Welcome to
the Xylem Second Quarter 2020 Earnings Conference Call. At this time, all participants have been placed on a listen only mode and the floor will be open for your questions following the presentation. I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.
Thank you, Christie. Good morning, everyone, and welcome to Xylem's Q2 earnings conference call. With me today are Chief Executive Officer, Patrick Decker and Chief Financial Officer, Mark Rakowski. They will provide their perspective on Xylem's 2nd 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 31. Please note the replay number is 800 585-8367 and the confirmation code is 7,095,996. Additionally, the call will be available for playback via the Investors section of our website under the heading Investor Events.
Please turn to Slide 2. We will make some forward looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future. 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 ks and in subsequent reports filed with the SEC, including in our Form 10 Q to report results for the period ending June 30, 2020. Please note that the company undertakes no obligation to update any forward looking statements publicly to reflect subsequent events or circumstances, and actual events or results could differ materially from those anticipated.
Please turn to Slide 3. We have provided you with a summary of our key performance metrics, including both GAAP and non GAAP metrics. For 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 presentation. Now please turn to Slide 4, 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 2 weeks ago, our Q2 performance was better than we had expected. In hindsight, April turned out to be the low point of the quarter.
We hope we'll eventually look back and say it was a low point of the pandemic. After April, we saw modest improvement in both May 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. So we felt it responsible to set our 2nd quarter guidance range intentionally wide to bracket a broad set of scenarios for the macro environment.
Today, we have far more insight and confidence on the supply side. That's because of one notably positive effect of feeling COVID's impact early. It catalyzed early action by our teams. Fortunately, we were working from solid financial foundations and a strong position. So we were able to focus on adapting to the uncertainty and managing the things under our control.
In addition to addressing the immediate need, those actions have built a more robust foundation for both the medium and long term. I want to make a point of giving credit 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 accepted demands on everyone. I want to credit everyone around the world who has 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 together 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. So while demand side uncertainties continue, our outlook now reflects greater clarity and confidence about supply, putting us in a much better position to guide to the Q3. 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 UK. The Telangana Irrigation Project is our largest win in the country to date and we do anticipate it will generate roughly $115,000,000 in revenue over the next 2 to 3 years. And our smart networking deployment with Angling in the UK, which combines metrology, communications and digital offerings, is expected to deliver revenues of roughly $90,000,000 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 3rd quarter results. Clearly, I'm very pleased that the team's hard work is evidenced both operationally and commercially. Having said that, the outlook for the second half is still not back to normal. Therefore, we are not reinstating full year guidance. Conditions are improving in a number of our key markets, but the shape of the COVID curve overall is still unpredictable.
Now I'd like to hand over to Mark to provide some detail on the Q2, 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 5. Our revenue in the quarter declined 12%, which was better than we anticipated coming out of the Q1. 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 5 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 Q2 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 6 and I'll review 2nd quarter results by segment. Water Infrastructure orders grew 7% and total backlog grew 24% in the quarter. This performance was largely driven by the $115,000,000 deal we won in India, which is expected to deliver revenue beginning late this year and over the next 3 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 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-nineteen across the emerging markets, we remain confident in the long term growth prospects for the water sector. The Chinese and Indian governments, for example, have expressed their ongoing commitment to continued investments in infrastructure for clean drinking water, wastewater treatment, and environmental protection.
Operating margin in the quarter was 16.2% contracting on lower volumes and unfavorable mix impacts from dewatering, partially offset by productivity, cost savings and price. Now please turn to Slide 7. The Applied Water segment's orders declined 17% in the quarter, while revenue declined 13% as site restrictions continue to impact customers across industrial, commercial, and residential end markets. As regions begin to reopen, we're seeing modest recovery in our book and ship business in both commercial and industrial markets. We also had a strong quarter in the North American Ag Business driven by dry weather conditions.
