Q1 2022 Xylem Inc Earnings Call
Zero.
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Welcome to the Xylem first quarter 2022 earnings conference call. At this time, all participants have been placed on a listen only mode and therefore will be opened for your questions. Following the presentation. If you would like to ask a question at that time. Please press star one on your telephone keypad.
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I'd now like to turn the call over to Matt Latino head of Investor Relations. Please go ahead.
Thank you Ashley.
Everyone and welcome to Xylem first quarter 2022 earnings conference call.
With me today are Chief Executive Officer, Patrick Decker, and Chief Financial Officer Sandy Rowland.
They will provide their perspective on xylem first quarter 2022 results and discuss the second quarter and full year outlook.
Following our prepared remarks, we will address questions related to the information covered on the call.
I see that you. Please keep to one question and a follow up and then return to the queue.
As a reminder, this call and our webcast are accompanied by a slide presentation available 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 May 11.
Please note that replay number is 818 hundred 90, 345153 or one four O 22201182.
Please turn to slide two.
We will make some forward looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future.
These statements are subject to future risks and uncertainties such as those factors described in the islands. Most recent annual report on Form 10-K and in subsequent reports filed with the SEC.
Please note that the company undertakes no obligation to update any forward looking statements publicly to reflect subsequent events or circumstances and actual events or results could differ materially from those anticipated.
We have provided you with a number of with a summary of our key performance metrics, including both GAAP and non-GAAP metrics in the appendix.
For purposes of today's call all references will be on an adjusted basis, unless otherwise indicated and non-GAAP financials have been reconciled for you and are also included in the appendix section of the presentation now please turn to slide three and I'll turn the call over to our CEO Patrick Decker.
Thanks, Matt and good morning, everyone.
The team came into 2022 with strong momentum and they've taken full advantage of robust underlying demand around the world to deliver our first quarter operational results above expectations.
Revenues grew 4% organically, surpassing our guidance.
Despite ongoing chip shortages constraining, our utilities business supply is slowly improving which.
Which is reflected in quarter sequential revenue growth and EBITDA margin expansion in our metrology business.
Revenue strength was also broad based globally, we saw healthy growth in every region, excluding China, given the Covid impact there Western Europe was the standout delivering 10% growth in the quarter.
But the robust global demand for our offering comes through most clearly in the pace of order intake.
Orders were up 14% for the quarter with record order bookings in every segment M.
M and see us at the fastest pace with a 25% order surge as the value proposition of digital technologies continues to fuel demand.
Orders performance across the portfolio have pushed our already healthy backlogs at 50% growth year on year.
EBITDA margin performance was also above our previous guidance due to strong price realization, which mitigated much of the inflationary pressure while at the same time, we continue to drive productivity and further simplification throughout the business.
As a result of that good work and the team we delivered EPS of <unk> 47, again above our expectations.
The quarter did present, some fresh challenges.
China's ongoing response to Covid is having significant impact on our business and it will have global effects for some time in the global supply chain.
And while our European business delivered exceptional revenue growth the euro rate began to move unfavorably.
So conditions are dynamic, but the courts the quarter's operational results show that the team is doing an excellent job navigating the challenges and managing what it can control on a global basis.
Looking ahead, we're in a very strong position as structural demand continues to be robust in all end markets and regions.
And we have market leadership in the categories, where demand is greatest especially and digitally enabled solutions. So.
So we are raising our guidance for the year and are on track to deliver the longer term growth and strategic milestones, we laid out at our Investor day last fall.
Before turning over to Sandeep for performance detail by segment I want to mention how proud I am of the xylem team and of our partners for their response to the war in Ukraine.
When the war broke out the xylem team stepped up right away to provide for the safety and well being of all of our Ukrainian colleagues and their families.
Similarly, our team has shown extraordinary support by raising more money for the humanitarian relief work of our NGL partners, whose activities include providing essential water and sanitation services, both in Ukraine, Andrew refugees.
Become one of our most successful masks, giving campaigns ever and I could not be prouder of the team now.
Now I'll hand over to Sandy to review the quarter's results by segment.
Thanks, Patrick Please turn to slide four and I'll give some additional color on our first quarter results.
Given the quarter's challenges the team did a great job of delivering on our commitments with particularly strong performance on price and backlog execution.
Revenue growth was healthy in all regions led by double digit led by a double digit result in western Europe and mid single digit gains in the U S.
In emerging markets revenues grew high single digits, excluding China, which was affected by Covid shutdowns.
In a moment I'll offer detailed performance by segment, but enjoy utilities was down 3% strength in Western Europe was offset by ongoing chip supply constraints and their outsized impact on our smart metering business in the U S.
Industrial grew 10% and increasing activity in all geography, excluding China with particular strength in Western Europe .
Commercial was up 11% led by healthy growth in the U S and residential was up 15% also driven by the U S.
Organic orders were up 14% and acquire as Patrick mentioned acquire set historically high order impulse with robust demand for our technologies across all segments.
Okay.
EBITDA margin was 14, 2%, which was above our guided range, primarily driven by stronger than expected price realization.
Over here EBITDA margin contracted 290 basis points.
Healthy price realization and productivity benefits, but they were more than offset by inflation and lower volumes from chip shortages impacting our higher margin smart meter installation.
As previously mentioned, we will continue to offset inflation with progressive price realization.
Our EPS in the quarter with 47 cents.
Turn to slide five and I'll review, the quarter's segment performance in a bit more detail.
Water infrastructure orders in the quarter were up 12% organically versus last year with growth underpinned by sustained demand in our wastewater utility business in the U S and western Europe , and increasing demand for dewatering, particularly in emerging markets.
