賽莱默 (XYL) 2013 Q3 法說會逐字稿

Good morning.

My name is Jackie and I will be your conference operator today.

At this time, I'd like to welcome everyone to the Xylem third-quarter 2013 earnings conference call.

(Operator Instructions).

Thank you.

I would now like to turn the call over to Phil De Sousa, Head of Investor Relations.

Please go ahead.

Thank you, Jackie.

Good morning, everyone, and welcome to Xylem's third-quarter 2013 earnings conference call.

With me today are Chief Executive Officer, Steven Loranger; and Chief Financial Officer, Michael Speetzen.

They will provide their perspective on Xylem's third-quarter results and discuss the full-year outlook for 2013.

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

I'll ask that you please keep to one question and a follow-up, and then return to the queue so 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 in the Investors 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 Tuesday, November 12, at 6 PM.

Please note the replay number is 404-537-3406, and the confirmation code is 725-205-15.

Additionally, the call will be available for playback in the Investors 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 as filed with the SEC.

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

Please note that the Company takes 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, Steve Loranger.

Thanks, Phil, and thank you all for joining us this morning.

I'm now 50 days into my tenure at Xylem, and I've managed to cover a lot of territory.

Let me start by saying that I am thrilled by the dedicated team that we have here; and, likewise, I'm very excited by the significant growth opportunities in front of us, and especially our team's performance in this third quarter.

I'm going to offer a little more detail on what I've seen and how we're prioritizing in a moment, but let's first start with the third-quarter results.

We achieved revenue of $965 million, up organically for the first time since the third quarter of last year.

We booked orders of $955 million, up 6% organically over 2012.

Our view is that some market conditions are showing stabilization, and we could see some slight improvement in the European public utility and industrial markets as we look ahead.

While we are cautiously optimistic on these markets, we are very proud of our sales teams, who continue to drive hard in this environment.

Their focused efforts, along with a slightly improved Europe, were significant factors behind the pickup in revenue and orders this quarter.

Equally important is the progress we're making with improved operational performance.

Our operating margin was up 330 basis points sequentially from the second quarter, or up 60 basis points year-over-year.

This represents record margin performance for the business since spinning out from ITT two years ago.

We clearly see the benefit derived from our earlier restructuring actions, and we are delivering better volume leverage.

We also drove incremental improvement by executing on the second phase of our European realignment, and these activities have significantly lowered our tax rate.

And we also think that our short-term focus on business accountability and cost action has had a positive effect.

The bottom line -- we realized 11% earnings per share growth over the prior year, up 36% sequentially from the second quarter.

With a lot of market volatility, we have had some forecasting difficulties.

And as a result, we've taken a conservative approach, not unlike our peers and other industrial companies, who also see the same challenge.

But over the last quarter, we've taken significant steps to improve forecasting, particularly in Europe.

We have driven substantial integrated activities to add more financial discipline.

And our work continues; we are not finished yet.

We have improved our business visibility by streamlining processes, delayering parts of the organization, and eliminating complexity.

One of the key impressions I got initially was that we needed to make things simple, enable faster decision-making, and clarify accountability.

Yesterday, we took a logical step to streamline our European operations and further clarify individual roles.

We are eliminating a redundant management level which was created by the overlay of our European regional businesses with our water solutions group.

Because we now have excellent traction with our integrated front end in both EMEA and Asia, along with strong selling organizations in the Americas, we made a substantial move to strengthen the management of our product-focused businesses.

As a result, we are eliminating water solutions as an umbrella value center, and refocusing on three global P&L businesses -- transport, treatment, and dewatering.

These three, along with Ken Napolitano's applied water and Chris McIntire's analytics units, will all access global markets through our regional selling organizations.

This did create some management changes.

Colin Sabol, who you know as our Chief Strategy and Growth Officer, will be transitioning to lead our global dewatering business.

Chris McIntire, who has done an impressive job running analytics, will also assume the treatment franchise.

And Tomas Brannemo, who was running global transport within water solutions, will continue to run this as a standalone P&L business.

Mike Kuchenbrod, who has been running water solutions, will leave Xylem, and I want to take this opportunity to thank Mike for his terrific 25 years of service and dedication to the Company.

To close out on the quarter, while we were conservative on the second half, we did deliver a strong third quarter, both with revenue and our operating metrics.

We are benefiting from our restructuring and realignment actions.

And with better visibility, we have more confidence going forward.

We do see slightly favorable conditions in emerging markets.

The US has remained stable for us; and Europe, albeit still slow, has improved, relative to the second quarter.

We are cautious in this assessment, but we do think it is slightly more positive.

We have begun to prioritize our growth initiatives; continue to invest for growth in a disciplined fashion, in applications and geographies most critical to our vision.

We're also targeting increased productivity by our global sourcing initiatives and lean process improvement in the manufacturing facilities.

And so I am very pleased with our team's second-half response to the first-half challenges.

We expect our businesses to be squarely focused on execution and delivering on their commitments for the remainder of the year.

