Welcome to the Xylem Second Quarter 2020 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. I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.

Thank you, Christie. Good morning, everyone, and welcome to Xylem's second quarter earnings conference call. With me today are Chief Executive Officer, Patrick Decker; and Chief Financial Officer, Mark Rajkowski. They will provide their perspective on Xylem's second quarter results and our 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 the 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 on August 31. Please note the replay number is 800-585-8367, and the confirmation code is 7095996. Additionally, the call will be available for playback via the Investors section of our website under the heading, Investor Events. 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. All references will be on an organic or adjusted basis, unless otherwise indicated. These statements are subject to 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 including in our Form 10-Q to report results for the period ending June 30, 2020. 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. Now, please turn to Slide 2. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. For purposes of today’s call, all references will be on an organic and 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 Patrick Decker.

Thanks, Matt. Good morning, everyone, and thanks for joining us. Let me start by expressing my sincere hope that you and everyone close to you are keeping safe and well. As you've seen from our release this morning, and consistent with our preannouncement two weeks ago, our second quarter performance was better than we had expected. In hindsight, April turned out to be the low point of the quarter. We hope we’ll eventually look back and say, it was a low point for the pandemic. After April, we saw modest improvement in both May and June, as demand began to stabilize in our key markets. Because our business is global, we were exposed to the pandemic effects early, and so we've also benefited from our presence in some markets that have already begun to recover. Back in April, it's fair to say that uncertainty overshadowed both supply and demand outlooks as COVID spread from Asia to Europe and then North America. So, we felt it responsible to set our second quarter guidance range intentionally wide to bracket a broad set of scenarios for the macro environment. Today, we have far more insight and confidence on the supply side. That's because of one notably positive effect of feeling COVID’s impact early. It catalyzed early action by our teams. Fortunately, we were working from solid financial foundations and a strong position, so we were able to focus on adapting to the uncertainty and managing the things under our control. In addition to addressing the immediate need, those actions have built a more robust foundation for both the medium and long term. I want to make a point of giving credit for my colleagues across Xylem and all of our external partners who made that happen. They've shown incredible resolve and resilience in a time that has put excessive demands on everyone. I want to credit everyone around the world who's kept the water flowing and kept the essential services running despite everything being thrown at them. Throughout this period of incredible challenge, they've focused on keeping Xylem safe and serving our communities. Within Xylem, I want to highlight the work of our supply chain, manufacturing, and distribution team. They've kept our customers supplied and serviced with very few interruptions. Today, we are up and running across our manufacturing network at greater than 90% availability. So, while demand side uncertainties continue, our outlook now reflects greater clarity and confidence about supply, putting us in a much better position to guide to the third quarter. I also want to recognize the dedication of our commercial teams despite the challenges of working remotely. They drove 10% backlog growth, despite COVID-related macro softness. You will have seen our announced wins in Telangana, India, and with Anglian Water in the U.K. The Telangana irrigation project is our largest win in the country to date, and we anticipate it will generate roughly $115 million in revenue over the next two to three years. Our smart networking deployment with Anglian in the U.K., which combines metrology, communications, and digital offerings, is expected to deliver revenues of roughly $90 million over the course of the project. These wins are further evidence of the durability of our business even in challenging times. Because of the differentiation of our portfolio and the resilience of our teams, we expect we will have more news to share about additional big wins when we deliver our third quarter results. Clearly, I'm very pleased that the team's hard work is evidenced both operationally and commercially. Having said that, the outlook for the second half is still not back to normal, therefore, we are not reinstating full-year guidance. Conditions are improving in a number of our key markets, but the shape of the COVID curve overall is still unpredictable. Now, I'd like to hand over to Mark to provide some detail on the second quarter, and then we'll come back to our outlook and the trends we see emerging through this period.