Total segment backlog grew 1% in the quarter. Geographically, both the United States and emerging markets revenue declined 14%. However, we saw demand in China begin to recover growing 2% in the quarter. Industrial and commercial end markets in China have been slower to recover than utilities and our customers are indicating that it may take several months to fully recover in those end markets. Operating margin in the segment was 13.4%.
Margins contracted primarily due to volume declines and inflation, partially offset by 570 basis points of productivity and cost savings, as well as 100 basis points of price. Now please turn to Slide 8. Measurement and Control Solutions orders declined 24% in the quarter and revenue declined 17% as the metrology business slowed due to utility workforce availability and physical distancing requirements, including restrictions on approaching or entering residents' homes. This is delaying both project deployments and installations of replacement meters. We expect order and revenue trends to normalize over the coming months as utility workers are able to safely return to meter replacement and installation.
Importantly, our 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 UK. The $90,000,000 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 offering 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-nineteen, while we continue critical investments to support growth. Looking forward, we expect meaningful leverage on the upside as revenue growth drives increased incremental margins from recent large contract wins. With continued commercial momentum and growing project backlogs, our MCS segment will be a significant source of revenue growth and margin expansion for the company in 2021 and beyond. Now please turn to slide 9. We ended the quarter with approximately $1,600,000,000 in cash and total liquidity of roughly $2,400,000,000 driven by the $1,000,000,000 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 $600,000,000 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 in liquidity, I'll take a moment to note that our capital allocation strategy remains unchanged. Alongside funding organic investments in key strategic areas, M and A remains a top priority and we maintain a healthy pipeline of opportunities which we closely monitor. Now turning to cash flow.
Our performance in the quarter was very strong. Operating cash flow improved roughly 50% year over year and our free cash flow of $137,000,000 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 $44,000,000 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 and we now expect free cash flow conversion for this year will be at least 100%.
And with that, I'll hand it back to Patrick.
Thanks, Mark. The end market dynamics we anticipate going into the 3rd quarter are consistent with what we saw in Q2. Utilities have remained relatively resilient as expected. However, there is significant divergence between wastewater and clean water. As Mark mentioned, our wastewater business was down only modestly.
We're seeing continued OpEx spending to service mission critical needs and continued execution of capital projects with approved funding. On the Clean Water side, the short term declines were steeper. They were in the mid teens. We are seeing some project delays, but not cancellations, and we do expect execution to pick back up when physical distancing requirements ease. And 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-nineteen hotspots. Our backlog remains robust. Those distributors who destock in the face of uncertainty are beginning to rebuild their inventory. We see these end market trends fairly consistent across emerging and developing markets. But it's clear that China and Europe are showing more resilience in the U.
S. As they emerge sooner from the pandemic. China's recovery, which was up 6% in the 2nd 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-nineteen has not changed. The most important is the role that water plays in society.
There is perhaps no service more essential than drinking water and wastewater. As a result, our strategy is as relevant as ever. The global challenges of water scarcity, affordability and the resilience of our water systems remain front and center. Innovation of all kinds is essential now more than ever to addressing those challenges. While the fundamentals are unchanged, other dynamics are accelerating.
Interest in digital adoption has clearly gained pace as operators seek a step change in their operational and financial resilience. In a constrained budget environment, they are rethinking how they spend their money. It'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. 2nd, we've reprioritized our investments. We're focusing further on the projects that deepen the differentiation and the market leadership of our portfolio.
Things such as increasing connectivity and interoperability across our solutions. And we continue to invest in our highest growth geographies. Lastly, we are reorienting the way that we work within ZYLA. We've accelerated deployment of the IT platforms that make remote engagement, business selling and virtual servicing easier for both our customers and our colleagues. And we are of course assessing the permanent changes that we make to travel, facilities and distance working, changes that no doubt will have a positive impact on cost and productivity and also on employee engagement and morale.
We are focused through the pandemic on managing the things that we can control. And we're taking the actions now that will make us even a stronger competitor in both the near and longer term. Now with that, I'll turn it back over to Mark for more specifics on our Q3 guidance.
