Xylem Inc.

Welcome to Xylem's second quarter 2023 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 zero. 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 second quarter 2023 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 perspectives on Xylem's second quarter 2023 results and discuss the third quarter and full year outlook. Following our prepared remarks, we will address questions related to the information covered on the call. I'll ask that you please keep to one question and a follow-up, and then return to the queue. As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website, www.xylem.com. A replay of today's call will be available until midnight, August 9th. Please note the replay number, plus 1-800-839-1320 or plus 1-402-220-0488. Additionally, the call will be available for playback via an investor section of our website under the heading Investor Events. Please turn to slide two. We will make some forward-looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future. These statements are subject to future risks and uncertainties, such as those factors described in Xylem's most recent annual report on Form 10-K and in subsequent reports filed with the SEC. Please note that the company undertakes no obligation to update any forward-looking statements publicly that 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 or 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. Today is a significant milestone for Xylem as we have the pleasure to present the performance and outlook of quite a different company than just a quarter ago as we describe our ability to make an impact on the world as society deals with growing water challenges. The combination of Xylem and Avoqua has already begun taking shape as an even stronger global platform that will have a profoundly positive impact on our customers and communities. We have a responsibility in front of us to help at exactly the moment when the world's water challenges are coming into more acute focus than ever. When we completed the acquisition in May, our capability to meet this moment expanded along with our opportunities for growth. Now, 10 weeks into the integration of these two great enterprises, we are even more confident about the value we will create with our combined company. There are three things that underpin that confidence. First, the team is delivering impressive performance across both companies. I am so very proud of our teams for staying focused on serving our customers at a potentially distracting time. Each team, both Legacy Xylem and Avoqua, turned in a quarter significantly exceeding expectations and giving us brisk momentum for the future. Second, Our early progress on integration has increased our confidence in the cost synergies we previously laid out and the growth synergies ahead of us. We have moved well forward on both sources of value. And third, as water challenges continue to intensify for our customers across many parts of our economy and society, they are seeking simpler, more affordable ways to tackle them. Well, we are now even more strongly positioned to solve those needs and capture that demand with increased exposure to attractive, durable end markets. We'll come back to these bigger points in a few minutes, but I want to make sure we also give appropriate attention to the very strong quarter we just closed. As we shared in our press release this morning, we significantly exceeded expectations on revenue growth, margin, and earnings per share. Organic revenue growth was 15%, with total reported revenue growth of 26%. EPS was up 32% and grew 28% excluding the impact of the acquisition. And we delivered EBITDA margin well above our guide at more than 19%. It was driven by strong demand and the team's continued focus on pricing as well as ongoing continuous improvement aimed at simplifying how we serve our customers. Organically, all segments contributed double-digit revenue growth in all end markets. And each of our regions grew, led by notably strong pace in the U.S. and a solid recovery in China. Our legacy backlog was up 7%. And then we added Avoqua's backlog of more than a billion dollars, and the two together bring our total backlog to $5.3 billion. While we have a lot to do with the integration of these two great companies, we have strong commercial momentum, which gives us the confidence to raise our guidance for the year. And again, I want to thank every one of our team members around the world and our partners for what they are doing every day to deliver real impact to our customers and our communities. In a moment, we'll get more color on our outlook as well as detail on our end markets and regions. But first, I'm going to hand it over to Sandy to dig into the quarter strong results.

