賽莱默 (XYL) 2012 Q2 法說會逐字稿

Welcome to the Xylem second quarter 2012 earnings conference call.

Hosting the call today from Xylem's headquarters in White Plains, New York is Gretchen McClain, Xylem's President and Chief Executive Officer.

She is joined by Michael Speetzen, Xylem's Senior Vice President and Chief Financial Officer.

Today's call is being recorded and will be available for replay beginning at 12.00 PM Eastern Standard Time.

At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation.

(Operator Instructions)

It is now my pleasure to turn the floor over to Phil De Sousa, Investor Relations Officer.

You may begin.

Thank you, Brandi.

Good morning, everyone.

Welcome to Xylem's second quarter 2012 earnings conference call.

With me today are Chief Executive Officer, Gretchen McClain, and our Chief Financial Officer, Michael Speetzen.

They will provide their perspective on Xylem's second quarter results and full-year 2012 outlook.

And, of course, we will allow for time to address your questions at the end.

This call and our webcast are accompanied by a slide presentation available in the Investor section of our website at www.XylemInc.com.

A replay of today's call will be available until August 9 at 6.00 PM.

The replay number is 404-537-3406, and the confirmation code is 93016589.

Additionally, the call will be available for playback via the Investor section of our website under the heading Presentations.

Please note that all references today will be on adjusted basis unless otherwise indicated.

Non-GAAP financials are reconciled for you in the appendix section of the presentation.

Now, 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.

These statements are subject to future risks and uncertainties such as those outlined in Xylem's annual report on Form 10-K and those described in subsequent reports as filed with the SEC.

These remarks constitute forward-looking statements for purposes of the Safe Harbor Provision and are made of as of today.

Please note that the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances, and actual results could differ materially from those anticipated.

So, with that, please turn to slide 3, and I'll turn the call over to our CEO, Gretchen McClain.

Thank you, Phil.

Good morning, and thank you for joining the call.

We appreciate your interest in Xylem.

I'll begin the call by providing you an update of our overall financial results for second quarter, spend a few minutes updating you on the progress we've made on our strategic objectives, and provide my perspective on our first half revenue performance and our full-year outlook.

I will also discuss the actions we're taking to address the continued economic uncertainty and to position us for future growth.

I'll then hand it over to Mike to walk through the details of our quarterly performance and our full-year guidance.

Today, we are reporting second quarter revenue of $966 million, reflecting growth of 4% on a constant currency basis.

Organic growth was 1% with acquisitions adding another 3%.

While overall revenue were below our expectations for the quarter, our performance was on top of strong growth last year and in a more challenging environment.

In Europe, where overall economic growth is negative, our revenues on a constant currency basis were down a modest 1%.

And, our continued focus on attractive acquisitions is helping us to drive top line growth.

YSI added $32 million in revenue in the quarter and continued to outperform our expectations.

On a year-over-year basis, YSI is up approximately 11%.

We received orders of $970 million, up 2% in constant currency, resulting in a book-to-bill ratio of 1.0.

During the quarter, we won some key public utility and industrial transport and treatment projects spread across the US, Europe, and emerging markets which will ship in 2013.

Let me highlight that in the second quarter we registered our highest order rate in treatment projects since the first quarter 2011.

This is a positive sign for next year, and we're encouraged by the number of projects still in the funnel.

As I mentioned, last quarter, bid activity for capital projects has continued to increase, but release of orders continues to be slower than anticipated.

A key focus for us has been margin expansion.

Despite the lower demand, we continue to reach higher levels of profitability.

This performance demonstrates the results of years of disciplined execution, a focused growth strategy, and processes put in place to drive price and reduce operating costs.

We will cover these details later on the call, but for now, I'd simply note that for the quarter, gross margin was 39.6%, up 60 basis points versus last year and fast approaching the long-term target we set out at our Investor Day.

Operating margin was 14.8%, up 100 basis points, excluding the impact of recurring standalone costs.

Earnings per share were $0.49, up 4% on a comparable or normalized year-over-year basis.

Core operations and YSI performance drove earnings up 13%, giving us confidence that we can continue to deliver fundamental growth in a tough environment.

The negative impact of foreign exchange knocked nine points off that growth rate, bringing it down to the 4% you see on the slide.

We've generated year-to-date free cash flow of $86 million, which represents 54% conversion of net income, and is consistent with our seasonal performance.

Please turn to slide 4.

As we laid out in our October Investor Day, we have three key focus areas in 2012 -- advancing our strategic position, deploying innovative new product applications and services, and continued strong execution.

We continue to make good progress in advancing these priorities, and this slide highlights just a few of these accomplishments.

On July 13, we announced another important step in advancing our strategic position with our first Xylem acquisition, MJK Automation.

MJK's strong position in the Scandinavian market and their flow and level sensor technology and expertise enhances our analytical instrumentation platform and provides energy-saving measurement and control equipment.

MJK is another example of a perfect bolt-on for our Water Infrastructure segment as it allows us to expand our wastewater and surface water applications and bring together our transport and test capabilities.

For those familiar with MJK's product, their products are used in water, wastewater, environmental, and irrigation applications where critical measurements are required in pipe, wells, open channels, and canals.

Their monitoring and control technologies are well-suited for field, online, and lift station applications, all areas where Xylem has a strong presence and can now offer even more value to our current and new customers.

MJK is the fifth acquisition we've closed in our analytical instrumentation platform, and much like YSI and the others, they bring a strong local market presence.

And, this provides the ability to sell our other products to their customers and expand its product sales globally through the rest of Xylem.

During the quarter, we also announced several plans to continue to expand our emerging market presence, including our plans to grow our dewatering platform in the attractive markets of Brazil.

We will start by strengthening our rental offering in three key locations before launching new services at additional locations across Brazil in 2013 and '14.

We're also making great progress in deploying innovative new product applications and services to address global water challenges.

I already mentioned the strong treatment orders in the second quarter.

Here, we are deploying our technologies into industrial adjacencies and new application solutions.

Let me highlight that just yesterday, we received an order for a small package turnkey water treatment plant in New South Wales, Australia.

