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Text: They will provide their perspective on Xylem's second-quarter results and our outlook.
I'll ask that you please keep to one question and a follow up and then return to the queue.
A replay of today's call will be available until midnight, on August 31.
Additionally, the call will be available for playback via the investors section of our website under the heading investor events.
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 period ending June 30, 2020.
We have provided you with a summary of our key performance metrics including both GAAP and non-GAAP metrics.
Let me start by expressing my sincere hope that you and everyone close to you are keeping safe and well.
In hindsight, April turned out to be the low point of the quarter.
We hope we'll eventually look back and say it was a low point of the pandemic.
After April, we saw modest improvement in both May and June as demand began to stabilize in our key markets.
Because our business is global, we were exposed to the pandemic's effects early, and so we've also benefited from our presence in markets that have already begun to recover.
Back in April, it's fair to say that uncertainty overshadowed both supply and demand outlooks as COVID spread from Asia to Europe and then North America.
So we felt it responsible to set our second-quarter guidance range intentionally wide to bracket a broad set of scenarios for the macro environment.
Today, we have far more insight and confidence on the supply side, that's because of one notably positive effect of feeling COVID's impact early.
It catalyzed early action by our teams.
Fortunately, we were working from solid financial foundations and a strong position.
So we were able to focus on adapting to the uncertainty and managing the things under our control.
In addition to addressing the immediate need, those actions have built a more robust foundation for both the medium and long term.
I want to make a point of giving credit to my colleagues across Xylem and all of our external partners who made that happen.
They've shown incredible resolve and resilience to a time that has put excessive demands on everyone.
I want to credit everyone around the world who's kept the water flowing and kept essential services running despite everything being thrown at them.
Throughout this period of incredible challenge, they've focused on keeping everyone safe and serving our communities.
Within Xylem, I want to highlight the work of our supply chain, manufacturing and our distribution team.
They've kept our customers supplied and serviced with very few interruptions.
Today, we are up and running across our manufacturing network at greater than 90% availability.
So while demand side uncertainties continue, our outlook now reflects greater clarity and confidence about supply, putting us in a much better position to guide for the third quarter.
I also want to recognize the dedication of our commercial teams, despite the challenges of working remotely.
They drove 10% backlog growth, despite COVID-related macro softness.
You will have seen our announced wins in Telangana, India and with Anglian Water in the U.K. The Telangana irrigation project is our largest win in the country to date, and we do anticipate it will generate roughly $115 million in revenue over the next two to three years.
which combines metrology, communications and digital offerings, is expected to deliver revenues of roughly $90 million over the course of the project.
These wins are further evidence of the durability of our business, even in challenging times.
Because of the differentiation of our portfolio and the resilience of our teams, we expect we will have more news to share about additional big wins when we deliver our third quarter results.
Clearly, I'm very pleased that the team's hard work is evidenced both operationally and commercially.
Having said that, the outlook for the second half is still not back normal.
Therefore, we are not reinstating full-year guidance.
Conditions are improving in a number of our key markets, but the shape of the COVID curve overall is still unpredictable.
Now, I'd like to hand over to Mark to provide some detail in the second quarter, and then we'll come back to our outlook and the trends we see emerging through this period.
Mark, over to you.
Our revenue in the quarter declined 12% which was better than we anticipated coming out of the first quarter.
As Patrick mentioned, our revenue and orders performance improved throughout the quarter with a very strong month in June.
Geographically, U.S. revenues declined 15% as our businesses felt the impact of site shutdowns and project deployment delays.
Emerging markets were down 15% driven largely by the lockdowns in the Middle East and India.
Notably, China grew 6% in the quarter as the utility end market returned to nearly pre-pandemic levels, and industrial and commercial businesses began to modestly recover.
Europe was also a relative bright spot for us as revenues declined a modest 3%.
Western Europe which is the majority of our European revenue base was down mid-single digits.
However, our business in Eastern Europe grew double digits.
This has been a region we've been very focused on, and I want to highlight the tremendous work our team has done there.
They have quietly but consistently delivered a revenue CAGR of mid-teens growth over the last five years.
Orders declined 9% in the quarter, while total backlog grew 10% driven by the large Signature deals Patrick mentioned earlier.
Backlog shippable in 2020 is down 1%.
However, backlog shippable after 2020 is up 23% which gives us confidence that we'll be emerging from 2020 in a position of strength with a solid foundation for growth in 2021 and beyond.
