賽莱默 (XYL) 2012 Q3 法說會逐字稿

Welcome to the Xylem third-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 SVP and Chief Financial Officer.

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

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

(Operator Instructions)

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

You may begin.

Thank you, Brandy, good morning, everyone, and welcome to Xylem's third-quarter 2012 earnings conference call.

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

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

Following their prepared remarks, they will address questions related to information covered on the call.

I will ask that you please keep to one question and return to the queue so that we will have enough time to address everyone on the call.

We anticipate that today's call will last approximately one hour.

As a reminder, this call and our webcast are accompanied by a slide presentation available on the investor section of our website at www.xyleminc.com.

All references today will be on an adjusted basis unless otherwise indicated.

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

A replay of today's call will be available until Thursday, November 15 at 6.00 PM.

Please note the replay number is 404-537-3406 and the confirmation code is 34764853.

Additionally, the call will be available for playback from the investor section of our website under the heading presentations.

With that said, 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 that's filed with the SEC.

These remarks constitute forward-looking statements for purposes of the Safe Harbor Provision.

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

Now please turn to slide 3 and I'll turn the call over to our CEO, Gretchen McClain

Thank you, Phil.

Good morning, everyone, and thank you for joining the call, we appreciate your interest in Xylem.

Today is a special day for us as it marks our one-year anniversary as a separately traded public Company.

As we are getting ready to celebrate this week, Hurricane Sandy hit the East Coast leaving a path of devastation behind.

I'm sure many of you and your families have been affected, as many of our Xylem employees have been, so please know that our thoughts are with you.

I'm always reminded in the aftermath of crisis situations such as this of the importance of the work we do.

In many of the areas where flooding is a huge issue, Xylem is there with our equipment and with our expertise helping to bring things back to normal as quickly as possible.

As I reflect back over the past year and on our accomplishments, I'm proud of our team and how we've come together, staying focused on our customers, advancing our strategic initiatives all while standing up a new Company, and in the face of some very difficult economic headwinds.

This has been a challenging year by any standards but a satisfying one as well.

The team has sharpened its execution, tightened spending and continues to drive cost reductions to navigate through these challenging times, and as a result, our business operations continue to improve even with lower than anticipated revenues.

But our journey has just begun.

We are laying the path for growth with investments to provide customers with new products, services and solutions they're looking for.

We're investing to expand geographically so we can reach our entire servable market and realize our full market share potential.

And we are continuing to expand our portfolio with our disciplined acquisition process, and today I'll highlight our latest addition, Heartland Pump.

So special thanks goes out to our 12,500 Xylem employees around the world that are dedicated to this business and are driving Xylem forward with long-term goals in mind.

Now I'd like to walk you through our third-quarter results.

Our team delivered another solid quarter of operating performance.

Today we're reporting third-quarter revenue of $931 million, reflecting growth of 3% on a constant currency basis.

Organic growth was 1% with acquisitions adding another 2%.

Revenue in Europe grew modestly despite underlying market weakness.

For the third quarter organic revenue in Europe were up 1% year over year.

Exiting the second quarter, we highlighted our expectation that US growth would moderate during the second half.

In the third quarter, US organic revenue declined 3% relative to a strong prior-year performance where we posted revenue growth of 20% and organic revenue growth of 9%.

This was driven by slowing industrial markets and continued drought conditions.

Emerging markets continue to drive growth, up 9% on a constant currency basis driven by strength in the Asia/Pacific and Latin America region.

Our continued focus on acquisition-- attractive acquisitions is helping us drive top line growth adding 2% during the quarter.

It's important to note that in September we celebrated our one-year anniversary of the YSI acquisition, and as a result for the quarter, those revenues for the month of September are now included in our organic performance.

We received orders of $882 million, down 5% in constant currency resulting in a book-to-bill ratio of 0.95.

Under normal market conditions, we would have expected a book-to-bill ratio of approximately 1.0 for the overall business.

This puts pressure on the top line leading into what historically has been the strongest quarter of the year.

When I look at the project funnel, I remain cautiously optimistic that orders will be released.

Good activity for capital projects has continued to increase but the release of orders still remains much slower than anticipated.

A key focus for us has been margin expansion, despite the lower demand, we continue to reach higher levels of profitability.

You may recall from our investor day last fall, we had set a long-term target of growth margins of greater than 40%.

We've made significant progress towards this goal in 2012 including 130 basis improvement for the third quarter compared to prior year and surpassing the 40% mark for the first time.

Operating margin was 12.9%.

Excluding the impact of stand alone cost, operating margin was up 50 basis points.

Earnings per share were $0.44.

Core operations in YSI performance drove earnings up $0.02 but were offset by foreign exchange and higher operating tax rates.

Overall, our operating performance was solid particular in light of the market dynamics around the world.

Please turn to slide 4. Let me provide you an update on the business and the progress we've made on our strategic initiatives.

We continue our focus on acquiring businesses that fit with our strategic objectives for growth and make strong additions to our portfolio.