Water infrastructure revenue was up 8% in the quarter industrial remains strong and we saw revenue acceleration in our U S wastewater utility business as prior quarter order to revenue conversion delays.
Geographically results were mixed for the segment the U S and Western Europe were up mid double digits, driven by treatment delivery in the U S and healthy utility opex in both regions.
Emerging markets was down low double digits due to a challenging prior year compare in China and impacts on their recent call that locked down.
EBITDA margin for the segment was down 140 basis points as strong price realization and productivity benefits were more than offset by inflation and investments.
Please turn to page six.
In the applied water segment first quarter orders were up 8% organically led by price and underlying global demand.
Revenues increased 10% on strong backlog execution across all end markets, along with solid price realization.
Graphically the U S was up mid double digits or end markets showed strength and we benefited from the attraction of new product launches.
Western Europe delivered high single digit growth with healthy gains across all end markets and increased activity in large industrial accounts.
Emerging markets was up mid single digits on backlog execution that activity.
Segment, EBITA margin declined 380 basis points in the quarter.
Similar to water infrastructure, we delivered solid price realization and productivity benefits, but they were more than offset by inflation.
And now, let's turn to slide seven and I'll cover our measurement and control solutions.
M. A C. S orders grew 25% organically in the quarter, reflecting continued strong demand for our metrology solution as well as healthy demand and pipeline assessment services.
A portion of our MSA backlog includes orders that had been delayed due to chip shortages or MSS backlog is up 60% versus the prior year. It is now more than 2 billion.
As we enhance anticipated revenue declined 9% due to constrained chip supply. We are encouraged by the gradual improvement in availability and we realized significant quarter sequential glass.
It's worth noting that the growing metrology backlog is both margin accretive and there have been no cancellation of amyloid.
Geographically Western Europe , and emerging markets were flat with some growth from our pipeline assessment services business chip shortages pressed U S revenues down 14%.
Yeah.
Segment EBITDA margin in the quarter was down 470 basis points compared to the prior year, but higher than last quarter.
As we've noted in previous calls the business gets very strong operating leverage from higher volumes and revenues and those are still being held back by the supply constrained conversion of orders.
We were able to partially offset those effects with price and productivity gains and now let's turn to slide eight for an overview of cash flow and our balance sheet.
Consistent with typical seasonality patterns, we used cash in the first quarter. This year. We also strategically increased safety stocks to mitigate supply chain volatility and are carrying higher inventory balances.
Our financial position remains robust with $1 1 billion in cash and available liquidity of approximately $1 9 billion.
Net debt to EBITDA leverage is one five times.
And please turn to slide nine and I'll hand, the call back over to Patrick to look forward at the rest of the year.
Thanks, Andy.
We will turn to a detailed guidance in a moment, but as I mentioned, we are increasing our revenue outlook due to continued strong demand and higher price realization.
We're also raising the bottom end of our EPS guidance by <unk>, despite increasing foreign exchange headwinds.
The team is demonstrating that we are able to use our market leadership to drive price, while holding and in many cases, even gaining share as reflected in the level of our order growth trends and expanding backlogs.
In fact, I don't want to give a big shout out to the team, including our channel and distribution partners for doing such a great job, making sure our pricing moderated the effects of inflation.
We also continue to foresee chip supply playing out much as we anticipated we.
We've had improved supply this quarter and we expect that trend to continue in each successive quarter through the year.
Supply of chips remains well below our current needs and is expected to remain that way through at least early 2023 yet.
Yet our team along with our most critical suppliers and our customers continues to navigate the challenge and maintain current backlog, while still winning new business.
With our ability to capture price on surging demand and with progressive order to revenue conversion, we're confident in lifting our full year guidance.
Inflation will continue to be a significant factor of course, so we will keep driving further price realization as appropriate.
And just a moment, you'll see we've significantly modified our euro exchange assumptions and that will have a moderating impact on our reported EPS, but we expect the team will be able to cover the majority of those headwinds operationally.
Sandy will give more color on that at a segment level in a few minutes.
But the overall picture is more positive than we previously anticipated for the year and puts us squarely on track to deliver our longer term growth and strategic milestones.
When we laid out those milestones we also detail the strategic pillars that would enable us to deliver them.
They included making it easier for customers to do business with us making.
Making it easier for our colleagues to serve them and continuing to reduce business complexity.
So today alongside our quarterly results, we've announced that we are further unifying and simplifying our segment and regional leadership.
Since the acquisitions that created our Mcs segment, we maintained a separate commercial interface utility customers.
This was necessary for some time to create a strong and focused new offering from xylem, which has proven successful in achieving record deal wins and backlog.
Now we believe we have the opportunity to move to the next phase of our journey and building a single platform one that leverages the market, leading breadth of our portfolio and makes it easier for customers to access it.
We'd previously done that across the rest of the world, except North America.
So today, we announced that we are moving to one interface for our customers across the Americas as well.
We are integrating and unifying the leadership of the Americas commercial team.
They will report to Matthew Pine, who will also now assume leadership of both the AWS and <unk> segments.
In Europe <unk> continues to lead commercial operations as well as the water infrastructure segment, and we will now lead the build out of xylem services offering globally.
In France, or Winco will continue to lead commercial operations across the emerging markets.
As a result of the changes we've announced today colonsay, but we'll leave xylem after a transition period during which he will focus on a smooth leadership handover and provide advisory support to me and the leadership team.
Most of you know Collyn and so you know he has been a stalwart contributor to xylem growth story since the beginning.
