Xylem Inc.

We stand by. Your program is about to begin. If you need any assistance during your conference today, please press star zero. Welcome to Xylem's fourth quarter and full year 2022 earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star 2. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star 0. I would now like to turn the call over to Andrea Vanderberg, Vice President of Investor Relations.

Thank you, Operator. Good morning, everyone, and welcome to Xylem's fourth quarter and full year 2022 earnings call. With me today are Chief Executive Officer Patrick Decker, Chief Financial Officer Sandy Rowland, and Chief Operating Officer Matthew Pine. They will provide their perspective on Xylem's fourth quarter and full year 2022 results and discuss our outlook and guidance for 2023. 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 on the Investors section of our website, www.xylem.com. A replay of today's call will be available until midnight, February 14th. Please note the replay number, plus 1-800-8255. or plus 1-402-220-1111. 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'll 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 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 three. 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 four, and I'll turn the call over to our CEO, Patrick Decker.

Thanks, Andrea, and good morning, everyone. As we indicated in our press release, the team delivered a very strong operational performance in the fourth quarter, exceeding our expectations across each segment and region. and strong backlog execution delivered 20% revenue growth for the quarter and healthy EBITDA margin expansion. That performance continued and built upon the team's solid delivery through the year, fueling healthy momentum coming into 2023. On a full year basis, revenue grew 11% and earnings per share grew 14%. Water infrastructure grew 15% in the quarter on robust utilities and industrial demand in the US and Western Europe, and the segment was up 12% for the full year. MNCS posted very strong fourth quarter performance. The segment was up 35% in the quarter on backlog execution from improved chip supply and continued strong demand, bringing full year growth to 8%. Applied water grew 17% in the quarter and finished 2022 with 14% growth for the full year. Overall, higher volumes and positive price-cost performance drove significant EBITDA margin expansion in the quarter, up 250 basis points versus the same period a year ago. The team delivered that growth and margin performance on continuing resilient demand globally. We saw healthy orders grow sequentially, and for the full year, orders were up 4%, demonstrating the durability of our business. I am so proud of the team's performance in serving our customers and of their commitment to our purpose, solving water. The global trends driving investment in water systems continue to intensify, and as today's results demonstrate, we are already very strongly positioned to address them. That said, our recent agreement to acquire Avoqua announced two weeks ago will create a powerful platform to address the world's most critical water challenges with greater capability, depth, and scale. We've begun the important work of integration planning to set the combined company up for success and are well into the process of seeking the necessary approvals. Until the deal closes, which we anticipate will be mid-year, we remain focused on delivering results for the stakeholders we serve today. On that standalone basis, we see continuing resilient demand in our largest end markets, particularly utilities, despite the possibility of macroeconomic softness, execution of our backlogs with ongoing price-cost discipline, further supply chain improvements, and a return to 100% free cash flow conversion. We expect that this will allow us to deliver 2023 organic revenue growth in the mid-single digits with solid EBITDA margin expansion, resulting in earnings per share between $3 and $3.25, up 10% versus last year at the midpoint of the range. We'll give more color on the outlook and guide in a moment, but first I'll hand it over to Sandy to dig in briefly on the quarter's results before we look ahead at 2023.

Thanks, Patrick. Please turn to slide five and I'll cover our fourth quarter results. As Patrick highlighted, the team closed out a strong 2022 with another quarter of robust growth and margin expansion. Revenue grew 20% year over year, led by 26% growth in the US and mid-teen growth in Western Europe and the emerging markets. In a moment, I'll give you detailed performance by segment, but in short, utilities was up 24% with strength in the U.S. driven by chip supply improvements in MNCS and robust OPEX demand in water infrastructure. Industrial grew 15% on particularly strong demand in Western Europe and emerging markets and sustained strength in the U.S. Commercial was up 24%, mainly due to continued backlog execution in the U.S. and Western Europe. And residential was up 17%, driven by strength in emerging markets partially offset by softness in the U.S. Compared to prior year, orders were down 3% in the quarter, versus up 23% in the same period last year. But underlying demand remains resilient and in line sequentially. Water infrastructure orders were up 13%, AWS down 6%, and MNCS down 19%, following exceptionally high orders last year. However, MNCS orders were in line with the last quarter with a book-to-bill ratio of 1.1 times. EBITDA margin was 18.7%, up 250 basis points from the prior year and up 40 basis points sequentially on strong volume and price, which more than offset inflation. Our EPS in the quarter was 92 cents, up 46% year-over-year. Please turn to slide 6. and I'll review the quarter's segment performance in a bit more detail. Water infrastructure outperformed expectations with revenues up 15% in the quarter. Growth was robust across the portfolio, led by our wastewater utility business in the U.S. and industrial strength in emerging markets on continued dewatering demand. Geographically, the U.S. was up 26% with solid price realization on strong utilities OPEX demand and continued improvements in the supply chain. Western Europe grew low double digits, driven by healthy industrial activity. And emerging markets was also up low double digits, driven by dewatering demand in Latin America and Africa. Orders in the fourth quarter were up 13% with solid dewatering demand in emerging markets and continued utility strength in the U.S. EBITDA margin for the segment was up 80 basis points as price, net of inflation, and volume conversion more than offset strategic investments. Please turn to page seven. The applied water segment also exceeded expectations with fourth quarter revenues up 17% on strong price realization and backlog execution. Geographically, Western Europe was up over 20% led by supply chain improvements and strong industrial and commercial demand. Emerging markets was up mid double digits on strong residential demand in the Middle East and India. The U.S. was up low double digits as supply chain improvements and price realization were partially offset by moderating residential volumes. Orders were down 6% in the quarter, with healthy industrial demand in the U.S. and Western Europe offset by slowing U.S. residential orders. Segment EBITDA margin was up 270 basis points in the quarter. Margin expansion was driven by continued strong price realization, more than offsetting inflation, and further supplemented by productivity savings. And now let's turn to slide eight, and I'll cover our measurement and control solutions business. MNCS revenue was up 35%, driven by recoveries in chip supply year over year, and strong project execution in our test and measurement and pipeline assessment services businesses. Geographically, all regions were up more than 20%, led by U.S. growth of over 40%. MNCS orders were down 19% in the quarter, lapping a prior year compare of 28% orders growth during the peak of supply chain constraints. Demand for our AMI offering remained strong, and our $2.1 billion backlog in MNCS is up 14% versus prior year. EBITDA margin for the segment was up 800 basis points versus the prior year, and importantly, 130 basis points quarter sequentially. Strong volume conversion coupled with price realization offsetting inflation drove the expansion. And now let's turn to slide nine for an overview of cash flows and the company's financial position. In the fourth quarter, we generated free cash flow of $302 million. The team did a great job driving down working capital to hit our previous outlook of 80% free cash flow conversion for the year. While inventory remains elevated versus where we targeted to be longer term, as there still are pockets of the supply chain that necessitate the extra safety stock that we are carrying, Our performance in Q4 gives us confidence in our path to return to 100% conversion in 2023. Our financial position remains robust as we exit the year with over $900 million in cash and available liquidity of $1.7 billion. And this is after paying down over $500 million of debt in December. Net debt to EBITDA leverage is 1.0 times. Please turn to slide 10 And I'll hand back to Patrick to look forward at 2023.

Thanks, Sandy. The team did an excellent job delivering for our customers and communities in 2022. Their commitment and performance stood out during a tumultuous year of global economic and geopolitical uncertainty, lingering pandemic effects, especially in China, and a challenging supply chain environment. I'm very proud of everything the team achieved. and they are already carrying all that commercial momentum, operational discipline, and resilience into 2023. As we look forward, we see continued healthy demand in our major markets, despite the possibility of macroeconomic softness in certain sectors of the global economy. We expect that the essential nature of our solutions and the secular trends in water will continue to underpin demand in the attractive, stable end markets that we serve. And we expect to be even better able to serve that demand as supply chain friction continues to ease and we can progressively work down our $3.6 billion backlogs. Looking ahead, we are advancing our strategic delivery of solutions to the acquisition of Avoqua. As I mentioned earlier, and as you would expect, until the deal closes, we are only providing organic guidance for Xylem on a standalone basis. But there's no doubt that the combination of Xylem's global utility scale and Evoqua's strength in attractive industrial end markets creates a powerful platform for growth. We expect significant revenue synergies in areas such as cross-selling of our respective utility and industrial portfolios in North America and growing Evoqua's international exposure via Xylem's global channels and customer relationships. Now, those are just two of the areas where we see tremendous potential to add to the growth of the combined companies and expand our value to customers globally, especially in a number of the most attractive water end markets. But it's not the only inorganic move we're making to give customers more of what they need most. We've also taken a big step forward in helping them adopt the digital solutions they need to increase the resilience of communities' essential water infrastructure. In the shadow of our big announcement with Avoqua, another important partnership flew under the radar, one which will accelerate and enhance our ability to deliver more digital solutions to utility customers around the world. Last quarter, we signed an exclusive commercial partnership with Adreca to make adoption of digital technologies easier, faster, and more affordable for our utility customers. Headquartered in Valencia, Spain, ADRIKA is a leader in data management and analytics for water utilities. ADRIKA's Galagua platform simplifies deployment and operation of new digital capabilities in any water utilities operations. It gives them one secure, integrated interface that brings together data capture, analytics, and asset and process management onto one platform. Having been born out of a utility operator itself, the platform has the advantage of having been built by utility for utilities. And it's already been deployed by over 300 customers around the world. Under the partnership, we will take a minority stake in ADRIKA and become the exclusive global distributor of their technology. Together, we will enable more utilities to harness the power of connected solutions. We're very excited about it, and we look forward to sharing more as the partnership progresses. We made one other important announcement recently. This one was just before the end of the year, appointing Matthew Pine as Chief Operating Officer. The move ensures that we have continuing focus on operational excellence from an enterprise perspective across all our business segments and regions. To continue delivering on our commitment to faster the market revenue growth and margin expansion. At the same time, it's also freed up some of my capacity to deliver on Xylem's strategic evolution and capital deployment. In a moment, we'll turn the call back to Sandy for more detail on our guide. But first, I want to invite Matthew to say a few words on his key areas of focus in the new role and provide some color on our in-market outlook. Matthew? Thanks, Patrick.