During the third quarter, we announced the acquisition of MJK and we've been successfully integrating the business into our analytical instrumentation platform.

We're still in the early stages, but I'm very pleased with our progress.

Just last Friday, we announced the acquisition of Heartland Pumps, a perfect fit for Xylem as it expands the geographic reach of our dewatering platform.

These acquisitions and those that we completed over the last few years have positioned us in two very attractive areas namely dewatering and analytics.

Before I move on to highlight some of our latest product launches, I'd like to recognize that during the third quarter Xylem was selected to the Dow Jones Sustainability Global Index where we were 1 of 340 companies selected out of 2500 applicants and we're also included in the North America index.

An important step in a long journey to demonstrate Xylem's focus on sustainable solutions in our business and in the communities we live.

We continue to make great progress in deploying innovative new product applications and services that differentiate Xylem in the marketplace.

Earlier this quarter, at the WebTech Trade Conference, we launched our Sanitaire Bioloop Oxidation Ditch into the US market.

Globally this is roughly $1 billion market.

Importantly, in the time of limited CapEx spend -- expenditures by the public utilities, this offering is targeted to retrofit the significant number of aging oxidation ditch treatment plant around the globe, requiring energy-efficient solutions to address needed repairs, higher affluent standards and population growth.

Bioloop's extended aeration process effectively removes nitrogen and total phosphorus, but more importantly, by combining our aeration and mixing expertise with our controls technology, the Sanitaire Bioloop can deliver energy savings of more than 50% providing us with a clear competitive advantage.

I'm happy to report that this product has captured the market's attention and we received our first order from the City of Liberty, Kentucky.

In Europe, we launched our Energy-Efficient Lowara Ecocirc in advance of the EU new Ecodesign Directive which mandates certain energy efficiency standards for the region beginning on January 1, 2013.

Ecocirc not only meets the 2013 standard, but also the more stringent energy efficiency standard set forth by the directives for 2015.

Our year-to-date sales for this product line are up 13%.

Lastly, I'd like to quickly highlight that our FLOJET business has been recognized by the Coca-Cola Company as supplier of the year.

The recognition stems from all of our team has done in terms of strategic execution, product innovation and customer intimacy.

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

For example, growing industries and the need for water and waste water infrastructure are driving year-to-date organic growth rates of 20% in the Latin America and Asia/Pacific regions respectively.

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

Progress continues against our key of priorities as evidenced by our growth and operating margin expansion.

Through operational excellence initiatives, we were driving factory efficiencies, lowering production costs and improving on customer satisfaction.

For example, continued progress improvement have significantly increased our on time delivery at our Auburn and Dallas manufacturing sites this year.

Our global supplying-- our global sourcing supply team has increased our efforts in low cost countries where we currently have over 100 parts under development to lower our product costs.

These projects are focused on expanding and improving the quality of our emerging market supplier base for future growth in the region and globally.

Finally, we recently completed a project to reduce packaging costs and as a result, we have decreased the consumption of wood by 36 tons at our Buffalo facility.

This is one example of the many projects our teams are working daily to reduce costs and implement sustainable solutions throughout Xylem.

On the front end of our business, the processes and disciplines we have implemented around pricing through our customer excellence program continues to pay off.

We're delivering strong price realization in our results, approximately 1.5% during the quarter after delivering 1.7% in the first half of the year.

And in order to better position us for growth in 2013, we're executing on the restructuring and realignment actions we mentioned during last quarter's call.

Turning to slide 5. Last Friday we announced the $29 million acquisition of privately held Heartland Pump rentals and sales with 2011 revenues of $33 million.

This acquisition is consistent with our strategy to expand our dewatering business globally, including in the United States and provides the additional opportunities to leverage our portfolio.

With 40% of revenue coming from rental equipment and services, we further enhance our position in attractive profitable space.

With our dewatering platform now over $600 million, this acquisition will benefit from scale advantages around cost and CapEx.

Similar to Godwin, Heartland serves a wide range of customers including industrial, public utilities and agencies addressing disaster recovery situations.

Turning to slide 6. Before we look ahead to the fourth quarter, let's take a quick look back and review our performance on a year-to-date basis.

Orders of $2.9 billion have slightly outpaced revenue of $2.8 billion.

Revenue has increased 4% on a constant currency basis.

Gross margin was 39.7%, up 110 basis points over the prior year.

Operating margin was 12.7%, up 60 basis points versus the prior year after adjusting for stand alone costs.

To put this in perspective, our year-to-date operating margin of 12.7% is the same as where we ended 2011 after absorbing $26 million of stand alone costs as an independent Company.

And finally, we reported EPS of $1.29 and generated $171 million of free cash flow.

Turning to slide 7. Looking ahead, I'm confident we're taking the appropriate actions and have the plans in place to position Xylem for growth in 2013.

Because we've not seen any significant signs of turnaround in the marketplace, we've accelerated additional restructuring and realignment actions and now expect to be at high end of our previous range, approximately $20 million in 2012.

