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spk03: Welcome to the Xylem fourth quarter and full year 2021 earnings conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.
spk10: Thank you, Ashley. Good morning, everyone, and welcome to Xylem's fourth quarter and full year 2021 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 fourth quarter and full year 2021 results, and discuss the first quarter and full year outlook for 2022. Following our prepared remarks, we'll address questions related to the information covered on the call. I'll ask that you please keep to one question and a follow-up and then return to the queue. As a reminder, this call and our webcast are accompanied by a slide presentation available in the investor section of our website at www.xylem.com. A replay of today's call will be available until midnight on February 10th. Please note the replay number is 1-800-695-0395 or 1-402-220-1388. Additionally, the call will be available for playback via the investor section of our website under the heading Investor Events. Please turn to slide two. We will make some forward-looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future. These statements are subject to future risks and uncertainties, such as those factors described in Xylem's most recent annual report on Form 10-K and in subsequent reports filed with the SEC. Please note that the company undertakes no obligation to update any forward-looking statements publicly to reflect subsequent events or circumstances, and actual events or results could differ materially from those anticipated. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics in the appendix. For purposes of today's call, all references will be on an adjusted basis unless otherwise indicated. and non-GAAP financials have been reconciled for you and are also included in the appendix section of the presentation. Now, please turn to slide three, and I will turn the call over to our CEO, Patrick Decker.
spk07: Thanks, Matt, and good morning, everyone. As we indicated in our release this morning, the team delivered a strong operational performance in the fourth quarter, meeting or exceeding our expectations across all major metrics. Despite the challenges that 2021 presented us, especially in the second half, I'm very proud of the team for what they did to deliver on our commitments. And as a team, they delivered a very strong full-year performance. This was reflected by mid-single-digit organic revenue growth, solid EBITDA margin expansion of 80 basis points, and adjusted earnings per share growth of 21%. And orders grew 23% for the year and in the fourth quarter, giving us very strong momentum coming into 2022. We posted our strongest orders growth in our MNCS segment. And it reflects the need and desire of our customers for digital solutions to address their growing needs around water affordability and infrastructure resilience. Our water infrastructure and applied water segments also posted very strong orders growth for the year and the fourth quarter, demonstrating the healthy demand across our portfolio. We continue to experience very strong underlying demand globally, with double-digit orders growth across all regions, and we expect that momentum to continue throughout 2022 and beyond. And our investments in R&D are clearly paying off, enabling us to win market share due to the customer value we're creating. And our investments in geographic coverage have made significant contributions to our overall growth, especially in emerging markets, where we posted double-digit revenue growth in 2021. Of course, the other side of the story in 2021 was the constrained supply chain challenges of the second half, along with inflation that really accelerated in the last quarter. As we anticipated in our last conference call, the severe chip shortage affecting the entire tech sector held back our ability to convert such strong orders into revenue, especially in our MNCS segment. Against that backdrop, the team did an excellent job managing what we can control, bringing discretionary costs down below 2020 levels and taking aggressive pricing actions to mitigate inflationary pressures. In fact, price realization in the fourth quarter was modestly higher than our expectations. And we expect to offset inflation further as we deliver creative margins in our backlogs. So despite all the year's headwinds, the team not only delivered solid operational results, but they did it with heart and purpose. Along the way, we made significant progress towards our 2025 signature sustainability goals. One example of that is that the team set a Xylem record for hours volunteered to solve water challenges in our communities around the world. It's a privilege to be a part of a team with that level of commitment to our mission. Now, looking ahead at 2022, we see continued strong demand for our products and solutions, strong fundamentals across our business in terms of productivity and free cash flow conversion, and continued ability to drive price as a market leader to offset inflationary pressures. Nevertheless, our outlook is tempered by the reality of a prolonged chip shortage, limiting the speed at which we can convert orders to revenue. So we are being balanced in our guidance based upon the visibility we have. Our guidance assumes modest and gradual increases in chip supply in the second half and into 2023. And as volumes return, we expect to realize significant margin expansion consistent with the first half of this past year when we operated in a less chip-constrained environment in MNCS. And we see this in the backlog margins we have coming into 2022. In the second half of this year, growth and margin expansion, both gross margin and EBITDA, are expected to return to levels that put us on track to deliver on the 2025 strategic and financial framework that we outlined last September at our Investor Day. In a moment, we'll discuss the assumptions in our 2022 outlook and speak to our intentions for capital deployment given the strength of our financial and competitive position. But first, I'm going to hand it over to Sandy to dig in briefly on the quarter's results before we turn back to 2022.
