賽莱默 (XYL) 2015 Q2 法說會逐字稿

Welcome to the Xylem second-quarter 2015 earnings conference call.

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

(Operator Instructions)

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

Thank you, Brandy, and good morning, everyone, and welcome to the Xylem second-quarter 2015 earnings conference call.

With me today are Chief Operating Officer Patrick Decker and interim Chief Financial Officer Shashank Patel.

They will provide their perspective on Xylem's quarterly results and discuss the full-year outlook for 2015.

Following our prepared remarks, we will address questions related to the information covered on the call.

For those participating in the Q&A, I will 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 ensure everyone the opportunity to ask a question.

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 midnight on August 13.

Please note the replay number is 1-800-585-8367, and the conference ID is 74050051.

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

With that said, please turn to slide number 2.

We will make some forward-looking statement 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 the future risks and uncertainties, such as those factors described in Xylem's most recent Annual Report on Form 10-K and in subsequent reports filed with the SEC.

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

Now please turn to slide 3, and and I will turn the call over to our CEO Patrick Decker.

Thanks, Phil, and thank you all for joining us today.

We have a number of items to cover this morning, but before we get started, I'd like to address the news regarding our Chief Financial Officer transition that we announced earlier this month.

First, my sincere thanks to Mike Speetzen for his many contributions to the Company over the past six years.

As many of you know, he played a key role throughout the separation process from ITT, providing strong leadership for the finance organization, as well as broadly across the business.

We wish Mike and his family the very best as they transition to a great new opportunity at Polaris.

I would also like to recognize and thank Shashank Patel, who is here with us this morning, for quickly stepping into the role of CFO on an interim basis.

With nearly two decades of experience at ITT and Xylem, Shashank has deep knowledge of our many businesses and is a highly respected finance and operational leader.

He has been able to hit the ground running and help facilitate a smooth transition, which is allowing us to proceed with a disciplined, thorough search for a permanent successor.

Now let's turn to the current market environment, our second-quarter results and finally our outlook for the balance of the year.

The combination of our uniquely diversified portfolio, along with strong execution, enabled us to deliver solid results in the second quarter.

I am pleased with our team's ability to perform well in a challenging environment, increasing long-term backlog, continuing to gain share and taking cost actions to mitigate pricing pressures.

And our Applied Water systems business turned in another record operating margin performance.

In addition, we are encouraged by what we're seeing in key end markets.

The commercial market, for example, generated solid growth over the first half of the year, and we anticipate growth to accelerate in Public Utility during the second half.

However, market conditions do remain mixed.

The industrial market broadly speaking is challenged.

As we've noted previously, the significant downturn in the oil and gas sector is having an unfavorable direct impact on our dewatering business.

As that downturn has persisted, the impact has expanded to other industrial sectors that are currently served by dewatering.

That said, dewatering is a very attractive business with a compelling historical growth profile, but we currently are working through some near-term market challenges.

Looking ahead, our focus remains centered on executing our long-term strategy and delivering on our commitments.

I am confident that we are well-positioned to whether the near-term headwinds and generate solid results within the range of expectations we previously announced.

As you saw in our press release this morning, we have narrowed the range of our full-year outlook to reflect our latest view.

Now let's review our results.

Orders in the quarter were up 1% organically against record bookings last year.

We continue to build backlog, exiting the quarter with just over $800 million in projects.

Notwithstanding that, we are still primarily a book and turn business.

I am encouraged by the strong execution that resulted in an increase in our sequential backlog, shippable beyond this year by nearly 40% in the quarter.

Let me highlight a few project samples.

We recently won a $6 million rental contract for Godwin Pumps for the Panama Canal expansion project.

As many of you know, the expansion project will double the canal's capacity and allow even larger vessels to utilize this waterway.

Our dewatering pumps are being used to fill the new lock basins with nearly 2 billion gallons of water as part of the testing phase for this new system.

This is a very complex application that needed tremendous technical expertise, and the team moved very quickly to meet the customer's tight timeline.

On our call last quarter, I discussed one of our innovative water reuse pilot projects in California where interest in water reuse continues to grow.

This past quarter, Xylem was commissioned to deliver a unique water reuse solution (technical difficulty) water reclamation plant in Los Angeles.

Our advanced oxidation process from Wedeco will be used to ensure that the plant complies with California's stringent groundwater recharge regulations for indirect portable reuse.

Finally, an example in the Middle East.

ASHGHAL, the public works authority of Qatar, has commissioned the construction of a new wastewater treatment plant in Al-Baqarah, northeast of the capital city of Doha.

Included in this plant will be a 56,200 cubic meter per day capacity water reuse facility.

In addition to our flight pumps and mixers, our state-of-the-art reuse technology, including products from Leopold, Sanitaire and Wedeco were selected for this new plant.

We expect to deliver product for this project in both 2016 and early 2017.

Shifting back to the second-quarter results, organic revenue growth in the quarter was 1%.

We generated growth of 3% in our Applied Water segment, including double-digit increases in China and Latin America, as well as continued strength in the US commercial building sector.

The Water Infrastructure segment was flat for the quarter, primarily due to a decline in our dewatering rental services business, which serves the US and Canadian oil and gas markets.

We expect these oil and gas sector headwinds to continue, but we are working to minimize the overall impact in the near-term.

For example, we currently are redeploying assets to regions where they can be utilized and at the same time help us to expand our international dewatering presence.

Partially offsetting these near-term challenges is growth in other key applications, including our water and wastewater pump business.

