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Xylem Q3 2022 Earnings Call Transcript


View Latest SEC 10-K Filing View Latest SEC 10-Q Filing

Participants

Corporate Executives

  • Andrea van der Berg
    Vice President, Investor Relations
  • Patrick Decker
    President and Chief Executive Officer
  • Sandra Rowland
    Senior Vice President and Chief Financial Officer

Presentation

Operator

Welcome to Xylem's Third Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for your questions following the presentation. [Operator Instructions] I would now like to turn the call over to Andrea van der Berg, Vice-President of Investor Relations.

Andrea van der Berg
Vice President, Investor Relations at Xylem

Thank you, operator. Good morning, everyone. And welcome to Xylem's Third 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 Third Quarter 2022 results and discuss the fourth 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 Investors section of our website, ww.xylem.com. A replay of today's call will be available until midnight on November 8th. Please note the replay number is plus 1 (800) 839-9881 or plus 1 (402) 220-3100. Additionally, the call will be available for playback via the Investors section of our website under the heading Investor Events.

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. 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.

Please turn to Slide 3. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. For purposes of today's call, all references will be on an organic and adjusted basis unless otherwise indicated. And non-GAAP financials have been reconciled for you and are included in the appendix section of the presentation. Now please turn to Slide 4, and I'll turn the call over to our CEO, Patrick Decker.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Andrea, and good morning everyone. We're pleased to announce a very strong third quarter performance, continuing our momentum from the first half of the year. Across the board the team delivered above expectations with all our business segments and regions posting strong double-digit revenue growth. And we see quite resilient demand in our backlogs and bidding pipeline. Overall, revenues were up 16% for the quarter beating the high end of our guidance by four percentage points. Applied Water grew fastest at 20%. Water Infrastructure exceeded expectations by the widest margin and M&CS came in right on target with healthy mid-teens growth. Regionally, Americas, Western Europe and emerging markets each grew mid-teens.

Demand in all of our largest end-markets continued to be strong, driven by the essential nature of our solutions and services and by the intensifying long-term trends in water. The team from our factories to our channel partners and distributors also delivered a tremendous operational performance. Their actions entirely offset inflation with very strong price cost discipline, and effectively managed through continuing chip supply constraints. That focus paid off in growth, but also with very strong EBITDA margin expansion. Margins exceeded the high-end of our guidance by 130 basis-points. This delivered on our previous commitment to significantly improve our margins in the second half of this year. Strong organic revenue growth and accretive margins drove third quarter earnings well-above expectations with earnings per share of $0.79.

As you all know, our key end-markets have consistently been resilient in the face of macroeconomic headwinds. And we expect that underlying demand pattern to continue. M&CS orders continued to be very strong. Water Infrastructure was up solidly. Backlogs continued to be up sharply year-over-year and the Digital Solutions proportion of our backlogs continued to expand. That said, some of our smaller end-markets are more cyclical such as residential within our Applied Water segment. Orders in those markets were down in the quarter and are expected to remain soft. Looking-forward, we anticipate the demand dynamics of the third quarter to continue into 2023. On supply, especially chip supply, the outlook remains consistent with what we said last quarter. As expected we, have not seen meaningful easing of chip supply constraints, but forecasting visibility has improved, as has the reliability of deliveries. We expect to exit the year as we've outlined before. Things are gradually improving. Given the resilience of our demand profile, the vitality of our business, and the team's strong operational track record in this environment we are raising our full-year guidance. We now expect full-year adjusted earnings per share to be between $2.65 to $2.75 on organic revenue growth between 9% and 10%.

In a few minutes, we'll discuss dynamics in our different end-markets along with some trends we're seeing through the current cycle. I'll also touch on how we're serving communities as they invest to become more resilient in the face of intensifying water challenges. But first, let me hand it over to Sandy to offer you some more detail on the third quarter.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Thanks, Patrick. Please turn to Slide 5. The team did a great job over-delivering on commitments with disciplined commercial and operational execution on continuing strong demand. As a result, revenues grew globally high-teens in the US and mid-teens in emerging markets and Western Europe on strong price and backlog execution as supply chains modestly improved. In a moment, I'll detail performance by segment, but in short Utilities was up 15%, led by strength in the US and Western Europe. Industrial grew 16% with strength across all geographies, particularly in emerging markets and Western Europe. Commercial was up 17%, mainly due to strong backlog execution in the US, and residential was up 19%, led by commercial execution and backlog conversion in the US. Global demand remains healthy on strong end-market fundamentals, especially in Water Infrastructure and M&CS. That said, organic orders were down 1% in the quarter versus up 20% in the same period last year. Water Infrastructure was up 3%, AWS down 4%, and M&CS down 2%. Adjusted EBITDA margin was 18.3%, up 40 basis-points from the prior year and up 170 basis-points sequentially as price more than offset inflation. And as Patrick mentioned, our EPS in the quarter was $0.79, well above expectations.

Please turn to Slide 6 and I'll review the quarter's performance by segment. Water Infrastructure revenue grew 13% organically in the quarter exceeding expectations. Growth was broad-based, led by our wastewater utility business in the US and Western Europe, both up high-teens as supply-chain constraints improved. Industrial growth remained robust driven by continued dewatering demand in emerging markets and increased activity in Western Europe. Geographically, Western Europe grew mid-teens driven by robust transport and treatment demand. The US was up low-teens led by strong Utilities opex demand. Emerging markets was up low-double-digits driven by strength across Latin-America and Africa, and continued growth and dewatering. Orders in the third quarter were up 3% organically with robust dewatering demand in emerging markets and continued Utilities strength in the US. Segment EBITDA margin was largely in line with the prior year as favorable price realization offset inflation, but was also impacted by unfavorable mix and strategic investments.

