Welcome to the Xylem First Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on 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. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Matthew Latino, Head of Investor Relations. Please go ahead.
Thank you, Ashley. Good morning, everyone, and welcome to Xylem's 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's 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'll ask 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 investor section of our website at www.xylem.com. A replay of today's call will be available until midnight on May 11.
Please note that replay number is 1-800-934-5153 or 1-402-222-01182. 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 Xylem's 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 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 will 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 a first quarter operational result above expectations. Revenues grew 4% organically, surpassing our guidance. Despite ongoing chip shortages constraining our utilities business, supply is slowly improving, 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 a standout, delivering 10% growth in the quarter. 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&CS set the fastest pace with a 25% order surge as the value proposition of digital technologies continues to fuel demand. Orders performance across the portfolio pushed our already healthy backlogs to 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 continued to drive productivity and further simplification throughout the business. As a result of that good work from the team, we delivered EPS of $0.47, 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 flow-on effects for some time in the global supply chain. While our European business delivered exceptional revenue growth, the euro rate began to move unfavorably.
Conditions are dynamic, but 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. We have market leadership in the categories where demand is greatest, especially in digitally enabled solutions. 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 Sandy for performance detail by segment, I wanna 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 money for the humanitarian relief work of our NGO partners, whose activities include providing essential water and sanitation services both in Ukraine and to refugees. It's become one of our most successful match giving campaigns ever, and I could not be prouder of the team. 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 delivering on our commitments, with particularly strong performance on price and backlog execution. Revenue growth was healthy in all regions, 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 in short, 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% on increasing activity in all geographies, 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% in the quarter. As Patrick mentioned, the quarter set historically high order intake with robust demand for our technologies across all segments. EBITDA margin was 14.2%, which was above our guided range, primarily driven by stronger than expected price realization.
Year-over-year EBITDA margin contracted 290 basis points. We got 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 metering solutions. As previously mentioned, we'll continue to offset inflation with progressive price realization. Our EPS in the quarter was $0.47. Please 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 remained strong, and we saw revenue acceleration in our U.S. wastewater utility business as prior quarter order-to-revenue conversion delays eased.
Geographically, results were mixed for the segment. The U.S. and Western Europe were up mid double digits, driven by treatment deliveries 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 from their recent COVID lockdown. 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. Geographically, the U.S. was up mid double digits. All end markets showed strength, and we benefited from the traction 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 and activity. Segment EBITDA 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. Now let's turn to slide seven, and I'll cover our Measurement & Control Solutions business. M&CS orders grew 25% organically in the quarter, reflecting continued strong demand for our metrology solutions as well as healthy demand in pipeline assessment services. While a portion of our M&CS backlog includes orders that have been delayed due to chip shortages, our M&CS backlog is up 60% versus the prior year. It is now more than $2 billion.
As we intensely anticipated, revenue declined 9% due to constrained chip supply. We are encouraged by the gradual improvement in availability, and we realized significant quarter sequential gains. It's worth noting that the growing metrology backlog is both margin accretive and resilient. There have been no cancellations of AMI awards. 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%. 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.
Now let's turn to slide eight for an overview of cash flows 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 1.5 x. 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, Sandy. We'll turn to 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 $0.05 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 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'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 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. In 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.
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. 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 detailed the strategic pillars that would enable us to deliver them. They included making it easier for customers to do business with us, making it easier for our colleagues to serve them, and continuing to reduce business complexity. Today, alongside our quarterly results, we've announced that we are further unifying and simplifying our segment and region leadership. Since the acquisitions that created our M&CS segment, we maintained a separate commercial interface to 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 in building a single platform, one that leverages the market-leading breadth of our portfolio and makes it easier for customers to access it. We've previously done that across the rest of the world, except North America. 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 M&CS segments.
In Europe, Hayati Yarkadas continues to lead commercial operations as well as the water infrastructure segment and will now lead the build-out of Xylem services offering globally. Franz Cerwinka will continue to lead commercial operations across the emerging markets. As a result of the changes we've announced today, Colin Sabol will 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 Colin, and so you know he has been a stalwart contributor to Xylem's growth story since the beginning. In his 16 years with the company, both 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&CS orders growth 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 is highlighted in our annual sustainability report, which we'll publish later this month. I won't steal too much of its thunder, but I'm happy to share that Xylem is well ahead of schedule in reducing carbon emissions. Since 2019, we've reduced our greenhouse gas intensity by 12% across scope one and two emissions.