spk04: Thanks, Patrick. Please turn to slide four and I'll cover our fourth quarter results. As Patrick indicated, significant chip shortages impacting the utilities and market in the U.S. more than offset utilities growth in Europe and strong growth in the industrial segment globally. Given the quarter's challenges, the team did an outstanding job delivering on our commitments, in increasingly tough circumstances, with particularly strong performance on price and discipline on cost. In a moment, I'll give you a detailed performance by segment, but in short, utilities was down 9%, a result of supply chain constraints acutely impacting our smart metering business in the U.S. Industrial grew 7% on sustained strength in China and healthy activity in the U.S., Commercial was up modestly at 1%, and residential was down 4% on challenging comparisons in the prior year when we grew mid-teens. Organic orders were up 23% in the quarter as demand for our technologies continues to be healthy across all segments. EBITDA margin was 16.2%, which was within our guided range. Year-over-year EBITDA margin contracted 260 basis points as productivity savings and strong price realization benefits were more than offset by inflation, mix, and strategic investments. We continue to invest, for example, in geographic market coverage to serve increasing demand and enhance digital capabilities across the portfolio. Our EPS in the quarter was 63 cents. And please turn to slide five, and I'll review the quarter's segment performance in a bit more detail. Water infrastructure orders in the fourth quarter were up 30% organically versus last year. That includes a project cancellation last year in India, which we discussed on a previous call. Otherwise, orders were up mid-single digits. This orders pace reflects resilient demand in our wastewater utility business in the US and Europe, as well as increasing demand for dewatering, particularly in emerging markets. Water infrastructure revenue was up modestly in the quarter. Healthy growth in industrial was partly offset by a small decline in our wastewater utility business in the US, where order to revenue conversion was challenged by long ocean transit times. Geographically, results were mixed for the segment. The US and Western Europe were up low single digits and mid single digits, respectively. Healthy treatment deliveries in both geographies were offset by the delays I just mentioned. Emerging markets was down low single digits, largely due to an especially strong performance in China last year. EBITDA margin for the segment was down 50 basis points as significant savings from productivity and cost reduction were offset by inflation and strategic investments. Please turn to page six. In the applied water segment, orders were up 10% organically in the quarter, driven by healthy demand in all geographies. Revenues increased 3% with high single-digit growth in industrial and a modest increase in commercial partially offset by sales down mid single digits in residential. Geographically, the U.S. was up high single digits. Growth in all end markets was led by ongoing industrial recovery. Emerging markets was up mid single digits on continuing industrial strength in China and momentum in Eastern Europe. Western Europe delivered low single digits growth with moderate gains balanced across all end markets. Segment EBITDA margin declined 340 basis points in the quarter. Material and freight inflation more than offset solid productivity gains and accelerating price realization. And now let's turn to slide seven, and I'll cover our measurement and control solutions business. MNCS orders grew 28% organically in the quarter, reflecting strong demand for our metrology solutions, as well as healthy demand across all other applications in this segment, including test and pipeline assessment services. This puts our MNCS backlog up 63% versus the prior year. As we anticipated, revenue declined 17% due to constrained chip supply. It's worth noting that the growing metrology backlog is both resilient and margin accretive. There have been no cancellations of AMI contracts, and we expect large project deployments will resume in the back half of the year as component supply becomes available. Geographically, U.S. revenues were down 21%. Western Europe and emerging markets declined more modestly at 10% and 2%, respectively, from pockets of growth in our water quality test business. Segment EBITDA margin in the quarter was down 750 basis points. Volume was the biggest factor, as this business gets very strong operating leverage from higher revenues, which were constrained by the lower conversion of orders. Those volume effects along with higher inflation were partially offset by productivity gains and cost discipline. And now let's turn to slide eight for an overview of cash flows and the company's financial position. Our financial position remains robust as we exit the year with 1.3 billion in cash and available liquidity of more than 2 billion. Net debt to EBITDA leverage is 1.2 times. After delivering free cash flow conversion of 181% last year, our free cash flow conversion was 77% in 2021, slightly below our target for the year. While our team made continued progress driving collections, we consciously increased our inventory safety stocks in the second half of the year to mitigate supply chain volatility. But we remain committed to at least 100% conversion over the cycle. A further item of note, as we previously advised, we are de-risking our balance sheet with a buyout of our largest defined pension plan in the UK. We expect to finalize this transfer in 2022, at which point we'll recognize a non-cash charge of approximately 170 million, primarily consisting of unrecognized actuarial losses, which are reflected in equity today. Lastly, in line with our capital allocation framework, today we announced an increase in our annual dividend of 7%. And that is our 11th consecutive annual increase. Please turn to slide 9, and I'll hand back to Patrick to look forward at 2022.
spk07: Thanks, Sandy. We see strong demand continuing through 2022 and strong fundamentals in all our businesses. On the other hand, the reality is that supply constraints will continue to be an important and not entirely predictable variable. So we are reflecting a responsible set of assumptions in our guidance while working aggressively to improve the situation. We anticipate CHIP availability will improve through the year, but not linearly and not all at once. In the first half, shortages are still likely to hold back conversion of orders to revenue with disproportionate impact on our higher margin solutions. So we'll be focused on operating with discipline, driving price, productivity, and cost during what we foresee being a transitory period. In the second half of the year, supply should begin to improve modestly, and the pace of chip shipments will have a determining effect on our growth rate and margin expansion. As components begin to come through, the margin upside is highly accretive to our margin profile. The positive side of this dynamic was apparent in the first half of 2021 when chip supply did not limit MNCS growth, and we saw margin expansion of more than 500 basis points in the portfolio. Given the size and growth of our metrology backlogs, it's worth expanding on a point Sandy made a moment ago about the resilience of those backlogs. Large AMI projects are not easily substituted, and they offer a compelling business case for our customers particularly as they are addressing issues of affordability and regulatory commitments. Our utility customers often spend years in pilot testing, approval, and procurement to determine these solutions. So despite these near-term delays, we do not anticipate backlog erosion. Turning to slide 10, you can see our focus areas for 2022, which will keep us aligned to our long-term financial framework. The team is managing through the current challenges with great discipline, working with both suppliers and customers. Even though we expect chip supply will gradually improve in the second half, we don't anticipate suppliers will be able to serve 100% of our requirements, given the sheer size of our order books. So we're working with our most critical supply partners to accelerate redesign options, and we're staying close to our customers to prioritize serving their most mission critical needs. Since visibility about the likely rate of improvement is imperfect, we're also phasing our ongoing strategic investments with an eye on leading indicators of supply recovery. Now, before I turn to Sandy for more detail on our outlook, I want to comment briefly on capital deployment. We're coming into the year with a strong balance sheet and more than $2 billion in liquidity. So M&A naturally comes to mind as a strategic accelerator for sustained growth and margin expansion. And those of you who've been with us a while, you know that we're not hesitant to do a deal when there's a good deal to be done in service of advancing the company's overall strategy. And our view is that there are opportunities for strategic value creation in the marketplace for a company like us with our financial strength and sector leadership. But we will continue to be disciplined and selective with an eye towards significant value creation. Now, I'll turn it back over to Sandy for more color on our outlook.
