Welcome to the Xylem First Quarter 2021 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Matt Latino, Vice President of Investor Relations..

Thank you, Hillary. Good morning, everyone, and welcome to Xylem's first quarter earnings conference call. With me today are Chief Executive Officer, Patrick Decker; and Chief Financial Officer, Sandy Rowland. They will provide their perspective on Xylem's first quarter results and our 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 at www.xylem.com.

A replay of today's call will be available until midnight on June 2. Please note that the replay number is (800) 585-8367, and the confirmation code is 5567508. Additionally, the call will be available for playback via the Investors section of our website under the heading Investor Events. Please turn to Slide 2.

We will make some forward-looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future. All references will be on an organic or adjusted basis unless otherwise indicated.

These statements are subject to future risks and uncertainties such as those factors described in Xylem's most recent annual report on Form 10-K and in subsequent reports filed with the SEC, including in our Form 10-Q to report results for the end -- the period ending March 31, 2021.

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.

In the appendix, we have also provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. Now please turn to Slide 3, and I will turn the call over to our CEO, Patrick Decker..

Thanks, Matt. Good morning, everyone, and thank you for joining us. We announced earlier this morning that our first quarter results reflect strong operational performance, exceeding our expectations on orders, revenue, margin and earnings per share.

The quarter's growth was broad-based, reflecting increasing demand across all of our segments, our end markets and geographies. Our momentum coming into the year accelerated through the quarter, with the team taking full advantage of economic recovery and pent-up demand in our markets.

Orders were up double digits in all 3 of our business segments, and backlog was up 23% organically. Both Western Europe and emerging markets delivered exceptional organic revenue growth, with Western Europe up 11% and emerging markets up 33% year-on-year, and with momentum up strong sequentially. U.S.

demand also continued to recover with orders up 18%. Alongside top line growth, our results reflect considerable margin expansion. I credit the team's discipline, building on the benefit of volume effects and positive impact from the cost actions we took in 2020.

Our financial position, which was robust coming into the quarter, strengthened even further on the combination of revenue growth and margin expansion. Looking forward, we are confident about the remainder of 2021 and beyond. Therefore, we are raising our full year guidance on the top line, margin and EPS.

I'll talk a bit more shortly about trends and focus areas for the team. But first, let me hand it over to Sandy to provide more detail on performance in the quarter..

Thank you, Patrick. The first quarter was clearly a meaningful step forward. The team delivered exceptional performance, capitalizing on demand recovery in the majority of our markets. Revenue grew 8% organically versus the same period last year, with performance better than our expectations across the board.

Strong double-digit revenue growth in wastewater utilities was paired with broad-based industrial demand recovery. Geographically, emerging markets in Western Europe both grew double digits, while the U.S. was down 1%. I'll touch on revenue performance in more detail covering each of the segments.

But in short, utilities were up 3%; industrial was up 14%; commercial, up 5%; and residential was up 31%. Organic orders grew 19% in the quarter as all 3 business segments contributed double-digit order gains. Importantly, it was also the third consecutive quarter of sequential orders improvement. Looking at the key financial metrics.

Margins were above our forecasted range with EBITDA margin coming in at 17.1% and operating margin at 11.4%. The 480 basis points of EBITDA expansion came largely from volume and productivity, partially offset by inflation. Earnings per share in the quarter was $0.56, which is up 143%.

Please turn to Slide 5, and I'll review our segment performance for the quarter. Water Infrastructure orders in the first quarter were up 14% organically versus last year with revenues up 11%.

And geographically, Western Europe grew on healthy demand, while emerging markets delivered strong performance, recovering from a COVID-impacted quarter last year. The U.S. was flattish as double-digit growth in wastewater transport was offset by soft industrial performance.

EBITDA margin and operating margin for the segment were up 430 and 490 basis points, respectively, as strong productivity and volume leverage offset inflation. Please turn to Slide 6. In the Applied Water segment, orders were up 25% organically in the quarter, driven by recovery in demand in North America and strength in Western Europe.

Revenue was up 13% in the quarter with growth in all end markets and geographies. Residential and industrial grew 31% and 15%, respectively, while commercial grew 5%. Geographically, the U.S. was up modestly as residential and industrial gains were offset by lagging commercial end markets.

By contrast, improving commercial demand in Western Europe contributed 15% growth with additional strength in residential. Emerging markets were up 51% due to the timing of prior year COVID shutdowns as well as commercial recovery in Middle East and Africa. Segment EBITDA margin and operating margin grew 250 and 280 basis points, respectively.