And as a result, we are raising our full-year guidance.

Finally, in the third quarter, our Board approved our $250 million share repurchase program.

Since that approval, we have repurchased approximately 1 million shares, and we expect to remain active with this share repurchase program.

Let me now turn the call over to our CFO, Mike Speetzen, to walk through the third-quarter results and guidance.

Mike?

Thanks, Steve.

Please go to slide 4. Xylem's revenues were $965 million, up 4% from the prior year, primarily driven by 1% organic growth and an additional 2% from acquisitions.

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

First, in our largest end market, industrial, organic revenue was up 1%.

Europe was up low-single-digits due to increased demand for dewatering applications, driven by construction activity in Germany and mining strength in the Nordics.

The US was down low-single-digits, as slow mining and construction markets were only partially offset by an uptick in demand for fracking and dewatering applications.

Public utilities also increased 1% year-over-year, as growth in Asia Pac and Europe offset a low-single-digit decline in the US.

Consistent with past quarters, demand related to CapEx projects remained weak in developed markets, while we continued to see stability in demand associated with MRO activities.

As developing countries are at an earlier stage of building out and upgrading water and wastewater networks, we continue to see growth in CapEx-related projects; which, for example, is driving strong growth for us in China.

Commercial building services revenue was up 8% compared to the same period in 2012, when revenues were down a similar magnitude.

Promotional activities in the US contributed to growth in the face of continued weak end-market conditions.

Increased construction activity drove favorable results in Europe while we continued to see strong demand in emerging markets.

Residential building services revenue was down 7% year-over-year, driven by a decline in the US groundwater market and continued difficult market conditions in southern Europe.

And, lastly, agriculture was up 2%, driven by strength in Western US states.

Let me spend just a few minutes highlighting our overall geographic performance.

Europe grew 1% organically, as strength across most of the region was partially offset by continued weakness in the South.

Generally, our performance was significantly better than our previous expectations.

This was driven by three main factors.

First, we saw improved sales execution under the newly integrated European sales organization and from internal sales initiatives, such as Buy More, Win More, Keep More.

Second, market conditions modestly improved outside of Southern Europe.

And, lastly, we admittedly had a conservative forecast following the significant decline we experienced in second quarter.

The US was down 1%, driven by the mixed end-market dynamics I highlighted earlier.

And while sequestration and the government shutdown did not have a significant impact on our business overall, it did affect our analytics platform, which does serve various federal agencies in the research market, which were unfavorably impacted.

Emerging markets grew 8% organically in the third quarter, including continued double-digit growth in both Russia and China.

Before turning to our operational performance, I'll highlight that similar to prior quarters, we've excluded the restructuring and realignment costs.

In the third quarter, we have excluded $20 million of one-time special charges, including the costs associated with the CEO transition, including legal, PR, and search fees; and the resolution of a legal settlement associated with the use of the Xylem (technical difficulty).

More information regarding the settlement will be provided in our quarterly filing later today.

So now, turning to our operating income, we delivered strong operational performance.

Operating income of $130 million was up $10 million or 8% over last year; and margins reached 13.5%, our highest mark since spinning out from ITT.

As expected, we had strong incremental margins of 29% for the quarter, even after absorbing negative foreign exchange and acquisition impacts, as well as continued investments in the business.

Incremental volume leverage offset higher G&A costs for the European headquarters, pension expense, and unfavorable mix.

Price pressure has become a bigger challenge to our growth.

And in the quarter, it was a 30 basis point headwind against the overall operating margin improvement.

Difficult market conditions -- particularly in the public utility, industrial, and commercial end markets -- had driven overcapacity in the marketplace; and, as a result, has led to a more competitive environment.

Looking forward, the pricing environment is likely to remain challenged as long as this economic backdrop persists.

Offsetting the price pressure were cost reduction activities which drove 350 basis points of margin improvement, including $7 million of restructuring savings from actions executed in 2012 and 2013.

Inflation had a 210 basis point negative impact on operating margin, while foreign-exchange movements subtracted 10 basis points.

In addition, acquisitions were dilutive to margins by 40 basis points, as they contributed revenue but no income in this stage of integration.

In summary, operating margins increased 60 basis points despite considerable headwinds from price, the dilutive short-term impact from acquisitions, and the investments that we continue to make in order to grow the business over the long-term.

Turning to slide 5. This slide shows our EPS performance for the third quarter.

We're reporting $0.49 of EPS, up $0.05 or 11% from the prior year, and 36% on a quarterly sequential basis.

Core operations drove strong operating margin improvement, contributing $0.04, driven primarily by organic volume growth combined with good execution on productivity and cost management.

Restructuring savings provided a $0.03 benefit.

Ongoing European realignment actions, and the associated sustainable tax benefit from a lower tax rate, provided a $0.01 benefit in the quarter.

These benefits more than offset a $0.02 unfavorable impact of mix and price, as well as one-time separation costs and pension headwinds of $0.01.