spk04: Thanks, Patrick. We expect underlying demand will continue to be healthy through 2022. However, as Patrick just described, business conditions aren't likely to normalize on an entirely predictable path. So we've taken a view of the year that reflects those dynamics. balancing external constraints and potential upsides. We anticipate our utility business overall, which is just north of 50% of Xylem revenues, will grow low single digits in 2022. On the wastewater side, we expect low single digit to mid single digit growth as we see a continuation of resilient global demand. We anticipate strong demand in emerging markets driven by considerable investment in public utilities, increasing OpEx activity, as well as the benefit of our localization strategy. The outlook for longer term capital project spending and bid activity is very solid globally. On the clean water side, we anticipate revenues will be flat. Demand remains robust, but deliveries will be constrained by chip shortages mentioned earlier. We foresee healthy momentum in our test and assessment services businesses due to increasing focus on infrastructure and climate challenges. And now please turn to slide 12. Looking at the industrial end market, we expect to grow mid-single digits on steady demand for our solutions globally. We continue to see healthy growth in dewatering, especially in emerging markets from increasing mining demand and benefiting from our localization strategies. In the U.S. and Western Europe, we expect solid order rates and backlog expansion as activity ramps in light industrial applications. The commercial end market should deliver mid-single digit growth on solid replacement business in the U.S., as well as acceleration of institutional construction. In Europe, we see increased construction activity driven by the rise in funding for green buildings, driving demand for our new eco-friendly product offerings in that space. In residential, our smallest end market, we are expecting low single-digit to mid-single-digit growth with healthy demand. And now let's turn to slide 13, and I'll walk you through our updated guidance. For Xylem overall, we foresee full-year 2022 organic revenue growth in the range of 3% to 5%, with flat revenues in the first half and high single-digit growth in the second half. This breaks down by segment as follows. Mid single-digit growth in water infrastructure with solid growth in both wastewater utilities and industrial. Mid single-digit growth in applied water from solid mid single-digit growth in industrial and commercial applications and low to mid single-digit growth in residential. We expect measurement and control solutions to be flattish. As Patrick mentioned earlier, this assumes down double digits in the first half of the year and up double digits in the second half, although growth is still likely to be partially constrained by the gradual return of chip supply as the second half progresses. Despite that partial recoverability in the availability of chips, volumes and margins will remain supply constrained. The constraint will have an unfavorable impact on volume and mix, more than offsetting the benefits of price realization and productivity savings through the year. For 2022, we expect adjusted EBITDA to be in the range of 16 to 17%. In the first half of the year, we anticipate EBITDA will be approximately 14 to 15%, bouncing back to 18 to 19% in the second half. And this puts EBITDA in the second half in line with the long-term targets we laid out at Investor Day. This yields an adjusted EPS range of $2.35 to $2.70. Free cash flow conversion is expected to be at least 100% of net income. We have provided you with a number of other full-year assumptions on the slide to supplement your models. We're assuming a euro-to-dollar conversion rate of 1.13, And as foreign exchange can be volatile, an FX sensitivity table is included in the appendix. And now, drilling down on the first quarter, we anticipate total company organic revenues will be in the range of flat to up 2%. This includes mid-single-digit growth in water infrastructure and applied water, and MNCS is expected to decline low double digits. We expect first quarter adjusted EBITDA margin to be in the range of 13.5 to 14%, impacted by higher inflation and supply chain challenges. We expect this will be the low point in adjusted EBITDA in the year, with accelerating sequential quarterly improvement. And with that, please turn to slide 14, and I'll turn the call back over to Patrick for closing comments.
spk07: Thanks, Sandy. We're coming into 2022 in a strong and enviable position. The market demand for our solutions and technologies has never been greater. We have strong commercial momentum with very strong orders growth and high margin backlogs that prove our conviction about the investments we've been making and our customers' need and appetite. And the foundation and flexibility of a powerful balance sheet giving us strategic options in a dynamic marketplace. In the short term, of course, no one likes being constrained by externalities. But we have strong resolve and operating discipline and fully expect to deliver a year of results on track with our 2025 strategic and financial goals and that are aligned to our overall investment thesis. That of being a technology leader with a durable business model, bringing differentiated offerings to a market of rising demand for sustainable water solutions, committed to driving above market growth and margin expansion as our portfolio continues to digitize, and to accelerating value creation with disciplined, active capital allocation. So now, operator, I'll turn the call over to you for questions.
spk03: The floor is now open for questions. At this time, if you have a question or comment, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you pose for your question that you pick up your hands up to allow optimal sound quality. Thank you. And our first question comes from Dean Dre with RBC Capital Markets. Please go ahead.
spk09: Thank you. Good morning, everyone. Hey, good morning, Dean. How you doing? Good morning, Dean. Doing real well. Real well, thanks. Hey, look, since it's the biggest swing factor in your guidance, the chip shortage, and it didn't sound like you have Tony on the line this quarter, but I had some questions that, you know, if we can go into a little more detail on the shortage situation. Again, this gets a bit more technical, but can you give us color between your shortages on the microprocessor side, which typically you can get substitutes and alternative sources versus microcontrollers, which are so much more tied to firmware and it's really hard to substitute and redesign. You know, the extent to which that could be helpful, is there a distinction there in terms of shortages and both and when you expect to get recovery in those two classes of chips?