Please turn to, page 7. In the Applied Water segment, third quarter revenues grew 20% organically, exceeding expectations. Growth was robust across all end-market was each up high-teens or greater. Geographically, the US was up high-teens with strength across all three end-markets due to price realization and modest improvements in supply chain. Western Europe was also up high-teens led by growth in the Industrial on strong price and continued demand. Emerging markets was up almost 30% driven by strong industrial demand in China and commercial development in the Middle-East and Africa. Orders were down 4% organically with continued growth in emerging markets offset by some moderation in residential in the US. As a reminder, residential, our most cyclical end-market is only about 5% of our overall revenue. EBITDA margin for the segment was up 110 basis-points compared to the prior year and 200 basis-points sequentially. Margin expansion was driven by strong price realization more than offsetting inflation supplemented with productivity savings.

And now let's turn to Slide 8, and I'll cover our Measurement and Control Solutions business. M&CS revenue was up 15% organically in line with our prior guidance as chip supply played out as expected with continued modest improvement sequentially. We also saw strong growth in test applications and our pipeline assessment services business. Geographically, the US was up more than 20% on improved chip availability versus the prior year and favorable price realization. Emerging markets was up mid-teens and Western Europe was up high-single-digits driven by strength in our test and pipeline assessment services businesses.

M&CS orders declined 2% organically in the quarter lapping a tough prior year compare of 42% orders growth. Underlying demand for our AMI offerings remained strong and orders continued to outpace revenue, yielding backlog growth of 35% versus the prior year. Our M&CS backlog alone exceeds $2 billion. Segment EBITDA margin in the quarter expanded 400 basis-points sequentially and is now approaching prior year levels. The team did a great job driving margin improvement even though volumes continued to be constrained by chip supply.

And now let's turn to Slide 9 for an overview of cash flows and our balance sheet. In the third quarter we generated free cash flow of $149 million driven by income conversion, partially offset by higher working capital. You will note that our working capital levels are elevated as we've chosen to carry about 30 days of extra inventory. And while supply chains are gradually improving, delivery metrics are below historical levels, and we can best serve our customers and communities by making the short-term investments. Having said that, our financial position remains strong with $1.2 billion in cash and $2 billion of available liquidity, and our net debt to EBITDA leverage is 1.3 times.

Please turn to Slide 10, and I'll hand it back to Patrick to give some color on underlying demand.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Sandy. In our last quarter's earnings call, we impact [Phonetic] how demand in different end-markets response to macroeconomic headwinds. What we described then is what we're seeing in the marketplace now, with healthy underlying demand in our largest end-markets. Those patterns have repeated over past economic cycles. So they inform how we manage our operations in an environment like this one. Since all water is local, we experienced those patterns and trends playing out at a community level. What we're seeing is more-and-more communities feeling increasing impact from climate change. They are finding their aging infrastructure isn't up to the task and then confronting the economic anxiety of major upgrades. So communities are investing both in short-term response and in longer-term resilience. Infrastructure investment is the much bigger driver of underlying demand, but our customers have to know we will also be there in near-term crisis, which are happening all too frequently. For example, when Hurricane Ian hit Florida, our dewatering pumps were already in place ahead of the storm to prevent the worst and recover fast. And storms aren't the only immediate needs. One southeastern US city called us with sewer lines leaching waste into community groundwater, and their aging pipes are on the brink of collapse. Within days of that call, we were building a bypass that will help that city's wastewater treatment running without interruption while they make long-term repairs.

Helping communities respond to shocks is a fundamental part of our mission. But the more durable value is in helping communities build the strength to withstand future water challenges and economic stresses. Xylem solutions like advanced metering infrastructure, wastewater network optimization, and municipal water recycling amongst so many others provide much more than compelling economics. They deliver game-changing resilience. With AMI as an example cities can cut-off water in the event of storm damage, respond instantly to customer crisis, and even promote conservation through periods of scarcity and drought. And all of that additional capability costs the city less than their conventional meter networks. That value equation isn't unique to AMI. It's a hallmark of digital solutions across our Xylem portfolio, greater resilience and capability, delivered far more affordably than conventional approaches. Those benefits are so important to our customers that we have been steadily extending digital capability into every part of our portfolio.

The many water crises making headlines in recent months make it clear that the effects of climate change are already driving rapid increases in cost at the community level. To attack the problem at its source, more and more cities are making net zero emissions commitments. Our opportunity is to help water utilities reduce their own carbon footprint. More than 80 leading utilities around the world have already set net zero targets. Last month at WEFTEC which is one of the largest water trade events each year, we shared research showing how utilities can dramatically cut their emissions while boosting operational efficiency at the same time. The message is good for our customers, good for communities, and good for our business. With existing technologies, you can reduce emissions quickly at low cost, or even saving money. I am so proud of the team for leading the way on this topic with our customers and our communities. Several of my Xylem colleagues will be speaking at the upcoming COP27 Climate meetings in Egypt later this month to promote the discussion of water which we believe is the most important topic of our time.

