Xylem - Earnings Call - Q2 2014
July 29, 2014
Transcript
Speaker 0
Welcome to the Xylem Second Quarter twenty fourteen Earnings Conference Call. At this time, all participants have been placed on a listen only mode and and the floor will be opened for your questions following the presentation.
Speaker 1
At
Speaker 0
all have placed on a I would now like to turn the call over to Bill D'Souza, Vice President of Investor Relations.
Speaker 2
Thank you, Jackie. Good morning, everyone, and welcome to Xylem's second quarter twenty fourteen earnings conference call. With me today are our Chief Executive Officer, Patrick Decker and Chief Financial Officer, Michael Speaton. They will provide their perspective on Xylem's quarterly results and discuss the full year outlook for 2014. Following our prepared remarks, we will address questions related to the information covered on the call.
At that time, I'll ask that you please keep to one question and a follow-up and then return to the queue, so we will have enough time to address everyone on the call today. We anticipate that the call will last approximately one hour. As a reminder, this call and our webcast are accompanied by a slide presentation available on the Investors section of our website at www.xylaminc.com. A replay of today's call will be available until midnight on August 13. Please note that the replay number is 4045373406 and the confirmation code is 6684967.
Additionally, the call will be available for playback via the Investors section of our website under the heading Presentation. All references today will be on an adjusted basis unless otherwise indicated and the non GAAP financials are reconciled for you in the appendix section of the presentation. With that said, please turn to slide two. We will make some forward looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future. These statements are subject to future risks and uncertainties, such as those factors described in Xylum's most annual report on Form 10 ks 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. Now please turn to slide three and I'll turn the call over to our CEO, Patrick Decker.
Speaker 1
Thanks, Phil, and thank you all for joining us this morning. Today, we announced our second quarter twenty fourteen results. In a moment, I'll give you some headline comments and share my perspective. I'll then provide an update on our 2014 goals and some additional color on my observations since our last call. I'll then turn it over to Mike to share more details on this quarter's performance before I cover our full year outlook.
So let's get started. I'm proud of our teams and encouraged with what we achieved this quarter. Despite mixed levels of recovery in our key end markets, revenue growth was up 4% organically and coupled with the execution of cost savings initiatives drove an operating margin expansion of two twenty basis points and a 33% improvement in earnings per share. This marks the fourth consecutive quarter of revenue and earnings growth as well as margin expansion. Second quarter orders were just over $1,000,000,000 Now while the headline organic growth registers 1% in orders, the overall total is a new record passing the previous mark set during last year's second quarter.
As a result, we also exit the quarter with record backlog just over $800,000,000 up approximately 8% versus the prior year. Just a few additional comments. Relative to last year, we have a 5% increase in backlog that is shippable in the second half of this year and a more impressive 18% increase for next year. I'm encouraged by these results, but I also must point out that some of our end markets remain challenged and are still slow to recover and our business remains predominantly short cycle. All of this adds up to the fact that we still have a lot of work to do to deliver 2014.
Beyond the short cycle business, we are continuing to focus on building our longer cycle backlog. As an example, we recently won a bid for a $9,000,000 water filtration system which will address the critical water shortage in Sao Paulo Brazil. This is exciting because it's the largest award we have ever won in the region and it's a referential win with an important key account for us. We believe we'll be able to do more to help address the significant water crisis Brazil is facing and we expect there will be more opportunities in the country for Xylem. In The Middle East, we had another referential win, a $7,000,000 order to expand and upgrade existing ozone systems at the Tubley wastewater treatment plant in Bahrain.
These are just two examples of the opportunities that we think are plentiful in emerging markets. We intend to find and pursue these opportunities and expect that the breadth of our product line, the service proposition we offer and the skills and support of the Xylem teams will help us to bring in many more of these types of significant project wins. I'm generally pleased with the performance we're seeing in emerging markets, but I firmly believe the opportunity is greater. During the quarter, I spent two weeks visiting several customers and our facilities and management teams in Asia. I left very encouraged by the prospects of our businesses there.
It's clear to me that there is far more opportunity to grow our business and more opportunity to localize manufacturing and research and development, which will ultimately drive innovation, can support the local markets, but can also be leveraged globally. Experience tells me this does not happen overnight. It's a multi year process, but I am excited by what I see and by what I believe lies ahead for us. Tonight, I leave for South America, where I will spend the next week or so meeting with customers and we'll be assessing and evaluating new opportunities in that region. With that said, let me get back to the quarter.
Second quarter revenue was just over $1,000,000,000 and includes favorable contributions across most regions including 11% organic growth in emerging markets. Now let me give you some color as to how the quarter progressed. We started with flat year over year revenue in April, which was short of our expectations. As a result, the team focused on ensuring we would deliver every scheduled order we had on hand, working hard to reduce delinquent shipments. And as the quarter progressed, we did see some market improvement and also ended up seeing some business shift in the second quarter that we originally expected to deliver in the third quarter.
No heroics or big projects to note specifically, but rather strong focus and execution by the teams. Operating income increased 28% year over year and operating margin expanded two twenty basis points, reflecting strong incremental margin performance and the significant impact of cost reduction actions. We generated free cash flow of $50,000,000 primarily reflecting higher income and typical seasonality. Finally, on the capital deployment front, we opportunistically repurchased an additional $50,000,000 in common stock bringing our full year repurchases up to $100,000,000 and our total return to shareholders up to $147,000,000 including dividends. To wrap up the second quarter results, volume growth and improved operating performance drove earnings per share of $0.48 up 33% over the prior year.
And as you already read this morning, we are raising the lower end of our EPS guidance reflecting both our first half performance and our outlook for the second half. We will cover this in more detail on the call. Now turning to slide four. Before Mike covers off more details in the quarter, I'm going to take a few minutes and talk about how we're doing on the twenty fourteen goals we outlined as well as some strategic priorities that will ultimately improve our business over the long term. Our results continue to show we are moving the company in the right direction.