spk07: Sure, certainly, Dean. Great question. So, you've nailed it. If we look at our, you know, supply chain challenges right now, you know, 80% of the issue roughly is microcontrollers. And I'll come back in a moment to what we're doing there to try to mitigate that as best we can. And we can also talk about what we're doing to make sure that we hold on to the backlog that we've got right now, which has really attractive margins in it. But the 20% that is more on the microprocessing side, We faced those challenges in Q4, and the team did a terrific job on substitution, really going out into the open market in broad distribution, and really helped us mitigate that. Otherwise, we would have really had a bigger hit in Q4 than what we mitigated. Now, it really is about the microcontroller. So, what we're doing there, you know, we are partnering with our suppliers on redesign. And so, and there, what we're doing is we're redesigning along with where they see future designs going across the broader technology sector. But those really, those impacts really aren't going to hit us until, or benefit us until probably Q4 going into 23, because it is a lead time. We are doing alternate sourcing, and that certainly is helping us buffer some of the demand here. And we're also, you know, resurrecting some of our legacy meters as a bridge in some of these larger AMI implementations to go ahead and get these projects started. Lastly, I would say on the large AMI deals, What we work with our customers on is they've really been encouraged by us going out and beginning to build out the comm side, the communication side. So we get the products going. And we've also opened up them to have the opportunity to go out and use alternate meters. And honestly, Dean, they've come back to us because they realize they believe in the value proposition. They see what we're doing here and they want to be with us. So, you know, we're working it every day. We feel good about where we are in terms of protecting backlog. And the team is all over this in terms of what we can do to mitigate the chip supply situation.
spk09: All right, I'm glad I asked to that level of detail because oftentimes you just says, oh, chip shortage, and you move on.
spk07: Yeah, hey, Dean, on that point also, Dean, just to give you a feel for kind of how things are going with our suppliers right now, we had a number of decommits from our large suppliers in Q4. Those decommits have ceased. We haven't had a decommit for quite some time now. They've actually been delivering on forecasts. And the lead times, while they are still very lengthy, I mean, we had lead times up to 78 weeks on some of our key components here. Those have moved down modestly. But the good news is they're moving in the right direction.
spk09: Got it. And I appreciate the caller on the not losing share or having cancellations within the meter backlog. So that's real helpful. And just the follow-up question. This has come up a couple different times and ways in this call is you've you've booked the 23% organic order growth, which is really healthy and gives you that longer term outlook. And you've said that the implied margin are healthy or creative. I just want to, what base or margin are you comparing that to? And you're just the extent to which, you know, we're all looking at what the 2025 target is. And, and so how would the, orders you're booking now compare on profitability, either this year or for next year? Thanks.
spk04: Yeah, great question, Dean. You know, the momentum that we have on the orders front is really, really strong, and it's broad-based across our portfolio. So when I'll start with more of our book-and-ship businesses in AWS and water infrastructure and There we know that we've taken price actions throughout 2021, and actually we've taken some incremental price actions already in 2022. And so we know that those orders that we've recently secured are going to be more competitive and balanced against the inflation headwinds that we're facing. You know, when we think about the longer-term large AMI contracts, Most of those contracts have inflation adjusters, which are tied to CPI. And so while all of those won't be delivered in 2022, it's going to take us some time once we get back to good flow on the chip side to clear out that backlog. But those price resets will help protect the margin. And when we think about those large AMI deals, we're looking at gross margins above 40%.
spk02: Yeah, incremental margins. Real helpful. Thank you. Thank you, Dean.
spk03: And our next question comes from Nathan Jones with Stiefel. Please go ahead. Your line is open.
spk06: Good morning, everyone. Hey, Nate. How you doing?
spk03: Morning, Nate.
spk06: Very well, thanks. Very well, thanks. I want to start off just talking a little bit about price versus inflation. I think the disclosure for this quarter was inflation at 560 basis points and price at 200 basis points. I'm a little surprised you aren't able to capture more price and close that gap a little bit to inflation. Given demand is very strong, given customers across industry have been conditioned to expect price increases at the moment, are there opportunities for you to be not just a little bit more aggressive on price, but significantly more aggressive on price to close that gap?
spk04: Yeah, I think really good question, Nate. You know, the inflation rate certainly picked up on us in Q4. So when we look at sort of an exit, we look at an overall inflation for 2021, it was in the, you know, 8% range. And when we exited Q4, it bumped up to about 12%. So that was a, you know, a meaningful increase. And it actually outpaced what we had incorporated into our guide. On the flip side, we did get some more price in the fourth quarter than we had modeled, and so they kind of netted, which is why we came in with EBITDA margins in line with our forecast.
spk07: And so, Nate, what I would offer up here is... You know, it really is a story of momentum. So to Sandy's point, you know, we were very aggressive on price in Q4 and continue to be. And our price cost is going to be positive as we go into Q2. You know, we weren't able to go in and reprice all of our backlog. We repriced some of it. but we're going to be price-cost positive in Q2, and that really ramps in the back half of 22. And for the full year, we are going to be price-cost positive for the full year.
spk06: That's very encouraging.
spk07: The teams have done a great job on the pricing front.
spk06: Thanks. Cancellations, you talked about no cancellations. on the AMI side of the metering business. Have you seen cancellations on more the replacement side or losing some share on the replacement side? I understand there's differences between your business and some competitors' businesses. Maybe you could explain those differences a little bit. Their results, Badger had 20-odd percent metered growth. Neptune had double-digit metered growth. Can you talk a little bit more about what the differences between those businesses are? More tech in your side of it, I think, contributes to it. Just the differences there that are resulting in that differentiated performance. Sure.