Now I will turn it back over to Sandy to provide detail on our increased guidance and outlook for the year.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Thanks, Patrick. Consistent with our previous presentations, we will provide the key facts for each end-market in the appendix. The 2022 full-year outlook across our end-markets remains largely in line with previous guidance with an increase in commercial upon improved backlog execution. We expect healthy underlying demand will carry on through the remainder of the year with continued modest improvements in supply chain. The outlook for our utility business remains unchanged with mid single-digit growth across both wastewater and clean water. In wastewater, we see continued opex strength and the capex outlook is supported by modernization of aging infrastructure and continued new development particularly in emerging markets. For clean water utilities, although chip supply remains constrained, we do expect a continued modest easing of chip supply sequentially. We also expect momentum in our test and pipeline assessment businesses to continue due to increasing focus on infrastructure and climate challenges. Looking at the industrial end-market, we now expect low-double-digit growth lifted from a previous range of high single-digit to low double-digit growth driven by strong global demand for dewatering and continued underlying demand for our solutions in the US and Western Europe. We now expect the commercial end-market to deliver high single to low double-digit growth up from mid single to high single digits on strong demand and backlog execution. In residential, our smallest end-market, we expect strong price realization and continued backlog execution to drive growth in the high teens. As a reminder, our commercial and residential exposure is largely replacement driven, and is approximately 15% of our total revenue.

And ow let's turn to Slide 12, and I'll walk you through our updated guidance. Our continued outperformance gives us confidence to raise our full-year guidance for adjusted EPS to a range of $2.65 to $2.75, up from $2.50 to $2.70. Our raised guidance is driven by stronger price, backlog execution and continued underlying demand. We're also lifting the low-end of our full-year organic revenue growth now 9% to 10%, up from 8% to 10%. Our revenue outlook on a reported basis is largely unchanged due to FX headwinds.

Looking by segment, we expect high single-digit growth in Water Infrastructure and low double-digit growth in Applied Water. We expect Measurement and Control Solutions to be up mid single digits as chip supply continues to modestly improve. For 2022, we are raising our adjusted EBITDA margin outlook to approximately 17%. We now expect free cash flow conversions to be approximately 80% of net income. This is lower than our previous outlook largely due to higher working capital levels as I referenced earlier. While we are carrying about an extra month of inventory our position is fully aligned with the requirements needed to fulfill our backlog. As supply chains stabilize, we will bring inventory down, enabling us to return free cash flow conversion of at least a 100% as we've consistently done in prior years. We have provided you with a number of other full-year assumptions on the Slide to supplement your models, as well as our latest assumptions on our basket of currency exposures which can also be found in the appendix.

And now drilling down on the fourth quarter, we anticipate total company organic revenues will be up 12% to 14%. This includes mid-single-digit growth in Water Infrastructure, mid-teens growth in Applied Water, and M&CS growth of mid 20%. We expect fourth quarter adjusted EBITDA margin to be in the range of 17.5% to 18.5%. And with that, please turn to Slide 13, and I will turn the call back over to Patrick for closing comments.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Sandy. I'm very proud of the team's performance overall. We delivered strong results this past quarter by continuing to do what we said we would do. And indeed the team overdelivered, thanks to our commercial momentum and operational discipline. Even in an environment of macro uncertainty, the durability of our business model and the discipline of our team gives us great confidence in our continued growth and significant value-creation over the long-run.

Before we turn the call over to your questions, I'd like to share a couple of executive appointments we just made, adding even further strength to Xylem's leadership bench. Earlier I referred to our strategy of extending digital capabilities across Xylem's products, solutions and services portfolio. We've just taken an important step in accelerating that process, appointing Xylem's first Chief Digital Officer, Ci Apro [Phonetic] joined our senior leadership team last week, bringing extensive experience of growing digital businesses in the industrial sector. He'll be working with the team to further build out a simple, powerful platform of digitized solutions for our customers and communities. He joins us from Danaher and I look-forward to introducing him to you in future conversations.

Before sharing our second recent appointment, I first want to recognize a colleague many of you know. Tony Milando, our Chief Supply Chain Officer, has been looking forward to retirement for a while, but he graciously agreed to stay on while helping us guide the company through the challenges of the pandemic. He has built agility and durability into our supply-chain, put safety and sustainability at the center of our operations, and created a culture of continuous improvement that has made operational excellence a core part of Xylem's competitive advantage. We're finally letting Tony retire, but his contributions will continue to benefit our stakeholders for many years to come. To build on the foundation of excellence that Tony has laid, we've appointed Thomas Pettit, Xylem's Chief Operations and Supply Chain Officer. Tom joins us next week coming from Generac Power Systems, and he brings 20 plus years of experience leading global supply chains and operations in the industrial and services sectors. We're very pleased to welcome Tom at a time when supply chain and operations continue to be a foundation of competitive advantage. His remit is to take our operational excellence to the next level. Tony is going to stay on for a brief time to give him a good start and ensure a smooth transition. So with that operator, let's now open it up for Q&A.


Questions and Answers

Operator

[Operator Instructions] We'll take our first question from Deane Dray with RBC Capital Markets.

Deane Dray
Analyst at RBC Capital Markets

Thank you, and good morning, everyone.

Patrick Decker
President and Chief Executive Officer at Xylem

Good morning, Dan.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Good morning, Deane.

