Xylem Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
November 1, 2021

There are 15 speakers on the call.

Operator

Welcome to the Xylem Third Quarter 2021 Earnings Conference Call.

Speaker 1

Your

Operator

I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.

Speaker 2

Thank you, Ashley. Good morning, everyone, and welcome to Xylem's 3rd quarter earnings conference call. With me today are Chief Executive Officer, Patrick Decker questions. And Chief Financial Officer, Sandy Roland. Tony Melando, our Chief Supply Chain Officer is also joining today's call.

Speaker 2

They will provide their perspective on Xylem's 3rd quarter results and our outlook. Following our prepared remarks, As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website at www.xylem.com. A replay of today's call will be available until midnight on November 9. The telephone replay will be available at 1-eight hundred-eight thirty nine-eight 70seven or 1-four zero two-two twenty questions. Additionally, the call will be available for playback via the Investors section of our website under the heading Investor Events.

Speaker 2

Please turn to Slide 2. We will make some forward looking statements on today's call, including references to future events or developments that We anticipate will or may occur in the future. All references will be on an organic or adjusted basis unless otherwise indicated. These statements are subject to future risks and uncertainties such as those factors described in Xyrem's most recent annual report on Form 10 ks and in subsequent reports filed with the SEC, including in our Form 10 Q to report results for the period ending September 30, 2021. Please note that the company undertakes no obligation to update forward looking statements publicly to reflect subsequent events or circumstances, And actual events or results could differ materially from those anticipated.

Speaker 2

In the appendix, we have also provided you with a summary of our key performance metrics, including both GAAP and non GAAP metrics. For the purposes of today's call, all references will be on an organic and adjusted basis unless otherwise indicated. Non GAAP financials have been reconciled for you and are in the appendix of the presentation. Now please turn to slide 3 and I'll turn the call over to our CEO, Patrick Decker.

Speaker 3

Thanks, Matt. Good morning, everyone, and thank you for joining us. By now, you'll have seen that the team delivered a solid third quarter performance with earnings and margins above our expectations. The fast pace of orders growth that we saw in the first half of the year has continued With orders up 20% in the quarter, driving our backlog up 34%. That commercial momentum reflects Strong underlying demand for our solutions, which continues to be robust in all segments, markets and geographies.

Speaker 3

Nevertheless, supply driven constraints and volumes slowed the conversion of orders to revenue. A month ago, We indicated a probable $100,000,000 impact on full year revenue driven by the global supply chain environment. The continuing shortage of electronic components, especially microcontrollers and other chips is particularly affecting players with large Scheduled solution businesses like Xylem. So we're reflecting those ongoing challenges and our full year view. Having raised guidance at the end of the first and second quarters, we now anticipate that the constraints on volume will moderate our full year revenue Growth to between 3% 4% and bring adjusted earnings per share into a range of $2.40 to $2.50 which represents roughly 20% EPS growth over last year.

Speaker 3

The growth in the orders and EPS reflects the privileged position we're in. Macro trends in our sector are driving durable and increasing demand for sustainable digital water solutions. And the team is executing on a clear strategy to drive above market growth and expand margins as our portfolio continues to digitize. This quarter has been a vivid demonstration of those trends. Still given the impact that supply headwinds are having on volume, we'll provide some additional color on what we're seeing and how the team is addressing those conditions.

Speaker 3

I've invited Tony Melondo, our Chief Supply Chain Officer to join us on the call today. But first, Let me hand over to Sandy to look at the Q3 in more detail and then we'll turn to a discussion of the market landscape that we see through the end of the year. Sandy, over

Speaker 1

to you. Thank you, Patrick. Please turn to slide 4 and I'll cover our Q3 results in more detail. Revenue grew 2% organically compared to the prior year. Utilities, our largest end market, was down 5% Despite continuing strong demand, the decline was driven by supply chain impacts on order conversion, especially chip shortages, slowing M and CS deliveries.

Speaker 1

Industrial was up 11%, led by continued growth in emerging markets in Western Europe. Commercial grew 10%, led by the ongoing recovery in the United States, while residential, our smallest end market was up 4%. Geographically, emerging markets was up high single digits with particular strength in Eastern Europe and Latin America. Western Europe was up mid single digits, While the U. S.

Speaker 1

Declined modestly. As Patrick mentioned, the team delivered exceptional organic orders growth of 20%, which was broad based across all segments and regions. In fact, year to date order volume is higher at this point of the year than in any previous year in company history. MNCS led the way with nearly 40% 42% orders growth driven by large smart metering contract wins, impact of longer lead times and pent up demand from a COVID-nineteen impacted prior year. We're exiting the quarter with an overall backlog up 34%.

Speaker 1

And as expected, we are seeing positive momentum on price realization, which will continue ramping through Q4 and into 2022. Looking at other key financial metrics, margins were above our forecasted range with EBITDA margins coming in at 17.9%, reflecting strong productivity and good cost control by the team. Year over year EBITDA margin contracted 30 basis points as inflation and strategic investments were largely offset by productivity, price realization and cost containment. Earnings per share in the quarter was $0.63 Please turn to Slide 5, and I'll review our segment performance for the quarter. In Water Infrastructure, orders were up 9% on strength in wastewater transport wastewater utilities were down modestly, mostly due to delays in ocean shipping.