We are capitalizing on our strong product offering and well-earned reputation to outgrow the underlying market and increase share.

During the quarter, our business posted mid-single and double digit growth in the US and Europe respectively.

Again, this is an encouraging indicator the utility end market is stable and likely moving into an upward trend.

Our adjusted operating margin was flat year over year, excluding the unfavorable impact from foreign exchange.

The increased savings generated through continuous improvement actions preserve profitability, offsetting inflation and unfavorable mix resulting from the declines in dewatering rental services.

During the quarter, our new centralized procurement team was able to leverage our global scale in key categories to drive nearly $20 million in cost savings.

This team, which commenced late last year, is continuing to expand the universe of spin categories that it targets in order to reduce the consolidated Xylem spend.

I am very pleased with our contributions to date.

At the bottom line, we delivered earnings-per-share of $0.43, up 2% year over year, excluding the impact of foreign exchange translation.

Considering the muted topline growth and unfavorable mix, we were pleased with our team's ability to deliver earnings in line with expectations for the quarter.

And finally, we also improved free cash flow generation, up 21% year over year for the quarter.

Now let's turn to slide 4. I will briefly summarize our outlook for 2015, and on the next slide I will outline the changes relative to our previous guidance.

We now anticipate 2015 organic revenue growth of 1% to 2% for the full year.

Our adjusted operating margin is expected to grow in the range of 40 to 60 basis points.

We are narrowing the range of our adjusted earnings per share guidance to $1.82 to $1.87 for the full year.

We now expect year-over-year EPS growth in the range of 4% to 7%, excluding the year-over-year impact of foreign exchange translation.

Finally, we will continue to execute a disciplined approach to capital deployment, which is still expected to result in 100% free cash flow conversion.

With that, let's turn to slide 5, and I will provide some additional color on the outlook.

We are reducing the top end of our full-year revenue outlook by approximately 1 point of organic growth or $40 million.

This reflects the incremental weakness in our dewatering business.

While the dewatering rental declines in the oil and gas market generally remain in line with our previous expectations, we are seeing incremental unfavorable impacts on our distribution partners.

This is the result of a weaker industrial CapEx market, as well as a prolonged oil and gas decline.

We had also updated our pricing outlook.

We now expect pricing to be flat for the year, which is down slightly from our previous expectations.

In summary, organic revenue growth is now expected to be approximately 1% to 2% and, as a result of a slightly stronger euro, total revenue in the range of $3.64 billion to $3.68 billion.

From an earnings-per-share perspective, we have narrowed our guidance range to $1.82 to $1.87.

This reflects the change in revenue, as well as unfavorable mix.

We are diligently working to offset as much of these headwinds as possible and are driving for an incremental $0.07 of earnings from productivity actions.

These actions, which include global procurement opportunities, further lean deployment and strategic cost management, are currently underway.

However, we expect to realize the majority of the benefits in the fourth quarter.

Finally, we are also updating our second-half guidance for foreign exchange translation of $0.02.

As we look ahead to the second half, we are not counting on a significant uptick in the current macro environment.

We are confident in our ability to deliver modest growth as we navigate through the challenging conditions in the industrial market.

We intend to leverage that growth and execute on cost savings initiatives to deliver on our full-year commitments.

With that, let me now turn the call over to Shashank Patel to walk you through the results and full-year guidance in more detail.

Shashank?

Thanks, Patrick.

Please turn to slide 6. We generated revenues of $920 million, down $85 million from the prior year.

The year-over-year decline reflects the anticipated foreign exchange translation headwind driven by a stronger US dollar and the impact of our valves divestiture in the third quarter of 2014.

Excluding those items, organic revenue increased 1%, slightly below our expectations and the outlook we provided during our last call of approximately 2%.

From an end market perspective, commercial lead the way, up 6% with Public Utility and Agriculture up 2% and 1% respectively.

Partially offsetting these gains were declines in the residential market of 2%.

The industrial end market was flat year over year.

From a regional perspective, we again saw strong growth in emerging markets, up 9% combined with 10% growth in Australia and modest growth in Western Europe, up 1%.

This was mostly offset by declines in Canada and the US, which were down 16% and 2% respectively, primarily due to industrial oil and gas market headwinds.

Operating margin was flat at 12%, excluding the negative impact of foreign exchange translation.

Once again, despite headwinds in our largest end markets limiting our organic growth, we are able to demonstrate our ability to execute cost management to maintain our operating margin.

Focus on continuous improvement and restructuring savings reduced costs by $32 million in the quarter and resulted in 350 basis points of margin expansion.

Partially offsetting these reductions were inflation costs, unfavorable sales mix and the impact on the divestiture of our valves business last year.

Earnings-per-share declined by $0.05 to $0.43.

However, excluding the foreign exchange translation headwind of $0.06, we grew EPS by 2%.

Now, let me cover each of our reporting segments.

Please turn to slide 7. Water Infrastructure recorded orders of $585 million, flat organically.

Here, we saw high single-digit growth in treatment and modest growth in water and wastewater pump applications, offset by weakness in our dewatering business.

Book to bill was 1.06 in the quarter.

We exited the quarter with total backlog of $614 million, up 9% on an organic basis.

Of this amount, approximately 70% is due to ship this year with a balance of nearly $200 million expected to ship in 2016 and beyond.

The revenue of $551 million was also flat year over year on an organic basis.

From an application perspective, test and transport revenues were flat, while treatment was down 2%.

Regionally, we generated most of our growth in the emerging markets, which were up 8%.

