Q2 2022 Xylem Inc Earnings Call
Welcome to the xylem second quarter 2022 earnings conference call.
All participants have been placed in a listen only mode and the floor will be open 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. If at any point. Your question has been answered you may remove yourself from the queue by pressing the pound key since you. Please pick up your handset to allow off.
We'll sound quality lastly, if you should require operator assistance. Please press star Zero I would now like to turn the call over to Andrea Vanderburgh, Vice President Investor Relations.
Good morning, everyone and welcome to the Xylem second 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 Thailand second quarter.
2022 results and discuss the third quarter and full year outlook. Following our prepared remarks will address questions related to the information covered on the call I'll ask that you. Please keep to one question and a follow up and then return to the queue. As a reminder, this call on our webcast are accompanied by a slide presentation available in the investors section of our website.
Www xylem dot com.
Play of today's call will be available until midnight on August nine.
Note. The replay number is plus 18008395676 or plus 1402 Q2 zero to 565.
Additionally, the call will be available for playback via the investors section of our website under the heading investor events. 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 well or may occur in the future. These.
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 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 in Pennsylvania.
We've provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics in the appendix.
Purposes of todays calls 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, Andrea and good morning, everyone. We're pleased to report that the team delivered a very strong second quarter performance on all key metrics and well ahead of our guidance.
The result builds on the momentum and underlying demand we saw in the first quarter with disciplined operational execution on strong fundamentals.
And a moderate easing and chip supply constraints.
Revenues grew 6% organically, surpassing our guide.
The teens commercial performance was outstanding in all segments.
And supply improvements in Mcs and water infrastructure enabled increased conversion of orders into revenue.
Geographically the growth was broad based western Europe was up 9%.
North America, 6% in emerging markets, excluding China was up double digits.
While China was down due to Covid lockdowns backlogs continue to grow on underlying demand.
In addition to organic revenue growth the team posted 6% orders grew up.
That orders momentum reflects strong performance across each segment.
Water infrastructure at the strongest pace growing orders, 21% in the quarter.
Our backlogs are up sharply versus last year with digital solutions comprising more than half the total backlog.
EBITDA margin also came in well have our guidance, we delivered strong quarter on quarter expansion driven by disciplined execution.
All of that good work delivered earnings per share up 66 cents, which soundly beat our expectations.
As you can see some incremental improvement in chip supply came earlier than anticipated.
It had a strong positive impact on the quarter.
To be clear, we don't believe chip supply will improve much more quickly than previously expected.
What we are seeing is a gradual improvement in supply which provides further confidence in our second half outlook.
The team also delivered pricing actions to mitigate inflation across all segments.
And I want to give a big shout out to the entire team, including our distribution and channel partners.
We're managing through a dynamic market environment.
We combined those disciplined actions, but productivity savings from simplifying the way, we work and entirely offset inflation in the quarter.
We expect demand to remain resilient due to the essential nature of the services our customers need from us.
So as you've seen in this morning's release, we are raising our organic revenue guidance to 8% to 10% growth for the full year.
We're raising the bottom end of our EPS range by 10 cents.
We'll come back and discuss our forward view of the macro environment in a few minutes.
But let me hand, it over now to sandy for some additional color on the second quarter.
Thanks, Patrick Please turn to slide four the team did a tremendous job over delivering on our commitments with disciplined execution and strong fundamentals and continuing demand.
As a result revenues grew globally.
Single digits in Western Europe , and mid single digits in the U S.
Emerging markets revenue grew most low double digits, excluding China, which was slowed by ongoing COVID-19 restrictions.
In a moment.
Detailed performance by segment, but in short utilities was up 2% led by strength in Western Europe , and the U S. Industrial grew 12% and increasing activity in all geographies, particularly the U S Western Europe and Latin America.
Commercial was down 1% strength in Western Europe was offset by continued U S supply chain challenges.
And residential was up 13% led by commercial execution and backlog conversion in the U S.
Organic orders were up 6% in the quarter with water infrastructure up 21% and AWS up 2%.
Partially offset by Mcs.
Global demand continues to be strong and our book to Bill ratio was a healthy one point too in the quarter.
EBITDA margin was 16, 6% well above our guided range and that reflects a 240 basis point rise sequentially on strong commercial execution and discipline on discretionary costs.
Price contributed two points of incremental revenue growth sequentially.
As Patrick mentioned pricing productivity benefits combined more than offset inflation and our EPS in the quarter was 66% coming in above expectations.
Please turn to slide five and I'll review the quarter segment performance in a bit muggy counts.
Yes.
Water infrastructure revenue exceeded expectations growing 9% organically in the quarter.
Industrial remains strong driven by continued backlog conversion and our U S. Wastewater utility business grew double digits, our supply chain constraints improved throughout the quarter.
Geographically the U S and Western Europe were also up double digits, driven by robust transport demand in the U S and treatment applications and Western Europe alongside strong he watering graph.
Emerging markets, excluding China was up high single digits, driven by strength across Latin America and Africa.
These markets were down mid single digits, including China due to Covid site access restrictions there.
Orders in the second quarter were up 21% organically versus last year with growth underpinned by strong underlying demand supported by large infrastructure projects in the U S and Canada.
We also saw sustained demand sell wastewater utility business in North America and Western Europe .
EBITDA margin for the segment was up 240 basis points as strong price realization volume and productivity benefits more than offset inflation and investments.
Please turn to page six.
In the applied water segment second quarter organic revenues grew 7% modestly exceeding our expectations.
Geographically the U S was up high single digits with strength across industrial and residential partially offset by supply chain constraints in the commercial business.