Speaker 1

Industrial demand was broad based across all regions. Regionally, emerging markets delivered high single digit growth, led by increasing industrial dewatering activity. Western Europe was also up driven by resilient wastewater OpEx spending and recovery in industrial applications. The U. S.

Speaker 1

Was down modestly due to the shipping delays I just mentioned. EBITDA margin expanded Over the prior year, a strong productivity savings, price realization and volume leverage more than offset inflation and investments. Please turn to slide 6. In Applied Water, orders were up 17% organically in the quarter on broad industrial strength and commercial recovery. Revenue grew 8% in the quarter from continued commercial momentum and industrial growth in most regions.

Speaker 1

Residential growth moderated slightly due to volume constraints. Geographically, the U. S. And Western Europe both contributed 6% growth due to the uplift from commercial and industrial. Emerging markets were up 13% on continued strength in China and gains in Eastern Europe.

Speaker 1

Segment EBITDA margin contracted 60 basis points compared to the prior year as inflation and investments more than offset productivity benefits questions. And now please turn to Slide 7 and I'll cover our Measurement and Control Solutions segment. In MNCS, orders were up 42% organically, as I mentioned a moment ago. Our MNCS backlog now The bidding pipeline remains very active as customer demand for advanced digital technologies accelerates. Organic revenue was down 5%, which is a tangible effect of chip shortages.

Speaker 1

Water applications were down modestly As growth in our Test and Assessment Services businesses largely offset lower sales from smart metering. Due to the digital composition of our metrology portfolio, it has a greater exposure to chip shortages. By geography, Western Europe was up 1%, while emerging markets was flat. The U. S.

Speaker 1

Was down mid single digits. Segment EBITDA margin in the quarter was down 60 basis points compared to the prior year as volume declines from component shortages And higher inflation offset productivity and price realization. And now let's turn to Slide 8 for an overview of cash flows and the company's financial position. Our financial position continues to be very strong. We closed The quarter was $1,300,000,000 in cash after paying down $600,000,000 of debt in the 3rd quarter.

Speaker 1

Free cash flow conversion was 57% in the quarter, in line with our expectations and we continue to expect full year free cash flow conversion of 80% to 90%. Net debt to EBITDA leverage was 1.3 times at the end of the quarter. And now please turn to Slide 9 and I'll turn the call back over to Patrick.

Speaker 3

Thanks, Sandy. The team has clearly done a great job delivering a solid quarter's earnings in difficult circumstances. I want to give a special shout out to ourselves, service and supply chain teams. They've been pulling out all the stops to care for our customers despite the unusual challenges. Let's turn to the quarter now and look forward.

Speaker 3

Since the supply chain environment has everybody's attention, we want to provide more detail on what we're seeing and the actions we've been taking. So I've asked Tony Belanda, our Chief Supply Chain Officer to walk us through that. Tony, over to you. Thank you, Patrick. Questions.

Speaker 4

I'm sure many of you are already familiar with the various dimensions of stress on the supply chain across all sectors. Material shortages are having at least some effect on each of our segments with particular challenges in microcontrollers and other chips. In addition, logistics times have continued to lengthen and carrier reliability is at an all time low. We're also seeing labor tightness in markets where we have significant manufacturing, particularly in the U. S.

Speaker 4

Of course, all of this has contributed to inflation across commodities, We're managing the challenges with both short term mitigations and longer term actions. In the short term, we're committing freight with carriers nearly 2 months further ahead than usual. We're using fast boat options to gain access to smaller ports and thus improve lead times. And we've accelerated value engineering and dual sourcing. To create more resilience beyond that, We're working directly with our technology manufacturers to firm up allocations well into 2022 beyond.

Speaker 4

We've dedicated teams to accelerate product redesign around components that are unavailable or nearing the end of life. And we're taking advantage of this opportunity to take strategic actions around SKU rationalization. One more thing to mention, albeit with a slightly greater time horizon. There's been a lot of discussion about cross border supply chains. Our developed markets largely depend on global supply chains.

Speaker 4

What we've seen is that in several cases, the current challenges aren't hitting our emerging markets nearly as hard, simply because we have well established localization strategies there. So to that point, we'll continue to drive our strategy of making where we sell, always evaluating the benefit of shortening domestic supply chain. Patrick, that's the overview. Of course, I'm happy to go into more detail

Speaker 3

Thank you, Tony. So now turning from supply to demand, It's essentially the opposite story. Bidding pipelines are very active, order space continues to be brisk and we are not seeing project cancellations. We're staying as close to our customers as we are to our suppliers and doing everything we can to keep them served and in turn to help them serve their communities. Just last week, we had about 500 of our customers join us at our annual Xylem Reach user conference.