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

Please turn to slide 6. Water infrastructure reported revenue of $619 million, up 5% over the prior year on a constant currency basis, and up 1% organically.

Acquisitions contributed 4 points to the topline growth.

Transport grew 2%, primarily driven by mid-single-digit growth in Europe, as strength in Northern and Central Europe more than offset weakness in Southern Europe in the quarter.

Transport revenue in the US was flat, as stronger demand for dewatering applications, including fracking-related activity, was offset by declines in CapEx spending.

Treatment revenues declined 2%, as strong double-digit growth in Asia-Pac -- including China, which was up over 30% -- did not fully offset the ongoing weak demand environment in the developed markets.

Both the US and Europe continue to experience funding constraints and associated project delays.

Our European treatment results were also impacted by the decline in the biogas market and the comparison to 2012, which had strong shipments in the UK with the regulatory spending cycle.

And, lastly, test revenues were flat, as growth in Europe and the Middle East was offset by sequestration-related softness in the US.

Operating margins came in at 15.5%, up 50 basis points year-over-year.

We delivered very strong incremental margins despite significant price headwind, unfavorable foreign exchange, and acquisition impacts.

This also included increased investment in growth initiatives and higher pension expense.

With 2% growth in Europe, we benefited from the same factors that drove high decremental margins in Q2, namely volume leverage versus the fixed costs associated with the European direct sales structure in this segment.

Let me now turn to slide number 7 and talk to our applied water segment.

Revenue was up 2%, both on a constant currency and organic basis.

Building services was up 1%, as strong commercial performance discussed earlier was offset by a decline in residential-related sales.

In particular, US groundwater sales were weak, as market share gains could not offset the decline in the US groundwater market.

Industrial water was up 2%.

Sales in China were particularly strong on the back of demand for our products used in offshore oil and gas fire pump applications.

And, lastly, irrigation was up 2%, with the US up 7%, as weather conditions continued to drive strong demand in the West.

Operating margin was 12.2%, a decline of 40 basis points year-over-year.

While cost reduction initiatives more than offset inflation, lower price realization and negative mix drove margins down slightly.

Mix was impacted by two factors.

One, revenue was down 1% in Europe, which is where we carry higher fixed selling costs.

And, two, we saw a 13% increase in emerging markets, where our margins in general are slightly lower.

Now let me turn to slide 8 and review our financial position.

Xylem maintained a strong cash position, with a balance of $394 million at the end of the third quarter; and the majority is held outside of the US, consistent with our geographic business mix.

Our net debt to net capital ratio is a healthy 27%, and our commercial paper and revolving credit facilities remain in place and continue to be unutilized.

We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while enhancing shareholder returns through dividends and share repurchases.

Year-to-date through the third quarter, we have invested $172 million to acquisitions and CapEx.

Additionally, we've returned $107 million to shareholders via dividends and share repurchases, up substantially from $58 million in 2012.

The two key drivers here were the 15% increase in dividends we announced earlier this year, and the ramp-up of share repurchase activity.

Free cash flow was $72 million year-to-date; and, while down from the prior year, remains strong and at a level consistent with our capital deployment strategy.

The decline of free cash flow year-to-date versus the same period of 2012 is driven by lower income, unfavorable working capital, and higher restructuring payments.

As a percentage of revenue, operating working capital increased 170 basis points, driven by a number of factors this quarter.

First, we had a particularly strong September relative to the rest of the third quarter, which resulted in a higher level of receivables that we expect to collect in the fourth quarter.

In addition, we continue to hold higher-than-normal levels of inventory in order to compensate for shorter customer leadtimes.

And, finally, customer payment times continue to be elongated, although we have not experienced any significant bad debts associated with these lengthened payment durations.

Please turn to slide number 9, and I will cover our guidance update in detail.

As Steve mentioned earlier, we're revising our full-year guidance to reflect our strong third-quarter performance and the anticipated improvement driven by internal growth and cost savings initiatives.

As you can see from the chart, we are raising our full-year revenue expectations by $50 million, which brings our full-year revenue projections up to $3.8 billion.

As I mentioned earlier, this revision includes our third-quarter results, which was approximately $35 million of revenue and $0.10 of EPS better than we expected.

The additional $15 million of revenue and $0.08 of EPS is attributable to our improved outlook for the fourth quarter.

With respect to revenue, our guidance implies fourth-quarter organic growth of 1% and reflects what we think are stabilizing conditions we have seen in Europe, particularly with the public utility and industrial markets, partially offset by lower revenue from residential applications in both the US and Europe.

In addition, we have assumed continued growth in emerging markets, and the conditions in the US do not improve from what we've seen in the past quarter.

We are increasing our EPS guidance by $0.18 at the midpoint, which is driven by an increased focus on execution and continued disciplined cost management.

Let me point out that our guidance reflects the fact that we are on track to deliver the restructuring and realignment benefits and incremental cost savings I discussed at our last earnings call.

In summary, we now expect full-year revenue of approximately $3.8 billion, and EPS in the range of $1.60 to $1.65.