Based on our first half performance and outlook over the balance of the year, we are on track to deliver our 2014 financial commitments. We expect to achieve nearly $4,000,000,000 in revenues. In terms of operating income, we expect margin to improve to the 13% range and expect EPS in the range of 1.9 to $2 which would represent 14% to 20% growth. We continue to make progress around integrating our commercial front end. And while we still have much work to do to optimize our structure, I am confident that over the long term this investment will help us accelerate and achieve above market growth.
We also continue to make progress in our portfolio and capital deployment processes. Creating shareholder value requires a balanced and disciplined capital deployment strategy. Earlier this month, we announced K.-based oil and gas valve business for approximately $30,000,000 This transaction resulted from a continuous portfolio review process. I think it is well understood that this is a good business, but it was not scalable within our portfolio.
And over the long term, it would compete for valuable capital and human resources with other parts of our business that are more aligned with our core strategies. So it made sense to sell the business. And given where we are in the cycle, the timing of this transaction maximizes shareholder value and allows us to invest even more in organic and inorganic growth opportunities that are more attractive and strategic to Xylem. We continue to focus on optimizing our cost structure. I believe we can realize more benefits and will increase our productivity by developing stronger global strategic sourcing and lean Six Sigma capabilities.
We are working to build a mindset and a culture centered on continuous improvement. This is not just about the opportunity inside the four walls of our factories, but across all aspects of our value chain and business. But that's easier said than done. It will take considerable time to make this a cornerstone of our business. We are already making progress beginning with global sourcing.
I believe that by centralizing this function, we'll be able to move faster and drive more savings. So as a first step, we've just hired a global strategic sourcing leader whose sole focus will be to optimize the savings we can achieve by leveraging the consolidated global purchasing power of the entire company. As I said, this is a first step. We will also be further centralizing our continuous improvement efforts and leadership to ensure that we have the right people, processes and tools in place to drive productivity to new levels and to help facilitate the change management programs that are required to accelerate this and make it sustainable. We need to be consistent and confident in our decisions and focus on our execution.
So I'll wrap up with the same message that I delivered to you last quarter. It's not lost on me or any of my team that we faced and continue to face significant challenges, but I am convinced that we are well on our way to overcoming them. I don't expect that road ahead will be entirely smooth nor should you, but I am excited about the direction we're heading, confident in the future and very excited to be leading this team. So with that, let me turn the call over to our CFO, Mike Speetzen to walk you through the results and the company's financial position in more detail. Mike?
Thanks Patrick. Please turn
Speaker 3
to slide five. We generated just over $1,000,000,000 in revenues, up 5% from the prior year and up 4% on an organic basis. From an end market perspective, we saw strength in public utility and industrial partially offset by commercial. The public utility end market was up 7% driven primarily by continued infrastructure investment in emerging markets. Europe was also up thanks to a healthy northern region coupled with a relatively easy prior year comp.
The U. S. Was flat year over year. Industrial was up 5% with growth across most regions. It's worth reminding everyone that we serve a wide variety of industrial customers and that we supply this market with applications from both of our segments.
As expected, the largest contribution from this segment was attributable to growth in The U. S. And emerging markets. While we are excited to see solid growth posted in our two largest end markets, we were however disappointed with the 3% decline in commercial. The trend here remains the same given our overweight position in The U.
S. Institutional building Here we continue to see pressure as construction and the recovery continue to lag the broader commercial market. I'll cover off more specifics by segment, but generally speaking, we saw strong growth from emerging markets, up 11% and modest growth of three percent and one percent in Europe and The U. S. Respectively.
Operating income of $125,000,000 was up $27,000,000 or 28% over last year and operating margins increased two twenty basis points to 12.4%. The second quarter's performance was driven by the increase in organic volume and savings from cost reduction initiatives across our businesses. Cost reductions totaled $39,000,000 and including approximately $12,000,000 of restructuring savings with the balance coming from sourcing and lean initiatives. Partially offsetting these tailwinds was inflation of approximately 2% and unfavorable price and mix within our Water Infrastructure segment. Incremental margins were 60% including the benefit from restructuring on unfavorable foreign exchange.
Excluding these items, incremental margins were still strong at roughly 40%. Solid top line and operational performance coupled with strong execution against our cost reduction initiatives resulted in EPS of $0.48 up 33% versus the prior year and slightly better than we originally anticipated. Core operations drove the year over year EPS improvement contributing $0.13 driven by organic volume growth combined with execution on productivity and cost management including restructuring savings of $05 Now let me provide more detail on each of our reporting segments. Please turn to slide six. Water Infrastructure reported revenue of $636,000,000 up 7%.
We experienced organic growth in all of our applications. Regionally, we saw the most significant growth come from emerging markets which were up 16%. We also posted mid single digit growth in both Europe and The U. S. I'd summarize our revenue performance as follows.
Transport revenue was up 6% driven by public utility infrastructure investment across most regions and dewatering strength in The U. S. This was driven by an increase in hydraulic fracturing rental and related services and an increase in general demand for dewatering equipment. Treatment revenue was up 15% due to emerging market strength and the timing of project deliveries. Europe was also up driven by demand for biogas mixers ahead of the expiration of certain German government incentives.
Finally, Test was up 5% driven by growth in both The U. S. And Europe. Operating income of $82,000,000 was up $19,000,000 or 30% over last year and operating margins increased two thirty basis points to 12.9%. Performance was driven by the increase in organic volume and savings from cost reductions which totaled $26,000,000 and included approximately $9,000,000 of restructuring savings with the balance coming from sourcing and lean initiatives.
Partially offsetting these tailwinds was inflation of approximately 2% and unfavorable price and mix. Mix was a considerable headwind driven by lower dewatering rental for disaster recovery activities like Superstorm Sandy and increased project deliveries in emerging and developed regions. Finally, I would note that foreign exchange also negatively impacted operating margin by 40 basis points. Let me now turn to slide number seven and talk to our Applied Water segment. While revenue was up 2% overall, organically we were down 1%.