Thanks, Patrick. Please turn to slide five. Since this is the first time we're reporting as a combined company, I would like to walk you through how we will cover our performance. We now have four reporting segments. Avoqua's Applied Product Technologies business has been integrated into water infrastructure, immediately combining our two complementary treatment product businesses. Avoqua's Integrated Solutions and Services business, or ISS, is reported as its own segment, providing continued transparency on the segment's results. Our other two segments, measurement and control solutions, and applied water are unchanged. Additionally, since this quarter includes about a month of Evoqua's results, we have laid out organic results compared to our previously shared expectations and broken out the impact of the acquisition. Unless otherwise stated, all growth rates shared are on an organic basis. And lastly, we have reported EPS on an adjusted basis that adds back non-cash purchase accounting and tangible amortization from the evocable acquisition and xylem's previous acquisitions we have therefore recast 2022 amounts for comparison purposes and now let's turn to slide six for our quarters results the team delivered strong performance beating our expectations for both growth and margin expansion Total revenues grew 26% while organic revenue growth of 15% was led by double-digit growth in the US and Western Europe and high single-digit growth in emerging markets. Each business exceeded our expectations and we saw double-digit growth in all segments and end markets. Utilities was up 17% due to robust demand and price realization in both MNCS and water infrastructure. Industrial grew 11% on strong price realization and demand across all regions. And lastly, building solutions, which includes commercial and residential, grew 15%. Overall, demand remains resilient, as demonstrated by our $5.3 billion backlog, up 7% organically, as Patrick highlighted, and now includes Avoqua. And while orders were down 2% on the quarter, book-to-bill continues to be above 1%. EBITDA margin was 19.1%, up 250 basis points from the prior year on higher volumes, productivity savings, and favorable price-cost dynamics. Excluding the impact of Avoqua, EBITDA margin was up 200 basis points, exceeding our previous expectations. Our EPS in the quarter was 98 cents, up 32% year-over-year, and up 28%, excluding the impact of acquisitions. Please turn to slide 7 and I'll review each segment's second quarter performance in a bit more detail. MNCS revenue was up 21% driven by improved chip supply as well as strong demand in pipeline assessment services. U.S. and Western Europe saw robust growth and we continue to see favorable momentum in emerging markets. Borders grew 6% with a book-to-bill ratio of 1.2 And our backlog of $2.4 billion is up 17% versus the prior year, demonstrating continued strong demand for our AMI offerings. EBITDA margin for the segment was up 590 basis points versus the prior year on strong incrementals. Volume conversion, price realization, and productivity drove the expansion, more than offsetting inflation and unfavorable mix. And now let's turn to slide eight and I'll cover our water infrastructure business. Water infrastructure, which now includes the VOCLA's applied product technologies segment grew 20% on a reported basis and 13% organically. Growth was robust across the portfolio with revenues up double digits in all end markets and applications. Developed markets saw particularly strong growth driven by OPEX demand, while emerging markets grew 7%, driven by Latin America and Asia Pacific. Orders in the quarter were down 4% year-over-year, lapping prior year growth of over 20%, and book-to-bill was above 1%. EBITDA margin for the segment was roughly flat year-over-year, and up 20 basis points when excluding the contribution of Avoqua. Please turn to slide 9 for an overview of applied water. Applied water revenues grew 12% on continued strong price realization and backlog execution. The U.S. and emerging markets grew double digits, while Western Europe grew mid-single digits. Industrial demand was both resilient in both Western Europe and emerging markets, particularly due to recovery in China. And while orders were down 6% in the quarter, our backlog continues to be elevated versus historical levels, and book-to-bill is 0.9%. Segment EBITDA margin was up 290 basis points in the quarter with continued strong price realization coupled with productivity more than offsetting inflation. Please turn to slide 10. I'm very pleased to introduce integrated solutions and services as our newest reporting segment. ISS is a leading North American water treatment solution and services provider that brings access to a durable and highly recurring revenue stream as well as a diverse and attractive industrial vertical. With approximately 75% recurring revenue, ISS is known for dependability and bringing mission-critical water treatment expertise to our customers. Although we only reported ISS after our May 24th close, full quarter revenue was up 12%, driven by strong price realization and backlog execution. And orders grew 4%. with a book-to-bill ratio above 1 due to broad-paced demand across industrials and utilities. Backlog of nearly $1 billion to end the quarter was up 15% year-over-year. An adjusted EBITDA margin post-close was a solid 24%. And now let's turn to slide 11 for an overview of cash flows and the company's financial position. After retiring over $600 million of debt in conjunction with the closing of Avoqua, our financial position remains robust as we exit the quarter with over $700 million in cash and available liquidity of $1.6 billion. Net debt to EBITDA leverage is 1.4 times, and in the second quarter, we had solid adjusted free cash flow conversion of 86%. Please turn to slide 12, and I'll hand it back over to Patrick.

Thanks, Sandy. You know, just a little more than two months post-close, our excitement about the Evoqua acquisition has only grown. We've made great progress in three areas. First is our performance and outlook as the business stands today. We began the integration with an overarching principle, and that was to deliver continuity for our customers, keep our commitments, and not disrupt business performance. The results tell a clear story of focused near-term delivery. The combination of our team's disciplined execution, and healthy underlying market demand has given us the confidence to raise our Fool Your Guide. But our current performance is, as you would expect, largely a reflection of our businesses as they are. What we're most excited about is our future potential and the opportunities ahead of us, which brings me to the second dimension on which our confidence is only growing. When the transaction closed, we announced a combined leadership team. And frankly, I'm energized by the strong cultural fit the team has already been demonstrating and the early momentum we've created. We are well on track to deliver the cost synergies outlined when we announce the transaction. And as we progress through the integration, we have even more greater visibility of the operating efficiencies to be realized in coming quarters, along with the opportunity for significant further margin expansion. At the same time, the whole strategic rationale of this combination has always been about further accelerating our profitable growth And that's the third dimension I referred to in my opening comments. We are now even more strongly positioned in attractive, durable end markets with a significant component of recurring revenue streams. Now that we have deeper insight into the intersection of our businesses and customers, we see those opportunities even more clearly. So moving on to slide 13. This is the right combination at the right time. Together, we have the strongest platform of capabilities to address customers' critical water challenges. Those needs are increasing, and we have the scale and reach now to deliver differentiated solutions globally. Our teams are already detailing how we will do that. First, in utilities, we will deepen our penetration, especially with the addition of Evoqua's applied product technologies to our water infrastructure offerings. In industrial, we'll use the power of our combined offering to scale our presence in attractive industrial end markets. And then we will expand our services solutions business by leveraging Xylem's well-established global distribution platform. Now, as many of you know, this combination delivers on part of the strategy we laid out back in our 2021 Investor Day. And that was to expand our capability and our presence in industrial end markets. Increasing industrial exposure reinforces the durability of our overall business model and gains us greater access to attractive customer sets for even faster long-term growth. The recurring revenues of ISS, which deliver consistent performance throughout economic cycles, it complements our MNCS and water infrastructure businesses, which also benefit from the resilience of utility spending. We've already taken the first steps in offering our combined portfolio to light and general industry customers. And we're already targeting attractive industrial verticals such as life sciences and microelectronics. Both have strong long-term outlooks that are driven by secular trends that align well with Xylem's existing business. We look forward to keeping you up to date with our integration progress on a regular basis. and anticipate providing a longer-term growth outlook at an investor day likely to be scheduled in the first part of 2024. Now, with that, I'm going to hand it over to Matthew to say a bit more about our in-market outlook.

