Q3 2020 Xylem Inc Earnings Call

October 29, 2020

[music].

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I would now like to turn the call over to Matt Latino Vice President of Investor Relations. Thank you Amanda and good morning, everyone and welcome to the Islands third quarter earnings Conference call with me today is our Chief Executive Officer, Patrick Decker Senior adviser and former Chief Financial Officer, Mark Recalculate, and Chief Financial Officer Sandy Route.

They will provide their perspective of xylem third quarter results and our outlook. Following our prepared remarks, we will address questions related to the information covered on the call.

Well I say 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 Investor section of our website at Www Dot xylem Dot com.

A replay of today's call will be available until midnight on November 30.

Please note. The replay number is 800 585, athree six seven and the confirmation code is seven no 9669.

Additionally, the call will be available for playback via the investors section of our web site under the heading investor.

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 inorganic or adjusted basis, unless otherwise indicated.

These statements are subject to future risks and uncertainties such as those factors described in <unk>. Most recent annual report on form 10-K and in subsequent reports filed with the FCC, including in our form 10-Q, two about results for the period ending September Thirtyth 2001.

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 there.

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 an 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.

Now please please turn to slide four and I will turn the call over towards the O. Patrick Decker.

Thanks, Matt Good morning, everyone and thank you for joining us I.

I hope all of you and those close to you are keeping safe and well.

As reflected in our release this morning, our third quarter performance was better than anticipated.

The team's operational execution was strong right around the world.

You will recall that after the low point of April we saw sequential improvements in May and June and.

And we continue to build on that positive trajectory through the summer.

Our team took advantage of the market regaining pace and exceeded our revenue and margin guidance for the quarter, while generating very strong cash flow.

This performance reflects the team's focus on serving our customers and managing what we can control whatever the dynamics are of the macro environment.

Through the quarter, we saw solid foundations of recovery in a number of places and we are well positioned to further capitalize on that momentum.

The pandemics impact hasn't been uniform of course conditions varied significantly both by geography and by end market.

For example, China revenue returned to healthy growth of 17%.

Western Europe overall was back to relative stability at 2% growth.

The U.S. only slight recovery still dealing with pandemic response and coming in at down 11%, although improving sequentially.

In our end markets, we've seen ongoing resilience in the wastewater side of utilities and our wastewater solutions returned to solid growth in the quarter.

On the clean water side, we're delivering strong commercial momentum, including winning large long term transformational metrology deals leveraging our differentiated platform, particularly in advanced metering infrastructure.

In addition to big wins with Anglin and in Winston Salem, which we mentioned last quarter. The team recently won another marquee projects in Columbus, Ohio worth $94 million.

This customer is a combined utility, meaning we will provide both water and electricity meters plus advanced software and services.

It's worth noting how compelling our value proposition is for combined utilities addressing both water and energy applications with one portfolio.

And leveraging our unique flux net communication capability across both platforms to achieve economies of scale.

The Columbus Winston Salem, an inkling deals have together added about a quarter billion dollars design on backlog.

Our metrology and communications offerings are clearly differentiated in their own right, but we also have the advantage of delivering unique value by combining infrastructure platforms with complimentary digital solutions each value proposition enhances the other.

As anticipated cobot impacts are causing delays in some metrology projects, where timelines have shifted to the right.

And in part to the U.S. replacement meter installations have been pushed out in the short term.

Pipeline assessment services business that requires putting people on site has been affected by cobot driven restrictions on travel and field work.

At the same time, the pace of interest in digital solutions for remote monitoring and automated operations has accelerated.

The pandemic has not only spot led essential services. It is also eliminated utilities need for much greater operational and financial resilience, which is now at the top of every utility operators agenda.

Digital transformation has gone from being attractive to becoming an imperative.

And that's reflected in strong quoting activity and our digital solutions business, which has also increased by 50% gets number of revenue generating clients.

The revenues are still a small part of our topline, but the acceleration of interest further strengthens our view on digital adoption in the sector.

And as the number inside that this project growth, we are seeing a broadening scope of opportunities across software services and infrastructure products.

Well, we don't expect this to be a straight line recovery xylem is well positioned irrespective of how the pandemic plays out.

We anticipate quarter sequential improvements.

Our financial health and liquidity are both strong.

We are successfully reining in costs executing the actions we announced early this year.

And we are shifting investment to adapt quickly to customers evolving needs and new ways of working.

Our supply chain has been exceptionally resilient with the team keeping customer supplied even through the Pandemics peaks.

So we're operating with discipline strengthening our competitive position and helping our customers serve their communities with uninterrupted uninterrupted essential services, despite whatever macro uncertainty may present.

As Matt mentioned at the top of the call both Mark and our new CFO Sandy Rowland are with us today Sam.

Sandy joined US on October Onest, and it's been a great pleasure to welcome her to the team.

But since mark within the chair through the end of the reporting period till care the commentary on our third quarter performance, So mark over to you.

Thanks, Patrick.

Please turn to slide five and I'll cover our Q3 results in more detail.

Revenue declined, 7%, which was better than anticipated as we entered the third quarter.

We had strong performance in our wastewater utility businesses in the residential end market both of which grew mid single digits in the quarter.

The return to growth in these markets was offset by the expected declines in our.

Metrology project deployments, and industrial and commercial businesses, which continue to be impacted by project delays insight restrictions.

Geographically as various countries have reopened and recovered so has our business.

In China. For example, we saw very strong performance with double digit year over year growth.

Despite the China business, returning to pre pandemic growth rates.

Emerging markets overall declined 7%.

India was down only modestly while the middle East in Latin America declined double digits, if they continued to be impacted by shutdowns throughout the quarter.

Across North America recovery remains mixed well.

While revenues improved quarter sequentially, they were down year over year.

While our wastewater business remained resilient, we continue to see timing effects on the trilogy deployments and softness in industrial markets.