Deane Dray
Analyst at RBC Capital Markets

Hey, can you start with -- I want to wish Tony all the best. He has been a tremendous help all along, so will miss him but wish him well, and welcome to the two new leaders, Tom and Ci [Phonetic]

Patrick Decker
President and Chief Executive Officer at Xylem

Thank you, Dan. Happy to have them on-board, and with mixed emotions to see Tony move on but yeah, it's been a great run.

Deane Dray
Analyst at RBC Capital Markets

For sure. All right. So first question -- and look, really good numbers here, good growth, so that all kind of is a standout. What I'd like to talk about is the forward look, and for the fourth quarter just talk about the backlog conversion earnings visibility. and how has October -- how did October get off in terms of demand.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yes, Deane, let me start there. I think we've built a good momentum throughout the year. We've had -- throughout the year we've had strong orders growth all along. I think we have good visibility into Q4. The way we're kind of envisioning it is that it looks very much like what we just printed in Q3. So we'll see strong top-line growth, EBITDA margins that are very similar to the strong step-ups that we saw from Q2 to Q3 this year, and maybe a little bit of a difference in mix. Water Infrastructure typically has a stronger Q4 when projects get completed towards the end-of-the year. A little bit of moderation in AWS as we're doing some catch-up orders to work through some of the supply chain, and a slight ramp in M&CS as we we've talked about on prior calls we are continuing to see a more modest step-up on the chip supply situation and then sometimes towards the back-half, second-half of 2023 when the redesign work and some more supply comes online, you'll see a bigger ramp. So long story short, I think our Q3 and our Q4 look pretty similar. All along we've called for a stronger back-half compared to our first-half, and we're really happy to report that that's playing out very much in line with our expectations.

Deane Dray
Analyst at RBC Capital Markets

And specifically on backlog, what would be the typical 4Q backlog conversion verse -- on a percent basis, versus what you're expecting this quarter?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

I'll give you some color on the backlog. When we look year-over-year, the backlogs are up about 30%, it's a little higher than that in M&CS and a little bit lower than that in the other two businesses, So all-around, Deane, backlogs remain elevated and so we're not able to convert as much of the backlog as we would have in other periods and that's not because production levels are falling short, just because backlog still remain elevated.

Patrick Decker
President and Chief Executive Officer at Xylem

And Deane, I would just offer that coming into this quarter like we did this past, our Applied Water backlog is up almost -- at least up a month or more normally than what we would have the ability to. That's because of the supply chain constraints, we're going to -- and demand. We're going to see that begin to work-off in Q4 going into Q1 and so Applied Water will normalize down to its historical levels which is still going to be attractive at very attractive margins. But what you're really going to see the strength come through continued is in the Water Infrastructure resilience because the utility demand and again the conversion of chip supply on M&CS and given the deals that we've gotten backlog.

Deane Dray
Analyst at RBC Capital Markets

That's real helpful. And then just as a follow-up. On free cash flow, completely understand the tweak here adding more inventory, we're seeing that elsewhere. But maybe share for us Sandy the precision, adding an extra 30 days, how does that square out across the segments. And maybe we then like -- how has lead times -- how have lead times with your suppliers, how are those trending? Are they beginning anything close to normalization there? Thanks.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, great question. I think first of all Deane where our inventory is most elevated is within our AWS segment, and in that supply-chain we have more China dependency, more global dependency from a supply-chain perspective than we do in our other businesses. And so as -- that's where we've seen more disruptions as well. So that's exactly where we put some higher inventory levels. I would say that we've done a lot of scrubbing to make sure that that inventory aligns with what we're seeing from a backlog perspective and we feel very, very good about -- very good about that.

Deane Dray
Analyst at RBC Capital Markets

That's exactly what I wanted to hear. Thank you.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Deane.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Thanks, Deane.

Operator

We'll take our next question from Nathan Jones with Stifel.

Nathan Jones
Analyst at Stifel Financial

Good morning, everyone.

Patrick Decker
President and Chief Executive Officer at Xylem

Hey, good morning, Nate.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Good morning, Nate.

Nathan Jones
Analyst at Stifel Financial

I will -- I'll start-off on pricing, price cost. It was very good to see price more than offset inflation this quarter. Can you maybe talk about the pricing trends, the inflation trends, should we continue to see price ramp-up over the next couple of quarters as more price read through? Should we start to see the year-over-year inflation moderate, and so maybe price-cost becomes an even bigger tailwind to margins over the next two or three quarters?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, I think, Nate, obviously this has been something that our teams have been really focused on all year long. And I really applaud the good work that our commercial teams have done securing these important price increases to get in line with inflation. So a couple of milestones here. On a year-to-date basis now we're price-cost neutral. In the quarter we were ahead from a price-cost perspective on both a dollar perspective and a percentage perspective. Though we still expect that price will be a tailwind in Q4 and that's part of the year-over-year margin expansion that we're calling for. Having said that, we start to anniversary some of the quarters where we've secured price momentum. And so that starts to happen a little bit in Q4 and more as we move into Q3. But I think as we go into 2023, we'll be in a better spot from a price-cost perspective than we certainly were going in this year.

