Xylem Inc. (XYL) Earnings Call Transcript & Summary

Good day, everyone, and welcome to Xylem's Second Quarter 2026 Results Conference Call. [Operator Instructions] Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Mr. Gregory Giamatti, Senior Vice President, Investor Relations and FP&A. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Xylem's Second Quarter 2026 Earnings Call. With me today are Chief Executive Officer, Matthew Pine; and Chief Financial Officer, Bill Grogan. They will provide their perspective on Xylem's second quarter results and discuss the third quarter and full year 2026 outlook. Following our prepared remarks, we will address questions related to the 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. As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website. A replay of today's call will be available until midnight, August 11, and will be available for playback via the Investors section of our website under the heading Investor Events. 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 and 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 that 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. Please turn to Slide 3. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. For the purposes of today's call, all references will be made on an organic and/or adjusted basis, unless otherwise indicated and non-GAAP financials have been reconciled for you and are included in the Appendix section of the presentation. Now please turn to Slide 4, and I will turn the call over to our CEO, Matthew Pine.

Thank you, Greg. Welcome to the team. It's great to have you with us today. And good morning, everyone. Thank you for joining us. Across our markets, we're seeing a clear theme, both utilities and industrial customers are placing greater value on comprehensive water solutions that help improve resilience, performance and efficiency. Over the past several years, we've been intentionally positioning Xylem for this moment. And today, that strategy is increasingly taking shape. Municipal remains a core strength and a resilient foundation for our business. At the same time, we've been increasing our exposure to high-growth industrial verticals where our technology, services and water expertise create greater value for customers. This evolution is being driven by 3 factors: First, more industries are relying on water to support quality, reliability and operational performance. Second, the AI ecosystem build-out is increasing the strategic importance of water across a broader set of end markets. And third, our portfolio actions are sharpening our capabilities around the markets where we see the strongest long-term growth and value creation. One of the clearest trends we see is that customers increasingly want simplicity. They are looking to work with a strategic partner that can help them manage growing complexity around regulation, operational resiliency and risk management. We've seen this play out in a number of engagements this year from the expansion of our long-term partnership with Dow which became the largest contract in our company's history to our recent win with 1 of the world's largest chemical companies. In this engagement, we were selected over a long-term incumbent to secure a 20-year commitment. This opportunity brings together our advanced treatment technology, operations, maintenance and digital monitoring under a single integrated model. Importantly, this momentum reflects the stronger industrial platform we created through the Evoqua acquisition, which significantly expands our capabilities across treatment, reuse and services, deepening our presence in attractive industrial end markets. That brings me to the second area which we documented in the watering the new economy report we released at [ Davos ] in January. Water will play an increasingly strategic role in the AI ecosystem. As AI-related infrastructure expands from data centers and semiconductors to power and mining, access to reliable water is becoming increasingly important. We're already supporting data centers through wins with hyperscalers, HVAC OEMs and infrastructure partners, and this year's revenue is expected to increase by approximately 200%. However, this is only part of the story. We view data centers as an early indicator of a larger opportunity across the AI ecosystem where water is increasingly becoming a critical input to infrastructure development and industrial growth. And over time, we see the same value proposition extending into additional verticals such as food and beverage and life sciences for water quality, reliability and sustainability are also essential. To align our business with these growth drivers, we have actively reshaped the portfolio, sharpening our focus through more than $400 million of divestitures while acquiring assets that expand our ability to serve customers in high-growth markets. The recently closed TriOS acquisition strengthens the intelligence layer of our portfolio through advanced sensing and water quality capabilities that are highly relevant to industrial customers. We also recently signed an agreement to acquire water fleet, which expands our capabilities in mobile water treatment and strengthens our position across AI-related infrastructure markets. This is a services-led business with recurring revenue, established customer relationships and strong commercial momentum, including a multimillion dollar project supporting a hyperscaler's data center build-out in Texas. And importantly, we're not investing ahead of hypothetical demand. We are aligning the portfolio with demand patterns we are already seeing in the market and where customers are already choosing Xylem to solve increasingly complex water challenges. At the same time, demand in our municipal markets remains healthy, supported by strong infrastructure spending and backlog execution. I'll now turn it over to Bill to take you through the details for Q2 and our updated guidance.