Western Europe grew 2% in the quarter as countries reopened in activity resumed with revenue growing in each of our end markets with the exception of industrial.

We also saw operating margins expand quarter sequentially to 13%, which drove EPS of 62 cents both better than expected.

I'll cover the margin impacts by segment shortly.

Overall, our teams maintain very sharp focus and executed well operationally by driving strong productivity and cost reductions.

Please turn to slide six and I'll review third quarter results by segment.

Water infrastructure orders declined 5%.

Order trends in our waste water utility businesses continued to be solid.

Treatment orders were up 20%.

Wastewater transport orders down 9% for the quarter would have been up mid single digits, but for lapping the large deal we won last year in India.

Orders in the industrial end market were soft due to double digit declines in our dewatering business.

Long term backlog continues to build as were up over 30% for backlog shippable in 2021 and beyond.

Segment revenues declined 2% in the quarter compared to the prior year.

Okay.

As a reminder, this business is roughly two thirds weighted towards repair and replacement work, which held up relatively well in the quarter. Despite shutdowns in some regions.

Industrial was affected by similar regional dynamics, including site access restrictions and declined 7%.

A bright spot in the quarter was residential which grew 4%.

We saw particularly strong growth across western Europe and from China.

Overall emerging markets declined 8% in the quarter.

China had a very strong performance growing 23% as the team executed well delivering on pent up demand.

This was more than offset by the declines in the middle East and Latin American regions due to the ongoing lockdowns.

Revenue in the United States declined, 6%, but improve quarter sequentially with some softness across and markets driven by continued virus impacts.

Operating margin in the segment was 15.9%.

Volume declines and inflation impacts reduced margins in the quarter, but were largely offset by 530 basis points of cost reduction.

And productivity benefits.

Now please turn to slide eight.

Measurement and control solutions orders declined 19% in the quarter and revenue declined 15%.

We saw project timing significantly impact on metrology business.

And COVID-19 restrictions push out our project revenues in our pipeline assessment services business.

<unk>, we've seen relative stability in our opex replacement business from water metrology products.

As a reminder.

Binder.

Our opex exposure accounts for about 70% of our revenues.

We've seen much more variability in the 30% of our metrology business, that's tied to large project deployments or capex.

Particularly in our gas segment, where project revenues were down 60% in the quarter.

Here, we have been significantly impacted by project timing.

Particularly from lapping a large gas metrology project deployment, which was largely completed at the end of last year.

And delays in another large gas project this year due to home access restrictions.

Despite these challenges.

Our underlying north American water metrology book and build business has remained relatively stable and commercial momentum and when he new projects remains robust.

This is highlighted by the large contract wins, we had in the first half of the year.

And continued into the third quarter with the Columbus, Ohio, and Winston Salem, North Carolina wins.

Patrick already covered Columbus, but I'll quickly highlight a couple of important points on the Winston Salem when.

This is a 60 million dollar contract to provide water metrology products under our network as a service offering.

Leveraging our flex Med Communications network.

Importantly, our team's differentiated the value of our offerings by introducing several components from our digital solutions platform, enabling our customer to also seamlessly address critical needs around non revenue water and their wastewater network.

Our pipeline assessment services business has also been subject to significant near term delays and project revenues driven by COVID-19 travel restrictions and site closures.

As a reminder, through our two businesses within AIA.

Digital solutions and pipeline assessment services.

It's in the latter business, where we've experienced deferrals a pipe inspection work.

And we expect those push ups to continue into early 2021.

As a result, we booked an accounting charge reflect the impacts of those delays.

We continue to strongly believe that the medium and long term value proposition of this business is compelling, particularly as utilities move to address budget challenges by using pipeline assessment services to reduce future spend on pipe replacement.

We expect the project timing for deploying new new metrology projects and the COVID-19 related delays and pipeline assessment services to continue to impact us through the fourth quarter.

This is reflected in our fourth quarter guidance, which sandy will cover later as shippable backlog for the fourth quarter is down roughly 25%.

That said.

It's significant that we've not had any project cancellations.

Rather we're seeing an acceleration of growth in our project pipelines.

And we continue to win large new contracts.

As a result.

Mcs shippable backlog in 2021 and beyond is up over 30%.

Which is a pretty good indication of the power, we're seeing with our digital platform.

So while these projects are currently reflected in the orders metric. They are the latest in a series of important wins that gives us confidence in the medium and long term growth profile of this segment.

EBITDA margin in this segment was 14, 8%.

The year over year margin decline was driven by lower revenues of high margin North American metrology and pipeline assessment services due to project timing and COVID-19.

This impact was partially offset by 630 basis points of cost reduction in the quarter.

Now please turn to slide nine and I'll cover our cash flow performance for the quarter.

We ended the quarter with approximately $1.6 billion of cash and short term investments.

And $2.4 billion of liquidity driven by our very successful green bond issuance last quarter combined with our strong cash flow performance throughout the year.

In the face of substantial challenges presented by the pandemic I'm very proud of the work of our teams and managing all aspects of our working capital performance.

At quarter, and working capital was 23% of sales representing an improvement of 30 basis points versus this time last year.

The teams focus on working capital.

Disciplined capex spending and cost control.

Through the quarter have continued to pay off enabling us to generate free cash flow of $234 million.

Ah conversion rate of over 200% in the quarter.

Which did see some benefit from favorable timing on payments primarily related to taxes and interest.

Before I turn it back over to Patrick I'd like to take a moment to congratulate sandy.

And welcome her as she steps into this new role.

Having worked with Sandy previously I wasn't at all surprised by how quickly she has come up to speed on our businesses and our markets.

And the pace with which she has developed relationships.

All virtually.

And taken on the leadership of the global finance team over the past month.