spk07: Sure. So maybe, yeah, so perhaps what I can do is just spend a moment on explaining kind of the metering market. So you've got two different types of meters. You've got static, which is really kind of where the market is going. That's where the market overall is going. Our competitors are also moving that direction. And then you have the mechanical kind of traditional meters, which we certainly have those, but it's a much smaller portion of our portfolio. The benefits of static versus mechanical from our view and certainly customers' view is static meters are more accurate over the life of the meter. You have less moving parts in a static meter. You're able to build in other kind of bells and whistles like advanced alarms around leak detection. It obviously, with the data that's able to gather, helps around non-revenue water. So there's a lot of kind of economic and environmental value, and that's why the industry is moving towards static. You know, we are further along in that move. And so as a result of that, we are more exposed to chips because the microcontroller really is the brain of that static meter. And so to your question around kind of the day-to-day replacement business, To be honest, we have seen some customers that have gone back to traditional to say, hey, it's good enough right now, but that's only transitory. And even we are resurrecting our old mechanical meters to help bridge that time that we're there. Most importantly, on these larger signature wins, again, these large AMI deals, which are really the indicator of where the market is going, we've not lost those. And if anything, we've seen, you know, we're still winning deals in that environment because the value proposition is so strong. and so robust. And again, you know, what we're focusing on right now is making sure we get the communications platform in place to really secure those and move those forward.
spk06: Great. Thanks for taking my questions. I'll pause it on. Thanks, Nathan.
spk03: Our next question comes from Brian Blair with Oppenheimer. Please go ahead. Your line is open.
spk05: Good morning. Thanks for taking my questions.
spk04: Good morning, Brian. Good morning.
spk05: I was hoping you could offer a little more color on dewatering trends. You highlighted the strength in international markets, specifically emerging markets. I'm curious about the relative growth of equipment sale versus rental and the stronger drop-through on the latter and what's contemplated in your guidance for that business specifically.
spk04: So, you know, good question. I think we have seen increasing momentum in dewatering as we move throughout the year. And in fourth quarter overall, we saw, you know, high single digit growth. We actually saw growth in all of our markets. but especially strong momentum coming in emerging markets because of strong mining demand. Really, it was on both fronts, the rental front and the equipment sales front, both showed positive signs. We've taken some steps this year to invest a little bit more on the CapEx side to refresh our fleet, and we expect to see some positive benefits from that as we go into 2022.
spk07: Yeah, Brian, one of the things on that last point, one of the things that we had done, you know, when we were in the down cycle in that business, we were curtailing some of our CapEx to protect margins and just see kind of, you know, stabilize that business. Now we really see there being opportunity that as we invest even just a little bit more in the fleet and from a CapEx perspective, that traditionally has yielded very, very positive returns, both from a growth and a margins perspective there. And we don't have all that built into our guide, but we do see a strong recovery there.
spk05: Appreciate the color. As a follow-up, focusing specifically on the U.S. market, just curious how your team is thinking about the potential catalyst from infrastructure spending. There are other areas of your business that I guess somewhat naturally get more attention on that front, but I would imagine the tailwinds for general construction activity, commodity demand, would read through pretty nicely, perhaps more of a 2023, 24 catalyst, but any color on that front would be helpful.
spk07: Yeah, certainly. You're right. You know, we don't have any of that built into our guide for 22. It really is. And we didn't really even have anything built in meaningfully into our, you know, outline of kind of long range objectives in our investor day, because we always talked about that being a possible support mechanism for, So it is a 23 and beyond. But yeah, just some specifics on this. I know others have commented both positive and maybe not so positive on when it's going to happen. Our view is we're talking about $66 billion of investment in critical water infrastructure. 80% of that is going to be administered by the EPA, who we have very strong relationships with at the highest levels. Nearly a half of the 193 programs that are funded in this bill contain, you know, commercial opportunities for Xylem. You know, it is more than a one- or two-year thing. It really spans over several years. So there clearly are commercial opportunities there. But, again, they're not in our outlook, but we are net positive on the trends that we're seeing right now and the conversations we're having with customers.
spk05: Understood. I appreciate the detail there. I was – Perhaps we're missing, I was referring specifically to the dewatering outlook. But I understand there are broad-based perspective tailings.
spk07: Yeah, I think the areas that it would be most impactful for us would really be in predominantly three specific areas. It would be certainly dewatering on the construction side. You would see it in our water infrastructure business on the treatment side, most notably. You know, you would also see it on the clean water side as we're talking about, you know, the addressing non-revenue water issues. through some of our solutions there. And then there would be an ancillary benefit, you know, even on our commercial building and industrial side and applied water, where you've got a knock-on effect of some of this infrastructure demand. But it's really going to be predominantly in dewatering treatment and the clean water side.
spk05: Helpful color. Thanks again.
spk02: Thank you.
spk03: And we'll take our next question from Ryan Connors with Boning and Scattergood. Please go ahead. Your line is open.
spk12: Great. Thanks for taking my question. Sure. I wanted to just look at the MCS from a bigger picture standpoint. And I think it's fully recognized the supply chain has been a big challenge. But really, if you look back, the MCS profitability – issues really predated the pandemic and the supply chain issues. I mean, if you look back at some of the press release and commentary from 2018-19, I mean, that business has been sort of a drag on profitability, you know, for a long time. So, I'm wondering what your perspective is on that, and is part of the takeaway that it's not a great business in normal times, and we see it's a really bad business when things get tough, or I mean, what's the longer picture looking back at the pre-COVID challenges in MCS?