The expansion came from volume, absorption and productivity. And now please turn to Slide 7, and I'll cover our Measurement & Control Solutions business. In M&CS, orders were up 19% organically in the quarter with double-digit growth across both water and energy applications, driven by large metrology projects. Segment backlog is up 29%.

As anticipated, organic revenue growth showed solid quarter sequential improvement, but finished flat year-on-year. Water applications grew in the mid-single digits with strong demand in the test business. In energy applications, revenue was down mid-teens as certain large deployments were completed in the same period last year.

Geographically, the U.S. was down mid-single digits, but we anticipate project deployments will ramp through Q2 on loosening site access restrictions and then accelerate through the second half. Emerging markets were up 8%, and Western Europe grew 9% from metrology project deployments and demand in the test business.

Segment EBITDA margin and operating margins in the quarter were up 770 and 600 basis points, respectively. Modest price realization and strong productivity savings as well as a prior year warranty charge more than offset inflation. Now, let's turn to Slide 8 for an overview of cash flows and the company's financial position.

Our balance sheet continues to be very strong. We closed the quarter with $1.7 billion in cash. Free cash flow was in line with our expectations as well as our historical seasonality patterns. Managing working capital remains an enterprise-wide priority, and we are especially pleased with our accounts receivable performance.

Net debt-to-EBITDA leverage was 1.6x at the end of the quarter. Now please turn to slide 9, and I'll turn the call back over to Patrick..

the performance of our growth platforms, the team's operational discipline and our progress on sustainability. Turning first to our growth platforms. You've already heard about our emerging markets teams exceptional first quarter performance with revenue and orders up 33% and 21%, respectively. Up until now, China and India have taken the spotlight.

In both countries, our investments in capabilities and localization have created strong engines for sustainable growth. But of course, other areas of the emerging markets also represent great opportunity for us.

Many countries in Eastern Europe, for example, continue to modernize their economies and represent a long runway of investment in Water Infrastructure. And in Africa, there are clearly big water challenges to solve as the higher growth nations continue to urbanize.

We expect emerging markets overall will continue to be a source of healthy, sustainable growth for the foreseeable future. The second platform that continues to underpin sustainable growth is our digital strategy.

Our broad portfolio enables us to combine multiple digital technologies into integrated offers, including AI-enabled software platforms, advanced communications networks and automated endpoints.

Those capabilities have been key to our commercial momentum over the last several quarters with customer adoption of digital solutions accelerating through the pandemic. We've spoken previously about our headline wins in Texas and Ohio.

In Q1, we added a large transformation project in Greensboro, North Carolina, and we have just signed another exciting deal to be announced in the next few weeks. All of these projects deliver network-as-a-service, software-as-a-service and advanced analytics.

In each case, Xylem's ability to bring a suite of transformational capabilities distinguished us and was essential to winning. And just last week, we further extended the digital capabilities we can offer our customers by partnering with ESRI. ESRI is the global leader in geographic information systems, GIS for short.

These systems are an essential component of utility's operating environment. By integrating their technology with our advanced digital solutions, water operators achieved unprecedented network visibility and a clear path to increased operational efficiency and sustainability.

And with last week's agreement, Xylem and ESRI are bringing that powerful combination to the water sector together. Our partnership includes developing joint solution road maps and joint selling to water utilities around the world. We are very excited about this partnership and about the value we can deliver to customers together.

Turning next to operating discipline. Our operational capabilities were absolutely key to coming through 2020 on strong foundations. As you know, last year, we made difficult but essential decisions on structural cost. And we're now clearly seeing the benefit of those actions.

In addition, the team drove strong productivity gains in the first quarter, which offset the early impact of rising inflation. The result was solid margin expansion with incremental margins coming in at 55%.

Over the last year, we've learned that we can do more with less, and we will remain absolutely vigilant on cost as economies reopen and demand continues to recover. That said, we are expecting some impact from the broad-based inflation and component supply challenges that are affecting the industrial and tech sectors.

Now we've already taken action by strategically investing in inventory to support areas of strong demand, and we will continue driving productivity and pricing to mitigate inflation. Still, the supply environment is likely to remain challenging for some time. The third focus area we highlighted coming into the year was sustainability.

I think many of us worried that the cause of sustainability might suffer setbacks through the economic hardships of 2020. However, instead of a retreat, we've actually seen a broad and energetic global embrace of sustainability. As an enterprise over the last year, we've taken several meaningful steps toward our Signature 2025 sustainability goals.

We'll be those in our annual sustainability report to be published in June. We'll be reporting, for example, that in 2020, we helped our customers prevent 1.4 billion cubic meters of polluted water from entering local waterways. Now the report is largely retrospective, but of course, we continue to move forward.