I couldn't be more confident about the future of xylem or in sandy's capability to help Patrick and the team accomplish our mission and take the company's performance to the next level.

So with that I'll hand, it back to Patrick for the last time.

Thanks Mark.

For turning to our outlook I, just want to take a moment to reiterate to overall trends were saying as we look forward.

The first is the influence of regional differences around the world as.

<unk> Herb we've already seen big distinctions between China, Europe, and the us in the third quarter. So long as the impact of COVID-19 continues to influence demand. We believe those geographic effects will be considerable through at least the end of the year.

Violence global diversification puts us in a strong position as we serve the international markets that are furthest along in recovery curve.

It's worth noting for example, but about 70% of our wastewater businesses outside the U S.

The second overall trend to highlight as a shift of attention from reactive operational imperatives to medium and longer term resilience.

The pressures utility state at the beginning of the pandemic are well known.

You simply can't stop providing an essential service even if you are struggling to curves in the field and more end users unusual are having trouble paying their bills.

Our customers have come through the most intense part of the crisis serving their communities heroically.

It has also been a wake up call for the sector.

Utilities leaders and operators have become acutely aware of the pressing need to invest in greater operational and financial resilience.

Part of that investment will go to conventional infrastructure.

That will have to be combined with new approaches if utilities are to address their overarching challenges, making the cost of temperate structure more affordable extending asset life and dramatically increasing labor efficiencies, while maintaining safety.

So we've seen interest continue to ramp up and digital transformation.

Remote monitoring automated operations and smart infrastructure more broadly.

Of course, the implications of digitizing utility networth goes deeper than software platform and our digital solutions business.

Beyond software and endpoints transformation also requires the digitally enabled pumps and drives that make up the backbone of a smarter network.

Which is why we are implementing an integrated digital strategy across our entire portfolio.

We're very excited about the opportunity of working with our customers to build the digital water and energy networks that will carry their communities and in the future.

Turning from those trends the outlook.

In general we have a much clearer view on queue for then we had on Q3.

We're seeing stabilization and a number of markets, we have even greater supply chain confidence and we're executing well on cost.

All of which leads us to expect quarter sequential improvement in margins.

So by and market I'll start with our outlook for utilities.

The wastewater side has been exceptionally resilient.

We expect Opex to continue holding up well given the need to service mission critical applications and.

And capital projects with secured funding continue to move forward.

On the clean water side as I mentioned, we have strong commercial momentum with multiyear projects like ganglion Winston Salem in Columbus, setting us up for healthy growth in 2021 and beyond.

In the short term, we expect performance trail wastewater due to more pronounced covid impacts, but we're not saying structural changes in demand and the growth profile of this segment is expected to remain highly attractive we.

We simply anticipate some continuing covid impacts on deployment timing.

And standard meter replacements are likely to remain soft until physical distancing eases.

Please turn to slide 11.

Looking at industrial and commercial and markets.

The accessibility of industrial sites varies widely by region.

We're covid responses lag there have been site access restrictions and work has been deferred.

So we're still anticipating softness to the fourth quarter, especially in North America construction in industrial markets affecting already watering business.

And and commercial it's a mixed picture that varies by and customer.

Mandar hospitals Datacenters an apartment buildings for example is very different than for offices in hotels.

But less building use overall and soft North America construction suggest continued softness in the near term.

Now I have the great pleasure of turning over to Sandy for the first time. So she can provide some more specifics on our queue for guidance.

Thank you Patrick and Hello, everyone I, just want to kick off by expressing how excited I am to have joined design team.

Joey xylem because of the unique combination of strong commercial opportunities for crowds and the compelling mention at the company.

Xylem. It's also complimentary to my previous experiences, which is included bringing together cutting edge technologies with industrial products.

I spent the last month's getting up to speed with the team alongside Mark and I look forward to all we have ahead of us finding out 2020 and beyond.

With that let's get into a few more details on our fourth quarter guidance.

On the top line, we expect organic revenues in the range of down six tech to down 8%. This is a modest improvement in sequential performance versus the third quarter.

As a break it down by segment, we anticipate being down low single tickets and water infrastructure.

Nick single digits, and applied water and Darren mid teens and measurement and control solutions.

Reflecting the project deployment delays have continued to see through October.

Operating margin in the quarter is expected to be in the range of 13% to 35%.

Also a modest quarter sequential improvement.

I also want to highlight of feel full year items, we expect to end 2020 with free cash flow conversion of greater than 100% for the full year.

Restructuring realignment costs are now expected to be between 75 and $85 million.

Slightly lower than our previous guidance, while structural annual cost savings remain unchanged at approximately 70 million.

We are lowering our estimated tax this year to 18.5% to reflect our updated mix of earnings.

Before I hand, it back to Patrick for some closing comments I want to again, thank mark for his guidance during this transition.

Having worked with Mark before I know, he and I bring similar perspective and share a common approach to operational excellence and driving investment and innovation to support sustainable growth.

Market built a great team and I am confident we have the organizational cap capability to focus to deliver now please turn to slide 13.

Thank you so much sandy it's great to have you on the team.

Just to wrap up before turning the call over to your questions. The team continues to demonstrate strong operational delivery.

And that will enable us to capitalize on recovery everywhere, it's happening through the end of the year and beyond.

And we will execute from a position of competitive strength, even in the more challenging environments.

Our discipline on cost in cash will continue to pay off.

Both in the coming quarter and through 2021.

Looking ahead that quality of operational execution will enable us to continue driving sustainable margin expansion.

A robust financial health, which gives our customers confidence that they can rely on us in uncertain times is built on the foundations of a strong balance sheet and cash generation.

Are leading market positions are paired with a differentiated product portfolio and a durable business model at the heart of essential services.

And our strategy places xylem in the lead as the water sectors digital adoption curve accelerates, providing a multiyear runway of attractive growth.