Regionally, we saw growth in emerging markets more than offset low single digit declines in The U. S. And Europe. I'd summarize our revenue performance as follows. Building service applications declined 2% due to continued weakness in the commercial building market, specifically within the institutional building sector as as I mentioned earlier.
Our European residential business declined double digits due to continued market softness in the South. The weakness in Europe was only partially offset by growth in The U. S. Residential market, which was against double digit growth last year. Finally, I would highlight the continued strength in China drove modest emerging market growth against what was also a tough comp last year.
Operating margin expanded 100 basis points to 14.4% year over year. We were able to offset volume declines through disciplined cost management and restructuring savings. Now let's turn to slide eight where I'll cover the company's financial position. Xylem maintains a strong cash position with a balance $450,000,000 at the end of Q2 with approximately 80% held outside of The U. S.
Consistent with our geographic business mix. Our net debt to net capital ratio is a healthy 26% and our commercial paper and revolving credit facilities remain in place and continue to be unutilized. We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while enhancing shareholder returns through dividends and share repurchases. Over the first half of the year, we invested $48,000,000 in capital expenditures and we returned 147,000,000 to shareholders, which reflects a 10% increase in dividends per share and $100,000,000 under our share repurchase program. Over the first six months of the year, we generated $50,000,000 of free cash flow.
This reflects typical seasonality and working capital dynamics, which include an increase in receivables due to the timing of Q2 sales and certain projects and increased inventory ahead of the second half ramp in revenue. Relative to the prior year, our free cash flow performance improved by $48,000,000 Please turn to slide nine and I'll turn it back over to Patrick to cover our 2014 guidance.
Speaker 1
Thanks Mike. Let's start with the top line. We still anticipate 2014 revenues of nearly $4,000,000,000 which reflects organic growth of 2% to 4%. We've increased our organic growth range at both the low and high end by a percentage point of growth. For Water Infrastructure, we expect organic revenue growth of 3% to 4% higher than our previous expectations and primarily reflecting higher project revenue in emerging markets.
And for Applied Water, we expect revenues to be flat to up 1% organically reflecting our first half performance and soft end market outlook. This reflects a slight downward revision to our previous guidance. I will also note that the revenue range already reflects the reduction in revenue attributable to The U. K. Valve business we divested.
After posting 3% organic growth through the first six months, we expect second half organic revenue to be flat to up approximately 2%. This range takes into consideration relatively short cycle nature of our business and mixed strength in our end markets. It is important to note that our second half performance will be against tougher year over year comps. Segment margins are anticipated to be in the range of 14.2% to 14.6% and operating margins are projected to be in the range of 12.8% to 13.2%. And we anticipate earnings per share of 1.9 to $2 excluding 2014 restructuring and realignment cost of approximately 40,000,000 to $50,000,000 This reflects a $05 increase to the lower end of our range.
So let me provide you with some perspective on this. We feel good about the execution of our broad based restructuring actions this year from which we now expect to achieve savings of $17,000,000 This is in addition to the carryover savings of $25,000,000 from the actions executed in 2013 bringing total savings to $42,000,000 We also feel good about our first half performance and have reflected our outlook for the second half, which includes some mixed end market dynamics, lower benefits from FX and The U. K. Valve divestiture. Now let me provide some additional highlights around our end market outlook.
Please turn to slide 10. This slide summarizes our expected 2014 organic revenue performance by end market. Let me spend a few minutes providing some perspective on our first half performance, our expectations over the second half and what that all means from a full year perspective. Beginning with industrial, our largest end market representing 45% of total revenues. Through the first half, we saw organic revenue up 3% and expect second half performance to be up low single digits.
Full year organic revenue growth is expected to be in the range of 1% to 3%. Included in our second half expectation is sequential growth acceleration in The U. S. And continued growth from emerging markets. We are also assuming that Europe remains stable.
Utility at 34% of total revenue is our second largest market. Through the first half, we saw organic revenue up 6%, but expect second half organic performance to moderate considerably. This reflects tougher year over year comps and the timing of project deliveries. With that said, we expect second half revenue to be flat to up low single digits and therefore our full year expectation is in the range of 2% to 5%. This outlook has improved relative to our original expectations and reflects the positive performance realized over the first half and our project backlog over the balance of the year.
As a reminder, due to the considerable lead time for most CapEx projects, the majority of project orders received over the second half of the year will deliver in 2015 and beyond. I would highlight that leading indicators and market commentary suggest improving market conditions, which is supported by our growing pipeline of projects. Moving to commercial, which represents approximately 11% of our revenue, we are revising our full year outlook for commercial downward. While we originally expected low single digit growth, we now anticipate flat organic revenue performance. The revision downward reflects our first half organic revenue decline of 1% and only a modest improvement in the back half.
Our overall performance reflects our overweight position to the weak U. S. Institutional building market. We no longer expect this sector to recover meaningfully in 2014. We do expect new product launches and strengthen emerging markets to drive low single digit growth over the second half.
There is no change to our residential market outlook. We still expect low single digit growth driven by The U. S. Housing recovery. However, we do expect that growth in The U.
S. Will moderate over the second half and that continued weakness in Europe will at least offset second half growth. And lastly, while it's only 3% of our business, we expect full year ag revenue to be flat year over year. This is down slightly from our previous expectations. Please turn to slide 11 and I'll turn it back over to Mike to cover some additional details on the guidance.
Speaker 3
Thanks Patrick. I'd like to spend a minute calibrating everyone on the call around what we expect our revenue and operating income profile to be over the balance of 2014. I'll begin with some comments around our shippable backlog. Of the total $816,000,000 of backlog, $643,000,000 is shippable in the second half and the remaining $173,000,000 is expected to ship in 2015. Third quarter shippable backlog is approximately $445,000,000 and represents around 45% of our expected third quarter revenue.