Western Europe delivered low double digit growth with healthy gains across all end markets led by benefits from new energy efficient product introductions.
Emerging markets was up low single digits, driven by strong industrial demand.
Orders were up 2% organically and continue to outpace revenue with a book to bill ratio of 1.1 for the quarter.
Segment, EBITA margin declined 130 basis points compared to the prior year.
And while price realization more than offset inflation.
And mix for the quarter were negative.
Despite lower volumes demand remains robust as seen in our book to Bill ratio.
However, we expect to continue to deliver sequential EBITDA improvement as the benefit of pricing actions comes through our backlog.
And now, let's turn to slide seven and I'll cover our measurement and control solutions.
M. A C S exceeded expectations on strong demand and modestly better chip supply with revenue declining 2% organically.
Also saw strong growth in our test and pipeline and assessment services product lines.
Geographically the U S and Western Europe were down mid single digits in emerging markets was up high single digits.
And then she has orders declined 9% organically in the quarter due to lapping some large deals in North America and the U K.
Underlying demand for our Ams offering remains strong and orders continue to outpace revenue.
The book to Bill ratio of 1.4 and has built a backlog of over $2 billion.
Segment EBITA margin in the quarter was ahead of expectations, expanding 120 basis points sequentially unimproved volumes.
Our supply chain stability improves and convert our backlog, we will see strong margin accretion on higher volumes as we have previously discussed.
And now, let's turn to slide eight for an overview of cash flows and our balance sheet.
In the second quarter, we generated free cash flow of $67 million driven by income conversion, partially offset by higher working capital our financial position remains strong with 1.1 point 1 billion in cash and $1 9 billion of available liquidity.
Net debt to EBITDA leverage is one five times.
Please turn to slide nine and I'll hand, the call back to Patrick to look forward at the rest of the year.
Thanks, Andy.
<unk> seen the team is delivering strong results in a very dynamic environment.
Given the prominence of discussions about macro uncertainty in the economy, It's worth spending a few minutes talking about our confidence in the resilience of underlying demand for xylem as offerings.
The aspect of our sector and our business model that gets most discussed in this context and for good reason is that our offering is at the core of our central services through the ups and downs of economic cycles.
Cities and towns must provide essential water and wastewater services. So the demand associated with water management tends to be quite resilient.
It's also important to understand the dynamics between opex versus capex across economic cycles, particularly for water utilities.
Opex spending is very stable given the basic need for day to day water services.
Capex, which represents roughly a third of spending on xylem as offerings is focus on infrastructure expansion or refurbishment and it comes with longer regulatory and funding approvals.
So spending against these projects once approved historically has not wavered to a material extent and this is not just a U S dynamic, but it applies globally.
You see it in Europe , both at the regional level for example, with the ease of use recovery and resilient funding at the country level as seen in the U K, it's a process.
Similarly infrastructure funding is embedded in China's five year planning cycle and of course Youre all familiar with the recent U S federal infrastructure funding and the timelines on which the state revolving funds work.
Those structural advantages of the sector. However are only a benefit if our portfolio deliver distinctive value do walk customers through the cycle.
For many of our customers value as defined in terms of becoming more efficient.
And that means modernizing their infrastructure with digital technologies to make their networks more affordable.
Our ammo and metrology backlogs offer a proof point about the resilience of that demand.
Despite the ongoing chip supply challenges that a dog the tech sector for this last year, our backlogs have continued to grow.
Our distinctive data and communications driven <unk> solutions deliver a step change in both efficiency and resilience for utilities.
AMRI represents now roughly a third of all water meters in the U S.
Which shows the progress of adoption.
But also the potential for future growth.
Given the budgetary pressures that utility space, both to generate revenue and reduce water loss smart meters will remain a top imperative.
One other demand trend that will persist through the cycle and in fact is set to increase is the growing response to climate change.
Cities around the world are committing to net zero emissions.
At the same time, they were investing in mitigating the impacts of climate change that are already here.
Like those we've seen this summer in the form of historic and tragic flooding in the U S and Asia.
These are generational challenges.
Innovation and new approaches are absolutely essential to solving them.
Because water management is a significant carbon contributor.
Accounting for up to 10% of greenhouse gas emissions globally.
In commercial and residential markets cities had begun introducing building regulations to reduce emissions, including efficient water management standards for both Greenfield construction and retrofits.
And the utility market, which produces greenhouse gas emissions equal to the entire global shipping industry.
It's going to be required to reduce its carbon intensity in line with the commitments of their cities.
Municipalities and countries.
And we have xylem or an outright leader in this space and are in a unique position to support our customers and their sustainability commitments.
You may have seen that we released our annual sustainability report in May.
Among all of the progress made against our 2025 goals I'd highlight that we enabled our customers to reduce their carbon footprint by 730000 metric tons in 2021 alone using our technology.
That is the equivalent of taking 160000 cars off the road.
And we're on track to help them reduce their emissions by $2 8 million metric tons by 2025.
So stepping back we're very confident that the macro forces driving our underlying demand will continue.
We're also confident that xylem is better positioned than ever to create value by helping our customers respond to them.
So now I'll turn it back over to sandy for more detail and color on our outlook and guidance.
Thanks, Patrick.
Staying with our previous presentations, we've provided key facts for each end market in the appendix.
Across our end markets has broadly improved we expect healthy underlying demand will continue through the remainder of the year with improved price cost mix and modest improvements in supply chain.
I expect our utility business to grow mid single digits up from low single digits.
On the wastewater side, we now expect mid single digit growth up from low to mid single digit growth and improved backlog conversion and resilient global demand.
The outlook for longer term capital project spending and activity remains solid globally.