Australia and Western Europe both contributed approximately $3 million of growth or 11% and 1% respectively.

However, declines in the US and Canada mostly offset our growth.

To further summarize our revenue performance, I would highlight international expansion of dewatering and tests drove growth in emerging markets like Latin America, India and China.

In Western Europe, we saw broad-based demand for water and wastewater pumps, partially offset by a decline in treatment project deliveries in Spain and France.

Australia was up double digits, proudly driven by strength in treatment where we are benefiting from regulatory growth drivers around controlling sewer outflows and increasing wastewater recycling for reuse.

Test was flat overall, probably because of the timing of a multimillion dollar project shipment which slipped into July.

Lastly, we saw significant declines in the US and Canada derived from lower demand for oil and gas dewatering applications.

Operating margin decreased 30 basis points from 13.1% to 12.8%, excluding a 30 basis point headwind from foreign exchange translation.

Operating margin was negatively impacted by inflation and unfavorable mix, coupled with an increase in growth investments and pension costs.

This was partially offset by cost reductions resulting from sourcing and lean initiatives, as well as $3 million of restructuring savings.

Let me now turn to slide 8 and walk through our Applied Water segment.

Applied Water recorded orders of $359 million, up 3% organically.

The strength was headlined by commercial building services as we continued to see recovery in the institutional building market in the United States.

Additionally, we saw significant growth in the commercial sector and, to a lesser extent, in industrial within emerging markets.

As a result, we enter the third quarter with a total backlog of $198 million, up 6% on a constant currency basis.

Approximately 80% of this backlog is expected to ship this year.

Revenue was $369 million, up 3% organically from the prior year.

Building service applications were up 3%.

Industrial water increased 3%, and irrigation grew 1%.

Regionally, we generated growth in emerging markets and the US, which grew 13% and 1% respectively.

Western Europe was slightly down overall for the quarter.

To summarize further our revenue performance, I would highlight we continue to see growth in emerging markets region, particularly Asia-Pacific and Latin America as commercial and industrial markets continue to expand.

Additionally, growth in building services was driven by strength in US commercial up 6% where we have seen distributed stocking due to the continued recovery in the institutional building sector.

Irrigation increased slightly as strength in the US and Latin America offset weak market conditions in Europe.

Residential was down 2% globally from weakness in Europe and roughly flat performance in the US.

Operating margin expanded 10 basis points from 14.7% to 14.8% year over year, excluding FX translation headwinds.

Margin improvement was driven by the favorable impact of cost reduction initiatives and volume leverage.

These factors were partially offset by negative sales mix, inflation costs and the unfavorable impact of the valve divestiture.

Now let's turn to slide 9 where I will cover the Company's financial position.

Xylem maintains a strong cash position with a balance of $600 million at the end of Q2.

Our net debt to net capital ratio is a healthy 25%, 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.

During the second quarter, we invested $20 million into capital expenditures, and we returned $25 million to shareholders through dividends.

We have approximately $60 million of additional potential repurchases under our authorized share repurchase program.

Free cash flow was $64 million during Q2, which marks the improvement of $11 million from the prior year and primarily reflects improved working capital performance.

With that said, please turn to slide 10, and I will cover our 2015 guidance.

At the segment level, we expect Water Infrastructure revenue in the range of $2.2 billion to $2.3 billion, reflecting organic growth of 1% to 2%.

And for Applied Water, we expect revenue of $1.4 billion with organic revenue growth of 1% to 2%.

Segment margins are anticipated to be in the range of 14.3% to 14.5%, and operating margins are projected to be in the range from 13.0% to 13.2%, reflecting margin expansion of 40 to 60 basis points, excluding the impact of foreign exchange translation.

At the bottom line, we anticipate earnings-per-share of $1.82 to $1.87, excluding restructuring and realignment costs of $20 million.

As Patrick noted earlier, we have narrowed our full-year outlook to reflect a slightly lower organic growth and unfavorable mix, partially offset by an increase in productivity and cost savings.

Additionally, we have also updated the projected impact from foreign exchange translation.

As noted on the slide, we expect EPS growth of 4% to 7%, excluding the negative impact of foreign exchange translation.

As mentioned earlier, we are driving to 100% free cash flow conversion of net income, and this takes into consideration expected CapEx in the range of $120 million to $130 million.

We expect return on invested capital to (technical difficulty) approximately 11%.

Excluding the anticipated impact of foreign exchange translation, we would expect approximately 50 basis points of improvements in 2015.

Our operating tax rate is still expected to be 21%, approximately 1% higher than 2014 given the expected mix in regional revenue.

Lastly, fully diluted share count is expected to be 183 million.

Turning to slide 11, w have provided for you a summary of our first-half performance by end market, along with our current full-year outlook, which, as you can see, has been adjusted to reflect current end market conditions and anticipated trends.

In summary, industrial, which represents 44% of our total revenue, is expected to be flat year over year versus our previous expectations of low single-digit growth.

Our current full-year outlook reflects our first-half performance and lower general industrial growth assumption over the second half of the year.

The Public Utility sector, which constitutes 31% of our total revenue, is anticipated to grow at a low to mid-single-digit rate.

Here, we have increased our outlook to reflect our first-half performance, solid backlog at our water/wastewater transport pump division, and encouraging signs of improving market conditions in the US.

For the commercial market, our full-year outlook remains unchanged with growth expected to be in the low to mid-single digits.

Again, the US market appears to be improving, and we continue to estimate strength in the emerging markets.

We do expect growth to moderate over the balance of the year, given the restocking activity we saw over the last nine months.