So we still have a lot of book and turn business to deliver in a quarter when Europe is on holiday. For revenue, we see the second half profile more similar to 2011 and 2012, down sequentially in the third quarter with a ramp up in the fourth quarter. More specifically, we expect revenue decline in Q3 2% to 3% sequentially from the second quarter, reflecting the impact of European shutdowns in July and August and the typical second quarter peak within our Applied Water segment. By segment for Q3, we expect Water Infrastructure to be flat sequentially and Applied Water is expected to decline sequentially approximately $30,000,000 again reflecting its typical seasonal profile and the impact of the Ballast divestiture. Operating income performance over the second half will be driven by volume and incremental cost improvements in areas such as global sourcing and lean, but will also be negatively impacted by mix and price.
We see third quarter margins improving sequentially from the second quarter by 80 to 130 basis points despite the expected volume decline. This performance reflects the savings we expect from the restructuring actions executed earlier this year. We're now on track to deliver $42,000,000 in restructuring savings, which includes approximately $20,000,000 of savings in the second half. By segment, we expect the sequential margin improvement to be more pronounced in Water Infrastructure than within Applied Water. We expect full year corporate expense of approximately $55,000,000 and our full year operating tax rate is expected to be approximately 21%.
Lastly, our fully diluted share count is expected to be approximately $185,000,000 With that said, please turn to slide 12 and let me hand the call back over
Speaker 1
to Patrick for some final comments. Patrick? Thanks again, Mike. Just a few comments before we get to Q and A. As you know this year is a critical one for Xylem.
We have begun to establish a track record of financial performance while also focusing on prospects for long term growth. While we still have a lot of work to do, I am encouraged by our performance to date. We're making progress and are improving our productivity and efficiency. We have many growth opportunities to pursue and we're doing the hard work now to be able to take advantage of the best ones to grow our leadership position in the world of water. Operator, we can now begin the Q and A session.
Speaker 0
The floor is now open for questions. Thank you. Our first question is coming from Scott Davis with Barclays.
Speaker 4
Hi. Good morning, Good morning, Scott. Off to a good start Patrick, so congrats on that. Thank you. I wanted to I mean there's a few things I want to dig into and I'm guessing that there's enough questions in the queue that you'll get to it.
But can you talk a little bit about public utility in The U. S? I mean, it's still flat against pretty easy comps. And is there an outlook there? When I talk to some of the local guys, they say there's pent up demand for projects and such.
But are you seeing anything that's tangible that would lead you
Speaker 5
to believe that that business gets better?
Speaker 3
Yes, Scott. This is Mike. There's a couple of things going on. If you remember from some of the commentary we had last year, we actually saw a decline in the what I'll call the longer term bookings for our treatment business project business in The U. S.
Last year. Essentially we see that carrying through in the current year shipping results. The good news is we are seeing the project activity picking up and so we're starting to build backlog in that business and less about just The U. S. But overall if you think about that backlog headed into 2015, we're up 18%.
And when you look specifically at water infrastructure, we're actually up 22%. So that's a very good indicator that things are at least starting to move in the right direction. The pipeline of bid and quote activity is at an all time high. So it's clear that there is definitely activity starting to move from a U. S.
Standpoint.
Speaker 1
And I would just add to that Scott that what I'm also seeing and we're seeing is that as we integrated our front end of the business, I would say our treatment business is one of the business that's probably benefiting the most in terms of getting more at best to the visibility that our transport and other businesses provide to them by now having an integrated front end. So our bidding activity on the pipeline is also improving.
Speaker 4
Okay. And I wanted to ask you guys about M and A. I mean, I think about legacy, well over the years just this business when it was within ITT always talked about M and A. But M and A was always a little disappointing I think. And there hasn't been a lot.
I think the volume of transactions overall in this side of the business been pretty light. I mean, how do you reinvigorate it? And how do you when you say reactivating M and A pipeline, I mean, do you do it when you're limited really to the concept of water?
Speaker 1
If that's I'll just leave it there. Sure. No problem. Well, first, I mean I've spent considerable amount of time with the team reviewing the pipeline. There are it is a pretty healthy pipeline from my perspective based on what I've seen.
As you know Scott it is a fairly fragmented industry. I think we've said that certainly we're not going to be dogmatic on water. I mean obviously we want to make sure that we don't stray from our identity here. And so we now that we've defined our three fields of play that being water productivity, water quality and the resiliency of water infrastructure, those are three pretty broad spectrums in the space of water and that also opens up the opportunity to fill the pipeline. I do expect that certainly early on here the acquisitions that we do are going to be bolt on.
They're going to be close to the core. And then obviously over time as we continue to expand that brings into play more meaningful acquisitions.
Speaker 4
Okay. I'll pass it on. Thank you guys.
Speaker 1
Thank you. Thanks, Scott.
Speaker 0
Our next question comes from the line of Deane Dray with Citi Investment Research.
Speaker 1
Thank you. Good morning,
Speaker 4
Good morning, Deane.
Speaker 6
I was
Speaker 1
hoping to get some additional color on what I would call your high quality problem of explaining how organic revenue growth sort of coming at the low end of the range that you said back in May came in at the high end. And Patrick you did give some good specifics. But just give us in context, you've got shorter cycle business, a little more limited visibility. So through April maybe that's 30% of the quarter you made the announcement. So what are the other dynamics in terms of did you look at can you quantify how much business got pulled in from July?
Is did you just convert more orders at the time into revenues? And what does it say about your forecasting on a go forward basis?
Speaker 3
Yes, Deane, this is Mike. Let me provide some comments and then Patrick can certainly weigh in. I think there's a couple of things. One, we were providing perspective on what we were seeing and at the time April was coming in essentially flat with where we were last year. And I'd say that the short cycle nature of the business obviously does create a bit of a challenging dynamic from that standpoint.
And I think we hit some of the points in the prepared comments that as we progress through the quarter, we start to see the market improve not substantially, but just enough to move us into that higher end of the range that we've been talking about. But more importantly, I think what you saw from us is the same thing you've seen for the past several quarters, which is we have much deeper visibility into the business now. The change that we made organizationally, we are now dealing directly down say at the dewatering level or the treatment level and we're able to to react more quickly. And so Patrick and I came back from seeing the April results and really pushed the team around making sure that we were cleaning up any of the delinquent shipments that we had, making sure that we were converting on all the orders that were to be shipped within the quarter. There wasn't anything large notable that we pulled in per se, but I would say that the team worked hard to make sure that we met the commitments that we had laid out.