Thanks, Patrick. Please turn to Slide 5. Our revenue in the quarter declined 12%, which was better than we anticipated coming out of the first quarter. As Patrick mentioned, our revenue and orders performance improved throughout the quarter with a very strong month in June. Geographically, U.S. revenues declined 15% as our businesses felt the impact of site shutdowns and project deployment delays. Emerging markets were down 15%, driven largely by the lockdowns in the Middle East and India. Notably, China grew 6% in the quarter as the utility end market returned to nearly pre-pandemic levels and industrial and commercial businesses began to modestly recover. Europe was also a relative bright spot for us, as revenues declined a modest 3%. Western Europe, which is the majority of our European revenue base, was down mid-single digits. However, our business in Eastern Europe grew double digits. This has been a region we've been very focused on, and I want to highlight the tremendous work our team has done there. They've quietly but consistently delivered a revenue CAGR of mid-teens growth over the last five years. Orders declined 9% in the quarter, while total backlog grew 10%, driven by the large signature deals Patrick mentioned earlier. Backlog shippable in 2020 is down 1%. However, the backlog shippable after 2020 is up 23%, which gives us confidence that we'll be emerging from 2020 in a position of strength with a solid foundation for growth in 2021 and beyond. Operating margin was 9.3% in the quarter, which I'll review in more detail by segment shortly. Based on our experience in China, we entered the second quarter cautious of COVID potential impacts on our supply chain. However, based on those learnings and the great work of our global supply chain teams, we successfully managed through the COVID challenges and turned those learnings into a competitive advantage. Our teams quickly adapted and began to work in new ways with our customers, our suppliers, and internally, enabling us to deliver earnings per share of $0.40, an achievement punctuated by commercial savvy, operational excellence, cost discipline, and a focus on what really matters. Please turn to Slide 6 and I'll review second quarter results by segment. Water Infrastructure orders grew 7% and total backlog grew 24% in the quarter. This performance was largely driven by the $115 million deal we won in India, which is expected to deliver revenue beginning late this year and over the next three years. Shippable backlog for the remainder of 2020 is up 5%. Segment revenue declined 8% in the quarter and was significantly impacted by declines in the dewatering, industrial, and construction rental business. As we noted last quarter, we expect utilities to continue to remain resilient as they focus on maintaining critical infrastructure for wastewater collection and treatment. This was certainly true this past quarter as our wastewater transport business declined only 4%. To date, we've seen wastewater capital projects continue with minimal delays. This was an important driver of the strong quarter from our treatment business, which grew 7%. While U.S. sales were impacted by double-digit declines in the dewatering business, Western Europe revenues were flat in the quarter, showing resilience and some early signs of recovery, especially with our utility customers. As we continue to feel the near-term impacts from COVID-19 across the emerging markets, we remain confident in the long-term growth prospects for the water sector. The Chinese and Indian governments, for example, have expressed their ongoing commitment to continued investments in infrastructure for clean drinking water, wastewater treatment, and environmental protection. Operating margin in the quarter was 16.2%, contracting on lower volumes and unfavorable mix impacts from dewatering, partially offset by productivity, cost savings, and price. Now, please turn to Slide 7. The Applied Water segment's orders declined 17% in the quarter, while revenue declined 13%, as site restrictions continue to impact customers across industrial, commercial, and residential end markets. As regions begin to reopen, we're seeing modest recovery in our book and ship business in both commercial and industrial markets. We also had a strong quarter in the North American ag business driven by dry weather conditions. Total segment backlog grew 1% in the quarter. Geographically, both the United States and emerging markets revenue declined 14%. However, we saw demand in China begin to recover, growing 2% in the quarter. Industrial and commercial end markets in China have been slower to recover than utilities, and our customers are indicating that it may take several months to fully recover in those end markets. Operating margin in the segment was 13.4%. Margins contracted primarily due to volume declines and inflation, partially offset by 570 basis points of productivity and cost savings as well as 100 basis points of price. Now, please turn to slide 8. Measurement and control solutions orders declined 24% in the quarter, and revenue declined 17%, as the Metrology business slowed due to utility workforce availability and physical distancing requirements, including restrictions on approaching or entering residents' homes. This is delaying both project deployments and installations of replacement meters. We expect order and revenue trends to normalize over the coming months, as utility workers are able to safely return to meter replacement and installation. Importantly, our billing pipeline remained strong, and there have been no project cancellations. Despite the near-term challenges, we're very encouraged by the large win we announced with Anglian Water in the UK. The $90 million contract demonstrates the competitiveness of our AMI and digital solutions to drive key international wins. This win in a robust pipeline of AMI opportunities highlights the continued commercial momentum and the differentiated value our offering brings through our combined digital platform, networking, data analytics, and metrology capabilities. Total segment backlog grew 3% year-over-year, with backlog shippable in 2021 and beyond up 12%. Segment margin performance was primarily driven by the impacts from volume declines on meter replacement activity and project deployment delays stemming from COVID-19, while we continue critical investments to support growth. Looking forward, we expect meaningful leverage on the upside as revenue growth drives increased incremental margins from recent large contract wins. With continued commercial momentum and growing project backlogs, our MCS segment will be a significant source of revenue growth and margin expansion for the company in 2021 and beyond. Now, please turn to Slide 9. We ended the quarter with approximately $1.6 billion in cash and total liquidity of roughly $2.4 billion, driven by the $1 billion Green Bond offering we issued in June, as well as strong cash flow performance in the quarter. The Green Bond offering was opportunistic, enabling us to lock in longer maturities at historically low rates, while effectively prefunding $600 million of maturities due in October 2021 at an after-tax cost of less than 1%. This offering was also the latest example of the importance of linking our financing strategy to our sustainability goals. Given the strength of our financial position and liquidity, I'll take a moment to note that our capital allocation strategy remains unchanged. Alongside funding organic investments in key strategic areas, M&A remains a top priority, and we maintain a healthy pipeline of opportunities, which we closely monitor. Now, turning to cash flow. Our performance in the quarter was very strong. Operating cash flow improved roughly 50% year-over-year, and our free cash flow of $137 million more than doubled from the prior year. This was driven by the continued focus and discipline around working capital, the timing of payment on taxes, and the prioritization of our capital spend, which was $44 million in the quarter, down almost 30% from the prior year. Working capital as a percentage of sales improved 110 basis points year-over-year, as our teams continued to drive hard on collections and payment terms, while managing inventories in a very challenging demand environment. I'm pleased with our overall cash performance to the first half of the year, and we now expect free cash flow conversion for this year will be at least 100%. And with that, I'll hand it back to Patrick.