We will deploy capital to continue strengthening our portfolio investing in the solutions and services that anticipate our customers needs.

Both the economic and social returns of those investments will be attractive over the medium and long term.

And our commitment great value for all our stakeholders will continue to underpin the sustainability and resilience of our company our customers and our communities.

We're not going to move your questions, but first I need to mention that although mark will be advising us through the end of the year. This is his last earnings call. So let me take this opportunity to say once again as I've said before that all of xylem stakeholders have benefit profoundly from marks leadership and tenure at xylem, but non more than me.

As I have benefited tremendously from Miscounsel. Thank you Mark.

And with that I'd like to turn it over to your questions. So operator fleet really from the Q&A.

The floor is now open for questions.

At this time, if you have any questions or comments. Please press star one on your touch downtown.

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Our first question is coming from Scott Davis with Milius research.

Oh.

Okay.

A bit of a bad connection, perhaps but anyways are you guys surprised if you can hear me of course are you surprised by her you Scott.

Are you surprised by the negative price the extent of it.

I can't remember a quarter or you had this big of a cost price dislocation.

So, perhaps maybe take into that a little bit more.

Yeah, Hey, Scott it's Mark.

The.

Price overall for the company in the quarter was 50 up 50 basis points. So we continue to to drive drive price.

A lot of a lot of inflation has been you know.

Labor related and.

We had some very strong.

Price increases over the past eight.

18 months and some of this is reflective of the.

The demand profile on the market. So we continue to look to drive.

For a price and get value for the products and services that we render but it's we're doing it all within the context of the current competitive environment.

Does that mean, mark you're seeing pretty.

Tucker price in the rental market.

We've heard some competitors hey, it's actually been pretty stable this quarter. So I was like.

Curious to see what your view I will thank goodness.

Yes, it's competitive in in the rental market for sure.

Again, some of that's a function of the demand profile and but that's not that's not the whole new market. We're seeing it in a number of areas, but our our teams are out there being very thoughtful.

And certainly where there are opportunities to push on price.

Particularly where we're differentiated they're they're doing that yeah, I would say I would say Scott This is Patrick.

Prices not really been a concern of ours, it's not really been a a meaningful change and trajectory obviously, we've been thoughtful during the pandemic, but.

There's no structural change your in terms of how we feel about price.

And the market and I would say that.

Specially for US, we really focused in on on engineered solutions.

Versus commodity oriented offerings.

And where we have the more engineered solutions, we built those into our based business, but also new our contracts.

And that pricing has remained.

Constant in other words, we have not gone back and renegotiated contracts, we haven't had people coming back to us asking for changes in pricing given the pandemic that has been very stable.

Okay. That's super helpful. Thanks, I'll pass it on thank you good luck guys.

Thank you Scott.

Our next question comes from the line of Dean Dre with RBC capital markets.

Wish Mark all the best and thanks for all your help.

Thanks, Dean you got cut off they're a little bit.

You are a little choppy there so but I heard the last part of it.

The part the date that you wanted to hear.

Yeah, Let me just say yes.

Is this was also the welcome to Sandy.

And I appreciate.

All the color here. This morning, so the first question.

Question and this is an important part of the theme.

Four xylem is this accelerated interest in Smartwater systems by the utilities. We also the water conference in September we heard that directly from the utilities that we're all saying this you got to win in Columbus, that's impressive.

So Patrick.

Big question is how does this interest and quote activity start to translate into orders. We are seeing traction here, but if you can maybe give us some size with a quote activity is what the expectation is around the timing.

Sure Yeah. Thanks, Thanks, Dan and good morning.

So yeah as we as we mentioned at at your conference and I know many of utility meters spoke to this and as I mentioned in my prepared remarks utility leaders.

All of that I've spoken to this has really been one of the silver lining to the pandemic is the amount of time that iPad with with these leaders by zoom in other platforms.

Is they really.

They have moved from a number of beads digital solutions being a nice to have two imperative.

And.

Just to reinforce as I mentioned my comment the drivers behind that.

Or the whole issue of.

Them dealing with issues of how do they manage their assets remotely how.

How do they manage their workforces remotely zee.

They are very much.

Focus, especially post pandemic on this issue of affordability so.

And again.

Ah remind everyone that only 30% of our utility exposure as in the US it's a very different kind of funding and economic dynamic outside of the us whether it be in China, India or Europe, but here in the U S. 70% of their funding comes from 70% of their spending as an op.

X and that come from their existing right base.

When you think about the remaining 30%, which is capex that comes from new rate cases.

That need to be justified so on the base case.

On the Opex, they're looking for ways to reduce the operating expense to extend the asset life of those assets to do remote work on the Capex side. It really is about making those new projects affordable. So they can get right cases approved so anything that we are able to do to reduce the cost of that new capex.

And make it more affordable is going to be even more important to them as they come out of the pandemic.

In terms of.

What we're seeing in terms of proof points.

You're saying that we've had a 50% increase in the number of clients.

That's one.

We've seen.

In north of of a 20% uptick in order. So there was a conversion there in terms of orders off of a small base, but a growing base.

These typically are.

The time that we get an expression of interest and we'd seen a big uptick there of course with the 50% increase it's about a 12 to 18 months conversion on the digital side from owing from an expression of interest into turn that into an order and then into revenue.

Secondly, what I would say most importantly here Dean is that.

It's not just the digital components.

It's the broadening its the opportunity that gives us to broaden the scope of deals that would otherwise be negotiating so some of the amp ideals on the metrology side, we would not have won them. If it were not for the digital offering that we bring and complement to Amazon.

Bats, as important as actually going in and leading with digital and then pulling through amoy or also on the wastewater pumping side the treatment side. So the synergies here from from a from a pull through standpoint go to different directions. It can be we'd leave with.