In 2021, we've deepened and broadened the link between compensation and sustainability performance. It is now a component in the long-term incentive program for a range of key executives. Our commitment and our action has put us in a leadership position, which is both gratifying and a tribute to the team.

That said, we all know we have a lot more work ahead of us to deliver on our goals and on our mission and purpose. With that, I'll now hand it back over to Sandy to provide the forward view of our end markets, along with guidance for the remainder of the year..

mid to high single-digit growth in Water Infrastructure, up from low to mid single-digit growth previously; mid to high single-digit growth in Applied Water, up from low single-digit growth; and in Measurement & Control Solutions, we expect -- we continue to expect mid single-digit growth.

While we anticipate delivering a number of large project deployments, growth may be somewhat constrained by component supply challenges. For 2021, we expect adjusted EBITDA margin to be up 90 to 140 basis points to a range of 17.2% to 17.7%.

For your convenience, we are also providing the equivalent adjusted operating margin here, which we now expect to be in the range of 12% to 12.5%, up 120 to 170 basis points. This higher range reflects our expectation that volume, price and productivity gains will more than offset inflation.

Benefits from restructuring savings remain unchanged, and this yields an adjusted EPS range of $2.50 to $2.70, an increase of 21% to 31% over last year. We continue to expect free cash flow conversion of between 80% to 90%, as previously guided, putting our 3-year average right around 130%.

And we expect to continue delivering cash conversion of greater than 100% going forward. Our balance sheet will remain very strong even after $600 million of senior notes are retired in the fourth quarter, which clearly offers considerable room for capital deployment.

We are continually assessing inorganic opportunities to strengthen our strategic position, differentiate our portfolio and enhance market access. We have provided you with a number of other full year assumptions to supplement your models. Those assumptions are unchanged from our original guidance, including our euro to dollar conversion rate of 1.22.

And as you know, foreign exchange can be volatile, and therefore, we have included a foreign exchange sensitivity table in the appendix. Now drilling down on the second quarter. We anticipate total company organic revenues will grow in the range of 8% to 10%.

This includes high single-digit growth in Water Infrastructure, low teens growth in Applied Water and mid-single digits growth in M&CS. We expect second quarter adjusted EBITDA margin to be in the range of 16.7% to 17.2%, representing 140 to 190 basis points of expansion versus the prior year.

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

Thanks, Sandy. Xylem is clearly in a strong position coming out of Q1, and we expect this momentum to continue throughout the rest of the year and beyond. Demand recovery and strong commercial performance will drive organic growth. Operating discipline will deliver margin expansion and strong cash conversion.

And a robust balance sheet will continue to underpin our strategy. More broadly, our business and mission have never been more relevant than they are today. The economic and social value of critical infrastructure is more apparent than ever.

Not only it is critical in times of crisis, but also as a driver of economic recovery, and it's a prerequisite for broader prosperity. From the shocks of the last year, the world has embraced the need for greater resilience and the imperative of a sustainable future.

In that context, our mission, our business and our values put us in a privileged position, which will enable us to continue creating both economic and social value for our stakeholders over the medium and long term.

We look forward to providing an update on our strategy and long-term plans at our next Investor Day, which is currently planned for September 30. It will most likely be a combined virtual and physical format, but we do hope to host as many of you as possible COVID restrictions permitting.

Matt and the team will follow up with more details as soon as they're pinned down. Now with that, we'd be happy to take any questions you may have. So operator, please lead us into Q&A..

[Operator Instructions] Your first question comes from the line of Scott Davis with Melius Research..

Congrats on the incrementals. Good to see, for sure. I'm not sure, Sandy, if you mentioned anything about price. I didn't hear it in the prepared remarks.

But is price generally up with your cost structure? Is there any color you can give us there?.

Yes, sure, Scott. So I think you're asking specifically about the first quarter. If we look at our first quarter performance around price, it's basically flat. It's slightly positive and very much in line with our expectations. We did go out with a price increase, but that was back-end loaded in the quarter.

It didn't take effect until the back half of March. As -- we're not unique. We're seeing increased inflation headwinds. And so we do expect to see more realization on the price front as the year unfolds. We do have a second price increase that will take effect later in the second quarter.

And that actually was a higher price increase than what we went out with earlier in March. So..

And Scott, from our past experience, the teams are doing rather good job on making sure the pricing sticks. So we get pretty good realization when we go out with these price increases. And I think the market is clearly expecting something from us and our competitors..

Okay. That's helpful. And then it sounds like this quarter, at least, you have a lot higher confidence on the meter deployments. Is it -- has visibility -- is it -- clearly site access is an issue kind of everywhere still.