Thanks, Mark. The end market dynamics we anticipate going into the third quarter are consistent with what we saw in Q2. Utilities have remained relatively resilient as expected; however, there is significant divergence between wastewater and clean water. As Mark mentioned, our wastewater business was down only modestly. We're seeing continued OpEx spending to service mission-critical needs and continued execution of capital projects with approved funding. On the clean water side, the short-term declines were steeper. They were in the mid-teens. We are seeing some project delays but not cancellations. We expect execution to pick back up when physical distancing requirements ease. We've had some very impressive wins, reflective of healthier long-term trends. There was considerable discussion about the U.S. utilities’ CapEx budgets going into 2021. We do expect modest CapEx softening in the U.S. utilities, but as a leading indicator, we are not seeing a slowdown in our bidding pipeline for capital projects. It is worth noting for broader context that only 8% of our overall revenue is tied to U.S. utilities’ CapEx. By contrast, OpEx represents 70% of our overall U.S. utilities revenue, and it remains resilient. In addition, we see healthy multi-year trends in both OpEx and CapEx in emerging markets, Europe, and the rest of the world. Turning now to industrial and commercial end markets. Industrial didn't slow as much in the second quarter as originally feared, but it will remain soft while facilities continue to deal with restricted access. Commercial has lagged industrial, and the book and ship business will remain vulnerable in COVID-19 hotspots. Our backlog remains robust. Those distributors who destock in the face of uncertainty are beginning to rebuild their inventory. We see these end market trends fairly consistent across emerging and developing markets. But it's clear that China and Europe are showing more resilience than the U.S. as they emerge sooner from the pandemic. China's recovery, which was up 6% in the second quarter, is a strong indicator. Conversely, as the U.S. is still grappling with the pandemic’s impact, we remain appropriately cautious. Now, please turn ahead to Slide 12. It's worth noting a few trends that we're seeing more broadly across the sector. First, there are some fundamentals that COVID-19 has not changed. The most important is the role that water plays in society. There is perhaps no service more essential than drinking water and wastewater. As a result, our strategy is as relevant as ever. The global challenges of water scarcity, affordability, and the resilience of our water systems remain front and center. Innovation of all kinds is essential now more than ever to addressing those challenges. While the fundamentals are unchanged, other dynamics are accelerating. Interest in digital adoption has clearly gained pace as operators seek a step change in their operational and financial resilience. In a constrained budget environment, they are rethinking how they spend their money. It has become an operational and economic imperative to consider the benefits of remote monitoring, automated operations, and decision support systems. It is absolutely front of mind for every utility executive I speak with, and we're seeing their interest reflected in accelerated quote activity. We're also seeing a shift in the way that we work with customers every day. The trends are away from face-to-face interaction and more towards virtual customer engagement across sales, commissioning, and servicing. Because of that, we're making changes to reinforce our competitive strength. First, as you know, we took a number of structural cost actions across Xylem during the quarter. Second, we've reprioritized our investments. We're focusing further on the projects that deepen the differentiation and the market leadership of our portfolio, things such as increasing connectivity and interoperability across our solutions. Lastly, we continue to invest in our highest-growth geographies. We're reorienting the way that we work within Xylem. We've accelerated deployment of the IP platforms that make remote engagement, different selling, and virtual servicing easier for both our customers and our colleagues. And we are, of course, assessing the permanent changes that we make to travel, facilities, and distance working, changes that no doubt will have a positive impact on cost and productivity and also on employee engagement and morale. We are focused through the pandemic on managing the things that we can control, and we're taking the actions now that will make us an even stronger competitor in both the near and longer term. Now, with that, I'll turn it back over to Mark for more specifics on our Q3 guidance.