Thanks, Matthew. Please turn to Slide 5. We're pleased with the momentum we've built in the first half of the year. Our team stayed disciplined despite market volatility and delivered solid results that give us a strong base to build on. Demand remains healthy with our ending backlog at $5.3 billion and our book-to-bill for the quarter well above 1. This was supported by the Dow order in WSS as orders were up 41% versus last year, with growth in 3 of our 4 segments. Revenue was up 1% in the quarter versus prior year, in line with expectations as strength in key markets offset a 27% decline in China and walk away revenue of almost 2%. The team's operational discipline delivered quarterly EBITDA margin of 23.3%, up 150 basis points versus the prior year. The improvement was driven by productivity, price and mix, more than offsetting inflation and lower volume. Water Infrastructure led the way with strong leverage in North America transport growth. We also achieved record quarterly EPS of $1.46 and a 16% increase over the prior year. Net debt to adjusted EBITDA increased to 0.8x driven by our opportunistic share repurchases in the quarter. Free cash flow was strong in the quarter, driven by higher net income, partially offset by outsourced water contracts and the teams continue to make progress with our working capital efficiency metrics. Let's turn to Slide 6. For Measurement and Control Solutions, in the quarter, book-to-bill was below 1, but backlog remained at roughly $1.2 billion. Orders were up 2%, driven by continued smart metering demand in water with double-digit orders growth. offsetting declines in electric on difficult comps and project delays. Revenue was down 1%, driven by energy metering demand mostly offsetting softness in water. EBITDA margin of 21.1% was 200 basis points lower than prior year, driven by unfavorable mix, inflation and volume, offset partly by productivity and price. With recent project delays in electric metering, we are bringing down our outlook for the MCS full year performance to low single-digit revenue versus the prior year. The pipeline is strong and long-term electric demand remains healthy, but affordability concerns and a more cautious capital spending environment ahead of upcoming elections have slowed down near-term investment. We continue to win more than our share of that market and expect sustained growth in the years ahead, driven by the ongoing AMI 2.0 refresh cycle. In Water Infrastructure, orders were down 4% in the quarter, driven by continued softness in treatment due to 80/20 in China, offset by strong demand in transport. Revenue was up 3% and driven by transport offsetting softness in treatment related to our walkaway actions. Double-digit growth in U.S. municipalities more than offset a 40% decline in China. EBITDA margin expansion was outstanding for water infrastructure at 480 basis points, with productivity, mix, price and volume more than offsetting inflation and investments. In Applied Water, orders were up 9% and book-to-bill was well above 1, lifted again by data center wins. Data center orders in Q2 were up over 300%. Revenues were up 3% versus the prior year, primarily driven by strength in U.S. commercial buildings, offsetting softness in the residential end market and China. EBITDA margin was slightly below expectations, down 50 basis points year-over-year, driven by inflation and volume, mostly offset by productivity and price. Finally, Water Solutions and Services saw significant orders growth due to its largest order ever in April and approximately $850 million 23-year outsourced water projects. Revenue increased 1% year-over-year, driven by capital projects, including the impact of the finalized all contract and strength in dewatering. Segment EBITDA margin was 25.3% and up 90 basis points versus the prior year, driven by price, mix and productivity, offset by inflation and lower volume. Now let's turn to Slide 7 for our updated full year and third quarter guidance. We are narrowing our organic outlook against the prior guide with MCS electric project delays impacting the near-term outlook. Full year reported revenue is now expected to be roughly $9.2 billion, which delivers revenue growth of approximately 2%, while organic revenue growth will be in the 2% to 3% versus prior guidance of 2% to 4%. EBITDA margin is expected to be 23.1% to 23.5% versus the prior guide of 22.9% to 23.3%. This represents 90 basis points to 130 basis points of expansion versus the prior year, driven by productivity, volume and price more than offsetting inflation as well as investments in the business. Also, there is no material impact to our projected results from recently announced changes in tariffs or tariff refunds. Our strong first half performance, along with the benefits from share repurchases, and and higher margins more than offset the revenue headwind from electric metering delays and gives us confidence to raise the EPS range from $5.35 to $5.60 to $5.55 and to $5.70. Cash flow generation was strong in the first half, and we remain on target to achieve our low double-digit free cash flow margin for the year. Now drilling down on the third quarter. We anticipate revenue growth will be flat on a reported basis and up roughly 3% organically. We expect third quarter EBITDA margin to be approximately 23.5% to 24% and which is up 30 to 80 basis points, driven by price realization, productivity gains and higher volumes. These results will yield third quarter EPS of $1.42 to $1.47. We are exiting the first half of the year with strong demand and in a position of strength. Our balanced outlook reflects our strong commercial position, the durability of our portfolio and impacts and benefits from our simplification efforts. We also continue to monitor broader market conditions and volatility, including the Middle East conflict, changes in tariffs and other inflationary pressures. Overall, our expectations for this year remain extremely positive as we build momentum to a strong fiscal year in 2027. With that, please turn to Slide 8, and I'll turn the call back over to Matthew for closing comments.