But is the increased confidence more around the efficacy of vaccines and some reopening in developed markets? Or is there other -- any other factors that you want to discuss?.

Yes. I think, Scott, I'll look at the data, right? So very encouraged about the projects that we have lined up from a deployment perspective. As we kind of track, we book an award. It goes into our backlog. The next phase is that we receive tangible orders from our customers. And then you start to see it reflected in our revenue.

And so we're kind of at that middle stage now. If you look at our orders performance in the quarter, within M&CS, we're right about 20% orders growth year-over-year. And a big piece of that is the large project deployment starting to convert into tangible orders, so..

And we saw -- Scott, to your question, it absolutely is being driven largely by sites opening up, not everywhere. But part of that is, again, the vaccine being distributed. I think part of it is just growing confidence in the part of the utilities to move forward with these projects.

And that's also what drove our strong order growth and backlog growth in dewatering that we're seeing at this point in time is site access..

Your next question comes from the line of Deane Dray with RBC Capital Markets..

I would like to talk about guidance and some of the embedded assumptions here. First of all, I fully recognize it's a first quarter, and you guys don't typically boost guidance. So that's for starter is different. And we certainly recognize there's lots of COVID uncertainty still. We're early in the year.

But -- so it really does flag the just the questions about component shortages. And the second quarter guide looks fine. And just that looks perfectly fine. So you're probably pretty locked in, in terms of visibility on the component supply.

So is this a second half component supply? Just a risk? And maybe you can give us some more details about what particular components? I know it's probably changes day-to-day, but just as it stands today, which ones are -- where the supply chains are more stretched in a meaningful way?.

Yes. Sure, Dean. Let me start with some color. First of all, we think that our team did a really good job in the first quarter in meeting supply in what was a challenging supply chain environment. We feel like we're in good shape for Q2. And we're continuing to monitor the situation for the back half of the year. It's a fairly dynamic situation.

And we have certain components, microchips that look good and then that can change and then we solve that problem. So it's a dynamic situation. Our team is on top of it, very focused on it. We've worked -- we work closely with our contract manufacturer partners, and they're very plugged in and larger than we are.

And so we think that provides some protection. But having said that, it's a risk item for the second half of the year. And so we want to be measured and watch how this unfolds over the next 90 days. And next time together, we'll come back to you with an update..

And this is -- Dean, as you well know, this is happening across our sector, especially in the metrology piece of the business. But it's broad -- it's widespread across the sector. So it's not really creating any competitive pressure right now.

It would be a matter of -- if we had shortage, things would move to the right in terms of installations, et cetera. So we're not seeing that as of yet. But it certainly -- if it's a risk, it would be a risk in the latter part of the year..

That's good to hear. And so certainly, that's helpful in terms of the assumptions.

And then the second question is a broader discussion around the ESRI partnership because it really looks like this has significant implications and expanding your offerings in smart water, especially applications using artificial intelligence in this -- the launch project with the utility that you cite, the water main feature.

So just talk about specific applications? What does ESRI bring to the table? A little more color about this utility deal using AI for water main monitoring? And then any color on the economics of the partnership? Is this shared economics? And how is that structured?.

Sure. Yes. So on the -- in terms of what problem are we trying to solve for here? Particularly with the utilities, we already had some of our businesses working with ESRI. That was our pipeline condition assessment business, the formalin is pure as well as was water, which does a lot of the kind of valve pipe replacement work for utilities.

And so really building off of that long-term partnership, but really expanding now across the rest of our portfolio that is sold into the utility. So it really is about harnessing the power of the geographical data that ESRI has -- they've got a very large share base of utilities around the world. This is not limited to a U.S. opportunity.

We think that the power of the collective. I know they are very, very excited about working with us because what they don't have right now -- we don't have access to the weather data they do.

At the same time, they don't have the deep subject matter expertise of being able to advise the utility on how to use this data to go address pipeline issues or water treatment plan issues, whatever challenges that utility may be facing and that's what they're looking for us to really bring in.

And they see it's the power and breadth of our portfolio since we're not limited on a few offerings in terms of equipment. The case study example of the 1 utility that we talked about in the Mid-Atlantic, we help them reduce their non-revenue water through a 4x reduction in pipe failures.

And that 1 project is going to end up cutting their pipe replacement cost by $70 million. On the commercial side of the relationship, I'd rather not get into details on that right now. We can perhaps cover that maybe at our Investor Day later in the year..

Your next question comes from the line of Andy Kaplowitz with Citigroup..

Patrick, you mentioned that China was up 90%, I think, year-over-year. So while it's an easy comparison versus last year, I think you had a 36% drop. I do think you put your business there well over where it was pre-COVID.