We're excited because it's the first order that includes our ZeeWeed membrane system through our expanded partnership with GE.

We expect this to be the first of many orders to come from a growing pipeline of projects being developed by our global sales team.

A new product launch out of our analytics business, [XO], is the next generation of multi-parameter field water quality instruments.

The largest order we received since the launching in June was from the New York City Department of Environmental Protection.

The Department is using the equipment to monitor the Hudson and East Rivers for water quality parameters such as oxygen and pH.

This data is used to confirm that the rivers are safe for recreation and public use.

In addition to supplying the instrumentation, Xylem is also providing training, installation, and field support services to ensure the department is receiving the highest data quality.

Another example is how we're working with the public utilities to address one of their key challenges -- reducing their energy costs.

As part of our total care offering, we have been performing energy audits as a new service for our public utilities customers at their sites, providing extremely valuable data in consultation regarding the efficiency level of their operations.

By highlighting areas of improvement and having the energy-efficient solutions, we can help them significantly reduce operating costs and put ourselves in position to win additional business.

Taking this a bit further, energy represents the highest cost for a wastewater treatment plant, and research shows that the aeration process accounts for up to 60% of that total energy consumption.

Just a few weeks ago at the Singapore International Water Week, we shared the results of our study performed at a full-scale wastewater treatment plant.

The study concluded that Xylem's energy-efficient, secondary treatment solutions can help customers reduce energy costs up to 65% through an optimized aeration system.

Just one example of exciting opportunities in front of us that leverages our product breadth and our applications' depth.

The third area of focus is strong execution.

We continued our journey to increase our presence in emerging markets.

We had an exceptional quarter, growing at 22% on constant currency basis with positive contributions from all emerging markets.

We're also working a number of areas to ensure we achieve the growth and margin potential our businesses are capable of delivering, independent of market conditions.

As you can see, we're making progress against our key priorities as evidenced by our growth and operating margin expansion.

The processes and disciplines that we have implemented around our pricing through customer excellence programs continues to pay off.

We are delivering strong price realization in our results, approximately 1.7% over the first half of this year, and we continue to gain momentum and improve profitability with our lean factory and global sourcing initiatives as well as driving product rationalization.

These activities are all key in delivering more value to customers and getting the right cost structure for the future.

So, now turn to slide 5.

Let me provide some perspective on our first half revenue performance by end market and by region.

This will help frame for you how we're looking at things heading into the second half of the year.

First, in industrial, our largest end market segment, we saw mid-single-digit organic growth in the first half.

On a sequential basis, industrial grew in the second quarter but not at the rate we had anticipated.

North America was generally in line with our expectations of mid-single-digit growth.

However, weakening macroeconomic conditions unfavorably impacted Europe.

We continue to see and expect resiliency out of our public utility market with flat year-over-year performance, despite lower revenues due to delayed capital projects in 2011.

I will remind you that we had a strong second quarter last year from our dewatering rental services which benefited from the heavy snowfall, a cold winter wet season, and severe flooding conditions in the US and Australia.

So, stepping back and considering the tough compare, I think of this as good performance given the budgetary pressures public utilities face in this environment.

This illustrates the mission-critical nature of the products and expertise we provide our customers, and the valued relationship we've built over many years of service.

As I've mentioned, we've had some good progress in our project business with our key wins in second quarter.

Unfortunately, the delay in these order bookings has pushed revenue recognition into 2013.

Our commercial business services business came through with low single-digit growth in the first half, certainly better than the flat markets in which we operate, but lower than our expectations.

During the first quarter, we saw healthy growth, particularly in the US and Asia-Pac regions.

The performance moderated in the second quarter, and Europe was down mid-single digits.

Residential was down low single-digits for the first half.

The US posted strong growth in the mid-single-digits following a tough first quarter which was unfavorably impacted by a warm winter.

Europe, on the other hand, continues to struggle while sequential revenues were up for the second quarter, year-over-year performance was down mid-single-digits.

Touching on ag.

We continue to see robust business in the US, given the drought conditions.

However, it's on top of already a very solid, good year in 2011.

Europe was challenged as you would expect.

On a regional basis, we have laid out for you on this slide all the major drivers.

I will just highlight a few.

The US saw the benefits of the industrial and residential growth, partly offset by the drought conditions and strong compares with the prior year in dewatering.

I will highlight that industrial dewatering applications continue to be robust in the first half.

Europe was down across most end markets with the exception being public utilities where we were flat year-over-year.

Emerging markets continue to drive top line growth, and we saw contributions across all regions during the first half.

We expect continued strength throughout the balance of the year.

Now, turn to slide 6.

Exiting the second quarter, it is clear we are faced with a weaker economic environment in Europe than originally anticipated, and some moderation in the US growth.

We expect significant foreign exchange headwinds to continue.

Despite volume challenges, we are confident that our performance in delivering solid productivity and strong execution will continue through the second half and beyond.

Although we will pay some investments, our disciplined approach is allowing us to continue to invest in our business while expanding operating margin and advancing our strategic position.

Simply put, our goal is to [maintain] our 2012 operating margin rate, as previously guided, despite the local projected revenues of approximately $150 million.

So, we are updating our full-year guidance and now expect our full-year EPS to be within the range of $1.72 to $1.82 per share, compared to previous guidance of $1.80 to $1.95.

This reduction reflects current macroeconomic conditions and end market dynamics, updated exchange rates, and continued productivity across all businesses.

Excluded from our guidance are restructuring and realignment costs estimated to be in the range of $15 million to $20 million in the second half of 2012.

We are taking aggressive cost actions targeted at reducing operating costs across our European operations and to align our Xylem business for flexibility given the lower levels of demand while strategically positioning the business for growth in a geographic region critically important to us.

These actions are similar to steps we took in 2008 to reposition our cost base, and as a result, we will have a more competitive business structure, and it will allow us to continue to lead within the global water industry.

Now, let me turn the call over to our CFO, Mike Speetzen, to walk through the detailed results.

Mike?

Thanks, Gretchen.

Please go to slide 7. In the second quarter, Xylem revenues were $966 million, reflecting 4% growth on a constant currency basis.

Organic revenue growth contributed 1 point to the total, and acquisitions added another 3 points of growth.