Speaker 1
Is this the calibration that book and ship is about 70% of your business, 30% project? Is that a fair split? Yes. I'd say right now
Speaker 3
Deane it's probably 70% to 80%. And obviously as we see the longer term orders improving that dynamic is going to start to shift probably closer to that 70% mark over time. But I'd say that the short cycle nature of things like our rental dewatering business those still weigh pretty heavy on the results and are areas where we try and stay as close as we can. We've developed some new processes for monitoring what we would term backlog in those businesses to give us better indicators around what the trajectory looks to be, but they're still short cycle in nature.
Speaker 1
Great. And then just in terms of the businesses, what I thought was very interesting in your release you talk about this win in Brazil and it's noteworthy on a number of points. Importantly, maybe give us some context. Are these types of whole system high end project bidding that you'd like to do more of? And I'm pretty sure I heard Patrick call it a referential win.
And does this qualify as a reference site? Maybe some of the economics when you're putting in one of these reference sites because it becomes a showcase for the ability to do similar projects elsewhere.
Speaker 4
So a little color there would be helpful.
Speaker 1
Sure, Dana. These absolutely are the kind of things that we would like to be involved in. I mean you find and from my background and experience certainly in the developing markets our customers and clients do tend to look at I wouldn't call it complete turnkey solutions, but certainly looking at bundling services and technology. And I think that's where we've already seen some of the biggest impact on the integration of our front end. I would say that in a number of those markets our the front end of our commercial organization has long been integrated.
And so they've been working together for quite some time. These are long processes you can appreciate to come to closure and win a victory. We call it referential, I think because these are key accounts. We don't share too much on the customer specifics and economics for obvious competitive reasons, but these are healthy projects. They bring with them a very attractive aftermarket service component to it as well.
But more importantly, it demonstrates that we've got the capability in these emerging markets when we focused on them. And secondly, helps build the Xylem brand name, not that we're always leading with that brand name in all cases, but it certainly increases our recognition of our brand in those developing markets. Great. And that the membranes, is that part of the joint venture with GE? Yes, is.
Terrific. Thank you. Thank you. Thanks, Deane.
Speaker 0
Our next question comes from the line of Ryan Connors with Janney Montgomery.
Speaker 5
Great. Thank you. I had a question for you Patrick on kind of the portfolio review in The U. S. I guess the fact that you're moving on to South America kind of suggested some of your initial tour in The U.
S. Is done. Can you kind of give us your comments and perspective on how you believe the company's position in terms of The U. S. Manufacturing footprint and whether you're satisfied with where you're at there or whether you believe there's consolidation opportunities domestically?
Speaker 1
Sure. I think that over time this is a multiyear journey where we're trying to integrate a number of legacy standalone businesses. And I would say that we've historically probably not had a comprehensive manufacturing strategy across the various businesses that we've got whether that be in The U. S. Or whether that be globally.
And that is an area that will be a focus for me and the team is to better understand what those opportunities are from our supply chain globally, but certainly specifically here in The U. S. As well. And I think as I talk a lot about the emerging market opportunity, which I think is large and real. At the same time, that's not to suggest that we don't also have meaningful growth opportunities in the more mature established markets.
I think there's an opportunity for us to drive more improvement on the aftermarket piece of our business. It's not as applicable to all of our businesses, but certainly some of them have a very attractive aftermarket opportunity that I don't believe that we fully mined. And then I would say something that I've spoken a lot about and that is I see consistently across the company. There are further opportunities for lean deployment certainly here in The U. S.
Across not only our factories, but the entire value chain.
Speaker 5
Okay, great. And then another kind of more tactical question on pricing environment. I'm hearing less about it in your prepared remarks than we were six, twelve months ago. And I guess we can read that as a positive that the pricing environment has improved a little bit or at least isn't negative. Can you kind of give us an update on the pricing environment out there and the outlook?
Speaker 3
Yes, Ryan. So it's Mike. We're still seeing what I'd say is a negative bias from a pricing standpoint more particularly in infrastructure business. Applied water still is in a positive territory although not at the same levels and I'd say a good portion of that's really more commodity pricing driven. But I would say that the dynamics really haven't changed a lot.
I mean I think you can hear it with many of our competitors that the markets are improving, but we're all still in a much more slow growth environment than we have historically been. And so the competitive dynamics are such that it's still putting a negative bias on pricing. You're not hearing a lot of it in our prepared remarks because it's in line with expectations we had of somewhere in the 25 to 50 basis points of pressure coming out of that particular segment.
Speaker 5
Okay, great. Well, that's very helpful and congrats on a great quarter and safe travels Patrick.
Speaker 1
Thank you very much. Thanks.
Speaker 0
Our next question comes from the line of Mike Halloran with Robert W. Baird.
Speaker 3
Good morning, everyone. Hey, Mike.
Speaker 7
So could you help frame the sourcing opportunity today? Where it stands on a percentage basis? What kind of targets you might be putting out there? Or maybe better put, who are you looking at from a peer group perspective? And what kind of ranges do they have from a guidance perspective, so we can see kind of where you think you guys can go over time?
Speaker 1
Sure. Well, think it's probably too early to tell right now exactly to put a number out there as to what I think the global sourcing opportunity is. I think that it's probably better to talk about the journey as to where we're coming from and where we're going. Certainly don't want to suggest that there's never been any kind of leverage gained across the businesses, but each one of the value centers and the businesses in them have historically operated on a standalone basis in terms of having their own procurement functions. And we have a number of categories that clearly if we leverage our global spend here, there's meaningful upside to be gained in doing that.