Thank you, Patrick. Turning to slide 14. Before I cover our in-market outlook for the year, I want to thank the team and our partners for a great quarter. Our continued outperformance and momentum give us confidence to deliver in 2023 and beyond. We have record backlogs, and the value proposition of our differentiated portfolio in attractive end markets puts us in a strong position, even in a potentially dynamic macroeconomic environment. We continue to take a balanced approach in our outlook and are monitoring leading indicators, watching for signs of moderation. That said, we expect resilient demand in utilities and continued steady growth in industrial water applications. And now I'll turn to our 2023 outlook by end market, which will be on an organic basis. Utilities, which is approximately 45% of our revenue, continue to be healthy. And we now expect growth of mid-teens up from low teens. On the clean water side, we anticipate growth of low 20s up from high teens previously due to robust demand for our AMI solutions and backlog execution on improved chip supply. In addition, we are seeing great traction on solution selling with our digital platform, and customers are increasingly interested in bundling offerings. On the wastewater side, we continue to expect high single-digit growth. Resilient OpEx in developed markets, as well as continued CapEx spend in emerging markets, will underpin demand. Turning now to the industrial end market, which is 45 percent of our revenue, we expect steady global growth amid single digits, but are keeping a close watch for signs of moderation. We expect any softness from developed markets to be somewhat offset by growth in emerging markets, including China, where industrial momentum has continued to outpace utilities. Lastly, in building solutions, which is about 10% of our revenue, we expect growth of mid-single digits driven by steady replacement business and backlog execution. The overall demand outlook remains healthy. And although we are not including Avoqua in our organic outlook, we expect the contribution of mission-critical solutions and services and attractive high-growth verticals, such as life sciences and microelectronics, to further increase the durability of our business. That outlook, combined with our operating discipline, commercial momentum, and large backlogs, gives us confidence for the rest of the year and beyond. Now I'll turn it over to Sandy to walk you through the detail of our raised guidance.

Thank you, Matthew. Turning to slide 15, we are increasing our full-year guidance across revenue, EBITDA, and EPS, and also incorporating Evoqua. I want to take a moment to walk you through the puts and takes of how we now see the full year. We expect total revenues to be around $7.2 billion for the year, which includes approximately $1.1 billion from Evoqua and another increase in our organic revenue guidance. We now expect full-year organic revenue growth of 9% to 10%, up from 8% to 9%. We are raising the low end of our EBITDA guidance to about 18%. And in addition, we are lifting full year adjusted EPS guidance to $3.50 to $3.70, up approximately $0.35 at the midpoint. This incorporates a $0.15 raise from our strong organic outlook and a $0.20 increase due to acquisition-related adjustments. This includes a contribution from Avoqua of approximately 45 cents, the add-back of legacy purchase accounting intangible amortization of 30 cents, and partially offset by incremental share dilution of about 55 cents. As Patrick highlighted, we've made great progress on integration. We expect to be at $40 million of run rate cost synergies by the end of the year, And we remain on track to deliver $140 million of run rate cost energies within three years. Turning to slide 16. For 2023, our organic revenue growth by segment breaks down as follows. Approximately 20% growth in MNCS, high single digits growth in water infrastructure, and mid-single digit growth in applied water. And we are still on track to achieve free cash flow conversion of at least 100% of net income. We've also provided you with a number of other full-year assumptions in the appendix on slide 21. And now, drilling down on the third quarter, we anticipate total company growth will be in the range of 40 to 45 percent on a reported basis and 4 percent to 6 percent organically. By segment, we expect revenue growth to be in the high teens in MNCS and mid-single digits in water infrastructure and remain flat in applied water. We expect third quarter EBITDA margin to be approximately 18% driven by higher volumes, continued price realization, and productivity gains. And with that, please turn to slide 17, and I'll turn the call back over to Patrick for closing comments.

Thanks, Sandy. We've covered a lot here, so we look forward to your questions. But just before we do that, I want to reiterate a fundamental point. This is a transformational step forward for Xylem, and we believe it is transformational for our customers and our communities. We are very excited about this strategic evolution, but the most important things about Xylem are not changing. Our investment thesis is one of those unchanging constants. We are creating significant economic and social value with a durable business model that addresses intensifying water challenges. And we're doing that with a differentiated portfolio of solutions and services and attractive and growing in markets. This gives us a multi-year runway of profitable growth with sustainable margin expansion on the foundations of a strong balance sheet and cash generation with capital deployment to further strengthen our portfolio. It has become increasingly apparent that the need for solutions to the world's water challenges is only growing. And we are in a very privileged position to serve those needs. So now we look forward to taking your questions. So operator, let me turn the call back over to you for Q&A.