In his 16 years with the company, but with xylem and our predecessor ITT. His insight has been at the center of our strategic vision.
His leadership has contributed to our emergence as a market leader in digital technologies as our M and P. S orders grow shows.
And I am profoundly grateful to have benefited from his considerable talent and unwavering commitment.
We will miss him at the leadership table and our colleagues will miss him as a leader.
Turning to sustainability.
Our growth framework emphasizes the creation of both economic and social value.
Our performance on social value creation as highlighted in our annual sustainability report, which we'll publish later this month.
I won't steal too much of a stander, but I'm happy to share. The xylem is well ahead of schedule and reducing carbon emissions.
Since 2019, we reduced our greenhouse gas intensity by 12% across scope, one and two emissions.
We have also driven our own water use down by more than 20% and doubled our rate of water recycling versus just three years ago.
The rigor and transparency of our reporting reflect our commitment to accountability as a sustainability leader.
So I invite you to dig into the report when it comes out.
Sustainability is so fundamental to our strategic differentiation to our investment thesis and to our growth.
Now I'll turn it back over to Sandy for more color on our outlook and guidance.
Thanks, Patrick consistent with our previous presentations, we've provided key facts for each end market in the appendix, we expect healthy underlying demand will continue through the remainder of the year with modestly better volumes and stronger price realization across our end markets.
Our end market outlook remains largely consistent with the view, we offered last quarter with a few notable changes we continue to expect our utility business to grow low single digits.
On the wastewater side, we expect low to mid single digit growth and resilient global demand.
We anticipate wastewater demand in emerging markets to continue being driven by investment in public utilities healthy opex activity as well as the benefit of our localization strategy.
One note, though is some shift to the second half due to the impacts from Covid closures in China.
The outlook for longer term capital project spending and bid activity remains very solid globally on.
On the clean water side, we continue to expect demand to remain very robust as the Ami and the advantages of a static meters continued to gain momentum with an increasingly broad spectrum of utilities.
With double digit revenue growth in the second half on improving kept supply we expect full year revenues to be flat.
Continued momentum in our test and assessment services businesses due to increasing focus on infrastructure and climate challenges.
Turning to slide 11.
Looking at the industrial end market, we continue to expect mid single digit growth and steady demand for our solutions globally.
We foresee healthy growth in dewatering, especially in emerging markets from robust mining demand and our channel expansion strategy in.
In the U S and Western Europe , we expect solid order rates and backlog expansion at <unk>.
<unk> continues to ramp and light industrial applications with considerable traction from new product introductions and large account activity in western Europe .
The commercial end market is now expected to deliver mid single to high single digit growth.
For mid single digit growth on solid replacement activity and new product introductions in the U S and Europe .
In residential our smallest end market. We now expect mid single digit growth up from low single digit to mid single digit crouse unhealthy demand.
And now, let's turn to slide 12, and I'll walk you through our updated guidance.
Yeah.
As Patrick mentioned, our outperformance in the first quarter is giving us good momentum and we are increasing full year guidance for organic revenue growth and raising the low end of the adjusted EPS range.
I want to take a moment to walk you through the puts and takes of how we now see the full year.
Well, let's take full year organic revenue growth to 4% to 6% up from 3% to 5%.
The 1% organic growth increase is driven primarily by strong price realization.
But from a reporting perspective, we anticipate it will be offset by a lower euro.
We are narrowing the EPS range to $2 40 to $2 70, which boosts the low end from $2.35.
This reflects strong price realization, which will be partially offset by inflation and a euro FX headwinds.
The emerging impact from a weakening euro is significant to us our initial full year guidance assumed a euro of $1. One three our updated guidance now assumes a euro at 1.15, which is a 10 cent headwind for the full year EPS guidance.
For your reference we have included an FX sensitivity table in the appendix.
We will closely monitor the global supply chain environment and continue to proactively manage impacts from China's COVID-19 lockdowns and the secondary effects of the warrant in Ukraine.
On slide 13, we've shown how our guidance breaks down by segment.
We continue to expect mid single digit growth in water infrastructure.
High single digit growth in applied water up from mid single digit growth due to stronger price.
We continue to expect measurement and control solutions to be flattish.
This assumes down roughly double digits in the first half of the year and up double digits in the second half.
So growth is still likely to be constrained by the gradual return of chip supply as the year progresses.
For 2022, we still expect adjusted EBITDA to be in the range of 16% to 17%.
And this yields adjusted EPS range of $2 40 to $2 77 that I just mentioned.
And we still expect free cash flow conversion to be 100% of net income.
We've also provided you with a number of other full year assumptions on the slide to supplement your model.
And now drilling down on the second quarter, we anticipate total company organic revenues will be flattish to up 1%.
This includes low single digit growth in water infrastructure and mid single digit growth in applied water.
And <unk> is expected to decline low double digits.
We expect second quarter, adjusted EBITDA margin to be in the range of 14, 5% to 15%.
<unk> improvement over the prior quarter.
And with that please turn to slide 14, and I'll turn the call back over to Patrick for closing comments.
Thanks, Andy we came into 2022, and a strong and enviable position even in the face of headwinds from chip supply and inflation.
Our performance in the first quarter as shown the team's ability to capitalize on our market leadership and delivered with discipline. Despite the various challenges around the world.
Demand has never been greater.
We have strong commercial momentum and we have a powerful balance sheet, giving us strategic flexibility.
And we have a great team showing resilience agility and experience in managing the dynamics of a truly global business.
While our customers are as local as water is the biggest water challenges are global and the water sector is increasingly well networked internationally.