Given the uncertainties related to the reemergence of COVID-19 across parts of the U.S. and other geographies and its potential ramifications for the back half of the year, we're not reinstating full-year guidance. However, we do have reasonable visibility through the third quarter, which I'll briefly highlight. We expect revenue declines of 8% to 12%, and operating margins in the range of 11% to 11.5%. This reflects approximately 200 basis points of sequential margin improvement and year-over-year decrementals of approximately 45%. The decremental margins are impacted by continued softness in our high-margin dewatering and North American census water businesses, along with a tough prior year compared to last year's third quarter, where we had 90% incremental margins on revenue growth. While we've seen some positive trends in the second quarter, the global economic landscape remains uncertain, and we are, by no means, out of the woods. While Europe is showing positive trends towards recovery, we're closely monitoring the trajectory in the United States. The pandemic's impact varies widely across emerging markets, from a return to normalcy in China to ongoing shutdowns in India and in parts of Latin America. Lastly, I want to provide a little more clarity on the structural cost actions we announced in early June. In that announcement, we detailed our plans for permanent actions to simplify our operations and increase our ability to act as one company. These actions help us better serve our customers and afford us long-term financial resilience. This year, we expect to incur $80 million to $100 million in restructuring and realignment charges. This predominantly reflects the actions that we announced in early June, but also some carryover related to prior programs. We've also provided a summary table on the slide that details the total savings we expect to realize in 2020 and 2021 from our announced structural cost programs. As a reminder, that includes savings from restructuring and realignment actions we initiated before this year, as well as savings from actions we announced in June of this year. In total, we expect to realize approximately $70 million in savings this year, and an additional savings of approximately $80 million in 2021.

So, before we go to Q&A, there are a few other milestones that deserve a mention. The first, to touch on sustainability, we've released our most recent sustainability report in June, and I'm very proud of the work done by the team, which reflects the impact our colleagues have delivered across the company. It shows how we've delivered on our 2019 goals and establishes comprehensive 2025 targets. It also reinforces the relevance and the value of a strong sustainability approach even in these difficult times. We follow that up with a launch of our green financing framework which underpinned our recent $1 billion green bond offering. In addition to showing off our financial strength and liquidity, it extended our commitment that sustainability is at the heart of our business strategy, something we've been doing and will continue to do. We recently announced that Mark will be retiring at the end of the year. I feel confident in saying he will take with him the gratitude of all Xylem stakeholders, but most of all, mine. His impact has been undisputed, and his commitment to both our principles and to delivering value has been constant and unwavering. We have appointed an outstanding CFO to succeed Mark. Sandy Rowland has been CFO of Harman International both while they were publicly traded and since becoming part of Samsung. That experience has put her right at the intersection of innovation, technology, and disruption. Her board role at Oshkosh makes her no stranger to capital goods, manufacturing and municipal markets. We look forward to introducing her after she joins us on October 1. Mark is going to be with us through the end of the year, which will ensure an orderly and smooth transition. Lastly, we also announced today that we've appointed two new members to our board of directors as part of our normal board succession process. The board has appointed Lila Tretikov, who's a Corporate Vice President at Microsoft and a globally renowned technologist. We look forward to her bringing that perspective to the digital transformation of our sector. Our second board member is Uday Yadav, who's President and COO of Eaton’s electrical sector, and he brings a disciplined global operating perspective to our board. These appointments further deepen our board's diversity, technology depth, and global orientation. I'm very pleased that Xylem continues to attract this quality of talent to our purpose and to our mission as a company. With that, let's open up to questions. And, operator, please lead us into Q&A.

Our first question is coming from Deane Dray of RBC Capital Markets.

For Mark, I wish you all the best. And this is your second retirement, do I have that right? Is this going to be your last one?

That is correct, Deane, on both counts.

Okay great. We're definitely going to miss you.

Absolutely.

So first question, so the whole premise of the growth opportunity for Xylem really does hinge on this adoption of digital. I love seeing this Anglian win that has a digital offering. So could you clarify what part of digital that they're taking? And then Patrick, you've also hinted that the backlog of orders also has some digital component, could you reflect on where you're seeing traction there?

Sure, yes thanks, Deane. So on the Anglian win, certainly the cornerstone of the deal is the smart network deployment which is really centered around AMI metering deployment. But when you look back and circle what problem is Anglian and quite frankly other utilities across the U.K. that we are pursuing right now as part of the AMP7 cycle. Certainly, non-revenue water, our stormwater overflow and overall affordability are three major themes that each one of the utilities is dealing with. So beyond the AMI metering deployment, there's also a level of data analytics as well as remote monitoring that is built into that project. In terms of the backlog, we do have a number of other deals in the pipeline. One that we just recently announced, literally live as we speak, we won a large deal just shy of $60 million in Winston-Salem. Again, that's also a smart networking deployment. We feel good again; it's a big market, lots of activity. Right now, what I'm most encouraged by is that we're not seeing a slippage or a cancellation of projects as a result of the pandemic. If anything, in some areas, it’s being accelerated based upon this need for operational results.

Great, and then the second question is on the outlook and the guidance for the third quarter. I appreciate all the detail on Page 13. If you can just clarify - the notion here is you've got a pretty similar revenue sequential ramp, but you're getting 200 basis points of margin improvement. Is that all the cost savings reading through driving at 200 basis points? So, how much is coming through for the third quarter?

Yes. Deane, that's exactly what it is. It is the benefit of the ramp in some of those restructuring savings in Q3.