spk07: Sure, Ryan. You know, fair question. I look at the proof points of this business, and that is I look at the backlog. So I look at the investments we've made. I look at the deals that we've won. I look at the margin profile of those deals in the backlog. I look at the margin profile of even our, you know, repair replacement business. And it is very attractive. I look back at the first half of 2021, where we demonstrated even, you know, mid single digit growth. And we showed, you know, 500 basis points of margin expansion from an EBITDA standpoint during that timeframe. Have we been, have we had our licks and our NOx over the last few years, absolutely. Whether it be a battery supplier having a fire, whether it be trade conflicts, now we have the impacts of chip shortages. Yes, that is the nature, unfortunately, of us being in a technology-leaning business. But the proof points are there. The investments that we've made are paying off in terms of demand, margin profile, and we love this business. And, you know, we, again, we're guiding responsibly this year. We want to give you a balanced view. And even within that balanced view, you know, look at the margin profile of what we're committing to in the second half of the year. And that is right in track and right on line with what we laid out in Investor Day back in September.
spk12: Now, you know, one of the things that a relevant peer company does, had an issue with a tech business where it was repeatedly the source of trouble and discussion, disproportionate to its size, and decided, you know what, we're going to just fold that into the other businesses to keep it from attracting so much attention to itself. I know MCS was a relatively new segment. Census, I guess, was within water infrastructure for a while. and then it was broken out. Would there be any sense to making a similar move to kind of changing the reporting structure so that MCS doesn't repeatedly sort of dominate the discussion as it has?
spk07: Yeah, just for a matter of correction. So actually, since this was not part of water infrastructure, so I just want to clarify that. It's always been a standalone piece. And no, we don't have any plans for any reporting changes or integration. I mean, I want to be clear to all listening that Not everything we're doing from a digital standpoint is happening within MNCS. MNCS is a proxy for the clean water side of the utility market. Water infrastructure is a proxy for the wastewater side of the utility market. And applied water is a proxy for those customers in the world that consume water. Digital runs through all three of them. It just right now is more prominent. within MNCS. And as a result of that, that's why we're getting hit on the chip side. I mean, 30 to 40% of our MNCS revenue is exposed to chip shortages right now. And two thirds of our backlog is dependent on chips. But that is a result, quite frankly, of the demand that we've created in the marketplace because of the innovation that we're driving. So no, there's no plans to rethink or change our reporting structure. Okay.
spk12: Thanks for your time. Thank you.
spk03: Our next question comes from Brian Lee with Goldman Sachs. Please go ahead. Your line is open.
spk08: Hi, everyone. This is Miguel on for Brian. Thanks for taking the time. Hey, Miguel. Good morning, Miguel. Good morning. Just wanted to touch back on the MNCS cadence that you laid out for 2022, low double digits in the first half and then high double digits in the second half. And then you also noted that organic growth is going to be flattish for this year, but that the backlog is going to be rolling through and that backlog has grown. So when we think about the cadence for the year, how much of that first half, second half cadence is that backlog getting converted? And then how much of that might be any additional price actions that might be also contributing to that cadence? Thanks. And then follow up.
spk04: Yeah, so just to give you some perspective on how we're thinking about MCS and how it shifts through the year, we exited Q4 of 2021 with about $300 million of revenue in the segment. And so that would put us at a $1.2 billion run rate for the year. You know, getting back to flat assumes that throughout the year we kind of add about $20 million of incremental revenue each quarter. And it puts us back at the end of 2022 very much like what we saw in the first half of 2021 from a size perspective. And while we're starting to eat into some of the backlog, we're by no means clearing all of that in 2022. That's going to take, you know, 18 to 24 months to get that worked through. And so we would expect, you know, very strong growth coming out of this segment in 2023 and 2024.
spk07: So we've, Brian, we've, again, built what we believe to be a balanced and responsible guide here. By no means is there a, you know, a huge hockey stick built into this guide. And certainly, you know, what we see in terms of backlog conversion, I mean, that is the upside variable for us as we look at over time here. And, again, the margins that are built into that.
spk08: Okay, great. That's super helpful. And my last question, I can pass it on. So, last quarter, you called out some order pushouts from the fourth quarter into 2022. And then, you know, just thinking through the guidance for this year, it's 3 to 5% organic. And then long-term annual organic growth is 46. You mentioned you didn't lose orders. But how do we think about, I guess, a bridge on those orders coming out of 2021 and into 2022, the guidance of 3% to 5% organic in 2022, and that compares to the long-term guidance of 4% to 6%. Just trying to think through those orders. But then you also mentioned the 18- to 24-month, I guess it'll take to flow through all that backlog. So, just looking for a little bit more color there. Thanks.
spk07: Sure. Yeah. We've got, you know, we came into the year talking about, I think in the last call we talked about there being about $100 million of orders that had moved to the right based on supply issues. That number right now would probably be about $120 million that's moved to the right. And so to Sandy's point, you know, we're really not eating tremendously into backlog orders. in this guide. That happens even more in 2023. So, you know, when you look at our orders growth for the full year of 21 and even Q4, a big chunk of that is deals in the MNCS backlog that don't convert until 23. And so, you know, that really is the big swing factor here in our guidance is how quickly can we convert that volume based upon supply. So we exit, you know, we exit this year, you know, second half more in line with that, you know, up mid to high single digits year over year. And we would expect that to continue in line with what we talked about in investor day.
spk02: Okay, great. Thanks. That's very helpful. I'll pass it on. Sure.
spk03: And we'll take our next question from Andy Hapowitz with Citigroup. Please go ahead.
spk00: Good morning, everyone. Good morning. Good morning, Andy. Good morning. Just focusing on capital deployment for a minute, your balance sheet is obviously in really good shape here, and we know you've been a little more quiet on the M&A side lately. So you think 2022 is more of an active year for you, which could include M&A or maybe the potential for a bigger repurchase, given what the stock is doing?
spk07: Yeah, thanks for the question. As you said, I mean, we are coming into the year with a really strong balance sheet, again, over $2 billion in liquidity. You know, as always, it takes two to tangle here. And, you know, I think we've shown before that we're not hesitant to get a deal done when there's a really good deal to be done. I do think that there's an attractive market right now. You know, there are assets out there, both of scale markets, and even, you know, kind of small to medium size that we have been studying. And I think this will be an active year. And certainly, you know, what's going on in the markets right now by no means deters us from that commitment. They will always tie back to our overall strategy. But it's a rich market, and, you know, we're looking forward to 2022.