Speaker 3

These are utility operators who are at the forefront of digitizing their networks with AMI and advanced analytics. What we continue to hear from them is that the value they're getting from these technology deployments continues to grow. In the short term, Supply constraints are top of mind for nearly all of them. And from their vantage point, they're seeing the same challenges industry wide. So they're being patient and staying as flexible as possible.

Speaker 3

On longer term demand, the Trends driving the water sector are more durable than the causes of today's supply headwinds. One example is the growing market for sustainable solutions. A month ago, we announced Xylem's commitment to net 0 greenhouse gas emissions and to science based targets. Over the next 2 weeks, the water sector will be turning out in force at the COP26 climate conference in Glasgow To encourage utilities around the world to do the same, Xylem will be sharing platforms at COP utility leaders as they call on their peers questions. To also make net zero commitments with the aim of decarbonizing the entire sector.

Speaker 3

More than 65 water utilities around the world have already done so. And it's a movement that's gaining momentum, which is just one reflection of the trend toward technologies that affordably decarbonize water systems. Turning back to the near term drivers in our end markets. I'm going to hand it back over to Sandy to share some detail on what we're seeing and to lay out our guidance for the balance of the year.

Speaker 1

Thanks, Patrick. The full year outlook for our end markets remains largely consistent with our view from last quarter, With the exception of utilities, underlying demand for our technologies continues to be very strong in both wastewater and clean water. But in the immediate term, we expect growth will come down from a range of mid to high single digits to flat. Questions. On the wastewater side, we have seen steady performance in Western Europe on resilient utility OpEx and continued growth in emerging markets as a result of large capital projects and our localization efforts there.

Speaker 1

Ordering rates remain solid in the U. S, but revenue growth is challenged by constraints on volume. On the Clean Water side, demand for smart water solutions and digital offerings continues to be robust. However, consistent with our earlier commentary, the impact of chip shortages is particularly acute in the clean water end market. And now please turn to Slide 11.

Speaker 1

Looking at the industrial end market, we continue to anticipate growing in the high single digits. Water in business in emerging markets as well as share gains with OEMs and the impact of the new product introductions in Western Europe. We're also seeing continuing strength in marine and food and beverage driven by ongoing recovery in outdoor recreation and the hospitality sector. We are also maintaining our high to mid single digit outlook in the commercial end market. The U.

Speaker 1

S. Business continues to recover at a brisk pace as new commercial buildings begins to ramp and key leading indicators reflect optimism for continuing recovery in the institutional sector. The same growth in Western Europe and China is coming from new product introductions and energy efficiency mandates. In residential, we're maintaining our expectations of low teens growth for the full year on strength of backlog and continuing market momentum. Now let's turn to slide 12 and I'll walk you through our updated guidance.

Speaker 1

For Xylem overall, We now see full year organic revenue growth in the range of 3% to 4%, down from the previous range of 6% to 8%. This reflects the adverse effects of chip shortages and other supply chain disruptions. This revenue guidance breaks down by segment as follows. For Water Infrastructure, we maintain our expectations of mid single digit growth. We expect high single digit growth in Applied Water, down from low double digits.

Speaker 1

And in Measurement and Control Solutions, we now expect to be down mid single digits rather than up mid single digits.

Speaker 4

We are

Speaker 1

now expecting EBITDA margins in the range of 17.1% to 17.4% compared to our previous guidance range of 17.2% to 17.7%. This guidance represents full year margin questions. Our adjusted EPS guidance is now $2.40 to $2.50 Our cash flow conversion is in line with previous guidance at 80% to 90%, putting our 3 year average right around 130%. We have provided you with a number of other full year assumptions to supplement your models. Those assumptions are largely unchanged from our original guidance.

Speaker 1

We have updated our euro to dollar conversion rate assumption for the Q4 from 1.18 to 1.16. And as you know, foreign exchange can be volatile, so we've included our typical foreign exchange sensitivity table in the appendix. Now before wrapping up, let me share some thoughts on our 4th quarter outlook. We anticipate total company organic revenues will be down roughly 4% to 6% in the quarter. This includes flattish growth in Water Infrastructure and Applied Water We expect 4th quarter adjusted EBITDA margin to be in the range of 16% to 17%.

Speaker 1

And with that, please turn to Slide 13, and I'll turn the call back over to Patrick for closing comments.

Speaker 3

Thanks Sandy. Just in the last couple of days, we've been recognizing Xylem's 10 year anniversary. The Xylem ticker started trading a decade ago when the company spun out of ITT. Some of you have been with us since the very beginning And I want to say thank you for your confidence in us. 10 years ago, it wasn't nearly as obvious to the market that water was an investable thesis, much less that it was about to become a growth sector.

Speaker 3

Our anniversary has been a reminder to reflect on how much progress we've made. I genuinely believe our team has created something special. And along the way, we've been creating a lot of value. Xylem's total shareholder returns have been nearly double the S and P 500 over the decade. Supply chain are a good reminder that growth rarely happens in a straight line.