So can you talk about what is going on over there in terms of your penetration to that market? You mentioned strength in transport and treatment.

But maybe you could talk about how much is just more awareness about water sustainability, your own sustainable growth strategy? How much that's helping you in emerging markets? And what it could mean for Xylem's underlying growth moving forward?.

Yes, sure. Great question. I would say that -- you're right, part of the growth in Q1 is an easy comp, but we are expecting double-digit growth for the full year in China. It's really -- it's broad-based. It really is cutting across each one of our end markets.

So it's not limited to treatment or transport or utilities even -- part of that is, again, there has been improvement in China in terms of side access, kind of an opening up more broadly of the economy. And so we see that investment flowing. From a long-term perspective, there really are -- we see a couple of key drivers here.

The whole focus on sustainability and environmental impact by the central government there, which has been part of their long-range plan for a while now, is driving real investment, and we see that in our bidding pipeline and our project backlog.

Secondly, it is really being driven also, from a competitive standpoint, by all of the work that we've done over the number of years to localize our supply chain as well as strengthening our engineering capabilities on the ground there and our selling capabilities.

We've got a great team there, and we've got a quite strong brand name actually across China, especially on the utility side..

Got it. And then, Sandy, just following up on Dean's question. It looks like your implied incremental margins in the second half of the year are quite a bit lower than Q1. We know you have more difficult comparisons in the second half.

But is your second half guidance reflecting just conservatism regarding the component shortages we just talked about and price versus cost? And would you say -- would you just be careful about how we model M&CS margin improvement given those issues?.

Yes. So good question, Andy. I think first of all, when we went out with our guidance for the full year of 2021, we did expect that the margin expansion would be stronger first half, second half. And there's multiple reasons for that.

So starting with the restructuring actions that we took in 2020, we realized about $70 million of restructuring and structural cost benefit last year. About $50 million of that was in the back half of the year. And we're calling for about $60 million of restructuring savings in 2021, and that will be more front-end loaded.

So 2/3 of that should come in the first half. So you have a little bit of a difference from a timing perspective on the restructuring side. And then the other thing is some of our discretionary costs. We took out about $60 million of discretionary costs last year. And in our plan, we have about 40% of that returning.

That actually was a tailwind for us in Q1 because we've had travel and other items going on last year in Q1. That will start to flip in the second half of the year and become a headwind. And the other area, I think that it's really important is, we've strategically staggered the timing and phase, the timing of our investments.

And so those are to support our growth platform. So things like building out our digital platform, continuing to -- we just talked about the emerging markets. We're expanding our channel in the emerging markets. We're continuing to focus on localization. And so those investments will come in higher in the second half of the year.

And I think the new thing is that inflation and -- has continued to tick up. And while we're taking pricing actions, they don't always perfectly offset from a timing perspective. And certainly, we're watching the supply chain constraints closely..

Your next question comes from the line of Nathan Jones with Stifel..

Patrick, I'd like to start off with a comment you made in your prepared remarks talking about network-as-a-service. I know you guys have been testing various business models around that area.

Has there been some movement on potentially putting Xylem's balance sheet to work a little bit more to transform the business model around how some of those things work? Any comments you can give around that initiative there?.

Yes. We do a combination of structures. And these are not actually for us, large-scale investments that are required. So I wouldn't want to spook anybody on the call thinking that when we say we'd be using our balance sheet, that we're talking about something larger than what it actually is.

These are rather small investments in a network that we can make. And it oftentimes happens when maybe there's a consortium of utilities where on their own they can't really afford it, they don't need to have it, dedicated to them. So we will make the investment, and we'll lease it back to them.

It does address the affordability issues for the utility for the customer. But that's not the only model we do. I mean there are customers that literally make the investment themselves. And so, two different models there. I would say we're still in early-stage of scaling.

And again, we'll have -- we have much more to share there in Investor Day in September..

Fair enough. The next one -- my follow-up question then on productivity. I think productivity in the quarter was 510 basis points, which I don't think I've seen a number that high out of Xylem before in that category.

Can you talk about what exactly goes into the productivity bucket? And what drove such good performance there in the first quarter?.

Yes. So we've put a number of things in that bucket. And first of all, I need to give a shout out to the team because the performance in the first quarter was exceptional and stronger than what we had modeled. So we put things in there like our continuous improvement activities that take place in our manufacturing centers and within our supply chain.

We also put our procurement negotiation upside that comes through productivity. That kind of offset some of the inflation headwinds that we're feeling as we're able to incorporate things like value engineering or better designs for existing products. Our restructuring savings were a contributor this quarter as well.

