mid single digit just what are the key headwinds.
And how would you calibrate those.
Yeah, you know I think it's a modest shift I think if we take the water infrastructure guide up in the first.
At the end of the first quarter, we initially guided to about a 4% increase we.
We took that up I think we're very close of the same in the same spot. It's largely largely unchanged. Yes. I think there is some timing of theres. Some timing of project deliveries and shipments we had some pretty impressive comps versus last year.
I wouldn't I wouldn't read anything into that I mean, we're trying to be we're trying to be prudent just in terms of the guide for the second half of it there is nothing nothing happening from a market standpoint that is changing our view on that segment.
We're very confident it continued to be very much in the healthy mid single digit kind of growth rate as.
As we've expected and there.
But it also cuts across geographies Dean.
We're not we're not seeing any kind of slowdown of our shift in spending in the U S. Because of infrastructure discussion or any of that is just again I'm trying to be prudent.
That's real helpful. Thank you thank.
Thank you it makes sense.
Your next question comes from the line of Ryan Connors with Boenning and Scattergood.
Great. Thanks for taking my questions.
I wanted to not to beat the dead horse on the supply chain issues, but just wanted to drill down there.
Some of the sort of peer companies have talked about sort of foregone revenue because it's so tough to get some components of things, but it sounds like you're not really saying, though you mentioned Patrick paying up for components and it sounds like in your case, it's more of a.
Are you willing to take it on the margin.
If you have too.
To get the business and be able to ship the business and it hasn't really been a revenue headwind of leaving business on the table either in the past or in the second half is that a fair characterization of 1 of them.
1 of them here.
No that's fair Ryan again.
I'd be remiss, if I didn't get it.
A huge shout out to the team that's working through this because it is challenging I mean, it's not insignificant.
<unk>, they're trying to overcome at this point in time, but just to put some kind of parameters.
Parameters around this and we estimate right now we'd probably move.
The at least $20 million of revenue.
All of the second half of the year into 'twenty 2.
Obviously theres never any guarantee of the obviously that comes with healthy margins.
And so if it werent for that we'd probably be talking about it a further adjustment to our guide, but that's the reality that we are working through at this point in time and it's not without risk. So our teams are working their backsides off in that regard, but we don't feel that we are losing revenue from a competitive standpoint, because we're all facing the same challenges.
And this is a pretty sticky business, it's hard to swap out.
Supplier so.
That's the right characterization of Orion hopefully that a little bit of extra color for me was helpful.
Yes, It certainly wasn't and then as a follow on to that.
You at the corporate level as well as all your sales people that you've given.
Given us all access to with the trade events and things I always talk about pricing for value as opposed to pricing for commodity. So so how do you. How do you handle this weird environment, where you suddenly having the price for commodities I mean do you build in the escalators of certain things go down in the future I mean, it just seems like a very different discussion than you'd normally like to have.
And sort of.
Pricing for value yes.
No Youre absolutely right Ryan I mean, the teams are continuing to range remain primarily focused on pricing for value and.
Matt again really tying back to again what are the 1 of the customer outcomes that we're looking to achieve here in terms of helping them achieve their goals and so we are getting better.
Think of pricing for value I would say in these kinds of interesting environments.
We.
We're not really doing surcharges, so it's not like we're putting it out there, whereas we entered the dial it back.
The later.
So we're trying to be disciplined in that regard.
At the same time, we also dealt with this it wasn't that long ago, we were talking about the tariffs and all of the other interesting pricing challenges that we had to overcome so again I don't want to minimize the incredible hard work. The teams are doing to deal with this pricing environment.
I'm very pleased and very proud of what they've accomplished thus far.
Okay. Good and then I did have 1.1 last 1 I didn't hear of 2 question restriction, so hopefully I'm not going over here, but.
Right.
I'll hop back in later.
Hey, Ryan.
Okay.
The big very Big picture, but just obviously the stock sitting at an all time high you have got a great currency.
And we've seen this weird kind of valuation GAAP develop you know you've got a great story to tell around ESG, maybe others do not so there's the huge valuation GAAP has opened up I mean has there been any thought to how that influences. Your M&A strategy, where you use that currency to raise capital and kind of arbitrage that by some of these smaller companies who.