Please turn to slide 10.

Let me highlight just a few items I haven't covered yet.

First, we still expect free cash flow conversion to be approximately 90% of net income.

We anticipate a normal seasonal increase in free cash flow generation and conversion on our last quarter of the year, coupled with higher receivable collections resulting from the strong sales we experienced in September.

Our operating tax rate is expected to be 21% for the year, consistent with our previous guidance.

This is indicative of the progress against the realignment initiatives we started earlier this year.

We expect our share count to be approximately 186 million for the full-year calculation, but down to 185 million for purposes of the fourth quarter.

This reflects the impact of approximately $25 million deployed towards repurchases during the third quarter, and an assumed similar outlay with our approved program in the fourth quarter.

And, lastly, we expect restructuring and realignment costs to be in a range of $65 million to $80 million.

With that, Operator, we can now begin the Q&A.

(Operator Instructions).

Deane Dray, Citi Research.

Thank you.

Good morning, everyone.

And, Steven, welcome back to the front lines.

Thank you, Deane.

Great to be back.

All right, so I want to hit you with a first question.

And this is kind of like a high-quality problem, to have to answer this question, and it's -- how would you characterize the upside this quarter?

We've gotten some of the nitty-gritties on terms of where the upside is -- how it has been reported.

But maybe you can characterize it.

Is this too much conservativeness in the previous guidance?

Is this a catch-up from some of the second quarter?

Or are we at this meaningful inflection point where we are now seeing some projects being released?

Deane, the real answer to that question is, all of the above.

And we've had a number of dynamics occurring which came together nicely.

First and foremost, I think that previously Gretchen and the team had done a really nice job in the summertime of outlining the necessary cost reductions that were needed to make the third and fourth quarter -- with a relatively sluggish top line.

The teams executed against those cost benefits, so we certainly got every bit of what we're looking for.

Second of all, there had been some ongoing restructuring, as you know, in 2012/2013 timeframe, and that's coming through.

We did see some slight favorability in markets, although we're not going to forecast any real trend here.

These markets have been moving around.

But certainly the markets were a little bit favorable.

But we also had our sales teams out there really working hard.

We put a lot of pressure to go get the order and focus, and the teams did a good job.

And then, finally, there was certainly some conservativism when the July forecast was announced.

The team really wanted to make sure that we had a number that we could make.

So it really was all of the above.

You take a little conservatism out of it, and what I'm mostly pleased about is just really the operating performance of the teams, both on the sales line and the operational execution line.

Great.

And then just as a follow-up, make sure I understood some of the nuances here within the realignment.

And if you could just clarify about water analytics.

Because, Steve, when you put this business together back in ITT, you talked about the transport, treatment, and test -- the three T's of water.

And so analytics seems to be not one of the cornerstones within the three businesses.

So just clarify where water analytics is.

Okay, fine.

First of all, on transport and treatment and dewatering, the purpose of associating all those underneath the umbrella of what was water, wastewater, and later, water solutions -- was less about the relatedness of the operations in the product technology, and more about the ability for water solutions to enable access to a global market.

So in the presence of our integrated front end, which we have essentially migrated in most of our regions, we now can go back with respect to running really, really, efficient product businesses in those dimensions.

Analytics, or test, remains separate underneath Chris McIntire and is part of this, as it has been.

So there's no change there.

But as part of this, Chris has been doing an outstanding job.

And there is some more relatedness with some of the treatment technology and some of the test.

And we invited Chris to be the leader over both of those franchises.

That's terrific.

Okay.

That's still part of this, so we should think of it as part of the treatment division?

Well, think about Chris McIntire as leading both the analytics, test, and the treatment businesses now, yes.

Okay, that makes all kinds of sense.

And just special shout out, that's great to see Colin getting an operating role (multiple speakers).

And we're thrilled by the change in leaderships.

Operator?

Matt Summerville, KeyBanc.

Morning.

I think, Mike, on slide 10 you talked about the net cost savings in 2013 being in the range of $14 million to $15 million.

Based upon what you're doing this year, and anything left over from 2012, if you will, what would be the incremental cost saving benefits that we should expect for 2014, based on stuff done as of the end of the year here?

Yes.

So we, consistent with what we've talked on in the past, there's a few components to that.

First, the carryover restructuring is going to be in the range of about $15 million.

In addition to that, as we guided, there were still some one-time spend costs that we were dealing this year, the two biggest drivers being IT-related cost as well as moving our corporate headquarters, and that's about $5 million.

So those two items give about $20 million.

And then, as we indicated in our last discussion, there's an additional $15 million related to the cost actions that we're taking here in the second half that will play out into 2014.

And what I would say is -- Steve talked to a little bit in the upfront comments -- we're continuing to look for more.

I think the key component that we want to signal is, even with flat top line in 2014, we feel confident we can deliver EPS growth in 2014.

And then just one follow-up on what you're doing, at least in the near-term, from a cost standpoint.

Have you cannibalized any growth investments?