We are very strongly positioned on intensifying trends with technology leadership and a large and growing installed base in attractive end markets. My focus as Chief Operating Officer is to further accelerate profitable growth and maximize the value we deliver to customers and communities around the world. Across the business, we continue to remove complexity, increase our local agility, and unlock further scale efficiencies. This is all aimed, of course, at better serving our customers at the same time we deliver continuing margin expansion. We're driving this margin focus across the enterprise, taking particular aim at even more enhanced productivity and customer satisfaction. For example, in the MNCS segment, improvements in chip supply enable us to build momentum, delivering the accretive backlog, redeploy resources back to productivity, as well as new product introductions from innovation. Secondly, we continue to enhance our digital portfolio, as Patrick covered. Our customers need simple, integrated digital technologies that solve their problems cost effectively. Our portfolio increasingly meets that demand with attractive growth and margin profiles. Lastly, our customers depend on Xylem as a trusted partner to deliver ongoing support. So our third operational focus is in standardizing our solutions and creating new offerings. This will take us deeper into our installed base with aftermarket sales and services. New offerings, such as outcome-based solutions and condition-based maintenance, will enable us to capture demand, address customers' needs, and expand reoccurring revenues. It's no accident that there's a theme running through all three of these priorities. Each is about growing revenues and improving our margins by serving our customers better, more thoroughly, and more simply, making it even easier for them to do business with us and solve more of their challenges. When we talk about being in a privileged position, that's not meant solely to refer to our strategic or market positioning. It also reflects our view that we are fortunate to work alongside the kind of customers that we do, partnering with them to solve their critical water challenges they face. It's a privilege and also a great opportunity for continuing value creation from our shareholders, communities, and all stakeholders. Now let's turn to slide 11, and I'll walk you through our end market outlook. We expect underlying demand in most of our end markets will continue to be healthy through 2023. We take in a balanced view based on the strength of our backlog, critical nature of our largest end markets, and the continued value proposition of our differentiated products. We anticipate our utility business overall, which is our largest end market, will grow high single digits in 2023. On the wastewater side, we expect mid-single-digit growth as we see a continuation of steady global demand. We anticipate resilient OPEX demand in developed markets due to the critical nature of our offerings, as well as the benefit of continued capex spend in emerging markets. The outlook for longer-term capital project spending and bid activity remains robust. On the clean water side, we anticipate revenues being up low teens. This growth is driven by continued robust demand for our AMI solutions and expected improvements in chip supply through 2023, allowing for significant large deal deployments already secured in our backlog. We foresee healthy momentum in our test and measurement and our pipeline assessment service businesses due to increased focus on infrastructure and climate challenges. Looking at the industrial end market, we expect to go low to mid single digits on steady demand for our solutions globally. we continue to see strong growth in dewatering due to mining demand in emerging markets and the benefits of our strategic investments in our U.S. and European dewatering business. The commercial end market should deliver low single-digit growth on solid replacement business and backlog execution, partially offset by moderation and new construction. In residential or smallest end market, we are expecting low single-digit decline due to normalizing demand in the U.S., partially offset by continued strength in emerging markets. In both commercial and residential, we would expect moderation to emerge in the second half results as we continue to work through the backlog in the first half of 2023. Now I'll turn it over to Sandy to walk you through our updated guidance.

Thank you, Matthew. Turning to slide 12. As mentioned, we expect a VOQA to join us in mid-2023. Until then, our full-year guidance is on an organic basis and excludes the combination of the two companies. For Xylem overall, we foresee full-year 2023 revenue growth in the range of 4% to 6%. This breaks down by segment as follows. Mid-single-digit growth in water infrastructure with solid growth in both wastewater utilities and industrial. Low single-digit growth in applied water from growth in industrial and commercial infrastructure. partially offset by residential. We expect measurement and control solutions to be up low teens. For 2023, we expect EBITDA to be in the range of 17.5 to 18%. This represents a 50 to 100 basis point margin expansion versus prior year. And this yields an EPS range of $3 to $3.25, up 10% at the midpoint over the prior year. Free cash flow conversion is expected to be 100% of net income. In addition, today we announced an increase in our annual dividend of 10%, aligned with our capital allocation framework to grow dividends in line with earnings. We've also provided you with a number of other full-year assumptions in the slide to supplement your models. We're assuming a Euro to dollar conversion rate of 1.08. And as foreign exchange can be volatile, FX sensitivity table is included in the appendix. And now drilling down on the first quarter, we anticipate total company revenues will be in the range of 7% to 9% growth. By segment, we expect high single-digit growth in water infrastructure, low single digits in applied water, and high TEAMS growth for MNCS. We expect first quarter EBITDA margin to be approximately 16%, driven by higher volumes and make more favorable price-cost dynamics. And with that, please turn to slide 13, and I'll turn the call back over to Patrick for closing comments.

Thanks, Sandy. We're coming into 2023 very strongly positioned. Our end markets continue to show resilient underlying demand. We're confident in delivering mid-single-digit revenue growth and strong margin expansion. And the team continues to outperform on strong operational and commercial execution. Beyond 2023, we remain well on track to deliver our longer-term strategic and financial milestones. We are very excited about all of the combination of Xylem and evocable offer toward the creation of a more water-secure, resilient, and sustainable world, while driving value for our shareholders by accelerating growth and scale. The integration team met last week at our headquarters in D.C., The first of many meetings to set us up for success on day one. And last week, I traveled with Ron Keating, a local CEO, to a number of their key sites to spend time with their incredibly talented people. Those visits only heightened my appreciation of the potential opportunities ahead and confirmed the strong strategic and cultural fit of our two companies. We've also taken the next step in the regulatory process. having submitted the required filings here in the U.S. and progressing toward filings in the relevant international jurisdictions. We continue to anticipate the deal closing mid-year. A great deal of opportunity will open up when we bring our two companies together. During our next earnings call, we will provide an update on our progress. Meanwhile, our business remains squarely focused on delivering on our 2023 financial commitments and continuing our commercial momentum and execution. Now, operator, I'll turn the call back over to you for questions.

We'll take our first question from Dean Dre with RBC Capital Markets.

Thank you. Good morning, everyone.

Good morning, Dan.

Good morning.

Hey, strong finish to the year, both revenues and margins. And I just want to say congrats again on finally getting to the altar on Evoqua. This has made strategic sense for so long. And to have a mid-year target closing is lightning fast in our view. I know that there's a lot of heavy lifting, so best of luck.

Thank you very much, Dean.

Hey, can we start with MNCS margins? It sounds like the two drivers here, the chip supply improving, and this has been kind of a steady story for the past couple of quarters. How much have you worked through that backlog and how much of the chip supply improvement contributed to the margin improvement in the segment? And then I've seen a nice shout out for pipeline assessment. Is this all pure and what's driving that? Thanks.

Yeah, Dean, thanks for the question. Let me start and Matthew can add some color here. So, you know, we are very pleased with our Q4 performance in MNCS. The year has unfolded very much like we thought it would with continuing improvement in chip supply. The story in Q4 is actually a two-fold story. We saw some upside compared to what we had forecast, and half of that upside came from some better chip supply, and the other half of the upside came from some of our other businesses in the portfolio that we don't you know, talk as much about. So our pipeline assessment services business, a lot of projects were completed in Q4. Really good results in our test and measurement business. And, you know, all of the, really the entire portfolio across MNCS has good margin potential and good leverage. And so, you know, as we've got the top line going again, we're really encouraged that you're seeing that drop to the bottom line.

Yeah, I think the only thing I would add, Dean, is that we did pivot in Q4 to more continuous improvement as we started to roll off of our product redesigns. So we saw a really good lift in Q4 and continuous improvement. And if you look at the price cost and the exit rate in Q4, it was really solid building momentum. This was, if you recall, this was the last segment to really be impacted by inflation and really overcoming that in Q4, which also led to the margin improvement.