So clean water utilities, we now expect mid single digit growth upfront flat. The main driver is earlier than expected easing of chip supply constraints.
Although supply has improved lead times continue to remain elevated and our volumes continued to be constrained.
We also expect momentum in our test and pipeline assessment services business to continue Q2, increasing focus in our end markets and infrastructure and climate challenges as evidenced by our strong backlog.
Please turn to slide 11.
Looking at the industrial end market, we now expect high single digit to low double digit growth up from mid single digit growth on increased activity in the U S and Europe and strong global demand for our solutions.
We continue to expect the commercial end market can deliver mid single to high 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 healthy demand to drive double digit growth up from mid single digits.
As a reminder, the majority of our commercial and residential end market exposure is replacement driven versus new construction.
Now, let's turn to slide 12, and I'll walk you through our updated guidance.
Our outperformance in the second quarter gives us confidence to increase our full year guidance for organic revenue growth and to raise the low end of the adjusted EPS range.
We now expect full year organic revenue growth of 8% to 10% up from 4% to 6%.
Raised the bottom end of our EPS range by Tencent.
The increase in our reported revenue guidance is more modest as the strength of the dollar offsets roughly half of our operational improvements.
We have modified our assumptions on a basket of currency exposure, which is included in the appendix.
These changes result in an incremental five cent headwind to the full year EPS guide.
And this is on top of the 10 cent EPS FX headwinds that we discussed last quarter.
On slide 13, we show how our guidance breaks down by segment.
We now expect high single digit growth in water infrastructure up from mid single digits and low double digit growth in applied water up from high single digits.
And by disciplined commercial execute execution and backlog conversion and continuing strong demand in both segments.
We now expect measurement and control solutions to be up mid single digits up from flat. This reflects the outperformance in the first half from chip supply improving sooner than expected.
For 2022, we are raising the bottom end of our adjusted EBITDA margin range, which is now 16.5% to 17%.
And as you'll see adjusted EPS range of $2.50 to $2.70 that I just mentioned.
We now expect free cash flow conversion to be approximately 90% of net income.
We're carrying about a month of extra inventory to mitigate the risk of supply chain disruptions and provide continuity of service to our customers.
We expect to bring conversion back to historical levels of supply chain stabilize enabling us to return to free cash flow.
Free cash flow conversion of at least 100%.
We've provided you with a number of other full year assumptions on this slide to supplement your models.
And now drilling down on the third quarter, we anticipate total company organic revenues will be up 10% to 12%.
This includes mid single digit growth in water infrastructure and mid double digit growth in applied water and M. N C S.
We expect third quarter adjusted EBITDA margin to be in the range of 16.5% to 17% a sequential 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 saw the power of some short term swings this past quarter.
A small improvement in chip supply had a big impact.
Currency movements had been offering what you could call a challenging forecasting environment.
And the unexpected duration of Covid shutdowns held China back.
Just a quick note on China, our team and our customers there had been continuing to serve their communities under very tough conditions, given the extensive restrictions in place to manage COVID-19.
I'm incredibly proud of the team.
We expect to see progressive improvements in the market for the second half and have full confidence China will continue to be a source of innovation and growth for the long run.
In the context of short term uncertainty our job is to manage through the unexpected.
Meeting those challenges is what being a good operator is all about and the team has certainly been doing that.
The team's strong operational execution is built on the same foundation as our 2025 growth and strategic milestones a consistent story at the heart of our investment thesis.
We're building on our leadership position as a technology company with a durable business model.
We're benefiting from long term secular trends of rising demand driven by water and climate related challenges.
We're driving above market growth and margin expansion as we digitize our portfolio to serve our customers' imperative to be more efficient.
We're successfully putting sustainability at the center of everything we do across our company our customers and our communities.
And we will create additional stakeholder value with disciplined capital allocation as opportunities warrant.
Strong continued demand and the kind of performance, we're seeing from the xylem team show our ability to deliver on that thesis.
And with that operator, let's open it up for Q&A.
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 is answered you may remove yourself from the queue by pressing the pound key I can lead you asked so while you're poised. Your question you can pick up your handset total optimal sound.
Quality. Thank you.
Our first question is coming from Deane Dray with RBC capital markets. Your line is open.
Good morning, everyone.
Good morning, James Good morning gain Hey, maybe we can start with the better news on the chip supply.
And we've been hearing that from other manufacturers that it's starting to improve gradually and your commentary is pretty consistent with that but just some additional color.
Would you see in the quarter and what's that outlook for the second half how much of.
The backlog in digital might you be able to ship.
Yeah. Good morning, Dean Thanks for the thanks for the question you know, we certainly were pleased to see definitely slightly better chip supply throughout the quarter.
And I think if you go back to where we were from a low point from a revenue perspective last year. In Q4, you know were under $300 million of our revenue now we've clawed that back and we're approaching $3 50 in the second quarter. So it was definitely a bigger step up than we had anticipated.
As we look at the second half of the year Deane.
We see a more modest increase from Q2 to Q3, and then you know a little more of another step up into Q4, we think we're going to exit the year really in line with what we had modeled.
We've just been benefiting from some better supply earlier in the year and you know I give credit to the team that has been in really close contact with all of our key suppliers.
Leaning in and and also being opportunistic opportunistic in the you know in the spot market. So that we can take care of our take care of our customers and I would just add units.
Sorry for my voice.
That in addition to that the team has done terrific work not just on landing ships in the spot market, but a lot of the redesign work that we talked about in past quarters is nearing completion and so.
There were some added cost in the quarter for that but it was there to really make sure we secured supply for our customers and we also shipped out more mechanical meters in the interim bridge.