Digital we help the utility understand where they're needs are are and then we bring in solutions behind that on the hardware and networking side, but it can also be where we're already in there negotiating on the hardware side and the digital comes in over the top and differentiates us versus other so that's where we see.

The biggest opportunities going forward and the expression of interest right now is absolutely accelerating based upon the economic challenges that the utilities are facing.

That's great to hear and then just to clarify I knew it was like a year ago. The focus was on pilot programs and it sounds to me some of those were a revenue generating but.

Are you waiting for any the pilot programs to confer two orders or where does that stamp.

Sure certainly I mean, when I, when we say that there is a 50% increase and.

Client acquisition.

Those are predominantly speaking to pilots.

And so we continue we continue to see pilots, increasing now I want to be clear when we say pilots these or revenue generating pilots were not given these things away.

And I would say that again that that balance of interest is as much outside of the U S. As it is inside of the U S. So, we're saying big uptick and China, India, Europe, and then certainly equally as much in the U S.

Great I, just I had a follow up question for Mark just didn't want him to think he was getting off easy.

Decrementals or touch weaker than what we were expecting and I'm just trying to bridge that difference and does that include the the charge that came through on the pipe inspection or just help us understand Decrementals and then what you were expecting for the fourth quarter.

Yeah, no that was.

That.

That was on an operational.

Basis now are you talking about two three or Q.

Q for outlook.

Yeah, Yeah and so.

Some of that is.

Just just a function of mix.

So we're continuing to see.

Impacts in several of our lines of business, whether it's dewatering, whether whether it's.

Some of the.

The pipeline assessment work or insensitive.

Oh metrology deployments that are higher margin that.

Most impacted from a mixed perspective in the fourth quarter.

Got it much appreciate it thank you.

Thank you too.

Our next question comes from the line of Nathan Jones with Stifel.

Welcome to the same sandy and best of luck market's been a pleasure getting to know him last year.

Yes.

Same here thanks mate.

I'd like to dig into Mcs, a little bit more here do you have a large domestic made a competitor who would put up some double digit growth in the third quarter and was probably more bullish on the outlook less concerned about kind of project delays that you were talking about here today I know you have other lines of business and a lot more international things going on.

And here sounds like the pop inspection businesses is one of the worst ones.

But you may be digging a little bit more to the different paces of empty yet.

What you are saying specifically on the domestic water water made a business and have that outlook progressive.

Sure Nate good.

Good morning, this is Patrick so.

First of all I think when you look at the.

Take the metrology piece of the business first which is opposite the lion's share of Mcs.

Cause I think we can take we can take digital solution is off the table, it's training very well.

For the reasons that I Express Dudeen earlier will.

We will come back to pipeline assessment and a moment, obviously there we've had challenges in terms of site access it has not been an issue in terms of.

Level of interest the orders are there. The work is there really is literally a matter of getting access on the site given the nature of the work that's that's done there.

So back to metrology, which is obviously the census business. There again on the that kind of 70% to 80% of our business. There of that revenue is again basically made a replacement.

Day to day kind of installation of.

Replacement meters.

That business was down low to mid single digits in the quarter.

And that largely was again site access restriction, a big chunk of that and differentials between us and maybe others. Some are similar some are different from a competitive standpoint, it really depends largely where you are geographically and so we've got a heavier presence and some of the larger metro areas certainly.

Here on the East coast, where there have been tighter covid restrictions and perhaps parts of other the rest of the country.

So we were down low to mid single digits and the Keith right.

We expect that business to be up low single digits.

Q for Ass site restrictions begin to ease obviously that depends upon.

Kind of next wave of the virus. So we keep our eyes closely on that.

But right now in our assumptions.

We expect that to begin to recover and see growth in Q4, and certainly end of 2021, where it normalizes it really.

The peace and.

Census that hit Us and Q3.

It was the the capital projects.

These large deals that we won and executed last year. So one we have a tough.

Versus last year.

To this year, we had some of the projects that we had already one think about fill a water very.

Very large project.

Project.

That has been shifted to the right it has not been cancelled.

It's simply a matter of side access and so we do see that coming back in queue for and certainly into 2021.

It's also when.

When you look at the.

We had some delays and some of our gas project implementations again because of Covid. So Ah number. These projects that are pandemic related are still there they're going to be executed there simply a matter of shifting out to the right because of timing of being able to get people on site.

When you look at we also had when you look at the backlog that we've got our <unk>, our shippable backlog for the metrology business. It for 2021 and beyond is up 30%.

So this is not an issue of projects being cancelled or projects being differed with uncertainty, it's simply a matter of side access and and so we're very confident about that when you think about the wind that we've got and Winston Salem, Columbus et cetera.

Really speaks to the health of the market overall.

The dynamic competitively is is simply the fact that we have a larger project orientation of or because of the <unk> ideals that we're winning versus a base.

Meet a replacement business.

I think that makes a lot of sense, then I would have expected you guys to have a higher share in more densely populated areas, where you side access could be different all of the all of the folks that we've talked to on the utility site. It said that these non revenue non revenue water pipe assessment projects.

And they made a deployment are likely to really go unaffected you. If you take it over a few quarter kind of time frame, which would suggest tomatoes always is doing here is really creating pent up demand, it's going to be released here over the next couple of quarters and should probably really old get caught up in 2021.

This is not shifting permanently to the ride it's shifting the front end to the right, but the back end should be fixed.

That that's exactly that's exactly what we're saying Nate and that's exactly what I'm hearing from utility leaders that I speak to.

Is when you think about the long term structural demands and the water sector around the issues of affordability of water, whether it be at the macro level, meaning at the rate case level, whether it be affordability at the end user meeting a household on are those issues are becoming even more prominent.

Because of the pandemic, whether it be scarcity of water on on the clean water side.

Whether it be the resilience of their infrastructure.

What we're hearing from utility leaders is that gets becoming even more prominent for them.