Still xylem was one of only a small handful of global water players that puts us in a strong position to play a leadership role in support of both the sector and our mission to solve water.
So would you likely saw in our March announcement, we made the decision to move xylem headquarters to Washington D. C, which is one of the main crossroads of the global water sector.
Washington is not just the seat of U S water policy, it's where water thought leaders from all over the world convene.
Including the private sector governments around the world multilateral academia and Civil Society we've.
We've also taken the opportunity of the move to re imagine our footprint for more flexible ways of working and simplifying and leaning our headquarters.
The new location is on water Street, yes, it's on water Street right on the Anacostia River.
We will be officially opening this space in mid June and look forward to welcoming all of you when you visit D C.
Before turning to your questions I have one more special note of thanks. This is Matt Latino his last quarterly earnings call at the helm of Investor Relations.
We previously announced that Matt is taking a new role in xylem and it's an exciting new chapter for him.
I know from comments. So many of you have made over the years that you deeply value mass energy accessibility and professionalism and I've benefited from his insightful counsel and it's persistent positive encouragement through every kind of circumstance. So thank you Matt.
Some of you have already met Andrew Vanderberg, who's taking the reins as our Investor Relations leader.
Android has had great impact as the head of financial planning and analysis for xylem. So she brings distinctively deep knowledge of the business to her leadership of IR.
I'm confident you'll really enjoy getting to know Andrea and we will find great value in working with her and from her insights and perspectives.
Now operator, I will turn the call over to you for questions.
The floor is now open for questions. At this time, if you have a question or comment. Please press star one on your telephone keypad. If at any point. Your question has been answered you may remove yourself from the queue by pressing the pound key again with you asked why are you posed for your question that you pick up your handset to provide optimal sound quality.
Thank you and we'll take our first question from Deane Dray with RBC capital. Please go ahead. Your line is open thank.
Thank you and good morning, everyone.
Good morning, Dan Good morning, Deane, and maybe we could start with M. C. N S and just yeah more encouraging news on the chip shortage front can you give us a sense now you've got record backlog.
It is I'd be interested in hearing what the implied margins are and maybe some sense about so customers are giving you. These orders knowing they're going to be delayed to a degree. So it doesn't sound like you've lost any competitive positioning there.
Maybe you can start there thanks.
Sure. Thanks, Dan.
I'll start with the latter half of your question and then I'll have I'll have sandy speak to the margin profile in more detail.
Youre right I mean, we've we.
I think the team's done a great job working both with the suppliers of chips, but also with our customers on hanging onto deals in backlog. So we've had no. We've had no losses of deals here in terms of cancellations.
Also what we're saying is really good traction in terms of momentum, especially around midsize utilities as we're seeing greater adoption, there as well which is really encouraging.
And so it smooths out kind of what our demand is going to be over time.
But we would say on the chip supply as we said in our comments is that we've seen a gradual recovery.
And so we're not changing our outlook for the full year. It's just more confident in terms of what we're seeing there. So really encouraging sandy you want to speak more to the margin profile. Yeah. Thanks, Patrick you know I think Deane when we look at the profile of the orders that we've been bringing and we're really encouraged about the margin structure, it's accretive to the company.
And you know as you already know this business gets really good leverage I think you can see that already when you look at the quarter sequential improvement even from Q4 to Q1, where we had about a $20 million pick up in revenue and seeing very good margin recovery as the revenue line grows so.
Very very satisfied with the profiles of the orders that we've been bringing in not out of the woods, yet Dan I mean, obviously still risk there, but we think we've got that embedded in our guide for the full year.
That's really helpful. And then the follow up question or on the.
The recent headwinds I am.
And look FX is always been we know your exposure, that's the math and I'm glad you lay that all out but.
But how about reflect on China.
It's roughly 8% of revenues just threw me up on that and how what's the expectations on how this plays out yet we know your headquarters is in Shanghai.
And just some some real time update and expectations of opening.
Sure. Thanks, Deane, yeah. So our revenue exposure is roughly $350 million about 7% of our total revenue.
The impact in the first quarter was about $20 million in revenue.
Our guide implies another $20 million in Q2.
So first half of the year right now it would be down about 20% in revenue second half, we expect to be up about 20% because we saw some of the impacts of locked down even in the fourth quarter still lingering in China, We got four factories in China. As you said, we get a headquarters in Shanghai three.
Three of those factories were closed for a few weeks.
Later, they opened up at 50% capacity all four of our sites right now are 100%.
Utilization of our.
Our Nanjing plant, which is the one that supports our applied water business it actually never closed.
And that's the reason why you know AWS actually had mid single digit growth in China.
In the first quarter. So we expect there to be a gradual opening in China.
We think it's all manageable within our guide obviously, there's risk there, but our people are all safe and sound and.
They are they are working their backsides off to make sure we deliver on our commitments.
We did talk about also that there is the.
Global supply chain effect.
And we think that's the one that really is kind of the wildcard going into the second half of the year, but we feel that we've got that embedded in our guide.
That's all helpful and just lastly, with all the comings and goings want to wish calling all the bass will miss him as a class Act great insights on the water sector for Matt well.
Well deserved promotion I still have a cell phone just let them know that.
[laughter].
Well Andrea as well thank you.
Thank you Dan I really appreciate the comments thank you.
And we'll take our next question from Mike Halloran with Baird. Please go ahead. Your line is open.
Morning, everyone just wanted to echo Dean's comments on the comings and goings.
Thank you Mike.
So first on the.
Utility side of the equation, it's kind of a broad question because it's.
Both for the wastewater in the water side, but.
You look at the tailwind that are emerging there really across regions.