And then we also – Deane, we didn't guide for obviously, the entire back half of the year. So, we didn't talk about Q4, but we also expect even a larger portion of those restructuring savings to roll through in Q4. We would also expect improving mix as we do see a return to some level of normality within the clean water side of the utility in terms of being able to do meter installs domestically here in the U.S.

And just lastly, this doesn't count as a question, but Patrick, I think you undersold Page 12 that picture of the head of your India business that you were there in a hazmat suit. I think you should tell that story. And thank you.

Yes, no, I appreciate that, Deane. Yes, Bala is our leader of our business in India. He actually just got promoted to leader of the Global Treatment business. That's just one example of many where what our team has gone through to continue serving customers. Our customers are the ones who keep the resources flowing. So, it's a joint effort. We've had a number of all these large deals have pretty much been negotiated on Zoom or some remote platform. We have customer service locations where calls are being moved to people's homes. Again, we're not alone in this. These are not normal times, and our people are really climbing mountains here to contend to deliver. I've never been more proud of them.

Thank you.

We had a gentleman sitting in a car for eight hours waiting to get into a building to close the deal and driving hours back and forth from home to get there.

It was a $115 million deal, but it was still a heck of a sacrifice.

Your next question is from Scott Davis of Melius Research.

And I'll echo Deane's comments, Mark. Congrats.

Thank you.

It was a great run. Sorry to see you go. But...

It's more to come.

But don’t disappear on us. Anyway, I have a couple of questions, if you entertain me a little bit. The first one is just Patrick, can you help me understand what a green bond is? I mean, what’s, other than it sounds good, and I know obviously?

Yes.

Optics matter too, but what does it mean? Let’s leave it at that?

Yes, I'll take it off, and then Mark can go through a little bit more of the granularity. But effectively, it's a financing structure that is tied to certain KPIs that we have to deliver on in order to achieve that financing. It is tied to our sustainability goals and metrics as a company. But Mark, do you want to get that?

That’s right, Patrick. Our 2025 goals and the way it works is, as we achieve those goals, we get credit. Those goals are audited, and that performance is audited by Sustainalytics. It was interesting; in addition to the benefit on the rate, the amount of demand we received from investors who are focused on sustainable missions was fascinating. The offering was five times oversubscribed, in no small part due to nearly 50% of those investors being focused on sustainable mission. Not only do we have an opportunity to execute against our very important sustainability goals to drive the rate down, but it was very helpful from a pricing perspective.

Okay good color. And then Patrick, you commented on project delays, which I think everybody is seeing. But does that change the economics of the deal for you guys at all? I mean, does it make it less attractive? Because you end up perhaps having lots of projects all having to be done at the same time because everybody restarts, and you're having to put in a lot of overtime wages. I mean how do you cadence that I guess, is another question to ask and not run into having all kinds of project challenges?

Yes, and that's predominantly a U.S. issue. We've already begun to see - I don't want to call it a return to normalcy, but if you follow the virus around the world, our businesses have been affected along that same line. So, China and Asia Pacific, we're already seeing good growth and signs of recovery, so that's not creating a pinch in our supply chain as we’re back up north of 90% in terms of capacity. Europe is also already beyond even Eastern Europe. Europe, broadly speaking, is already showing signs of recovery. We're kind of working through that demand rebuild as we speak. It really is centered around the U.S. and is predominantly in the utility space because, we mainly deal through distribution and channel partners on the industrial and commercial building. They, of course, are close to the street. It's primarily inventory replenishment. We're not anticipating a big pinch in terms of workforce demand. Our people are still very engaged. Our supply chain is very robust. So, it’s a long way of saying we don't really see that being a major concern for ourselves.

Your next question is from Scott Graham of Rosenblatt Securities.

Again and actually, we don't hope to see you again. We hope you're just sort of riding off into the sunset.

Thank you very much.

So just a couple of questions here, really regarding the access to sites on the water side. It looks like the access on the water infrastructure side is maybe coming a little bit more easily or just is less intensive than it is on the metering side. The third quarter metering guidance is up, I guess a little bit less than what I would have thought. Could you talk about that sort of the intensity around the need to be at the site for that? Thanks.

Yes, it's a good question, Scott. So I think simply put, first of all, for utilities, while all these services are essential, I would say they would all agree that the wastewater side of utility is absolutely mission-critical. They have little choice but to continue keeping those operations running and deployments expanding, etcetera. I'd also say in our water infrastructure business and certainly wastewater is much more of a global business today than it is through Measurement and Control Solutions on the clean water side, which is still largely a North America or U.S.-centric business. We are certainly working hard to change that. Some of these international deals will help in that regard. On the metering side, those are also critical, and they will get done. We're not seeing projects canceled at all. Right now, it really is a matter of site access at the home level as opposed to more of the outdoor and the treatment facilities that we serve on the Water Infrastructure side. But on the clean water side, it really is just a timing and safety dynamic.