Have you substantially throttled back discretionary spending?

Can you talk about maybe some of the more temporary levers you may or may not be pulling right now?

Yes, there's a couple of things.

One, we're clearly seeing a lower level of inflation, and that has helped.

We've gone from just under 3% in the first quarter; we're down near around 2% in the third quarter.

So there's been a little bit of help from that.

But there's certainly been a mixture.

I would say that there were some short-term measures that we took; nothing, from my perspective, that's damaging the business.

I think it was prudent cost management, in light of a volatile top line.

But we are also working right now to identify what are more permanent cost reductions as we head into 2014.

As Steve highlighted, we've got opportunities around global sourcing; we've got opportunities around the Lean and Six Sigma avenues relative to our business.

And the other key point I'd make is we continue to invest in the business.

As I mentioned in my prepared remarks, it continues to be a slight headwind relative to margin performance through the third quarter.

So one thing we've made sure of is we're not going to do anything that damages the long-term potential of the Company.

Thank you.

Scott Davis, Barclays.

Hello, good morning, guys.

And welcome back, Steve.

Thank you, Scott.

Can you guys talk a little bit about what you're looking for in a new CEO?

Are you looking for a restructuring person?

Are you looking for somebody with water experience?

Just give us a sense of what type of profile you're looking for.

Well, first of all, the CEO search is well underway.

And I don't have anything definitive to say there, but clearly Xylem is a company that has just terrific global assets.

You guys know about our technology; our market and customer reach around the world; and some really, really good supply chains.

And we think that, clearly, the opportunities in front of the Company are every bit as rich as they were when we created the spin-out.

So, the notion about having a very, very strong global product business that can access these markets and become greater than the sum of the parts is still in the front of our minds.

And, clearly, a CEO who has the leadership, the vision, and the track record of experience in that dimension would be first and foremost.

Okay.

Fair point.

And when you think about, Steve, what's happened since the spinoff, clearly Xylem has been the most disappointing of the three; and, arguably, had the most promise, really.

What's gone wrong?

Are you just behind -- did restructuring come too late for the slow global macro?

Just give us a sense of the playbook of what went wrong, so we can get a better sense of what you are going to change in the near-term.

Well, I think focusing on where we're going in the future, it's really responsive to that question.

We clearly have had some challenges with these markets, and we have such a broad portfolio.

I think what we do need to do is to focus and reprioritize both our investments and growth activities in a way that can create more total value.

As an example, we really do like the Flygt product line; that's been a fabulous product line.

We're going to be increasing some investments in that to continue to drive competitive advantage in the transport segment.

The same thing in the emerging markets as I could mention.

But the operative component there is to really prioritize those investments where they matter the most to execute our vision around Let's Solve Water.

So that's a big piece of, I think, where we need to go in the future.

The second big piece really just has to do with the structure and efficiency of the Company.

With these markets, we have diluted operating margin, as you well know.

And the team collectively have come to the conclusion that we simply need to get back up to the level of operating metrics that we know that we're capable of -- in a hurry.

And so that really induces strategies like a global strategic sourcing organization; a simplified and streamlined product line focus; an integrated front end that, quite frankly, not only is more capable than the independent selling organizations, but it has the potential of being more efficient.

So that's a lot to talk about, but it has to do with delevering, organizational simplicity, and clarification.

And I think all those things are going to go into the operating efficiencies that we know are possible in front of us.

Fantastic.

Well, thanks, guys, and good luck to you.

Brian Konigsberg, Vertical Research.

Hello, good morning.

Maybe first just with Mike.

Just trying to get a better sense of how the quarter, particularly on water infrastructure, progressed sequentially.

You had decent or modest topline growth on a quarter-over-quarter basis, and the drop-through to operating profit was just pretty extraordinary.

And I know you had sequentially -- I think you were suggesting $10 million, $11 million or so of incremental restructuring benefits hitting Q3 versus Q2.

But even removing that, you're looking at close to 100% drop-through of the revenue.

Maybe can you just talk about where there are other contributing factors -- what the other intervening factors were there, so we get a sense of how that played out.

(Technical difficulty) And actually this gets back to, I think, one of the questions that was asked earlier in terms of the conservatism in the forecast.

I guess a couple comments I'd make is, when we put our guidance out after second quarter, the one thing we were looking at is we were looking at July results, which were relatively weak and supported a --obviously, a much lower view of the trajectory we were headed on.

So, I think the first statement I'd make is the momentum started to build towards the end of July.

And then clearly as we got into August, it got a little bit more difficult to see, just given the dynamics that go on in Europe.

But it was clear that we were pulsing at a level that would suggest that we were going to have stronger revenue performance.

I think, given the dynamics we were facing, one of the things that we did is, not only did we have the cost actions identified, we had outlined what we called an EPS assurance plan.

So, essentially, we had identified additional cost activity to basically go and execute if the revenue didn't materialize.

So, essentially, we ran a scenario that said, what if we're flat sequentially for the first to second half?