It feels like Theres, a lot of momentum, particularly with the backlog the underlying demand where tax receipts are et cetera.
If you take a step back and you know obviously, you've got some geopolitical concerns out there, but what do you think could derail that momentum at this point it seems like it's been a pretty good track.
I think the it's a great question, Mike I think from a demand standpoint.
We don't see many storm clouds on the horizon here right now just where we are in the overall investment cycle.
I know some may have questions even around.
What's happening in Europe .
From a geopolitical standpoint, and focus on moving towards oil and gas alternatives et cetera will money b.
D router directed there that's not even the way that the funding mechanisms work in Europe from a water utility standpoint, So we think even that's a pretty pretty robust at this point in time I think the I think in the near term the challenges remain.
Our case chip supply.
And just being able to continue to execute what we have in our pipeline.
Our bidding pipeline.
<unk> is very healthy.
North of north of almost $2 $5 billion in the bidding pipeline at this point in time, so again.
I'm paid to be paranoid so.
We're looking at any any storm quite out there that we could that we could possibly see but it feels pretty it feels pretty healthy right now.
How far how far out are you or your backlog stretching at this point and how do you think about the conversion.
And that's more of a broad comment.
I'm, hoping you can compare that to what a typical conversion cycle looks like look we all know that everything is getting stretched into 2023, given the chip shortages, but you know help give us some magnitude for how far out do you have visibility at this point.
Yeah, I think great great question and it obviously it varies by segment when we look at our AWS segment, that's where we typically carry a very small backlog, but as we look over the past 18 months. There orders has you know orders have really been high and we've been constrained constrained.
I'm, a delivery perspective because of supply chain challenges. So in that case, there we have a backlog that gives us really good coverage for that you know the next quarter next couple of quarters out.
In water infrastructure is a little bit of a mixed bag. We have some short cycle business is there and we have some longer cycle businesses, they're and so and the shorter cycle.
Coverage as we look out for more coverage than we typically have as we look out for the rest of the year.
And MSC as you know the story there is we keep getting orders that are outpacing the amount of revenue that we're able to deliver and I think it's going to take US you know.
About two years to catch up on the demand.
Demand that we have today and the balance between supply chain and Mike.
I'd offer up I think to your question around visibility from an overall market sentiment standpoint.
Our bidding pipeline, especially on the treatment and on the on the wastewater side mean treatment and even on the clean water side being metrology, we've got visibility there and our bidding pipeline of at least two to three years out.
And that's why we're speaking with the level of confidence around what the overall market sentiment is.
Thanks for that and then follow up then is the.
Capital deployment side, you've been pretty constructive last few quarters on what the pipeline looks like and it seems optimistic on your ability to convert some of that pipeline, maybe just an update and what you're seeing in the market and how actionable with us.
Sure, Yes, so we still feel really good Mike about the about the pipeline in terms of opportunities and they range from larger opportunities of moves into various end markets, but.
Even in the small to medium size opportunities that are there. We've got some things here that we're pretty excited about the near term that hopefully we'll be able to execute on some more to say there over the coming quarter or two but.
In general in general sense.
I feel certainly we feel the M&A pipeline is as healthy as it's ever been.
We continue to be continue to be disciplined on valuation.
Really appreciate it thanks, everyone.
Thank you.
Yes.
And we'll take our next question from Connor Lynagh with Morgan Stanley . Please go ahead. Your line is open.
Yes. Thanks, I just wanted to follow up on that capital allocation conversation. So.
Given given what the share price has done I'm, assuming that you would be less interested in using share currency for deals, but just curious how you view the calculus about.
How do you think about share repurchases.
How are you.
The competing uses of capital twin organic investment M&A and buybacks and sort of how you pay for M&A.
Sure Yeah. So again, we come into the year with really strong balance sheet.
Sandy laid out what our firepower is at this point in time and.
And we are not hesitant to do deals obviously, we're gonna be discipline around valuation.
Would not preclude equity from from being used in the right situation, but it's not our first labor.
To really lean in on.
Around capital deployment in General we also don't see.
M&A and any repurchases of shares being at odds with each other.
In the past we've used share repurchase authorization that we have out there right now to offset dilution of our long term incentive grants.
We realized now there are times to be opportunistic given the current environment.
And again, we think we're able to be both opportunistic on share repurchase as well as still do strategic M&A. These are not binary decisions and archive.
Okay.
Makes sense and I just wanted to follow up on this.
Separate line of questioning from earlier, which is the.
Basically it seems like your customers at this point you have to be pretty aware of what's going on in chip supply chain I'm curious have they changed their behavior around awarding new contracts. It's most of the ordering that youre seeing related to existing customer relationships or is the pace of.
Sort of newer deployment stayed steady accelerated decelerated.
On the other side are you changing how much youre bidding.
In terms of timeline or how aggressive you are being on some of these bigger projects given the time to deliver.
Sure Great Great question.
So let me parse it a part of it in terms of.
Kind of.
Existing contracts and deals we've seen no cancellations there our customers are very well aware of the challenges.
In many cases, they've got multi source and so they're seeing the same thing from our competitors along the way so they realize that.
Alone here.
But.
Secondly, it's the fact that so much work has gone into getting the regulatory approval of these large ami deployments.
The returns on investment for them are so substantial in terms of revenue generation that they just want to continue to move forward and execute these things and so the likelihood of them going back is minimized in that context.
Are they frustrated of course, we all are but.
We've been weathering this for a while now and we've been working closely with them to find alternatives.