Foreign exchange was a headwind of 5 points.

Organic growth was driven by strength in the industrial and public utility end markets where we continue to see growth opportunities.

The US continued to show modest growth, and emerging markets were strong, up 22% on a constant currency basis.

Europe continued to present challenges given the worsening economic environment.

YSI had a strong quarter, adding 3 percentage points to our top line.

I think it's also important to note that YSI once again had double-digit organic growth and is not included in our organic growth performance articulated earlier.

Organic order rates were down 1%, and book-to-bill was one.

Orders were impacted by sluggish demand from Europe, coupled with tough compares to prior-year treatment orders.

Operating income, adjusted for one-time separation costs, increased 1% in the second quarter and was up 7% when adjusted for incremental standalone ramp-up costs incurred in Q2 of 2012.

Despite lower than expected organic revenue, second quarter operating margins came in at 14.8%, up 100 basis points excluding separation costs and the impact of standalone ramp-up costs.

Gross margin was 39.6% the second quarter, up 60 basis points versus the prior year as price, cost improvements, and YSI more than offset inflation and unfavorable mix.

By driving gross margin performance, we were able to continue to invest in our business while expanding operating margins.

Investments in the second quarter impacted operating margin by 30 basis points.

The impact of foreign exchange translation and transaction was neutral to the operating margin.

As the chart reflects, on an operating basis, we drove incremental margins up 36%, excluding standalone costs and foreign exchange.

I would add that this 36% incremental margin was achieved on modest organic volume growth and reflects additional investments to further our strategic execution.

These additional investments were a six point drag on our incremental margin.

Now, turn to slide 8.

This slide shows our EPS walk for the second quarter.

This is a transition year for Xylem, and as such, there are a lot of moving parts.

So, I want to spend some time this morning as we did on the last call, describing the components of our performance.

As the middle section of the chart depicts, we have adjusted both 2011 and 2012 EPS to a normalized basis to provide a clearer picture of how we performed operationally versus last year.

The walk starts with GAAP EPS for 2011 and ends with GAAP EPS for 2012.

In between, we make two sets of adjustments.

For the second quarter, on the left side of the chart, we increased 2011 GAAP EPS of $0.39 by $0.08 to show how 2011 would have looked had Xylem been a standalone Company with interest expense on debt and required independent Company costs.

We have also adjusted the number to exclude the 2011 impact of one-time separation costs and special tax items.

For the second quarter of 2012, on the right hand side of the chart, we adjust GAAP EPS of $0.48 by adding back the net negative impact of 2012 one-time separation costs and special tax items.

Making these adjustments puts both second quarters on a comparable, normalized basis to allow for a better view of operational performance.

This analysis shows that normalized EPS increased 4%, or $0.02.

I would also highlight that excluding the impact of foreign exchange translation, our core operations plus YSI less the tax rate differential drove a 13% increase in EPS.

Now, let me provide more details on each of our reporting segments.

Please turn to slide 9.

This slide shows the results of our Water Infrastructure segment.

For the second quarter, this segment reported revenue of $609 million, up 7% over prior-year on a constant currency basis and up 2% organically.

The YSI acquisition contributed 5 points to the top line growth, and foreign exchange was a six point headwind.

Transport grew 6% for the quarter, driven by the global industrial market and strong emerging market growth.

A significant portion of transport is driven by the public utility market, and here we continue to benefit from the stability that comes from a large install base and growing [tariffs].

Public utilities were up mid-single-digits in Q2, and industrial continued to demonstrate strength.

Drought conditions in the US and Australia negatively impacted our dewatering rental business.

Treatment declined, driven by the softening we saw in developed market project orders in 2011.

As a reminder, treatment orders for large projects slowed after the first quarter of 2011, and given the longer lead times associated with these projects, we are seeing the impact in our year-over-year revenue performance.

We're encouraged by the win rate we've seen in the second quarter for treatment projects.

Conditions appear to be improving, and we anticipate order growth to continue in the second half.

Test revenues were up significantly, driven by the inclusion of the YSI business acquired in Q3 of 2011.

Excluding YSI, the test application was down year-over-year, coming off a strong 2011 performance and reflecting weakness in Europe.

Second quarter operating margins came in at 16.1%, up 20 basis points from 2011 excluding the impact of standalone costs.

YSI contributed 50 basis points to the segment margin, highlighting the strong business that we've added to the portfolio.

In addition, our operational and customer excellence initiatives are more than offsetting the impacts of inflation and have provided flexibility to continue to invest in the business while expanding margins.

Our margins were, however, negatively impacted by the previously mentioned lower rental volume.

Let me now turn to slide number 10 and talk to our Applied Water segment.

Applied water's second quarter revenue was flat on a constant currency basis.

Building services was down 2%.

Commercial building services were down low to mid-single-digits, reflecting slow institutional demand for retrofits.

Residential building services were down low single-digits.

US performance was up mid-single-digits, more than offset by challenging economic conditions in Europe and continued instability in the Middle East region.

Industrial water was up 4%, driven by favorable general industrial market conditions and strength in our food and beverage applications.

And lastly, irrigation was down 4% against a difficult compare versus the second quarter of 2011.

US strength, reflecting strong demand given current weather conditions, was more than offset by weakness in other regions.

Second quarter operating margin came in at 14.4%, up 140 basis points from 2011, excluding standalone costs.

Price and productivity actions more than offset the impact of inflation and enabled continued investment in this segment.

Margins continue to improve sequentially as we execute on our cost reduction initiatives.

Now, let me turn to slide 11 and review our financial position.

Slide 11 reflects the key elements of our balance sheet and capital structure.

We generated $86 million in free cash flow year-to-date, a conversion on adjusted net income of 54%, reflecting typical seasonality for our business.

Our cash flow is down from Q2 of 2011 as anticipated, driven primarily by incremental interest payments of $26 million related to the debt put in place as a result of the spinoff from ITT.

In addition, we had incremental US federal and state tax payments in 2012.

As a reminder, the 2011 figures are a result of the carve-out financials provided in the Form 10 and reflected an allocated portion of US tax payments that were deemed a Xylem obligation for the purposes of the Form 10 statement.