Conditions in Europe remain soft, but we continue to expect that new products will drive growth over the second half.

We now project the residential end market to be flat, reflecting first our first-half performance and expected stable US market conditions.

Previously we had anticipated a low single digit decline.

Finally, our smallest sector, Agriculture, will likely be down low single digits for the year.

Strength in the Western US region driven primarily by continuing drought conditions is expected to be more than offset by unfavorable flooding impacts in Texas and other parts of central US.

It is also important to note that we face very difficult year-over-year comparisons in this market segment, as well as weak European market conditions.

Turning to slide 12, given the continued focus on foreign exchange and expected incremental headwinds, we thought it would be appropriate to revisit the information we covered last quarter.

So, first, let's begin by discussing Xylem's foreign exchange transaction exposure.

This is true economic exposure and, as such, we have in place a comprehensive hedging program that substantially mitigates our overall transaction exposure.

Our strategy is to proactively hedge and mitigate up to 75% of net cash flows for our seventh-largest currency pair exposures.

We do this on a rolling 12-month basis.

Furthermore, we hedged the monthly mark-to-market exposure on our balance sheet, and all of our hedging activity utilizes forward instruments.

Finally, as it relates to foreign currency transaction exposure, I would highlight that any residual impact not offset by our hedging program is reflected in our underlying operational performance.

Now let me address foreign currency translation exposure, which is the impact resulting from translating financial statements of foreign entities back into US dollars for financial reporting purposes.

Given the nature of this exposure and the anticipated impact on our financial results in 2015, we will continue to isolate the impact so you will be able to better judge the operational performance of our Company and progress against strategic initiatives.

The table illustrates the top five currency exposure for Xylem.

It provides you with the average exchange rate for each currency last year and the rate assumed in our previous guidance, as well as the average rate during the first half.

Perhaps most importantly, because FX rates have continued to significantly fluctuate, we have also included the rates we assumed in our guidance update.

Similar to last quarter, the table includes the full-year expected impacts on revenue and operating income.

To summarize, based on the rate assumptions used for our guidance update, full-year revenue will be negatively impacted by approximately $300 million and operating income by approximately $64 million, which will result in $0.23 of EPS headwind.

As you can see from this slide, we already saw revenue negatively impacted by $162 million and operating income by $25 million over the first half.

And we expect second-half results to be negatively impacted by $138 million on the top line and $29 million for operating income.

As Patrick highlighted earlier, we are reflecting the recent strengthening of the euro in our forecast.

This benefit is reflected in both our second-quarter performance and the outlook for the balance of the year.

We will continue to provide quarterly updates with full transparency.

Turning to slide 13, I will provide some color with regards to our expectations for the second half.

I would like to spend a minute calibrating everyone on the call around what we expect our revenue and operating income profile to be over the balance of 2015.

I will begin with some comments around our shippable backlog.

Of the total $812 million in backlog, $573 million is shippable in the second half of the year, and the remaining $239 million is expected to ship in 2016 or thereafter.

Third-quarter shippable backlog is approximately $405 million, and that represents approximately 45% of our expected third-quarter revenue and is consistent with what we had last year.

So we still have a lot of book and turn business to secure and deliver in the quarter.

As for the revenue growth, we expect second-half organic revenue to be approximately 1% to 2%.

We see the second-half profile similar to years past, down sequentially in the third quarter with a ramp-up in the fourth quarter.

More specifically, we expect revenue to decline in Q3 approximately 3% sequentially from the second quarter, reflecting the impact of European seasonality in July and August.

On a year-over-year basis, we expect third-quarter organic growth of approximately 1% to be more than offset by foreign exchange impact of approximately $80 million.

We expect sequential operating income performance in the second half to be driven by volume and incremental cost improvements in the areas such as global sourcing, lean and strategic cost management.

Second-half sequential experimental margin is expected to be approximately 56%, lower than last year's sequential performance, primarily reflecting unfavorable mix.

As for the third quarter, we anticipate margin declines of approximately 20 basis points year over year, including FX translation.

By segment, we expect the sequential margin improvement to be more pronounced in Water Infrastructure than in Applied Water.

Finally, we expect full-year corporate expense of approximately $50 million.

With that said, please turn to slide 14 and let me hand the call back over to Patrick for some closing comments.

Patrick?

As we move past the midpoint of the year, I am pleased with the progress the team has made.

Particularly in terms with of their continued focused execution.

While we are weathering some near-term market challenges, several areas of the business have delivered solid growth.

Importantly, we continue to advance our strategic agenda, and I look forward to updating you in more detail on that agenda at our upcoming Investor Day.

As a reminder, it will take place on Thursday, September 24 in New York City.

At that time, we plan to outline our long-term growth strategy, which will include organic and inorganic growth plans, our continuous improvement agenda, as well as our capital deployment framework to drive shareholder value.

It will also be an opportunity for you to engage directly with my leadership team.

We will share more details on the agenda in late August.

And now operator, we can begin the Q&A session.

(Operator Instructions) Deane Dray, RBC Capital Markets.

I was hoping we could start on the comments on muni, and it's been a while since there has been some positive comments about growth and rebounds.

And so take us through first geographically the European municipal buyers versus the US and address where the pickup is coming.

Is it from break and fix, MRO, or are there any projects getting released?

Thanks, Dean.

Yes, so let me give some overall commentary here.

I would say it is a combination of both in terms of break and fix, as well as some project activity there that we see rebounding.

