Xylem Inc. (XYL) Earnings Call Transcript

That's exactly what we're looking for. And for me, when you say doesn't necessarily move the needle, I don't think that's what investors are looking for as much as they want to see the orders, and they want to see the embracing of the technology. Because from our perspective, it looks compelling, but I understand completely that the water utilities move at a glacial pace, pun intended. And it really just -- you just need that tipping point, and maybe COVID is one of -- is a catalyst.

That's correct. One of -- so part of it is affordability. And the other is -- I think we oftentimes forget the fact that while we all are, for the most part, working remotely -- I mean some of us are traveling, I get all that. But the utilities are also dealing with the whole remote workforce aspect. So they also are looking at monitoring their assets remotely, using digital there. So it plays across different spectrums.

Yes. Exactly. All right. I want to get back into some of the P&L discussion. The forecast for the third quarter decrementals, potential at 45%, if I've got that correct. But that also includes some of the expense on employee support payments, which you all have done instantly and immediately to support your folks in a really troubled time. Is that still the right goal? And is there anything about mix that could change that?

Yes. So that is the number for Q3. And again, we're taking a very balanced view on that within the quarter. If you read through the quarter, it's important that we look at some impacts we had last year. We had a 90% incremental last year, which was some of the census, some of the metrology project revenue recognition. We had some tariff rebates in Applied Water and some other one-off items. So if you kind of pull all that aside, our decremental would really be in that kind of mid- to high 30% range, which is more consistent with what we've seen historically. We've had the realization of cost savings from the actions that we began to take back in Q2. Those are going to come in through Q3. And they're really going to ramp up in Q4 and into '21, and those, really, are around business simplification. And Matt, if you're on the line, you can certainly provide a little bit more color on that. There is some employee support, Deane, that continues into Q3. It's a few million bucks, so $0.01 or $0.02 there. The majority of that commitment that we did around employee support, about $20 million to $25 million was really in Q2, which, again, was kind of the low point as we were taking care of our people there. Our margin expansion sequentially from Q2 to Q3 is about 200 basis points, and that's really being driven by the cost actions that we took as a result of the pandemic. And then the last piece is mix. We still see some softness in dewatering, although things are trending a little bit more positive there. And our North America business in Sensus, from the metrology piece, which is really high margin. So those are kind of the puts and takes from year-over-year and quarter sequential. But we feel good about what we laid out in Q3. Obviously, we haven't given guidance for the full year or next year yet. We'll talk about that in our upcoming earnings call. But things are trending pretty well right now.

Good to hear. On -- in the second quarter, there was a positive preannouncement, which was a welcomed event because there had been a number of quarters where there was either disappointing guidance or shortfalls in margins. But how much of the second quarter is kind of the establish of a new trend? What has changed fundamentally in terms of like the cost out, the cost structure? I just -- everyone said, is this a turning point? And I want to know how relevant that might be.

Yes. I think -- look, I -- we feel that we are giving very balanced guidance. We're being prudent around that. I would say coming out of Q2, there were a couple of things going on. One, given our global exposure, Deane, where, again, we were really following the virus. I mean we truly are a global organization, especially given our Emerging Markets exposure. And we learned a lot from that. So we felt it prudent to be conservative in [ Q2 ]. We also were coming off of a year where we had -- taking down guidance. And I don't want to revisit that neighborhood anytime soon. So we were prudent and balanced. I would say in Q3 and going forward, we're going to continue to be balanced and prudent in that regard. I would say that I'm very proud of the team in terms of getting at the cost actions early. We opted to not go too much temporary and really focus on what was permanent to give our teams clarity. Temporary actions are necessary at times, furloughs, et cetera. But I think people, what they really want is clarity, and so we try to provide that to them. On the demand side, the supply chain, we are back up to prepandemic capacity levels. We've also learned a lot of things, so we've become even more efficient in that regard. I think it's become a competitive advantage for us, especially on the service side relative to some competitors. In terms of how we're thinking philosophically, we'll have more to say about that in the upcoming earnings call. But I'm really -- just really proud of what the team has done here. And net-net, we feel good about where we're going from here.

Good. Talk about the CFO transition and what does Sandy bring to the table.

Yes. So Mark's going to be around through the end of the year, which is making a very smooth transition for Sandy coming on board. Sandy actually worked with Mark in a former life. And so she's well-known by Mark and myself. And she's already begun to transition in with ourselves and board meetings and operational reviews coming up. So even though she's not officially started, she's going to hit the ground running. I want to take the opportunity -- not that anybody is looking for this, and I'm sure Mark's not, as I'm sure he's listening. Mark's just been outstanding. I mean I just -- I hate to see him move on, although we all want to go do other things. And he's delivered incredible value over the time he's been here. He's going to -- he's totally behind Sandy. So he's here to make sure she makes a really strong transition. She's got a really strong operational finance pedigree, given her background. We'll -- on the upcoming earnings call, we'll do a true profile of Sandy. But she also brings a big tech background. Coming in from Harman and what they've done in the auto space. I mean most of us think about Harman as being the audio company, but they did a lot of moves there with her and Dinesh in moving into automotive and transforming that space. She sets us up well for where we're heading around the whole connected digital solutions piece in the water space. And so really excited for her to start next month. October 1 is her first day. And again, while we're sad to see Mark go, we're really, really excited about what she brings to the table and can't wait to get her on the team.