Note that adjusting for these tax payments would bring the 2011 conversion in line with our current year performance and normal seasonal trend.

And lastly, we incurred additional cash outlays associated with costs to operate as a standalone Company.

As you can see from the slide, we also improved our working capital as a percent of revenue year-over-year.

As it relates to our capital structure, we ended Q2 in a strong position.

Our available cash on hand was $358 million, up from the first quarter of 2012.

We have a solid net debt to net capital ratio of 30%, and our credit metrics are in line with expectations and our credit ratings.

Our commercial paper and revolving credit facilities remain in place and continue to be unutilized.

Now, let me transition to slide 13 and talk through our guidance for 2012.

As Gretchen mentioned at the beginning of the call, we are revising our guidance down to reflect the impact of the current and anticipated economic environment.

Let me spend a few minutes walking through our assumptions and revised guidance.

Slide 13 reflects our revised view of the various end markets we serve.

As a reminder, we discussed our original end market projections on February 28.

We view the industrial end market performing in the low to mid-single-digits for the full year versus the previous assumption of mid-single-digits.

As Gretchen highlighted, industrial was strong in the first half, but we saw moderating growth in Q2.

We are assuming a slowing in this end market predicated on the current European market conditions as well as a slowing market in the US.

The revised outlook still assumes moderate sequential growth in the second half.

The public utility end market was previously projected to grow low single-digits.

We're now revising this to flat to low single-digits based on the delay in project order bookings.

This revised outlook still reflects modest second half sequential growth.

The commercial end market is now projected to grow low single-digits versus low to mid-single-digits given the lack of improvement in the underlying market.

We see this end market as flat to up slightly in the second half, driven primarily by energy-efficient solutions.

Lastly, we see the residential and agricultural end markets performing in line with our prior guidance.

The bottom line is that a weaker Europe economic environment and some level of moderating US conditions are driving our revised revenue outlook.

Our revised guidance assumes sequential organic growth in the second half.

On a year-over-year basis, our guidance assumes a second half organic growth of over 2% based on the end market dynamics and our seasonal profile.

Turn to slide 14 for a roll-forward of our guidance.

This chart illustrates the walk from our previous guidance midpoint for revenue and EPS to our revised guidance.

Our previous guidance was for $3.95 billion in revenue and EPS of $1.87.

Foreign exchange has become a substantial headwind, driven primarily by the continued weakening of the euro to the dollar.

Our guidance assumes a $1.22 exchange rate for the balance of the year versus the $1.31 assumed in our previous guidance.

The weakness experienced in the first half, coupled with the projected weaker euro in the second half, impacts revenue by $50 million and has a $0.03 negative impact to EPS.

The majority of this impacts the second half of the year.

We recently announced the acquisition of MJK Automation.

This acquisition will add approximately $6 million in revenue and will be $0.01 dilutive as acquisition costs and purchase accounting impact the first six months of ownership.

We expect that the acquisition will be accretive in 2013.

Lastly, the previous communicated end market weakness will impact the top line by approximately $105 million.

The effect of the lost margin on this revenue decline is approximately a $0.16 headwind to EPS, partially offset by approximately $0.10 of cost actions to mitigate the lost margin impact.

These net to a $0.06 impact to EPS.

Relative to previous guidance, our current outlook reflects a three point reduction in organic revenue, partially offset by cost saving initiatives which nets to a 3% decrease in EPS as illustrated on this slide.

Turn to slide 15 for more details on our revised guidance.

This slide provides all the relevant details for our revised guidance range.

I'd like to highlight a few key points.

We are now projecting a full-year organic revenue growth of 1% to 3% versus a prior 4% to 6%.

From a sequential perspective, we expect approximately 45% of Water Infrastructure second half revenue to come in in the third quarter.

And, we view Applied Water to be essentially evenly split between the two quarters.

We expect full-year segment margin in the range of 14.2% to 14.6%, up 20 basis points to 60 basis points over the prior year.

We're holding our operating margin range to our previous guidance -- flat to up 60 basis points over the prior year, despite slower organic growth and incremental standalone costs.

Excluding standalone costs, this represents a 90 basis point improvement year-over-year.

Our revised EPS guidance range is now $1.72 to $1.82 with the midpoint of $1.77.

As Gretchen mentioned earlier, we've taken initial steps to address the softening European economic environment and have initiated several restructuring and realignment actions.

We anticipate these charges in 2012 to be between $15 million and $20 million.

These actions will be substantially completed in 2012 with approximately $2 million of additional costs being incurred in 2013.

The run rate savings will be approximately $10 million beginning in 2013.

We anticipate less than $1 million of savings in 2012.

I would also add we are tracking to our one-time separation costs of $15 million to $20 million.

Please note that our EPS guidance does not include any impact from restructuring and realignment costs, one-time separation costs, and unannounced acquisitions and related costs.

Let me now turn the call back over to Gretchen to wrap up.

Thanks Mike.

Let's turn to slide 16.

There is no question today's economic conditions are volatile, but we have faced similar conditions in the past and we have successfully managed through them with strong focus and attention to the many levers that we control in our business.

In 2009, our business declined 9% on an organic basis.

Despite the external factors, we were able to hold our operating margin flat year-over-year.

Our demonstrated performance and our continued margin expansion are the result of several key drivers and management decisions.

These include a portfolio of businesses that have demonstrated resiliency during difficult times thanks to the large install base of leading products and critical customer applications and strong customer relationships.

A disciplined management approach, including proactive actions beginning in 2008 at the onset of the decline.

And, again this year, taking appropriate steps to position us in the future in the face of continued economic uncertainty.

In addition, we are aggressively managing our costs through our continued customer and operational excellence initiatives.

This has enabled us to continue to invest in our business, to capture growth as markets rebound, and to gain market share.

And, our acquisition strategy has led to higher than average profitability while expanding our market reach.

As the slide illustrates, based on our midpoint guidance, we expect to have expanded operating margin by 290 basis points since 2008.

Collectively, through the actions we control, we have shaped the Company into what it is today, and we are laying the path for Xylem's future -- a better positioned leader in the global water industry.