spk00: Patrick, water infrastructure is hung in there in terms of margin performance a fair amount better than the other two segments. We obviously know about the chips impacting MCS, but is there anything different in terms of that segment's performance that you might be able to apply to other segments to improve their performance as you wait for the chip shortage to run its course and your backlog to burn?
spk07: Sure. You know, I would say both water infrastructure and applied water, you know, are, you know, they are more mature businesses. They are, you know, we're market leaders in that space, as we are in MNCS, but they, you know, they're in different end markets than our MNCS segment is in terms of a conversion to digital and kind of, you know, being a large deal kind of dependent. So, you They've done a great job. Those teams have done a great job of operational discipline around productivity, price realization. They continue to do that. We continue to invest And those businesses, our vitality indices in both those businesses continue to be quite impressive in terms of how we're driving innovation in that space. So very pleased with it. You know, I think the water infrastructure business, you know, serves the wastewater side of the market for the most part. That does tend to be a more stable environment where the big chunk of that is OPEX versus CAPEX from a utility perspective. And on the applied water side, you know, they're serving the users of water, which, again, tend to be more stable in terms of in-market demand. And the reason we've outperformed the market there is really the, you know, the aggressive stance we've taken on new products and entering some new markets on the emerging market side. So there's nothing I would say we translate from those two over to MNCS. Each one of them is in a different part of the cycle and serving a different part of the market. Appreciate it, Patrick. Thank you.
spk03: We'll take our next question from John Walsh with Credit Suisse. Please go ahead.
spk01: Hi. Good morning. Good morning. Hey, maybe just two quick ones from me. Following up to Dean's question, we've been starting to hear some companies talk about this metric of kind of how much of semi-chip or components they've already secured to give them visibility into their outlook. So you made the comments you've had no decommits, but I'm just curious, you know, on your commitments from your suppliers, do you have the majority of what you need committed at least to deliver on your guide? Or do you need to get more commitments from your suppliers to deliver on the guide?
spk07: Yeah, no, great question, John. So our guide, you know, really reflects a modest recovery in the chip supply. So to put some numbers at least directionally around that obviously depends upon the product line and specifically the component. But Overall, coming into the year, we only were getting about half of what our demand was on the critical components. If you think about what we could ship, in terms of backlog versus what we were able to. We're talking 50% supply there. Our guide has reflected in that a gradual recovery that really does not start even until the second half of the year. And we get roughly back to about 75% of our demand that's there. And then that improves continually into 23 and beyond. You know, we think we've been responsible here and balanced in our guide. It does not assume a miraculous recovery. And clearly, that is the big swing factor. If that were to improve considerably, then so would our outlook. But right now, that's what we see, and that's why we're guiding the way we are.
spk01: Great. Thank you for that color. And then maybe just one on, you know, expectations of where Backlog and orders could go for the year. You obviously talked about a lot of demand. Would you expect that backlog kind of burns through the year as you convert into sales or, you know, could we expect to see backlog kind of continue to grow?
spk04: Yeah, you know, John, I think we talked a lot about this, that we're not going to be able to eat into a tremendous amount of our backlog, particularly in the MNCS segment because of the supply chain shortages. So when I look at Xylem overall, we would expect backlog to continue to grow in 2022. There are a couple of segments where we have especially large backlogs that are really book and ship business. And if we get customers back into more normal ordering patterns, you may see a modest reduction there. But overall, we expect next year that we'll be talking about strong backlogs as well. the pipeline, you know, the bidding pipeline and funnel still look really robust.
spk01: Great. Appreciate you taking the questions. I'll pass it along.
spk02: Thank you.
spk03: And once again, to ask a question, that is star and one. We'll take our next question from Andrew Buscaglia with Barenburg. Please go ahead.
spk11: Good morning, guys. Good morning. Good morning, Andrew. I was hoping you'd talk a little bit about, you know, you're talking about you're not seeing cancellations, which is great in your backlog building. If we are to see some of these projects move forward, I guess, where do you feel more optimistic regionally that this is going to occur? And I think I say that because, you know, I think earlier this week, the finance minister of India is calling out $530 billion in public infrastructure spending in one year, I think. So I'm just wondering if we're going to see upside, if these delays, move forward, where would it be coming from, do you think?
spk07: Sure. So, you know, certainly, you know, I would say the two areas that we would see, you know, more meaningful progression, you know, and We feel very good about our emerging markets business. You know, we continue to expect that to be growing in the high single digits. It's been a great performing part of our portfolio for a number of years now. And if anything, that business has become more balanced I would say before we were, you know, very largely dependent on China. China is still a great business for us and we expect great results there, but it's good to see the rest of our portfolio there move forward. It's also more mature in terms of OPEX spend versus CAPEX. So that's one area where we think, you know, we feel good about it and there could be opportunities to accelerate that. It really, you know, the biggest swing factor would be within MNCS. And it's mostly water utilities in North America. And I would say there it really is the large utilities where we've won these large AMI deals where it is less likely that they would ever switch out to someone else. And as I said earlier, we're already doing the comms work to secure that volume going forward. And so if there were any kind of releasing of orders in terms of being able to convert them, it would be in that space. Those are the two big swing factors for us.
spk11: Okay, interesting. And maybe, you know, one last one on, you know, with your capital allocation and M&A, you had some commentary there. I'm wondering, you know, now that these supply chain challenges seem to be more prolonged, does that kind of make you hesitate in terms of moving forward with anything until you get a better handle on right-sizing the ship here? Or is it the other case where you think some of your targets might feel more comfortable being part of a bigger entity like yours where these supply chain challenges may work in your favor, I wonder?