Coming out of a pandemic the issue is simply depending upon where you are looking around the country. Because this really is more of a U S phenomenon.

The geographic differences are stark in terms of the approach to the pandemic.

I think that makes a lot of sense. Thanks for the color.

Thank you and a thing.

Our next question comes from the line Ryan Connors with founding Scattergood.

Great Thanks, Mark and welcome Sandy.

My my question bit a bit of a bigger picture question I wanted to kind of discuss the utility market from a different angle in terms of.

The municipal utilities versus the Investor owned utilities I know if if you if you listen to the Investor owned utilities. Since this thing is hit they're really now talking up the outlook for privatization, saying that some of these more stressed local systems are really coming under financial strain and that's an opportunity for them to.

To to really accelerate their acquisitions and expand.

And so I wanted to get your take on that that theme in terms of a remind us of your current customer mix between those two groups and how they compare in terms of pricing and margins and that sort of thing and then B are you seeing that do you see that and if so would that be a good thing or bad thing different.

What's your take on that privatization angle here.

Sure Yeah.

Great question, So certainly.

You, obviously, we all know the whole privatization.

Debate has been going on for quite some time and it took quite.

Contentious do within the utility space.

And it's always harder for the private utilities to do the consolidation than what they would certainly like but we certainly see that as being a trend that is accelerating for the reason that you mentioned are terms of about some level of economic distress.

In the sector.

You know to be to be transparent.

The private utility portion of our revenue is certainly far less than the public as you well know.

And while we love our public owned utilities, and we've got great sure there across the board.

When typically we find that when utilities are privatized it does become us slightly bit easier.

Negotiation, because then become it comes down a bit more to basic fundamental economics returns on investment it's easier to sell longer term solution and have them based upon the paybacks and financial benefits.

That's not to say that on the public side. It's the exact opposite that's just it's a mix of utilities in terms of how they think about that but we see that Ryan very much as a as a positive trend for us overtime, but again I wouldn't want to parse between public and private as to whether one is good or the other one not.

And I know you're not suggesting that.

Sure no. That's that's understandable, but now that that is useful.

Perspective, My other question is a little more tactical but you know you you mentioned residential as a tailwind and applied water and you release in your slides there there's not a market you'd normally talk a lot about it and there was material enough that you did put it in there pretty prominently can you just remind us of of what exactly you.

Doing there and sort of the outlook and what the real materiality is there.

Yeah, Hey, Hey, Brian.

It's mark and you're right that that is not.

A recent highlight and well.

The business has done a really nice job in really.

Upgrading improving their product sets there.

And the what we've seen is that is more folks have spent more time at home working from home.

They're spending more money on those homes, including.

Well pumps and other products that that that they need to maintain them. So there has been.

Really strong growth not just in.

Europe, but but we've seen some some pent up demand in the Asia Pacific region.

And and even in the U S.

We're seeing improvements and.

And expect that to continue into the fourth quarter. So it's a function of.

Just one of the impacts of the pandemic, but also importantly.

Some nice improvements that our team that's made to our product sets in that area. So I would just add that I think that they are getting this is Patrick I would say to complement what market indicated the team has done a great job of enhancing some of the product offerings and we continue to to build that pipeline.

But I would say this is predominantly a short term phenomenon we.

We don't have a different look over the long term as to what you should expect from a growth standpoint in that business. I mean, it really is kind of a low single digit kind of GDP kind of business and this quarter. It was predominantly driven by growth Outside's growth that we saw in Europe and.

And China.

Spike the numbers and that was really the reason we called it out.

Got it okay that makes sense. Thanks, so much.

Thank you.

Our next question comes from the line of Joe.

Donna with Cowan.

Hey, guys.

Hey, Joe Joe.

Keep going on the digital side here Uhm.

I don't think anyone really debating.

How valuable those types of technologies are long term too dirty as I think the dining compositions pretty clear, but when we were just recently.

Surveying utilities, we got a pretty clear response that right near term those types of digital technology investments are being deeper advertise because of necessity and where they have to spend money. So like what are you. What are your thoughts on push-ups or anything like her capital projects that or maybe sign but not show.

And the ground yet like it seems like there's more risk can be pushed like more more meaningfully out. We're just kind of what are you seeing there.

Sure Joe So I <unk>, so again I.

I'm always trying to do here, let's first global.

So.

Again, you know.

30% of our utility exposure as in U S vs outside of the U S and so this is a global phenomenon.

And we're saying you know.

Even more I'd say outside interest and the emerging markets.

That's the first 0.2 would be in North America are specifically in the U S.

What we're seeing marriage as we've indicated we always view these projects as being you do a pilot. It's a 12 to 18 month conversion from the pilot into orders in revenue.

And the way that we've structured these arrangements, where we're leading with purely digital where our team goes in and they're doing a diagnostic a consultative diagnostic with the utility that that whole thing I mean, it's not a high it's not a high cost venture for the utility.

To help them understand.

What are.

The needs they've got where do they spend the next dollar of capital or Opex going forward and that helps inform them on how they can manage their opex and capex needs more effectively and those situations when we talk about pull through.

That's always going to be a 12 to 18 months kind of horizon.

And we've got proof points of those already in hand, the other approach to selling is where a team is going in most notably when it's finished and am I am a trolley G. Dale.

And you know it's.

It's a competitive bid and we're able to overlay unique digital solutions, whether it be meter optimization.

Whether it be adding on link detection, where to non revenue water solution.

These are the kind of things that can oftentimes help us seal the deal. That's the per point there is the quarter of a billion dollars of of deals.

Deals that we've gotten over the last quarter to wear absolutely. The digital piece of the offering was a proof point that helped secure that deal. So.

These are not high cost.

Item for a utility as it relates to purely the digital component.

As much an enabler.

For them as they go forward, but no doubt in the immediate term there are utilities that have had to make tough choices.