Don't seem to be have their ducks in a row in ESG and bring some of your best practices. There I mean is that.
Something that you've thought about.
Absolutely right.
It's a great point.
If I bring it back to center on.
On that theme around kind of capital deployment.
Again, the pipeline is very active.
We believe there are things that are actionable there of different shapes and sizes.
Absolutely.
We believe in using.
Our currency.
In the right way.
And the leverage that in the right way to go after really attractive strategic assets that are of good strategic fit.
Obviously, we still are going to be discipline around returns.
And it really is around growth, making sure it's accretive making sure of margins.
Accretive.
Acknowledging component.
Believe it's very important that there is a.
Services recurring revenue component that are very attractive so those fundamentals don't change.
But to your question around using stock of the currency.
It is something that we are very much open to in a disciplined way and I'd like to point you made.
I do believe that and again I'm very proud of what the entire team.
Team has done here on <unk>.
Making sure that sustainability for us and the broader ESG is not just some kind of standard 1 thing.
Deeply integrated into our business, it's what we do as the company.
And it's in our operating processes, we have incentives tied around it and I do think that that is an area of synergy as we look at other companies that we could bring into the portfolio. So I think very good pointed in your part Brian.
Great well, thanks, and thanks for letting me squeeze that went in.
Thank you.
Your next question comes from the line of Connor Lynagh with Morgan Stanley.
Yes, Thanks, I wanted to return to the orders, which obviously pretty much across all segments looked very impressive I'm curious and I. Appreciate this is probably difficult to quantify but im curious if youre seeing behavior from customers that would suggest that they are anticipating of supply chain bottlenecks of their own in other words are you seeing over ordering or do you.
I think this is just representative of very strong demand trends and a true underlying sense.
Yeah. Thanks. Thanks for the question I think first of all we are seeing great momentum on the orders front and so we do believe that demand is coming back in the very sustainable way.
I think if you break it down a little bit by our segments I think in water infrastructure in particular, we're probably seeing the most natural order flow and not really an acceleration of our deviation from historical timing of when.
When you shift over and look at AWS and M. A C S where I think we're up 43% in AWS in the quarter and 70% of M. A C S.
There is true of demand returning.
But we are seeing customers try to get in line a little bit.
Whether it's ahead of longer lead times that we've published some incremental pricing actions that we've announced.
More importantly, the supply chain components that we've talked about extensively on the call.
All of that in combination is certainly impacting some of the buying behaviors.
But I think the order momentum that we have is.
We're really excited about it and we think it positions us well not only for the second half of the year, but as we look forward into 'twenty 2 and beyond.
Yes, that's helpful color. Thank you.
Just on the guidance and water infrastructure is the is the loan area, where you seem to revise down the view of little bit of Mr.
If there is specific projects or specific regions that are driving that and I guess, how would you contrast that with the strong ordering activity that you've seen year to date.
Is it more of just the temporary supply chain issue or is there something more significant underlying that.
You know I think it is minor we track of tightened the range of little bit as we move into the second half, but we did have some U S treatment of orders that just got pushed out a little bit.
In the <unk>.
In Q2 that have gotten pushed out and some of that plays through the rest of the the rest of the guide, but I think fundamentally we're seeing good orders momentum treatment, we're seeing good orders momentum and keep watering and transport is continues to be strong. So there's nothing there from an order perspective that gives us any concern and I view it.
And we are tightening the range of little bit as we move into the second half.
Makes sense, thanks, I'll turn it back.
Your next question comes from the line of Nathan Jones with Stifel.
Good morning, everyone.
Hey, Good morning, Matt Inc.
I had a follow up question on the Mcs order rates of.
Obviously, you know all time record so fantastic stuff there.
I know you guys account for that a little bit differently your Dutch.
The entire audit for a 10 year project into the backlog.
When you received that you need to have payoffs in hand to actually book of it as an order. So can you talk about what's driving that is it.
The ramp up of projects that you had previously won or are the orders here for new projects that you're just waiting now.
So so I think you know great question, Nate I think you've got the flow well understood. The first step for us is to bring something into our backlog.
And we tend to see that a lot around large metrology.
Deployments and as we get closer to the rollout phase we start to see we all of orders that come in from our customers and I think we're seeing a pop in the order rate because some of the the large orders. The large awards that we brought into the backlog are starting to convert into orders now.