Speaker 3

But the trends driving demand in the water sector are only intensifying. And we're strongly positioned on those trends. We have an outstanding purpose driven team that's passionate about solving the world's water challenges. We built technology leadership on the foundation of a durable business model. We're benefiting from the growing market for sustainable solutions and we're driving growth and margin expansion on the back of digitization, All of which underpins our commitment to the growth framework that we laid out last month at our Investor Day.

Speaker 3

So I'm confident that our current market momentum will carry us strongly into 2022 and beyond And we're happy to take any questions you may have. Operator, please lead us into Q and A.

Operator

The floor is now open for your questions. We'll take our first question from Scott Davis with Melius Research. Please go ahead.

Speaker 5

Good morning, everybody.

Speaker 3

Hey, Scott. Good morning. How are you doing?

Speaker 1

Good morning, Scott. Good morning.

Speaker 5

I'm good. It's a busy day here, but The comments on chip shortage are not unique just to you guys. But can you help us understand, Particularly with Tony on the line here. I mean, how does this work? Do you know when you're getting chips in?

Speaker 5

Do you have visibility around deliveries? Do we get a bunch of them in, in January and then you're able to make deliveries in 1Q next year? I mean, Help us understand a little bit about how you think about when you get chips and when you can actually and visibility around that?

Speaker 4

Sure. I mean, we deal with our contract manufacturers and our electronic suppliers. We give them forecasts and it's very similar in a way we deal with all of our materials. We provide forecasts in advance. We're committing forecast out over 12 to 24 month horizon depending on the component.

Speaker 4

So it's not very different than anything else we do in terms of how we Supply in, no more complicated than that.

Speaker 3

I think the Scott to your question also, How quickly will this snap back? And Tony, maybe you can comment on that because we don't see this being all of a sudden to your question, Scott, In the month of January, a bunch of chips show up, and the problem is resolved. It's going to be a better duration here as we Work through the constraints, but Tony, you want to comment on that?

Speaker 4

Yes, absolutely. No, so there's a number of industries that are all clamoring as you guys know from the constraints, whether it's industrial or automotive For the personal electronics industry. So we're all looking for the same things. And so we are working very closely with our contract manufacturers and directly with our Technology manufacturers, the IDMs to make sure that they understand our demand and what they're committed to and we're looking to get those in Over the course of the next 12 to 24 months. And so we anticipate it to get better.

Speaker 4

We don't know when that's going to

Speaker 3

get better, But it will certainly we certainly do expect to get better as we move into next year. And I think Scott, there are a number of people that are out there right now that are prognosticating on when this is going to get resolved. And on when this is going to get resolved and there are different views across the board. What we're trying to do is to give you a very balanced responsible view, because there still is uncertainty. And Tony and the team are Working their backsides off to make sure that we get hopefully more than our fair share of allocation of the chips.

Speaker 3

And again, we'll know more about that as we come back around in our Q4 earnings call.

Speaker 5

And when you And perhaps goes to somebody else. I mean, are the lost revenue risk, I mean, mechanically help us understand that? Thanks.

Speaker 3

Yes, Scott. So yes, we've not Any project or order cancellations, things are moving to the right. The reality is our competitors are dealing with the same issues. And as I mentioned in my prepared remarks, customers are being patient, because they're seeing this as an industry wide issue. And when you think about the criticality of what we do here for especially utilities, It's a comment I made about our Reach user conference.

Speaker 3

We got a lot of really good feedback from again more than 500 attendees there And they understand the situation. So things move to the right. And I mean, do they have the right in some cases to cancel? Certainly, but they don't have other Right now to go for.

Speaker 5

Good luck. Thank you.

Speaker 3

Thank you, Scott. Thanks, Scott. Questions.

Operator

And we'll take our next question from Andy Kaplowitz with Citigroup. Please go ahead.

Speaker 6

Hey, good morning, guys.

Speaker 3

Good morning. How are you

Speaker 6

doing? Good. Maybe you could just give us more color on overall how you're thinking about getting ahead of cost pricing productivity. I know you've previously mentioned You raised price a number of times. Do you think you can get ahead of inflation logistics costs as you turn the calendar into 2022 with pricing and productivity?

Speaker 1

Questions. So we expected to start seeing that tick up in Q3 as we work through some of the backlog of earlier orders. And we would expect we do expect that momentum to continue to accelerate into Q4 and into 2022. When you look at where we stood in the Q3, if you look at price and material and freight costs as a basket or neutral. And as we move into Q4, we expect that will be modestly positive.

Speaker 6

Got it. Thanks for that Sandy. And then I want to follow-up on Tony's prepared remarks where he mentioned that Xylem is better positioned in emerging markets Because it is very local for local supply chain, whereas in developed markets maybe a little more of a global supply chain. So could you give us a little more color on what can Done to improve localization in developed markets. Does that mean a ramp up of investment here in the U.

Speaker 6

S. For example?

Speaker 4

Andy, good morning, Andy. So first of all, our underlying strategy is to make where we sell. So while in emerging markets, we're highly localized there. We're pretty substantially localized also in Europe and in the U. S.

Speaker 4

From a manufacturing perspective. But we will continue to move in that direction to bring local supply to those regions where the business case makes sense. So We are less localized in the U. S. And in Europe, but we're still substantially supporting those regions by In region supply chains basically.