Just to meet their needs, even though it may not be the level of metrology and originally spec. It's good enough right now to move forward, but still with a clear view of what the original approved our implementation is going to look like in terms of new deals. Yes. This is not just with existing customers. We are winning a number of new customers along the way.
Especially in that medium size part of the utility sector, which is really encouraging for us.
In terms of changing our own behavior.
We are we've been very disciplined along the way on being very open and forthright on what delivery.
Frictions are right now so that we're not over promising and under delivering to any new deals that we're winning we're being very clear about that.
And I think customers appreciate that transparency as I'm sure our competitors are being transparent as well with them on what their own delivery lead times are.
Alright, thanks very much.
And we will take our next question from Nathan Jones with Stifel. Please go ahead. Your line is open.
Good morning, everyone.
Good morning Nathan.
Patrick I'd love to follow up on some of the comments there about medium sized utilities starting to adopt this.
Technology and all of the conferences.
I've been going to which admittedly are probably larger utility hitter attending knows but it seems like the shift of Ams is going to become ubiquitous here and it's.
The inflection point being here and I don't think there's any doubt that that's getting adopted so it's definitely encouraging to hear about medium sized utilities.
Beginning to get onboard with that kind of stuff can you talk about the market opportunity that that presents because I know a few years ago. When you bought sensus that we'd really targeting those larger and leading utilities to try and drive that waterfall down into the market. Just any update you can give you some what youre seeing out there what that market opportunity could be.
How long that drives this high level of order growth for you.
Sure Nate again, good question you're right.
We had been very focused on the larger utilities initially because in many cases as you will note from the conferences that you attend oftentimes the medium to smaller utilities are looking to some of the larger ones for the lead in terms of proven technology et cetera, but not always I mean, they've got their own they've got their own minds and their own their own investment plans.
Oftentimes for those medium utilities theyre looking at entire implementations of Ami as opposed to maybe for a larger metro area. It could be sections of our city. So when they make the decision to go full scale.
It takes them a little bit longer to make that decision because it is a bigger bigger strategic choice for them.
To make it so it is encouraging to see that level of adoption.
<unk>.
Great.
Sorry.
They also their timing Tim.
<unk> is tied more to the retirement of the existing.
Metrology deployments that they have within their cities or communities and so we see this as being a really healthy steady stream of conversion over time.
Because while they may study.
Ami for a while getting ready for a complete upgrade or overhaul.
These things are phased out over time, it's not going to happen all within a few years, it's going to be staged out over a decade or more at least across the course of the U S.
Which is good for long term demand trends are.
I think it's the point that I'm trying to get too out of that that you should have that steady stream of Danville to orders in the Mcs business.
Yeah.
Oh go ahead.
Nate sorry, just really quickly I mean, just another another data point for you I know you're aware of this but maybe others are not I mean again when you think about the U S alone, we're talking about more than 50000 water utilities.
And the largest majority of those are small to medium size. So that's why we're so excited about this part of the market.
And still less than half of that market has adopted Ami.
Yeah.
I did want to ask one on price cost the math I did this morning shows you're about $35 million negative on price cost and that's responsible for a large portion of the <unk>.
<unk> compression that you saw year over year, great to say that pricing step up from 200 basis points in the fourth quarter to 420 basis points. In this quarter can you talk about the outlook for continuing to to close that gap and to generate more price to cover the inflation that you are saying in the business.
Yeah, Great question, Great question. Nate This is something that our teams have been very focused on.
And since we saw inflation start to rise last year. He has implemented numerous price increases in some cases, we had to work through existing backlog before the new prices took effect and so we saw a big step up from Q4 to Q1 and our price realization.
And you know as we look forward throughout the year, we would expect that to continue to ramp in each successive in each successive quarter.
We look at Q1, we are price did cover material inflation in freight.
But youre right, we were still underwater we didn't cover instead of our labor inflation or overhead inflation.
As we look out to Q2, we expect that to be neutral and then then in the second half of the year price should outpace the inflation effects and you know I think it is important to note in our guide we did increase it for a stronger price realization based on what we experienced in Q1 and what our outlook is for <unk>.
Next next quarter.
And we can also get up our inflation outlook.
So the point there is that by the second half of the year does price and inflation numbers that you put on the first page of the slide deck outgoing price is going to cover all of that inflation.
But that's our expectation.
Thank you very much.
Okay.
And we'll take our next question from Brian Lee with Goldman Sachs. Please go ahead. Your line is open.
Hey, everyone. Thanks. This is miguel on for Brian Lee. Thanks for taking the question I just had two quick ones follow up questions from from the prior quest.
Questions on price cost real quick.
Yeah. So so price cost was negative in the first quarter I think that was expected and then and then you just mentioned expect it to improve for the rest of the year is the expectation still for the full year that the price cost would be it would be positive.
That's our expectation for the full year, yes.
Okay. Thanks, that's helpful and then I appreciate all the additional color on the on the backlog on an Mcf.
So the backlog gives you visibility on orders for I think you said next two to three years I know you haven't seen any cancellations, yet, but at what point would customers consider canceling orders at the lead times become become so stretched out or.
Is there a way to think about it where our customers intentionally placing orders well in advance of projects to get their spot in line hopefully that makes sense.
Sure, Yes, so we have not seen any theres been no double ordering.
Regard I mean, the team is very disciplined around that and the nice thing about these large metrology implementations as we we know exactly what the endpoint count is.
That they need and so we work very closely with our customers there to make sure that we're not.
Taking duplicate orders.
We are prioritizing our customers we have someone allocation obviously, we're trying to prioritize those that are.
Most stressed at this point in time.