In addition, we are focused on integrating MJK and Heartland quickly and effectively into our portfolio while continuing to deploy capital in the disciplined and thoughtful fashion we have demonstrated thus far, an approached focus on delivering sustainable long-term returns on investment for our shareholders.

So from a full-year perspective, we still expect to deliver revenues of $3.8 billion reflecting 1% organic growth, the low end of our previous guidance.

Despite volume challenges, we will deliver solid operating performance with margins in the range of 12.7% to 12.9%.

And we expect EPS in the range of $1.72 to $1.79, a midpoint of $1.76 including the $0.01 dilutive impact of Heartland.

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 8. In the third quarter, Xylem revenues were $931 million reflecting 3% growth on a constant currency basis.

Organic revenue growth contributed 1 point to the total and acquisitions added another 2 points of growth.

Foreign exchange translation was a headwind with 4 points.

Let me provide you with some perspective of our third-quarter revenue performance and how we see the remainder of the year by end market and by region.

First in our largest end market segment, industrial, organic revenue was down slightly year over year versus expectations of low single-digit growth.

The North American region continues to be negatively impacted by dry weather conditions versus the prior-year period which had seen double-digit growth in dewatering activities.

European industrial market weakness continues for the second consecutive quarter.

These results were partially offset by strength in mining, particularly in Latin America and South Africa.

On a sequential basis, industrial declined low-single digits in the third quarter driven by weakness in North America and Europe versus our previous expectation that these regions would be relatively flat.

We now expect full-year organic revenues for industrial from flat to up low-single digits year over year.

This range assumes fourth-quarter revenues will be down low-single digits.

We continue to see and expect resiliency out of the public utility market.

Third-quarter revenue was up high-single digits with growth coming across most regions but generally in line with expectation and flat on a sequential basis.

We expect second half 2012 revenue to be up low-to mid-single digits over the prior year.

The timing of deliveries favorably impacted our third-quarter performance and we expect fourth-quarter revenue results to be down as a result of project deliveries in 2011.

While bidding activity continues to improve, we continue to see capital expenditure delays.

Based on the order activity we've seen this year and the strong fourth-quarter performance in 2011, we expect fourth-quarter organic revenue to be down low-single digits.

For the full year, we anticipate public utility revenues to be flat to up low-single digits compared to the prior year.

Commercial building services were down high-single digits reflecting challenging market conditions in Europe, a sluggish recovery in the US and a tough prior-year comparison when we delivered 9% global organic growth.

We expect the commercial market will continue to be challenged and project full-year performance to be flat to down low-single digits.

This assumes low-single digit growth in the fourth quarter.

Residential was down low-single digits in the third quarter compared to a very strong third quarter 2011 where we saw double-digit organic growth in the US.

As we look forward to the fourth quarter, we expect low single-digit growth in the US and double-digit growth in Europe driven by high energy-efficient circulator demand.

Overall, we now expect residential revenue to be flat to down slightly for the full year.

As for agriculture, we were up high-single digits for the third quarter driven by better than expected results out of the US given continued drought conditions.

Overall, we expect full-year agriculture to be up low-single digits.

Let me spend a few minutes on our overall geographic performance.

The US was down 3% on an organic basis, up 1% year to date.

As a result, we expect flat year-over-year organic performance for the full year.

Europe was up 1% for the third quarter and is now flat year to date.

We also expect full-year organic performance to be flat in this region.

Emerging markets continue to drive top line growth, up 6% for the third quarter with double-digit growth coming from both Latin America and Asia/Pacific regions.

Year-to-date emerging market revenue growth is 9%.

We were now projecting full-year organic growth to be up high-single digits.

Organic order rates were down approximately 7% and book-to-bill was 0.95.

Orders were down year over year reflecting large project order delays, drought conditions driving lower demand for dewatering applications and continued softness in the US commercial market.

Adjusted operating income was up 2% when adjusted for incremental stand alone ramp up costs incurred in Q3 of 2012.

Despite lower than expected organic revenue, third-quarter operating margins came in at 12.9%, up 50 basis points after adjusting for the impact of stand alone costs.

Gross margin was 40.2% for the third quarter, up 130 basis points versus the prior year as price and cost improvements more than offset inflation and unfavorable mix.

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

Investments in the third quarter impacted operating margins by 40 basis points.

For this quarter, our value GAAP, measured as our operating margin contribution from price versus material cost inflation, was positive adding 60 basis points.

And the impact of foreign exchange translation and transaction negatively impacted operating margins by 60 basis points.

Please turn to slide 9. This slide shows our EPS walk for the third 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 have on previous calls, describing the components of our performance.

As the middle section of the chart depicts, we've 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 third quarter, on the left side of the chart, we increased 2011 GAAP EPS of $0.42 by $0.03 to show how 2011 would have looked had Xylem been a stand alone Company with interest expense on debt and required independent Company costs.

We have also adjusted the numbers to exclude the 2011 impact of one time separation cost and special tax items.