What would we need to do to ensure that we got to our EPS range?

So, when I look at what happened in the third quarter, we got the revenue growth that was targeted; albeit it came a little bit late in the quarter.

And we also executed on the additional cost actions.

And so you got the double benefit of those.

And then you're obviously correct, and the restructuring kicked in substantially in the third quarter.

And we've been signaling that throughout the first half, relative to all the activities that we undertook in the first and second quarter, relative to primarily what is our European realignment.

Okay.

And then just secondly, Q4 revenues at $965 million -- so, flat sequentially.

I think, typically, we've seen over the last several years when you roll everything up, you did have anywhere between 5% and 15% uptick on a sequential basis, but you're looking for flat now.

Is that -- and also I think you've spoken before about the [interest] from municipal spending being very Q4-loaded.

Is that some conservatism there?

Or was there some pull-forward of revenue into Q3 from Q4?

If you could touch on it, it would be helpful.

Yes, I wouldn't characterize it as a pull-forward.

But, definitely, we saw a very strong third quarter.

Quite frankly, it was actually opposite of what we've typically seen, which is third-quarter drops from second-quarter.

So, admittedly, there is a little bit of conservatism in the fourth quarter.

If you look at the upper end of our range, it's more indicative of what you would typically see in terms of the seasonality uplift.

The one comment I would make is, our backlog position going into the fourth quarter has increased about 13% from what we had going into the third quarter.

So that's obviously a very good indicator, and gives us confidence.

But at the same time, as Steve highlighted, these markets have been volatile.

We've been dealing with this for the past year and a half.

And it's too early to call it a trend.

We're optimistic, and we'll continue to drive; and if it's there, we're going to get it.

Great.

Thank you very much.

Kevin Maczka, BB&T Capital Markets.

Thanks, good morning.

Can we just go back to visibility in general that you have, and the forecasting issues, Steve, that you mentioned?

I understand having a conservative forecast coming off a bad June and early July like you did as we went into Q3, but are there actual forecasting issues that you had that have now been fixed?

I think you mentioned Europe in the context of your new management change, but can you just address that?

What's different or improved that allows you, going forward, to have better visibility, and then allows investors to have more confidence in the guidance that you're giving?

Well, thank you.

The forecasting issues that I talked about were principally in the creation of an integrated, regional business, and the integrated front end, particularly in Europe; to some degree, in some of the other regions.

Where in order to make that effective and put the accountability out at the point of sale, there was a lot of moving parts internally on the forecast, with respect to things like transfer pricing and cost allocations.

And so we just finished about nine months of organizational change in that area, which made it difficult to see as clearly as we wanted to.

We'd had outstanding actual cost in revenue visibility, but that's always rearward-looking.

So, quite frankly, it was just a lot of financial discipline; some blocking and tackling; refining of formats and processes; and understanding of things like cost allocations and transfer pricing levels that, to some degree, have been -- with good financial work, with Mike and his team, have just gone through the system.

So, not that we aren't finished in that area, but we do feel better.

Mike, do you want to add to that?

Yes, I guess the only thing I'd add is the organizational changes that Steve talked about, I think, puts us closer to the point of impact and being able to see the inner workings of the business.

Because the thing I'll go back to is, we are improving visibility and our ability to put financial discipline.

But our business is heavy short cycle, and so it's important for us to be close to those trends to understand what's going on in the marketplace in a real-time.

If we go into any given quarter with less than 50% of our shipments sitting in backlog, and so I think that's always an important piece to keep in mind.

But I think the discipline; the financial changes that we've made; I think the organizational change that Steve announced is going to put everything closer to the point of impact.

And I think we'll have a lot greater visibility and accountability.

Okay.

And if I could just follow up, in terms of the short cycle nature, Mike, I think last quarter we were still talking about destocking at your distributors -- and that's a big chunk of your business -- seemed smaller.

[Or] orders and less frequent orders; and, therefore, you're carrying more inventory.

So, in the context of your bookings being better now, and the momentum starting to build in late July, are you seeing any notable change on that front?

I wouldn't say any notable change.

I would say, in our dewatering business, we saw the distributors start to restock.

We had been dealing with them destocking for the past couple of quarters.

And I think that's shown up in the positive results we've seen in our dewatering business, which has been on a nice, steady growth trajectory.

And I'd say, in our commercial segment, there's clearly been a strong performance there.

Resi continues to be -- it was down for us here in the third quarter.

The groundwater market, we're primarily servicing the well water market, as well as boiler circulators.

And we've seen a little bit of downward movement there.

But I wouldn't characterize that we've seen some big shift.

And I would not anticipate, in the near-term, seeing the distributors go back into a significant restocking mode.

Okay.

Thank you.

Chip Moore, Canaccord.

Morning.

With the increased emphasis on redeploying some capital back to shareholders, can you just talk about how that impacts your thoughts around M&A?

And then, as you look out at longer-term targets, if you do see acquisitions coming in at less than that, call it, 2% to 4% range, or organic growth a little below, do you think you can make that up through better execution and operating performance here?