Speaker 3

And there's definitely not a you should not expect Andy to see any significant uptick And either OpEx or CapEx to address localization in the U. S. This is not a material thing. It's more working with our suppliers And our 3rd party manufacturers to have them work with us to move that on an accelerated basis.

Speaker 7

Appreciate it guys.

Speaker 4

Thank you.

Operator

We'll take our next question from Deane Dray with RBC Capital Markets. Please go ahead.

Speaker 3

Thank you. Good morning, everyone. Hey, good morning, Dean.

Speaker 8

Good morning, Dean. It sounds like the supply chain conditions have worsened. This is true sector So no surprises there. But since your Analyst Day, a month ago, you had sized $100,000,000 that you thought would of revenues that would be pushed, some into 4Q and some into 2022. Where does that stand?

Speaker 8

Just your best calculation, how much did it end up getting pushed? It sounds like it was more than 100.

Speaker 1

Yes, Dean. I think let me size it up. I think 30 days ago, we thought that we'd have somewhere between $35,000,000 $40,000,000 impact in the Q3. We saw about $50,000,000 impact in the Q3. About Half of that was related to chip shortages and the other half related to sort of other supply chain delays.

Speaker 1

As things tighten, we've probably sized Q4 right around $120,000,000 And the greatest impact will be, again on the chip size. And that's why you see the guide in our MNCS business Down in Q4 quite a bit.

Speaker 8

All right. That makes sense. And if you just step back, it really does sound like The meter side of your business is most impacted because that does have exposure to semiconductor. So If you think about the shortfall, how much of that is centered in your meter business?

Speaker 1

When I look at Q3 and Q4 combined, I'd say about 65% of the impact is in our metrology business.

Speaker 3

And the large majority of that impact gaining Q4 is the metrology business. And again, that's again, it's not a demand issue. So it's simply shifting to the right and Something I don't think we shared in our prepared remarks, but it's important I think for everyone to see is when you look at the Whether it be the issues around getting access to chips, whether it be the port delays, the logistics challenges, the margin on our backlog, Which is shifted to the right, is equally as attractive as we had laid out at Investor Day. And so we're not giving up margins to chase Volume here. And that's where I think the partnership with our customers has been really, really important.

Speaker 8

That's helpful. And how about just Just stay on that backlog margin thought for a moment. Are you doing any like partial assemblies? We're hearing companies that are just lining up partial, nearly completed products in the hallways and so forth. And the reason this is important is when you do end up shipping those in the following quarter, you've already expensed a portion of that assembly and labor and so forth.

Speaker 8

So it actually goes out with decent margins. But just are you doing partial assemblies and where does that stand?

Speaker 4

Yes. Hi, Dean, this is Tony. Yes, we absolutely are. You'd see our inventory ticked up a bit. And part of that is a result of parts coming in being rescheduled, but also pre builds with waiting for those extra parts to come in so we can ship them out.

Speaker 4

So we're absolutely doing that.

Speaker 8

Great. And Tony, I love the color about using smaller ships in different ports. We're hearing about other companies doing that. So We applaud those efforts and keep up the good work. Thank you.

Speaker 9

Thank you, Dane.

Operator

We'll take our next question from Saree Boroditsky with Jefferies. Please go ahead.

Speaker 10

Great. Thanks for taking my question. The dewatering business and water infrastructure seemed like it was really strong. Can you provide more color on how you're thinking about demand in that business going forward? And should that be a tailwind for margins?

Speaker 1

Yes, great question. When we look across the portfolio And within our Water Infrastructure business in the Q3, this was a bright spot for us. We saw 8% growth in the quarter On revenue, we saw strong orders. And the cost structure in this business when we do get growth, it helps us from a margin perspective. So do you want to shout out emerging markets, doing really well in this business.

Speaker 1

We're seeing good strength in mining and some of the other industrial markets. And that's been a part of a key part of our growth.

Speaker 3

And it definitely is it's one of the highest kind of margin accretive businesses in the portfolio when we get that volume growth. So That certainly will help us as we go into 22.

Speaker 10

And then just sticking with MNCS, how does pricing work on some of these long term contracts? We will get price for some of the supply chain inflation that you're currently seeing within the current backlog.

Speaker 1

Yes. So I think this is We're pretty well positioned here. The way a lot of most of our MNCF contracts work, the longer term ones, There are escalator clauses embedded in those contracts where they look at a basket of price indexes questions and then we're able to adjust our prices based on where the index is.

Speaker 3

And this is a historically consistent situation that we've seen in the past when there have been periods of upticks in inflation or Supply challenges and part of the reason why we have that flexibility is again, we're not in this alone. Our competitors are also dealing with supply challenges. But 2, it also is the fact that These deals when they've been approved by regulators and authorities are being approved because they're going to be generating Significant revenue for utility. So it's in their best interest to go ahead and move these things forward even if they have to wait or take on some adjustment in price escalation. It really comes down to what our overall value proposition is with those utilities.