Nathan Jones
Analyst at Stifel Financial

And you'd probably start to anniversary there were to be inflation comps at the same time, right?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah. And so I think inflation, we've definitely seen an increase in inflation compared to what we guided initially this year. We sort of came into the year thinking inflation would run around 10% or 11%. When we look all-in for the year inflation is running more in the mid-teens. I would say there is some slight moderation from a commodity perspective but we're still seeing headwinds on inflation in both areas like energy, particularly in Europe. And labor inflation is still out there. And when we look at labor inflation, that's not transitory, that's probably more permanent. So our pricing strategies are dynamic and they need to be in line with what we're seeing and experiencing from a costing perspective.

Nathan Jones
Analyst at Stifel Financial

And. I would think we should probably see the pricing improve in M&CS we go forward. It's the segment where it looks like pricing is coming through the lowest. Some of that backlog that doesn't get repriced, I would think some of that it's bit hard to tell your customers you're raising prices when you have all that past due backlog. So should we see price read through more in 2023 in the M&CS segment as we start to clear some of that?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah. I think our -- where we've seen price we've seen -- it's sort of match [Phonetic] where we've seen the highest inflation levels and so from an ordering perspective that's been AWS, Water Infrastructure and M&CS. Having said that, if you look at the past couple of quarters we're starting to see some of our price increases that we implemented in M&CS drop through. And so we still have good momentum there from a pricing perspective and I think you'll continue to see that in the next couple of quarters. And I think that's also Nate a significant part of why we saw quarter sequential improvement in the M&CS EBITDA rate.

Patrick Decker
President and Chief Executive Officer at Xylem

And I think, Ned, I would just offer on the M&CS side specifically AMI ideals. Again, these are long lead time negotiated regulatory approval deals. They got great economics associated with them. And I think our customers understand that we're operating in a fairly high inflationary environment, and they understand. And they understand that we're being very transparent with them around what the inflation impact was on us and that we're being responsible and disciplined. And the economics of these deals are so important to them that right now the most important thing we can do is just continue to get chips and get the meters installed. And the good news is we've not seen any cancellations of those deals and backlog. So we feel good. We wish we had more chips of course, but again, these projects require multi year planning and utilities don't tend to go backwards on these deals. Great. Thanks for the feedback there [Technical Issues] Thank you, Nate.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Thanks, Nate.

Operator

We'll take our next question from Michael Halloran with Baird.

Michael Halloran
Analyst at Robert W. Baird

Hey, good morning, everyone.

Patrick Decker
President and Chief Executive Officer at Xylem

Hey, good morning, Mike.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Good morning, Mike.

Michael Halloran
Analyst at Robert W. Baird

So a couple here. First, just on the utility building cycle which I suppose dovetails a little bit the comments you just made there, Patrick. But what's the front log look at this point, and what's the -- and that's kind of part one of the question, and what the kind of underlying thought processes at the utility level today. And then secondarily, any update on what the adoption looks like for the more technology-oriented pieces of that utility pie?

Patrick Decker
President and Chief Executive Officer at Xylem

Yes, so as you know Mike, the -- so roughly 70% of our demand in Utilities is opex, so it's repair, replacement. Very stable. If anything right now I would say it's probably overcharged because of just aging infrastructure and climate change so we're seeing really strong growth there. Capex which is the 30% roughly, and this is a global number, not just the US. That's the one that we do keep a close eye on throughout cycles. And as you know what we've tended to see is the one driver that can lead to a reduction in capex spend historically, if we were to see it which we've not seen it yet. I mean our frontline right -- our front log right now is very strong. The bidding pipeline is very strong right now. But if we were to see a slowdown in muni tax receipts, if we were to see a slowdown. prolonged, and residential expansion in the US. Those things tend to be later cycle so it'd be a couple years down the road. We're not seeing it right now, Mike, but that's what we would look for. On -- and that's on the wastewater side. Now, historically even during the past recessions around the world, if you set aside dewatering for a moment which does tend to be more short cycle, and we've diversified that part of the business away from kind of pure mining oil and gas, we're much more in the muni space now and broader industrial space. But we would see it there. We haven't seen it. And we would ultimately see maybe a low single digit kind of water infrastructure growth if we were to see a recession. But we've not seen that in our front logs at this point in time. So we're keeping a close eye on it, and we're trying to be responsible and prudent in our planning here.

Michael Halloran
Analyst at Robert W. Baird

Great, thanks for that. Second one just on the European side of things. It seems awfully resilience from you at this point, just some thoughts on the trends you're seeing on that side.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, we look at our results, Mike, in Europe and they are very, very strong. We're also seeing good orders growth especially on a year-to-date basis. And when we look historically and benchmark kind of one region to the other, Europe tends to be very steady and I think you'll see very disciplined and resilient spend from the European, so I think -- or the European market. So on the industrial side, we're not seeing a slowdown -- slowdown either, so we're staying close to it, we're talking very frequently with our commercial teams who are in constant contact with our our customers. But so far it's hanging in there.

Michael Halloran
Analyst at Robert W. Baird

Great. Really appreciate the time. Thanks.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Mike.

Operator

Our next question comes from Scott Davis with Melius Research.

Scott Davis
Analyst at Melius Research

Good morning, Patrick and Sandy.

Patrick Decker
President and Chief Executive Officer at Xylem

Hey, good morning, Scott, how're you doing?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Good morning, Scott.

Scott Davis
Analyst at Melius Research

Good, thanks. Can we talk a little bit about M&A in your backlog -- your pipeline and such as it seems your balance sheet is in just great shape and asset prices are coming down a bit, so just some color on that would be helpful.