Between the wastewater side the clean water side is this a nice to have versus they need to have we see that momentum accelerating but if we said before this is still a relatively small piece of our revenue and the opportunity is all in front of us.

Yes, Sir.

Last question for me.

I'm on pure and yeah I understand that this is like the most.

No one could ever kind of budget, it or what's going on now but.

We've had over the last few years Writedowns basically happy investment now so just curious as to how that kind of informs the capital deployment decisions going forward and how you kind of evaluate new potential target.

So I will let me take that one first Joan I'll I'll have mark kind of walk through.

The thinking behind.

You know the right down a additional goodwill et cetera strategically our view on this business is we remain very.

Very bullish on this business again, when you think about the needs of the utility has around reducing their non revenue water a big part of that is leak detection.

And so everything I've heard from the utilities I've spoken to is they absolutely see that as being essential but right now again at his side access and when they have to.

When you think about the nature of the cruise that we deploy around basically brand name of pure.

The cruise that we deploy there are travelling across state lines, they're very technical so we have to deploy them broadly there are basic.

You know what.

Requirements are being sequestered when you're traveling state lines. I mean, there are very they're very practical aspects of style of our workforce right now that nobody could possibly imagine coming into this but the fundamental needs remain the same when you think about the fact that only.

That market is only been penetrated by like three per cent of the need all of that opportunity as in front of us and it's going to be even more essential coming out of the pandemic than it was before because of the whole affordability angle.

So there's no fundamental change in view on this business in our in our view in terms of how attractive. It is I'll, let Marc talk about kind of the accounting drivers behind why there was a second impairment on this.

Yeah, I mean, and you know I know.

You're in a in a <unk>.

The train account by background. So you go [laughter] is really.

A function of.

Patrick significant.

Temporary delay.

In the expected revenues for a pipeline system services. So it's more of a push out to the right.

A couple of years and and when you look at this business.

The March the gross margin put phone business is greater than 50%, so really rich gross margins. So those revenues approach out.

Is it has a big impact on the discounted cash flows.

Used to determine the fair value of the business.

And you also.

When when we did our first right now.

Last year.

A year ago, you write that down too.

You've reset the fair value and that value is based on future.

Future forecasted revenues. So you really don't have a lot of head.

So when you see a shock like this from the pandemic.

It has an impact in terms of of the account. It then.

Patrick said long term medium term long term opportunities in this business.

We remain very positive.

And Joe we take a.

Our our nature on these things whether it be from accounting standpoint, or an outlet perspective, as we take a conservative approach on this I mean, we want to make sure that we're right down the middle of fairway, we're not going to move things around.

And so the team Felted important at this point in time, given the shock of the pandemic on this particular business most notably given it's still based services aspect that this was <unk>. It was the responsible thing for us to dividend no change in strategic view on the assessment services business.

<unk> and Sandy look forward to it.

Thanks, Thanks, Jeff.

Your next question comes from the line of Andy Capital, It's with Citigroup.

Hey, good morning, guys.

Good morning.

Patrick you mentioned that your utility businesses more international that and then the U S. So it was good to see Europe returned to gross and China was obviously very strong but could you give us more cartoons you're thinking about these two mediums going forward have you seen any curtailing of the momentum you you recently had in Europe, given the various resurgence may.

Any more color would be helpful.

Sure it's great Great question and thanks for the International Bank.

Given that's the largest piece of that that market for us. The so we certainly we just continue to see momentum building and in Asia.

And we feel I mean, obviously.

Who knows I can't prognosticate on on the pandemic in where cases are going to research et cetera, but.

Certainly with in Asia, We have no reason to have any concerns either in queue for our going into 21 based upon what we see right now if anything the pent up demand. We got hit first earliest in Q1 and Q2 because of our when it exposure in China and India.

And our teams have proven very resilient there as has the market. So.

That's Asia week would expect that to have now returned to pre pandemic levels.

With respect to Europe.

Obviously, we like all of you are monitoring case count we're seeing what's happening in the resurgence here the last few days.

You know there is uncertainty there we feel that our guide for Q4.

Is a balance guide obviously, if there was.

Disproportionate shock to the system that needs to be factored into our outlook for Q4, but our teams.

I've been managing through this pandemic and the complexity the pandemic for several months now.

And one of the most important things that we've learned is is really making sure that we have a resilient and robust supply chain.

And it's not just us but at the suppliers around us in the system and so we don't believe that there is a near term meaningful impact on our business and the quarter around that but you know if there is uncertainty there and so we want to make sure that we continue to monitor that but it really is too early to tell.

At this stage. So we think we've taken a balanced approach to the quarter.

Thanks for that Patrick and then just can you help us think about there's probably some arcosanti the the structure them cost savings that you're focused on and how that can manifest itself beyond queue for I mean, you already mentioned Decrementals are still a little high in Q4 versus normal but as you go into 21 would you expect to see improved detrimental and or Incrementals.

Given the level of cost out that's ramping for Ya.

Yeah. This is mark.

And for a couple of reasons.

One.

We'll see some ramping.

In terms of the is a structural costs into 2021 cost cockpit cost savings.

And yes cost savings and then.

<unk>.

It's it's early to call, but when you think about the cops that we're going to be coming off and as we move through into 2021.

Additional volume will certainly play well relative to the what will then be incrementals.

Thanks Bye appreciate it.

Thank you.

We have time for one final question. Your last question comes from the line of Prat Lindsay with vertical research partners.

Hey, Thanks for squeezing me and guys. He just wanted to some morning back to yeah, How're, you doing and yeah, Mark Congratulations on the retirement and best of luck to Sandi, but you just wanted to start with you yes.

Encouraging to see better engagement on the software SaaS side, but just wanted to understand the profitability of monetization of that should we think of those opportunities and sort of an mcs average margin out the gate and then something that skills over time or does it kind of lower and the initial.