spk07: Yeah, so it's a great question. You know, what we're experiencing right now in terms of the chip supply issue does not change our view on M&A. Our resolve there is strong. We see attractive opportunities. You know, working through these supply chain challenges, we have the team in place that's all over this, and they would not be distracted by anything we might do on the M&A side. At the same time, you know, I think you're pointing to the fact that certainly the In these types of situations, you know, companies of size and scale, you know, certainly have an advantage, and we certainly look to leverage that strength, you know, when the time is right and the opportunity is right. And, again, it takes two to tango.
spk02: All right. Thanks very much. Thank you.
spk03: Well, the next question comes from Joe Giordano with Cohen & Company. Please go ahead.
spk08: Hey, guys. Good morning. Thanks for squeezing me in. Hey, Joe. Good morning. Hey, so, Patrick, we've referenced a couple times on MCS, like, you know, first half of 21 is, like, a barometer of where, you know, where we might exit. If I look back, though, like, you know, even first half 21 is still pretty far away from a margin standpoint from, like, what we saw in 2017, 18 on EBITDA. Like, what kind of conditions need to be in place to really get that business, you know, to, like, a 20% level? Is that, like, a realistic couple-year outlook?
spk07: yeah no it's it's a great question joe so uh you know if you think back over time uh you know after we acquired the census business and we built the mncs uh segment the portfolio uh we also made a you know a fairly significant investment uh in digital uh whether it be in the metrology business and some new product introductions designing for large deals that we were looking to win uh and also uh you know we were pardon me, making investments in some of the new digital acquisitions that we made. So again, that's, you know, that's paying off now when you look at the growth in orders and backlog, the margin visibility we have in that. So that is a period of time that we were going through. And, you know, when we've looked at this segment, You know, when we get to a run rate of roughly $400 million in revenue, which we have visibility to in our backlog, you know, you're looking at EBITDA margins that are 20% plus. So I realize that, you know, people have been patient. People have been wondering kind of what that curve is. And, again, it really is about demand that we see in backlog and the margin profile that we see. But that timeline that you're talking about, Joe, was a period of investment.
spk08: Yep. No, that's fair. I also noticed that the inflation at AWS was like significantly higher than the other two segments. I don't know if that was just like a weird kind of way it flowed in on the quarterly cadence, but anything that we need to note there?
spk04: No, that's a great observation, Joe. I think that's a trend we've been seeing all year, that the inflation has impacted our AWS business the most. We did see that pick up in Q4. I would say that's the part of the business that we're also seeing the greatest price realization. And, you know, we're a little bit out of balance in Q1. And as we move into Q2 and the back half of the year, we're going to be in a much stronger position there in light of the actions that we're taking to drive more price realization.
spk07: And I would say, Joe, you know, the other piece of this is Applied Water is the business that is also more U.S.-centric in terms of impact there. We clearly have seen higher inflation there. from a geographic standpoint in the U.S. We've seen that also in MNCS, but the reason you don't hear us talking as much about it is because, again, we have these price clauses in our large deals and the backlog. So it's a different kind of cycle that we're facing in those two businesses.
spk08: Thanks, guys.
spk02: Thank you.
spk03: I'm going to go next to Graham Price with Raymond James. Please go ahead.
spk02: Hi, good morning, and thank you for taking my question. I guess on the infrastructure spending side, you know, you talked about the U.S. emerging markets, and you specifically called out strong funding activity in Europe. So I was wondering what you're seeing there, both with respect to spending and then timeframes as well. you know, a 2022 story or, or more of a 2023.
spk07: Yeah, I think in the aggregate, discussions around infrastructure spending by geography, I would say certainly in U.S. and Europe, that is more of a 23 story. We don't have that really reflected in our guide. I think that when you look at it in the various countries that we label as emerging markets, China is in its first year of its latest five-year plan. So, you know, there will be softness there in the early part of this year based upon our historical experience. and then it will quickly begin to ramp. So we still feel very good about China. India, other parts of, you know, Eastern Europe is an example. We see those being opportunities and benefits that we will see in 22 because those programs are already active. But I think for U.S. and Europe, which is the largest chunk of this, it really is more of a 23 story. Otherwise, Europe is in a very healthy state right now from a demand standpoint. And, you know, we don't really see any shocks or big inflection points there. It's pretty predictable for us right now as it relates to Europe.
spk02: Got it. Thank you. That's certainly helpful. And then just curious, I guess, for 4Q, did you see any site access issues due to Omicron and COVID? And then is that an issue that you're tracking going forward?
spk07: We didn't. It definitely is one we're tracking going forward. We didn't have any meaningful side access impacts from Omicron, but we certainly had supply chain challenges in terms of logistics and port delays, and we navigated through that. We didn't really highlight it a lot in our coverage on Q4 because the teams really just did a great job of working through that. So we did get impacted by that on the supply chain. We have some of that carryover in Q1. And we have that reflected in our guide for Q1. But certainly, as we look forward, we don't see that as being a lingering issue for the balance of the year, at least based upon, you know, this current strain.
spk02: Got it. Understood. Thank you very much. Thank you.
spk03: There are no further questions at this time. We'll now turn the floor back over to Patrick Decker for any additional or closing remarks.
spk07: Great. Thank you. So thanks, everybody, for your time and attention this morning. And, again, appreciate the support and the great questions. We'll be back in touch with you on our next earnings call, if not between now and then. So have a good day and stay safe.
spk03: Thank you. And this does conclude today's Xylem fourth quarter and full year 2021 earnings conference call. Please disconnect your line at this time and have a wonderful day.
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