That was about 100 basis points, purely restructuring and other structural cost savings, takeout was another 100, 150 basis points. So it's really a combination of a number of factors, and every -- all parts of it contributed this quarter..

Your next question comes from the line of Ryan Connors with Boenning & Scattergood..

I think you slides in Q&A, have been very comprehensive. So I just kind of have a couple of bigger picture questions. Patrick, you talked earlier about the sort of tech to M&CS side of the business. And I understand that smart water is sort of an irresistible theme.

But M&CS, it's kind of lagged the growth and profitability relative to other parts of the portfolio. You're not alone in that. We've seen that from some other peers as well, where sort of the more boring business, if you will, actually outperforms some of the sexier stuff, if you will.

And what are your thoughts on that? And to what extent can we conclude from that, that maybe boring is good in mature markets with good channels that are established or good? And how does that inform your M&A mindset going forward?.

Yes. So obviously, we love all of our businesses. So I don't consider them being boring. But I know that's a bit tongue and shake on your part.

The -- but if we think about our -- kind of our core businesses over the history of Xylem, we continue to invest organically in those businesses, and we've done some small tuck-in bolt-ons like in treatment, et cetera, as well.

But we're increasing that investment in the second half of the year to where about 2/3 of the investment that we're going to be making in the second half is weighted towards kind of the core equipment product offerings that we need to do. The remainder really being in more the digital side. From an M&A standpoint, we are open.

We evaluate opportunities across the spectrum for each one of our businesses in this segment because, hereby, it's really important that we maintain and extend our market share leadership in those businesses and not be purely fixated on just what's going on within M&CS. So that's a big theme across the company right now.

In terms of the dynamics of slower ramp in top line growth and margin expansion in M&CS. I know we said this before, and you began to see that here in the first quarter. That really is a function of timing.

I mean as these large deals begin to get deployed over the course of this year, second half and then next year and beyond, you're going to see that turn, especially when we look at it from an EBITDA standpoint relative to the rest of Xylem..

Okay. That's helpful. And then my second one was, again, another big picture question, Patrick. You're an important kind of voice in this industry. And I want to get your response to something as it relates to federal dollars, right? So we've seen some great progress in the last decade on full cost pricing by local water systems.

We've seen great progress on consolidation and acquisitions by investor-owned players who are great customers for you, as you've demonstrated in your past Analyst Day's and so forth.

So my question is, to what extent does a big infusion of sort of no strings attached to federal money into that sector put those sustainable drivers of full cost progress and consolidation at risk? In other words, you throw a lifeline, they don't have to increase price, they can even lower price, they don't have to sell through investor-owned.

What are your thoughts on that and the risks associated with federal money coming in, in a big way?.

Yes. It's a great question. And the answer right now is no one really knows because nothing has been approved yet. But I think directionally, as you well know, historically, CapEx in the U.S. water utility space, which is really what we're talking about is more on the CapEx side, has not been funded by federal legislation.

And so if this pilot money comes through -- I mean quite frankly, on a relative basis, right now, the number is around $110 billion, I believe. That to me personally is underwhelming relative to the price tag of the rest of infrastructure was being kicked around.

And so I think by the time you spread that out across the utilities in the states or at a local level, I don't think it's going to put as much pressure on utilities, as you pointed out. Moving away from otherwise progress they would be forced to make to protect their investments. So we'll see when we get there.

That's not the rumbling that we're getting. I mean we stay close, for example, to NACA, which you will know is the North American Clean Water Association. And that's one of the questions we ask of those large utility players, is what do they think about the proposed bill? They're encouraged, but they're not making any plans based on it right now.

I mean not at least widespread..

Your next question comes from the line of Connor Lynagh with Morgan Stanley..

I think we've spent a fair bit of time on the chip supply chain issues, but obviously, there's plenty of issues in sort of basic commodities as well.

I was wondering if you could just discuss any sort of material pressure you're feeling from steel or copper or anything like that? What your sort of sourcing strategy is? And if we should expect any sort of impact on your margins from that?.

Yes. So thanks for the question, Connor. We're feeling -- it's something that we're watching closely, both from an inflation perspective and a shortage perspective.

Particularly from a shortage perspective around resins and plastics, we think that the storm that took place earlier in the year in Texas put some pressure on the global -- on the supply chain. And our teams have been working at that, and I think they've been making good progress.

And so when it comes to plastic shortages, we feel good about the supply that we've secured for the second quarter. And I think we're in a good place from a momentum perspective. Still work to do, but those are kind of resolving themselves in a favorable way. We're seeing inflation in copper, aluminum and steel.