Bridge that gap, while we're waiting on the chip to come through so they were multiple dynamics, but as sandy laid out being certainly got better.
And we feel more confident now about the second half than we did before.
That's real helpful and just the context of this and I'm not sure. If you can give us specific numbers, but our expectation is that the profitability of these digitally enhanced products and services, they're roughly 50% more profitable than the legacy you don't Wanna say dumb, but.
Not digitally enabled products and services is it still that magnitude of difference in margins on the digital side.
Yeah Deane.
The margins are clearly richer on the on the digital side and we saw that in our mix at EM and see us in the quarter that we were about 5% less digital this this year compared to last year and I think that was with a purpose of taking care of our customers and putting yeah.
Product into the hands of our customers were to keep them up and going and so that took a more mechanical meaning. This time. This time around you know I think you know as we look at longer term, where we expect to land from a margin perspective, you know nothing has changed structurally from what we.
Aid out in our Investor Day, you know last last year in September if anything deemed the backlog has it gotten stronger, especially with some of the large deals that we brought on over the last few quarters in the bidding pipeline remains very robust just given how early we still are in terms of a conversion of MRI across especially the U S on the water side.
Things, so we expect that runway to be there for quite some time.
Got it and then just last question for Sandeep on the free cash flow. We've seen most of the companies. This earning season trimming free cash flow guidance, all because of higher working capital commitments you know both supply chain inefficiencies.
These are in big demand just.
How do you the expectation for returning to a 100% free cash flow is that really dependent on the supply chain and you know what would be the timeframe.
Yeah, I think great great question Deane when.
When we built our our plan for 2022, we expected that supply chains would be meaningful meaningfully improved in the second half of the year and we're not seeing big changes yet and therefore, we think it's prudent to carry some extra inventory with a leaning of delivering on <unk>.
Revenue and delivering on our backlog. So you know theres a couple of things that are going on lead times are still elongated you know were still having problems, where you know we're missing one or two key components and then we're not able to get the entire solution out the door.
And of course, you know inflation is bringing up.
The overall balances in our in our inventory, but you know what we will bring that down we'd expect that is certainly in 2023 at the at the latest and it will be a key focus item for our team. This is not something that we plan to do for a long period of time.
And from a segment perspective Deane it was most notable in applied water.
<unk>, where again, we've had continued knock on effects.
Whether it be supply chain castings come out of China due to Covid. Obviously, we expect those to continue somewhat in the second half and that's why to Sandys point, we brought in an extra month of inventory.
And of that business. So it's very visible we know exactly what it is is totally under control, it's simply a matter of needing to do that in order to supply customers and maintain that demand.
Alright that was great color. Thank you.
Thank you.
We will take our next question from Nathan Jones with Stifel. Your line is open.
Good morning, everyone.
Good morning, Nate Martini.
I'm going back to <unk>.
Yes.
Hi, Dana.
A couple questions on the chip supply and how that's progressing.
Maybe you could talk a little bit about the.
The expected profitability of that business as we see revenue pick up in the third quarter and then you've talked about it being a step up in the fourth quarter.
Assuming that it's probably going to continue to improve going into next year.
Talk about the path to getting back to those profitability targets.
I know you've laid out in Investor day.
We'd be able to get to in 2023, how quickly can you get to that kind of.
<unk> margin level in the business.
Yeah, I think obviously really important question Nate you know I think one thing I want to call out is you know we've already seen from the low point in Q4, you know 300 basis points of margin expansion from Q4 to Q2 and you know that's that's evolving because of the higher volumes.
You know partially constrained by some of the things that we referenced earlier call earlier in the call the mechanical mix the redesign costs on the optimal manufacturing flows.
But as you know we'd look out into the back half of the year, because theres not as much of a pickup from a revenue perspective, but we would expect margins to kind of continue along the same trajectory that we recognize from Q4 to Q2, and you know I'm not going to give guidance on 'twenty three on on this call, but as we look out to 'twenty.
25, you know, we don't see anything structurally different about where margins should land in that in that time period.
Okay. My follow up is.
Europe and industrial one of the biggest concerns we get from investors is Europe and industrial AR.
I know, you're not saying that I think that was one of the stronger areas in terms of growth in the quarter and a solid orders there.
Maybe you could talk about the trends that you're seeing there and then if you could talk about the resilience of the industrial business in general, particularly the light industrial side of the business and how you would expect that to react in the potential for a recession in Europe .
Yeah, I think you know for US Europe has been a real bright spot and it's not just in one segment, it's really across the entire entire portfolio.
We've seen good revenues in Europe , we've seen good orders you know I know, there's a lot of concern about you know potential recession in in Europe , and the industrial market. In particular, you know I think one thing I would call out is that if you look at our dewatering business for example, which is.
As you know more industrial.
You know we've done a lot to diversify the end markets there much less exposure to oil and gas than we did in the prior recession I think we're down to about 1% revenue in that you know in that end market.
Then of course, there we've also been diversifying from a you know a geographic geographic perspective.
And I would just offer up.
Nader you probably recall this but if you go back over time and look at previous kind of industrial recessions back in kind of a 2015 and 16 timeframe.
Our European business.
Still would hold up in terms of growth during that time frame.
Because the results are much less cyclical.
They're given the end market exposure that we've got and also you know so for example, I think the numbers in 2016, you're still grew 3% despite being in the middle of an industrial recession. So.
We feel we feel pretty good about that we think it would be that resilient again.
As you well know.
If we were to first see.
Any softening in orders, which we've not seen to this point it would be it would be in our short cycle businesses, which would be more applied water Andy.
And the water and again, we've not seen that yet.