Some of the site access restrictions are easing and some of it also is what I just answered before if we are seeing that some of the customers are trying to get your line sooner to get in front of some of the component shortages.
But I think the.
Backlog is the leading indicator and the.
The water it means that it's starting to kind of we'll start to convert into revenue in a more short term basis and I would add natus.
Net is not so much.
Specifically in the reaction to your question on the order flow and so forth, but we we didn't call out earlier.
Really didn't want to give a shout out to our team within Mcs that manages our.
Analytics business some of they've been performing very well, it's really high margin.
And that business really hasnt been showing robust growth of strength, so that it doesn't move the numbers dramatically in the aggregate, but it is very rich in margin and I'm, just I'm very proud of what the team's doing there.
Great follow up question on the on the restructuring expense and the higher natural attrition.
Comment.
You say you were looking to take some of those heads out anyway, but can you talk about whether or not you are you worried at all about high natural attrition, if you're if you're losing talent.
For 1 reason or another and any steps you might need to take there to protect that talent base.
Yes.
Again, another great question I would say.
Labor shortage managing attrition.
It is a challenge.
Yes. It is.
It's something that I and management team of worry about a lot, but it's not our primary challenge I mean, I think our primary challenge right now is again.
Working through the component shortages in the supply chain challenges, which in some cases, you know is an indirect impact of the labor shortage.
Broadly speaking.
I would say 1 of the areas also that we are very focused on is free.
Retaining.
Critical areas like software engineers at the very competitive landscape at this point in time I mean, we are we are focused on it we feel that our not only our purpose and mission of the company is very compelling for attracting and retaining.
A wide variety of talent.
2 we are continuing to look at some flexible areas that we can just drive for the retention of.
Obviously, the pandemic has been hard.
Everyone around the world.
And there is some dislocation occurring right now and so we're being very thoughtful as to how we work through that.
Phil any of that incremental cost into our outlook, but thats something that we are going to continue.
The stay very closely because of the talent is just so so with central here in terms of what we're trying to accomplish.
Great. Thanks, very much for taking my questions. Thank you.
Your next question comes from the line of Scott Graham with Rosenblatt Securities.
Hey, good morning, Thanks for taking my question Hey, Scott.
Scott So couple of things.
If you said it I Didnt hear did you can you offer us some.
A single point number for what pricing once.
Yes.
Yeah, it's about 50 basis points in the in the quarter.
Okay, and then to that end it looks like the pricing of occurred in.
The applied.
Water and <unk> segments and.
It looks like water and infrastructure pricing was negative as that.
True.
In water infrastructure, it's about it's flattish.
And then we see the greatest price realization within AWS, and that's where we're seeing some of more of the the commodity increases hit.
The most rapidly and we did see a little bit of a little bit of pricing benefit in Mcf switches.
Into our contract terms with our with our customer I think what's the what's important to note is that we're going to see we do expect incremental pricing benefits as we move through the year and you can see that number rise.
Each of our each of our upcoming calls to the the other thing I would add Scott is just and I think the.
Sandy touch.
Touched on this in our in our response to it.
Oh.
Commodity inflation has not hit us equally we're consistently in each aspect of our business. It really of the different issue of mix and so obviously, our pricing is driven by our views on selling.
Selling value, but dealing with commodity inflation. So we just saw more of that earlier on given the shorter cycle nature of our applied water business and because of some of the component shortages and other things in EM and CFS I don't I am not.
The thing that was not an issue in water infrastructure our team.
We would not be happy hearing me say otherwise they've dealt with it also but it's just the timing of windows commodity inflation impacts that hit us.
But we feel good about the run rate within each of the segments here.
I have no doubt the price is going to get better idea of you guys have made that clear I'm just wanted to stay on water infrastructure for 1 more second then I have a quick follow up.
Then it would imply from.
The slide on.
Slide 5 of that mix was negative.
In the water infrastructure right.
Yes.
Yeah, that's right that's right.
So Scott we have we did see do watering return to growth, which was great to see it was more in the sale of pumps.
Our channel than it was about the rental side, which would have driven a higher incremental.
Margin for us with just how rich the rental side is.