All sounds good. And just as a follow-up, I was hoping to get some more color on this announcement of the software platform investment, Edrica. If you listen to all of the trade shows and conferences, the biggest pain point for utilities is they get so much data, but none of it's connected and it's all different formats. So this sounds really promising if it's one platform that then is able to integrate all of this. So Some color on the pricing. Is this a SaaS business? Is it on-prem? Is it licensed? How will it fit in terms of the revenue stream? And you've got 300 customers now. What's the pipeline for new customers, new logos? Thanks.

So, Dean, I'll just make a few comments and I'll have Matthew go a little deeper because Matthew was part of the team that was integral to this courtship over the course of the past year or more. so he's well-versed, along with other team members, on the opportunity here. But you're right. You said it best. It's the amalgamation of data coming from different data sources that we refer to as the Tower of Babel. Different languages, different code, and it makes it very difficult for the utility to optimize their overall network. So that's really what as Rick is getting at. They've got a great platform already around the world, and our channels to utilities is really the big opportunity for them. But overlaying this solution to where effectively the way I describe it is it's almost as if they've built the interoperable operating software on which our operating technologies will sit along with other apps that make it easier for the utility user to interface. Matthew, you want to talk a little bit about pricing and just the opportunity and the upside?

Yeah, so from a pricing point of view, Dean, really there's an implementation cost, obviously, to go implement the platform, which is a fee. And then it's really, to your point, a software as a service. It's a subscription fee that's ongoing in some term is really the model that we've built. And just, you know, really amplifying your point, again, one of the biggest pain points we hear, and we believe really this partnership will translate into really the digital adoption rates in the water sector. We see this as really being an aggregator in terms of bringing all these disparate systems together that Patrick mentioned. And our teams are engaged in building commercial momentum. We've implemented a few pilots that are starting to see great results from our collaboration already. But as we ramp through the year and build backlog, that'll start to really unpack in Q4 and into 24.

And I would clarify, Dean, that when we say pilots in this case, These are actual commercial arrangements that are revenue generating. It's not a pilot where we're going and testing something. So we've already had some very impressive potential wins there that we'll talk about in hopefully the next quarter.

That's all great to hear. Thank you. Thank you, Dan.

And we'll take our next question from Joe Giordano with Cowan.

Hey, guys. Good morning. Good morning, Joe.

Hey, Jeff. So I just want to follow up on that Adrika stuff real quick and then move on. But is that something that utilities would put in, like, on top of what they already have, or would it, like, more likely go, like, something that they would decide to move forward with, like, if they're putting in a new deployment?

You know, a lot of utilities don't have anything like this, so it's really on top of what they have, Joe, and it's integrating all their disparate systems, their SCADA systems, their PLC systems, their ERPs. anything that's bringing data into their ecosystem gets consolidated into the platform with one dashboard and one interface. And as you think about a lot of the challenges of our utility customers and lots of different industrial customers in general, is they've got multiple applications, multiple passwords, all the information is siloed, and they don't have a way to aggregate it. So this would come on as a layer to do that aggregation and give them a way to, as people say, democratize the data be able to get the data to a user to make sense of all the information coming in.

And Joe, just to add, when we say it's built by utility for utilities is that there are many other solutions that are out there, but they can tend to be quite complex and overly sophisticated. And this really allows them to design a solution that meets the utility where they are on the journey. Not every utility is at the same place on the journey as to how sophisticated the system needs to be, and so it can be tailored in that regard, but it's also a highly standardized platform, and that's part of the efficiency of their rollout is how easy it is to maintain.

And then you guys were spending a decent amount of resources kind of thinking about developing something like this internally at Xylem, if I'm correct. Now that you've made this decision here, which looks like it's already kind of packaged and ready to go for you, how do you reallocate the resources and what kind of impact does that have of not spending money trying to develop this internally?

Yeah, so I think that's a great question, Joe. You know, there are certainly some overlaps between what we're spending money on from an R&D perspective. You know, just to remind you, the structure of the transaction is that, you know, It's a commercial agreement, which allows us to take the product and sell it on a global basis. And on top of that, we have a minority investment. And so, you know, there are certain things that we're going to keep going on our end. And then there are certain things that we're going to be able to leverage between the two companies. But, you know, there are certainly some synergies there. But really, this is a growth play.

Yeah. Okay.

just want to move to the 1Q guide here. Can you kind of talk a little bit about a bridge from maybe where we're exiting to where we are in 1Q? Yeah, I'm trying to discern how much of this is being conservative versus how much is it, I guess it's early in the year and it's uncertain year. Like if I look at, let's say applied for example, or even MNCS, you know, your guiding applied basically up low single digits for the quarter and for the year, I would have thought that Just given what's happening in resi, maybe it starts the year well above that and then finishes maybe flattish. So now you're kind of anticipating similar growth all year. Maybe talk us through that. And MNCS, the guidance there kind of was what we expected heading in. But after the 4Q suggests like a 1Q step down off the 4Q run rate on revenue. So maybe talk us through that. Thank you.

Yeah, Joe, I mean, there's a few things to unpack there. Let me start and team here will remind me what else you asked. So, you know, look, there is some seasonality in our business. And if you look at it from a revenue perspective, you know, we'll have a step down in revenue. between Q4 and Q1. We always do. The biggest step down is actually in water infrastructure. That has a big Q4. MNCS, there will be a little bit of a step down, too. It's not so much in the metrology business, but some of the other businesses that we highlighted earlier on the call are pipeline assessment services business, our test business. There's some seasonality there. You know, I think it's, you know, somewhere between a $150 and $200 million step down Q4 to Q1. And, you know, that aligns with sort of our historical patterns. You know, as we think about the year and the seasonality in the year, different businesses look a little bit different. You know, certainly you touched on AWS, which is our most cyclical business when it comes to macro. From an AWS perspective, we're entering the year with a very, very strong backlog. And so, you know, as we've modeled that business, we have modeled a stronger first half versus a stronger second half. The other businesses don't have quite as much seasonality built into the plan. Other than in MNCS, we have been calling for, you know, a bigger ramp up in the second half when some of the redesign work comes online. and that coincides with better chip supply.

I just had a couple things, Jill, from a historical perspective just to amplify what Sandy had said here, we are reflecting in our guide that backlog in AWS carries us through the first half of the year, but we are forecasting softness in the second half. So obviously that remains to be seen. Hopefully things recover faster and we kind of glide through this and don't get impacted by that. But right now we're embedding in our guide that there is softness that hits us in terms of conversion in the second half. Historically, water infrastructure has a bigger Q4 and slows down in Q1 because we're serving the wastewater side of utilities, and they spend out their capital and OPEX budgets through the end of the fourth quarter, and then they ramp up again in the following year. So just to give some context for those of you that may be new to the story.

Thanks, guys. I'll pass it along.

Thanks, Jeff.

And we'll take our next question from Mike Halloran with Bayard.

Hey, good morning, everyone. Good morning, Mike. So just following up on that last little bit there, you know, Patrick, you gave some context on the applied backlog. It seems like you're expecting normalization as you work through the year there. It makes sense. I mean, it's a short cycle business. Maybe some thoughts on how you're thinking about the backlog tracking for the other two segments. And if you think that there's a chance for normalization, either of those as we move towards the end of the year, towards a more consistent runway or more consistent balance between how you think about orders and backlog and revenue conversion?

Yeah, Mike, I think, you know, we are already starting to see some normalization. If you look at the orders rate that we've had in the second half of the year, particularly as the pockets where the supply chain has stabilized, we're seeing some of our customers there return to normal behaviors. You know, I would say Water infrastructure is a great example of that. We've had a more stable supply chain there. And so that's where we've seen more normal order patterns. And we don't see a backlog that has been as elevated. We still have quite a bit of our backlog that's past due in MNCS. And we do expect to start eating into some of that in 2023. And I think that's a good thing, because that means our projects are getting deployed.

Yeah, I was just going to build on the MNCS comment. You know, we still have 30% of the backlog past due, you know, coming into the year, and so we'll still continue to monitor that as the chip supply continues sequentially to improve. You know, that's something we're looking at. But, you know, orders sequentially are good in that business, and we see good momentum going forward commercially.

Thanks, Matthew.

And then... On the kind of order side and the quotings or pipeline side of things, obviously orders making the quarter, not a surprise. I'm giving the comps, giving some balancing out here. How do you think that the sequentials will work out through the year on the order side? What are the expectations there? And maybe any comments on how you're looking at the bidding pipeline as we sit here today in the areas where that's relevant?

Yeah, from a bidding pipeline standpoint, I would say, look, industrial remains really strong globally. We primarily play in the general industry there, and that's been pretty resilient, so that continues strong. Commercial is a bit of, you know, it's showing strength. However, expected to be slow in the back half, primarily due to new construction moderating. You know, we track the ABI index, the Architectural Billing Index. That's been less than 50 the past three months, and so looking for a little bit of a slowdown in the bid activity for new construction for commercial. And we've talked resi, that's primarily replacement for us. You know, the orders are slowing down, largely due to the improved supply chain. It's probably the biggest area that we've seen the supply chain improve, and also from pandemic investments. And so that's really what's impacted that. And then, you know, a strong pipeline in MNCS plus water infrastructure, especially treatment. We're starting to see treatment really ramp up, and then that backlog also continues to build, and we have a strong funnel.