Now, turn to slide 17.

In summary, we had strong second quarter operating performance.

Our businesses' performance illustrates the stability of our portfolio in the face of challenging global economics backed by disciplined execution.

However, we're not immune to the environment, and we expect some headwinds during the second half of the year, particularly in Europe.

We are addressing the challenge head-on, taking action, and making strategic investments today that will drive future growth.

And, of course, our strong cash flow generation and financial position provides the flexibility to continue to execute our long-term strategy.

With that, we will be happy to take your questions.

Brandi?

(Operator Instructions) Ryan Connors with Janney Montgomery Scott.

Good morning.

Thanks for taking my call.

I'm just interested in exploring for a minute this issue of that you mentioned several times, bid activity continuing to increase while release of orders among your customers is disappointing.

Can you just expand on that a bit for us?

Your remarks imply that you think order release will ultimately follow.

So, I would be interested in your perspective on whether you've seen this kind of dynamic in the past?

And, if so, how that ultimately played out.

Ryan I would look at it first from a broad perspective.

We are seeing large issues around the water industry and public utilities and then having to pull back to be able to support their operating and maintenance activities.

A lot of activities around capital expenditures have been deferred or put off.

Though the activities are being planned so when they get the additional funding they're able to let them go.

This last fall, we didn't see much activity.

All through last year, our project activity was quite low, and so the stacking of projects in the queue has continued to come forward.

We've been doing a lot of activity around first quarter and second quarter in bidding.

They just have not been released as quickly.

We believe given the tariffs that continue to increase with the public utilities that they will be released as we go forward.

And, the other area that we've been focused on is trying to help the public utilities bring their operating costs down so they can free up money for capital expenditures.

Okay.

And then, to your knowledge, is there any correlation with project release around fiscal budget resets?

Most of your customers, I assume, are either June or September fiscal year so as those new budgets get set, is that when we start to see some of that money start to flow?

It varies, because if you look at US, you will see the June timeframe.

Some around, obviously, the government-type funding.

But, you also have many of them that are on a year-over-year especially when you look globally.

So, it does flow differently throughout the year.

We are planning on treatment and our activities continuing to pick up during the second half from an orders perspective, but given the length of the projects, you will typically see the revenue come into 2013.

Okay, great.

That's helpful.

One last one.

You mentioned that you took 170 basis points in price in the first half.

Obviously, that's a very impressive figure in this kind of environment, and I know you focus more on the value-added, technology-driven-type product lines, but do you feel like you are sacrificing share anywhere in the portfolio as a result of your stance on price in this tough environment?

Yes, it's a great question.

It's something that we try and stay very close to.

We feel really good about our strategic position in the market.

We're still having good growth, in general, when you strip away couple of the activities that I talked about.

On top of the very great growth in 2011.

So, we have individual market and regional and really project strategies that we deploy in a framework of an overall portfolio strategy.

So, I feel good about where we are.

We've put a good process in place that we review our wins and our losses, and then we make the appropriate adjustments as required.

Feel good that we're driving the right thing, and of course, we're driving profitable growth as we continue in the future.

Ryan, the only other thing I would add is, what you're seeing come through in the first half is also the product of the price actions that were taken in the second half of last year, primarily in our applied water segment where we saw pretty significant inflation.

Obviously, that will moderate a bit because the compares become a little more difficult in the second half, but that also plays into it in terms of similar dynamics that we saw play out across the broader market.

Very helpful.

Thanks for your time.

Thank you.

Deane Dray with Citi Research.

Thank you.

Good morning, everyone.

Good morning, Dean.

I wanted to first start with Mike.

If you could just give us an update about the expectation of separation costs?

How those may taper off during the course of the year.

What are the big components of that?

If you would start there, please.

Let's talk -- pardon me, one-time separation costs.

So, we had indicated that we would have $15 million to $20 million.

We've incurred about $10 million through the first half.

As we've indicated in the past, we see that being -- tapering off really in the fourth quarter.

I would look at Q1, Q2, and Q3 being at that same level, and it's really as we finalized legal aspects as well as any of the branding, signage of the Company, and those types of activities.

And, there is some IT work that has to go into that.

We've got a pretty disciplined process around that.

Not a lot of concerns relative to the range that we've put out there on that particular bucket.

From a standalone cost perspective, we've indicated $25 million to $30 million.

We're holding to that range.

We've, obviously, as you can see in our results, did take some actions relative to our corporate cost structure in the second quarter in light of the current economic environment.

But, we don't see that impacting the incremental standalone costs.

As I've indicated in the past, there is a good chunk of these cost that really relate to IT infrastructure that we had to put in place and some of the incremental costs that were added.

Not only at corporate, but also within our business segments.

Again, we have a good line of sight to that, and we feel pretty comfortable that we will but right in the range on those.

Great, that's real helpful.

I should have prefaced my comments with the fact that these slides that you're providing and the bridge and the individual business line commentary is really helpful.

Next question is, to go into the businesses with the impact of the drought.

Obviously, from the dewatering side, there are some positives that I would expect.

You mentioned ag and some of the irrigation, but also has there been much impact to weigh on the well business.

Any time you've got drought and water tables get lower, there's problems with wells.

Any time you open up a well, you usually put a new pump into it.

So, just give us some of the puts and takes that are drought-related on your businesses?

Sure, Deane.

Just in terms of the other businesses that you see upside -- as you mentioned, agriculture is obviously an area when we look at our [TTO] business with vertical turbines and so forth.

Great business during a time of a drought helping the farmers continue to grow.

As I look at US -- North America -- we're up 5% in our residential markets.

So, we feel good about where we are.

You also have, as you mentioned, the well pumps.

They're working harder.

You see water levels drop, and so you have the opportunity for a replacement.

So, we feel good again where we are with that position and continue to grow that.

Coming back to your dewatering question, the one thing I would just bring up is -- yes, it was impacted by the drought, but our dewatering model in itself supports many other end markets.

So, where we're continuing to help in mining.

We're still helping with public utility bypass in other areas.

Still a very robust business and a great opportunity where you have similar equipment that can be used in many different applications.

Great.

Just last question for me.

It's a related question to the MJK acquisition.