Well, most certainly, we think the very best in acquisition that we have in front of us right now is Xylem stock.

So you can expect us to continue to deploy there.

Also, we have had some operating concerns as we have been talking about the whole call.

And we thought it prudent to take a pause on some of the actual acquisitions.

We're continuing to cultivate, and we still have a rich pipeline.

And, to the note of your question, yes, with respect to some of the operating metrics we're forecasting, and free cash flow generation, we will be able to continue to redeploy capital in the share repurchase and generate capacity for the acquisitions.

And we expect, over the next quarter or so as things settle down, we'll get back into the market.

We're absolutely committed to meeting our long-term targets that you are all aware of, in terms of operating margin, EPS, ROIC.

So that's all highly intact.

Perfect.

Thanks.

David Rose, Wedbush Securities.

Good morning.

I was hoping I could follow up a little bit on Europe, the upside surprise for the quarter, at least for us.

Maybe you can walk us through in terms of what you're seeing in Europe.

Were a large number of orders just released?

Was there a push?

And then maybe you could talk about -- I think you implied that there was a push for orders in September.

Was that Europe?

Was it across the board?

And what's the implication for margins going forward?

Was that at the expense of margins, or is it really what we've been seeing?

Yes, so, let me talk just a little bit about the -- I'd say the overarching dynamics around Europe.

We certainly had seen some dynamics, as I talked about in the last call, around public utilities pulling back.

And as evidenced by our overall aftermarket performance, which was up low-single-digits, we've seen a return to what I'll say is a more normal pattern around the break-fix, the operating maintenance, from a public utility standpoint.

In the industrial side, I think there was a de-cycling there in the first half.

And I think with more positive signs in Europe in general, we've seen things -- I wouldn't say that I would call it a recovery -- I'd say things are just starting to move again.

And then certainly the construction market has been favorable, specifically in areas like Germany.

And that's helped our commercial business, as well as our dewatering business, as we look at those dynamics.

From a margin standpoint, I guess I'd say a couple of things.

One, with the recovery in Europe, that's actually helped.

Because, as I mentioned, we got impacted pretty heavily in the second quarter, given our fixed cost structure in Europe -- which is on average 7 to 10 points higher from an SG&A standpoint -- because of our direct selling channel.

Obviously with a return of volume in Europe, that helps us more than cover those costs.

And you saw that come through in the third-quarter results.

The one dynamic we are facing, which we talked a little bit about in my prepared remarks, is pricing.

That is causing some topline pressure to the tune of about 30, 40 basis points in the third quarter.

I don't think that it's anything atypical of what the competitors are seeing either.

So I don't think there's any distortions in the market, nor do I think we've done anything to gain volume.

But I do think that's going to continue to be a headwind for us.

I think just given the overcapacity across public utility and the industrial space, that's going to continue to weigh a little bit on margins.

But, as Steve indicated, we've got ample opportunity to go out and drive improvements in our sourcing; in our Lean, value-based Six Sigma.

So we'll be able to go out and use that as an advantage to offset some of those headwinds.

Mike, that's helpful.

And I was also trying to see if there was any sort of -- and I think you made some commentary around potential pull-forward -- but when Steve mentioned the push for orders in September, did that mean at lower margins?

Where there some sort of special terms?

Was anything unusual or different that took place in September that would've taken place in any other month?

We had some marketing initiatives, like in our standard care and mixer lines.

We introduced some new products, and went out with some attractive new programs.

But for the most part, I'm just going to say it was disciplined blocking and tackling, and getting the sales teams focused on winning more.

Colin and Joe Vesey and the team have been driving a program called Find More, Win More, and Keep More, which is just a series of classic, good, strong marketing activities.

And they've been deploying that and I think we got some benefit from it.

Did you see the momentum continue in October?

Yes, we've seen -- the comment I gave you about October is our performance from a bookings standpoint, has roughly been in line with the guidance that we've provided.

So we've not seen anything substantially shift in the month of October.

Okay, thank you.

Jim Krapfel, Morningstar.

Hello.

Good morning, everyone.

How much industry overcapacity do you think there is in public utilities and industrial?

In other words, how much demand do you think would have to improve to bring pricing back to more normalized levels?

It's hard to say that, but it's got to be several percentage points.

If you just -- one way to think about it is -- you go back to the 2007, 2008 timeframe, and figure that the industry was probably at pretty full capacity at that point in time.

And you can sort of subtract from that what the gross markets have done since then, and probably divide that difference in half to get to the answer to your question.

The half being that companies have taken out some capacity on these downsides, but not all of that.

And, Jim, the only thing I'd add to that is if you look at just the US water and wastewater spend as a proxy for what Steve was just walking through, it's down to levels that go back to, say, 2004.

And so I think that gives you an indication of what would need to start to happen, which is essentially we'd need to start to see fully embodied projects released.

That's meaning not just treatment projects, but projects that include transport products, pumping primarily.