For the third quarter of 2012, on the right side of the chart, we adjusted GAAP EPS of $0.38 by adding back the net negative impact of 2012 one time separation costs, restructuring and realignment cost, and special tax items.

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

The analysis shows that normalized EPS decreased 2%, or $0.01.

Core operations and the net impact from acquisitions provided $0.02 of EPS growth, or 4%, but was more than offset by higher a operating tax rate and an unfavorable impact of foreign exchange translation.

Now let me provide a little bit more detail on our reporting segments, please turn to slide 10.

For the third quarter, water infrastructure recorded revenue of $595 million, up 7% over prior year on a constant currency basis and up 3% organically.

Acquisitions contributed 4 points to the top line growth and foreign exchange was a 5 point headwind.

Beginning in September of this year, YSI revenues are included in our organic growth performance.

Transport grew 1% for the quarter driven by favorability in the public utility market where we saw mid single-digit growth for the quarter, which was slightly better than our expectations.

From the US and Europe, we continue to get stable environment with growth driven by aftermarket sales and services.

In addition, we continue to see strong emerging market growth.

Industrial transport was down low-single digits as US drought conditions continue to negatively impact dewatering rental services.

Treatment revenues grew 11% for the third quarter driven by public utility strength and we expect that public utility treatment revenues will be up on a sequential basis in the fourth quarter.

However, due to significant project deliveries last year, revenues will be down low-single digits year over year.

From an orders perspective, we continue to see large robust bid and quote activity, but conversion to booked orders continues to push to the right.

We've increased our focus and set forth a specific initiative targeted at increasing our share in the high potential industrial treatment market.

For example, we highlighted a large order win within the pulp and paper market in the second quarter and we recently won a large ozone order for Aquaculture in Canada.

Test revenues were up significantly driven by the inclusion of the YSI and MJK businesses.

Excluding acquisitions, the test application was up 7% organically year over year due to strength in the US and Asia/Pacific regions, partially offset by continued weakness in Europe.

Third-quarter operating margins came in at 15.5%, down 80 basis points from 2011 excluding the impact of stand alone costs.

Our operational and customer excellence initiatives more than offset the impact of inflation and provided flexibility to continue to invest in the business.

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

Let me now turn to slide number 11 and talk to our applied water segment.

Applied waters' third-quarter revenue was down 2% on a constant currency basis.

Building services was down 6% driven by the commercial and residential performance I articulated earlier.

Industrial water was up 1% due to favorable general and industrial market conditions across most regions.

In the US, revenue declined low-single digits due to shipment delays.

We expect these shipments to be delivered in the fourth quarter, and as a result, anticipate high single-digit growth in the US.

And lastly, irrigation was up 9%.

US revenues increased by double digits reflecting strong demand given current weather conditions.

Third-quarter operating margins came in at 13.2%, up 70 basis points from 2011 excluding stand alone costs.

Excluding a $2 million asset impairment charge recognized during the third quarter of 2011 and the benefit from foreign exchange, our operating margins would have declined only 20 basis points despite a 2% reduction in volume.

Price and productivity actions more than offset the impact of lower volume, unfavorable mix and inflation enabling continued investment in the segment.

Now let me turn to slide 12 and review our financial position.

We generated $171 million in free cash flow year to date, a conversion on adjusted net income of 73%, reflecting typical seasonality for our business.

Our cash flow is down from Q3 of 2011 as anticipated, driven primarily by incremental interest payments of $38 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 in 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, a normal seasonal trend.

As you can see from the slide, working capital as a percent of revenue has increased year over year.

The majority of this increase was driven by foreign exchange rates, but additionally we are carrying slightly higher inventory levels to ensure we can meet shortened customer lead times.

As it relates to our capital structure, we ended the third quarter in a strong position, our available cash on hand was $424 million up from the second quarter.

We have a solid net debt to net capital ratio to 28% 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.

And last week, the credit rating agencies affirmed their previous ratings of Xylem.

Now let me turn to slide 14 and talk about our guidance for 2012.

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

Our previous guidance was for a midpoint EPS of $1.77.

FX continues to fluctuate, based on quarter end currency spot rates we expect a $0.02 tailwind when compared to rates assumed in our previous guidance.

For example, our current guidance assumes a dollar to euro exchange rate of $1.28 for the balance of the year versus $1.22 assumed in our previous guidance.

As you can see from the chart, these tailwinds coupled with additional cost savings actions enable us to offset the impact of the volume decline.

So before we update our full-year guidance for the newly announced Heartland acquisition, I would highlight that the mid-point guidance remains at $1.77, consistent with our previous guidance.

As we highlighted earlier, we recently announced the acquisition of Heartland, which will add approximately $4 million in revenue and will be $0.01 dilutive due to acquisition cost and purchase accounting impacts in 2012.

We expect the acquisition will be accretive in 2013.

Please turn to slide 15.

This side provides all the relevant details for our guidance range.

I'd like to highlight a few key points.