We've 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. I invite you to dig into the report when it comes out, because 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 guide.
Thanks, Patrick. Consistent with our previous presentations, we have 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 on 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 the clean water side, we continue to expect demand to remain very robust as the AMI and the advantages of the smart meters continue to gain momentum with an increasingly broad spectrum of utilities. With double-digit revenue growth in the second half on improving chip supply, we expect full year revenues to be flat. We expect continued momentum in our test and assessment services businesses due to increasing focus on infrastructure and climate challenges. Please turn to slide 11. Looking at the industrial end market, we continue to expect mid-single-digit growth on 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 the US and Western Europe, we expect solid order rates and backlog expansion as activity continues to ramp in 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, up from mid-single-digit growth on solid replacement activity and new product introductions in the US and Europe. In residential, our smallest end market, we now expect mid-single-digit growth, up from low single-digit to mid-single-digit growth on healthy demand. Now let's turn to slide 12, and I'll walk you through our updated guidance.
As Patrick mentioned, our outperformance in the first quarter is giving us brisk 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. We are lifting full-year organic revenue growth to 4%-6%, up from 3%-5%. The 1% organic growth increase is driven primarily by stronger 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-$2.70, which boosts the low end from $2.35. This reflects strong price realization, which will be partially offset by inflation and the euro FX headwinds.
The emerging impact from a weakening euro is significant to us. Our initial full year guidance assumed a EUR 1.13. Our updated guidance now assumes a EUR 1.05, which is a $0.10 headwind to the full-year EPS guide. 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 impact from China's COVID lockdowns and the secondary effects of the war 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. Although 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%-17%, and this yields adjusted EPS range of $2.40-$2.70 that I just mentioned. We still expect free cash flow conversion to be 100% of net income. We have also provided you with a number of other full year assumptions on the slide to supplement your models. 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. M&CS is expected to decline low double digits. We expect second quarter adjusted EBITDA margin to be in the range of 14.5%-15%, a sequential improvement over the prior quarter. With that, please turn to slide 14, and I'll turn the call back over to Patrick for closing comments.
Thanks, Andrea. We came into 2022 in a strong and enviable position, even in the face of headwinds from chip supply and inflation. Our performance in the first quarter has shown the team's ability to capitalize on our market leadership and deliver 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. 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 is 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. As you likely saw in our March announcement, we made the decision to move Xylem's 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 from around the world, multilaterals, academia, and civil society. We've also taken the opportunity of the move to reimagine 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'll be officially opening the space in mid-June, and I 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's 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 Matt's energy, accessibility, and professionalism. I've benefited from his insightful counsel and his persistent positive encouragement through every kind of circumstance. Thank you, Matt. Some of you have already met Andrea van der Berg, who's taking the reins as our investor relations leader.
Andrea 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 will find great value in working with her and from her insights and perspectives. Now, operator, I'll 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, we do ask that while you pose 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 Markets. Please go ahead. Your line is open.
Thank you. Good morning, everyone.
Morning, Dean.
Morning, Deane.
Hey, maybe we can start with M&CS, and just, you have more encouraging news on the chip shortage front. Can you give us a sense now you've got record backlog. I'd be interested in hearing what the implied margins are and maybe some sense about. Customers are giving you these orders knowing they're going to be delayed to a degree. It doesn't sound like you've lost any competitive positioning there. Maybe we can start there. Thanks.
Sure. Thanks, Deane. I'll start with the latter half of your question, then I'll have Sandy speak to the margin profile in more detail. You're right. I mean, we've I think the team's done a great job working both with the suppliers of chips, but also with our customers on hanging on to deals and backlog. We've had no losses of deals here in terms of cancellations. You know, also what we're seeing is really good traction in terms of momentum, especially around mid-size utilities, as we're seeing greater adoption there as well, which is really encouraging. It smooths out kind of what our demand is gonna be over time.
What we would say on the chip supply, as we said in our comments, is that, you know, 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. Really encouraging. Sandy, you wanna speak more to the margin profile?
Yes. Thanks, Patrick. You know, I think, Dean, when we look at the profile of the orders that we've been bringing in, 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 this quarter sequential improvement, even from Q4 to Q1, where we've, you know, had about a $20 million pickup in revenue and seeing very good, you know, margin recovery as the revenue line grows. You know, very, very satisfied with the profile of the orders that we've been bringing in.