Operator

We'll take our next question from Andrew Boscaglia with Berenberg. Please go ahead.

Speaker 11

Hey guys. Question. Good morning. I guess, I guess the margin dynamics impacting MCS. But can you talk a little bit about you did so well on Water for structure on margins.

Speaker 2

Applied water was just a

Speaker 11

little bit, below what I was thinking. So I guess, what are the differences there that would, Yes, impact margins between those two segments.

Speaker 1

Yes. So I think there's a couple of dynamics. One was One of the points that we talked about through an earlier question, you saw the uptick in the dewatering business and that's good mix for us. So that helps helps margin. I'd say the other impact was there are some differences in inflation impacts between what we saw, for example, in our water infrastructure business and our AWS business.

Speaker 1

So it was more modest in our water infrastructure business.

Speaker 11

Okay. And, you've got about utility weakness. I'm wondering, questions. Are you seeing any initial signs of hesitation around spending given that this infrastructure stimulus Seems to be dragging on. We don't have quite the clarity we thought we'd have at this point in this year.

Speaker 3

No, we've not seen any signs of that in our bidding pipeline continued to be very robust. And again, the conversations We had with, again, this 500 plus utilities, at our Reach Conference, which is not just around metrology. This actually Beginning last year was the first time we had turned that into a Xylem reach conference. It used to be Census. And so the conversations we're having with utilities there are across the entire portfolio of solutions.

Speaker 3

The entire portfolio of solutions. There I've said before, I think that there is historically not Really ever been a reliance at the utility level on federal government subsidization or funding. Nobody's kind of relying on that in a significant way. Again, the orders activity in the U. S.

Speaker 3

Was up very, very strong. And again, it's really just comes down to some of the port and shipping delays that we're working through. But We've seen no hesitation in demand or order outlook.

Speaker 11

Yes. So those orders just keep you Confident that the demand is still there. I guess as long as we don't see cancellations that you feel confident there. Okay.

Speaker 3

Yes, that's correct. And again, I would reinforce that it's not just the orders in the backlog, but it's the margin on those orders in the backlog that remains robust.

Speaker 11

Yes. Okay. All right. Thank you.

Speaker 3

Thank you.

Operator

We'll take our next question from Nathan Jones with Stifel. Please go ahead. Your line is open.

Speaker 12

Good morning, everyone.

Speaker 3

Hey, good morning, Nate.

Speaker 1

Good morning, Nate. Hey.

Speaker 12

Just wanted to go back to MCS for a minute. Just under 3 $20,000,000 of revenue in the Q3. The guidance looks like it's maybe $300,000,000 of revenue or slightly below that. Is that kind of the level of revenue that you're restricted to with these chip shortages, logistics shortages and that's the way we should think about At least the next couple of quarters, 3 quarters until some of this stuff starts to loosen up? Or are there product redesigns or other things that you can do to try and boost that in the short term?

Speaker 1

Yes. I think, Nate, if you look at our guide for Q4, we're right in that neighborhood. We think that over time, the chip supply is going to improve and so that will gradually ramp. I think we've also seen some strength in some of our other businesses outside of metrology, which have Opportunity to grow sooner than that. So assessment services is part of our portfolio.

Speaker 1

Our test business is a key part of that portfolio with really good margin structures. So, we can grow there. The chip Supply will constrain us over the next couple of quarters, but we do expect that to gradually recover.

Speaker 3

And again, Nate, again, I go back. It's not this is not a demand issue. So it's simply a matter of when we're able To convert these orders into revenue. And again, we're not seeing any signs of cancellation. So and the bar has remained So I know you've heard me say that a number of times this morning, but I think it's an important point to reiterate.

Speaker 12

Yes. No, I'm just trying to get an idea of what the first half of 22 might look like in MCS.

Speaker 3

And Nate, we're trying to give you a responsible prudent view. There is a fair amount of uncertainty out there, not around backlog or margins, but we're trying to again, we're trying to be balanced here.

Speaker 12

Yes, it's about getting it out the door and not getting the orders in the door.

Speaker 3

That's right.

Speaker 12

On the localizing supply chains question. Question that people have been asking about. I mean the contract manufacturing that you're doing and the importing that you're doing, I assume it's mostly on the technology side and it's coming from Asia to Europe and the U. S. Is it even Possible to localize that manufacturing?

Speaker 12

Are there suppliers that you could leverage in the U. S. And Europe to localize that? Is it just cost prohibitive because they're much higher cost than Asian suppliers would be? Just is it even possible to do that?

Speaker 4

Yes. Hi, Nathan, it's Tony. So we our large contract manufacturing we use contract manufacturers everywhere, but the largest one that we have is Mexico actually. And so that's really supporting our U. S.

Speaker 4

Business. So it's largely the assembly and Some of the componentry is localized here. Now granted the electronics are coming from Asia. And so we continue to look at possibilities to bring that closer. That will be I mean that's not something that we're looking to do necessarily, but that's largely localized right now.

Speaker 12

Is it just not possible to localize that from Asia?