We're now projecting full-year organic revenue growth of 1% which is at the low end of our previous guidance.

We expect approximately 1% organic growth from each of our two business segments.

Because we've lowered the top end of our revenue guidance, we are also lowering the top end of our operating margin range.

We now expect operating margins in the range of 12.7% to 12.9%, flat to up 20 basis points over the prior year including the impact of incremental stand alone costs.

Excluding stand alone costs, this represents an 80 basis point year-over-year improvement.

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

We anticipate these charges in 2012 to be approximately $20 million.

In the third quarter, we incurred $5 million of these costs.

We still anticipate that these actions will be substantially completed in 2012 with approximately $3 million of additional costs being incurred in 2013.

The run rate savings will be approximately $11 million beginning in 2013, we anticipate less than $1 million of savings in 2012.

Year to date, we've recognized $15 million in one time separation costs and we expect full-year separation costs to be approximately $20 million.

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

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

In summary, we had another strong quarter of operating performance.

We are and will continue to position ourselves for long-term growth.

By investing in our growth platforms, executing a disciplined acquisition strategy and advancing our geographic growth initiatives, I am confident we will deliver long-term growth and higher returns for our shareholders.

We continue to launch new products and have the financial ability to continue to invest for future growth.

As for our customer and operational excellence initiatives, we will continue to expand operating margins.

And as I mentioned at the beginning of the call, we had a series of restructuring realignment actions underway and our developing plan should the markets deteriorate further.

By making these difficult decisions today, we're preserving investment capabilities and defending and improving our competitive advantages.

This will lead ultimately to higher levels of profitability.

My last point, we're entering the fourth quarter and shortly thereafter 2013 with a strong financial position and the flexibility to continue to execute our long-term strategy.

With that, we'll be happy to take your questions.

Brandy?

The floor is now open for questions.

(Operator Instructions)

Deane Dray with Citi Research.

First question is regarding the impact of Hurricane Sandy.

And of course, we're still early in the process, we understand, but from a disaster recovery standpoint can you comment on any business interruptions that Xylem has had?

And then balance that with what are the opportunities for the Company on the recovery process?

Every time I heard you say low dewatering rentals in the quarter, I'm thinking that's obviously see the big reversal this quarter and even Heartland should participate as well.

But if you talk about what the opportunities are residential, commercial, industrial.

And maybe comment on I heard on a radio that you all were shipping pumps on an emergency basis and you got a shout out, so maybe you can comment on that as well.

Thank you.

Sure, Deane, let me talk about Sandy.

In terms of the first question interruptions to the business, I can't really comment right now.

What we've been mostly focused on is making sure that we're deploying our equipment and we're trying to get (inaudible) to those who obviously are in need at this time.

We've shipped over 200 pumps into the north-- this whole northeast region.

We have I understand another 100 some pumps coming and we also made sure that sump pumps and effluent pumps, water system pumps are available through our channel and trying to help them as quickly as we can.

It's a horrible situation, but it is an opportunity for us to be able to engage with our expertise and our equipment.

In terms of where we are with fourth quarter, as we're going into the fourth quarter, our orders are not where we want them to be, so this is an opportunity to backfill that.

There will be some things that will be offset because things will be pushed to the right because of the disaster.

We'll have to look at it through this quarter and into next-- and the first of 2013 to see what the overall impact will be.

And then as a follow up on your point about some of these water push outs, maybe you can take us through the different markets, what types of push outs are you seeing?

On the muni side both in and on the industrial side, are these push outs as a result of funding issues or a lack of confidence in the outlook, the fiscal cliff and so forth?

But color on the motivation behind the push outs and potential timing.

Okay let me first start with industrial.

Industrial, what we're seeing now is the capital expenditure being challenged.

A lot of that's driven by the uncertainty in the economy, people holding back to see what happens here.

So where we're seeing the significant part of project delays is in the industrial side.

As we've been talking about on the capital expenditure side on the public utilities, we saw nice orders in second quarter.

We've seen our bid activity in third quarter increase.

But again, we're not seeing the orders being released at the level that we would have anticipated.

That's the result of the CapEx in the public utilities been down, I don't think it's down any further.

I think right now they're trying to determine which projects to let go since they've got a backlog of activities.

Commercial area, we saw the same thing in terms of capital expenditures pulling back, people holding back because of the confidence in the region.

But no pull back on what would be the break and fix side of your muni business which was about 70%, is that still the aftermarket percentage?

Yes, I think our business in terms of operations, maintenance, repair, services has been robust, continues to be resilient in Europe and our large install base and those relationships we have with the customers continue to be strong.

Deane, our aftermarket services are up about 4.5% through the first three quarters of the year as evidence of that.

Matt Summerville with KeyBanc.

Hi, good morning, this is Joe Radigan on for Matt.

In terms of the bidding activity that you talked about, Gretchen, what are you seeing in terms of the pricing dynamic on that project side?