Not out of the woods yet, Deane. 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. Then the follow-up questions are on the recent headwinds. Look, FX has always been. We know your exposure, that's the math, and I'm glad you laid that all out. How about reflection on China? It's roughly 8% of revenues. Just true me up on that. How, what's the expectations on how this plays out? We know your headquarters is in Shanghai, and just some real-time update and expectations.
Sure
the reopening.
Sure. Thanks, Dean. Yeah, so our revenue exposure is roughly $350 million, about 7% of our total revenue. You know, the impact in the first quarter was about $20 million in revenue. Our guide implies another $20 million in Q2. So, you know, first half of the year right now will be down about 20% in revenue. Second half, we expect to be up about 20% because we saw some of the impacts of lockdown even in the fourth quarter still lingering in China. We got four factories in China. As you said, we got our headquarters in Shanghai. You know, 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% at utilization. Our Nanjing plant, which is the one that supports our Applied Water business, it actually never closed. That's the reason why, you know, AWS actually had mid-single-digit growth in China here in the first quarter. We expect there to be a gradual opening in China. You know, we think it's all manageable within our guide. Obviously, there's a risk there. You know, our people are all safe and sound, and they're working their backsides off to make sure we deliver on our commitments.
You know, we did talk about also that there is the, you know, global supply chain effect, and we think that's the one that really is kind of the wild card going in the second half of the year. We feel that we've got that embedded in our guide.
That's all helpful. Just, you know, lastly, with all the comings and goings, wanna wish Colin all the best. We'll miss him. He's a class act, great insights on the water sector. For Matt, well-deserved promotion. I still have his cell phone. Just letting him know that. His accessibility.
Same here with the new phone, Deane.
Welcome to Andrea as well. Thank you.
Thank you, Deane. Really appreciate the comments.
Thank you.
We'll take our next question from Michael Halloran with Baird. Please go ahead. Your line is open.
Hey, good morning, everyone, and just wanna echo Deane's comments on the comings and goings.
Thank you, Mike.
First on the utility side of the equation, it's kind of a broad question because it's both for the wastewater and the water side. You know, you look at the tailwinds that are emerging there, really across regions, and it just feels like there's 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 on a pretty good track.
I think 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, you know, what's happening in Europe, from a geopolitical standpoint and focus on moving towards, you know, oil and gas alternatives, et cetera. Will money be, you know, derailed or directed there? That's not even the way that the funding mechanisms work in Europe, from a water utility standpoint. We think even that's, you know, pretty robust at this point in time. I think in the near term, the challenges remain, in our case, chip supply, and just being able to continue to execute what we have in our pipeline.
Our bidding pipeline, you know, remains very healthy, you know, north of almost $2.5 billion in the bidding pipeline at this point in time. Again, I'm paid to be paranoid. We're looking at any storm cloud out there that we could possibly see, but it feels pretty healthy right now.
How far out are your backlogs stretching at this point? How do you think about the conversions? Just 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. You know, help give some magnitude for how far out you have visibility at this point.
Yeah, I think great question, and it obviously varies by segment. You know, when we look at our AWS segment, that's where we typically carry, you know, a very small backlog. As, you know, we look over the past 18 months there, orders have, you know, really been high, and we've been constrained from a delivery perspective because of supply chain challenges. In that case there, we have, you know, a backlog that gives us really good coverage for the, you know, the next quarter, next couple quarters out. You know, in Water Infrastructure, it's a little bit of a mixed bag. You know, we have some short cycle businesses there, and we have some longer cycle businesses there.
In the shorter cycle thing, you know, we have coverage as we look out for more coverage than we typically have as we look out for the rest of the year. M&CS, you know, the story there is, you know, we keep getting orders that are outpacing the amount of revenue that we're able to deliver. I think it's gonna take us, you know, about two years to catch up on the demand that we have today and the balance between supply chain.
Mike, I would offer up, I think, you know, to your question around visibility from an overall market sentiment standpoint. You know, our bidding pipeline, especially on the treatment and, you know, on the wastewater side, meaning treatment, and even on the clean water side, being metrology, we've got visibility there and a bidding pipeline of at least two to three years out. That's why we're speaking with the level of confidence around what the overall market sentiment is.