The idea that there is still a lot of fragmentation to the analytics market?

And, maybe you can give us a sense of a roadmap of how you would like to build out this segment?

Just in terms of priorities.

Is it geography?

Is it adding more technology?

Is it broadening the line of contaminants that you want to test for, and maybe it's all of the above.

But, just the roadmap for the build-out and maybe a sense of the pipeline today?

Yes, Dean.

I'd say you laid it out very nicely.

Those are all the areas that we're looking at.

In terms of our healthy backlog of candidates, we feel like we've got a healthy deal pipeline, and we're working that very aggressively.

The bolt-on strategy has worked for us, and we think that is a nice way to continue to expand as well as invest back into the organic platform that we're continuing to build.

So, geographic, technology, and clearly regional areas are going to help us or channel into the market with these areas we continue to expand in.

That's real helpful.

Thank you.

Thank you.

Matt Summerville with KeyBanc.

Good morning.

Couple of questions.

First, I apologize if you gave this, but what was the EPS hit from FX in the second quarter?

And, what is the expectation for the full year relative to your prior estimate?

The foreign exchange impact in the second quarter was $0.04.

And then, we are talking relative to the guidance range, $0.03 year-over-year in terms of the change in guidance.

That's on $50 million of revenue.

Matt, really where that's coming from is although we've seen some of the currencies that make up our basket come down, the biggest impact has been in the euro.

It has moved down about 7%.

We had given previous guidance $1.31.

It's now at $1.22.

If you think back to some of the framework we put in place in the past where we'd talk about a 10% move in the euro, yield is about a 3% to 4% move in the top line.

You can ratio that down, and it gets you pretty close to the movement you are seeing right now.

Got it.

And then, can you -- is there a way to quantify the magnitude of push-out you've seen on the project side of the business into 2013?

Trying to help you -- clearly on the treatment area, we've seen a significant push into next year.

We're anticipating our treatment business to be down for the rest of the year.

Continuing to get orders and continue to get book-to-build shipping, but we will see a large portion of our treatment business falling into next year.

Matt, when you think about the guidance we initially gave for public utilities, we had guided that they would be in the low single-digits.

We're now saying flat to low.

That change in guidance is been primarily driven by the fact that the anticipated order bookings that we were planning for coming out of last year didn't materialize, and so that push has essentially moved that range from low single digits to that flat to low.

(Multiple speakers) Matt, in terms of public utility treatment, we're also trying to take, as I mentioned, our treatment technology into industrial, and we've seen some very nice orders and wins there.

Again, some will be pushed into 2013.

There will be some that obviously play into 2012.

But, given the length of time, typically a 2013-type revenue recognition.

All other variables held constant, what is your view on Xylem's raw material input costs in the second half of the year versus what you experienced in the first half?

Yes, at this point, we are planning to be essentially flat, meaning about 3% inflation in the second half.

At this point, we felt it was better to plan for a higher level of inflation -- both in our cost actions as well as our cost structure.

And, if that ends up playing to the benefit then we will obviously have that as an opportunity.

The thing that I would also note is our susceptibility to the current period fluctuations is -- I won't say that we are not -- but, it's minimized by the fact that we tend to put ourselves on long-term supply agreements which essentially dampened some of that volatility.

Our direct exposure to commodities is relatively small.

And so, some of that is going to be taken out of the equation.

But, we've obviously planned conservatively, and we will look for any opportunities to improve that as we can.

Thanks.

David Rose with Wedbush Securities.

Good morning.

Real quick ones.

If you could, can you reconcile the difference between the slides showing emerging market growth in constant currency for the second quarter at 20% and for the first half at 11%?

Is the implication that it accelerated in Q2 significantly?

Our emerging market -- let me address that.

Our emerging market growth -- what we've seen nice growth in the first half, and we continue to see that sequentially growing as we go through the second half of the year.

Maybe I can back up Gretchen -- on page five, you show organic growth versus prior year of 11%.

And, on page four, it shows emerging market growth of 22%.

Both in constant currency.

It implies a meaningful step up in the second quarter versus the first quarter.

Yes, that's true.

We had about 17% growth in the second quarter in our emerging markets.

We've got a couple of big projects that we've won in India, and a few others that shifted into the second half of the year.

And, we've had nice order-taking and good business execution in our emerging markets strategy.

Think about this.

We announced that we positioned ourselves in Russia.

Our organization is up and running, and we have got an opportunity to continue to grow there.

We've put a very focused strategy around our emerging market activity, and so as we are expecting sequential growth from first half to second half, we believe we've got good line of sight with from some of our projects that we will ship as well as what we need to do and execute in our end markets.

Okay, that's helpful.

And then, this is probably going to sound (inaudible) question.

You discussed -- we had all discussed at one point in time pricing swap.

How much of the pricing swap do you think you still have in terms of your powder for the second half?

I think I recall there was maybe a 200 basis point movement in pricing swap.

You took advantage of some of that in the second quarter.

How much is left in the back half?

When you think about it, we talked about 170 basis points for the first half.

I'll still go back to what we have set -- our goal is one to points a year, and we're driving that aggressively.

You're going to see a couple dynamics in the second half of the year.

One, we drove very aggressive pricing last fall so you're going to have some tougher compares to where we were at the first half, and we've been at it for a while.

So, the team is getting very disciplined about the approach.

The other area is, it is a tougher markets where you are going to have market pressures in the second half, and so we've accounted for that as we look through the second half of the year.

Our next question is coming from Chip Moore with Canaccord Genuity.

I was wondering if you could take us back to the financial crisis in '08?

What you saw in Europe then, and how that compares to some of the trends you are seeing now?

In 2008, when the onset, you saw the primarily focus was in the US at that point in time.

Europe came much later -- I would say at the end of 2009.

I would say we are -- where we are seeing the issues in Europe, and I think it's important to really focus where Europe is.

It has been driven primarily by southern part of Europe.

We are still seeing strength substantially in the Nordic regions.

We're seeing strength in the UK.

We're still holding our own in Germany.

So, it really has been more of a southern Europe exposure.

Now, coming through the second quarter, we did see some volatility across Europe which had us concerned.