Speaker 4

Yes. On the chip side, it will be something that I think will be we'll wait for the supply base. The supply base is a little thin for chip suppliers In North America. So most of that still comes from Asia.

Speaker 12

Got it. Okay, thanks. I'll pass it on.

Speaker 3

Thanks, Nate.

Operator

We'll take our next question from Connor Lynagh with Morgan Stanley. Please go ahead.

Speaker 9

Yes, thanks. I wanted to return to water infrastructure and I wanted to clarify a comment you made before. Obviously, orders have been very strong within that business and I think you called out the dewatering business in particular EM as an area of strength. But is that the main driver Of the significant increase in orders this year or are there other areas that you would point to?

Speaker 1

In orders growth, The orders growth has been really across the board in water infrastructure. It's impacting we're seeing good growth on the treatment side And the largest part of our business is transport and so orders there have also been very strong.

Speaker 9

Okay. And then just thinking through that strength, I mean, this might actually be a better question for just the whole company, but you called out some change in the typical So order intake to actual revenue conversion or shipment timing. I'm curious How different that looks versus history because basically the order intake would suggest that 2022 is going to be quite a good year for a lot of the segments, but just hoping you Sort of frame how we should risk that relative to history.

Speaker 3

Yes. So the so this is Patrick. We won't comment yet on 2022. We'll come back around to that in our next earnings call as we give guidance for 2022. But yes, we do not have a demand issue here And water infrastructure and the challenges that we saw in Q3 and were weathering in Q4, We do believe to be more transitory and it really was around, again, some of the port delays and other freight challenges and shortages.

Speaker 3

So we think we'll get through those over the coming months here. And yes, we feel good about what

Speaker 1

And I think just the other question you had was about conversion time between when orders get placed and when converts to revenue. And certainly there is an increase in demand, strong demand. You don't put orders growth of the magnitude that we're posting. But we do acknowledge, everybody is recognizing that lead times are getting longer across the board. And so There is a bias for customers to put their orders in a little bit earlier than they usually have.

Speaker 9

Okay. Appreciate the context. Thank you.

Operator

And we'll take our next question from Praval Moshneel with Raymond James. Please go ahead.

Speaker 13

Thanks for taking the question. You alluded to the fact that everybody is in the same boat In terms of supply chain complications, with that in mind, are you seeing any distressed M and A opportunities in terms of acting as a consolidator with regard to some smaller players for whom the supply chain issues are perhaps even more problematic than they are for blue chips?

Speaker 3

Sure. We definitely see ourselves as being in a Privileged and strong position from an M and A standpoint, whether it be, again, our financial wherewithal, our bandwidth to do M and A, both financial and human, The balance sheet, and so we still remain very confident on that front. I don't know that I would say that question. The chip shortage and supply chain challenges are necessarily unlocking any opportunities that we would not have already had in our pipeline. We remain continued focused on what our priorities are strategically in that area.

Speaker 3

And that really is around we see some opportunities to do some bolt ins with utilities, industrial, Commercial building continue to be areas that we are very positive and very focused on. Again, it takes 2 to tango. And so again, we'll keep you updated on that. We feel we're very confident. We're very excited about the M and A pipeline.

Speaker 3

But I wouldn't say it's changed dramatically because of the supply chain situation.

Speaker 7

Okay.

Speaker 13

And the infrastructure builds in Washington. But given that the European Union Fit for 55 package is already finalized and very much being implemented. I'm curious if you've seen a pickup And customer activity orders from the EU within the context of their climate policy?

Speaker 3

Yes, I would say that not in the immediate term, although I would say We are hearing more and more discussion around that. And so we see that as being an opportunity a bit further out. And I think even the conversations around COP26 are providing a backdrop. And as I mentioned in my opening comments, we're going to be very prominent there as is the water sector. And So we do think that that bodes well for demand, but it's down the road.

Speaker 3

It takes time for these to convert into orders.

Operator

Question from Brian Lee with Goldman Sachs. Please go ahead. Your line is open.

Speaker 7

Hey, everyone. Good morning. Thanks for taking the question. Question. I know you all alluded to this, but I just wanted to understand a little bit more.

Speaker 7

If I look across the 3 segments, it seems like price Hasn't read out as much in MNCS versus Water and Applied Water. You mentioned sort of the inflation escalators in some of the Contracts and then some of the, I guess, regulators stepping in and approving those. But can you sort of give us A sense of the timeline for that? Is that sort of an annual review? And then if you do have unregulated utilities in your mix For the meter business, is the construct the same or is that case by case?

Speaker 1

Yes. So one thing, I think To level set, if you look at, 1st of all, inflation, where it's hit us the hardest, it has been outside of our M and CS business. It's been Higher because of the types of commodities that we purchased that we've seen greater inflations in these other two segments. Slides coming through in MNCS.

Speaker 3

Yes. So the just to add to that, Brian, when you look at our Metrology business, which is where the largest majority of our longer term deals reside. We typically have price escalation clauses built into them. And those are negotiated on a deal by deal basis. And so that really we expect that to roll through questions as those orders get implemented.

Speaker 3

And so we're less concerned around the margin expansion or price realization in that part of our company.