Thank you, Bill. Stepping back from the quarter, I think it's important to keep sight of what's driving demand across our markets over the longer term. We continue to see healthy demand for water infrastructure investments as the underlying need to modernize and maintain water systems remain strong. At the same time, the growth of AI is making water a more strategic input across a broader ecosystem. -- driving demand from semiconductors and power generation to mining and other critical industries. Beyond AI, we see similar opportunities emerging across high-growth industrial sectors such as food and beverage and life sciences, where water is increasingly central to quality and operational performance. These trends are creating demand opportunities across the markets we serve and reinforcing the value of the capabilities we have been building. As we position Xylem for the future, we remain focused on strengthening our portfolio, our capabilities and our leadership team. Recent leadership changes reflect that ongoing focus, and I'd like to recognize Meredith and Joe as they take on their new roles while also thanking Mike for his many contributions to Xylem and wishing him the very best. Across the organization and portfolio, the strategic decisions we're making today are expanding our ability to serve customers increasing the quality of our growth and positioning Xylem to create greater value over the long term. And now let's open up the call for your questions.

[Operator Instructions] And our first question today comes from Deane Dray from RBC Capital Markets.

Love to put the spotlight on Applied Water in that organic revenue growth of 9%, nice upside there. And I know you've talked about the data center growth and the 300% in the orders. But can you just kind of flesh out for us that 9%, what were the key industrial nonmunicipal drivers there? And kind of what the outlook is for the balance of the year?

Yes, Deane, thanks for the question. Primarily, it was, I would say, in Applied Water, it was largely data center-driven. Although in North America, our commercial building services business has done well across multiple verticals. Data centers remain a very attractive growth area for us, and we expect our exposure to continue to increase over time. And like we said in the prepared remarks, we expect revenue to be up 20% this year, and we'll probably be exiting this year about 2% of our revenue tied to data centers. But I think also, I just mentioned and maybe we'll get into it later, our acquisition of Water fleet which is not in the Applied Water business, but in the WSS segment also gives us more exposure into that part of the marketplace as well.

Yes, I did want to put the spotlight on capital allocation, just really balanced here and we like that water fleet deal and its positioning. And maybe just step back and talk about the opportunities in the outsourced contracts. I mean the Dow got a milestone deal for you all, but it does sound like there is more to do, and this was like the whole premise of the Evoqua deal to begin with. So what can you talk about in terms of that pipeline for these contracts?