Okay, thanks.

Stewart Scharf, S&P Capital IQ.

Good morning, thanks.

You have obviously leading positions in many markets -- transport, industrial, water, test, building services.

And regarding the pricing again, are there any of those areas where demand might be more inelastic; or customers you have a relationship with, whether they'll stay and not base their decisions totally on price?

Yes, Stewart, I think you have to almost take it segment by segment.

I'd say that our applied water business probably has a little bit tighter curve.

When you look at our Flygt business, our direct selling channel I think gives us some ability to leverage.

But, again, I'm going to point back to the overcapacity in the industry I think has put all the competitors in a position where every bid is being competitively quoted.

And so I think that's putting some pressure from a topline standpoint.

Clearly, from a project business perspective, given the fact that projects are down some 15% to 20% from the height, pricing is extremely competitive.

And, quite frankly, the fact that things are not converting from bid to actual order is indicative of the fact that folks want to have another one or two looks at pricing.

In some of our premier brands, such as Flygt, we probably can get some good price just simply because we represent some very high quality.

But with the question earlier about some slight overcapacity in these markets, we've got great competitors out there that we are very respectful of, and everyone's working hard.

So price is going to continue to be an issue.

But that just merely underscores the comments I made earlier about the necessity for us to drive higher levels of operating efficiencies.

When I mentioned this global strategic sourcing group we're going to be establishing -- that is, in part, in effect now.

But we're going to make a holistic, global group out of it.

We're going to be able to substantially improve our net productivity in the areas of sourcing that will start adjusting our cost base, in ways that are going to address some of the front-end pressures.

So that's why we're working on that side of the equation as well.

Well, with that -- Operator, is there anybody else in the queue?

David Rose, Wedbush Securities.

Yes, I'm sorry.

I just have a follow-up question on your inventories, the jump in inventories for the quarter.

Can you just give us a little bit more color if that was raw materials, finished goods?

Was it in Europe?

Where did it come from?

It was kind of a big jump.

Yes, there's a couple of areas.

But I'd say we're -- as I've indicated the past -- we've probably impacted our inventory turns by 0.2, 0.3, in an effort to make sure that we can deal with what has been relatively volatile dynamics around the inventory delivery requirements.

And it's pretty equally weighted across the businesses, and from on geography standpoint.

David, I don't know that I could isolate it to one particular area.

It is an area of focus.

Steve and I clearly are not happy with the inventory and, broadly, the working capital levels that we're at today, so it's a key area of focus for us.

We're going to continue to monitor it.

And hopefully as the market starts to return to some level of growth, that will give us a little bit of pressure to be able to take some of that inventory out of the system, as leadtimes start to move back into something that's more reasonable, versus the very short nature that they are today.

Just to be clear, if the business started to get a little bit better than you expected, I would have assumed that you would have been running pretty lean on the inventory, given your guidance.

So, was there some sort of make-up at the very end as you got inventory out?

Well, like I said, we started to see order rates improving in the month of August.

And I'd say that the teams were moving quickly to make sure that they were able to satisfy the promotions that we were putting out into the marketplace; as well as to support the Find, Win, Keep initiative that we had underway.

So I think in light of what was a pretty disappointing level of performance in Q2, we were doing everything we could to make sure that if an order came in, we were in a position to satisfy it.

Okay.

So the 90% free cash flow conversion seems fairly reasonable then, by year-end?

Yes, I think so.

We had some dynamics with the way the receivables came in at the end of the quarter.

But that's not too out of the normal for what we see at the third-quarter point.

Okay, great.

Thanks, Mike.

I appreciate it.

That was our final question.

Now I'd like to turn the floor back over to Steve Loranger for any additional or closing remarks.

Well, thank you, and let me summarize what I hope everyone has ultimately taken away from this call.

We do have a lot of work in progress.

We are going to stay focused on doing the basics well.

And clearly we have a lot of work in front of us.

We have faced some real challenges, and those challenges are not going to subside any time in the future.

But we do have the foundation, the tools, and the global assets.

We've got some great technology, premium brands, terrific applications expertise, with comprehensive selling and distribution channels.

And I could tell you we've got some of the greatest, talented employees of any company in our space.

So, we've got these assets; and, collectively, we will eventually overcome some of these challenges and help realize our vision.

We do have three priorities right now.

First and foremost, as should come as no surprise, we have got the entire organization working to achieve the 2013 commitments.

Second, we are prioritizing our strategic to drive more topline growth, as I outlined.

And, finally, we're focusing both our strategy and our operating framework to accelerate and increase shareholder value, not only in 2013 and beyond.

So we've taken some decisive actions to improve our performance in the face of these ongoing challenges.

And I believe there's a lot that we can still do to perform better and grow faster across the businesses.

And our commitment, as you would expect, is -- we will move as quickly as we can to make all of that happen.

So, with that, I want to thank you for your participation.

And we look forward to talking with you next quarter.

Thank you.

This concludes today's conference call.

You may now disconnect.