The floor is now open for questions. At this time, if you have a question or comment, please press star 1 on your telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing star 2. Again, we ask that you pick up your handset when posing your questions to provide optimal sound quality. Thank you. Our first question is coming from Dean Dre with RBC Capital Markets. Thank you.

Good morning, everyone.

Hey, good morning, Dean.

Hey, just a comment to start, and we really appreciate all the heavy lifting that went on, all these moving parts, you know, recasting financials, the resegmentation, the new end market mix, and the move to cash EPS. And look, from our perspective, that all makes sense, but we appreciate all the work

Hey, Dean, before your question, I do want to give a shout-out to the entire team here and around the world that have been a part of not just closing this transaction, but all the moving parts and pieces that you talked about. In the midst of exciting momentum, a lot of work, and we really appreciate that recognition.

Yeah, that's exactly what I was doing. And just the fact you did not skip a beat on the organic side of the business – cash conversion, order intake, and so forth. So that was the comment part. And now I go to my question. On this resegmentation, ISS is standalone, check the box. That's what we'd expect you to do. And then combining APT with water infrastructure, that also makes sense because that's where there's some interesting overlap in terms of go-to-market customer, not so much on the technologies, but on the go-to-market side. So First question, because that is where there's some integration that will be going on. So give us a sense of what that integration effort is on combining those businesses and anything about the cost or cost synergies and any conceptual thoughts on revenue synergies. Thanks.

Yeah, thanks, Dean. So I'm going to hand it to Matthew to comment on your specific question. I would say that, you know, the integration efforts are really off to a great start. And, you know, APT, you know, that part of OCWA, is a clear and obvious opportunity for us, and I've been really pleased and impressed by the cultural assimilation of the teams. But with that, I'll let Matthew comment a bit more on why that integration, why now, and what that kind of looks like for us.

Thanks, Patrick. Hey, Dean. First of all, as Sandy mentioned a few minutes ago in her remarks, they're very complementary businesses, first and foremost. And there is immediate synergies both on the revenue and the cost side. So that's getting us out of the gate fast. The teams are making great progress, as Patrick mentioned. And it allows us to quickly cross-sell our products, both in industrial and utilities. And an example of this would be in the utility space, being able to bundle our solutions and kind of walk through the front door with a total solution across the whole treatment train, if you will, from beginning to end. We didn't have that capability before. Bringing the two companies together enables us to bring that that full offering to the table. Also, something that maybe is not as intuitive is our technicians, what we call aqua pros, are out with our customers. Now they have a broader portfolio to solve customer pain points, and we're already seeing that play out just organically with our technicians recommending new products in the portfolio very quickly. So that may be something that's not as intuitive, but it's happening already. I'd say thirdly, I'd say the R&D synergies. There's obviously R&D synergies when we bring the treatment businesses together. And then lastly, Patrick mentioned leadership in the very beginning. We brought over three leaders to the senior leadership team from Avoqua. Hervé Fage will lead the combined treatment business. He has tremendous experience here. And bringing those two pieces together will be instrumental for our out-of-the-gate performance on cost and revenue.

It's all really good to hear. And so second question is, the theme is digital. And first, just give us an update on the chip supply. Does it continue to be a gradual supply improvement there? And what's the outlook? And then related to that is, Patrick, there's been this digital path for xylem uh where you were targeting a 50 of revenues by 2025 and i know it's still early and i'm not asking a real specific number here but just conceptually how and our view is evoqua is significantly on the path of digital themselves so now combined that should help you towards this goal so just chip supply and then conceptually where you on the path on uh half of digital revenues by what time frame?

Sure. I'll let Matthew start on where we are on chip supply, and then he and I will tag team on where we are in digital. Great.

Chip supply, Dean, as you mentioned, is continuing to, you know, the moderate improvement as we expected. Q3 will look a lot like Q2. We do expect to pick up in Q4, and also as we head into 2024. We do expect chip supply to improve, but also our redesigns will be coming online as we head into really the end of 2023, end of 2024. So that gives us confidence that we'll see that ramp Q4 and then end of 2024. Maybe just a few comments on digital, and then Patrick can wrap it up. We are making good progress towards the 50% of revenues digital goal. That was a legacy Xylem target. We can see it in the backlog. We have a lot of digital content that's trapped in the backlog. And that will start to release as we get better chip supply and we get better just in general electronic supply over the course of the next six to 12 months. You know, the continued adoption of AMI, as you see in the backlog increase this quarter with MNCS, we're up $300 million. So, you know, making significant progress on digital, especially buoyed by AMI. And then I'd say lastly, you know, the partnership with Adreca is really important because it enables us to pull through more digital content. We're already starting to see that play out. So I'd say all in all, we're on a good trajectory. We're making good progress.

Yeah, I would wrap that up, Dean, with, first of all, a great question because it's a key underpinning of our overall story and differentiation in the marketplace, which is I know why you raised the question. So high confidence in Adreca. both the heritage kind of xylem business. I would say what I'm most encouraged by there also is we continue to see really exciting adoption on AMI in the marketplace, which really is borne out by the print and our increased backlog and deal wins. With Evoqua, you know, the opportunity there, it really is more of a complementary strategy on digital. In the Evoqua businesses, you know, we're really talking about the ISS business, The digital path that the team there has been on is really more around how do you use digital and connectivity to actually improve the productivity of the services offering, you know, making it easier for our Aqua Pros to do their jobs. That leads to margin enhancement. That's a big opportunity within the ISS portfolio to improve our EBITDA margins by, again, digitally enabling kind of what they do every day, making less truck rolls, less visits to serve the customer, give the customer more data insights. predict where the issues are before they have to go out and find them. So there's a whole exciting area there that for those that are new to either the Xylem or the Evoqua story, we'll have more to share on that at our investor day going forward. It's very exciting.