Is it-- do you see folks chasing that business so it's getting more competitive price wise or given the pent up demand now and as you project capacity out as some of these orders you adequately let in the future, is it actually firming up and getting better?

Well I wouldn't say the competitive nature has gotten any worse.

I really think it's a lot of activity.

Of course our customers are making sure they are looking at choices and getting options, but they're looking specifically on how to resolve the issues.

And the bidding activities, there are funnels as rich as it's been in quite sometime.

Now the question is a matter of getting those released and getting them actually turned into firm orders.

Okay and then if I could-- a quick follow up on Deane's first question around Sandy, how much do you typically bake into your guidance for severe weather clean up?

I know it's impossible to predict the number of storms and where they are geographically, but there is a hurricane season, so there's some irregularity there.

Can you give some color on maybe more broadly your thought process on when you think about guidance and how you bake in that unpredictability?

In third quarter and you think of the dewatering business, third quarter is typically a large time for seasonal effects, you've got the storms, the hurricanes coming in.

And we only saw Isaac third quarter, part of the reason why our orders and sales are down in our dewatering business.

Typically you'll see three or four different types of storms and we would react appropriately.

You'll see that typically more so in the third quarter, going into the fourth quarter, you typically don't see that type of seasonality.

We try to factor in an average amount of storms, so in some cases you'll be down, other cases you could actually benefit from it like we saw the year before.

Okay, thanks, Gretchen.

Kevin Maczka with BB&T Capital Markets.

Question on gross margin, obviously very strong here at 40%, matching your long-term goal.

It sounds like Gretchen, from what you're describing in terms of your order cadence and initiating new restructuring maybe the top line gets more challenging here before it gets better.

I'm wondering on that gross margin line, can we sustain this type of level in that environment or was there anything unusual in terms of mix or one offs that really helped profit up this quarter?

I would comment in general on how we're driving the gross margin.

It's coming from several different things.

One, we've been driving our commercial excellence activities which is driving price and we're seeing nice price.

We're also seeing the shift in our portfolio through the acquisitions that we've done.

The other benefit is we're seeing the sales that we are getting from our new product launches and our new product launches have higher margins.

And we're also of course doing a lot of the things I had talked about in my opening statements, is a lot of activities and there are many of them around continued productivity in our factories and our supply chain, sourcing and so forth that are giving us benefit.

When I look forward and say what's in front of us, we still have a lot of work to do around product rationalization, which will continue propel us in the future.

But volume does have an impact and we're living right now in a low growth environment and I don't see that changing any time soon.

David Rose with Wedbush Securities.

Follow-up questions.

One is going back to an earlier question on the read in terms of why are projects being delayed, is there any commentary is it-- I understand part is fiscal cliff, any of it potentially election related?

I can't comment on that, I think it's the uncertainty in the market in general.

I think most of our customers they've got constrained budgets, they're trying to make the choices.

And the public utilities what they're trying to determine is which project do they let loose first before the other ones, and so they're going through that and I think it's daily basis.

Okay, so there's really not much sense in terms of does this go live in December or January or February, so there's no sense of timing--

No.

Okay.

Secondly, if we could going back to the notion of dewatering, clearly you benefited in the past by in the oil and gas shale plays as we've discussed, you're expanding into other markets.

Can you discuss the strategy in dewatering as it relates to both opportunities, risk management and working capital requirements?

Clearly you're going to have to step up inventory if you have a lot of storms.

And as you go internationally, what sort of inventory will you have to have for emerging markets like China, et cetera?

Great question.

And let me take a step back in terms of our dewatering strategy.

The one thing we acquired when we acquired Godwin was a very good business model around 24/7 in terms of being able-- rental and services with equipment not only for public utilities but also in the industrial market being mining, whether it be shale, whether it be disaster related activities and most of that equipment can be deployed in multiple uses.

So that is the positive part of it.

Typically in the US you would typically see maybe the East Coast being a drought and the West Coast being wet or vice versa and you typically wouldn't see the whole US in a drought situation like we've seen this year.

Typically that will offset itself.

One of the things we're trying to do with our dewatering strategy is to take that model and now take it geographically.

And we talked about expanding in Brazil, we've talked about expanding in other regions around the world and we think that ultimately will allow us to better utilize our footprint, get maximum utilization in terms of our assets which it is a costly model but is a very profitable model when deployed appropriately.

David, the other thing I'd add is we've mentioned before we manage that business in a different manner given the nature of the CapEx that's involved.

And so for example when we see lower volume rates, we dial back the investment because we're looking at utilization rates and return on assets.

The other thing I'd point out is given the nature of the equipment, it can be moved pretty easily between applications, so it can be moved from construction to municipal bypass relatively easily.

So that allows us to get some efficiency, whether it's in the CapEx or the inventory that's used to support the equipment.

It's definitely an area that we watch very carefully and as we go into new markets, we're very deliberate about how much investment we make and we monitor that closely against the utilization rates we have in the business.

As the footprint expands, you'll probably see less volatility in top line and margins I would take it?