Speaker 7

Okay, fair enough. I guess that's sort of a segue into the second question I had. Just in general, There's been a lot of discussion here on the call around the chip shortages you're seeing. In terms of question. It does sound like it's less of an impact in that segment versus the others.

Speaker 7

Can you kind of give us a sense of what you're seeing there? And then At a company level, I think you're talking about seeing price costs go positive here in Q4. Would you say That's the same sort of timeframe for MNCS or is that more into 2022 as you see price readout?

Speaker 1

Yes, Brian, I think I mentioned a little bit earlier on the call that we were across the company, we were neutral from a price cost perspective in Q3 and that we expected that to turn positive in Q4 as we're seeing price realization sort of ramp sequentially through the year. And so we feel like in the 1st part of 2022, we'll continue to see that trend So our teams have worked really hard to be thoughtful and responsible as it comes down to price. This year we've taken multiple price actions. When we look sort of at Our expectations around where we thought inflation would be, we thought it would be around across the company around 3% at the beginning of the year. And it's going to turn out to be closer to 5% on an annual basis.

Speaker 1

And so that's been the reason we've gone out with price increases to keep that in balance.

Speaker 7

Okay. That's great. Helpful color. Appreciate it.

Speaker 11

Thank you.

Speaker 1

Questions.

Operator

We'll take our next question from Ryan Connors with Boenning and Scattergood. Please go ahead. Your line is open.

Speaker 14

Hey, Hey, thanks. Thanks for fitting me in. A couple of questions, sticking on the supply chain, I wanted to get your take on something that We've begun to hear just in the last week or so from some of the macro economists about sort of a surge in double ordering and even triple ordering In all sorts of products across the economy. And so I'm curious about what your take is on that on both sides of your business. Do you think there's any of that going on in terms of the orders that you're seeing from customers?

Speaker 14

And then on your side, are you doing any Access ordering and chips and other things to kind of stockpile supply just sort of place multiple orders, hope something gets through in time.

Speaker 3

Yes, sure, Ryan. I'll go first and then I'll have Tony talk about the what we're doing on the ordering side ourselves. I would say where we've seen some of that uptick in people trying to get ahead of the supply chain constraints has actually been more around the port delays, the logistic challenges, and some of those orders that we see, it's hard to put a specific number on it. But the order growth, I think, certainly in Water Infrastructure and most notably Applied Water, some of that certainly, which is largely book and ship business, Has been people trying to get ahead of the supply chain delays.

Speaker 13

Not that we aren't seeing any

Speaker 3

of that within MNCS, but The large majority of that business again is driven really by some of these large deals and those orders converting. So there's some ordering in advance, but it's less Prominent there than it is within the other two segments.

Speaker 14

Okay.

Speaker 4

Yes. And Ryan, I would just add that questions. We're not doing double or triple ordering. What we are doing is working with multiple suppliers to try to get parts wherever we can, whether it's brokers or distributors or The IDMs, but it doesn't I mean that's a natural outcome of the bullwhip effect is to double and triple order and double down on these things. But We're not seeing we're not doing that here.

Speaker 4

We're just working with multiple suppliers.

Speaker 14

Got it. Okay. And then my other one just had to do with Another thing that's been in the news a lot in the quarter is sort of labor issues and strikes in some big industrial companies like Deere, for example. And Your own financials reports say 17% of your U. S.

Speaker 14

Labor force is I believe most of that is census. Anything coming up there in terms of CBA negotiations or anything that anything we should you could share with us there?

Speaker 4

No, nothing with our unions. We have very good relationships with the unions around the world, particularly in the U. S. We are seeing labor tightness as we mentioned earlier in the script of particularly in the U. S, not so much in Europe or emerging markets.

Speaker 4

But we're not anticipating any challenges with our unionized facilities.

Speaker 3

And I would just add there as well that where we are Saying some of the labor tightness is in some of our distribution locations around the U. S. Where we are in High traffic distribution centers competitively, and that's obviously a very tight part of the labor market right now. So we've been taking actions to try to be more flexible, To try to get the workforce in hiring ahead, knowing that we're going to have some natural attrition. But as Tony said, it's really not to do with our unionized workforce.

Speaker 14

Got it. Okay. Thanks for your time.

Speaker 3

Thank you. Thank you.

Operator

At this time, I will turn the call back over to Mr. Patrick Decker for any additional closing comments.

Speaker 3

Well, thank you all very much. Really appreciate your interest, your support. I know we've covered a lot here this morning. Look forward to our follow-up conversations with many of you. And we'll see you on our next earnings call.

Speaker 3

And in the meanwhile, stay safe, stay well. And again, I just want to say thank you to all of you who have been a part of this journey of ours over the last 10 years As we celebrated yesterday our 10th anniversary of trading for the first time as Xylem. So thank you all very much and we'll be back in touch.

Operator

Thank you. And this does conclude today's Xylem's Q3 2021 earnings conference call. Please disconnect your line at this time and have a wonderful day.

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Earnings Conference Call
Xylem Q3 2021
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