When you take a look at what we have seen thus far, we looked at about 2% growth in muni in the second quarter, about 2% through the first half of the year.

We are seeing an acceleration in that area.

We expect the second half of the year to be up mid single-digits, and so we are seeing some acceleration there.

It is being driven primarily both treatment and transport, predominately in the US, but I would say also as well as Europe.

But Europe, to a lesser extent than the US.

Are you actually seeing projects getting released?

It is a combination of both.

Yes, we are seeing projects getting released.

Again, it is still a bit slow, but we also have seen an increase in the quoting activity, as well as in our win rate on that quotes.

This is Shashank.

Just to add to that on the pump side from our transport division in the second quarter, we are up 6%.

For the half, we were up 4%, and that's where we see trends in the second half of the year as well.

Understood.

And just the second question to maybe you can expand on the expectations regarding pricing.

It doesn't sound like it's a big headwind, but directionally it looks like it has gotten a little bit tougher for you.

And maybe if you can parse out what the pricing environment is like on OE versus your aftermarket business?

Sure.

A good question.

So I would say, first of all, through the first half of the year and continuing through the second quarter and we expect this to continue through the rest of the year, pricing has pretty much been neutral.

We had previously expected it to be up about 30, 40 basis points, and right now we're seeing that being neutral across the business.

But that is an aggregated number.

When you take a look at the individual pieces of the portfolio, I would say we are beginning to see the supply/demand mix work in our favor over time on the muni side of the equation.

We haven't seen that fully come to realization yet, but we expect that to be the case more in 2016 and beyond as we see increase in demand.

Where we have seen the most pressure from a pricing standpoint has been predominately in Applied Water, and that is the well pump business there, where again it is a soft market, tough competition, and so we are taking a very disciplined strategic approach in that area.

Obviously we are also working to put that pressure back on our suppliers by being more aggressive on the sourcing side, so we can mitigate any of that pricing pressure we are seeing.

Thanks.

And just hopefully if he is listening, wanted to wish Mike Speetzen the best, and we will really miss him.

Absolutely.

I'm sure he is listening.

Nathan Jones, Stifel.

If we could just start on the commercial side there, you had first-half plus 8%, you're looking at low to mid singles for the full year, which would kind of imply a pretty wide range of download singles to up mid singles in the second half.

I know you talked a little bit about distributed stocking in the first half and destocking in the second half.

If you could give us a little bit more color around the slowdown in commercial in the second half and how much of that is destocking versus end market slowdown.

This is Shashank.

I will take that one.

We actually saw growth in the first half of 7%, and there was distributive stocking in the first half, primarily in the US, as well as we had strength in China.

China was up in the high, high teens.

And what we expect in the second half, specifically in the US, a little bit of destocking going on, as well as slower growth in China in the second half, driving to a -- we are calling it low single digit growth in the second half versus the plus 7% we saw in the first half.

I would say that we are quite encouraged by what we see happening in the commercial building sector.

As you know, we are heavily weighted towards the institutional side of that market, and we are seeing a continued recovery in that space.

Okay.

Then just on the overall margin guidance for the Company, it's gone from a 13.2[%] midpoint to a 13.1[%] midpoint.

You said you had expected 30 to 40 basis points in prior, so that is now neutral.

There is a couple million dollars lower expectation of restructuring savings.

Can you talk about where the offset on the positive side is coming from to those two negative things?

Sure, yes.

So a couple of areas.

First of all, we have really been driving the global sourcing, global procurement and productivity effort here quite aggressively, and we've seen an uptick in that progress.

So that is certainly helping us out here.

Obviously we also saw some uptick as we talked about in the area of commercial and public utilities, and those tend to be good margin businesses for us.

And so that helped mitigate.

The biggest single driver of our margin outlook for the balance of the year really is driven by industrial being weaker than expected, and that is just given the very higher-margin nature of our dewatering and rental business.

And so that's really what's driving predominantly that downtick.

We are trying to more than offset that as much as possible through other productivity efforts.

And just another note on that is realizing that we were in competitive markets, as well as tough markets industrially, as well as dewatering mix impact, we have taken a more -- we always take a good approach on cost management, but we've also focused more on the cost management side to help with all the other productivity that we work on.

All right.

Thanks very much, guys.

Ryan Connors, Boenning & Scattergood Inc.

I wanted to talk a little bit about the Europe side.

You noted stronger growth in industrial applications in the slide deck in Europe.

I assume that is some of the new products on the HVAC side that might be driving that, but if you could just expand on the drivers behind that strength in European industrial?

Actually on the HVAC side, we did have significant launches last year as well as this year.

So we have seen some of the benefit of that during the first half of the year, and we expect to see additional products that will be launched in the Q3 time period of this year.

So we expect to see continued strength from them, primarily driven by product launches.

This is Phil.

We also saw an uptick in the quarter, particularly from our wastewater pump division.

Patrick's comments earlier I think were directed to the Public Utility market, and we did actually strength there as well.

But the industrial wastewater pump market also was up quite significantly in the second quarter.

Okay.

And will that pipeline of new products continue to be refilled as we move into the balance of 2015 and into 2016, or will we kind of start to anniversary some of those and then hit some tougher compares?

Good question.

First of all, we definitely will continue to see an uptick in the amount of new product launches.

Obviously we need to manage that in terms of we don't want to over load our sales teams with too many new products.

But there's quite a bit in the hopper right now that we are quite excited about, and we will be walking you guys through an investor day, some of those exciting launches and some of the key focus areas that we are targeting.

But the short answer is yes.