Thank you. Really appreciate it.

And we'll take our next question from Nathan Jones with Stiefel.

Good morning, everyone. Morning, Nate.

I think I'm going to go to questions and see if I can get any answers around revenue synergies from the combination of Zalem and Evoqua. I mean, this is clearly a growth enabling deal. And Patrick, you highlighted a couple of avenues for that. Investors have been very hungry for information on what kind of value that might add. So is there any color on kind of what your targets are going to be in terms of the acceleration? growth for the combined businesses? How are you going to approach it? Are you going to have specific growth teams assigned to these kinds of projects? Any color, more color you can give us around those kinds of things.

Sure, sure. Yeah, so as you've said, Nate, I mean, so first of all, I mean, the economic returns of this combination are justified on the cost synergies alone. And I don't want to look past those because I want to make sure that our investors understand that we've got strong conviction around the $140 million of cost synergies within three years. Going forward, we will lay out exactly what not only the three buckets are that we've talked about, and I can reiterate those if we need to, but specific delivery timeframes, ownership, et cetera. So strong conviction around that cost synergy. Then, beyond that, clearly this combination is about growth. It really is taking a long-term view, not on the realization of synergies, but a long-term view on what the world needs right now in terms of a water company at scale and depth. And there are so many things that we can do together that we could not do as separate companies. Now, on the revenue synergies, I'm not going to give you a specific number as of yet. We clearly will do that, and I can talk a little bit about process. But clearly, we expect that there's going to be an accelerated growth rate of the combined company, and we will put a specific target out there as we get closer to finalization of this. In terms of the process, there is going to be clear ownership within our integration work that's already kicked off. We have teams that have been assigned to go after each one of the several areas of gross energy. Obviously, we have a view on that before we got the deal approved by both boards, but we're looking to see where there might even be other opportunities beyond that as we go forward. I laid out in my prepared remarks what some of those areas are. A few others that we did not highlight in my comments were around the combination of digital enablement. In both companies, you know, Avoqua is already doing a fair amount in digital enablement of their services, really focused on productivity and growth. And we continue to progress quite nicely in our digital enablement of more on the product side and the aftermarket service side. Last area is, you know, we believe between Ron and I and the team that there is tremendous opportunity in the area of joint R&D. innovation, and portfolio enhancement, whether that be organic or inorganic, given the complementary nature of the businesses. So that's what I can share with you right now. Nate, obviously we're as excited as you all are at being in a position to come out and share numbers around this, but right now we're focusing on getting the deal closed.

I have one follow-up question on a specific avenue of revenue synergies. So Xylem's historically been a product company and Evoque has developed this service-based model. Do you see the opportunity for you to implement new kinds of service-based business models on the legacy Xylem portfolio, averaging their service footprint?

Yes, we certainly do. I mean, it will take some time. That will not be a day one thing. synergy and likely not even a year one synergy, but absolutely we see bringing some elements of their best in breed service offerings and quite frankly just the whole cultural model around services we believe is going to be an enhancement to our more legacy traditional product-oriented aftermarket services that are out there. Two, they've already done terrific work and I realize that Ron would say they're still on that journey. and I certainly appreciated that last week whenever I spent a few days with him at multiple sites, is that they're very much focused on outcome-based solutions. And so I think there's an opportunity there to enhance our business models and offerings, whether that be both on the utility side but also on the industrial. As you know, Nate, there's a fair amount of complementary nature of pulling through. They've got some terrific products within their APT business on the treatment side that complement what we do. and vice versa, our treatment portfolio enhancing what they can deliver in their industrial services offering.

Yeah, it seems to be a lot of avenues for growth there. So look forward to hearing more about it over the next few months and few quarters. Thank you.

Thank you, Nate.

And we'll take our next question from Scott Davis with Mellius Research.

Good morning, everybody. Hey, Scott. Good morning.

Just a couple, one kind of point of clarification, then a real question. But are you still raising price here now that we're into 23? Or are the price increases you did in 22 pretty much enough to offset your inflation?

Yeah, we did, Scott, we did the last round of price increases back in November of 2022. So, you know, really the price increase in essence would be for 23 kind of heading into this year. So obviously we're continuing to watch the marketplace. and understand only the inflationary environment and how that continues on. It's moderated some, but it's still up. And also make sure we're monitoring our win-loss rate in the marketplace and making sure that we're appropriately priced accordingly in the market.

All right. Helpful. And then I think about 2022, so much of the year, not just you guys, but most companies were held hostage by the chip makers. And how... Where do you guys see yourselves going forward and kind of a redundancy or flexibility or whatever other words we want to use to kind of describe it just to make sure that this chip issue doesn't come back every time there's some sort of dislocation that the xylem is more protected in the future?

Sure. Scott, this is Patrick. So I'd say, first of all, we by no means are out of the woods on this yet, even though we've seen sequential improvement. I would say that the health of the discussions that we have with both the chip suppliers themselves and our intermediaries have stabilized and strengthened. Clearly, I know people are looking at auto right now and hearing about weakness there and wondering whether or not all of a sudden we're going to get a boatload of chips that show up. It just doesn't work that way in terms of the allocation. The substitutes aren't easy in this space, and so the main thing we did, as Matthew alluded to earlier, was we spent a lot of time and energy and, quite frankly, money this past year redesigning our offerings to get to the next generation so we could be best in line. I do think that as other sectors perhaps show slowness, that will simply further strengthen the recovery for us, but we're not counting on that right now or baking that into our outlook for the year.

That's helpful, Patrick. Just to be clear, so when you talk about redesigning, are you talking about going to a chip design that's more ubiquitous and more commonly used in consumer electronics, or is there some sort of level in between where you're at and that next-gen chip?

It's just really getting to next-gen chips where the capacity is being allocated or being built so we have more capacity for the future, yeah, because we're on legacy designs that they're bringing down the capacity on those chips.

Yeah, that's why I asked. Okay, super helpful. Thanks, and congrats, and good luck this year, guys.

Thanks, Scott. Appreciate it.

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

Hey, good morning, everyone. Good morning, Andy.

Hi, Andy.

Patrick, I know you've talked about forecasting a slower second half in applied water, especially as new construction potentially slows in commercial, but have you begun to see any evidence of channel destocking or other customer behavior that concerns you in commercial markets? And then separately, Have you put in any contingency in your guide for China reopening related noise? It looks like China was still strong for you in Q4.

Yeah, so Andy, on the first one on channel inventory, we had really good visibility into the inventory given our relationship with our channel partners. You know, the teams we meet monthly and actually quarterly with council meetings in addition to weekly sales calls and contacts. So we have really good insight into the inventory. The levels are healthy and normalizing, and they're not sitting on any excess inventory, as reported back to us. There are some pockets that have not fully recovered. You know, commercial is not back to kind of pre-pandemic levels in terms of inventory. But resi, I would say, is normalized due to the improved supply chain and softening from the pandemic investments. On the industrial front, it's really more of an engineer-to-order product. There's not a lot of build-to-stock, and so that's where I'd leave it on the channel inventory there.

Let me take the China part of your question. China was tough for us this year. We were down in China about 20% in the first half of the year. We saw moderation in the second half. A little bit stronger Q3 than Q4 given the outbreak of COVID in Q4. And I think we've taken a measured approach to China in our guide for 2023 We do expect more of a recovery in the second half of the year in China You know the slowdown has been more more acute more on the utility side of the business and we've seen stronger performance on the industrial side and so, you know our focus for our team is on you know, building orders momentum again. And, you know, we remain very bullish long-term on China. We're just working through some of the dynamics there now.

Appreciate that, Sandy. And then it seems like industrial dewatering continues to hold up well as, you know, it does tend to be more historically cyclical. But could the business be much less cyclical during the current cycle given the amount of activity that's out there? I know you mentioned mining. Maybe you could comment on the support you're getting from your strategic growth investments as well as what exactly you're doing there.

Yeah, we made a conscious effort back a few years ago to be a bit more balanced in our segmentation of that business, especially shifting more to the muni side, which is a bit more stable. And we've seen that part of the portfolio grow. And also just making investments in our fleet and upgrading our technology. We are digitizing those assets and making those remotely connectable so we can improve the productivity for our customers. So it's a mixed bag of really, I'd say, some innovation as well as being thoughtful about being more balanced in the segmentation of the business.

Appreciate all the color.

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.

Thank you. So, again, thanks, everybody, for your time today. I know you're all very, very busy this time of the year. Really appreciate your ongoing continued interest in Xylem. Very much look forward to providing you updates on our progress around the Evoqua transaction. And between now and then, safe travels, everyone, and all the very best. Thank you.

Thank you. This concludes today's Xylem fourth quarter and full year 2022 earnings conference call. Please disconnect your line at this time and have a wonderful day. Thank you. Thank you.