Thanks for that. Follow up then, it's the capital deployment side, you've been pretty constructive the last few quarters on what the pipeline looks like and seems optimistic on your ability to convert some of that pipeline. Maybe just an update on what you're seeing in the market and how actionable it is.
Sure, yeah. We've you know, we still feel really good, Mike, about the pipeline in terms of opportunities, and they range from you know, larger opportunities who have moved into you know, various end markets. Even the small to medium-sized opportunities that are there, we've got some things here that we're pretty excited about in the near term that hopefully we'll be able to execute on. More to say there over the coming quarter or two. You know, in general sense, you know, I feel, certainly we feel the M&A pipeline is as healthy as it's ever been. We're you know, we continue to be disciplined on valuation.
Really appreciate it. Thanks, everyone.
Thank you.
Thank you.
We'll take our next question from Connor Lynagh with Morgan Stanley. Please go ahead, your line is open.
Yeah, thanks. I just wanted to follow up on that capital allocation conversation. You know, 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 of that, how you think about share repurchases. You know, how do you weigh the competing uses of capital between organic investment, M&A and buybacks, and sort of how you would pay for M&A?
Sure, yeah. You know, again, we come into the year with a really strong balance sheet. You know, Sandy laid out what our firepower is at this point in time. We are not hesitant to do deals. Obviously, we're gonna be disciplined around valuation. I would not preclude equity from being used in the right situation, but it's not our first lever to really lean on. You know, around capital deployment in general, we also don't see, you know, M&A and, you know, any repurchase 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 realize now there are times to be opportunistic, given the current environment. Again, we think we're able to be both opportunistic on share repurchase as well as still do strategic M&A. You know, these are not binary decisions in our case.
Makes sense. I just wanted to follow up on a separate line of questioning from earlier, which is basically, it seems like your customers at this point have to be pretty aware of what's going on in chip supply chain. I'm curious, have they changed their behavior around, you know, awarding new contracts? You know, is most of the ordering that you're seeing related to existing customer relationships, or has the pace of newer deployments stayed steady, accelerated, decelerated? On the other side, are you changing how much you're bidding, you know, where in terms of timeline or how aggressive you're being on some of these bigger projects given the time to deliver?
Sure. Great question. So let me parse it apart a bit. In terms of existing contracts and deals, you know, 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. They realize that, you know, we're not 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 wanna continue to move forward and execute these things. You know, the likelihood of them going back is minimized in that context. Are they frustrated? Of course. We all are.
You know, we've been weathering this for a while now, and we've been working closely with them to find alternatives to meet their needs, even though it may not be the level of metrology they'd originally spec'd. It's good enough right now to move forward, but still with a clear view of what the original approved implementation is gonna look like. In terms of new deals, yes, this is not just with existing customers. We're winning a number of new customers along the way, especially in that medium-sized part of the utility sector, which is really encouraging for us.
In terms of changing our own behavior, you know, we've been very disciplined along the way on being very open and forthright on what delivery frictions are right now, so that we are not overpromising and under-delivering to any new deals that we're winning. We're being very clear about that. 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.
All right. Thanks very much.
Thank you.
We'll take our next question from Nathan Jones with Stifel. Please go ahead. Your line is open.
Good morning, everyone.
Good morning, Nate.
Good morning.
Good morning, Nate.
Patrick, I'd like to follow up on some of the comments there about medium-sized utilities starting to adopt this AMI technology. You know, all of the conferences I've been going to, which admittedly are probably larger utilities that are attending those, but seems like the shift to AMI is going to become ubiquitous here and it's, you know, the inflection point's been hit, and I don't think there's any doubt that that's getting adopted. It's definitely encouraging to hear about medium-sized utilities beginning to get on board with that kind of stuff. Can you talk about the market opportunity that that presents? 'Cause I know a few years ago when you bought Sensus, it was really targeting those larger and leading utilities to try and drive that waterfall down into the market.
Just any update you can give us on what you're seeing out there, what that market opportunity could be, how long that drives this high level of order growth for you?
Sure, Nate. It again, good question. You're right. You know, we had been very focused on the larger utilities initially, because in many cases, as you well know 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 minds and their own investment plans. Oftentimes for those medium utilities, they're looking at entire implementations of AMI as opposed to maybe for a larger metro area, it could be sections of a city.