Yes. We have multiple contracts, but build on operates are obviously a big part of that as well as capital and services. But let me just maybe first say that Municipal does remain a source of strength for us in the core part of our business. But what's changed is that we've expanded our capabilities and really increased our participation through the Evoqua acquisition especially in high-growth verticals like high-tech power, life sciences and things of that nature. So we view it as complementary to municipal. But maybe a couple of examples that I would highlight, Deane, that are kind of been this build on operator capital service type of a deal. We recently won a job in the lithium battery space. So we secured a win with the world's largest lithium battery cell manufacturer. We built the solution to treat the recycling of really a novel wastewater system. It includes, I would call it, cutting-edge wastewater treatment and really took the entire treatment train, including our most recent acquisition of [ Wacom ], the 0 liquid discharge asset that's helped us kind of have the complete front-to-back part of the treatment train. So -- that's a really big win. The second I would point to is a data center in Pennsylvania. We're finding not all the time, but sometimes data centers are having to secure additional water outside of mini water through river streams and wells. And we're treating settled river water in bringing that into a state-of-the-art facility to make sure that they've got the quantity and the quality of water that they need.

Our next question comes from Mike Halloran from Baird.

Let's start on the MCS commentary and just kind of help frame how you're thinking about things. The electric piece sounds like there are some push outs -- what's going on there? Any change in thought process from those customers on a medium to long-term horizon and then maybe contrast that with the water utility side of things, all else equal, what you're seeing more on the water side as we move to the back half, any change on that side? And how you think about what that trajectory means for out years.

Yes, Mike. If we start just -- our revenue take down from 4 to 3 on the high end is really all around MCS, and that's really directly attributable to the slowdown in electric meter deployments. We talked about affordability concerns and more cautious capital spending environment ahead of upcoming elections have just slowed down the near-term investment cycle. And we've really seen politicians take a hard stand on electricity rate increases and utilities have pulled back and pockets the short-term investments to compensate. I think, again, we continue to gain share versus competitors as we look at our bid and win rates and do expect this to be a healthy market in the years ahead, primarily driven by the ongoing AMI 2.0 refresh. But again, the near-term pullback is trading a little bit of pressure for us. But to your point, on the water side, we actually continue to see strength. Order activities really positive and customer engagement is really constructive. Our funnel is up about 30% versus last year. Water orders have been up double digits in both the first and second quarter, and we expect that to continue into the second half. Helping offset some of the declines we're going to see on the electric side and expect water to be up about low single digits for the year with a strong second half.

And then maybe some thoughts on orders more holistically and how you're thinking about things from here. the treatment side of things that seems concentrated overseas and intentional, what's the run rate for the U.S. piece on the infrastructure side? And then -- maybe just put all this together between the applied comments that Dean was talking to, some of your 80/20 initiatives, what you just mentioned on the water, timing in the electric, however you want to answer the infrastructure piece. Are we looking at something more normalized as we exit this year from a growth perspective relative to how you think about long-term growth for Xylem?

Yes, definitely. Maybe if I started at a high level, revenue progression through the year is generally in line with the exception of the electric metering delays. Yes, we said we're flat in the first quarter, we're up 1% here in the second quarter. Expectations are for 3 here in the third, and then we're going to exit the year in fourth quarter at mid-single digits. So I think we're building momentum leading into next year. And if you break it down by segment, obviously, Matthew highlighted, again, strength in Applied Water, right? They've had really strong orders consistently with book-to-bill above 1 for the last several quarters. On top of the data centers, we really see resiliency in the U.S. commercial building space and expect them to continue to build backlog here in the second half, leading into a strong $27 million to your point, water infrastructure, even with the China headwind and some of the 80/20 walk away on the treatment side, we've built backlog in the first half and expect positive orders growth here in the second half. They'll finish the year with positive book-to-bill and again, with strong momentum leading into next year, again, with a lot of the 80/20 walk away in the China comp behind us. WSS obviously, has had a phenomenal first half of the year, but it's always going to be lumpy. We talked about just the shift in outsourced water in the funnel that's creating across a variety of different end markets. Really excited about that and the backlog that they're going to end with this year puts us in a strong position. And again, my commentary around MCS I think we have here a little bit near-term mitigation on the electric side, but water momentum continues to build, right? We'll see a positive book-to-bill in the second half with high single-digit orders growth. So I think there's lots of momentum across the organization and continues to give us confidence in the outlook from a commercial perspective heading into next year.