Our backlog continues to grow good book to Bill and again, obviously, there would be actions that we would take if we began to see those those metrics coming through as we've done in the past we can phase investments, we still have further productivity opportunities to go after across the organization and we're setting.
On a record backlogs.
And.
We've been able to weather the chip supply issue without losing any business.
And those deals in backlog is pretty pretty strong statement about the resilience of our pipeline and the markets that we serve.
Yeah.
Thanks for taking my questions I'll pass it on.
Thank you.
We will take our next question from Connor Lynagh with Morgan Stanley . Your line is open.
Yes. Thanks, just wanted to talk a little bit about cash flow and capital allocation. So on the cash flow side Youre. Your full year free cash flow guidance does seem to anticipate some pretty good relief on working capital investment in the back half.
I'm just thinking through it looks like you have a capex acceleration, obviously, we can sort of get to that EBITDA number. So is that is that because you think that you will be starting to work down inventories or is that just sort of a seasonal release in working capital that you are anticipating.
Yeah, No I you know great. Great question, we do we do have a plan to start working down some of our inventory through the back half of the year. Its nothing dramatic it's going to take place over the next six months on a very gradual basis, you know and I think we are our teams have been doing a good job on the.
Elements around working capital, we are going to continue to lean in hard on collections and make sure. We bring those those in and that we've seen really good results through the through the pandemic on our collections front and you know similarly, we're doing work around getting better terms from a payables perspective.
I may have referenced it on another call we have a supply chain financing program, that's quite active and it allows our supplier base to take advantage of our credit rating, we're getting more of our supply supplier base engaged on that program and that will give us some incremental days from a payables perspective, and you know I think it all ties into.
<unk> being prudent also around costs and discretionary spend and our capex spend to make sure we start seeing a better cash conversion in the second half, which lines up with our historical seasonality as well.
Makes sense and then I was noticing it looks like you slowed your cadence of buybacks in the quarter is that driven by you know any concern around the state of the business is it because youre starting to see more opportunities emerge on M&A, just any color on what youre thinking there.
Yeah, So we haven't changed our strategy or our capital allocation strategy. We've typically bought stock back in the first quarter, which is when we have a vesting dates in our equity compensation programs and so this was nothing nothing new we bought back stock in Q1, we wrap that up at the in my in the March time.
Frame and you know as we look at our M&A funnel and pipeline now we still see you know I'm really we're really encouraged by the funnel the range of opportunities and you know that remains a higher priority for us than than buying back our stock Yeah. I would just add to that if you look at our balance sheet, we've got upwards.
$4 billion of dry powder.
And you know we're not hesitant.
To do a deal when it needs to be done, but again that would all be in advanced disturbing our strategy that we've laid out.
As Sandy said the pipeline is very active all different size of opportunities in that pipeline, but again, we want to continue to be disciplined and selective.
With an eye towards significant value creation.
And again as I always say it takes two to tango.
Right makes sense I'll leave I'll leave that comment for somebody else to ask about but.
[laughter].
We will take our next question from my Colorado with partner with Baird. Your line is open.
Hey, good morning, everyone. Good morning, Mike.
He thinks that so the obviously you guys seem pretty Thompson and the underlying trends of the end market and you know you spent a lot of time talking about the.
No your ability to react as things do so here or there, but how do you see backlogs really strong maybe you could talk a little bit about how that visibility from the backlog stretches out here, how does that compare to what that normal visibility looks like and <unk>.
Any color you can around how much book how booked out you are as we get to out years at this point.
Yeah, I think Mike really really good question.
Thank has changed structurally about our you know our backlog if you look at our AWS business that has a larger book to bill ratio than the other the other segments and we're carrying record backlogs across really all three of our all three of our segments.
And we did see really strong book to bill ratios across the portfolio in the quarter from an orders perspective, you know as we look at our water infrastructure and and then C. S backlogs they stretch out for longer periods of time water infrastructure is in the middle you know we have our transport business.
What's it turns fairly quickly and a treatment business that extent has projects that extend out for multiple years.
And then M and T S. As though is the longest you know coupled with the supply chain constraints, which don't magically disappear at any one months you know we have a $2 billion backlog. There. So that's going to take you know a couple of years to couple years plus to work to work through.
Okay I appreciate that and then the price cost cadence sequential improvement.
Catching up on the price side relative to the inflation pressures how does that work in the back half of the year on an EBITDA dollar basis. When do you think you're a whole what do you think margins.
Start, reflecting the positive pricing you're putting through.
Yeah, I mean, we were really pleased with what we saw from a price perspective, we've leaned in harder on price because inflation is also coming in higher throughout the year.
Hum.
Big milestone, we did get price cost positive in the quarter from a dollar perspective, you know given the magnitude it's slightly dilutive to the rate in Q2.
Q3 is a little bit lower from a seasonality a little bit more on the revenue side compared to Q2, just because of the typical seasonality in our water infrastructure business and so in Q3, we expect to continue to be price cost positive on a dollar basis, probably still in the same order of magnitude about 30 days.
Points this quarter and that order of magnitude dilute diluted from a rate perspective, and then we think in Q4, we should be positive again from a dollar perspective and neutral from a rate perspective, so really good progress across across the portfolio to reach this important milestone.
Thank you Mike if I can if I could just go back to your question on visibility and backlog I think the other dimension that we feel much better about now that we even did in the last.
Industrial downturn is the visibility.
And the closest we have to our channel partners, our distributor distribution channel partners. Both here in the U S as well again.
Europe .
Where we have meaningful indirect channel business.
And we've got much better visibility in coordination with them now than we did back then so we you know we got hit with a couple of surprises last time around in a quarter.