You never say never on these things in terms of at some point in time somebody canceling, but I think again as I mentioned earlier the customers understand that there are few other alternatives and these implementations have gone through such rigorous long long range regulatory approvals and there are so critical to their own revenue generation capability.
With.
As long as we're able to you know.
Meet their kind of.
Basic demand as best we can and give them a school transparency as possible we have been.
Very proud and very pleased and working with them as well as with our chip suppliers, we talk a lot about the customers.
We are working as closely as possible with our suppliers.
To redesign.
Number of our chip requirements for next generation, we're redesigning our own products to meet minimum needs here in the immediate term.
Multifaceted angle here and that's why I'm. So proud of the effort of the team to navigate this including our customers' patients.
Okay.
Great. Thanks, I appreciate that I'll pass it on.
Thank you.
And we'll take our next question from Andrew Buscaglia with Bamberg. Please go ahead. Your line is open.
Hey, good morning, guys.
Good morning too.
Just looking at your organic growth guidance range.
The underlying excuse me underlying that applied water is really the only one you nudged up.
I was surprised water infrastructure, you wouldn't you weren't willing to take that up and could you just could you comment on that first off and then secondly, you shouldn't we start to see some of the benefits of this water infrastructure stimulus barefoot.
Bear fruit later this year or what are you guys thinking on that front.
Yeah, you know I think when we looked at adjusting our revenue guidance or forecast. The primary reason that we had yesterday is for a stronger price realization and we're seeing that in AWS more than any other any other segment you know as we look out for the you know the rest of the year.
We're still monitoring chip supply for the other segments and water infrastructure has a high concentration in China. When we saw the impact in Q1 from China. They were largely concentrated in water infrastructure and Thats also where we'll see the impact in Q2.
And on the on the infrastructure Bill no real meaningful change there I mean, we do think it's going to be a positive over time don't really see that being a big impact here in 'twenty, two if things continue to settle out.
We see that more as a benefit in 'twenty three and beyond.
No okay.
Okay, and then just to be clear so.
You, obviously expect some nice price cost tailwind in the back half of the year.
But based on your Q2 guidance it really does seem.
It's been a pretty big step up in margins in the second half is there anything else specifically that.
Yeah. It would provide that tailwind beyond just price costs or is it is it.
Recent cost savings or anything that you expect will drive higher incrementals or something like that.
It's really four things you touched on the first thing. The first thing is price cost and that will continue to prove improve throughout the year. The second thing is chip supply in EM and see us as that revenue ramps in the second half it has very good contribution margins.
The third point I would say is China, we have a very modest revenue declines in the first half in China, we're expecting to see a good a good pop in the back half in China, and then you know we announced today some leadership changes, we're pursuing some simplification opportunities and some.
Some of those will drive cost savings in the back half of <unk> as well.
Okay, Yeah, and presumably free cash flow same thing like you are in kind of a hole in Q1, but.
That is that EBITDA goes up you'll you'll generate more cash and that I assume working capital management, probably takes over from there.
Yeah, you know what we saw from a free cash flow perspective in Q1 is very much in line with our historical patterns. We typically use cash in the first first quarter you know as we work through the rest of the year one of the things you may notice that our inventory balance is you know is up.
That was purposeful we've taken on some incremental inventory to try to mitigate some of the impacts of the supply chain challenges and we're gonna be thoughtful as we try to work that down in the in the back half of the year.
Yeah, Okay. Thank you.
Hi.
And we'll take our next question from Scott Graham with.
Loop capital markets. Please go ahead your line is open.
Hi, Good morning, Patrick Sandy and once again, congrats Matt you'll be great.
So I have a.
Sorry to beat a dead horse here on the Sandy but.
Pricing in the you know the price cost I think I heard you say during your prepared comments that.
You had increased your assumption for inflation.
I'm just wondering whatever other.
Metrics, you can give us around pricing would be helpful, whether its where youre expecting that ramp to go in the second quarter and what your full year pricing will be because the gap is still pretty large right. Now so anything you can give us on pricing.
Give us a little bit more color on what you mean by ramp thanks.
Yeah, you know I think just to give you some context Scott in Q4, we had about 200 basis point impacts from our price increases that doubled to 400 basis points in Q1, and we would expect that to continue to increase now since the invasion of Ukraine by Russia, we've seen some of our key.
Commodities increase our costs, particularly around stainless steel, which is impacted by nickel and so as we roll forward inflation assumptions for the back in the next three quarters. We see you know more headwinds in the neighborhood of $40 million to $50 million and so in response to that our teams have gone out and implemented incremental price.
Actions.
Some that were you know they were not contemplated when we put together our budget and so our teams are acting quickly we've changed some of the practices around price increases we used to have over a 60 day lag time between when we announced the price increase and when it went into effect and you know now we're down to less than two weeks across our across our business.
And I would just offer up Scott.
Again, I think what we've been really pleased with is the resilience of our volume and our share.
And in some cases, even gaining share in certain parts of the business and so the market really has shown a level of resilience in this area and I think again, we've been we've been acting as a leader in this area and.
So pleased and as things continue to to.
To move from an inflationary standpoint, we will continue to act responsibly yeah.
Got it.
<unk> on our margins is price cost has gotten a lot of attention the secondary impact of mix. When you look at our revenue mix with Mcs being down this year be the revenue that we lost because of the chip supply constraints comes with high margins.
Get it I was going to say, who would've thought utilities would have given up so much on pricing, but it's a brave new world out there. Okay. My other two questions are around what is the percentage of the backlog for EM.
And so yes that is being held up by the shortages.
If you've got it you could ship it you know kind of what's that percentage.