We will continue to see new products be a very integral part and critical part to our growth strategy.

When you look at our vitality index, it's up to 18%.

So there's something we've been working on for the last two, three years, and it continues to tick upwards.

So that continues to be a focus, and our goal is to continue growing that so the pipeline will continue.

Okay.

And then this is kind of a tough one to answer I realize, and I know we are going to hear more about this at the analyst day.

But if you could just kind of qualitatively discuss for us, Patrick, your initial thoughts on 2016 top line.

There are so many moving parts.

I guess we have the ForEx headwind will analyze and go away on a translation basis, and we've got the different end markets.

What is your kind of thought process about how 2016 will shape up relative to the Company's longer-term topline growth goals?

Sure.

So yes, as you said, obviously we will give more color at Investor Day, and it's a little early for us to project given somewhat of the short cycle nature of the business here.

But let me speak at a top level.

I am very encouraged by what we are seeing, particularly on the public utilities and the commercial side of the equation.

And the fact that you are looking at a sizable increase in our backlog that is shippable in 2016 and beyond, again we have seen more than a 50% growth in that in a total companywide basis.

So that is quite encouraging.

I would say, so looking at it from that perspective, that all net-net is positive and probably positive up versus what I would have been thinking previously.

Having said that, the one big unknown that we have got obviously is how long this oil and gas weakness is going to continue and given the impact it has on our dewatering business, which is such a high margin business for us.

So that's really in my view the biggest wildcard right now.

But everything else net net I am feeling more encouraged.

Okay.

So I guess if we look at the long-term growth goals that the Company has thrown out there in the past, would it be safe to say 2016 has given us some puts and takes, but it is more or less kind of a normal year, right?

I mean you've got some nice drivers and a few offsets.

That's correct.

Okay.

Great.

Thanks for your time this morning.

David Rose, Wedbush Securities.

Just a couple quick ones.

One, following up on the procurement initiatives, can you quantify how much of the spend as a percentage of total spend is left to target and what your expectations are in terms of the dollar amount of savings left?

And maybe the big buckets if you could.

Yes, I will stop short of giving specific numbers here today.

We certainly will be in a position to kind of lay out what that overall target opportunity is, certainly at Investor day.

This is a multi-year journey that we are on, and we have obviously been going after the biggest spend categories and the most obvious spend categories, things like castings for example.

So I would say most of our progress thus far has been in those direct spend categories.

There is still plenty of room for us to move there, and certainly as we see growth in volume as we look into the out years, just that increased level of volume and spend will continue to refresh and give us an opportunity to drive procurement savings there.

Obviously indirect spend in some of the other categories of spending are areas that are still very rich and fertile for us to go after.

But, again, we will talk more about that in detail at Investor Day.

Can you just maybe bracket and ballpark about how much spend is left to go after?

I would say that on the direct spend, which we have been working on for many years, we have captured most of that.

On the indirect spend category, where we had a big effort starting about 12, 18 months ago, there I think is where the biggest opportunity is.

As far as a percentage, I am not exactly sure.

But I think we probably targeted at least 50%, 75% of the indirect spend categories.

So there still is -- as Patrick said, there is still more opportunity for that.

Yes, this is a multi-year journey effort.

So the buckets evolve.

The level of spending evolves.

So I will stop short of talking about a specific number or percentage right now.

But again, we can get into that in more depth on Investor Day.

Okay.

I appreciate that, and I certainly understand.

And maybe if I could, one more kind of on a big picture item.

The cash flow is great for the quarter.

You seem a little timid on the share buyback, and maybe you can articulate for us what you're thinking about that?

Sure, yes.

So share repo, it continues to be one of the elements of our capital employment framework.

It will continue to be an important element of our capital deployment framework.

Obviously beyond offsetting dilutive impacts from equity grants, we do view repurchases as an opportunistic lever to return capital back to shareholders.

Again, we are going to update you in terms of what our outlook and what our plans are for that at analyst day as well.

But you can rest assured it will continue to be an important element of our framework.

Okay.

Great.

Thank you.

I look forward to hearing more.

Joseph Giordano, Cowen and Company.

It's Tristan Margot for Joe today.

Just a couple of quick ones here.

Most of my questions have been answered.

But could you give us a breakdown of the organic quarter growth that you have by region and by end market?

Tristan, this is Phil.

That is information we don't typically provide, but if you get a sense -- just as a reminder, the Applied Water division is very much so a book and ship business.

And so you can pretty much approximate the same geographic profile application profile as the revenue organic profile, organic growth that we highlighted earlier today.

As far as the organic order growth for Water Infrastructure, perhaps I would just leave you with the thought process that we are seeing an uptake in orders on the treatment side in both the US and Europe, and we continue to see continued healthy growth on the emerging markets side.

All right.

Great.

Thank you.

And then just a quick one, oil and gas, I know you have highlighted I think a 40% decline in the second half.

What are you seeing directly in oil and gas?

Is it have we flattened out here, or what are your expectations?

What do you see right now?

The 40% decline that we talked about previously is still in line with our latest outlook and expectations as we talked about in our prepared comments.

What you're seeing here in terms of us talking about further weakness there is really more of a broader industrial knock-on effect and the impact it has on some of our distribution partners.

So our outlook remains unchanged.

It's, again, roughly 40% down year over year.

In terms of weather, that's the bottom.

I mean it certainly -- we hope it's the bottom.

It feels it's like the bottom.

But I think it's hard for anyone to make that prediction just yet.

So that's why we are taking a cautious approach here.

Okay.

Great.