Secondly, it's not just about the cost takeout, but it's also about getting better quality, better service, better delivery from our suppliers. So really again it's the whole value chain from a sourcing standpoint. I think there are a number of companies that are out there obviously that we model against and put ourselves up against as a benchmark. Certainly the Danaher's of the world, the Roper's of the world, few others that are out there that I think have been on that journey and really have delivered quite a value by standardizing their processes across areas including procurement.
Speaker 7
That's fair. On the dewatering side, a couple of things there. Just one, what kind of rental utilization levels are you guys seeing now? Or at least how have those tracked as you look through the quarter? It sounds like the oil and gas piece in particular is starting to strengthen up here.
What's the customer cadence sound like? And what's the trajectory look like as you look out a little bit farther?
Speaker 3
Yes, Mike. The cadence has been improving pretty much starting back in late February and we've seen that continue now through the second quarter and obviously continue to monitor that. Utilization rates, they're not at the what I'd call the peak yet and that's a broad comment because we have obviously model mix within that that we continue to watch. But I would say we're getting up around that 50% mark, which is pretty close to getting to optimal. And so we'll be moving into the decision around what additional assets do we need to contemplate, would be a good thing to start talking about.
Speaker 7
Thanks for the time gentlemen.
Speaker 4
Thank Thanks.
Speaker 0
Our next question comes from the line of Matt Summerville with KeyBanc.
Speaker 8
Good morning. Just a follow-up on the dewatering business. Can you talk about how much that was up in Q2 and whether June in particular was stronger than you would have thought and then what your expectations are for the back half?
Speaker 3
Yes. So Matt, we saw dewatering kind of on a sequential improvement. Like I had mentioned when I was answering Mike's question, we've seen that kind of improving month to month. In the second quarter, we were up 4% and that brought our first half up call it mid single digits and that's vast improvement over the anemic growth that we had in the first quarter. And we see that trend continuing and we're optimistic optimistic given the strength we've seen in hydraulic fracturing and just overall what looks to be a rebound in construction and use in the public utility market should support that continued growth through the balance of the year.
Speaker 8
And then with respect to the applied water business, I guess whether you talk industrial, commercial, residential maybe sticking with those three buckets. You've been sort of down here in this business for a little while organically and it doesn't sound like your construction oriented business is picking up yet. I guess what can you say to sort of give us confidence that you're not losing market share in these businesses?
Speaker 1
Yes. Well, as you probably know in these businesses market share data is not always easy to get. And but certainly all of the indications that we've got right now we've been asking ourselves that question with the teams is that actually when you look at some of our other companies that have reported in this space, if anything we've probably certainly held if not even possibly gained some ground especially in areas like groundwater etcetera. So we don't really comment on share positions and really comment on our competitors, but we certainly don't have any reason right now to believe that we've lost any share.
Speaker 8
And then Patrick just one final one. Similar to how you talked about your U. S.-based footprint, what's your initial appraisal of the manufacturing footprint you guys have in Western And Northern Europe?
Speaker 1
Sure. Well, again, I think it's early assessment. I think that one of the areas that is fairly apparent to me and that is certainly when I think about the needs that we have to be able to accelerate our growth in a number of the developing markets. There's only so far that we're able to go by relying upon in some areas an import model. And so we already have some footprint in some of our developing markets, but I would say we will expand that footprint over time.
And then obviously over time we'll evaluate what our needs are from a global supply chain and make the changes necessary at that point.
Speaker 3
Thanks
Speaker 4
guys. Our Thanks,
Speaker 0
next question comes from the line of Joe Giordano with Cowen.
Speaker 9
Hey guys. Thanks for taking the questions. On the quoting activity on the muni side, I guess you'd focus on U. S. And Europe.
Just curious as to how competitive that's been? I know in Water Infrastructure you say price has been a headwind. So when you're saying quoting activity is picking up, does the level of competitiveness there seem to be exacerbating pricing pressure?
Speaker 3
Yes. I mean, I'd say it's a fair characterization of the market. I wouldn't put the pricing pressure as a huge dynamic at this stage. I think the competitive environment is certainly there, but I think folks are being smart about the pricing dynamics. I think what it's that coupled with the fact that commodity prices have been relatively tame over the past year really has lowered our ability to get additional price.
But I think the important thing to remember is we're still priced at a premium relative to the competition. We're getting the growth. We may be losing a little bit on the pricing side, but overall it's still a pretty positive equation for us.
Speaker 9
Okay. And then on the restructuring side, you mentioned the savings you expect for the full year on top of what you got last year. So where are we at as of one half? And I'm not trying to pin you down for next year kind of guidance, but this year you're saying we're talking about 20% or so EPS growth on around 4% revenue a lot of restructuring savings. How would you categorize broadly what your expectation is kind of would next year be characterized more of a revenue driven year or more of a restructuring cost out type of year?
Speaker 3
Yes. So let me answer the more tactical side and then I'll let Patrick provide a perspective as we look forward. Through the first half, we've incurred about $18,000,000 worth of restructuring cost and the savings that we racked up is about 22,000,000 and big portion of that 22,000,000 is actually the activity we had underway last year. For the second half, we're guiding around $20,000,000 of savings and that's largely due to the actions that we've taken through the first half relative to that $18,000,000 of cost. I would think about that going into next year is probably about an 18,000,000 to $20,000,000 tailwind as we lap and get pickup favorability essentially in the first half of next year from the actions that we will have executed.
And then, Joe just to remind you, we are guiding 30,000,000 to 35,000,000 of total restructuring costs this year. So you can see that we still have a ways to go in the second 12,000,017 million dollars But with that I'll turn it over to Patrick for any comments relative to as we look out
Speaker 1
Sure. Yes. Obviously, well short of giving any kind of guidance for SIGNAL-one hundred fifteen, I think certainly we are very much focused on how do we accelerate the growth of the business. Obviously that will not be at the expense of margins. We're looking at healthy profitable growth.
And so certainly we're making sure we're making the investments there to drive the top line. Secondly, we will continue to maintain the focus on the cost side and the margin side. While I would never rule out restructuring, our focus right now really again is on ramping up again the continuous improvement opportunities in global sourcing and lean. So we certainly would expect margin expansion to continue from those areas. But it's going to be a balanced look as we go forward from 2015 onward.