So you know I think if you look at our Mcs backlog is around $2 billion and you know we have I would say between 20 and 25% of that backlog has held up by the delays and that's you know that.
That's been growing each quarter, because our orders have been outpacing our revenue conversion, yes got it and then lastly, savi I know as you entered here you know I guess itself.
Over a year ago now I don't know have you ever.
Or you would totally calculated what is the organic.
Sales rate that you guys need to generate a certain level of operating leverage you know as it is.
Is three five I mean, how do you look at that.
Yes.
Yeah.
I'm not sure I totally follow your your your question Scott You know I think we when we model our long range plan we.
Understand assumptions around inflation, we also said productivity targets across our organization both.
Both in the in the manufacturing centers and across the functions and we have a goal as an enterprise through our productivity to outpace inflation now the past 18 months have been a little bit different but that's our overall philosophy.
I think I think Scott the I mean.
Just some other trying.
Trying to parse out your question here I mean, if you think about the Incrementals on this business I mean any dollar of growth that we get in this business is going to drop very healthy incrementals to the bottom line between the 30% to 40% range.
In terms of what we've laid out in our long term guide is in that mid single digit range, which obviously really drives heavy.
Margin expansion, especially given the mix with <unk>. So maybe that helps frame out a little bit but I mean this is a business that generates very healthy incrementals at whatever level of growth there as well.
I got it thank you both.
Thank you.
And we'll take our next question from March.
<unk> with Raymond James. Please go ahead your line is open.
Thanks for taking the question first on the M&A front.
Given that blue chip companies, such as yourself are struggling with semiconductor and other component availability.
Presumably <unk>.
Safe to say some smaller players are struggling even more.
Does that create any kind of opportunistic quasi distressed M&A.
Opportunities that perhaps you would not have seen a year ago.
It's it's an interesting angle.
It's not really one that we're prioritizing right now I mean, the things that we have in the pipeline again, we really focus on the.
The strategic logic behind them in terms of for the long run we kind of look through the cycle in terms of chip demand I understand where you're coming from with the question, but I wouldn't say that that's really a heightened our view on any particular asset based upon chip distressed.
Understood following up on Europe , the the weakness in the currency.
Does that.
Reflect any underlying softness in European GDP and demand patterns.
It might impact the volume in the second half of the year.
Not not not not as we see it.
Based upon our experience in Europe over many years Europe is a very resilient when it comes to underlying demand. So it's a much heavier opex.
Element there in terms of repair replacement of installed infrastructure.
Less reliant on new Capex.
And even when there is new capex to funding mechanisms tend to be.
Pretty pretty well sheltered at least in the.
The larger economies across Europe , I'm, not saying there are no economies that are better that are that are not immune to it but we really never seen big swings there on.
On the Capex side.
In terms of what we do see is the lion's share of our business there is repair and replacement.
Which is very stable very steady as.
As well as really attractive margins and so we feel pretty confident right now around the outlook for for Europe , as we see it today.
Thanks very much.
Thank you.
Yeah.
Yeah.
Yeah.
Okay.
Actually I think we are in.
Any more questions, yes, I apologize, we'll go next to Joe Giordano with Cowen. Please go ahead. Your line is open.
Hey, guys. Thanks for squeezing me in here.
Sure Joe.
Hum, we've talked a lot about price, but just curious how you think about like is there a level where.
It just the amount of price that's required to increase it just starts causing demand destruction biggest projects start to be did not make sense in customers like I understand why you're raising but I'm just not going to buy right now.
Joe it's something that our teams stay close to everyday.
That's one of the biggest challenges obviously in this kind of inflationary environment is.
Where does that limit.
And you know we're always looking at.
When loss ratios, we leverage our capabilities and sales force.
And our bidding pipeline there to get a feel for what that tradeoff is.
And so the team stays very close to that and we look at that on a regular basis and so until we see meaningful moves and that win loss ratio that tells us that we need to continue to make sure we cover the inflationary impacts.
What we're encouraged by.
Thus far is that you know and the areas, where we've taken price increases we continue to see volume growth.
And those businesses and so that's a good healthy indicators as well, but it's not something by any means Joe that we take for granted something we're very very close to.
Yeah.
And there's less Patrick.
I think raising the low end of the guide, but it was such an important kind of tone here for you guys, but just on the other side of that was their thoughts on trimming the high end and maybe talk through your thoughts around that and or what the scenario is that gets you. There this year.
Sure Yes.
Yes, you can imagine all management team has been a lot of time thinking about when you make a change in guidance, how you want to approach that we.
We just felt that it was.
As prudent at this point in time and confident to raise the lower end are trimming. The top end, we still see a path there.
And obviously things have to go in the right direction.
And obviously there are there are clouds on the horizon that every company is saying right now, but we see a path there.
And we will continue to monitor that in terms of what those are it's as we've talked about before we need to continue to see price.
Pricing momentum, we need to continue to see improvements in the chip supply.
Delivery around those areas and.
Hopefully, we will see some improvement on the outlooks for for China.
China is not a demand issue for us, it's really a matter of when we're able to ship out our backlog there.
As well as mitigate what the downstream impacts on the supply chain are.
Thanks, guys.
Thank you Joseph.
And there are no further questions at this time I'll turn the call back over to Patrick Decker for any additional or closing remarks.
Well. Thank you all again for your time and attention this morning and for your support and look forward to catching up with you between now and in the next earnings call in the meantime, stay safe stay well and wish you all the very best Thank you.
Thank you and this does conclude today's xylem first quarter 2022 earnings conference call. Please disconnect. Your line at this time and have a wonderful day.
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Yeah.
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Hum.
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