That's fabulous. And not all companies are able to orchestrate in time and signal the CFO transitions as smoothly as you guys have done. Too often, we see the sudden kind of announcement that so and so is leaving and there's a search and you end up having more questions than you do have answers. And that's far, far, far from the case here. So congrats on that. And we'll have plenty of opportunity for a tearjerker goodbye for Mark as he has done a fabulous job, and it's been a pleasure for us to work with him and the upgrades of how the financials have been communicated and the precision and so forth. It's been great to see. So -- but we'll have opportunity that send-off. For the time we have remaining, I'd love to hear a bit more about M&A. What's fascinated me is you all have done a kind of an interesting angle -- other than Sensus, which has been a terrific technology reach into smart meters but also on the communication side. But when you've bought so many of these small start-ups that it's basically a proxy for R&D, and it has put you in a, like, leadership position in the smart water offerings. Is there more that you can do there?

Yes. No, it's a great point you make, Deane. I -- again, I definitely -- we definitely view M&A -- well, let me step back and say, what I'm really proud of the team, especially during the pandemic but even before that -- and I want to go back for a moment to ESG because what Mark and the finance team and our commercial teams have been able to do, along with legal support and elsewhere, is to just even further strengthen our capital deployment position through being able to issue green bonds that are tied to ESG metrics. I mean, again, this is not us just talking fluff. I mean these are real, hard-core metrics that I'm held accountable for and the team is. We've got financing now tied to that, which is really attractive. And so we didn't do that necessarily for M&A, but we did that to kind of replace some of the financing we have expiring next year in some bonds. But the point is we're in a really great spot from a balance sheet and capital deployment position. So I just want to give that shout-out to the teams. But in terms of M&A, absolutely, we're in a great spot. I would say that activity has ramped up a bit in terms of conversations. I'm not foreshadowing anything. But I think where things were very much kind of dry and stuck 6 months ago coming into the pandemic, time heals all that in terms of people beginning to get a view of what valuations kind of looked like. So we'll see what that looks like over the course of 2021. In terms of priorities, we look at it by vertical, so end market. So utilities, you're right. We continue to have some opportunities out there in the pipeline to add smaller bolt-ons that are really a proxy for R&D. Somebody already owns the IP. And therefore, you have to license it or go acquire it. So we've got a list of those opportunities that we'll continue to kind of peck away at. They're not going to move the needle in terms of capital deployed, but they will in terms of adding to the digital portfolio. Things of larger size and scale, we've got a few of those in the pipeline. We continue to stay close to them. Some of those are stand-alone, some of those are built into larger strategics and we stay close to those. And as you know, it takes two to tango. So we'll see how those play out, but we certainly are in a capital position to do some things there. And that really is tied probably more to the industrial side of the equation where, right now, we've got some gaps in terms of channel, maybe product offering, technology offering, but it's an attractive space to be in. So hopefully, over the course of the next year or more, there will be more to talk about there. But again, we're in a great spot right now to be able to execute those when the opportunities present themselves.

That's great to hear. And it looks like we've got just 2 more minutes. Patrick, when you were rattling off some of the recent wins, the Anglian win, to us, was important because there was a digital component to it. And maybe if you could expand on that. We're always interested when a municipality takes on either the digital part of smart meters. But what can you tell us? Because in developed market, water utility, big profile taking some digital service offerings and product offerings. What did they take? And what's the significance?

Yes. Thanks, Deane, for that question because I think that, oftentimes, because of the way we've positioned and explained things, the synergy around digital use of data, kind of smart networks, can come in 2 directions. One, there is the consultative offering that we bring, vis-à-vis what we now have branded Xylem Vue, V-U-E, which is where we use digital to help a utility better understand where should they invest their next dollar of OpEx or CapEx to get the best return. And that is a new, growing digital offering that we are doing both in our own, but also with some of our engineering consulting firm partners. But there's also the other side, which is where we already have relationships where we might be selling a metrology deal or a treatment offering or a submersible wastewater offering. And what we're looking to build here, Deane, and we've seen early successes of this, is helping our teams understand how do they upsell with those utilities and other customers to say, hey, we're providing this today, but there's all these other things that we can do. And a good example of that is we've had some of these opportunities around the world where it might have started off with maybe being a $5 million, $6 million kind of opportunity and it turns into a $50 million, 5-0 opportunity, because our teams are upselling the portfolio. But it -- really, Deane, to your point, it comes down to what problems are the utilities trying to solve. And in the case of the U.K. is one example, but it's not limited there. It really is around water losses, nonrevenue water, storm water overflow, energy efficiency within the treatment plant or the pumping stations. So it really is exciting to see the utilities taking a broader, smarter approach to how they're thinking about their capital allocation.

That's great to hear. And Patrick, you know and I know we could be talking all afternoon about these opportunities, but we are time constrained today. Thank you for participating. Thank you for doing all the investor calls. I appreciate all your insights. Matt, thank you for orchestrating all this. Best of luck to you. I will declare the Xylem presentation to a close. And thank you all for participating.

Thanks, Deane.