Thank you. Music. Thank you.

Welcome to Xylem's fourth quarter and full year 2022 earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If at any point your question has been answered, You may remove yourself from the queue by pressing star 2. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star 0. I would now like to turn the call over to Andrea Vanderberg, Vice President of Investor Relations.

Thank you, operator. Good morning, everyone, and welcome to Xylem's fourth quarter and full year 2022 earnings call. With me today are Chief Executive Officer Patrick Decker, Chief Financial Officer Sandy Rowland, and Chief Operating Officer Matthew Pine. They will provide their perspective on Xylem's fourth quarter and full year 2022 results and discuss our outlook and guidance for 2023. 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 webcasts are accompanied by a slide presentation available on the Investors section of our website, www.xylem.com. A replay of today's call will be available until midnight, February 14th. Please note the replay number, plus 1-800-388-6509, or plus 1-402-7000. 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'll 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 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 three. 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 four, and I'll turn the call over to our CEO, Patrick Decker.

Thanks, Andrea, and good morning, everyone. As we indicated in our press release, the team delivered a very strong operational performance in the fourth quarter, exceeding our expectations across each segment and region. Resilient demand and strong backlog execution delivered 20% revenue growth for the quarter and healthy EBITDA margin expansion. That performance continued and built upon the team's solid delivery through the year, fueling healthy momentum coming into 2023. On a full year basis, revenue grew 11% and earnings per share grew 14%. Water infrastructure grew 15% in the quarter on robust utilities and industrial demand in the U.S. and Western Europe, and this segment was up 12% for the full year. MNCS posted very strong fourth quarter performance. The segment was up 35% in the quarter on backlog execution from improved chip supply and continued strong demand, bringing full year growth to 8%. Applied water grew 17% in the quarter and finished 2022 with 14% growth for the full year. Overall, higher volumes and positive price cost performance drove significant EBITDA margin expansion in the quarter, up 250 basis points versus the same period a year ago. The team delivered that growth and margin performance on continuing resilient demand globally. We saw healthy orders grow sequentially, and for the full year, orders were up 4%, demonstrating the durability of our business. I am so proud of the team's performance in serving our customers and of their commitment to our purpose, solving water. The global trends driving investment in water systems continue to intensify. And as today's results demonstrate, we are already very strongly positioned to address them. That said, our recent agreement to acquire Avoqua announced two weeks ago will create a powerful platform to address the world's most critical water challenges with greater capability, depth, and scale. We've begun the important work of integration planning to set the combined company up for success and are well into the process of seeking the necessary approvals. Until the deal closes, which we anticipate will be mid-year, we remain focused on delivering results for the stakeholders we serve today. On that standalone basis, we see continuing resilient demand in our largest end markets, particularly utilities, despite the possibility of macroeconomic softness, execution of our backlogs with ongoing price-cost discipline, further supply chain improvements, and a return to 100% free cash flow conversion. We expect that this will allow us to deliver 2023 organic revenue growth in the mid-single digits with solid EBITDA margin expansion. resulting in earnings per share between $3 and $3.25, up 10% versus last year at the midpoint of the range. We'll give more color on the outlook and guide in a moment, but first I'll hand it over to Sandy to dig in briefly on the quarter's results before we look ahead at 2023. Thanks, Patrick.

Please turn to slide five and I'll cover our fourth quarter results. As Patrick highlighted, the team closed out a strong 2022 with another quarter of robust growth and margin expansion. Revenue grew 20% year over year, led by 26% growth in the U.S. and mid-teen growth in Western Europe and the emerging markets. In a moment, I'll give you detailed performance by segment, but in short, utilities was up 24% with strength in the U.S. driven by chip supply improvements in MNCS and robust OPEX demand in water infrastructure. Industrial grew 15% on particularly strong demand in Western Europe and emerging markets and sustained strength in the U.S. Commercial was up 24%, mainly due to continued backlog execution in the U.S. and Western Europe. And residential was up 17%, driven by strength in emerging markets, partially offset by softness in the U.S. Compared to prior year, orders were down 3% in the quarter. versus up 23% in the same period last year. But underlying demand remains resilient and in line sequentially. Water infrastructure orders were up 13%, AWS down 6%, and MNCS down 19%, following exceptionally high orders last year. However, MNCS orders were in line with the last quarter with a book-to-bill ratio of 1.1 times. EBITDA margin was 18.7%, up 250 basis points from the prior year, and up 40 basis points sequentially on strong volume and price, which more than offset inflation. Our EPS in the quarter was 92 cents, up 46% year-over-year. Please turn to slide six, and I'll review the quarter's segment performance in a bit more detail. Water infrastructure outperformed expectations with revenues up 15% in the quarter. Growth was robust across the portfolio, led by our wastewater utility business in the U.S. and industrial strength in emerging markets on continued dewatering demand. Geographically, the U.S. was up 26% with solid price realization on strong utilities OPEX demand and continued improvements in the supply chain. Western Europe grew low double digits driven by healthy industrial activity, and emerging markets was also up low double digits, driven by dewatering demand in Latin America and Africa. Orders in the fourth quarter were up 13% with solid dewatering demand in emerging markets and continued utility strength in the U.S. EBITDA margin for the segment was up 80 basis points as price, net of inflation, and volume conversion more than offset strategic investments. Please turn to page seven. The applied water segment also exceeded expectations with fourth quarter revenues up 17% on strong price realization and backlog execution. Geographically, Western Europe was up over 20% led by supply chain improvements and strong industrial and commercial demand. Emerging markets was up mid double digits on strong residential demand in the Middle East and India. The U.S. was up low double digits as supply chain improvements and price realization were partially offset by moderating residential volumes. Orders were down 6% in the quarter with healthy industrial demand in the U.S. and Western Europe offset by slowing U.S. residential orders. Segment EBITDA margin was up 270 basis points in the quarter. Margin expansion was driven by continued strong price realization more than offsetting inflation. and further supplemented by productivity savings. And now let's turn to slide eight and I'll cover our measurement and control solutions business. MNCS revenue was up 35% driven by recoveries in chip supply year over year and strong project execution in our test and measurement and pipeline assessment services businesses. Geographically, all regions were up more than 20% led by U.S. growth of over 40%. MNCS orders were down 19% in the quarter, lapping a prior year compare of 28% orders growth during the peak of supply chain constraints. Demand for our AMI offering remains strong, and our $2.1 billion backlog in MNCS is up 14% versus prior year. EBITDA margin for the segment was up 800 basis points versus the prior year, and importantly, 130 basis points quarter sequentially. Strong volume conversion coupled with price realization, offsetting inflation, drove the expansion. And now let's turn to slide nine for an overview of cash flows and the company's financial position. In the fourth quarter, we generated free cash flow of $302 million. The team did a great job driving down working capital to hit our previous outlook of 80% free cash flow conversion for the year. While inventory remains elevated versus where we target it to be longer term, as there still are pockets of the supply chain that necessitate the extra safety stock that we are carrying, our performance in Q4 gives us confidence in our path to return to 100% conversion in 2023. Our financial position remains robust as we exit the year with over $900 million in cash and available liquidity of $1.7 billion. And this is after paying down over $500 million of debt in December. Net debt to EBITDA leverage is 1.0 times. Please turn to slide 10, and I'll hand back to Patrick to look forward at 2023.

Thanks, Sandy. The team did an excellent job delivering for our customers and communities in 2022. Their commitment and performance stood out during a tumultuous year of global economic and geopolitical uncertainty. lingering pandemic effects, especially in China, and a challenging supply chain environment. I'm very proud of everything the team achieved, and they are already carrying all that commercial momentum, operational discipline, and resilience into 2023. As we look forward, we see continued healthy demand in our major markets, despite the possibility of macroeconomic softness in certain sectors of the global economy. We expect that the essential nature of our solutions, and the secular trends in water will continue to underpin demand in the attractive, stable end markets that we serve. And we expect to be even better able to serve that demand as supply chain friction continues to ease and we can progressively work down our $3.6 billion backlogs. Looking ahead, we are advancing our strategic delivery of solutions to the acquisition of Avoqua. As I mentioned earlier, and as you would expect, until the deal closes, we are only providing organic guidance for Xylem on a standalone basis. But there's no doubt that the combination of Xylem's global utility scale and Evoque with strength and attractive industrial end markets creates a powerful platform for growth. We expect significant revenue synergies in areas such as cross-selling of our respective utility and industrial portfolios in North America. and growing Evoqua's international exposure via Xylem's global channels and customer relationships. Now, those are just two of the areas where we see tremendous potential to add to the growth of the combined companies and expand our value to customers globally, especially in a number of the most attractive water end markets. But it's not the only inorganic move we're making to give customers more of what they need most. We've also taken a big step forward in helping them adopt the digital solutions they need to increase the resilience of communities' essential water infrastructure. In the shadow of our big announcement with Avoqua, another important partnership flew under the radar, one which will accelerate and enhance our ability to deliver more digital solutions to utility customers around the world. Last quarter, we signed an exclusive commercial partnership with Edureka. to make adoption of digital technologies easier, faster, and more affordable for our utility customers. Headquartered in Valencia, Spain, ADRIKA is a leader in data management and analytics for water utilities. ADRIKA's Galagua platform simplifies deployment and operation of new digital capabilities in any water utilities operations. It gives them one secure, integrated interface that brings together data capture, analytics, and asset and process management onto one platform. Having been born out of a utility operator itself, the platform has the advantage of having been built by utility for utilities. And it's already been deployed by over 300 customers around the world. Under the partnership, we will take a minority stake in Adreca and become the exclusive global distributor of their technology. Together, we will enable more utilities to harness the power of connected solutions. We're very excited about it, and we look forward to sharing more as the partnership progresses. We made one other important announcement recently. This one was just before the end of the year, appointing Matthew Pine as Chief Operating Officer. The move ensures that we have continuing focus on operational excellence from an enterprise perspective across all our business segments and regions to continue delivering on our commitment to faster the market revenue growth and margin expansion. At the same time, it's also freed up some of my capacity to deliver on Xylem's strategic evolution and capital deployment. In a moment, We'll turn the call back to Sandy for more detail on our guide. But first, I want to invite Matthew to say a few words on his key areas of focus in the new role and provide some color on our end market outlook. Matthew? Thanks, Patrick.