That's one of the benefits from the global expansion absolutely, that and the diverse end market exposure.

Okay, great.

Thank you.

Chip Moore with Canaccord.

Back to Sandy, once you get passed the immediate disaster recovery clean up efforts, what does it open up longer term for you guys in terms of infrastructure investments?

What did you see back with Katrina in New Orleans, is there any opportunity there for the rest of the portfolio?

The area that I'd say where we play is in building services.

We will have a lot of businesses that will have to go back and retrofit some of their services whether it be boilers, heating, ventilation, air conditioning and so forth, so there's opportunity in the future as that expands out.

But that won't be the first need, obviously the first need will be the initial clean up.

And as a follow up, on the M&A side, clearly the balance sheet is very strong.

Can you talk about the thought process, analytics, dewatering, where you're looking, what we should be looking for?

Yes, I'd comment that we have a healthy pipeline.

We have been continuing to work our-- the different candidates that we're cultivating.

I feel very good about the process in which we are and I'm very optimistic of what's in front of us.

We continue to use the same process.

First start with our strategy.

Our strategy has been to expand in these nice profitable growing areas like dewatering and analytics.

We will see that continuing to play out.

We'll continue to use our demonstrated process that we have and make sure that we're managing and integrating and getting value out of the acquisitions that we've executed so far.

I see it as a ripe pipeline and an opportunity in front us to continue expand.

Thanks, folks.

Ryan Connors with Janney Montgomery Scott.

Good morning, thanks for taking my call.

I apologize if this has already been covered, we've been shuttling between calls with the Sandy related conference call delays here.

But pricing, I wondered if you could talk a little bit about your strategic pricing initiative and the goals you've laid out for us there and how you believe the current environment and the book-to-bill headwind you talked about, Gretchen, and how that impacts your short-term ability to meet the guidance you've given us on pricing annualized through strategic pricing?

And then longer term, update us on what kind of contribution you think pricing can make to the top line.

Yes, as we've talked about, we said pricing we'd like to be able to get 1 to 2 points from pricing each year.

Our whole commercial excellence activity has really driven our whole strategy, our strategic pricing thought process and the actions that we're driving throughout the organization in a very positive way.

As I mentioned, in third quarter we got 1.5% price after the first half of the year being 1.7%.

Now we're going into the fourth quarter, it's going to trend downward.

We're wrapping around from some of the price actions we got from last year and we're also in a tough environment in terms of competitive nature with the low growth markets that we're living in.

But that's not going to make us step back.

We believe we've got strong products.

We've got a strong understanding of where we play.

We've got a good discipline to continue to look at our losses and our wins and re-adjust appropriately.

We think we've got the right position to go after price and the right strategic differentiated areas.

And other areas where it makes sense, we'll aggressively play so that we can make sure we don't lose the market share.

Ryan, I'd add to what Gretchen said in the sense of the mechanics.

One of the things we're doing is making sure that as we see price increases on the back end of the business, I commented about the value gap that those are being built into the pricing model.

But I'd also point out this pricing initiative is not a broad initiative in terms of the way we apply it, it's very targeted in terms of end markets and products and it helps that we have such a healthy pipeline in new product that gives us the ability to differentiate and get improved pricing in the marketplace.

I think Gretchen is absolutely right, we're going to continue to see headwinds given the economic environment but we're pretty confident that we've got a good process in place to maximum our potential.

Great and then a follow on to that, one of the things we've been trying to figure out is whether there's been change, C-change in the public utility channel in particular in terms of resistance to price increases and how hard utilities are driving a bargain on pricing given all that they've gone through from a financial standpoint the last couple of years.

Any color you can provide on that will be helpful.

Do you sense any difference today versus two years ago even for your customers that are spending, do they have a more -- are they more aggressive at the bargaining table than they used to be?

Well let me address it from this perspective, we're seeing price involve our water infrastructure and our applied water.

We're seeing it both in the public utilities as well as cost to our end markets.

Your question around public utilities, and there's no question they're challenged for to be able to do all the projects they want to do.

Now the one thing is their budgets continue because tariffs still continue to go up.

But they are-- the real strategy here in my mind is helping them understand how we can help them reduce their operating costs that allows them to ultimately spend less in their maintenance and operations and be able to free up money to be able put on their capital expenditures.

If you have the dialogue you can demonstrate in terms of the energy efficiency, cost of ownership, they're inclined to go after quality reliable parts because they're talking about water and waste water that's critical for all of our health.

And then a follow up lastly to a prior question there on the M&A environment.

There's been a lot of talk about the tax changes at the beginning of 2013 and how that's driving some small or business owners to actually seek an exit prior to that.

Is there any -- do you believe that could drive some deal activity for you all in the near term and then maybe a little bit of a fall off first half of next year?

No, I wouldn't say that.

When you look at our pipeline and what we're cultivating and working on, it's not driven by the need to sell a company because of tax reasons.