Patrick Decker
President and Chief Executive Officer at Xylem

Sure, yes, as you said Scott, we've got a really strong balance sheet and we've got $2 billion of liquidity. We've got probably firepower north of $4 billion. We're not going to hesitate if the opportunity presents itself. Pipeline remains really robust, the combination of larger opportunities but we've got a number of small and medium-size opportunities that are out there mainly in the utility space but also in the industrial services space. And so we're going to continue to be disciplined. As you well know it always takes two to tango, but nothing has changed in our view on valuations and our discipline in that space.

Scott Davis
Analyst at Melius Research

Okay, helpful. And then can you guys just remind us, perhaps Sandy you can help with this. These big extreme moves we've had in FX and you guys are -- have a little bit different clearly situation than most of the companies we cover. But the net-net of all the different moves in FX, what that really means for you guys?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, so I think when you look sort of year-over-year -- or actually compare to our budget, we're seeing significant headwinds from an FX perspective. I would say from an EPS perspective it's been a negative of -- by about $0.15 to $0.20. We'll see where the things ultimately shake out in the fourth quarter because even over the past month the FX rates have been volatile. But I think we're really proud of the team. That's one of the challenges we've been able to overcome when we look at sort of where we started the year and where we stand today. Just as an example, we started the year planning for a euro assumption at 1.13 dipping down below a one-to-one ratio for the end of last quarter and into this quarter. So good work that we've been able to overcome, continue to staying disciplined and controlling what we can control.

Scott Davis
Analyst at Melius Research

Okay, that's helpful. Thank you, I'll pass it on. Good luck, everybody.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Scott.

Operator

We'll take our next question from Joe Giordano with Cowen.

Joe Giordano
Analyst at Cowen

Hey, good morning, everyone.

Patrick Decker
President and Chief Executive Officer at Xylem

Hey, good morning, Joe.

Joe Giordano
Analyst at Cowen

I thought it was interesting on the new role for Chief Digital Officer. Can you talk about like the buy versus build proposition for a true digital platform kind of like on top of your AMI platform?

Patrick Decker
President and Chief Executive Officer at Xylem

Sure, that's great question, Joe. So Digital, it's certainly not new. So we've got a great foundation that we've already built, both organically as well as through a number of the acquisitions we've done. So Ci [Phonetic] comes in really building on that solid foundation. We are continuing to look at the opportunity to both build internally which is really as much about talent capability, commercializing, selling those opportunities. But our pipeline from an M&A standpoint is still very much focused on adding other solutions and technologies to the mix. And I look forward to having Ci join us on one of our upcoming calls and share his perspective on what he sees and the opportunities in front of us. But it's a combination Joe between organic and M&A.

Joe Giordano
Analyst at Cowen

Okay, great. I know it -- look, it's good to see the progress in M&CS but I know that you're not happy with where margins are like big picture. So can you kind of walk us from where we're exiting this year. So like what the 20% margin looks like at M&CS, like what on EBITDA what things have to happen to get there?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, I think great great question, Joe. We've been working really hard to get our margins back up in the M&CS side and obviously volume plays a big role in that. We've talked historically that when we get revenue up into the $350 million level per quarter you'll see revenues -- you'll see EBITDA margins in the mid teens. To get to the high teens 20% benchmark, we need to be north of $400 million of revenue per quarter. And we are certainly focused on productivity initiatives, the disciplined steps we're taking around pricing and looking at our backlog and incremental pricing opportunities there are important catalyst as well. And then of course our backlog has a higher digital mix, and so that will naturally bring with it some higher margins. So it's a real combination of factors. And the good news is we've seen some uptick in the revenue. A little bit of a flattening from Q2 to Q3 and we'll expect a continued moderation and then another kind of step-up more in the back-half of next year.

Patrick Decker
President and Chief Executive Officer at Xylem

And Joe, I would just add that one of the things that we've not really punctuated in the past is as we were going through the redesign of our chips to be able to help support our customers through this challenging time to move these installations along, there were cost that we added in our P&L to support that. At the same time, we had to redirect some engineering resources away from classic productivity continuous improvement. So we're working through that but despite that you see the margin expansion that we've laid out in the quarter and that we expect for the year and that we expect even the next year. So I just want to make sure we're making strategic choices here to take care of our customers not just for the future for the long-run but like right now because that's the value they expect from us.

Joe Giordano
Analyst at Cowen

No, that all makes sense. And just last quick for me. Just given how shorter-cycle AWS is, I know backlog is extended there but it's like the shortest backlog throughout the Company. And just when I think about price this quarter 1,000 basis points, when price starts to normalize and orders are coming down and that business just starts to get to more reasonable levels, what do we -- how do we think about like margin deleveraging in that kind of scenario as you've made a lot of progress there, so how much of that do you expect to be able to hold onto as volumes kind of come down? Thanks.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

I think one thing that it's important to remember is if you look back the past few quarters, our price increases were not in line with inflation. So we're now at a point where we're getting back to our more historical margins and we can drive margin expansion through productivity levels and incremental growth. So I think we're getting back to a place that's good and healthy for that business, and a lot of work to make that happen.

Patrick Decker
President and Chief Executive Officer at Xylem

And we continue Joe to make investments in innovation and R&D within that segment also within Water Infrastructure. I know M&CS has kind of gotten more the headlines over the last few years but we continue to make increases in R&D spend in those segments because that kind of refreshment of our offerings and portfolio we see in our new products that we bring to market that they've got much higher margin and growth rates than what they're replacing. So it's important to note that there is a refresh that continues to go on in both of those segments.