We are very strongly positioned on intensifying trends with technology leadership and a large and growing installed base in attractive end markets. My focus as Chief Operating Officer is to further accelerate profitable growth and maximize the value we deliver to customers and communities around the world. Across the business, we continue to remove complexity, increase our local agility, and unlock further scale efficiencies. This is all aimed, of course, at better serving our customers at the same time we deliver continuing margin expansion. We're driving this margin focus across the enterprise, taking particular aim at even more enhanced productivity and customer satisfaction. For example, in the MNCS segment, Improvements in chip supply enable us to build momentum, delivering the accretive backlog, redeploy resources back to productivity, as well as new product introductions from innovation. Secondly, we continue to enhance our digital portfolio, as Patrick covered. Our customers need simple, integrated digital technologies that solve their problems cost-effectively. Our portfolio increasingly meets that demand with attractive growth and margin profiles. Lastly, our customers depend on Xylem as a trusted partner to deliver ongoing support. So our third operational focus is in standardizing our solutions and creating new offerings. This will take us deeper into our installed base with aftermarket sales and services. New offerings, such as outcome-based solutions and condition-based maintenance, will enable us to capture demand, address customers' needs, and expand reoccurring revenues. It's no accident that there's a theme running through all three of these priorities. Each is about growing revenues and improving our margins by serving our customers better, more thoroughly, and more simply, making it even easier for them to do business with us and solve more of their challenges. When we talk about being in a privileged position, that's not meant solely to refer to our strategic or market positioning. It also reflects our view that we are fortunate to work alongside the kind of customers that we do partnering with them to solve their critical water challenges they face. It's a privilege and also a great opportunity for continuing value creation from our shareholders, communities, and all stakeholders. Now let's turn to slide 11, and I'll walk you through our end market outlook. We expect underlying demand in most of our end markets will continue to be healthy through 2023. We take in a balanced view based on the strength of our backlog, critical nature of our largest end markets, and the continued value proposition of our differentiated products. We anticipate our utility business overall, which is our largest end market, will grow high single digits in 2023. On the wastewater side, we expect mid-single digit growth as we see a continuation of steady global demand. We anticipate resilient OPEX demand in developed markets due to the critical nature of our offerings, as well as the benefit of continued capex spend in emerging markets. The outlook for longer-term capital project spending and bid activity remains robust. On the clean water side, we anticipate revenues being up low teens. This growth is driven by continued robust demand for our AMI solutions and expected improvements in chip supply through 2023, allowing for significant large-deal deployments already secured in our backlog. We foresee healthy momentum in our test and measurement and our pipeline assessment service businesses, due to increased focus on infrastructure and climate challenges. Looking at the industrial end market, we expect to go low to mid single digits on steady demand for our solutions globally. We continue to see strong growth in dewatering due to mining demand in emerging markets and the benefits of our strategic investments in our U.S. and European dewatering business. The commercial end market should deliver low single digit growth on solid replacement business and backlog execution. partially offset by moderation and new construction. In residential, our smallest end market, we are expecting low single-digit decline due to normalizing demand in the U.S., partially offset by continued strength in emerging markets. In both commercial and residential, we would expect moderation to emerge in the second half results as we continue to work through the backlog in the first half of 2023. Now I'll turn it over to Sandy to walk you through our updated guidance.

Thank you, Matthew. Turning to slide 12. As mentioned, we expect Evoqua to join us in mid-2023. Until then, our full-year guidance is on an organic basis and excludes the combination of the two companies. For Xylem overall, we foresee full-year 2023 revenue growth in the range of 4% to 6%. This breaks down by segment as follows. Mid-single-digit growth in water infrastructure with solid growth in both wastewater utilities and industrial. Low single-digit growth in applied water from growth in industrial and commercial, partially offset by residential. We expect measurement and control solutions to be up low teens. For 2023, we expect EBITDA to be in the range of 17.5 to 18%. This represents a 50 to 100 basis point margin expansion versus prior year. and this yields an EPS range of $3 to $3.25, up 10% at the midpoint over the prior year. Free cash flow conversion is expected to be 100% of net income. In addition, today we announced an increase in our annual dividend of 10%, aligned with our capital allocation framework to grow dividends in line with earnings. We've also provided you with a number of other full-year assumptions in the slide to supplement your models. We're assuming a euro to dollar conversion rate of 1.08. And as foreign exchange can be volatile, our FX sensitivity table is included in the appendix. And now drilling down on the first quarter, we anticipate total company revenues will be in the range of 7% to 9% growth. By segment, we expect high single-digit growth in water infrastructure, low single-digits in applied water, and high TEAMS growth for MNCS. We expect first-quarter EBITDA margin to be approximately 16%, driven by higher volumes and more favorable price-cost dynamics. And with that, please turn to slide 13, and I'll turn the call back over to Patrick for closing comments.

Thanks, Sandy. We're coming into 2023 very strongly positioned. Our end markets continue to show resilient underlying demand. We're confident in delivering mid single digit revenue growth and strong margin expansion. And the team continues to outperform on strong operational and commercial execution. Beyond 2023, we remain well on track to deliver our longer term strategic and financial milestones. We are very excited about all of the combination of Xylem and evocable offer toward the creation of a more water secure, resilient, and sustainable world, while driving value for our shareholders by accelerating growth and scale. The integration team met last week at our headquarters in D.C., the first of many meetings to set us up for success on day one. And last week, I traveled with Ron Keating, a local CEO, to a number of their key sites to spend time with their incredibly talented people. Those visits only heightened my appreciation of the potential opportunities ahead and confirmed the strong strategic and cultural fit of our two companies. We've also taken the next step in the regulatory process, having submitted the required filings here in the U.S. and progressing toward filings in the relevant international jurisdictions. We continue to anticipate the deal closing mid-year. A great deal of opportunity will open up when we bring our two companies together. During our next earnings call, we will provide an update on our progress. Meanwhile, our business remains squarely focused on delivering on our 2023 financial commitments and continuing our commercial momentum and execution. Now, operator, I'll turn the call back over to you for questions.

We'll take our first question from Dean Dre with RBC Capital Markets.

Thank you. Good morning, everyone.

Good morning, Dean.

Good morning.

Hey, strong finish to the year, both revenues and margins. I just want to say congrats again on finally getting to the altar on Evoqua. This has made strategic sense for so long. have a mid-year target closing is lightning fast in our view. I know that there's a lot of heavy lifting, so best of luck.

Thank you very much, Dean.

Hey, can we start with MNCS margins? It sounds like the two drivers here, the chip supply improving, and this has been kind of a steady story for the past couple of quarters. How much have you worked through that backlog and how much of the chip supply is improvement contributed to the margin improvement in the segment. And then I've seen a nice shout out for pipeline assessment. Is this all pure and what's driving that? Thanks.

Yeah, Dean, thanks for the question. Let me start and, Matt, you can add some color here. We are very pleased with our Q4 performance in MNCS. The year has unfolded very much like we thought it would with continuing improvement in chip supply. The story in Q4 is actually a two-fold story. We saw some upside compared to what we had forecast, and half of that upside came from some better chip supply, and the other half of the upside came from some of our other businesses in the portfolio that we don't you know, talk as much about. So our pipeline assessment services business, a lot of projects were completed in Q4. Really good results in our test and measurement business. And, you know, all of the, really the entire portfolio across MNCS has good margin potential and good leverage. And so, you know, as we've got the top line going again, we're really encouraged that you're seeing that drop to the bottom line.

Yeah, I think the only thing I would add, Dean, is that we did pivot in Q4 to more continuous improvement as we started to roll off of our product redesigns. So we saw a really good lift in Q4 and continuous improvement. And if you look at the price cost and the exit rate in Q4, it was really solid building momentum. This was, if you recall, this was the last segment to really be impacted by inflation and really overcoming that in Q4, which also led to the margin improvement.