It's the reason why we have re-forecasted our forecast for the rest of the year.

But, it's not the same dynamics as what we saw in the 2009 time frame.

But there's a lot of volatility, and we want to be prepared appropriately.

And, that's why we're taking aggressive steps.

Chip, I think the way I would think about it is -- in 2008 to 2009, we were coming off some market highs specifically around commercial and the CapEx side of public utilities.

And since then, those markets really have not had a significant improvement.

We've seen gains in areas like retrofits and specific projects, and so what we're really seeing is more of a moderating environment which I think is consistent with how we've articulated versus a dramatic falloff in terms of what we saw back in that '08-'09 time period.

I guess I'd add one more thing is, the public utility business has been stable, and what we're seeing is you saw industrial, you saw ag, you saw the rest of the industry going up.

You are seeing that now start to slow back down but still stability in the public utilities across the board with the exception of southern Europe.

Maybe just one follow-up.

In terms of the reduction in revenue -- the $105 million, market--related.

Can you give us a sense of how much of that is European-related?

Here's the way to think about the full picture.

We had been anticipating the US to be in the mid-single-digits.

We're now projecting it in the low single-digits.

We had expected some level of European growth from a full-year standpoint, and we are now assuming Europe will essentially be flat.

And, we really haven't moderated the emerging market growth that we had assumed.

So, it's -- I'd say more heavily weighted toward a European reduction than is the US, but we are seeing moderation in both those markets.

Great.

Thanks.

Terry Darling with Goldman Sachs.

Thanks.

Maybe just a follow-up on that last comment, Mike.

Why would Europe get better in the back half relative to the slight decline in the first half?

What are you seeing in there?

Couple of things.

One, we do see some of the typical seasonality that has held up over the past several years especially coming out of the vacation season that we will see in August.

A couple other components.

One, the public utility side tends to ramp.

They're on a different fiscal calendar So, you can obviously read into that in terms of some of the dynamics that play out as you get into the back half of the year.

And then, our analytical instrumentation business was down heavily at the end of last year.

That has, obviously, moderated, and we see that continuing to improve sequentially.

That will also fuel some of the growth.

And then, we've obviously got a good presence in Eastern Europe, and we will see that to continue to be an opportunity for growth.

Okay, that's the Russia piece in particular, then?

Yes.

Okay.

And then, on emerging market, what is the assumption on the full year now that is unchanged?

We are essentially looking at approximately 10% growth coming out of the emerging markets.

Okay, so similar second half to first half.

Very similar

You have had very strong growth there.

I'm just wondering in China in particular, are people looking for any signs that some of the stimulus in places like Changsha and others will help the industrial sector.

Are you seeing anything there from a bid perspective in China that gives you optimism that maybe China gets better in the second half?

Yes, we've actually seen our bid activity in China pretty well.

If you think about their twelfth five-year plan, it's around waste water, and our teams the been aggressively working, not only the large cities, but moving westward and trying to capture the growth there.

We've got a disciplined approach.

I think we will continue to see some nice execution from our China team.

Gretchen, can you remind us -- China as a percentage of total revenues -- 3% to 5%?

Something in that range?

(Inaudible)

That range.

Okay.

Then, on the restructuring efforts, couple questions there.

First, any breakdown of the $15 million to $20 million between infrastructure and applied for us?

In terms of the details of it -- I do want to get into the details here.

It's too early to do that, but we've got detailed plans.

It's spread across both of our segments, and it's really going to position us appropriately for what we're seeing in terms of volume.

But also, strategically to position us as we come together as a Xylem team to maximize our penetration in the market based upon our strategic objectives going forward.

Gretchen, does the -- obviously, the step-up in restructuring view that Europe probably stays a little weaker for longer implicit in that.

I'm wondering from the way you are thinking about the portfolio, is there any change in your thinking on potential divestitures within the context of the changed landscape?

Yes, we've looked at Europe in terms of it's going to be volatile for some period of time so we are thinking through that as we make these decisions.

We still think Europe is a critically important region for us.

And, we don't want to lose that focus on our customers and our ability to continue to invest for the long-term growth.

So, feel very good about what we need to do, but we need to right-size, both from the economy as well as strategically position ourselves so we can execute our strategy.

In terms of our portfolio, and you look at our fundamental business of our Xylem -- solid business, solid set of portfolio pipeline, product lines, and businesses.

I feel very confident what we have.

Our strategy more is in acquiring and continue to bolt on to our business and continue to run our foundation even more effectively.

Then just lastly, in the $0.10 of cost -- from cost saving actions in the new guide that is above and beyond the restructuring program -- just the paced investment comment.

Can you add some color there?

Where are you pacing those investments?

Is R&D in the mix there?

Is it feet on the street in emerging markets?

Where are you pacing the investments incrementally there?

We're doing a couple things.

Obviously, our first focus is really around discretionary cost reductions and running our business more effectively like we've been doing over the last several years.

We will look at pacing some of the investments.

One, when we do that we look at what is happening in the economy and are there some end markets where we're going to be launching certain activities that we ultimately should be slowing down based upon the execution.

So, it's really aligning it based upon the strategy that we have which we are still advancing but aligning that geographically based upon where we have the growth.

So, pulling back a little bit, but it's not stopping our growth strategy.

Terry, we're heavily focused probably more on the discretionary side.

You saw it come through in the second quarter.

And, pulling the levers where we're clearly not jeopardizing the stewardship of the Company, but that we have opportunities to defer or cancel out cost levels within the business to preserve the investments.

And then, really going after the restructuring is a way to make sure that we're in a good position heading into next year to preserve our ability to continue that investment level in the business.

Maybe just clarify Mike, on the free cash flow for the year -- 95% excluding one-time separation costs.

Just make sure we're on the same page there.

$290 million to $300 million is implied by that?

Have I got that about right?

It's in that range.

Thanks very much.

Thank you.

Kevin Maczka with BB&T Markets.

Good morning.

Good morning.

Just to clarify on the cost savings, that $0.10.

That is not coming from the new or accelerated restructuring?

But, those savings from that program will be more achieved in 2013?

Is that correct?

Correct.

Can you just repeat, what is the savings do you expect from that in 2013?