Or two we feel much better about that not happening going forward. So they are also our eyes and ears of what's going on in marketplace at a local level.
Thanks for that Patrick Thanks Sandy.
Thanks, Mike.
Well take our next question from Scott Davis with the most research your line is open.
Hey, good morning, everybody Hey, good morning, Scott.
A couple of little things here.
The supply chain issues, I mean chips have been talking about for quite some time.
Other supply chain challenges gotten a lot better than non chip related stuff getting materials faster easier.
Yes.
Sure.
Scott now there's another great question, it's a mixed bag.
No I'd say supply chain in the aggregate has modestly improved versus Q1, but it really does vary across the three segments. So you know as we mentioned chip supply to getting a bit better within Mcs, but lead times are still long, but they're not worst they're getting they're getting better.
And water infrastructure.
We have seen improvement in lead times from our European factories into the U S.
And certainly water infrastructure has benefited over the last year by offering more competitive lead times due to better vertical integration that.
We did win within the company.
I would say as we mentioned earlier one of the reasons, we're carrying an extra month of inventory is because of applied water is not limited to apply water, but that's the main driver and Thats really again, just knock on effects in China, mainly castings, but also we see continued delays in shipping.
In logistics that we're just having to work through it so I'd say, it's getting marginally better across the board, but it really varies by segment.
And we talk a little bit about China.
How does it work.
When you think about there in a controlled economy like that in their capex budgets and how they think about cadence and projects and Stephane.
You have the Lockdowns like you've had this year does it.
Does it push the projects to 2023, but then the existing 'twenty three plan remains.
They try to catch up.
Yeah, just everything pushed right and how does China kind of work sure yeah. So obviously.
If it's a big market. So it does vary depending upon the the the vertical you know the end markets that we're talking about.
What we find is that the utility side is much more stable. So right now the issue for us has not been so much.
For our plants not to be up and running now we return back to kind of normal levels in terms of staffing and presence back in May I believe it was a it.
It really though is the logistics and transportation had been at a standstill.
Because customers and colleagues are required at home.
Sure.
These impact all kinds of projects, Scott, but mainly the government funded projects.
But that's not a bad thing because those projects don't go away they simply shifted a right and we would see from the past that there would be an accelerated catch up as the restrictions are lifted so we've got plenty of capacity in our factories <unk>.
And as to your distribution partners to get the stuff out.
It's simply a matter of sites not being open I mean.
Customer job sites utilities, not being open that's what we're waiting to see recovery, we're not assuming that we're going to get much if any recovery in the second half of this year.
But we do expect that to recover to come back.
Quite strongly in 2023.
But no no structural changes in our view on on the attractiveness of China. This is simply things moving to the right.
Okay. That's really helpful. Best of luck. Thank you. Thank you.
Well take our next question from Brian Lee with Goldman with Goldman Sachs.
Your line is now open.
Yeah.
Sure James.
Brian Your line is now open Hey, Hello. This is miguel on for Brian .
Just a quick question on the on the on the supply chain on the chips and a lot's been talked about there, but it sounds like on chip supply. It's it's definitely.
Our commentary sounds a it's it's improving but you know some of them. Some of your peers has still been kind of been more more cautious on the chip supply is there anything at all.
On the supply side or what Youre doing specifically that maybe is helping you out a bit more recently versus peers.
You know you.
Can't speak for all of our peers I think we have been working very as we said earlier, we're working very closely with our suppliers that trajectory on where we exit the year is very consistent with what we expected.
It's been good work to get some you know some some better kit supply earlier and you know also within EM and see US there has been some other product lines that have been strong as well, it's not only the the chipset drove the upside in them and so yes. So we're seeing good results from our test business.
And traction with our pipeline services business and so you know that broader portfolio is also helping us get out ahead of what we had modeled for the for the year, yeah, because the only thing other thing I would add which I I.
I'm cautious to share too much on this because.
You know, we've got good visibility, but it's not perfect because things can change, but I do think depending upon who you're including in that peer group. It talks about digital.
You know, we've got a somewhat higher concentration therefore, we get a bit more leverage with suppliers and we've got some really strong relationships with our partners whether it be the direct suppliers from the chips and wafers or whether it be our partnership with flex we aggregate our demand and I think it gives us extra.
Longer platform at least stronger than what it would be if we were doing it all on our own. So some of these things. Its also just spend a minute.
The number of calls and I and others have been on a you know with the leaders of these companies and you just got the team that's been working at and we've had to be more patient and we wanted to but I think those I think those relationships and those are investments and relationships are beginning to pay off.
Understood. Thanks, a lot of I'll pass it on appreciate the color.
Yes.
We will take our next question from sorry for that ski with Jefferies. Your line is open.
Good morning.
So you highlighted strong growth in dewatering applications across most geographies could you talk about the benefit that had on margins in the quarter and should that continue to be a margin tailwind for the remainder of the year.
Yeah. So if you look at water infrastructure from where our dewatering business said, we saw really good margin performance and we know that business has been the most resilient when we look over the past past couple of years and you know certainly there the recovery in dewatering is a it is a contributing.
Factor and so there are a lot of hard work has gone into our dewatering business both to diversify it from an end market perspective from a geographic perspective, we've made some purposeful investments in our fleet.
To make it more modern and current and now we're seeing that upside on the rental side is as well so certainly dewatering positive.
Good orders momentum there continue in the quarter.
On a global basis. So certainly certainly helpful to the margin expansion story within water infrastructure, Yeah, and I would just add it's I mean, it's certainly it's one of the shorter cycle businesses that we've got and it's not immune to a cyclical downturn just like it it gets it up on the way up.