Given the uncertainties related to the reemergence of COVID-nineteen across parts of the US 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 Q3, which I'll briefly highlight. We expect revenue declines of 8% to 12% and operating margins in the range of 11% to 11.5%. This reflects approximately 200 basis points of sequential margin improvement and year over year decrementals of approximately 45%.
The decremental margins are impacted by continued softness in our high margin dewatering in North American Sensus Water businesses, along with a tough prior year compared to last year's Q3, where we had 90% incremental margins on revenue growth. While we've seen some positive trends in the 2nd quarter, the global economic landscape remains uncertain and we are by no means out of the woods. While Europe is showing positive trends towards recovery, we're closely monitoring the trajectory in the United States. The pandemic's impact varies widely across emerging markets from a return to normalcy in China to ongoing shutdowns in India and 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 better serve our customers and afford us long term financial resilience. This year, we expect to incur $80,000,000 to $100,000,000
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 $70,000,000 in savings this year and an additional savings of approximately $80,000,000 in 2021.
Now please turn to slide 14 and Patrick will close with some final remarks.
So before we go to Q and 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 grain financing framework, which underpinned our recent $1,000,000,000 grain bond offering. In addition to showing up 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 undisputable and his commitment to both our principles and to delivering value has been constant and unwavering.
We have appointed an outstanding CFO to Steve, Mark. Sandy Rowland has been CFO of Parmit International, both while they were publicly traded and since becoming part of Samsung. And Verint has put her right at the intersection of innovation, technology and disruption. And 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 1.
Mark is going to be with us through the end of the year, which will ensure an orderly and a smooth transition. And lastly, we also announced today that we've appointed 2 new members to our Board of Directors as part of our normal Board succession process. The Board has appointed Laila Tredegoff, who is a Corporate Vice President at Microsoft and a globally renowned technologist. And we look forward to her bringing that perspective to the digital transformation of our sector. Our second new Board member is Uday Yada, 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. And operator, please lead us into Q and A.
Certainly. The floor is now open for questions. Thank you. Our first question is coming from Deane Dray of RBC Capital Markets.
Thank you. Good morning, everyone.
Hey, good morning, Dean.
Hey, and for Mark, I wish you all the best. And this is your second retirement. Do I have that right? Is this going to be your last one?
That is correct, Dean, on both counts.
Okay, great. We're definitely going to miss you.
Thank you. Absolutely.
So first question, so the whole premise of the growth opportunity for Xylem really does hinge on this adoption of digital. And I love seeing this Anglian win that has a digital offering. So if you just clarify what part of digital that they're taking? And then Patrick, you've also hinted that the front log of orders also has some digital component to it. And just if you could reflect on where you're seeing traction there?
Sure, Bill. Thanks, Dean. So on the Anglian win, certainly the cornerstone of the deal is the smart network deployment, which is really centered around AMI metering deployment. But when you look back and say, okay, what problem is Anglin 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 and stormwater overflow and overall affordability are 3 major themes that each one of the utilities are dealing with. So beyond the AMI metering deployment, there's also a level of data analytics as well as remote monitoring that is built into that project. In terms of the 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 $60,000,000 in Winston Salem.
And again, that's also a smart networking deployment. So we feel good. Again, it's a big market, lots of activity. And 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 need for operational resilience.
Great. And then, the second question is on the outlook and the guidance for the Q3. And I appreciate all the detail on Page 13. And you can just clarify the notion here is you've got a pretty similar revenue sequential ramp, but you're getting 200 basis points of margin improvement. Is that all the cost saves reading through driving that 200
the ramp in some of those restructuring savings in Q3.
And then we also, Dean, we didn't guide for obviously the entire back half of the year, so we didn't talk about Q4, but we also we expect even a larger portion of those restructuring savings to roll through in Q4. And then 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.