Thank you for taking the questions.

Scott Davis, Barclays.

I just wanted to get some clarity on where you spend your capital, where you think there is growth, and what kind of projects and things you are spending money on, whether it be adding capacity versus productivity and things like that?

From an overall capital perspective, I would say -- and I will talk about this both in terms of true CapEx versus where we are directing maybe our ongoing expense focus as well, certainly we see the opportunity.

We are executing on that in terms of investing more in a few of our critical emerging markets.

And so again, building some extra capacity in China to support the growth in demand there, as well as certainly in the Middle East, we have approved an expansion there that I talked about a little bit briefly in the last earnings call, and that will be localizing our assembly and test capabilities and adding some additional feet on the street.

We have been investing as a priority more in R&D to again drive our new product development pipeline.

And again, we are quite encouraged by some of the opportunities there.

And then I would say third, probably not big news to any of you on the phone, simplifying our IT environment and reducing the number of systems that we've got and investing more in the IT implementations to support the front end of the business is the third area, I would say, of priority from a capital perspective.

Okay.

Good.

Fair answer.

And then I don't know how you can comment on this, but I'm curious to hear your thoughts at least on Pentair and [Tryon] and at least the concept to consolidating the industry.

I mean how easy -- I will approach it from this angle since you'll probably tell me you're not going to comment.

But how easy is it to consolidate this industry and how much consolidation do we need to see?

When I think about flow in general, it is one of the most fragmented of the sectors that we industrial analysts cover.

There are probably 25 players out there, and we've got a number of verticals that are consolidated down to four or five major global players.

How do you think about this industry and how it stacks up in the next several years and what kind of consolidation we might see and how easy is it to consolidators?

Just does it look easy from the outside, but when you really dig in, there's channel conflict and all kinds of other issues that you have to navigate that makes it less adjusting.

Sure.

Well, I may please you here.

I won't say no comment.

But obviously as a general practice, we don't comment on speculation or on other kind of moves.

But obviously being a flow control veteran and following the space for a number of years, I think it is easier said than done.

Having said that, it is still fragmented, and there are opportunities to consolidate in the space.

There is more complexity behind that than meets the eye for many of the reasons that you pointed out.

And so in terms of predicting what will happen, what could happen, I wouldn't go further than that to speculate.

Again, we remain focused on our strategy and executing what we are going to do.

Obviously deployment of capital toward M&A is going to be a very meaningful part of that.

We will be sharing a bit more about that in terms of areas that are particularly interesting to us at Investor Day, and that will be a richer dialogue at that point, Scott.

Okay.

And then just last question.

When times are tough like this, you normally see market share shifts go back to the best players or the strongest players, most well-capitalized and most cost suppliers, producers and the scale and such.

It's progressed to get external validation.

But do you feel like you are gaining share?

Does it feel like you are outperforming your sub industries?

I am always cognitive not to get too far ahead of my skis here in terms of talking about share.

But the bottom line is, I am very pleased by what I have seen through the first half of the year when you have taken a look at our growth rates and our key end markets relative to what the underlying end market growth is.

I think you see that most prominently in, again, our pump businesses.

You also see that I think to a meaningful extent in a number of our businesses, including treatment, but it's too early to kind of declare that.

It is still a tough market.

We are using all the levers that we have at our disposal, but it does feel quite encouraging on behalf of the team right now.

But again, we have still got a lot of work to do to make this sustainable.

Okay.

Fair enough.

Good luck, guys.

Chip Moore, Canaccord Genuity.

Just wanted to follow up on the rental biz a bit.

Do you think headwinds bottom out here in the second half, some of those idle assets get redeployed, or where do you think we stand in that process?

Maybe if you have some historical context.

Sure, yes.

So the team -- I've been very pleased with what the team has done in proactively addressing this, and we do expect to see benefits of the redeployment of a large number of our pumps, to put them out for rent in some of the international markets.

And so I think we are looking at this as a silver lining on the situation because it does help us accelerate building out that international business.

That takes time to get the pumps there, to get them in place and ready to rent, and obviously you've got to create demand.

But we are quite encouraged and optimistic about the opportunities there.

That certainly will help us as we go into 2016 as well.

Certainly in terms of do we think it's the bottom, do we think it gets better from here, as I mentioned earlier, that's hard to predict.

It feels like it.

I think the team is optimistic that it is the bottom at this point in time.

What I feel good, though, about is again the approach the team has taken, and I do think that will help buffer relative to some of the other players in the marketplace.

This is Phil.

I will just add, not that we want to exclude obviously portions of the business from our results, because it's the whole idea behind the diversified portfolio.

But if you did take a side the oil and gas related, say, dewatering rental branches out of the equation, we are seeing very solid growth in all the other ranches.

And I think that plays into the diversified application expertise of our Godwin business here in the US and more broadly speaking across the globe.

Okay.

That's helpful.

Thanks, folks.

Brian Konigsberg, Vertical Research.

A couple quick questions.

On just the adjusted guide for the year, the productivity number of $0.07 just seems like it's decently large.

I know you guys put in place spending curtailments late in 2013 as well, which seemed to yield pretty good benefits.

Has kind of the belt loosened over the course of 2014 and now you are bringing that back down, or are you finding more opportunities?

And maybe a little bit more color on that book it would be great.

Sure.

Yes, I would say the belt has absolutely not loosened.

I think it is an issue of just continuing to apply good disciplined cost management and constraint, as well as identifying further opportunities for cost reduction efforts, as well as we talked about just the acceleration in our global procurement capabilities as well.