Thank you and best of luck.

Thank you, Dan.

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

Hey, good morning, everyone. Hey, good morning, Mike. Hey, Mike. So the first question I think is a relatively straightforward question, but I just want to level set everything given how many moving pieces here that there are. So it sounds like guidance was raised both organically as well as your expectations that have moved higher on the Evoqua piece if we compare this to call it two, three months ago whenever you last gave an update. Can you just talk through the pieces of why? those expectations have moved higher. I know some of it's the second quarter outlook, but it feels like it's a little broader than that. So can you just, you know, maybe line out those moving pieces for us?

Yeah, let me take a crack at that, Mike. You know, if you, you know, rewind back to February, if you look at where compared to our initial guide, organically we're now forecasting about $300 million higher revenue. You know, we did raise our guidance the last time we spoke, and this quarter we raised it by another $75 million. So, you know, in MNCS, we started the year thinking that the business would grow somewhere in the low teens. We now are expecting, you know, 20% growth in that segment. And, you know, we're seeing very good, strong incremental margins come from that business. So, you know, it's a combination of metrology. It's also a combination of the other businesses that we wrap around metrology and MNCS that's giving us good, you know, good upside. And then the other two businesses, they've been performing really well. They've gotten ahead of the curve from a price-cost perspective. We've sustained that momentum. But I think what's also encouraging is we're seeing more increases on the volume side as well. And so it's really all parts of our portfolio that are contributing to the beat and raise. When I look at the Avoqua side of the house, we talked about them contributing about $1.1 billion this year. This past quarter, we brought in about $175 million of revenue from of Volqua. Margins there are developing really nicely. If you look at our implied outlook for the rest of the year, the margins for both companies are really right on top of each other. So it's really good to see strong momentum from both sides of the house. And I think it goes back to the deal operating principles where we've kept both teams really focused on delivering on the organic plan.

Great. No, that's exactly what I was looking for. Appreciate that. And then Second question, maybe you could just talk a little bit about the momentum you're seeing on the utility side as we work through next year. Book-to-bills seems pretty good on the utility pieces. Obviously, MCS, it's healthy. I think the infrastructure piece is healthy, though. Obviously, you've got some industrial in there. Backlugs, very high on the MCS side. You know, maybe just talk about the visibility you have on those pieces in the next year. Wrap in ISS into that a little bit as well. and talk about how you're looking at the contribution from some of these regulatory drivers coming up, some of the funding that might or might not get released here.

Yeah, so I'll start, Mike, and then I'll hand it over to Matthew. Just, you know, to your question, zooming out around utilities, we remain, I would say, more confident than ever around where utilities, again, this is a global statement, where utilities are in the cycle. One, we see here in the US that while we're still early in the adoption of AMI, we continue to see an increased excitement around that. And that shows up in our bidding pipeline. It shows up in our deal wins. It shows up in our backlog. And I think the numbers speak for themselves there on where AMI adoption is going and our ability to successfully compete and win in that space of the market. You know, secondly, the, you know, there are the underlying fundamentals of You know, the largest part of utility spend, as you well know, is OPEX. It's repair, replace. And given the age of infrastructure around the world, most notably here in North America, but also in Europe, we see continued increases, you know, in that demand and outlook. And that's going to continue as a long-term trend. You know, I think in terms of other demand profiles beyond that, you know, as we think about whether it be the Inflation Reduction Act, other infrastructure legislation here in the U.S. We get a lot of questions around PFAS, and obviously with our Evoqua capabilities coming in, that's obviously a very exciting area for us. But as we've said before, and I know, you know, Ron, the CEO of Evoqua in the past has said, that's a dimmer switch. You know, it's not like all of a sudden one day it's going to show up. It's going to be adoption over time. And it just reinforces the positive tailwind. that we believe we have in the areas that we're focusing on at Xylem. So that's my commentary around utilities. I don't know, Matthew, if you want to add anything to that.

I think the only thing I would add to that, you know, we have really close relationship with our customers, especially our utility customers. And based on conversations that we've had with them over the past few months, we don't see a reason that there's going to be any slowdown. You know, the draft muni budgets for the next year for some of our bellwether utilities are showing growth year over year. So I'd say that's kind of customer-backed, the feedback we're getting. Obviously, we play very globally in utilities, not only in the U.S., but half of our revenue is outside the U.S. And to Patrick's point, there's a lot of public funding globally, both in the U.K. with the AMP cycle, in China, the EU, and then obviously in the U.S.

So it feels pretty good.

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

Hey, guys. Good morning. Good morning, Joe. Can you talk through, like, kind of how the quarter went in Western Europe and China? I mean, that's where the data has been kind of squishy and maybe getting worse there a little bit. And I'm just curious on your thoughts on potential for Chinese stimulus and, you know, where that might get directed if it has an impact to you guys.