So it was really just a little bit of of the mix of where we were seeing the returns, particularly in the industrial side you saw it in the emerging markets and you saw it in some of the areas, where we serve the mining sector.
It was a lot of pump sales as opposed to the rental but we have seen rental start start to come back here I think thats something that that could be.
Could could be something that we see in the second half of particularly in North America as the construction markets and other.
Other areas get going.
I think 1 thing that's important to recognize if you look at water infrastructure. If you look at it quarter sequentially. We did see an uptick in margins as we move from the first quarter to the second quarter, and we think that that they were well positioned on that front.
Okay and then my last question is the Sandy this is.
With you I think you said youre expecting strong margins in the second half.
But flattish based on the construct of your guide that you'd be happy with your second half margins, you're pulling them strong but think.
The guide implies of essentially flat right.
Yeah. So I think if you look first half second half, we expect higher margins in the in the second half of the year. If we look Q2 to Q3 of those 2 quarters actually are shaping up to look very similar they're about the same size. Some of our revenue perspective, and you know are our guide is very close to what we realized in Q3.
And then we do expect an uptick in margins in the in the fourth quarter.
But not as much year over year improvement in the second half and I think that's very consistent with our guide for the year, we expect it to come out of the gate strong from a margin expansion of perspective, and I think we've really.
It's about 300 basis points of margin expansion in the in the first half.
We look into the second half we don't have that same tailwind last year, we had restructuring and most of those savings came in the second half of the year and we realize that in the first half of the year.
I think we've also been very purposeful about how we phased our investments. So we were purposely phasing those in in the second half of the year and some of those investments.
We will start to ramp up a little bit in the in the second half and then of course, you know inflation of just higher than what we had initially incorporate it into our initial guide and I think those are all of the all the pieces I think the 1 thing I would add Scott is that I think the probably the most important thing is the read through is how we see margins in our backlog.
We are looking at very high backlogs here of the margin looks very very encouraging very sound, taking in consideration pricing the mix et cetera, So it sets up well for.
Even more for 'twenty, 2 and beyond and as Sandy said, we are making some investments here in the second half as you would expect us to do I mean, we always do but.
But we were purposeful on how we phase those into our to our outlook.
Patrick do you mean that the margins in the first of all of Sandy. Thank you for that clarity of that was great Patrick.
Patrick do you mean margins in the backlog are up versus the first half gross margin.
What I am saying is margins will continue to continue to be accretive coming through the backlog.
Got it thank you.
Thank you.
Your next question comes from the line of Andrew Pasquale of what's been Burke.
Good morning, guys.
Good morning.
Instead of last year, you guys were talking.
Things seem pretty positive around the movement in the emerging markets and things.
They sound like they're going okay, so far year to date, but I wonder.
Yeah, Matt you mentioned some site access.
The issues, it's broadly in some of their some of your peers are experiencing the similar thing so what about some of these countries that are maybe less vaccinated, you think put the pause and what Youre seeing do you think.
There might just be of lag there.
Before we start to see some of that.
Sure, Yes, so I mean youre absolutely right.
We are very global business and so we we monitor.
You know this whole issue of not just the most recent variant but the the.
Pandemic overall very closely.
And.
We've not seen any meaningful change in customer demand.
As a result of that.
Obviously, we continue to take all precautions to keep our own people safe to respect.
Our customers protocols.
And I'm very very proud of the work that the team has done from the very get go I mean first quarter of last year, we saw it first in China.
It's hard to believe now where you're going to have on.
But our teams are very disciplined around this.
We.
The the really I mean, despite the sharp deceleration in India.
In the quarter because of the Delta variant.
Sure.
We still saw very strong growth.
In emerging markets collectively China.
Most notably, but eastern Europe, and others are performing extremely well so we're keeping a close eye on.
But again really haven't seen any meaningful impact as of now on the Delta Darrin.
Yes interesting.
And then.
Just broadly it's been an act of your for M&A I'm, just wondering you know what.
What's the latest with you guys on that front of it definitely seems like you are in a strong position to.
To make the move if you'd like to so you know of any sort of update there would be great.
Yeah, So again.
The pipeline is very active and attractive pipeline and again, it's a combination of we I always bring it back to what are we solving for.
With M&A and so.
We look at it first by the end markets in terms of what we're trying to build out in our offerings for our customers and then I look at it we look at it from a technology and kind of application standpoint.