Okay. Great. And if
Speaker 9
I can sneak just one fast one in. If M and A if you don't find anything attractive in the second half does that would that imply potentially more repurchases at the levels we've seen in the first half?
Speaker 1
I think it'd be I think it's premature right now for me to comment on that. I mean, certainly, we feel good about the return to shareholders that we've already committed to. And we'll have more to comment on that as we get further along on the M and A assessment. Obviously, and A opportunities you can fully appreciate take time to cultivate. And so us having kind of reignited that it may take a little bit of time, but we feel good about the prospects and we'll have more to comment.
Great. Thanks guys. Thank you. Thank you.
Speaker 0
Our next question comes from the line of Nathan Jones with Stifel.
Speaker 6
Good morning, Patrick, Mike, Phil.
Speaker 3
Good morning. Good morning.
Speaker 6
So Patrick, we've been talking about several things here that probably going to take some investments ramping up on Lean and Six Sigma. We've talked about 200 basis points potentially of SG and A coming out. You talked today about localizing manufacturing global sourcing investments. Can you talk about whether we should be expecting some increased CapEx over the next year or two? And what impact might be seen on the margin line as well?
Speaker 1
Sure. I think that one of the things that we're very much driving here in the company right now is kind of what I call a productivity for growth mindset. And that is again given where we are in our lean deployment, global sourcing, some of the other restructuring benefits we're getting from the actions taken. These are all intended not only to expand margins which you're seeing obviously here in 2014 and will continue in 2015, But part of those savings go to fund some of these investments that we're talking about. And so I don't think that we should be looking at any kind of dilution in margin as we go forward.
We will continue to expand margins and as well as continue to accelerate the top line growth assuming the markets cooperate.
Speaker 6
And if we could just take a look at specifically on Lean Six Sigma with what you've seen since you've been at the company, can you talk about where we are in terms of lean deployment and how long you think it's going to take until you're at a reasonable level?
Speaker 1
Sure. I think that the way I would characterize it is we've got pockets of excellence right now across the company. And I think that's clearly a reflection of the fact that these businesses historically had been I think early adopters of Lean Six Sigma other continuous improvement tools. And my assessment and I think the assessment of many of the people in the company is that during the transition of the spin other things going on some of those things began to fade. I think historically the focus had predominantly been on inside the four walls of the factory, so very much focused on cost takeout etcetera in the factories themselves.
I think the opportunities here are not only to now reignite that in the factories, but more importantly to apply these tools across the entire value chain. So speed to market efficiency, transactions, back office, but also using these tools to help us get at what our overall global manufacturing strategy is going to be. And so I look at this in a bigger picture rather than just applying lean within any given factory. And that to me is where the big opportunities lie.
Speaker 6
Yes. Makes sense. Could you possibly quantify you said pockets of excellence, kind of what percentage of the portfolio you describe as excellent and what percentage of the portfolio you think needs a significant amount of work?
Speaker 1
Yes. It's a tough one to say because we've got such a distributed footprint across the board. But I'd say the way I characterize it, I'd say probably at about one third of the locations that I've been to I've seen a pretty heavy adoption of classic tools being deployed. I think the whole point of continuous improvement in lean is that it is a journey. So it never ends and you're always kind of revitalizing refreshing things.
So there's opportunities all over the place. But I think that there's probably still two thirds of the organization that I think are still fairly early on in the whole process.
Speaker 6
That's helpful. Thanks very much.
Speaker 1
Okay. Thanks, Nathan.
Speaker 0
Our next question comes from the line of Kevin Maxko with BB and T Capital Markets.
Speaker 10
Thanks. Good morning.
Speaker 3
Good morning, Kevin.
Speaker 10
Just to follow-up on that last question. So even with some additional spending that you may be planning for productivity and footprint and other things, is it still the way we should be thinking about this in terms of incremental margins that we ought to normalize into something in the low 30s as we get out beyond the second half of this year?
Speaker 3
Yes. I think so Kevin. I mean, I think largely speaking we want to hold to the guidelines that we've provided around the incrementals as well as when you think about our capital expenditures, we've post 2.5% to 3% of revenue. And we may have one off investments that we have to make and we'd obviously provide clarity around that. But and we think we can largely handle it within those guideposts.
And I think it's back to Patrick's comments around productivity for growth and making sure that we've got an engine that can produce the room to make the investments to keep the growth
Speaker 10
And the first half was of course very strong up around 60% and we all know that will normalize. But can you just give a little more color on the incremental margin guide for Q3? It looks like that's actually doing more than normalizing. It's quite a bit below the normal range.
Speaker 3
Yes. So I think when you think about the third quarter sequentially we're going to be down 2% to 3% from a revenue standpoint. And we're actually expanding margins 80 to 130 basis points. And that's largely due to the fact that we've got the incremental restructuring kicking in, in the back half, but we're also driving additional sourcing and lean initiatives to try and improve the gross margin as we head into the back half.
Speaker 10
Okay. So there's some additional spend that's happening on things like sourcing and lean that wasn't happening at the same magnitude in the first half?
Speaker 3
There's a little bit. I mean you can see it and I'll use the corporate line as an example. We've guided to a $55,000,000 full year corporate number which is slightly above the run rate coming out of the first half. Given the weakness we saw coming out of January and February with the weather, we obviously like we did last year, we took some actions to move things around within the year. Given where we're at, we feel confident that we can move forward with those initiatives in the back half.
I think Kevin the important thing to note when you compare whether you're looking at Q3 versus last year or the second half versus last year, you have to really look back at twenty thirteen first and second half because they were really a tale of two different halves. That first half of last year we were looking at a negative 5% growth rate and pretty heavy decremental margins in areas like Europe and dewatering. The 2013 not only did we have positive organic growth which we got volume leverage out of in areas like Europe and dewatering. But on top of that we got the positive benefits of all the things we had done in terms of the restructuring actions that improved us incrementally from first half to second half. So there is a bit of that compare that plays into it.