Part of that contract and then it any color you can give us in terms of how those contracts will work.

Once they're executed thanks.

Sure. So I'll I'll I'll take it first which is Patrick yeah. The the projects that we've announced here the deals that we've talked about these would be accretive <unk> would not be this is not one of those where you make a big huge investment of of margin upfront and then it pays back later.

These are creative to to the to the <unk> to the segment margins.

And so and that's a big part of the attractiveness would be deals.

Is the value that we are selling to the utility and the payback. It gives to them in terms of immediate revenue generation gives up the ability to really price it appropriately.

And protect ourselves from a future pricing kind of pressure once you're locked in their locked in and.

We start making really really really attractive margins the very outset.

Uh-huh Mark you I mean, they're they're all those are those recent wins, our water deals and they're they're very profitable and.

The service and software part on top of that makes them even more attractive in their longer term. Yeah. So typically typically the way. These contracted work is there's gonna be depending upon the number of we call them and points, but then the number of meters that are being installed you know the.

The meter metrology itself is very profitable and then as those get installed you layer on the ongoing monitoring a piece of the contract the data analytics.

A piece of that contract in the AI wrecked wrap wrapped around that those are then kind of your SaaS margins that you would expect going forward and those have a long tail.

<unk> again can be anywhere between 10 15 years.

Of revenue tied to these it's a smaller piece of the contract.

But even the large piece of the contract which is meters is very attractive.

Okay got it and then just just one follow up on the the cost targets are we still thinking $80 million structural for for 2021, and then just trying to put a finer point on some of the the moving cost items within 2020 in terms of temporary employee support costs and and what that looks like in terms of the.

Netting of kind of headwind or tailwind as we get into to next year.

Yeah, and then I'll I'll jump in and you know the.

In terms of.

Both the Opex and the.

Some of the the cost that we've incurred.

This year I mean listen we've learned a lot in terms of working through the pandemic and.

We're going to be driving hard too.

Cheap.

Find ways to keep these costs out right and and so we would expect to be able to continue to.

Maintain those efficiencies.

Based on learning secondly, the in terms of the.

The support costs and other payments.

Payments that we've made this year certainly.

Assuming we we move through this that will be some that will be some tailwind as well yeah, I I would just punctuated by saying that.

So the the.

The permanent structural savings that that sandy alluded to and the prepared remarks, we don't see any give back on that.

That should be locked in for 2021, so again, you're talking about roughly $80 million, a kind of ongoing savings there and to Mark point on the on the on the discretionary items, Yeah. I mean, we like pretty much every other company. We started early on the discretionary side, we have $60 million of discretion.

Larry savings that are there how much of that comes back.

Yeah, we're still in the planning process, but as Mark said, we've learned a lot we've learned how to do a whole lot more with a whole lot less.

Becoming more efficient effective whether it be travel remote working you know, making sure that our service providers and suppliers are doing the same thing.

So what teams have gone back and renegotiated contracts, there and lastly, making sure that our own our own approach to work as a line with what our customers are doing.

And you know they to our our App pullback significantly.

On their own discretionary costs in terms of people working from home et cetera. So.

We're still working through that but we're leaning in in a big way. So you know I wouldn't expect a lot of that to come back there will be some no doubt because you always have some level of inflation on your wages and salaries, etc. We're gonna do the right thing by our workforce overtime, because we did take some very swift and aggressive actions on air.

On our on our head count during this pandemic. So we're going to remain disciplined and agile and what is otherwise an uncertain environment.

Uh-huh, great and just a point of clarification on the structural cost savings. So the the 70 and 20 in the 80 and 21, that's an incremental 80 versus an incremental 10 is that is that correct.

Yeah.

Yeah Okay.

Got it alright, thank you so much.

Thank you.

Okay.

Ladies and gentlemen, we have reached are a lot of time for Q&A I would like to turn the floor back over to Patrick Decker for any additional closing remarks.

Okay. Thank you so again I want to reiterate where I start on that is I I really hope it all of you and the people close to you are are are safe and healthy.

You know make sure you stay such really appreciate your continued interest and support thanks for joining the call today and we'll be back in touch soon thank you all very much and we won't speak to many of you can at least as a group until after the holidays. So have a very safe and happy holiday season.

Thank you. This does conclude today's island third quarter 2020 earnings Conference call. Please disconnect. Your lines at this time and have a wonderful day.

[music].

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Welcome to these islands third quarter 2020 earnings conference call.

At this time, all participants have been placed on a listen only mode and the floor will be opened for your questions. Following the presentation.

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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 Amanda and good morning, everyone and welcome to diodes third quarter earnings Conference call with me today are Chief Executive Officer, Patrick Decker Senior adviser and former Chief Financial Officer, Mark Recalculate.

And Chief Financial Officer Sandy route.

They will provide their perspective of xylem third quarter results and our outlook. Following our prepared remarks, we will address questions related to the information covered on the call well.

Well, let's say 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 Investor section of our website at Www Dot <unk> Dot com.

A replay of today's call will be available until midnight on November thirtyth.

Please note. The replay number is 805 eight by 867 and the confirmation code is seven no 9669.

Additionally, the call will be available for playback via the investors section of our web site under the heading investor.

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.

<unk> results for the period ending September Thirtyth 2000.

Please turn to slide 13.

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 basis, unless otherwise indicated and non-GAAP financials have been reconciled for you and are included in the appendix section of the presentation now.

Now please please turn to slide four and I will turn the call over to our CEO Patrick Decker.

Thanks, Matt Good morning, everyone and thank you for joining us I.

I hope all of you and does close to you are keeping safe and well.

As reflected in our release this morning, our third quarter performance was better than anticipated.

The team's operational execution was strong right around the world.

Recall that after the low point of April we saw sequential improvements in May and June.