Joe Giordano
Analyst at Cowen

Thanks, guys.

Patrick Decker
President and Chief Executive Officer at Xylem

Thanks, Joe.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Thanks, Joe.

Operator

We'll take our next question from Andrew Kaplowitz with Citigroup.

Andrew Kaplowitz
Analyst at Smith Barney Citigroup

Hey, good morning, everyone.

Patrick Decker
President and Chief Executive Officer at Xylem

Good morning.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Good morning, Andy.

Andrew Kaplowitz
Analyst at Smith Barney Citigroup

Patrick, I know you've said that you have elevated backlogs and a strong pipeline of opportunities, but I'm just focusing on orders for a second, down a bit this quarter, they decelerate over the last couple of quarters. I know it's really just more difficult comps. But you did mention [Indecipherable] in Applied Water for instance. So could you give us more color into what you're seeing in orders and whether you believe orders will continue to decelerate or how to think about orders going into '23.

Patrick Decker
President and Chief Executive Officer at Xylem

Sure. So we feel we feel good about the trend lines on demand. And again, that goes back to the question around what our front logs look like in terms of bidding pipeline whether that be AMI, whether that be treatment which is a precursor for wastewater demand, and we see a healthy demand within our channel partners, even on the Applied Water side. So it is really a year-over-year comp issue. If you look at our orders year-to-date we are still up 7% year-to-date. And it really is a tough comp in the third quarter. I would say that again, it varies by end-market. We've obviously -- we haven't talked China for example. China is 7% of our revenue. China was up 10% in the third quarter on revenue. But I would say that the Public Utility funding there in China has been pushed to the right because of the lockdown restrictions there. But we still expect there to be a recovery in Utilities but it's probably not going to be until later next year. And there is no change in our long-term plan or outlook on China, but it's a meaningful part of our revenue, we've overcome that with demand across the rest of the portfolio. So the fundamentals are there. We are watching all the signs. We've got our KPIs that we track especially in our short-cycle businesses. We have seen some moderation as Sandy said earlier in residential which is very small part of our business. We've seen some slowdown in a couple of other small pieces of our business. So we'll keep a close eye on it. I mean, we're not out of the woods yet but even in commercial, the ABI, the architectural billing index, it's still strong at north of 50. And when it's north of 50, that indicates strength in that part of our segment which we continued to see growth in. But again, we're keeping a close eye on all of this, Sandy.

Andrew Kaplowitz
Analyst at Smith Barney Citigroup

Very helpful, Patrick. And maybe if I could just follow-up on your dewatering business. Kind of a similar question, I know you raised your industrial growth to low teens but what are your industrial customers telling you about the opportunities in dewatering, and do you see those orders staying positive in dewatering into '23?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, Andy, good question. We're seeing both strong revenue conversion in dewatering and we're seeing good orders momentum there. I think Patrick referenced a little bit earlier on the call, I think there are some important things to note if you look at our business today [Indecipherable] our business look like a couple of years ago, seeing good emerging markets growth. Good growth that includes Latin America as well where there we're seeing good activity. We've made some investments on the rental fleet and really all of our markets on a global basis. And those projects are -- have good returns, fast paybacks. We're seeing a lot of that equipment out on order and converting to revenue. And we're still seeing resiliency on our equipment sales side of the business and dewatering. It -- I'd put it right up there in one of those end markets that we need to really continue to focus on, it is absolutely one of the shorter cycle businesses, and understanding the -- what our customers are seeing is important there. So -- but so far that's been pretty resilient.

Patrick Decker
President and Chief Executive Officer at Xylem

I would just add Andy that the thing -- when we say customers and dewatering there is the part that we handle direct where we have our rental fleet. And then there are our channel partners that we actually replenish their fleet and then they have their own rental fleet. And in the past part of that business that can turn very quickly is if our channel partners that are all local around the US predominantly, if they get nervous and they see things they then pulled back on replenishing their fleet, and that can happen very short cycle. And so we are in regular calls with them to get a feel for how they're feeling about the general macro economy right now. Thus far it's strong and resilient but that's the area that we would keep a very close eye on.

Andrew Kaplowitz
Analyst at Smith Barney Citigroup

I appreciate all the color.

Operator

We'll take our next question is from Brian Lee with Goldman Sachs.

Brian Lee
Analyst at The Goldman Sachs Group

Hey, everyone, good morning. Thanks for taking the questions.

Patrick Decker
President and Chief Executive Officer at Xylem

Hey, good morning, Brian.

Brian Lee
Analyst at The Goldman Sachs Group

Hey. I guess first question I had is following up on an earlier one, price readout by almost 250 basis points more this quarter than in 2Q. It sounded like based on Sandy's comments that maybe we're starting to see peaking sort of cadence in terms of price. So just wanted to make sure that I heard that correctly. And as we start to lap some of the price increases over the past year and we head into '23, are we thinking more like a typical low single digit price year starting early next year, just kind of get a sense of the cadence of price from here and into next year?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, Brian, I think I touched on it a little bit earlier. Last year starting in Q4 is really where we started to see some of the impact of our price increases hitting our revenues. So absolutely the compares start to get tougher. A little bit tougher next quarter, I think you're going to still see strong pricing, it should be one of the key drivers for the margin expansion that we're calling for. And then obviously pricing has become very dynamic, it's not a decision we make at one point in time. We need to continue to take all the inputs from what we're seeing on all the different components of our bill of materials, everything from the commodities we buy to the freight cost to deliver the product. So I'm not going to share what our full price realization looks like for 2023 at this time. Certainly we're in a much, much better position as we go into '23 from a equilibrium perspective around price cost.