And then you have the challenge that we're facing in the 2014, which is primarily around things like pricing and then the timing of the investments throughout the year.
Speaker 10
Okay. And just finally Mike, since you mentioned the corporate line that's tracking in the first half well below that guide. Is it still a 55,000,000 to $60,000,000 outlook you have there on that line?
Speaker 1
55,000,000
Speaker 4
55,000,000 Okay.
Speaker 1
Thank you. Yes. You bet.
Speaker 0
Our next question comes from the line of Brian Konigsberg with Vertical Research.
Speaker 1
Yes. Hi. Good morning.
Speaker 3
Good morning, Good
Speaker 1
morning. Actually just coming back a little bit to the Applied Waterline. I mean you talked about the markets just being generally difficult, but you don't think you're losing share. Just on residential, I mean it doesn't seem like that ever really got off the ground much very significantly at all. And now you're saying that it's still going to be fairly flat.
I mean is it just the nature of the business that it's more replacement that never really went away? Or why is that not stronger? Maybe give a little more color on why it just never saw any benefits through kind of the upturn of that cycle?
Speaker 3
Yes. Brian, I guess I'd point back to some of the stats. I mean, first and foremost, we actually saw six percent growth last quarter in the residential market. And then if you look at last year, the second quarter, we actually posted 6% growth. So some of it is compares and timing in the cycle.
But I'd also say we're not as exposed to all the new construction and some of the things that are driving the improvement in the residential market. The majority of our business is really focused around ground well and circulator pumps that go on boilers. So it's bit of a more niche play, but we have seen some of the positive effects of the residential recovery overall. And I think you've seen that play out in different quarters throughout the course of the last couple of years.
Speaker 1
Okay. And then just on the commercial side, I mean, so it's weak kind of in near term, but do you anticipate you will participate if that starts to gain traction or is it a similar type of dynamic?
Speaker 3
Well, I think we'll participate, but again it's going to be driven by a couple of different things. One, the institutional market specifically in places like The U. S. And we think we're aligning well in the emerging markets China in particular to take advantage of what could be the resumption of the commercial build out.
Speaker 1
I got you. And I just wanted to clarify. Did you quantify the revenue pull forward from the project shipments this quarter? I know you talked to it. I didn't hear a specific number unless I missed it.
Speaker 3
No. It was there wasn't anything notable or material that we would point to.
Speaker 1
Okay. All right. Great. Thank you very much. Thank you.
Our
Speaker 0
final question comes from the line of David Rose with Wedbush Securities.
Speaker 11
Good morning. Thanks again for taking the call. A couple of final ones. Going back to some of the metrics on lean and maybe on time delivery in the last quarter you've improved it. Does this mean that this is sort of an on your on time delivery numbers have improved moving forward?
Is this something structural that you did? Or was this sort of an urgent effort to ship out everything? That's one. And then two is if you can talk about some of the lean metrics about which we should measure outside of the four walls particularly on the SG and A side going forward? I mean what sort of productivity measures should we be looking at?
Speaker 1
Sure. Well on the first one, I would say this is right now pretty much brute force in terms of just people focusing on making sure that delinquencies are managed and handled. And so I wouldn't suggest there was any kind of big enhancement of lean deployment that drove that. That's certainly a long term activity. Although again some of the businesses that we're experiencing this are fairly far along in the lean journey.
So I wouldn't say it was all brute force, but largely so. In terms of metrics that are out there, not prepared to disclose any just yet. I mean certainly a little bit further down the road here, I'll speak more openly and candidly around what are those big metrics that we're going to be measuring against. There will be some classic ones in there. And obviously, certainly as we go after further improvements in the area of SG and A and particularly G and A that will certainly be one of those metrics that we're focused on.
The others are very much focusing on what our penetration in terms of our certification rates are as well as the deployment of resources on active projects. So we're fairly far behind and that is a starting point. But again as mentioned before, the good news on this from a company standpoint is that this is not a foreign language for many people in the company. It's just a matter of reinvigorating the focus and deploying it beyond the four walls of the factory.
Speaker 11
Okay. That's helpful. And then lastly Patrick, given your background of highly engineered products in the aftermarket side you hit up on it. What do you need to do? Maybe first of all, what is the number today that you're with which you're working in terms of aftermarket as a percentage of total sales?
And what number do you want to get to? And what do you have to do to get there from an investment standpoint? Do you have to invest in some of those emerging markets, la Brazil and setting up the infrastructure there?
Speaker 1
Sure. It's a great question. And I'll have more to say here in future calls on exactly again what these goals metrics are and some of the structural moves that we would be considering making here in the organization to get after that. I mean today we do just below 40% in aftermarket if you consider the parts to service the replacement piece. That number in my view certainly needs to be higher than that.
It's not just about the percentage itself and the profitability that you get in that business relative to the OEM, but it's also just the intimacy that you get with the customer by being in there with them and getting visibility of what's happening from a competitive standpoint as well. And so I think that what we need to do in the area is obviously set some big goals and metrics, make sure that we're organized effectively to get at that. Right now again we do it very well in pockets depending upon which value center that we're talking about. And then secondly, I would say a big piece of this is making sure that as we go into ramping up our presence in some of the key emerging markets, You want to make sure we want to make sure that we really maintain control of our installed base and that we're also selling aftermarket as part of the initial sale rather than trying to chase it afterwards.
Speaker 11
Okay. Well, that's helpful. Thank you very much.
Speaker 1
Thank you. Thanks, David.
Speaker 0
Was our final question. I'd like to turn the floor back over to Patrick Decker for any additional or closing remarks.
Speaker 1
Well, I just want to thank everybody for taking the time to join us this morning. We very much appreciate your support and interest. And I look forward to catching up with you and updating you on our progress in our next call. So between now and then safe travels and we'll talk soon.
Speaker 0
Thank you. This does conclude today's Xylem second quarter twenty fourteen earnings conference call. Please disconnect your lines at this time and have a wonderful day.