Welcome to the Xylem Second Quarter 2020 Earnings Conference Call. At this time, all participants have been placed on listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.
Thank you, Christy. 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 a follow-up, and then return to the queue. As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website at www.xylem.com. A replay of today's call will be available until midnight on August 31st.
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. 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. 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 30th, 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. Please turn to slide three. 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 four, and I will turn the call over to our CEO, 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 pre-announcement two weeks ago, our second quarter performance was better than we'd 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 the low point of 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's effects early, and so we've also benefited from our presence in 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. 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 needs, those actions have built a more robust foundation for both the medium and long term.
I want to make a point of giving credit to my colleagues across Xylem and all of our external partners who made that happen. They've shown incredible resolve and resilience through 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 essential services running despite everything being thrown at them. Throughout this period of incredible challenge, they've focused on keeping each other safe and serving our communities. Within Xylem, I want to highlight the work of our supply chain, manufacturing, and our 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.
While demand-side uncertainties continue, our outlook now reflects greater clarity and confidence about supply, putting us in a much better position to guide through 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 do anticipate it will generate roughly $115 million in revenue over the next two to three years. In 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. 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. Mark, over to you.
Thanks, Patrick. Please turn to slide five. 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 have 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, backlog shippable after 2020 is up 23%, which gives us confidence that we'll be emerging from 2020 in a position of strength and 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's 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 six, 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 their 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 seven. 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%.
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. Please turn to slide eight. Measurement & 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 bidding pipeline remains 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 U.K. The $90 million contract demonstrates the competitiveness of our AMI and digital solutions to drive key international wins. This win and a robust pipeline of AMI opportunities highlight the continued commercial momentum and the differentiated value our offerings bring 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 nine. 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 pre-funding $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. 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 continue 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 through the first half of the year. We now expect free cash flow conversion for this year will be at least 100%. 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. 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 serve as 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, and we do 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 is 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 a 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 de-stocked 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 kind 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's become an operational and economic imperative to consider the benefits of remote monitoring, automated operations, and their 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 reprioritized our investments. We're focusing further on the projects that deepen the differentiation and the market leadership of our portfolio. Things such as increase in connectivity and interoperability across our solutions. We continue to invest in our highest growth geographies. Lastly, we are reorienting the way that we work within Xylem.
We've accelerated the deployment of the IT platforms that make remote engagement, distance selling, and virtual servicing easier for both our customers and our colleagues. 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. 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%-12% and operating margins in the range of 11%-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 in North American Clean 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 U.S. The pandemic's impact varies widely across emerging markets, from a return to normalcy in China to ongoing shutdowns in India and 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-$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 have also provided a summary table on this slide, which 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. Now please turn to slide 14, and Patrick will close with some final remarks.
Before we go to Q&A, there are a few other milestones that deserve a mention. The first two touch on sustainability. We released our most recent sustainability report in June, and I'm very proud of the work by the team, and it reflects the impact our colleagues have delivered across the company. It shows how we 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 followed that up with the 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 indisputable, his commitment to both our principles and to delivering value has been constant and unwavering. We have appointed an outstanding CFO to lead Mark. Sandy Rowland has been CFO of Harman International both while they were publicly traded and since becoming part of Samsung. Her 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 muni markets. We look forward to introducing her after she joins us on October the 1st.
Mark is going to be with us through the end of the year, which will ensure an orderly and a 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 new board member is Uday Yadav, who is President and COO of Eaton's Electrical Sector, and he brings a disciplined global operating perspective to our growth. These appointments further deepen our board's diversity, our technology depth, and our 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. Operator, please lead us into Q&A.
Certainly. The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you pose your question, that you pick up your handset to provide optimal sound quality. Thank you. Our first question is coming from Deane Dray of RBC Capital Markets.
Thank you. Good morning, everyone.
Hey, good morning, Deane.
Hey, for Mark, I wish you all the best. 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.
Thank you. Absolutely.
First question. 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. If you could just clarify what part of digital that they're taking. Patrick, you also hinted that the Frontlog of orders also has some digital component to it. If you could reflect on where you're seeing traction there.