Great. And just lastly, this doesn't count as a question, but Patrick, I think you undersold Page 12, that picture of the head of your India business that's sitting there in a hazmat suit. I think you should tell that story. And thank you.
Yes. No, I appreciate that, Dean. And yes, Bhalla is our leader of our business in India. He actually just got recently promoted to lead our global treatment business. And so 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. So it's a joint effort. But we've had a number of 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, but 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.
And really, I've never been more proud of them.
Thank you.
We had a gentleman sitting in a car for 8 hours waiting to get into a building to close the deal and driving hours back and forth from home to get there. So it was $115,000,000 deal, but it was still a heck of a
sacrifice. Yes.
You. Your next question is from Scott Davis of Melius Research.
Hi, good morning, guys.
Hey, good morning, Scott.
And I'll echo Dean's comments. Mark, congrats.
Thank you.
A great run. Sorry to see you go. But enjoy your
More to come, Scott.
All right. Well, don't disappear on us. Anyways, I have a couple of questions if you entertain me a little bit. The first one is just, Patrick, can you help me understand what a green bond is? I mean, what's other than it sounds good, and I know, obviously, optics matter too, but what does it mean?
Just leave it at that.
Yes. I'll kick it off and then Mark can go through a little bit more of the granularity. But effectively, it's a financing structure that is tied to certain KPIs that we have to deliver on in order to be able to achieve that financing. And it really is tied to our sustainability goals and metrics as a company. But 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.
And but 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. And the offering was 5 times oversubscribed in those small part to the fact that we had almost 50% of those investors as focused on sustainable mission. So 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. And then, Patrick, you commented on project delays, which I think everybody is seeing. But does that change the economics of the deal for you guys at all? I mean, does it make it less attractive because you end up perhaps having lots of projects all having to be done at the same time because everybody restarts and say, sick of argument January and you're having to put in a lot of overtime wages.
And I mean, how do you cadence that, I guess, is another question to ask and not run into having all kinds of project challenges?
Yes. And that's predominantly Scott, that's predominantly 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 I just say follow the virus around the world, our businesses have been affected along that same line.
So China, Asia Pac, already seeing good growth, signs of recovery. So that's not creating a pinch in our supply chain. As we 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.
So we're kind of working through that demand rebuild as we speak. So 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. And they certainly are close to the street.
It's mainly an inventory replenishment. And so again, it's going to be more on our supply chain just to be able to provide that inventory to them. Then it really you're back down to quite frankly that roughly 8% of our revenue that is U. S. Utility CapEx.
And 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. So it's a long way of saying we don't really see that being a major concern for ourselves.
But I had to go through a bit of deduction, Scott, to kind of help you get there on that piece.
That's really helpful. Well, best of luck, guys. Hope you have a great summer.
Thank you.
Thanks, guys. Thank you. You too.
Thank you. Your next question is from Scott Graham of Rosenblatt Securities.
Yes. Hey, good morning. And Mark, congratulations again. And actually, we don't hope to see you again. We hope you just sort of ride off in the sunset.
Thank you, George.
Thank you very much.
So just a couple of questions here really regarding the access to sites on the water side. It looks like the access on the water infrastructure side is maybe coming a little bit more easily or just is less intensive than it is on the metering side. The 3rd quarter metering guidance is, I guess, a little bit less than what I would have thought. Could you talk about that sort of the intensity around the need to be at the site for that? Thanks.
Yes. It's a good question, Scott. So I'd say simply put, 1st 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 is much more of a global business today than what we do through M and TS on the Clean Water side, which is still largely a North America or U. S.
Centric business. I mean, we're certainly working hard to change that. And obviously, some of these international deals will help in that regard. But I would say it's as much also the geographic focus of our M and CS business. So on the metering side, those are also critical and they will get done.
We're not seeing projects canceled at all. But right now, it really is a matter of site access at the home level as opposed to more of the outdoor and the treatment facilities that we serve on the water infrastructure side. But it really is just a on the Clean Water side, it really is just the timing and safety dynamic.