Yes, you bet.

We are going to have $15 million to $20 million of cost this year.

There will be an additional $2 million next year.

The run rate savings that we will achieve will be about $10 million.

Starting in 2013.

Got it.

Would you characterize this more as somewhat new -- defensive, if you will, move in reaction to something you saw in Q2 and expect in the back half?

Or, is this more something that we plan to do all along anyway, and we're just accelerating it now because maybe we don't quite have the volume in certain areas that we thought we would?

I'd say it's more proactive steps that we are taking to position us for some of the unknown in terms of the market that we see, but also as we think about ourselves strategically and how best to position in a geographic region.

Okay, and last from me -- one more quick one on pricing.

Where are you in the rollout of your initiatives there as it relates to rolling this out enterprise-wide to your sales force?

I'd say roughly we're about 70% deployed across the organization.

Our plan was to complete about 80% this year.

We are slightly ahead.

So, it's pretty much deployed throughout the leadership teams and very specifically across end market by end markets.

The teams are really driving it at a much more aggressive way than we had in the past.

I feel good about our process.

Got it.

Thank you.

Thank you.

Michael Roomberg with Ladenburg Thalmann.

Good morning.

I have a quick question for you on branding.

Can you refresh us on the extent to which you have or are planning to incorporate the Xylem brand across your platform?

And them, related to that, talk a bit about how you strike the right balance between leveraging the cross-selling opportunities of Xylem -- the umbrella of Xylem versus ensuring the customers can maintain their previous perceptions or loyalties to the brand they've grown accustomed to over many years?

Great question.

You look at Xylem -- brand-new Company, and we need to build our brand as a Company.

And, that's extremely important for people to know who we are, and we as a team of 12,500 employees come together as an organization with a common focused around water.

Our legacy brands are very strong.

Many of them have been in the market for over 150 years and have a very strong relationship with our customers and the end markets in which they serve.

I think of it like a house of brands.

Now, in that, we clearly will have some brands that we can send you to eliminate and really go after our strong brands.

So, when we go into different regions, just like I talked in our last earnings call was, we are taking products out of [Rvaypayvay] which is over in Europe in our analytics business, and we're bringing them into the US under our YSI brand because that makes some sense.

So, they will be cross-branding, maintaining those strong legacy brands, all under the house of Xylem.

Got it.

So, you are not looking necessarily to transform any of your existing brands into a new Xylem brand for instance?

Not at this point.

Okay.

Thank you.

Thank you.

Jim Krapfel with MorningStar.

Good morning.

Is your longer term margin and revenue goal target some place?

That being 14.5%, 15.5% on margin in 2015?

And then, water, up mid-single-digit organically, and applied water up low to mid-single-digit organically?

Yes.

Okay.

Our long-term strategy hasn't changed.

We still see we have got opportunity in our business to continue to get more leverage, more productivity, and we can -- and, as we think about deploying new products and new markets that we go into -- more attractive, more opportunity for profitable growth.

Okay, and then you talked briefly about your acquisition pipeline looks pretty good.

Would you see anything in the pipeline that maybe you do to the size of what you did with YSI -- $300 million acquisition costs?

Or, is this more smaller, bolt-on-type acquisitions?

We've got a healthy pipeline of opportunities.

Many of them focused around the bolt-on, but we've got some sizable of -- the size of YSI.

We look at the full industry, and we will make the decisions based around strategic, obviously, culture, how it fits, and then, final line being the financials -- and does it make sense for the business.

So, that strategy hasn't changed.

I would say though primarily bolt-on, but we are looking across the whole industry for the right strategic alignment.

The strategic focus would be on companies with more emerging market exposure and healthy margin levels?

Is that the idea there?

You go back to our growth platforms being dewatering and analytics.

That's clearly important to us, but emerging market is important.

Continuing to expand our technology.

And, as well, as channels that allow us to position ourselves in expanding areas.

So, when you think about products in the portfolio, we think of gross margin and how we can improve our gross margin so that aligns with our strategy as we go forward.

Okay, thank you.

Our final question is from Stewart Scharf with S&P Capital.

Thank you.

Good morning.

Good morning

On your long-term projections, are you pretty much over the next two years sticking with your long-term growth -- organic growth of say 4% to 6% and operating margins in the 14.5% range.

With 50 basis points to 75 basis points annually?

I'm sorry?

(Multiple speakers) I'm sorry.

Go ahead.

I interrupted you

Do you see that basically transpiring?

Over the next three or four years?

Our long-term growth strategy has not changed, and the goals that you outlined there are the same.

We see that continuing to play the actions that we are investing in.

Our core business as well as the acquisitions that we have pursued drive us in that direction.

And so, that stays the same, and we see ourselves on the right path.

Some economic headwinds that we are seeing right now, but nothing is taking our eye off the ball on achieving those.

Okay, and targeting around $300 million a year in acquisitions.

Would that basically mean that you are done for the year?

And, you are looking more toward '13 now?

For any acquisitions?

Yes, we've got a very active pipeline.

We're continuing to look at it, and we're not going to force something to happen.

We are going to be disciplined as we have been because that works for us.

Our processes [have] really demonstrated that is the right direction to go in because we're getting profitability out of our acquisitions that we've done, to date.

So, we've got the capability to spend $300 million, but it will be paced based upon strategic and opportunity at the right time.

Okay.

Thanks a lot.

Let me close with just a couple of comments.

Our business operations continue to perform even with the lower anticipated revenues.

We feel great about gaining share in the emerging markets.

We are introducing new products and services.

We're expanding our position in our dewatering and analytics businesses while we're continuing to advance our strategic and our acquisition strategy.

And, we're also -- as we talked about -- taking proactive actions to reposition ourselves given the uncertainty in Europe at this point in time.

We're focused on good earnings and a strong, solid cash flow, and so we feel good that our business is performing now that we're nine months as an independent Company.

So, feel good about the direction that we're headed in and the growth opportunities that are in front of us.

I want to thank you for your interest and the time this morning.

Thank you.

This does conclude today's Xylem second quarter 2012 earnings conference call.

Please disconnect your lines at this time, and have a wonderful day.