It varies depending upon what the candidate is doing if they need more investment in terms of their business, ultimately if they want they don't have something that a successor to hand the business off to, whether they like to be part of a bigger business that's focused around water that has played to our advantage.

I wouldn't say it's the tax issue and things will fall off after next year.

Got it, thanks for your time.

Thank you.

Michael Halloran with Robert W. Baird.

Orders were a little tougher in the quarter but you talked encouragingly about bid activity improving sequentially here, could you talk about the composition of that bid activity and if there's any inflection one way or another that's different from the broader trends you're seeing on the underlying order rates?

In other words, any pockets where you're starting to see things get a little bit better from a quoting activity but aren't seeing it in your core numbers at this point?

Right now I'd say the bidding activity across most of our end markets both industrial and the public utilities are probably the largest area.

Industrial is encouraging to us.

Again, we've not seen the release of it, but I'm encouraged when you think about where we played in our treatment business to be able to expand more in the industrial side.

Our teams are going after a number of activities and I do believe they're going to come-- break loose, it's just a matter of when.

And then on the restructuring side of things, other than the ongoing initiative you have in place to meet those long-term targets and specifically focusing on some of the actions you're taking to respond to the shorter term environment, anyway to delineate at least qualitatively how much of that's more permanent in nature and how much of it is the desire to flex up and flex down to meet the demand levels?

Yes, Mike, I guess the way I'd answer that question is the restructuring, the $20 million that we're executing this year, the majority of that is permanent in nature.

We're taking the opportunity given the fact that we have a view that Europe is going to be a challenging market for the foreseeable future that we're relooking the structure.

You can see it in the pay back quite frankly in terms of the pay back being around two years that we're taking some more difficult cuts that are going to position the business better for the long term and are more sustained in nature.

And I would add when we think of Europe and that's where the focus has been around their structuring is really aligning ourselves as one Xylem team.

We take-- we go to market in different ways today, we have the opportunity to leverage our portfolio to position ourselves even more effectively with our customers.

And so part of what we're doing is helping us get to our long-term strategy.

Great.

Thanks for the time.

Thanks, Mike.

Brent Thielman with D.A. Davidson.

It sounds like you obviously talk about some continued order delays in treatment or the pipelines getting larger, are these projects in any specific region?

And then it sounds like the private industrial treatment jobs are moving a little faster than the public utility side.

Did those jobs offer the same opportunities to leverage other products in your portfolio as you'd see on the public utility side?

Yes, let me talk about the orders and so forth.

Geographically, US there's a lot of bid activity.

The emerging market, there is significant activity.

Europe's a little weaker from an activity base and that plays with the economics we're seeing.

I'd say a lot more of the projects are smaller in nature as they are compared to large in nature, and today when we look at large projects, we look at full capability of our portfolio and how we can bring that together where it makes sense.

Thank you.

Jim Krapfel with Morningstar.

Question, what kind of returns on invested capital are you expecting out of your YSI and MJK acquisitions?

And how have the acquisitions tracked relative to your original expectations?

Jim, we're actually going to spend time in our Investor Day talking through the performance of the acquisitions because it's an important part of the story that we have.

But the criteria that we set out and that clearly YSI and the other acquisitions fall into is we look for returns in the mid-teens.

The way we characterize the series of acquisitions that we've done, Godwin, Nova and the string of analytics deals, is they are outperforming our models despite the economic environment.

And the reason that we do that is when we go through justifying the acquisition, we obviously don't load in all the expected synergies and then we obviously put more aggressive targets inside the business to ensure that we drive the growth.

As we've talked in the past, we've got a pretty robust integration model where we're measuring the business against those original plans, meeting with the business in the initial 30, 60 and 90 days of the integration to make sure it gets integrated well and then doing periodic check-ins after that.

I would-- I'd answer the question broadly that their performing better and we intend to get into that in a little bit more detail when we have our Investor Day next year.

And I'd say in both our dewatering and our analytics business, they're now becoming a large platform in which not only can we do-- continue to expand with acquisitions to expand them, but we also now have a core competence level to do organic growth and so you've got the benefits of both.

Okay.

And you mentioned that your acquisition pipeline is still pretty strong, are you seeing anything to the size of what you did with YSI?

Our approach has been a bolt-on strategy, but in our pipeline we look at all sizes, all shapes and all regions.

We'll continue to look at it from a strategic perspective and how that can help us accelerate our strategic vision.

So again mostly a bolt-on strategy, but we don't preclude looking at larger acquisitions as well.

Okay, great.

Thanks.

Thank you.

That was our final question and I'd like to turn the floor back over to Gretchen for any closing remarks.

Yes, I'd like to say thank you for your interest and your time this morning and really sharing our first year anniversary with us.

As I mentioned, the business operations to continue to improve even with the lower anticipated revenues.

We're aggressively positioning Xylem for the future with the many of actions that we've talked about this morning.

And while we do that, we remain of course very focused on good earnings and solid cash flow.

So again thank you for your time, we appreciate your interest.

Thank you.

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

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