Yes, 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 where by 2 quarters from now we could be looking at a mix issue or OpEx versus CapEx. Could you talk about the mix, the sales mix in Water Infrastructure, how that works?
Yes, 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 and you're right, those margins on that are a little richer for sure.
And 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. So that continues to be the case. But as we've done that now over the years, we'll begin to see a shift more into the OpEx side. But it is a richer mix of margin.
And the margins are typically about 1.5x 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 worrying business was actually not as down as I thought it would be.
Have you won new places there? What's the driver?
Yes. It was not as hard hit as we expected, but it was down substantially. I mean, all in, it was close over 20%, down year over year. So we were thinking it might be in the high 20s. So and it was really a lot of it was industrial driven, but it was down in most of
the verticals.
Yes. I mean, the good news was backlog was up helpfully, but again, the overall revenue was certainly down again considerably in the quarter.
Yes. But not as good as not
as much as I thought anyway. But look, thank you for all the information. Appreciate it. And good luck, Mark.
Thanks, Scott. Thanks, Scott.
Thank you. Your next question is from Ryan Connors of Boenning and Scattergood.
Great. Thanks for taking my questions and yes, congratulations and best of luck, Mark.
Thanks, Ryan.
So, Patrick, I appreciate your comments on the outlook for 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. So 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, but then Xylem was still seeing headwinds in utilities late as 2012, which was a good 3, 4 years removed from the recession. So 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. So just looking for any kind of tangible thoughts you have on what's different this time?
Sure. So it's a very relevant question. And obviously, we are not taking anything for granted here. I mean, we're staying close to the markets and the utility customers 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. And it really is the CapEx piece that is tends to show that kind of fluctuation from a funding standpoint. 2, we do have the MNCS platform on the Clean Water side. So 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 is that they don't see those projects being canceled or killed in any way. So 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.
And we see that demand continuing to increase considerably.
Okay. That's very helpful. And then related follow-up is, so much right now seems to ride on the federal government across 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 then how does your outlook differ in those two scenarios?
Sure. So I great question. I think certainly, as we've mentioned before, and 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. So any move there on the positive from the federal government would certainly be upside, but I wouldn't bake that into people's outlooks or forecast for the business because it'll be a while in the coming. But likewise, there's really no downside in that regard. Now, obviously, we're staying close to the local utilities and muni is to understand those parts of the country that are feeling more stressed at this point in time.
But 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. So can you elaborate on that in terms of the growth you saw as the quarter developed? And then what are you seeing in July, especially considering you did mention that you're not reinstating guidance given the recent resurgence in infections in the U. S?
Sure, Andy. Yes. We started off the quarter down mid single digits and yes mid teens. I wish it was mid single digits. Mid teens Matt's like flashing mid single digits.
But it and 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%. And as we mentioned, orders were still in the quarter down 9%. In July, we're seeing some modest improvement and that's encouraging. But as we look at the Q3 outlook, the fact is we're shippable backlog for the quarter is less than 2%.
And so we're still going to need a strong orders performance in the next 2 months. And 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 better some better visibility.
That's helpful, Mark. And I think in June when you announced sort of the bigger structural cost out, you also talked about spending $40,000,000 to $50,000,000 to exit certain business activities. I think they seem to be focused on M and CS as that's where it seems like you're taking the bulk of your restructuring. So could you just elaborate on what you're doing there? What you're getting out of and why?
Yes. And it's and I think the numbers, it's not quite that large. It's probably in the 20s and it's a number of smaller lines of business and just those that aren't as profitable and aren't as core to our mission moving forward.
Yes, 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. But again, the amount of revenue is a rounding error. Yes.
Great. Thanks, guys. Mark, good luck.
Yes. Thank you. Thank you.
Thank you. Your next question is from Joe Giordano of Cowen.