Yeah. Hey, Joe, it's Matthew. You know, just maybe just some comments on Europe. You know, it continues to be resilient, especially in utilities, which is over 50% of our revenue in Europe, with the majority of that being in OPEX, as Patrick just mentioned earlier. We were up low teens in orders in Europe in utilities, and so that was really good news. The softness that we're seeing is more on the building solution side, which is partially offset by industrial. All in all, Western Europe's up low single digits in orders. I'd say all in all, faring pretty well there when you take the balance there in account. China, which makes up around 6% of our revenues, we saw positive momentum both in orders and revenue in Q2. We were up 20% plus, which although it was an easier compare, it was really great work done by Xu Pinglu, who leads our team there, and the entire team in China. just incredible resolve and just really in China for China, localizing products and shifting where some of the slowness is happening and getting into more of the high growth areas. Industrials led the way in China for us, and we're starting to see a little bit of momentum in the utility space. And obviously in the commercial building space in China, that's where the weakness is, but it's not a big part of our business in China. 75% of our business in China is more utility centric. All in all, we're very confident in China in the long-term outlook, given really the critical nature and focus on water in-country there.

Joe, you know this already, but for the rest of the listeners, I've been a long-term bull on China. just because of the underlying demands and needs from a water and environmental standpoint there, continues to be a top policy mandate of the government. You couple that with the strength of our team and our portfolio of offerings. We've weathered a couple of cycles in China over the time that I've been here. But when you go back and look over the last seven or so years, it's like a double-digit cagger of growth. And we continue to see that potential going forward. So I'm very proud of the team and optimistic about China for us.

That's a good call. Thank you, guys. And then just I wanted to follow up on Indrika just Where is that in terms of like what needs to happen for that to become kind of like a core kind of beachhead for you and digitalization on a scale basis? And then, Sandy, I just had one clarification for you. APT within water infrastructure, just curious how that looked organically on like a full quarter basis for revenue and orders. Thank you.

Yeah, let me knock that out of the way and then Matthew can, you know, take a drink. When you look at the performance of the full quarter of Avoqua, The business grew 9% organically, and the APT piece of Avoca grew 4%.

Great. Yeah, in terms of ADRIKA, just for folks that are on the phone that may not know what ADRIKA is, we have an exclusive commercial partnership worldwide with ADRIKA, which is headquartered in Valencia, Spain. They were born out of a utility operator. And the digital platform that they have, that we're partnered with, addresses really the biggest pain point we hear from utilities' need for a singular platform to seamlessly integrate all of their applications and data. And I would say we have built really good momentum over the past four to five months. We've engaged over 200-plus utilities globally, and it's got really global reach. It's fairly balanced across the globe. And it built a solid funnel with really significant synergy wins through bundling our solutions. So I would say it is becoming the beachhead. It will become the beachhead. And earlier in Dean's question, it's going to help us pull through and drive more digital content and also reoccurring revenue, which is really important. Just one example I'll give you, in the U.S. recently where we leveraged this digital platform, we're calling Xylem View, which is the Adreca platform. We pulled through a large AMI order. Now you're seeing in the backlog. So you saw the backlog grow by 300 million. One of those big synergy wins was due to the digital platform that we enabled and pulled through this synergy order. So, you know, it's going to help us with recurring revenue, but it's also going to pull through content, which is really strong.

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

Good morning, everyone. Good morning, Nate. I'm going to start on the cost synergy side. Pretty good run rate to be at $40 million by the end of the year, like 30% of the targeted cost synergy number. So maybe you could just start off by talking about... where that's coming from to hit that kind of run rate that quickly in this kind of deal, the major buckets for the $140 million, and then if you can give us any color on how we should think about those layering in in 24, 25, 26.

Yeah, sure, Nate. Let me kick that off. I think the cost synergy buckets that we outlined when we announced the transaction have not changed. So You know, the first category was to go after public company costs, overlapping public company costs, as well as some of the SP&A savings. And so, you know, that is making up the lion's share of the savings that we're going to realize in 2023. And, you know, the other two categories of savings, which are going to come from procurement savings, as well as some site consolidations and manufacturing footprint overlap, You know, we expect the procurement savings to start to kick in later in 24. And, you know, the manufacturing site consolidations, that's going to happen over time. We have those phased because we want to make sure we're purposely taking care of our customers. So, you know, about $40 million exit rate in Q4. As I look into 24, you know, we'll be more than double that when we exit 24. So I think, you know, all signs, we're very confident about the 140.

Thanks for that. And I did want to ask a couple of questions or one probably long question about revenue synergies. It's obviously a big motivating factor for this deal to get done in the first place. Not looking for exact numbers. I know we might get some more of those in early 24. But if you can just talk conceptually about areas where you see potential for revenue synergies And kind of the phasing of those, I mean, there's obviously the APT and water infrastructure combination, I think certainly signals that there's revenue synergies there and you've talked about them before. But maybe talking about things like expanding Evoqua's service-based business model internationally, maybe leveraging their footprint in the US to develop some more service-based business models with Zalem's legacy products, and then any other channels you'd be willing to talk about to help us understand the opportunity here.