Operating margin was 9.3% in the quarter which I'll review in more detail by segment shortly.
Based on our experience in China, we entered the second quarter cautious of COVID potential impacts on our supply chain.
However, based on those learnings and the great work of our global supply chain teams, we successfully managed through the COVID challenges and turned those learnings into a competitive advantage.
Our teams quickly adapted and began to work in new ways with our customers, our suppliers and internally, enabling us to deliver earnings per share of $0.40, an achievement punctuated by commercial savvy, operational excellence, cost discipline and a focus on what really matters.
Water Infrastructure orders grew 7%, and total backlog grew 24% in the quarter.
This performance was largely driven by the $115 million deal we won in India which is expected to deliver revenue beginning late this year and over the next three years.
Shippable backlog for the remainder of 2020 is up 5%.
Segment revenue declined 8% in the quarter and was significantly impacted by declines in the dewatering, industrial and construction rental business.
As we noted last quarter, we expect utilities to continue to remain resilient as they focus on maintaining their critical infrastructure for wastewater collection and treatment.
This was certainly true this past quarter as our wastewater transport business declined only 4%.
To date, we've seen wastewater capital projects continue with minimal delays.
This was an important driver of the strong quarter from our treatment business which grew 7%.
While U.S. sales were impacted by double-digit declines in the dewatering business, Western Europe revenues were flat in the quarter, showing resilience and some early signs of recovery, especially with our utility customers.
As we continue to feel the near-term impacts from COVID-19 across the emerging markets, we remain confident in the long-term growth prospects for the water sector.
The Chinese and Indian governments, for example, have expressed their ongoing commitment to continued investments in infrastructure for clean drinking water, wastewater treatment and environmental protection.
Operating margin in the quarter was 16.2%, contracting on lower volumes and unfavorable mix impacts from dewatering partially offset by productivity, cost savings and price.
The applied water segment's orders declined 17% in the quarter, while revenue declined 13% as site restrictions continue to impact customers across industrial, commercial and residential end markets.
As regions begin to reopen, we're seeing modest recovery in our book and ship business in both commercial and industrial markets.
We also had a strong quarter in the North American ag business driven by dry weather conditions.
Total segment backlog grew 1% in the quarter.
Geographically, both the United States and emerging markets revenue declined 14%.
However, we saw demand in China begin to recover, growing 2% in the quarter.
Industrial and Commercial end markets in China have been slower to recover than utilities, and our customers are indicating that it may take several months to fully recover in those end markets.
Operating margin in the segment was 13.4%.
Margins contracted primarily due to volume declines and inflation partially offset by 570 basis points of productivity and cost savings as well as 100 basis points of price.
Measurement and control solutions orders declined 24% in the quarter, and revenue declined 17% as the metrology business slowed due to utility workforce availability and physical distancing requirements including restrictions on approaching or entering residents' homes.
This is delaying both project deployments and installations of replacement meters.
We expect order and revenue trends to normalize over the coming months as utility workers are able to safely return to meter replacement and installation.
Importantly, our bidding pipeline remains strong, and there have been no project cancellations.
Despite the near-term challenges, we're very encouraged by the large win we announced with Anglian Water in the U.K. The $90 million contract demonstrates the competitiveness of our AMI and digital solutions to drive key international wins.
This win, and a robust pipeline of AMI opportunities highlight the continued commercial momentum and the differentiated value our offerings bring through our combined digital platform, networking, data analytics and metrology capabilities.
Total segment backlog grew 3% year over year with backlog shippable in 2021 and beyond up 12%.
The segment margin performance was primarily driven by the impacts from volume declines on meter replacement activity and project deployment delays stemming from COVID-19, while we continue critical investments to support growth.
Looking forward, we expect meaningful leverage on the upside as revenue growth drives increased incremental margins from recent large contract wins.
With continued commercial momentum and growing project backlogs, our MCS segment will be a significant source of revenue growth and margin expansion for the company in 2021 and beyond.
We ended the quarter with approximately $1.6 billion in cash and total liquidity of roughly $2.4 billion driven by the $1 billion green bond offering we issued in June as well as strong cash flow performance in the quarter.
The green bond offering was opportunistic enabling us to lock in longer maturities at historically low rates while effectively prefunding $600 million of maturities due in October 2021 at an after-tax cost of less than 1%.