I guess my follow-up question would simply be, you know, in terms of the sales that you're seeing in Water Infrastructure, I know that a lot of that is, you know, to break and fix the OpEx. Is that a higher-margin business whereby two quarters from now, we could be looking at a mix issue or OpEx versus CapEx? Could you talk about the sales mix in water infrastructure and how that works?

Yes, Scott, roughly 70% of the revenue base is OpEx-related, and you're right those margins are a little richer for sure. And 30% would be CapEx. In the emerging markets, we have more of a mix towards the CapEx side as we build our position there and build our installed base. That continues to be the case. But as we've done that now over the years, we'll begin to see a shift more into the OpEx side. But it is a richer mix of margin.

Yes, and the margins are typically about 1.5 times the size of a project when you get into, again, installed base in the aftermarket piece.

And if I can just sneak one last one in here. The business was actually not as down as I thought it would be. Have you won new placements there? What is the driver?

Yes, it was not down as hard as we expected, but it was down substantially, over 20% year-over-year. We were thinking it might be in the high 20s decline. A lot of it was industrial-driven, but it was down in most segments.

Yes. I mean, the good news was backlog was up, hopefully. But again, the overall revenue was down considerably in the quarter.

Your next question is from Ryan Connors of Boenning & Scattergood.

So, Patrick, I appreciate your comments on the outlook for the intermediate-term utility market. But I wanted to probe on that a little bit just from the perspective of history. Xylem wasn't a stand-alone public company when the last recession hit. If we look at the earnings releases and the transcripts from your former parent and then Xylem later on, we had similar talk about resiliency early on. But then, Xylem was still seeing headwinds in utilities late 2012, which was a good three to four years removed from the recession. What is it that's really different this time that would cause us to believe that that history is not going to repeat, especially when that portfolio at least in Water Infrastructure is still relatively similar to what it looked like then? I'm looking for any kind of tangible thoughts you have on what's different this time?

Sure. It's a very relevant question, and obviously, we are not taking anything for granted here. I mean, we're staying close to the markets, and the utility customers are really understanding how they are viewing the world right now from a funding standpoint. I would say a couple of things are different this time. First of all, the percentage of our total revenue tied to utilities in the U.S. again is roughly 8% on the CapEx side, and it really is the CapEx piece that is - tends to show that kind of fluctuation from a funding standpoint. Two, we do have the M&CS platform on the clean water side. While we are absorbing some of those delays right now, we are not seeing cancellations there. These are projects tied to issues of affordability, non-revenue water. What we hear from utility leaders is that they don't see those projects being canceled or killed in any way. That's a different dynamic than we would have had back in the time in 2011 and 2012. Lastly, I would say it goes back to that overall percentage of revenue even tied to U.S. CapEx, and we also have a much larger portion of our revenue in emerging markets. We see that demand continuing to increase considerably.

Okay. That's very helpful. And then related follow-up is so much right now seems to ride on the federal government across the economy. I wonder if you can comment on how that outlook you just described in utilities differs under a scenario where Congress does bail out state or local governments versus a more laissez-faire scenario where things are just sort of left to run their course and maybe you get some greater budget cuts? How do you handicap that and how does your outlook differ in those two scenarios?

Sure. It's a great question. I think certainly as we've mentioned before, and I don't think our view on that has changed, is we are certainly not counting or riding on any kind of federal bailout or federal funding along the way. As you well know, Ryan, the water sector generally speaking in the U.S. has never really relied heavily on federal funding. It's always been at the state and local level. Any move there on the positive from the federal government would certainly be upside, but I wouldn't bake that into people's outlooks or forecast for the business because it'll be a while in coming. But likewise, there's really no downside in that regard. Now, obviously, we're staying close to the law of utilities and municipalities to understand those parts of the country that are feeling more stressed at this point in time, but I would say we're neutral on the whole federal funding aspect.

Your next question is from Andy Kaplowitz of Citigroup.

Just focusing on the cadence that you saw on Q2, because you didn't mention a very strong June. So can you elaborate on that in terms of the growth you saw as the quarter developed? And then, what are you seeing in July, especially considering you did mention that you're not receiving guidance given the recent resurgence in infections in the U.S.?

Sure. Andy, yes, the - you know, we started off the quarter down mid-single digits. I wish it was mid-single digits. Mid-teens. Matt is like flashing me, no. Mid-single digits. But, and that was true for got a little bit better in May and then we had a really strong June. We ended up down low double digits, 12%. Orders were still down 9% in the quarter. July, we're seeing some modest improvement, and that's encouraging. As we look at the Q3 outlook, the fact is we're well aligned with what we laid out in terms of the range, which is tighter than we had last quarter because we have better visibility.

That’s helpful, Mark. I think in June when you announced structural cost, you also talked about spending $40 million to $50 million to exit certain business activities. I think they seem to be focused on M&CS, as that’s where it seems like you’re taking the bulk of your restructuring. Could you just elaborate on what you’re now there, what you’re getting out of and why?