Sure. So, Nate, this is Patrick. So I go back to the three overarching kind of areas that we're focused on. And what I would offer is we've also got special incentives in place for our teams to go capture the revenue synergy because we want people to be highly motivated to to go do these things beyond their day job. So, you know, deep in our utility penetration. And that really is around, again, the combination of our treatment product portfolio of the two companies. They really do complement each other very, very well. And leveraging what Xylem's really market-leading utility position is around the world. These are not North America comments alone. They're around the world. is a big opportunity. Secondly, you know, scaling our offering to industrial customers. Again, we call them industrial, and there's a number of customer sets that are in that area that we think there are big opportunities. We don't think we see big opportunities to really go solve their needs. So if you think about, well, the third is expanding the ISS offering internationally. And two and three have a lot in common because it's part of our diligence when we looked at Avoqua. They have a really, really impressive roster of customers, market-leading customers that cut across areas of whether it be power, whether it be food and beverage, whether it be life sciences, whether, you know, again, whether it be microelectronics. that have needed even more of Avoqua's capability than Avoqua's been able to provide in the past, especially internationally. And that's where we as Xylem have the footprint, and we have the scale and the resources to be able to drive that adoption.

Great. Thanks very much for taking my questions. Thank you.

Thank you. And we'll take our next question from Joe Giordano with Jefferies.

Operator, I think we've heard from Joe.

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

Hi. Thanks for taking my question. Maybe digging into building solutions a little bit. Commercial demand has continued to be strong. I think this is one area. that you were anticipating a slowdown previously. So maybe just an update on what you're seeing there.

Yes. I mean, I'm sorry, sir. You were a little bit choppy. You asked about commercial. Yeah. So our commercial business has been pretty resilient this year. We've continued to see strong revenue growth. And our outlook for the back of the year is we still are going in with an elevated backlog. So nothing has changed materially there.

Seri, you were a bit choppy in the break. I want to make sure we clarify your question in terms of which segment.

Yeah, I think you were anticipating a slowdown previously. I think citing maybe ABI, just trying to get an update there on building solutions, and then maybe just following that up on residential. Obviously, small market for you guys, but how did that trend through the quarter, and are you seeing any positive signs there? Thank you.

Yes, sorry. I mean, I think, you know, when you look across the portfolio, we're seeing really good orders momentum, and strong book to bill, you know, the one soft spot in our portfolio is residential. And before the acquisition that made up about 5% of our revenue base. Now it's even lower than that it's two or 3% of our revenue base. So yeah, that is the weakest part of our portfolio, you're seeing, you know, a slower growth outlook in AWS for the second half of the year. offset by the other businesses that have more resilient end markets, such as utilities.

Thanks. Appreciate the call. I'll pass it on.

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

Good morning, everyone.

Good morning, Andy.

So Patrick, dewatering has obviously remained strong for you guys. We've talked about it in the past being a little more cyclical, but it seems like it's sort of holding up well. So maybe you can talk about sort of what you see going forward, maybe even into 24 in that business.

Yeah, so dewatering had historically, for those that may be relatively new to the story of Xylem, had historically been one of our more cyclical businesses. And because it's such a high margin business, it would tend to capture spotlight even with a little bit of movement in terms of downturn. And there have been a number of moves that we've made over the past handful of years to diversify the in-market exposure of that. I'll hand it over to Matthew to kind of give his take on kind of where we are positioned right now. But I'm certainly proud of the work the team's done. And there's been a lot of work done on synergy, commercial integration, even before the acquisition of Voqua. And it only gets stronger now.

Yeah, no, that's great, Patrick. You know, we've put a lot of time and effort into dewatering over the past couple of years, Andy. And I would say maybe a couple of things. One is we invested in the fleet, both in Europe and in the U.S., which has really helped us capture more wins. Number two, you know, really coming out of 2019, we needed to diversify our segments in dewatering. We were too oil and gas dependent. And we've done a nice job of mixing into light construction as well as into mini bypass and some different areas that are a bit more profitable and a bit more steady and less cyclical. So those are a couple of key drivers I would say that's really helped us. And the last thing I would say in the U.S. where it's predominantly our revenue is we've done a good job of driving the businesses together and driving synergies with our service organizations, passing leads back and forth to one another with our pipeline assessment service businesses, our valve maintenance business and whatnot. So really good on the synergy side that's helped drive growth as well.

I would just wrap up that answer by saying I think in this business, like the entire business, that certainly this area, it's about leadership. We've got a strong leadership team in that area that are working together. They're leveraging the portfolio. They're focusing on what happens at a site kind of local service level. This, just like our ISS business coming in, it's a people, very people-driven business. It's an emergency room kind of operation. It's what happens every day, 24-7. And so the hearts and minds of the people really, really matter here. They do everywhere, but they really matter here. in terms of what customers experience in the moment. And I, again, I just give an applause to the leadership team for what they've done.

Very helpful, guys. And I apologize, I joined the call a little late, so this has been asked, but like on price versus cost, maybe talk about sort of You know, you already talked about supply chain getting better, I think, but sort of what you're seeing on the pricing side versus that, you know, sort of improving supply chain. And then maybe, you know, looking at Evoqua, too, any sort of differences in markets as you're thinking about price versus cost as you go to the second half of this year and into 24?