Sure. Yeah. Thanks, Deane. On the Anglian win, certainly the cornerstone of the deal is the smart network deployment, which is really centered around AMI metering deployment. When you look back and say, okay, 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, stormwater overflow, and overall affordability are three major themes that each one of the utilities are dealing with. 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 Frontlog, we do have a number of other deals in the pipeline. One that we just recently announced, literally live as we speak, is we won a large deal just shy of $50 million down in Winston-Salem. Again, that's also a smart networking deployment. We feel good. Again, it's a big market, lots of activity. I think right now what I'm most encouraged by is 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 resilience.
Great. The second question is on the outlook and the guidance for the third quarter, and appreciate all the detail on page 13. Can you 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 saves reading through, driving that 200 basis points? How much is coming through for the third quarter?
Yeah, Deane, that's exactly what it is. It is the benefit of the ramp in some of those restructuring savings in Q3.
We also, hey, Deane, we didn't guide for obviously, the entire back half of the year, so we didn't talk about Q4. We also expect even a larger portion of those restructuring savings to roll through in Q4. Also we would 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.
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's sitting there in a hazmat suit. I think you should tell that story, and thank you.
Yeah, no, I appreciate that, Deane. Bala is our leader of our business in India. He actually just got recently promoted to lead our global treatment business. That's just one example of many where what our team has gone through to continue serving customers and obviously our customers are the ones who keep the resources flowing. It's a joint effort. All these large deals have pretty much been negotiated on Zoom or some remote platform. We've got customer service locations where calls are being moved to people's homes. Again, we're not alone in this. I do think it's worth calling out that these are not normal times, and our people are really climbing mountains here to continue to deliver. Really, 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 a deal. Driving hours back and forth from home to get there.
It was a $115 million deal [crosstalk] still a heck of a sacrifice.
Yes.
Thank you.
Thank you, Deane.
Thank you. Your next question is from Scott Davis of Melius Research.
Hey, good morning, guys.
Hey, good morning, Scott.
I'll echo Deane's comments, Mark. Congrats.
Thank you.
A great run. Sorry to see you go. enjoy your-
There's more to come, Scott.
All right. Well, don't disappear on us. I have a couple 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, other than it sounds good, and I know obviously optics matter too, but what does it mean? Just leave it at that.
Yeah. I'll kick it off, and then Mark can go through a little bit more of the granularity. Effectively, it's a financing structure that is tied to certain KPIs that we have to deliver on in order to be able to achieve that financing. It really is tied to our sustainability goals and metrics as a company. Mark, do you want to get-
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. That performance is audited by Sustainalytics. It's interesting. In addition to the benefit on the rate, what was fascinating was the amount of demand that we got from investors who are focused on sustainable missions. The offering was five times oversubscribed in no small part to the fact that we had almost 50% of those investors as focused on sustainable mission. Not only do we have an opportunity by executing against our very important sustainability goals to drive the rate down, but it was very helpful from a pricing perspective.
Okay, good color. Patrick, you commented on project delays, which I think everybody's seeing, does that change the economics of the deal for you guys at all? 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 in, say, sake of argument, January, and you're having to put in a lot of overtime wages. How do you cadence that, I guess, is another question to ask and not run into having all kinds of project challenges.
That's predominantly, Scott, a U.S. issue. We've already begun to see, I don't want to call it return to normalcy, but if you follow the, again, I hate to say it, follow the virus around the world, our businesses have been affected along that same line. China, Asia Pac already seeing good growth signs of recovery. That's not creating a pinch in our supply chains. As I mentioned before, 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. It's predominantly in the utility space, Scott, because we mainly deal through distribution and channel partners on industrial and commercial building. They certainly are close to the street.
It's mainly an inventory replenishment. Again, it's going to be more on our supply chain just to be able to provide that inventory to them. It really, you're back down to, quite frankly, that roughly 8% of our revenue that is U.S. utility CapEx. That's where you tend to see more of the bigger projects that we focus on. We don't see there being a big pinch in terms of workforce demand. Our people are still very much engaged. Our supply chain is very robust. It's a long way of saying we don't really see that being a major concern for ourselves. I had to go through a bit of deduction, Scott, to kind of help you get there on that piece.