This offering was also the latest example of the importance of linking our financing strategy to our sustainability goals.
Given the strength of our financial position and liquidity, I'll take a moment to note that our capital allocation strategy remains unchanged.
Alongside funding organic investments in key strategic areas, M&A remains a top priority.
And we maintain a healthy pipeline of opportunities which we closely monitor.
Now turning to cash flow.
Our performance in the quarter was very strong.
Operating cash flow improved roughly 50% year over year in our free cash flow of $137 million, more than doubled from the prior year.
This was driven by the continued focus and discipline around working capital, the timing of payment on taxes and the prioritization of our capital spend which was $44 million in the quarter, down almost 30% from the prior year.
Working capital as a percentage of sales improved 110 basis points year over year as our teams continue to drive hard on collections and payment terms while managing inventories in a very challenging demand environment.
I'm pleased with our overall cash performance through the first half of the year, and we now expect free cash flow conversion for this year will be at least 100%.
And with that, I'll hand it back to Patrick.
The end market dynamics we anticipate going into the third quarter are consistent with what we saw in Q2.
Utilities have remained relatively resilient as expected.
However, there is significant divergence between wastewater and clean water.
As Mark mentioned, our wastewater business was down only modestly.
We're seeing continued opex spending to service mission-critical needs and continued execution of capital projects with approved funding.
On the clean water side, the short-term declines were steeper.
They were in the mid-teens.
We are seeing some project delays, but not cancellations, and we do expect execution to pick back up when physical distancing requirements ease.
And we've had some very impressive wins, reflective of healthier long-term trends.
There is considerable discussion about the U.S. utilities capex budgets going into 2021.
We do expect modest capex softening in the U.S. utilities, but as a leading indicator, we are not seeing a slowdown in our bidding pipeline for capital projects.
It is worth noting for a broader context that only 8% of our overall revenue is tied to U.S. utilities capex.
By contrast, opex represents 70% of our overall U.S. utilities revenue, and it remains resilient.
In addition, we see healthy multiyear trends in both opex and capex in emerging markets, Europe and the rest of the world.
Turning now to industrial and commercial end markets.
Industrial didn't slow as much in the second quarter as originally feared, but it will remain soft while facilities continue to deal with restricted access.
Commercial has lagged industrial, and the book and ship business will remain vulnerable in COVID-19 hotspots.
Our backlog remains robust.
Those distributors who destock in the face of uncertainty are beginning to rebuild their inventory.
We see these end market trends fairly consistent across emerging and developing markets, but it's clear that China and Europe are showing more resilience in the U.S. as they emerge sooner from the pandemic.
China's recovery which was up 6% in the second quarter is a strong indicator.
is still grappling with the pandemic's impact, we remain appropriately cautious.
Now please turn ahead to Slide 12.
It's worth noting a few trends that we're seeing more broadly across the sector.
First, there are some fundamentals that COVID-19 has not changed.
The most important is the role that water plays in society.
There is perhaps no service more essential than drinking water and wastewater.
As a result, our strategy is as relevant as ever.
The global challenges of water scarcity, affordability and the resilience of our water systems remains front and center.
Innovation of all kind is essential, now more than ever, to addressing those challenges.
While the fundamentals are unchanged, other dynamics are accelerating.
Interest in digital adoption has clearly gained pace as operators seek a step change in their operational and financial resilience.
In a constrained budget environment, they are rethinking how they spend their money.
It's become an operational and economic imperative to consider the benefits of remote monitoring, automated operations and their decision support systems.
It is absolutely front of mind for every utility executive I speak with, and we're seeing their interest reflected in accelerated quote activity.
We're also seeing a shift in the way that we work with customers every day.
The trends are away from face-to-face interaction and more toward virtual customer engagement across sales, commissioning and servicing.
Because of that, we're making changes to reinforce our competitive strength.
First, as you know, we took a number of structural cost actions across Xylem during the quarter.
Second, we've reprioritized our investments.
We're focusing further on the projects that deepen the differentiation and the market leadership of our portfolio, things such as increasing connectivity and interoperability across our solutions, and we continue to invest in our highest growth geographies.
Lastly, we are reorienting the way that we work within Xylem.
We've accelerated the deployment of the IT platforms that make remote engagement, distant selling and virtual servicing easier for both our customers and our colleagues.