All sounds good. And just as a follow-up, I was hoping to get some more color on this announcement of the software platform investment, Edrica. If you listen to all of the trade shows and conferences, the biggest pain point for utilities is they get so much data, but none of it's connected and it's all different formats. So this sounds really promising if it's one platform that then is able to integrate all of this. So Some color on the pricing. Is this a SaaS business? Is it on-prem? Is it licensed? How will it fit in terms of the revenue stream? And you've got 300 customers now. What's the pipeline for new customers, new logos? Thanks.

So, Dean, I'll just make a few comments and I'll have Matthew go a little deeper because Matthew was part of the team that was integral to this courtship over the course of the past year or more. so he's well-versed, along with other team members, on the opportunity here. But you're right. You said it best. It's the amalgamation of data coming from different data sources that we refer to as the Tower of Babel. Different languages, different code, and it makes it very difficult for the utility to optimize their overall network. So that's really what as Rick is getting at, they've got a great platform already around the world and our channels to utilities is really the big opportunity for them. But overlaying this solution to where effectively the way I describe it, it's almost as if they've built the interoperable operating software on which our operating technologies will sit along with other apps that make it easier for the utility user to interface. Matthew, you want to talk a little bit about pricing and just the opportunity and the upside?

Yeah, so from a pricing point of view, Dean, really there's an implementation cost, obviously, to go implement the platform, which is a fee. And then it's really, to your point, a software as a service. It's a subscription fee that's ongoing in some term. It's really the model that we've built. And just really amplifying your point, again, one of the biggest pain points we hear, and we believe really this partnership will translate into really the digital adoption rates in the water sector. We see this as really being an aggregator in terms of bringing all these disparate systems together that Patrick mentioned. And our teams are engaged in building commercial momentum. We've implemented a few pilots that are starting to see great results from our collaboration already. But as we ramp through the year and build backlog, that'll start to really unpack in Q4 and into 24.

And I would clarify, Dean, that when we say pilots in this case, these are actual commercial arrangements that are revenue generating. It's not a pilot where we're going and testing something. So we've already had some very impressive potential wins there that we'll talk about in hopefully the next quarter.

That's all great to hear. Thank you. Thank you, Dean.

And we'll take our next question from Joe Giordano with Cowan.

Hey, guys. Good morning. Good morning, Joe.

Hey, Jeff. So, I just want to follow up on that Adreca stuff real quick and then move on. But is that something that utilities would put in, like, on top of what they already have? Or would it, like, more likely go, like, something that they would decide to move forward with, like, if they're putting in a new deployment?

You know, a lot of utilities don't have anything like this, so it's really on top of what they have, Joe, and it's integrating all their disparate systems, their SCADA systems, their PLC systems, their ERPs. Anything that's bringing data into their ecosystem gets consolidated into the platform with one dashboard and one interface. And if you think about a lot of the challenges of our utility customers and lots of different industrial customers in general is they've got multiple applications, multiple passwords, you know, all the information is siloed, and they don't have a way to aggregate it. So this would come on as a layer to do that aggregation and give them a way to, as people say, democratize the data, be able to get the data to a user to make sense of all the information coming in.

And Joe, just to add, when we say it's built by utility for utilities is that there are many other solutions that are out there, but they can tend to be quite complex. and overly sophisticated, and this really allows them to design a solution that meets the utility where they are on the journey. Not every utility is at the same place on the journey as to how sophisticated the system needs to be, and so it can be tailored in that regard, but it's also a highly standardized platform, and that's part of the efficiency of their rollout is how easy it is to maintain.

And then You guys were spending a decent amount of resources kind of thinking about developing something like this internally at Xylem, if I'm correct. So now that you've made this decision here, which looks like it's already kind of packaged and ready to go for you, how do you reallocate the resources and what kind of impact does that have of not spending money trying to develop this internally?

Yeah, so I think that's a great question, Joe. You know, there are certainly some overlaps between what we're spending money on from an R&D perspective. You know, just to remind you, the structure of the transaction is that it's a commercial agreement which allows us to take the product and sell it on a global basis. And on top of that, we have a minority investment. And so, you know, there are certain things that we're going to keep going on our end. And then there are certain things that we're going to be able to leverage between the two companies. But, you know, there are certainly some synergies there. But really, this is a growth play.

Yeah. Okay.

Just want to move to the 1Q guide here. Can you kind of talk a little bit about a bridge from maybe where we're exiting to where we are in 1Q? Yeah, I'm trying to. discern how much of this is being conservative versus how much is it because it's early in the year and it's uncertain year like if I look at let's say applied for for example or even mncs you know um you're guiding applied basically up low single digits for the quarter and for the year I would have thought that just given what's happening in resi maybe it starts the year well above that and then finishes maybe flattish so now you're kind of anticipating similar growth all year. Maybe talk us through that. And MNCS, the guidance there kind of was what we expected heading in. But after the 4Q suggests like a 1Q step down off the 4Q run rate on revenue. So maybe talk us through that. Thank you.

Yeah, Joe, I mean, there's a few things to unpack there. Let me start and team here will remind me what else you asked. So, you know, look, there is some seasonality in our business. And if you look at it from a revenue perspective, We'll have a step down in revenue between Q4 and Q1. We always do. The biggest step down is actually in water infrastructure. That has a big Q4. MNCS, there will be a little bit of a step down, too. It's not so much in the metrology business, but some of the other businesses that we highlighted earlier on the call are pipeline assessment services business, our test business. There's some seasonality there. You know, I think it's, you know, somewhere between a $150 and $200 million step down Q4 to Q1. And, you know, that aligns with sort of our historical patterns. You know, as we think about the year and the seasonality in the year, different businesses look a little bit different. You know, certainly you touched on AWS, which is our most cyclical business when it comes to macro. From an AWS perspective, we're entering the year with a very, very strong backlog. And so, you know, as we've modeled that business, we have modeled a stronger first half versus a stronger second half. The other businesses don't have quite as much seasonality built into the plan. Other than in MNCS, we have been calling for, you know, a bigger ramp up in the second half when some of the redesign work comes online. and that coincides with better chip supply.

I just had a couple things, Jill, from a historical perspective just to amplify what Sandy had said here, we are reflecting in our guide that backlog in AWS carries us through the first half of the year, but we are forecasting softness in the second half. So obviously that remains to be seen. Hopefully things recover faster and we kind of glide through this and don't get impacted by that. But right now we're embedding in our guide that there is softness that hits us in terms of conversion in the second half. Historically, water infrastructure has a bigger Q4 and slows down in Q1 because we're serving the wastewater side of utilities, and they spend out their capital and OPEX budgets through the end of the fourth quarter, and then they ramp up again in the following year. So just to give some context for those of you that may be new to the story.

Thanks, guys. I'll pass it along.

Thanks, Jeff.

And we'll take our next question from Mike Halloran with Bayard.

Hey, good morning, everyone. Good morning, Mike. So just following up on that last little bit there, you know, Patrick, you gave some context on the applied backlog. It seems like you're expecting normalization as you work through the year there. It makes sense. I mean, it's a short cycle business. Maybe some thoughts on how you're thinking about the backlog tracking for the other two segments. And if you think that there's a chance for normalization, either of those as we move towards the end of the year, towards a more consistent runway or more consistent balance between how you think about orders and backlog and revenue conversion?

Yeah, Mike, I think, you know, we are already starting to see some normalization. If you look at the orders rate that we've had in the second half of the year, particularly as the pockets where the supply chain has stabilized, we're seeing some of our customers there return to normal behaviors. You know, I would say Water infrastructure is a great example of that. We've had a more stable supply chain there. And so that's where we've seen more normal order patterns. And we don't see a backlog that has been as elevated. We still have quite a bit of our backlog that's past due in MNCS. And we do expect to start eating into some of that in 2023. And I think that's a good thing, because that means our projects are getting deployed.

I was just going to build on the MNCS comment. We still have 30% of the backlog past due coming into the year, and so we'll still continue to monitor that as the chip supply continues sequentially to improve. That's something we're looking at. But orders sequentially are good in that business, and we see good momentum going forward commercially.

Thanks, Matthew. On the kind of order side and the quoting pipeline side of things, obviously orders make in the quarter, not a surprise. I'm giving the comps, giving some balancing out here. How do you think that the sequentials will work out through the year on the order side? What are the expectations there? And maybe any comments on how you're looking at the bidding pipeline as we sit here today in the areas where that's relevant? Sure.

Yeah, from a bidding pipeline standpoint, I would say, look, industrial remains really strong globally. We primarily play in the general industry there, and that's been pretty resilient, so that continues strong. Commercial is a bit of, you know, it's showing strength. However, expected to be slow in the back half, primarily due to new construction moderating. You know, we track the ABI index, the Architectural Billing Index. That's been less than 50 the past three months, and so looking for a little bit of a slowdown in the bid activity for new construction for commercial. And we've talked resi, that's primarily replacement for us. You know, the orders are slowing down largely due to the improved supply chain. It's probably the biggest area that we've seen the supply chain improve and also from pandemic investments. And so that's really what's impacted that. And then, you know, a strong pipeline in MNCS plus water infrastructure, especially treatment. We're starting to see treatment really ramp up and then that backlog also continues to build and we have a strong funnel.