Yeah, thanks for the question, Andy. You know, we've seen really nice developments on the price-cost side, and it continues to, the way we've managed it, it's now been a tailwind for us from a margin perspective. You know, we are starting to anniversary some of the price increases that we took when inflation was peaking. And so you're not going to see as much of a tailwind from price in the back half of the year that you saw in the front half. You know, the positive thing is that this is actually the first quarter that we've seen inflation start to moderate and come through our results. And we would expect to see a little more of that as well in the back half of the year. Really great work by the commercial teams to to make that happen over the past past year Appreciate all the color We'll take our next question from Brian Lee with Goldman Sachs Hey, good morning everyone.

Thanks for taking the questions morning question on the MNCS margins. Kudos on super solid execution there. I don't think we've seen margins at these levels since I think right after you bought Census, so it's been a while. So just trying to get a better sense of what drove that, how sustainable it is, and then what we maybe should be thinking of run rates through year end. And if you think this is a good sort of jumping off point for potentially getting back to a double-digit margin on a full-year basis next year? Is that a reasonable sort of target to have at this point?

Yeah, thanks for the question. I'll start us out and then turn over to Sandy. But, you know, we've spent a lot of time in the past six to 12 months, really the past 12 months, on MNCS margins. And I'd say there's probably two or three things I would point to. Number one, obviously, you know, we were hampered by chip supply not being able to unlock the backlog. And so, Being able to unlock the backlog has really helped with absorption in our factories and helping cover fixed costs. So that's probably number one. Number two is we're getting back to productivity in that business. We had to redeploy resources to go after redesigned products for chips. And so productivity has increased this year, year over year, and we'll continue to drive that in the business. And then thirdly, I would just say, in general, price-cost has been a very good positive over the past two to three quarters. in MNCS, which has helped buoy margins as well. So we'll continue that pace going forward and expect margin improvement sequentially going forward.

And, Brian, this is Patrick. I'll just offer up some historical perspective here for those that may be early on in the story here. MNCS is not a turnaround. We, I mean, this has been an issue in terms of being able to deliver on what has been an impressively growing backlog over the course of the past few years. And we've had margin read through on what that backlog is for a long time. We've made commitments in the past as to when we reach certain levels of revenue, what the margins would be. That's exactly what you're seeing right now. So, again, I give a shout out to the entire team that drives, especially the metrology part of our business, because they've been executing on this ever since we did the acquisition. It's just it's always been something along the way, and now we're seeing that the clouds have kind of moved off the horizon, and you're now seeing what the full potential or at least the next stage of potential is for this part of our business.

Okay, that's great. I appreciate that, Collin. And then maybe just a second question around, you know, with the acquisition of Evoqua, Clearly, much bigger scale, but much more diversification across the business model. It seems like it'd be a lot less cyclical going forward. In the past, I know Evoqua has sort of broken out what their recurring revenue exposure is as a part of their portfolio or sales mix. Now, on the combined entity, any sense you can give us as to how you think about the recurring revenue revenue nature of the different segments where you have exposure there and kind of how that compares to, you know, Xylem standalone. Thanks, guys.

Yeah, yeah. No, certainly. Great question, Brian. I mean, you know, it was certainly not the reason for the acquisition, but certainly one of the big benefits is that recurring revenue component. The Evoqua business, we have tremendous line of sight going into any given year based upon contractual commitments as to what that looks like. And so you're talking about the largest portion of their revenue is predictable and repeatable going into the year. And so... And that really is ISS, which is obviously the largest part of what we got from Avoqua. If you look at the other parts of our business, historically, our MNCS business, which is metrology, also has a lot of revenue under contract. And so a majority of revenue there. is visible going into the year, but not even one year. It's looking at it over the course of a 10 to 12 year time frame given AMI deals that are there. Water infrastructure would be the next one given the fact that we've got such a large installed base of our particularly submersible wastewater pumps, but also our treatment products that we do that are typically long-term kind of projects that we're operating under. And it's just a very stable repair replacement environment. We feel very good about that. The area, the business that's always been short of cycle for us is our applied water business. But even there, you know, we would say upwards of a third to 40% of our revenue, while it's not under contract, it's a replacement model. And once you've specced your pumps into a commercial building or an industrial application, the likelihood of a customer changing out to a new supplier is very low. It's very sticky, and we have market-leading positions there. So even though it's not contractual, we can kind of have that visibility going into the year. So we will, in the future, we'll give you specific numbers in the aggregate of I don't want to overcommit to that right now, but we feel very good about the durability and nature of recurring revenue of this business much more now than we did a quarter ago because of bringing in Avoqua.

All right. That's great. I appreciate the call.

This concludes the Q&A portion of today's call. I would now like to turn the floor over to Patrick Decker for closing remarks.

Well, again, I mean, thanks to all of you for your time this morning and for your ongoing support. Look forward to seeing many of you over the coming months here before our next call. And just a reminder, lastly, again, really excited today about the power of the combination of two companies coming together that were strong on their own and performing well. And now is the time. It's the right time in this world for these two companies to come together because there are so many great water challenges out there to be dealt with. And we feel that we are in a position to really be a meaningful part of that. So thank you all very much.

Thank you. This concludes today's Xylem second quarter 2023 earnings conference call. Please disconnect your line at this time and have a wonderful day.