And we are of course assessing the permanent changes that we make to travel, facilities and distance working, changes that no doubt will have a positive impact on cost and productivity and also on employee engagement and morale.
We are focused through the pandemic on managing the things that we can control.
And we're taking the actions now that will make us even a stronger competitor in both the near and longer term.
Given the uncertainties related to the reemergence of COVID-19 across parts of the U.S. and other geographies and its potential ramifications for the back half of the year, we're not reinstating full-year guidance.
However, we do have reasonable visibility through the third quarter which I'll briefly highlight.
We expect revenue declines of 8% to 12% and operating margins in the range of 11% to 11.5%.
This reflects approximately 200 basis points of sequential margin improvement and year over year decrementals of approximately 45%.
The decremental margins are impacted by continued softness in our high-margin dewatering and North American Sensus water businesses, along with a tough prior year compared to last year's third quarter, where we had 90% incremental margins on revenue growth.
While we've seen some positive trends in the second quarter, the global economic landscape remains uncertain, and we are by no means out of the woods.
While Europe is showing positive trends toward recovery, we're closely monitoring the trajectory in the United States.
The pandemic's impact varies widely across emerging markets, from a return to normalcy in China to ongoing shutdowns in India and parts of Latin America.
Lastly, I want to provide a little more clarity on the structural cost actions we announced in early June.
In that announcement, we detailed our plans for permanent actions to simplify our operations and increase our ability to act as one company.
These actions help us better serve our customers and afford us long-term financial resilience.
This year, we expect to incur $80 million to $100 million in restructuring and realignment charges.
This predominantly reflects the actions that we announced in early June, but also some carryover related to prior programs.
We have also provided a summary table on this slide which details the total savings we expect to realize in 2020 and 2021 from our announced structural cost programs.
As a reminder, that includes savings from restructuring and realignment actions we initiated before this year as well as savings from actions we announced in June of this year.
In total, we expect to realize approximately $70 million in savings this year and an additional savings of approximately $80 million in 2021.
So before we go to Q&A, there are a few other milestones that deserve a mention.
The first to touch on sustainability.
We released our most recent sustainability report in June, and I'm very proud of the work by the team, and it reflects the impact our colleagues have delivered across the company.
It shows how we delivered on our 2019 goals, and establishes comprehensive 2025 targets.
It also reinforces the relevance and the value of a strong sustainability approach even in these difficult times.
We follow that up with the launch of our green financing framework which underpinned our recent $1 billion green bond offering.
In addition to showing up our financial strength and liquidity, it extended our commitment that sustainability is at the heart of our business strategy, something we've been doing and we'll continue to do.
We recently announced that Mark will be retiring at the end of the year.
I feel confident in saying he will take with him the gratitude of all Xylem's stakeholders, but most of all mine.
This impact has been undisputable.
And his commitment to both our principles and to delivering value has been constant and unwavering.
We have appointed an outstanding CFO to succeed Mark.
Sandy Rowland has been CFO of HARMAN International, both while they were publicly traded and since becoming part of Samsung.
And that experience has put her right at the intersection of innovation, technology and disruption.
In her board role at Oshkosh makes her no stranger to capital goods, manufacturing and muni markets.
We look forward to introducing her after she joins us on October 1.
Mark is going to be with us through the end of the year which will ensure an orderly and a smooth transition.
And lastly, we also announced today that we've appointed two new members to our board of directors as part of our normal board succession process.
The board has appointed Lila Tretikov, who is the corporate vice president at Microsoft and a globally renowned technologist.
And we look forward to her bringing that perspective to the digital transformation of our sector.
Our second new board member is Uday Yadav, who is president and COO of Eaton's electrical sector, and he brings a disciplined global operating perspective to our growth.
These appointments further deepen our board's diversity, our technology depth and our global orientation.
I'm very pleased that Xylem continues to attract this quality of talent to our purpose and to our mission as a company.
With that, let's open up to questions.
And operator, please lead us into Q&A.

user
xylem q2 adjusted earnings per share $0.40.
q2 adjusted earnings per share $0.40.
appoints two new board members.
not reinstating full-year guidance.
providing a framework for q3.
sees q3 organic revenue will be down in range of 8 to 12 percent - down 10 to 14 percent on a reported basis.
sees q3 adjusted operating margin will be in range of 11.0 percent to 11.5 percent.
lila tretikov and uday yadav have been elected to company's board.

assistant