I think the other area that we benefited from is a full on integration within our commercial team most notably in North America, where I think it's been upgrading leadership I think there have been investments that sandy talked about and the diversification hasn't really been away from heavy oil and gas and mining and looking at.
Or are.
Utility muni opportunities.
Where there's visibility with some of our other businesses in the portfolio. So good lead generation by sharing leads with their field services teams. So we're in the early stages of that but.
We've had some really good growth rates here Oh, maybe.
Yes double digit here through the first half of the year on the order side and we hope that continues.
And then obviously you talked a lot about it and it's yes, and kind of a strong growth outlook, there, but organic hours declined in the quarter. So just wondering do you expect to see orders turn positive again.
You know I think you know when orders you know we've had a real surge in orders over the past several quarters and so while the headline print on orders for M. C. S may have been negative when you look at the orders from a dollar perspective, we're still running well ahead.
Of what we're able to convert from a revenue perspective, I think we had $475 million of orders in the quarter, which is still a really good number relative to our revenue. The pipeline is continues to be robust and we're still in the early innings of the overall AMRI conversion journey.
You know about a third of the industry has converted to am I in the in North America. So there's still a lot of runway and you know we have a really differentiated product there that's getting gaining traction.
Yeah, I think as we said earlier you know I know none of us ever liked to be talking about difficult year over year comps. When you had big deals in a quarter last year, but it is there is some element of the nature of that business.
And you know, we'll certainly be.
Even more transparent going forward as to you know.
How big are those deals what other big deals are coming because you know it is a big rich pipeline right now that we're bidding on and so you.
We've been running hot for the better part of a year and a half or so on some big deals Big book, So, but we remain very positive on that pipeline.
Hey, Thanks for taking my questions. Thank.
Thank you.
We will take our next question from.
Anti capitalist with Citigroup Your line is open.
Good morning, everyone.
Good morning, Good morning, Patrick I said, maybe you could talk about what you're seeing on the municipal waterfront and how a J funding may be starting to flow in have you seen any of that funding yet and how are you thinking about that moving forward into 'twenty 'twenty three.
Yeah, No we've really we've not seen I mean, well first of all we see a demand and and in utilities very robust and especially here I mean stable in Europe . Good emerging markets, obviously ex China and was really strong in the quarter here and in North America.
We really have not seen anything meaningful all come through from a funding standpoint, yet so that would still be upside.
And you know we talk a lot about the infrastructure bill here in the U S. But as I mentioned in my prepared comments you know you've also got the recover and resilient funding going on in the U S. You've got at the country level in the U K is a five year process that we talk about and then you've got to get the <unk>.
What's your funding that's embedded in China's five year planning cycle, which remains unchanged. So all of those together, we think really point to a very strong funding infrastructure for utility spend globally.
Got it that's helpful Patrick and I know Sandy you talked about price costs improving.
As we've mentioned productivity in the past seems like it's also improving but maybe you can talk about that how constrained labor is and you're sort of pushing productivity as you go forward and how that impacts the overall price cost dynamic.
Yeah. So I think we were price cost positive excluding productivity in the quarter. So that was that was really encouraging you know we have a pipeline of continuous improvement project product projects.
That we're driving across the portfolio some of that has been a little bit constrained. This year as we've moved engineers off of continuous improvement projects onto redesign work.
Patrick talked about earlier in the call is that work matures and we moved to the sort of the test and certification part of that process, we'll be able to bring some of our our resources back and focus on continuous improvement projects and and you know continue to pick up momentum on the productivity scientists as well.
But I think he's looking across the globe. Our teams are doing a good job there and it's contributing to our margin improvement story on a quarter sequential basis.
I appreciate it.
And we will take our next question from Joe.
Janitorial with Cowen Your line is open.
Oh, Hey, guys. Good morning, Hey, good morning, Hey, Joe.
Hey, so when you think when we when we start when it all normalizes on supply chain you look back at how it went and you think about AWP sorry, when you think about Mcs like.
What do you think youre going to come out thinking like this is what we did really well. This is something that we need to like structurally maybe she altera going forward to kind of immediate reality.
It's a great question I think.
Right now Joe.
Certainly as I look at it and Sandy can certainly comment here.
I think what we're gonna look back on and say we did.
Quite well is up.
Now the getting through the.
The chip supply.
And holding a team together holding morale are people spending days and nights and weekends over and over and over again on the phone with suppliers customers working our commercial teams are working with customers keeping them on board nobody happy.
But the team's fortitude.
Really showing through and it continues to show through I think two.
The fact that there had been no cancellations.
And a record backlog is a testimony to that and no decline in the margins of that backlog due to chip supply.
Our margins have been impacted by some of the near term choices, we've had to make on spending money on and Redesigns on selling some mechanical meters in at lower margin than than our other meters and so.
Those I think are all going to be in the plus column I think if there were things that we could have done differently. The one that comes to mind for me was I think we probably waited a little too long to get going on some of the redesign work and I don't think we missed it by much but I think we all learned that the sooner you get on that the bedroom.
It takes them it takes a while.
To sort through that.
So that would be my high level takes on this but you know we're not we're not out of it yet so.
Still have time to reserve the right to get smarter.
That's good color. Thank you Beth and then.
Maybe I'll ask one some of your more international products. We've been hearing this from some other companies that have you seen like increased.
International competition from like maybe competitors, who are selling in U S dollars, but have little fully local currency cost basis. So they don't really need to raise prices because their margins are benefiting and you guys are in a comparably.
Will you talk where situations are you seeing any of that.
You know again, we're really not seeing anything anything meaningful on that front. We're seeing you know across our end markets with our competitors that they are also taking price increases I mean, nobody has been immune to inflation in this in this market and so you know we have been the price leader.