And that's an important part of why we've gone out with the second price increase in the second quarter..

Yes. Understood. So I think in the bridge you provided, it seems like price-cost is pretty neutral thus far. I mean I think you were guiding the full year to be marginally dilutive.

Any updated thoughts on that? Just how you're thinking about all those different moving parts there?.

Yes. I think that hasn't changed. But when you incorporate the productivity that we're going to continue to drive out of our manufacturing sites and within our supply chain that will be on the positive side of that..

And I think partly what we're really suggesting here is the uncertainty continues around the supply chain, in areas that -- it's moving around, and we've just gone out with price increases, and we have another one being rolled out. So we really want to see how that sticks and how that plays out as we get through Q2.

And then we'll have a better view on the second half at that point..

Yes, understood. I guess where I'm ultimately driving with this is you're starting from a very nice place on margins, particularly in the Water Infrastructure and Applied Water businesses. It doesn't sound like you're seeing anything right now that would suggest we should assume an abnormal seasonal trend, which usually is a positive one.

Correct?.

No. I think if you look at what we implied through our guide, you'll see margin expansion in the second half compared to the first half. So we are -- I think we're off to a great start. And we're -- on a quarter -- on a sequential basis, you should see margin expansion in the second half as well..

Your next question comes from the line of Saree Boroditsky with Jefferies..

Just a follow-up on your pricing commentary. You talked about this other price increase in the second quarter.

But given your strong orders and backlog, how do you think about when you actually see the benefit of this price increase?.

Yes. I think that's a good question. There have been some orders that have been placed to take advantage of pre-price, before the price increase takes effect. And so that's why what we've modeled is that we'll see greater price realization coming in Q3 and Q4 as we work through the existing orders that are in backlog..

And then it looks like the 25% order increase in Applied Water was partially attributed to extended lead times in North America.

How should we think about the impact of this? And how is underlying demand trending?.

Yes. So first of all, with 25% year-over-year growth, there is definitely an uptick in demand. And so we can't dismiss. We think that there was some placement of orders a little bit earlier than normal because many, many companies are dealing with the supply chain constraints and shortages.

And so customers want to get -- they want to be first in line to protect their supply. But net-net, very good performance. We're seeing good recovery on the industrial side. Residential remains strong. And commercial is starting to come back, particularly outside of the U.S..

Your next question comes from the line of Scott Graham with Rosenblatt..

Sandy, complements on your handle over the details, just really impressive. I'm hoping to maybe tap into that a little bit more on the productivity. I know some questions have been asked around the productivity of 510 basis points. Certainly, we know that discretionary was a little bit additive within that. And so structural, you said 100 to 150.

But or that still leaves a lot of just sort of core productivity improvement in the quarter.

And I'm just wondering if you can kind of take us underneath that a little bit and what that would look like for the rest of the year?.

Yes. So if we look at Q1, what we're seeing is about 70 basis points from -- came from what we call continuous improvement. And that's hard work that takes place day after day in our manufacturing centers. And then our procurement organization delivered about 220 basis points of savings this quarter, which was a really good number.

And so I think that's a high number. But net-net, this productivity element is a core part of our planned margin expansion for the year, and we're very glad to start seeing it right out of the gate..

So you think that, that -- you just laid out, that 300 is sustainable for the rest of the year?.

The -- our full year projection around productivity is right around 300 basis points..

Okay. So then that would imply that, that comes off a little bit in the second half. I understand..

The first quarter was very strong..

Yes, get it. This is one for you, Patrick. I didn't hear mention of AIA. Just maybe you can kind of -- assuming you still called that.

But kind of give us sort of what was the sales growth? And what you've called AIA? And what is the thinking for the full year?.

Sure. Matt, why don't you go through the numbers, and I'll talk about what we're seeing in terms of just momentum in the business. And we have -- I mean we still show it that from a reporting standpoint as AIA within the M&CS segment.

But from a branding standpoint, we now refer a piece of that, which is the pure digital as Xylem view, which is our consultative business. And then we have the Pipeline Condition Assessment business, the artist formally known as Pure that's in there as well. So, those are two very different businesses, and they're now run separately.

We saw nice momentum in both businesses. Matt can share the detailed numbers. But really good look at bidding activity on the digital side, order growth, backlog growth, margins, strong incremental margins on that business. So that team that we set up last year really is beginning to get some big traction now, not just with utilities in the U.S.

but also across emerging markets in Europe..

Yes, Scott. I would just say, looking at it in a whole, right, in terms of AIA, we've been down a little bit in the first quarter. Most of that is pure because seasonally, this is usually a slower period of time for them, doing a lot of that in-pipeline assessment service work. It's harder to do, as you know, in the lot colder freezing temperature.