Thank you. Really appreciate it.

And we'll take our next question from Nathan Jones with Stiefel.

Good morning, everyone. Morning, Nate.

I think I'm going to go to questions and see if I can get any answers around revenue synergies from the combination of Zalem and Evoqua. I mean, this is clearly a growth enabling deal. And Patrick, you highlighted a couple of avenues for that. Investors have been very hungry for information on what kind of value that might add. So is there any color on kind of what your targets are going to be in terms of the exciting growth for the combined businesses? How are you going to approach it? Are you going to have specific growth teams assigned to these kinds of projects? Any color, more color you can give us around those kinds of things.

Sure, sure. Yeah, so as you've said, Nate, I mean, so first of all, I mean, the economic returns of this combination are justified on the cost synergies alone. And I don't want to look past those because I want to make sure that our investors understand that we've got strong conviction around the $140 million of cost synergies within three years. Going forward, we will lay out exactly what not only the three buckets are that we've talked about, and I can reiterate those if we need to, but specific delivery timeframes, ownership, et cetera. So strong conviction around that cost synergy. Then, beyond that, clearly this combination is about growth. It really is taking a long-term view, not on the realization of synergies, but a long-term view on what the world needs right now in terms of a water company at scale. and depth, and there are so many things that we can do together that we could not do as separate companies. Now, on the revenue synergies, I'm not going to give you a specific number as of yet. We clearly will do that, and I can talk a little bit about process, but clearly we expect that there's going to be an accelerated growth rate of the combined company, and we will put a specific target out there as we get closer to finalization of this. In terms of the process, there is going to be clear ownership within our integration work that's already kicked off. We have teams that have been assigned to go after each one of the several areas of gross energy. Obviously, we have a view on that before we got the deal approved by both boards, but we're looking to see where there might even be other opportunities beyond that as we go forward. I laid out in my prepared remarks what some of those areas are. A few others that we did not highlight in my comments were around the combination of digital enablement in both companies. Avoqua is already doing a fair amount in digital enablement of their services. really focused on productivity and growth. And we continue to progress quite nicely in our digital enablement of more on the product side and the aftermarket service side. Last area is, you know, we believe between Ron and I and the team that there is tremendous opportunity in the area of joint R&D, innovation, and portfolio enhancement, whether that be organic or inorganic. given the complementary nature of the businesses. So that's what I can share with you right now. Nate, obviously we're as excited as you all are at being in a position to come out and share numbers around this, but right now we're focusing on getting the deal closed.

I have one follow-up question on a specific avenue of revenue synergies. xylem's you know historically been a product company and evoke has developed this service-based model is that do you see the opportunity for you to implement new kinds of service-based business models on the legacy xylem portfolio averaging their service footprint yes we certainly do i mean it will take some time uh that will not be a day one

synergy and likely not even a year one synergy but absolutely we see bringing some elements of their best in breed service offerings and quite frankly just their the whole cultural model around services we believe is going to be an enhancement to our more legacy traditional product-oriented aftermarket services that are out there too. They've already done terrific work and I realize that Ron would say they're still on that journey and I certainly appreciated that last week whenever I spent a few days with him at multiple sites, is that they're very much focused on outcome-based solutions. And so I think there's an opportunity there to enhance our business models and offerings, whether that be both on the utility side but also on the industrial. As you know, Nate, there's a fair amount of complementary nature of pulling through. They've got some terrific products within their APT business on the treatment side that complement what we do. and vice versa, our treatment portfolio enhancing what they can deliver in their industrial services offering.

Yeah, it seems to be a lot of avenues for growth there. So look forward to hearing more about it over the next few months and few quarters. Thank you.

Thank you, Nate.

And we'll take our next question from Scott Davis with Mellius Research.

Good morning, everybody. Hey, Scott. Good morning.

Just a couple, one kind of point of clarification, then a real question. But are you still raising price here now that we're into 23? Or are the price increases you did in 22 pretty much enough to offset your inflation?

Yeah, we did, Scott, we did the last round of price increases back in November of 2022. So, you know, really the price increase in essence would be for 23 kind of heading into this year. So obviously we're continuing to watch the marketplace. and understand only the inflationary environment and how that continues on. It's moderated some, but it's still up. And also make sure we're monitoring our win-loss rate in the marketplace and making sure that we're appropriately priced accordingly in the market.

All right. Helpful. And then I think about 2022, so much of the year, not just you guys, but most companies were held hostage by the chip makers. And how... Where do you guys see yourselves going forward and kind of a redundancy or flexibility or whatever other words we want to use to kind of describe it just to make sure that this chip issue doesn't come back every time there's some sort of dislocation that the xylem is more protected in the future?

Sure. Scott, this is Patrick. So I'd say, first of all, we by no means are out of the woods on this yet, even though we've seen sequential improvement. I would say that the health of the discussions that we have with both the chip suppliers themselves and our intermediaries have stabilized and strengthened. Clearly, I know people are looking at auto right now and hearing about weakness there and wondering whether or not all of a sudden we're going to get a boatload of chips that show up. It just doesn't work that way in terms of the allocation. The substitutes aren't easy in this space, and so the main thing we did, as Matthew alluded to earlier, was we spent a lot of time and energy and, quite frankly, money this past year redesigning you know, our offerings to get to the next generation so we could be best in line. I do think that as other sectors perhaps show slowness, that will simply further strengthen the recovery for us, but we're not counting on that right now or baking that into our outlet for the year.

That's helpful, Patrick. Just to be clear, so when you talk about redesigning, are you talking about going to a chip design that's more ubiquitous and more commonly used in consumer electronics, or is there some sort of level in between where you're at and that next-gen chip?

It's just really getting to next-gen chips where the capacity is being allocated or being built so we have more capacity for the future, yeah, because we're on legacy designs that they're bringing down the capacity on those chips.

Yeah, that's why I asked. Okay, super helpful. Thanks, and congrats, and good luck this year, guys.

Thanks, Scott. Appreciate it.

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

Hey, good morning, everyone. Good morning, Andy.

Good morning, Andy.

Patrick or Matt, I know you've talked about forecasting a slower second half in applied water, especially as new construction potentially slows in commercial, but have you begun to see any evidence of channel destocking or other customer behavior that concerns you in commercial markets and then separately Have you put in any contingency in your guide for China reopening related noise? It looks like China was still strong for you in Q4.

Yeah, so Andy, on the first one on channel inventory, we had really good visibility into the inventory given our relationship with our channel partners. You know, the teams we meet monthly and actually quarterly with council meetings in addition to weekly sales calls and contacts. So we have really good insight into the inventory. The levels are healthy and normalizing, and they're not sitting on any excess inventory, as reported back to us. There are some pockets that have not fully recovered. You know, commercial is not back to kind of pre-pandemic levels in terms of inventory. But resi, I would say, is normalized due to the improved supply chain and softening from the pandemic investments. On the industrial front, it's really more of an engineer-to-order product. There's not a lot of build-to-stock, and so that's where I'd leave it on the channel inventory there.

Andy, let me take the China part of your question. China was tough for us this year. We were down in China about 20% in the first half of the year. We saw moderation in the second half. A little bit stronger Q3 than Q4, given the outbreak of COVID in Q4. I think we've taken a measured approach to China in our guide for 2023. We do expect more of a recovery in the second half of the year in China. You know, the slowdown has been more acute, more on the utility side of the business, and we've seen stronger performance on the industrial side. And so, you know, our focus for our team is, you know, building orders momentum again. And, you know, we remain very bullish long term on China. We're just working through some of the dynamics there now.

Appreciate that, Sandy. And then it seems like industrial dewatering continues to hold up well. As you know, it does tend to be more historically cyclical, but could the business be much less cyclical during the current cycle, given the amount of activity that's out there? I know you mentioned mining. Maybe you could comment on the support you're getting from your strategic growth investments as well as what exactly you're doing there.

Yeah, we made a conscious effort back a few years ago to be a bit more balanced in our segmentation of that business, especially shifting more to the muni side, which is a bit more stable. And we've seen that part of the portfolio grow. And also just making investments in our fleet and upgrading our technology. We are digitizing those assets and making those remotely connectable so we can improve the productivity for our customers. So it's a mixed bag of really, I'd say, some innovation as well as being thoughtful about being more balanced in the segmentation of the business.

Appreciate all the color.

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.

Thank you. So, again, thanks, everybody, for your time today. I know you're all very, very busy this time of the year. Really appreciate your ongoing continued interest in Xylem. Very much look forward to providing you updates on our progress around the Evoqua transaction. And between now and then, safe travels, everyone, and all the very best. Thank you.

Thank you. This concludes today's Xylem fourth quarter and full year 2022 earnings conference call. Please disconnect your line at this time and have a wonderful day.