I'd say on the utility side we.
We will continue.
Certainly the second half of this year at all and where we will continue.
To look at and do you know.
Bolt ons and tuck ins from a technology standpoint of round out that utility offering.
And feel very encouraged by what we see in the in the pipeline there.
We've talked a lot through the past about industrial.
And certainly that continues to be something we are very interested in and we've got an active pipeline there.
We say it takes 2 to tango.
And so we can't control the timing of when these things happen, but we continue to cultivate those opportunities.
And then there are other verticals I mean in commercial and <unk> that we see.
Certainly keep on our radar screen of look at so we feel we feel good about the pipeline.
And you'll see some things there that will continue to do on the bolt on front and we will continue to cultivate some of the larger opportunities here.
Over time, we're going to continue to remain disciplined on valuation.
And as I mentioned earlier to 1 of the earlier questions. We certainly are open to using our stock of the currency.
Where it makes sense of that will not be.
It's an enabler.
When and if that makes sense to do.
Got it thank you.
Thanks, Andrew.
Ladies and gentlemen, we do ask that you. Please limit your question to 1.
Your next question comes from the line of Joe Giordano with Cowen.
Hey, guys. Good morning, Hey, Joe Good morning, Good morning, Jeff.
So now it's the 1 question huh Okay.
[laughter] alright.
Yeah, So just like with Delta and.
You touched on this earlier, but I.
Are you hearing just on the margin.
You said the orders are kind of getting released because of the site access the opening back up or what how you like doing the risk internally of that being walked back by your customers a little bit with like the vaccine restricted of requirements and having that issue in line.
Yes, no it's definitely something Joe I mean, my comment when I say, we're monitoring closely we'd rather thus far we've not seen meaningful impact.
Youre, absolutely right just to remind all of us.
We certainly are on top of it that we don't take this for granted.
And I think again.
We do build contingency plans into our our thinking here as the leadership team.
Unfortunately, we've had too much experience.
And dealing with this over the course of the last year and a half of the weather do well.
But we just all the things we haven't seen it yet at this point in time and obviously we are we are.
Being very vigilant we're encouraging.
Vaccinations within our own team, we are doing the face masking, we continue to maintain all necessary safety protocols within our own operations and again.
Very much respecting the wishes of our customers I would say that 1 of the things and you probably heard this elsewhere Joe is at least from of deal flow standpoint.
I think we've all kind of learned how to negotiate these projects and do these deals without being in front of each other all the time I don't think thats kind of changed dramatically to your point of it really is but when the deal actually has to get executed as something gets implemented and installed.
Yes, we keep our eyes wide open for that but again, we've not seen any impact on that certainly have them now.
Thanks.
Thank you.
Your next question comes from the line of Jacob Levenson with Melius research.
Good morning, everyone.
Good morning, Jack.
Just had a.
The thing that's pretty unusual that we're talking about having the working capital and proof of this.
<unk> levels in the middle of an up cycle. So maybe you can parse for us what what's really driving that.
Certainly not the first quarter were say, Matt but.
Is it lean manufacturing is the restructuring of the supply chain initiatives kind of.
Color you can provide there would be helpful.
Yeah.
Thanks. Thanks for the question I think the team is doing really good work keeping their eye on the ball of working capital and that's 1 of our key kpis that we monitor very closely throughout the throughout the year.
I think it's really the.
Aspects of working capital so our credit and collections team is doing a really good job driving down the past due so we're seeing good good results there.
On the inventory of fund actually we'd actually like to carry a little bit more inventory right now to manage through some of the supply chain challenges.
And we had actually built into our plan building up a little more inventory.
But the reality is as soon as we are getting that in its its going back out the out the door to meet to meet demand, which is which is a good thing.
And we haven't we have an act of supply chain financing program that.
Helps us take advantage of our strong credit ratings and we're seeing good adoption with some of our suppliers onboarding into that program and that's giving us some benefit so it's really across the board and we're going to continue to drive it through the rest of the for the rest of the year.
Yeah.
Excellent I appreciate the color I'll pass it on.
Thanks, Jason.
Okay.
Andrew Your line is open.
Yeah.
Yeah, Hi, good afternoon, I think it's the afternoon now how are you guys.
Yes.