As you heard us probably say before, I do think that the large majority of the opportunities that have been done this far have been happening within the individual business units themselves.

And to some extent, in the function, the opportunity going forward here as we talk about the opportunity to simplify the Company further is really looking at things horizontally from a Company perspective as opposed to just within the units themselves.

So they are harder to get at, but that is a big part of what I call the self-help story in terms of margin expansion.

The other point to note is from a productivity standpoint, historically the second half is stronger than the first half.

And that is just leveraging the incremental volume we have.

That helps productivity as well as the whole fixed overhead cost issue.

So if you look at even 2014 second half to first half, we had an improvement of almost $0.06 in productivity.

So $0.07 is kind of in line with that with the additional actions we have taken and the global procurement effort we are accelerating this year.

So just to be clear, that $0.07 when you build up from previous guidance to the new guidance, that $0.07 incremental versus what you planned as of, say, the first quarter, is that correct, and is that mostly coming from procurement, or is it mostly coming from discretionary spend that you are able to cut back on?

It's primarily coming from procurement.

And Brian, one element just to highlight, we got some of that benefit already here in Q2.

And so as you kind of think as we are trying to offset some of this unfavorable mix and we are certainly ramping up the GSS activities, given the deflationary environment, we want to go back and certainly push that with some of our suppliers.

Expecting, of course, that it will take some time to get a little bit of that acceleration.

So you should see more that benefit come in the fourth quarter.

Okay.

Got you.

And maybe you just touched on inflation or deflation.

I mean do you anticipate you are going to start to see some deflationary benefits in the second half of the year just from commodity prices coming down?

I know you are pushing down into the supply chain itself, but just kind of the raw materials you are purchasing, does that become additive to you versus the previous guidance, and is it baked into the numbers?

It's baked into the numbers, and you're right, it will help in the second half.

That will be in the second half, okay.

And if I could sneak one more in, just on the oil and gas part, so there has been a lot of discussion about US drillers kind of approaching, I guess, the market with refracking rather than just natural fracking.

Does that present the same type of opportunity for your transport dewatering business as it would for, I guess, a normal state of drilling?

It would be -- we would largely be indifferent to that.

So it would still be the same level of activity to be managed.

Okay.

All right.

Thank you.

Brent Thielman, Davidson.

Just one more question.

On the dewatering business, you have some headwinds in areas like mining and oil and gas.

Can you remind me how much these sort of commodity sectors represent as a portion of that business?

Yes, so oil and gas is about -- and again, oil and gas, mining, that whole commodity play is about 15% of our dewatering revenue.

Okay.

Great.

Brent, this is Phil.

I just want to make -- it's 15% each.

Between mining and oil and gas?

Correct.

So the two of them combined make approximately, call it, 30% to 35% of the dewatering profile.

Great.

Thank you.

Robert Barry, Susquehanna.

I was wondering if you could unpack the industrial outlook a little bit?

I guess especially on the applied side, it sounds like it's more than just oil and gas and mining getting worse.

And I know you have very broad exposure within what you call industrial and applied.

Yes, I would say that you're right.

It's primarily oil and gas in mining, but then there's a whole bunch of other segments that get impacted by industrial.

It's the all other industrial category.

And there, obviously we just like the rest of the business in Applied Water, we were soft in the first half.

In the second half, we actually have some projects that are shipping in the second half.

So when you look at the second half versus the first half, first half was [negative 1].

Second half we are projecting low single digits.

It's helped by the backlog that's in there, rather than improving market conditions in industrial.

So, whenever you say industrial, outlook is lower because industrial is weaker, and it sounds like you kept the oil and gas decline the same, and all but nine oil and gas and mining stuff actually looks better in the back half.

So is this incremental weakness kind of absorbed already, or are things actually getting worse?

(multiple speakers)

No, it's absorbed.

I mean it is absorbed in the revised guidance and outlook we are giving you, and the way that you read it is absolutely right.

What we saw deteriorate further was in the oil and gas mining piece, again primarily in dewatering.

We did see some weakness through the first half in Applied Water on that broader industrial piece, but to Shashank's comment, when you take a look at the second half of the year, based on very specific products and backlog and demand, mainly in the Applied Water business, we expect a more positive outlook for the second half.

When you blend all that together, it still ends up being flattish.

Gotcha, gotcha.

And then maybe just quickly, I wanted to clarify on the restructuring.

You said this already, just tell me and I will read the transcript, but it looks like the carryover savings are lower now from 2014, I think 2015 versus was $18 million.

Could you talk about why that's lower?

Robert, that's right.

So I think the key point to bear in mind here and perhaps we could have probably made this a little bit clearer in our prepared remarks or in that original Q&A, but the expected carryover savings this year is a bit lower.

But you should expect to balance that $2 million, $3 million that has essentially been reduced here.

We will see that early part of next year.

It's more of a timing shift, if you would, in terms of when we will actually realize some over of those year-over-year savings.

We have one specific project that is included in there that has been delayed, but it is still on the docket and will be executed by early 2016.

I see, okay.

Thank you.

Thank you.

There are no further questions at this time.

I would now like to turn the floor back over to Patrick Decker for any additional or closing comments.

Thanks, everybody, again for joining us this morning.

I appreciate your continued interest.

We look forward to seeing you all at our Investor Day, again September 24 in New York City.

Between now and then, safe travels to all, have a good summer, and we look forward to seeing you then.

Thank you.

Thank you.

This does conclude today's Xylem second-quarter 2015 earnings conference call.

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