When they make the decision to go full scale, it takes them a little bit longer to make that decision because it's a bigger strategic choice for them to make. It is encouraging to see that level of adoption happening. They also, their timing, typically is tied more to the retirement of the existing metrology deployment that they have within their cities or communities. 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 gonna happen all within a few years.
It's gonna be staged out over, you know, a decade or more, at least across the course of the U.S.
Which is then good for long-term demand trends, I think, is the point that I'm trying to get to out of that you should have that steady stream of.
Yeah
... continued orders in the M&CS business. I did wanna ask one on-
Yeah. Nate-
Oh, go ahead.
Hey, Nate. Sorry, just really quickly, I mean, just 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 50,000 water utilities. The largest majority of those are small to medium-sized. That's why we're so excited about this part of the market.
Yeah
than half of that market has adopted AMI.
Yep. I did wanna ask one on price costs. 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 margin compression that you saw year-over-year. Great to see the 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 close that gap and to generate more price to cover the inflation that you're seeing in the business?
Yeah, you know, great question. Great question, Nate. You know, this is something that our teams have been very focused on. Since we saw inflation start to rise last year, we've implemented, you know, numerous price increases. In some cases, we had to work through existing backlog before the new prices took effect. We saw a big step up from Q4 to Q1 in our price realization. You know, as we look forward throughout the year, we would expect that to continue to ramp in each successive quarter. You know, as we look at Q1, you know, our price did cover material inflation and freight, but you're right, we were still underwater. We didn't cover sort of our labor inflation or overhead inflation. As we look out to Q2, you know, we expect that to be neutral.
In the second half of the year, price should outpace the inflation effects. You know, I think it is important to note in our guide, we did increase it for stronger price realization based on what we experienced in Q1 and what our, you know, outlook is for the next quarter. We also did up our inflation outlook.
The point there is that by the second half of the year, those price and inflation numbers that you put on the first page of the slide deck, price is gonna cover all of that inflation.
That's our expectation.
Great. Thank you very much.
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,
Sure
Quick ones, follow-up questions from the prior questions. On price cost real quick, so price cost seemed negative in the first quarter. I think that was expected. You just mentioned expected to improve for the rest of the year. Is the expectation still for the full year that the price cost would be positive?
That's our expectation for the full year. Yes.
Okay, thanks. That's helpful. I appreciate all the additional color on the backlog on M&CS. So the backlog gives you visibility on orders for, I think you said, the next two to three years. I know you haven't seen any cancellations yet, but at what point would customers consider canceling orders if the lead times become so stretched out? Or maybe is there a way to think about it where are customers intentionally placing orders well in advance of projects to get their spot in line? Hopefully that makes sense.
Sure, yeah. We've not seen any. You know, there's been no double ordering in that regard. I mean, the team is very disciplined around that. You know, the nice thing about these large metrology implementations is we know exactly what the endpoint count is that they need. We work very closely with our customers there to make sure that we're not taking duplicate orders. You know, we are prioritizing customers. We have some allocation. Obviously, we're trying to prioritize those that are most stressed at this point in time. You know, you never say never on these things in terms of at some point in time somebody canceling.
I think, again, as I mentioned earlier, the customers understand that there are, you know, few other alternatives, and these implementations have gone through such rigorous, long-range regulatory approvals, and they're so critical to their own revenue generation capability, that as long as we're able to, you know, meet their kind of basic demand as best we can and give them as full transparency as possible, we've been very proud and very pleased in working with them, as well as with our chip suppliers. You know, we talk a lot about the customers. You know, we are working as closely as possible with our suppliers, to, you know, redesign a number of our chip requirements for next generation. We're redesigning our own products to meet minimum needs here in the immediate term.
There's, you know, it's a multifaceted angle here, and that's why I'm so proud of the effort of the team to navigate this, including our customers' patience.
Great. Thanks. I appreciate that. I'll pass it on.
Thank you.
We'll take our next question from Andrew Buscaglia with Berenberg. Please go ahead. Your line is open.
Hey, good morning, guys. I was looking into.
Morning.
Just looking at your organic growth guidance raise. Underlying, excuse me, that Applied Water is really the only one you nudged up. I was surprised Water Infrastructure, you weren't willing to take that up. Could you comment on that first off, and then secondly, shouldn't we start to see some of, like, the benefits of this water infrastructure stimulus bear fruit later this year? Or what are you guys thinking on that front?