Brian Lee
Analyst at The Goldman Sachs Group

Absolutely, yeah. Makes sense. And I guess follow up here just not to focus too much on the short term but if I look at the guidance here for 4Q, I know nothing about the past couple of years has been sort of normal but it does imply a pretty flattish performance across key metrics, revenue, EBITDA, operating margin. Seasonally you typically have a pretty meaningful increase from 3Q to 4Q across a lot of those headline metrics. So kind of walk us through is there anything impacting near term seasonality in the model here you just kind of working off more backlog in 3Q than you expected, just any sense of why this year maybe 3Q to 4Q is a little bit lighter than you typically see in past years?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Yeah, I think you touched on a bit of it Brian, if you look at particularly our Water Infrastructure business we typically see a bigger drop drop-box Q2 to Q3. We didn't see that as much this year that was a big part of why our revenue came in higher. And so as a result of that we see more of a flattening in Q3 to -- we still see a little bit of a step up going into Q4 on Water Infrastructure but not as dramatic, and some of that is we did see a little bit of supply chain improvement and we got some more projects across the finish line. So for the full year, yeah, Q3 and Q4 look good. It's a big step up from what we saw in the first half and we're exiting the year right on line -- in line with what we were expecting.

Patrick Decker
President and Chief Executive Officer at Xylem

Yeah, and I think, Brian, the other -- regionally, the two areas that I would say that we are just seeing things playing out a little bit differently this year than we have in the past, I mentioned earlier things shifting to the right in China. And again, we have the uncertainties in Europe. And so we just think it's prudent to build that into our outlook for Q4.

Brian Lee
Analyst at The Goldman Sachs Group

All right, thank you. I appreciate the color.

Patrick Decker
President and Chief Executive Officer at Xylem

Thank you.

Operator

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

Saree Boroditsky
Analyst at Jefferies Financial Group

Thanks for fitting me in. [Indecipherable] covered on the call but there is a big differential between the strong order growth -- between Applied Water growth and the decline in orders. So since you expect to work down the backlog through this year, how do you think about growth as we head into 2023?

Patrick Decker
President and Chief Executive Officer at Xylem

Is that specifically for applied Water?

Saree Boroditsky
Analyst at Jefferies Financial Group

Yes. for Applied Water.

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

Well, I'll take I'll it. We obviously have a very elevated backlog in AWS. We have more than double the backlog than we typically have in any one quarter. And so I think if we actually are able to work some of that backlog down, I think it's a real positive sign that supply chains are improving, that customers are reverting back to more typical ordering patterns. And as we look at that business longer term, it's probably the lowest grower in our portfolio. It delivers a lot of cash, it's a good operating business for us. But over a longer term basis, it's a low to mid single digit grower in our portfolio. And when do we exactly revert to those levels? It will take a little bit of time to work through the backlog. But that's sort of how we see that business longer term fitting in our portfolio.

Patrick Decker
President and Chief Executive Officer at Xylem

Yeah, I mean we look at that part of our portfolio as market growth itself is GDP on a global basis and we always look to and have historically beat that by some share gain. And that comes through investments in innovation, through R&D. We continue to refresh the portfolio, but to Sandy's point, we're coming off of elevated backlogs due to one demand but also supply chain constraints. We'll see that normalize as we go into 2023. And in our upcoming call we'll lay out by segment what our outlook is for '23.

Saree Boroditsky
Analyst at Jefferies Financial Group

Okay, that's helpful. And then obviously you pointed out the strong book-to-bill AMI, how long in advance are you seeing customers place their orders and then when do they -- when does that show up in revenues?

Sandra Rowland
Senior Vice President and Chief Financial Officer at Xylem

AMI is a -- it's a very long selling cycle. It's a big decision for the utilities to make. We're working on RFPs that go out anywhere from one year to three years. We have a big backlog in M&CS. If you look today, we still have about a quarter of it that's past due, and so we're going to start working through that as chip supply recover. What we're most excited about is that the pipeline remains strong. We're winning a good percentage of those awards, and the value proposition is very, very sound. So...

Patrick Decker
President and Chief Executive Officer at Xylem

We are still early in the conversion of large utilities across the US to AMI, let alone the smaller to medium-sized utilities. So that's why the front log the bidding pipeline looks so attractive across the market. And that's why we remain confident. But these are long-term deals that take a while to negotiate, and we're pleased with our position.

Saree Boroditsky
Analyst at Jefferies Financial Group

Perfect. Thanks for taking my questions.

Patrick Decker
President and Chief Executive Officer at Xylem

Thank you.

Operator

It appears that we have no further questions at this time. I will now turn the program back over to Patrick Decker for any additional or closing remarks.

Patrick Decker
President and Chief Executive Officer at Xylem

Well, thanks everyone for joining us this morning and for your continued interest and support. Really appreciate it. I know between now and the next earnings call we'll have a chance to meet with many of you in-person. Between now and then stay safe, and safe travels. Look forward to seeing you. Thank you.

Operator

[Operator Closing Remarks]

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