So down a little bit. That was expected. They both are kind of on target for what our plan was. That will ramp. We're seeing good activity, good interest, bidding around both of the businesses. Some good orders, good momentum on the BU side. And we'll have more to share about that digital strategy and the component that is view at Investor Day.

But I think importantly, too, it's also their synergies with that view business into other parts of the business. And so for example, we highlighted that Greensboro win that we had this quarter. And that is an AMI deployment, but it also comes with some digital components in terms of pipeline condition assessment service, on the water piece.

So it addresses nonrevenue water. And also our Valor analytics technology that goes at the meters that need to be replaced and targeted first to address. So both of those are in that deal. It's nice to see that bidding and scope work getting expanded..

And I would say, Scott, it was those digital capabilities that were, in some cases, the distinguishing competitive advantage that really kind of helped get it across the finishing line..

Yes. That was something you've been talking about for a while, Patrick..

Your next question comes from the line of Brian Lee with Goldman Sachs..

I just wanted to maybe talk about M&CS for a second. It's the only segment that isn't getting a bump up in the outlook for the guidance.

So just trying to understand how much of that is just project timing and visibility not having improved or changed much versus just building in more risk for supply chain issues? So maybe the puts and takes there as you thought about providing the updated guidance here? And if it is some of the latter.

I know you talked about this a little bit, but what specific actions are you taking to mitigate? Are you adding new suppliers? Are you building inventory? I just want to better understand kind of what the situation is there?.

Yes. Thanks, Brian. Good question.

I think from the orders growth, if we did not have supply chain constraints, we would have likely increased the guidance there because the large project deployments, which is a core part of our plan, are coming through in line with our expectations, and our customers are ready to go, which we're very, very encouraged about.

But the situation on the electronics components is very, very dynamic. And so we want to continue to monitor and see how that plays out over the next few months. And we've taken extra inventory where it was possible. It takes a little bit of time to substitute parts out and get those certified, but that's something that our team is also working on.

And I think we're not alone here. So I think this is well understood in the industry that there's a shortage of microchips. And so far, we've kept everything up and going, and we're going to keep fighting..

Yes, we have been -- I mean we have been working to qualify additional suppliers. But the predominant work that's been done is to work closely with our largest contract manufacturer, which is Flextronics.

And obviously, with their large procurement capabilities in the mass procurement they do, we've got a really nice partnership with them, and we've been able to make sure at this point that we're getting our fair share of the components that are out there despite the shortage.

And we just got to stay close to them and keep working that through the year..

Okay. Great. That's helpful. And then maybe one for you, Patrick, and I'll pass it on. Just a high level, big picture outlook for M&A. You guys obviously have a very healthy balance sheet, sticking to the free cash flow view here for the year.

Generally, what are you seeing in terms of multiples out there? Are there -- is there anything more attractive in the context of your stock having done well over the past year? And then just what focus areas or holes you might be looking to address in the portfolio here?.

Yes. No, thanks. M&A is clearly an important piece of our long-term strategy, and so we continue to actively cultivate the pipeline. It is a very robust pipeline. It's very active. We would really be focused on further strengthening our digital platform, really diversifying some of our end market concentration.

So as we said before, perhaps something in the industrial water space. And then, of course, as I mentioned earlier, always look at opportunities to strengthen our core. In terms of valuation, we have seen some multiple inflation there, but really tends to be around things in the digital space of scale.

We've not been actively participating in some of those deals have been announced here recently because we like the portfolio that we've got. But we're always in the game on those in terms of looking at it. But we do want to be disciplined on valuation.

What I would say is I acknowledge your comment and that is we've got a strong balance sheet, our equity is a valuable currency right now and both of those give us, we think, relative advantage to bring some of these differentiated assets into our portfolio. There is a reminder that we've got this $600 million note that's due in early Q4.

So we -- that's not going to constrain us. But as you all are modeling cash and balance sheet, just make sure that you keep that in mind..

We have reached the end of our allotted time for questions. I will now turn the floor back over to Patrick Decker for additional or closing remarks..

Thank you. Well, thank you all for joining and for your continued interest and engagement here. Really appreciate the support. Look forward to seeing you again on our next earnings call, but also at our Investor Day, September 30. Matt and the team will be reaching out and coordinating with all of you to make sure that we get that scheduled for you.

And so in the meantime, again, have a great remainder of your spring and summer. Stay safe. Stay well. And all the best of your families and colleagues. We'll see you soon..

Thank you. This does conclude today's Xylem First Quarter 2021 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day..