Hey guys, good morning. Hey, good morning, Joe.
Hey, Joe.
Congrats, Mark. As everyone's kind of said here, you will be missed. Just to start here, can we Patrick, I know that the situation can change dramatically between now and obviously 2021. But just given where we're at right now with the macro and your view on developed market utilities, is like the appropriate kind of benchmark for now to be like hopefully overall budgets are kind of flattish, maybe CapEx is pressured and maybe OpEx is kind of stable, but like with lower tax receipts, we're kind of hoping for flat overall spending environment at utilities. Is that like a fair benchmark right now?
I think, Joe, it's too early to tell. I think there is still a lot of uncertainty there. I mean, we're encouraged by the bidding pipeline. We're encouraged by lack of project cancellations. But 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. And obviously, we're certainly learning a bit about the financial resilience.
But we're really focusing in on with utilities on helping them do more with a whole lot less. And so that's where they are looking for alternative solutions, the whole digital dimension of things. And 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 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. And a couple of just related ones on MCS. Well, just one, are you confident that as soon as like a market deterioration, we're done with negative margins here? And then 2, you guys have done a lot over the last several years building out portfolio.
It's an interesting mix of applications there. There's been some issues, some Xylem issues, some market issues, but like 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 and A incremental from here?
Yes. So I would say that your question on margins, we certainly expect to be in the black and see positive margins. We'd expect second quarter to the Q3 to be positive. We were just about breakeven in Q2. So with a little bit of a ramp in terms of some of the deployments, the installations and just cost actions, we're going to see improvement there.
I think, Patrick, I'm sure I'll have you, I think in terms of lessons learned, I think the what we've learned is adoption of some of these new technologies is a little bit more challenging, particularly in the developed markets. But 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. So real quick,
Jill, on the 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 M and CS given the services profile in terms of the R and D investments and building out new product development rollouts, etcetera. And so so some of the restructuring actions we've taken do get at that overhead cost base. And so but our view on incremental is really unchanged, very attractive incrementals in that business. And so 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.
So 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. And anytime 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 anticipate being. But our view is 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.
And so it's not going anywhere. And so I think we want to be appropriately impatient in this regard, but we've got to keep it in perspective as to the long term journey that we're on here.
Thank you, guys.
Thank you, Ed.
Your next question is from Nathan Jones of Stifel.
Congratulations, Mark and Patrick, if you need somebody to wait in the car for 8 hours for $115,000,000 available. I wanted to go back to the utility funding question here. So 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.
And they're concerned about things like people not going into this into city, going to work, will reduce the water consumption there. So 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. So I wonder if you could comment on that angle of it.
I think people are a little too focused on state and local government and not focused enough on water rates. And then could you contrast that with how utilities are funded outside of the U. S. Versus inside the U. S?
Sure. Yes. So I think you've 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, etcetera. So 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 them. Now they're also letting me know that they're seeing increased consumption at the household level because people are staying.
So some of that just shift from one kind of metering point to another. But I don't want to minimize that in terms of 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. And 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.
And that's not all it'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. But 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. And that's because a large majority of the funding, certainly in emerging markets, is at a federal or state level. I mean, it is much more of a kind of independent funding and much more or much less reliant on the actual revenue collection.
Yes. 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 have 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 Q4?
Yes, Nate, absolutely. A couple of reasons. One, we're going to see a bigger ramp, as Patrick mentioned earlier, in terms of our cost savings. Then secondly, we had some items that made the compare some items last year that made the compare this year tougher. So
For Q2. For Q3. For Q2 and Q3.
So we do expect to see that normalize in the Q4.
Okay. Thanks very much for taking my questions.
Thanks, Nate. Thank you, Nate.
Thank you. We have reached our allotted time for questions. 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, and we'll be back with you on our next earnings call.
Thank you all very much. Thank you. This does conclude today's Xylem's Q2 2020 earnings conference call. Please disconnect your lines at this time and have a wonderful day.