No, that's really helpful. Well, best of luck, guys. Hope you have a great summer.
Thank you.
Thank you, Scott.
Thank you, too.
You, too.
Thank you. Your next question is from Scott Graham of Rosenblatt Securities.
Yeah, hey. Good morning, and Mark, congratulations.
Good morning, Scott.
Again. Actually, we don't hope to see you again. We hope you just sort of ride off in the sunset.
Thank you, Scott. Thank you very much.
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 and/or just is less intensive than it is on the metering side. The third quarter metering guidance is, I guess, a little bit less than what I would've thought. Could you talk about that, sort of the intensity around the need to be at the site for that? Thanks.
Yeah. It's a good question, Scott. I'd say simply put, first of all, for utility, while all these services are essential, I would say that they would all agree that the wastewater side of the utility is absolutely mission-critical. They have little choice but to continue keeping those operations running and deployments and expanding, et cetera. Two, I would say in our Water Infrastructure business, and certainly wastewater is much more of a global business today than what we do through MCS on the clean water side, which is still largely a North America or U.S.-centric business.
We're certainly working hard to change that, and obviously some of these international deals will help in that regard. I would say it's as much also the geographic focus of our MCS business. 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. It really is just a, on the Clean Water side, it really is just a timing and safety dynamic.
Yep, that makes a lot of sense. I guess my follow-up question would simply be, in terms of the sales that you're seeing in Water Infrastructure, I know that a lot of that is the 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, how that works?
Yeah. Scott, roughly 70% of the revenue base is, and this is in the U.S., it's a little bit different as you move around the world, but in the U.S., 70% is OpEx related. You're right, those margins on that are a little richer, for sure. 30% would be CapEx. In 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, as we've done that now over the years, we'll begin to see a shift more into the OpEx side. It is a richer mix of margin.
The margins are typically about one and a half times the size of projects when you get into, again, installed base and the aftermarket piece.
Okay. That's great. Thanks. If I could just sneak one last one in here. The dewatering business was actually not as down as I thought it would be. Have you won new placements there? What's the driver?
Yeah. It was not as hard hit as we expected, but it was down substantially. All in, it was over 20% down year-over-year. We were thinking it might be in the high 20s. A lot of it was industrial-driven, but it was down in most of them.
Yeah. The good news was backlog was up helpfully, but again, the overall revenue was certainly down again considerably in the quarter.
Yep. Not as much as I thought anyway. Look. Thank you f or all the information. Appreciate it, and good luck, Mark.
Thanks, Scott.
Thanks, Scott.
Thank you. Your next question is from Ryan Connors of Boenning & Scattergood.
Great. Thanks for taking my questions. Yeah, congratulations. Best of luck, Mark.
Thanks, Ryan.
Patrick, I appreciate your comments on the intermediate-term outlook for the utility market, but I wanted to probe on that a little bit just from the perspective of the history. Xylem wasn't a standalone public company when the last recession hit, but 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. Xylem was still seeing headwinds in utilities as late as 2012, which was a good four years removed from the recession.
I guess my question is, 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 the portfolio, at least in Water Infrastructure, still is relatively similar to what it looked like then. Just 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're not taking anything for granted here. We're staying close to the markets and the utility customers and really understanding how they're 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 that is tied to utilities in the U.S., again, is roughly 8% on the CapEx side. It really is the CapEx piece that tends to show that kind of fluctuation from a funding standpoint. Two, we do have the MCS platform on the clean water side. While we're absorbing some of those delays right now clearly, we're not seeing cancellations there.
These are projects that are tied to issues of affordability, non-revenue water, and certainly what we're hearing from utility leaders, they don't see those projects being canceled or killed in any way. That's a different dynamic than we would have had back at 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 is we've also got a much larger portion of our revenue today in emerging markets. We see that demand continuing to increase considerably.