Our next question comes from Nathan Jones from Stifel.

This is Adam Farley on for Nathan. Maybe just following up on some of that commentary. Maybe first on water infrastructure. Maybe could you speak to the underlying treatment market ex the AB20 actions that you're doing?

I think positive overall. I mean, even with the 80/20 actions and some of the projects where we've increased price, we've had a very strong win rate. So I think the treatment market here in the U.S. has been really positive for that business. And I think we expect that to continue in the second half. A lot of the challenges there, again, relative to China. Different decisions we've made on our bidding strategy around tenders in different emerging markets. So I think that business has got a lot of momentum here as we progress in the back half.

And then maybe switching gears. Are you seeing any signs of supply chain tightness anywhere in the portfolio -- do you think there's any need to increase more safety stock for electronic components?

I mean it's something we review really monthly in our leadership meeting. I don't think there's anything pressing right now that we already haven't taken action on. Obviously, we look at rare earth, and we've got most of our businesses about a year of supply we pulled in from a safety stock perspective. Obviously, we've made some investments, and I might have highlighted this on a prior call on chips. -- wafers looking to kind of get about 6 months of supply there. This is more of a safety stock buffer. But outside of those 2 areas, I would say, in general, we're pretty balanced, and we do review it, like I said, every month.

Our next question comes from Andy Kaplowitz from Citigroup.

Strong quarter margin, particularly in water infrastructure. So maybe you could just double click on what were the main drivers of the strong performance there. Did you sort of hit another glide path in terms of the '20 performance? And then I know you want to be conservative -- but Q3, up 30 to 80 basis points, Q2, you did 150. So maybe you can give us some more color on the puts and takes you see for that Q3 margin.

Yes. If we start with water infrastructure, again, they had a phenomenal quarter, and they continue to be the leader in margin expansion for the organization. I think they're definitely seeing increased benefits from their simplification efforts. They've kicked off 80/20 and have been doing this now for over 2 years. They've done a really good job optimizing their overhead more effectively and efficiently serve their customers. And then again, they've been really purposeful if their go-to-market strategies to be selective on bidding projects where they can create the most value, a little bit to my treatment commentary a little bit earlier. That's weighed a little bit on their orders and sales growth, obviously, but that's short term. I think the focus that they have will help them better lever as they get back into their mid-single-digit growth algorithm. Exiting the year with positive performance here in Q3 and Q4. We continue to see margin opportunities within the segment, though, right? They've made solid progress, and I think they still have operational productivity and things that they're going to be able to leverage and the 80/20 benefits that they've driven on the margin side, you're going to see them inflect on the growth side. Particularly in transport where they've made resource allocation decisions to refocus certain areas of their commercial and engineering teams to drive incremental growth. So they did have a little bit more transport mix within the quarter that helped overdrive relative to our expectations. That will balance a little bit, Andy. I think that's part of the Q4 sequential challenge that we'll have from a margin perspective. But overall, still really excited about their margin outlook.

That's helpful. And then I think we all know that WSS is a bit lumpy and talked about the shift toward outsourced water. But as you know, [indiscernible] you bought, it was big in end markets that we've been starting to talk about like microelectronics, mining, life sciences. So do you see more incremental projects there in general? Like what are your customers doing saying about that? So WSS overall could continue to improve in growth even outside of outsourced water.