Where we have competitive advantage and so we have a we have a structural probably somewhat.
Structure than some of our peers or other companies that you're following on that are our competitive base for products that we prefer for example sell out of Europe . Those product lines are also predominantly European competitors. So we've got great footprint, whether it be in Italy, whether it be in Sweden, whether it be in the U K. So.
And we've reduced our lead times on still being able to ship those things into the U S. In the North America, you know the markets. We serve our competitor there there are for the most part are U S. Based companies also so there's.
There is just structurally not that big of a of a disadvantage vis vis our competitors, where we're kind of all in the same boat.
And we don't take that for granted we're always looking for ways to further localize in and take cost out and reduce lead times.
Thanks.
Yeah.
Yeah.
We will take our next question from John Walsh with Credit Suisse. Your line is open.
Yeah.
Hi, good morning, and wanted to play nice quarter.
Thank you. Thank you I appreciate it.
Lot of ground covered question around price cost.
One just wondering if you could talk about what you're seeing sequentially, but some of the big cost buckets be materials logistics et cetera, and then I know you've done some structural pricing initiatives just how much of the price you think is structural and.
How much might be tied to surcharges. Thank you.
Yeah. Thanks, Thanks for the question John Yeah, I'll take the last one first and then when you look at what we've done from a pricing perspective, we haven't taken the approach to tack onto surcharges. What we've done is more permanent price increases so that that's been our roadmap there.
Let me get a little bit of color from a price perspective, we saw a big step up in our price realization from Q1 to Q2.
We would expect that to moderate in the back half of the year because it was the second half of the year last year that we started turning on our price increases so that will level out a bit in the in the second half and you know I think the other thing I would just close with to remind people you know there's been some headlines on some moderation in commodity.
Reising you know.
We're still seeing inflation in many of the other categories freight labor overhead etcetera, and so you know we're still facing an inflationary environment.
But you know net net Oh, and we're gonna be in a better place in the second half of the year than we were in the first half.
Yeah.
Yeah.
Great and then maybe just as a follow on any color you can provide kind of last time, we saw commodity deflation.
Experienced I mean, obviously as you just noted it's more than commodities, but just curious historically.
The ability of the <unk>.
<unk>.
Yeah. The the you know if you take one example of when we were in the heavy tariff situation.
And then a number of those tariffs were rolled back we did not give up those increases.
Because of the value that we were selling to our customers understand they understood. The situation we were in and so.
Historically, when there has been a rollback in material inflation, we've been pretty successful at hanging onto that so I think almost entirely successful in doing that but I'm sure there isn't any.
Exception or two here or there, but it's in the headline numbers they don't roll back.
Great. Thanks for fitting me in and taking the questions I appreciate it welcome.
We will take our next question from Paul Miller Cough with Raymond James Your line is open.
Thanks for taking the question.
Obviously supply chain problems of affect everybody and.
I probably touched on this.
A quarter ago or are you seeing any situations, where some of the smaller middle market players that could.
Could be prospective acquisition targets for you.
Are you know struggling disproportionately and no, perhaps creating kind of an opportunistic situation for you to look at M&A.
You know, it's it's it's an interesting question and I think it was perhaps raised earlier in a previous quarter. When we were all even more knee deep into supply chain challenges.
We haven't really looked at it that way, we havent really seen I mean, the companies that we look at our high quality.
And they may not always be a big scale.
But they are pretty good at managing their supply chains as well I mean, they're much more focused on a product line or a couple of offerings, having said that I do believe.
And this speaks to maybe the question that that Joe asked earlier.
I think all of US look at supply chain now as being one of the new most important competitive advantages that a company needs to have because whether it be chip supply. This time, it'll be something else down the road.
In the water so interdependent at this point in time, and we've got a whole lot better ourselves, we still have ways to go.
But I do think that it can be the form of a new synergy going forward, but it's not prominent in our thinking about the specific pipeline that we've got right now.
Understood.
A follow up about the U K, specifically there was a.
Report from.
I think one of the government experts the other day, saying that without the implementation of smart water metering.
The U K would be experiencing outright water scarcity by the end of the decade.
Yes pretty striking headline.
Just thought I'd get your perspective on that.
Yes.
I wont prognosticate on you know the prediction, but what I can reinforce is.
The lead.
So awful lot, which is the office of water and the U K. They regulate the 17 or so utilities that serve the U K and that five year Amp cycle. They go through there is a preamp a piece of that where they all have to come forward with their proposals in order to get their funding approvals there right.
Cases proved up and all that it's all of that is published very visibly as to what are the top three priorities that each utility is focusing on their mandate to have that and we can confirm that in this last cycle. Unlike any cycle before virtually every one of utilities when you look at.
What they were trying to solve for.
It was things around scarcity it was things around water losses.
And how they do all that in an affordable efficient way so that common theme.
It was a big deal and then also in some cases, a climate change impact in terms of flood prevention and building more resilient infrastructure. So there is there is a lot there it.
It makes it a very attractive market.
<unk>.
So hopefully that was helpful.
Thank you very much.
Thank you.
We have reached our allotted time for questions I would now like to turn the call back over to Patrick Decker for any additional or closing remarks.
Thanks, everyone for your time today for your continued support I know, we've run a bit long here I appreciate the questions and the interest.
I Trust you all have a very safe and enjoyable.
Maynard your summer Ah I know you're knee deep in earnings season. So we appreciate your time and your attention and now I look forward to hearing for you again.
Thank you. This does conclude today's xylem second quarter 2022 earnings Conference call. Please disconnect. Your line at this time and have a wonderful day.
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