Yes, and I think the numbers, it's not quite that large. It's probably in the 20s, and it's a number of smaller lines of business and just those that aren't as profitable nor is core to our mission moving forward.

Yes. There's nothing strategic in terms of we’re deciding to exit something from a material perspective; we wouldn't have even called them out if it weren't for the fact that it did contribute to some of the cost action or costs being taken. Therefore, we had to disclose that. But again, the amount of revenue is a rounding error.

Your next question is from Joe Giordano of Cowen.

Just to start here, can we - Patrick, I know that the situation can change dramatically between now and obviously 2021. But just given where we're at right now with the macro and your view on developed market utilities, is the appropriate kind of benchmark for now to be, like, hopefully, overall budgets are kind of flattish, maybe CapEx is pressured and maybe OpEx is kind of stable but, with lower tax receipts we're kind of hoping for a flat overall spending environment and utilities? Is that a fair benchmark right now?

I think, Joe, it's too early to tell. I think there is still a lot of uncertainty there. We're encouraged by the bidding pipeline. We're encouraged by the lack of project cancellations. But I really wouldn't want to start guessing what overall municipal budgets are going to be. I go back to what portion of our total revenue that represents in the U.S. and the fact that we are already seeing some emerging strength in other parts of the globe. The focus we have right now with our teams is this pandemic has highlighted for the utilities the need for greater operational resilience. We are really focusing in on helping them do more with a whole lot less.

And a couple of just related ones on MCS. Are you confident that as in like the market deterioration we’re done with negative margins here? And then two, you guys have done a lot over the last several years building out portfolio. It's an interesting mix of applications there. There's been some issues, some Xylem issues, some market issues, but curious what you learned from this whole experience of building this out and how you feel about whether that business is ready for M&A incremental from here?

Yes, so I would say that the question of margins, we certainly expect to be in the black and see positive margins. We expect the second quarter to - the third quarter to be positive. We were just about breakeven in Q2. So, with a little bit of a ramp in terms of some of the deployments, the installations and just cross actions, we're going to see improvement there.

Yes, so, real quick Joe, on the margin comments or question, I think it's important that all understand the level of fixed cost base that we have within M&CS given the services profile in terms of the R&D investments and building out new partner development rollout, etc. Some of the restructuring actions we've taken do get at that overhead cost base. But our view on incremental rate is unchanged, very attractive incremental in that business. As we see projects being deployed, return to work in the second half of the year, we would expect the incremental to be quite attractive in that business. No change in view there. On the lessons learned, I would also just throw in Joe, that it does speak to adoption, but it's also the fact that the solutions and value proposition we're bringing to the sector are disruptive. Any time that you're aiming to disrupt, it’s going to take longer than anyone ever wanted to. It's also going to be a bit harder than what it appears. Our views around the attractiveness and the need for the sector to get disrupted in a positive way remains unchanged.

Your next question is from Nathan Jones with Stifel.

Congratulations Mark, and Patrick, if you need somebody to wait in a car for eight hours for $115 million, I’m available. I wanted to go back to the utility funding question here. A lot of the utility leaders that we've talked to are far less focused on state and local government funding and much more focused on the ability to collect water rates, which as I understand it is a much bigger part of the funding equation for U.S. utilities anyway. They are concerned about things like people not going into cities going to work, which will reduce the water consumption there. Places like D.C. or New York City are the areas where those water rates are going to be collected less and those budgets are going to be a little more challenged. I wonder if you could comment on that angle of it. I think people are a little bit too focused on state and local government and not focused enough on water rates. Could you contrast that with how utilities are funded outside of the U.S. versus inside the U.S.?

You're absolutely right. The biggest concern that the utility leaders have at this point in time, especially on the clean water side of the equation, is again their revenue sources in terms of rate cases, rate collection, etc. I don't really have much to offer there other than it is a concern of theirs. They do look back at previous cycles and try to understand. It is a different dynamic now. They're also letting me know they are seeing increased consumption at the household level because people are staying home. Some of that’s just jumped from one metering point to another. But I don't want to minimize that there will be some potential impact there. Generally speaking, though, the utility leaders we’re engaging with are still pretty confident around their ability to weather this. It really is a matter of getting through the second half of this year. I think we'll learn a lot more as they go through their budget approvals, which are not all calendar-based. A lot of those are July 1, October 1 kind of fiscal budgets. We're keeping a close eye on that, but again, I want to keep it in perspective regarding what percentage of our total revenue that represents across the company. Outside of the U.S. it tends to be, and we saw this in the last downturn, much more stable, because a large majority of the funding in emerging markets is at a federal or state level, it is much less reliant on revenue collection.

Your next question is from Andy Kaplowitz of Citigroup.

Just focusing on the cadence that you saw on Q2 because you didn't mention a very strong June. Can you elaborate on that in terms of the growth you saw as the quarter developed? What are you seeing in July, especially considering you did mention you’re not receiving guidance given the recent resurgence in infections in the U.S.?