Yeah, yeah. You know, I think when we looked at adjusting our revenue guide and our forecast, you know, the primary reason that we adjusted it is for stronger price realization. We're seeing that in AWS more than any other segment.
You know, as we look out for the rest of the year, we're still monitoring, you know, chip supply for the other segments. Water Infrastructure has a high concentration in China. When we saw the impacts in Q1 from China, they were largely concentrated in Water Infrastructure, and that's also where we'll see the impact in Q2.
On the infrastructure bill, no real meaningful change there. I mean, we do think it's gonna be a positive over time. Don't really see that being a big impact here in 2022 as things continue to settle out. We see that more as a benefit in 2023 and beyond.
Yeah. Okay. Just to be clear, so that you got it, you obviously expect some nice price-cost tailwinds in the back half of the year. Based on your Q2 guidance, it really does assume pretty big step-up in margins in the second half. Is there anything else specifically that, you know, would provide that tailwind beyond just price-cost, or is it?
You know, recent cost savings or anything that you expect will drive higher incrementals or something like that?
It's really four things. You know, you touched on the first thing. The first thing is price cost, and that will continue to improve throughout the year. The second thing is chip supply in M&CS. As that revenue ramps in the second half, it has very good contribution margins. The third point I would say is China. You know, we have revenue declines in the first half in China. We're expecting to see a good pop in the back half in China. You know, we announced today some leadership changes. We're pursuing some simplification opportunities, and some of those will drive cost savings.
Yeah
In the back half of the year as well.
Okay. Yeah, presumably free cash flow, same thing. You're in kind of a hole in Q1, but as that EBITDA goes up, you'll generate more cash and then 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 quarter. You know, as we work through the rest of the year, one of the things you may note is 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. You know, we're gonna be thoughtful as we try to work that down in the back half of the year.
Yeah. Okay. Thank you.
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. I have a-
Thank you, Scott.
Sorry to beat a dead horse here on this, Sandy, but you know, the pricing and the, you know, the price cost. Now, I think I heard you say during your prepared comments that you had increased your assumption for inflation. I'm just wondering what other metrics you can give us around pricing would be helpful, whether it's where you're expecting that ramp to go in the second quarter, what your full year pricing will be. You know, because the gap is still pretty large right now, so anything you can give us on pricing, you know, to give us a little bit more color on what you mean by ramp. Thanks.
Yeah. You know, I think, you know, just to give you some context, Scott, in Q4, we had about 200 basis points impact from our price increases. That doubled to 400 basis points in Q1. You know, we would expect that to continue to increase. You know, since the invasion of Ukraine by Russia, we've seen some of our commodities increase our costs, particularly around stainless steel, which is impacted by nickel. As we roll forward inflation assumptions for the next three quarters, we see, you know, more headwinds in the neighborhood of $40 million-$50 million. 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. You know, our teams are acting quickly.
We've changed some of the practices around price increases. We used to have a 60-day lag time between when we announced a price increase and when it went into effect. you know, now we're down to less than two weeks across our businesses.
I would just offer up, Scott, that, 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. You know, the market really has shown a level of resilience in this area. I think, again, you know, we've been acting as a leader in this area and, so, you know, pleased and, as things continue to move from an inflationary standpoint, we'll continue to act responsibly.
Yeah. Who would have thought.
The other thing I would add, Scott, is the impact on our margins. It's price cost has gotten a lot of attention. The secondary impact is mix. When you look at our revenue mix with M&CS being down this year, the revenue that we've lost because of the chip supply constraints comes with high margins.
Yep, get it. I was gonna say, who would have 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 M&CS that is being held up by the shortages? You know, like, you know, if you got it, you could ship it, you know, kind of thing. What's that percentage?
You know, I think if you look at our M&CS backlog, it's around $2 billion. You know, we have, I would say between 20% and 25% of that backlog is held up by the chip delays. That's, you know, that's been growing each quarter because our orders have been outpacing our revenue conversion.
Yes. Got it. Lastly, Sandy, I know as you entered here, you know, I guess it's over a year ago now. I don't know, have you ever calculated it or you and Tony calculated what is the organic sales rate that you guys need to generate, you know, a certain level of operating leverage? You know, is it three, five? I mean, how do you look at that?
I'm not sure I totally follow your question, Scott. You know, I think when we model our long-range plan, we, you know, understand assumptions around inflation. We also set productivity targets across our organization, both in the manufacturing centers and across the functions. You know, we have a goal as an enterprise for productivity to outpace inflation. Now, the past 18 months have been a little bit different, but that's our overall philosophy.