Okay. No, that's very helpful. A related follow-up is so much right now seems to ride on the federal government across the economy. I guess for Xylem, I wonder if you can comment on how that outlook you just described in utility, how that differs under a scenario where Congress does bail out state and 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. Great question. I think certainly, as we've mentioned before, I don't think our view on that's changed, is we certainly are 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 a state and local level. Any move there on the positive from the Federal government would certainly be upside. I wouldn't bake that into people's outlooks or forecasts for the business because it'll be a while in the coming. Likewise, there's really no downside in that regard. Obviously, we're staying close to the local utilities and munis to understand those parts of the country that are feeling more stressed at this point in time. I would say we're kind of neutral on the whole federal funding aspect.
Got it. Very helpful. Thanks for your time.
Thank you, Ryan.
Thank you. Your next question is from Andy Kaplowitz of Citigroup.
Hey, good morning, guys. Mark, congratulations. Good luck.
Thanks, Andy.
Just focusing on the cadence that you saw in Q2, because you did 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 that you're not reinstating guidance given the recent resurgence in infections in the U.S.?
Sure, Andy. Yeah. We started off the quarter down mid-single digits. I wish it was mid-single digits. Mid-teens. Matt's like flashing me. Mid-single digits. That was true for, got a little bit better in May, and then we had a really strong June, so we ended up down low double digits, 12%. As we mentioned, orders were still in the quarter 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 shippable backlog for the quarter is less than 2%. We're still going to need a strong orders performance in the next two months. We think all in, we're well aligned with what we laid out in terms of the range, which obviously is tighter than we had last quarter because we have some better visibility.
That's helpful, Mark. I think in June when you announced sort of the bigger structural cost out, you also talked about spending $40 million-$50 million to exit certain business activities. I think they seem to be focused on MCS, as that's where it seems like you're taking the bulk of your restructuring. Could you just elaborate on what you're doing there, what you're getting out of, and why?
Yeah. 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 and aren't as core to our mission moving forward.
Yeah, there was nothing in there that was 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 the cost being taken. Therefore, we had to disclose that. Again, the amount of revenue is a rounding error. Yeah.
Great. Thanks, guys. Mark, good luck.
Yep. Thank you.
Thank you.
Thank you. Your next question is from Joe Giordano of Cowen.
Hey, guys. Good morning.
Good morning, Joe.
Hey, Joe.
Congrats, Mark. As everyone's kind of said here, you will be missed.
Thank you.
Just to start here, Patrick, I know that the situation can change dramatically between now and obviously 2021, 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 hopefully overall budgets are kind of flattish, maybe CapEx is pressured and maybe OpEx is kind of stable, with lower tax receipts, we're kind of hoping for flat overall spending environment at 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 lack of project cancellations, I really wouldn't want to start guessing what overall muni budgets are going to be. Again, 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. I think it's also, the focus we have right now with our teams is this pandemic has clearly highlighted for the utilities, the need for greater operational resilience. Obviously, we're currently learning a bit about the financial resilience, but we're really focusing in on, with the utilities on helping them do more with a whole lot less.
That's where they are looking for alternative solutions, the whole digital dimension of things. That's really where we have our teams focused in taking share. Obviously, at the same time, I think it's important that everyone on this call understand that I think what we're also seeing in our portfolio, and this goes back to maybe the questions earlier around what's different this time versus before. It really speaks to the durability and critical nature of our traditional heritage product lines, that we don't talk as much about over the last one year or so because of the acquisitions we've done, but they are absolutely core right now and essential to what the utilities need.
Fair enough. That's good color. A couple of just related ones on MCS. Well, just one, are you confident that as in like a market deterioration, we're done with negative margins here? Then two, you guys have done a lot over the last several years building out a portfolio. It's an interesting mix of applications there. There's been some issues, some Xylem issues, some market issues, but curious what you've 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.