Sure. Andy, yes. You know, we started off the quarter down mid-single digits. I wish it was mid-single digits. Mid-teens. Matt is like flashing me, no. Mid-single digits. But, and that was true for got a little bit better in May and then we had a really strong June. We ended up down low double digits, 12%. Orders were still down 9%. In July, we're seeing some modest improvement, and that's encouraging. As we look at the Q3 outlook, the fact is we're well aligned with what we laid out in terms of the range, which is tighter than we had last quarter because we have better visibility.

That’s helpful, Mark. I think in June when you announced structural cost, you talked about spending $40 million to $50 million to exit certain business activities. I think they seem to be focused on M&CS, as that’s where it seems like you’re taking the bulk of your restructuring. Could you just elaborate on what you’re now there, what you’re getting out of and why?

Yes, and I think the numbers, it's not quite that large. It's probably in the 20s, and it's a number of smaller lines of business and just those that aren't as profitable nor is core to our mission moving forward.

Yes, there's nothing strategic in terms of exiting something from a material perspective; we wouldn't have even called them out if it weren't for the fact that it did contribute to some of the cost action or costs being taken. Therefore, we had to disclose that. But again, the amount of revenue is a rounding error.

Your next question is from Joe Giordano of Cowen.

Just to start here, Patrick, I know that the situation can change dramatically between now and 2021. But just given where we are at right now with the macro and your view on developed market utilities, what is the appropriate benchmark for now? Are overall budgets kind of flattish, maybe CapEx pressured, and OpEx stable but with lower tax receipts? Are we looking at a flat overall spending environment in utilities?

I think, Joe, it's too early to tell. There is still a lot of uncertainty. We're encouraged by the bidding pipeline. We're also encouraged by the lack of project cancellations. I wouldn’t want to start guessing what overall municipal budgets will be in the U.S. and the percentage of our total revenue that represents. We're seeing emerging strength in other parts of the globe. But we are focusing on helping utilities do more with less.

A couple of related questions on MCS. Are you confident that the market deterioration is done with negative margins? Also, seeing the progress you've made in building the portfolio over the years, have you seen any lessons learned along the way, and is the business ready for M&A incrementally?

Yes, so I would say that we expect to see positive margins and improvements in Q3. We expect the second quarter to be positive. We were just about breakeven in Q2. So, with some ramp in deployments, installations, and other operational factors, we project improvements.

Yes, absolutely. I would also emphasize that the level of fixed cost within M&CS impacts the service profile and R&D investments. Some restructuring actions taken affect that overhead cost base significantly. On lessons learned, we find that our value proposition is disruptive and that it will take longer than anticipated, but our views on the adoption and needs for sector disruption remain unchanged.

Your next question is from Nathan Jones with Stifel.

Congratulations Mark. If you need somebody to wait in a car for eight hours for $115 million, I’m available. Wanted to revisit the utility funding question. A lot of utility leaders are less focused on state and local government funding and more on their ability to collect water rates, a crucial funding aspect for U.S. utilities. They’re concerned about reduced consumption with people not going into cities for work. Can you comment on this focus and contrast it with utility funding outside the U.S.?

Absolutely. The primary concern regarding rate collection is prevalent amongst utility leaders, particularly for the clean water sector. Leaders have expressed confidence in their ability to weather these circumstances but recognize potential impacts.

Your next question is from Andy Kaplowitz of Citigroup.

Just focusing on Q2 cadence. You mentioned a strong June—could you elaborate on growth as the quarter progressed? Also, how's July looking, especially with recent resurgence in U.S. infections?

Sure, Andy. The quarter started down mid-single digits, improved in May, and saw a strong June. We ended down 12%, with a strong July performance being encouraging.

That's helpful, Mark. In June, you mentioned spending to exit certain business activities; could you elaborate on that focus?

Sure, the amount is around $20 million and comes from exiting smaller, non-core lines of business.

These were not strategic exits but rather decisions made based on financial practicality.

Your next question is from Joe Giordano of Cowen.

What's your sentiment on overall spending in utilities, potentially looking flat with CapEx under pressure and OpEx stable?

There’s uncertainty but indications of resilience. Bidding pipelines remain encouraging, though municipal budget forecasts remain difficult.

Considering market fluctuations, do you predict an end to negative margins?

We expect to have positive margins in Q3, approaching breakeven in Q2 due to improved operations and project deployments.

Reinforcing operational resilience remains paramount while navigating disruptions.

Your next question is from Nathan Jones with Stifel.

Congratulations Mark. If you need someone to wait in a car for $115 million, I'm available!

Absolutely. We've seen emerging strength and firming demand as more projects are being initiated post-pandemic.

As we reach our time limit, would you like to provide any closing remarks?

Thanks for your interest and support. Stay safe, and we look forward to our next earnings call.

This concludes today's Xylem’s second quarter 2020 earnings conference call. Please disconnect your lines at this time and have a wonderful day.