I think, Scott, I mean, trying to parse out your question here. I mean, if you think about the incrementals in this business, I mean, any dollar of growth that we get in this business is gonna drop, you know, very healthy incrementals to the bottom line, you know, between the 30%-40% range. In terms of what we've laid out in our long-term guide is, you know, in that mid-single digit range, which obviously really drives heavy margin expansion, especially given the mix with M&CS. 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 is.
Yep. I got it. Thank you both.
Thank you.
We'll take our next question from Pavel Molchanov with Raymond James. Please go ahead. Your line is open.
Thanks for taking the question. First on the M&A front, given that, you know, blue chip companies such as yourself are struggling with semiconductor and other component availability, you know, it's presumably safe to say some smaller players are struggling even more. You know, does that create any kind of opportunistic, quasi-distressed M&A opportunities that, you know, perhaps you would not have seen a year ago?
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, you know, again, we really focus on, you know, the strategic logic behind them in terms of for the long run. You know, we kinda look through this 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 heightened our view on any particular asset based upon chip distress.
Understood. Following up on Europe, the weakness in the currency, does that reflect any underlying softness in kind of European GDP and demand patterns that might impact the volume in the second half of the year?
Not as we see it. You know, based upon our experience in Europe, you know, over many years, Europe is 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. It's less reliant on new CapEx. And even when there is new CapEx, the funding mechanisms tend to be pretty well sheltered, at least in the larger economies across Europe. I'm not saying there are no economies that are not immune to it, but we've really never seen big swings there on, you know, on the CapEx side.
In terms of what we do see is, you know, the lion's share of our business there is repair and replacement, which is very stable, very steady, as well as really attractive margins. We feel, you know, pretty confident right now around the outlook for Europe as we see it today.
Got it. Thanks very much.
Thank you. Ashley, I think. Do we have any more questions?
Yes, I apologize. We'll go next to Joseph Giordano with Cowen. Please go ahead. Your line is open.
Hey, guys. Thanks for squeezing me in here.
Sure, Joe.
We 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, like, just starts causing demand destruction because projects start to not make sense and customers are like, "I understand why you're raising, but I'm just not gonna buy right now"?
You know, Joe, it's something that our teams stay close to every day. You know, that's one of the biggest challenges, obviously, in this kind of inflationary environment is, you know, where is that limit? You know, we're always looking at, you know, win-loss ratios. You know, we leverage our capabilities in Salesforce and our bidding pipeline there to get a feel for what that trade-off is. The team stays very close to that, and we look at that on a regular basis. Until we see meaningful moves in that win-loss ratio, that tells us that we need to continue to make sure we cover, you know, the inflationary impacts.
What we're encouraged by, you know, thus far is that, you know, in the areas where we've taken price increases, we continue to see volume growth, you know, in those businesses. That's a good, healthy indicator as well. It's not something by any means, Joe, that we take for granted. Something we're very, very close to.
Just last, Patrick, I think raising the low end of the guide was, you know, it was such an important kind of tone here for you guys, but just on the other side of that, was there thoughts on trimming the high end? You know, maybe talk through your thoughts around that and/or what the scenario is that gets you there this year.
Sure. Yeah. I mean, you know, yeah, you know, you can imagine, you know, all management teams spend a lot of time thinking about when you make a change in guidance, you know, how you wanna approach that. We just felt that, you know, it was prudent at this point in time and confident to raise the lower end. Trimming the top end, you know, we still see a path there. Obviously, you know, things have to go in the right direction. You know, obviously there are clouds on the horizon that every company is seeing right now, but we see a path there. You know, we'll continue to monitor that. In terms of what those are, it's what we've talked about before.
You know, we need to continue to see pricing momentum. We need to continue to see improvements in the chip supply and delivery around those areas. You know, hopefully we'll see some improvement on the outlooks for China. China's 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, Joe.
There are no further questions at this time. I'll turn the call back over to Patrick Decker for additional or closing remarks.
Well, thank you all again for your time and attention this morning and for your support. Look forward to catching up with you between now and the next earnings call. In the meantime, stay safe, stay well, and wish you all the very best. Thank you.
Thank you. This does conclude today's Xylem first quarter 2022 earnings conference call. Please disconnect your line at this time and have a wonderful day.