[laughter] can you give us more color into your applied water business I think it is your only segment in terms of revenue. That's now decently above pre pandemic levels at least on a quarterly basis I know residential smaller than commercials. The residential seems to be driving quite a bit of strength. So how sustainable is that and then in commercial it does.
Seem like your commentary regarding commercial recovery, especially in the U S has changed significantly for the positive. So what are you seeing there.
Sure. So all of let me take the the first piece and then I may ask you to repeat the second part of your question.
On applied water.
I would remind everybody that it is predominantly a GDP kind of business I mean, we're confident that we can outperform that and grow faster than GDP.
But what we're seeing right now is obviously a fair amount of reopening activity.
And so some catch up there.
Obviously, it's a short cycle business, so as we've gone out with <unk>.
Successive price increases.
There has been some pull in in buying there no doubt, but we do feel good about the momentum I would say also 1 of the things that we're very pleased about there is.
The team has made an increasing number of investments in new product development.
In that business to refresh the product lines and so we're seeing.
The impact of the success of that and we're going to continue to.
To make those investments are really focused on things like energy efficiency as 1 example.
But again I think that it's a similar rebound right now that we're seeing from previous downturns.
On a global scale, so feel good about it think its sustainable but again that really what explains here in the immediate term.
What that stronger demand is and again, we expect that to continue.
Through the second half of this year and end of 'twenty 2.
And Patrick I was just the second part of the question was around commercial specifically I mean, it does seem like your commentary has turned more positive here. Obviously, we're all worried about the virus, but anything specifically that's changed in your business over the last quarter or 2.
Yeah, Okay. Thank you.
Average so if I talk about it first in the U S. Our replacement business, which is our book and ship is very solid there.
And we do expect new commercial building to be a bit soft through 'twenty..1 so that's not really driving.
Our growth here it really is the replacement piece.
You may have heard us say before when we talk about commercial we talked about the institutional sector of commercial.
Not so much kind of the pure non res.
And that outlook actually is improving and we think that will further improve just based upon some of the discussions right infrastructure spend.
Cetera, We've also seen healthy activity in Europe.
Where we had double digit growth in the first quarter, that's come from some modest share gains.
As well as we believe the resilience of our supply chain.
Versus some of our peers.
And again.
Really focusing on new product launches.
It's tied to things like smart driver again eco friendly products being launched the whole energy efficiency play.
Of that we're trying to get ahead of in terms of impending regulations that are coming forward.
Thanks, Patrick.
Thank you.
Your next question comes from the line of Pavel <unk> with Raymond James.
The.
Thanks for taking the question.
Just 1 will be about software in your MNC business.
Can you give an update on what the demand picture looks like in terms of.
Digitization virtualization from the utility sector of visa the software solutions.
Yes, certainly.
We are and we'll talk more about this at Investor day.
The real heart specifics of numbers around that to Dimensionalize kind of where we see the conversion.
Kind of pace being within the utilities specifically.
But now we are encouraged by the adoption there and that is not only a U S phenomenon.
We're seeing that in Europe, and the emerging markets as well.
And it really is.
What we see it's tied to most importantly is around affordability. So.
As we as our utility customers are looking to deal with these challenges in front of them around again, the scarcity of water equity building resilient infrastructure. It always comes down to how theyre going to pay for it.
And that's where we're really getting most traction right now is whether it be.
Around reducing the initial capital outlay because of the smart infrastructure, whether it be.
Reducing things like water losses.
The immediate revenue generation for them.
Those are the areas that we're seeing most traction.
Now in that dialogue and we're seeing some of those pilots that we've been talking about the last year or more really converting now into sustainable revenue. So absolutely interest absolutely adoption wish it was even faster we will have more to talk about that.
And the in the Investor day.
Thank you very much.
Thank you for all of them.
At this time there are no further questions I would like to turn the floor to Mr. Decker for any additional or closing remarks.
Well. Thank you again, thanks for all of you for your continued interest we look forward to our Investor day on September 30th again, as I mentioned, Matt the team will give of getting the details of logistically out to you very shortly.
Meanwhile, the <unk>.
Stay safe stay well and we wish you all of the very best talk to you soon.
Thank you for participating in today's conference call. You May now disconnect your lines at this time.
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Okay.
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