Yeah. I would say that your question on margins, we certainly expect to be in the black and see positive margins. We'd expect the third quarter to be positive. We were just about breakeven in Q2. With a little bit of a ramp in terms of some of the deployments, the installations and just cost actions, we're going to see improvement there. Patrick, I'm sure will allude. I think in terms of lessons learned, I think what we've learned is adoption of some of these new technologies is a little bit more challenging, particularly in the developed markets.
I think in terms of the capabilities that we've built, particularly what we're seeing through this pandemic and the discussions that we're having with customers, I think we're very pleased with what we have done, the acquisitions we've made and the capabilities we've built as we emerge from the pandemic, because that is going to provide us, we believe, with a competitive advantage.
Yeah. Real quick, Joe, I'll touch on both as well. On the margin comments or question, there, I think it's important that all understand the level of fixed cost base that we have within MCS, given the services profile in terms of the R&D investments and building out new product development rollouts, et cetera. Now, some of the restructuring actions we've taken do get at that overhead cost base. Our view on incremental has remained unchanged. Very attractive incrementals in that business. As we see projects being deployed, return to work in the second half of the year, we'd expect the incrementals to be quite attractive in that business. No change in view there.
On the lessons learned, I would also just throw in, Joe, that I think that it does speak to adoption, but I think it's also the fact that the solutions and value propositions that we're bringing to the sector are disruptive. Any time that you are aiming to disrupt the sector, it's going to take longer than what anybody ever wants it to. It's always going to be a bit harder than what we had anticipated it being. Our views around the attractiveness and the need for the sector to get disrupted in a positive way, especially around the idea of making infrastructure more affordable, that issue remains unchanged. It's not going anywhere. I think we want to be appropriately impatient in this regard. We've got to keep it in perspective as to the long-term journey that we're on here.
Thank you, guys.
Thank you, Joe.
Thank you. Your next question is from Nathan Jones of Stifel.
Good morning, everyone.
Hey, good morning, Nate.
Hey, Nate.
Congratulations, Mark and Patrick. If you need somebody to wait in the car for eight hours for $115 million, I'm available.
You got it.
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're concerned about things like people not going into city, going to work, 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.?
Sure. Yeah. I think you've hit it, Nate, on the U.S. side. 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, et cetera. I don't really have much to offer there other than, again, it is a concern of theirs. They do look back at previous cycles and try to understand. It is a different dynamic now, and they're trying to get their hands around that. Now, they're also letting me know that they're seeing increased consumption at the household level because people are staying home. Some of that just shift from one kind of metering point to another. I don't want to minimize that in terms that there will be some potential impact there.
They are still, generally speaking, from the utility leaders that we're engaging with, they're 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. That's not all calendar. As you know, a lot of those are July 1, October 1 kind of fiscal budgets, and so we're keeping a very close eye on that. Again, I want to keep it in perspective as to 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, it tends to be much more stable. That's because a large majority of the funding, certainly in emerging markets, is at a federal or state level. It is much more of a kind of independent funding and much less reliant on the actual revenue collection.
Yeah, I think it's an important point that outside of the U.S. tends to be much more stable on the collection side. You guys had said in the last call that a more normalized decremental level would be 35%, but we probably wouldn't see that until the second half of the year. Is that still a target we should be thinking about for the fourth quarter?
Yeah. Nate, absolutely. A couple of reasons. One, we're going to see a bigger ramp, as Patrick mentioned earlier, in terms of our cost-saving. Secondly, we had some items last year that made the compare this year tougher.
For Q2.
For Q3.
Q2 and Q3.
Yep. We do expect to see that normalize in the fourth quarter.
Okay. Thanks very much for taking my questions.
Thanks, Nate.
Thank you.
Thank you. We have reached our allotted time for questions. I will now turn the call back to Patrick Decker for any additional or closing remarks.
Well, again, thanks everybody for your interest and for your support. Really appreciate it. Again, I want everybody to stay safe, stay strong, have a great end of your summer, we'll be back with you on our next earnings call. Thank you all very much.
Thank you. This does conclude today's Xylem second quarter 2020 earnings conference call. Please disconnect your lines at this time and have a wonderful day.