Xylem Inc (XYL) — Q1 2015 Earnings Call Transcript

Thank you, Angie. Good morning, everyone, and welcome to Xylem's First Quarter Earnings Conference Call. With me today are Chief Executive Officer, Patrick Decker; and Chief Financial Officer, Michael Speetzen. They will provide their perspective on Xylem's quarter results and discuss the full year outlook for 2015. Following our prepared remarks, we will address questions related to the information covered on the call. We anticipate that today's call will last approximately 1 hour. As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website at www.xyleminc.com. All references today will be on an adjusted basis, unless otherwise indicated, and non-GAAP financials are reconciled for you in the Appendix section of the presentation. A replay of today's call will be available until midnight on May 14. Please note the replay number is (800) 585-8367 and the conference ID is 5381163. Additionally, the call will be available for playback via the Investors section of our website under the heading Presentations. With that said, 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. These statements are subject to future risks and uncertainties, such as those factors described in Xylem's most recent annual report on Form 10-K and in subsequent reports filed with the SEC. Please note that the company undertakes no obligation to update any forward-looking statements publicly to reflect subsequent events or circumstances, and actual results and events could differ materially from those anticipated. Now please turn to Slide 3, and I will turn the call over to our CEO, Patrick Decker.

Thanks, Phil, and thank you all for joining us. Before we get started this morning, I'd like to acknowledge the earthquake in Nepal that occurred last weekend and the events that continue to unfold in the aftermath. The resulting devastation and suffering are profound, and we, along with so many other global citizens, are responding with immediate resources to assist with their most urgent needs. We are also actively working to identify additional means and funds to help in this recovery. That spirit is core to our mission here at Xylem, and we're keeping all those who've been impacted in our thoughts. Now let me turn to our results. We started off the year on a sound footing, generating solid first quarter results. This morning, I'll share some highlights with you. I will also provide a brief update on a few of our key priorities for the year and discuss our 2015 outlook. I'll then turn the call over to Mike to share additional details, and we'll wrap up by addressing any questions you might have at the end. We delivered another quarter of solid operational performance, as our team steadily increased their focus and elevated their execution to deliver a seventh consecutive quarter of margin expansion. While growth rates in the immediate term are not particularly impressive, I am pleased with their execution, particularly as we faced mixed economic conditions, including weak industrial markets. And looking ahead, we see some encouraging signs in certain end markets we serve as well as attractive investment opportunities that will position us well for stronger growth over the longer term. As market conditions and macroeconomic variables fluctuate, we remain focused on the factors we can influence, mainly building stronger customer relationships to fuel sales and build backlog, driving better performance, and executing a disciplined capital deployment strategy. This is how we will create more value for our customers and our shareholders. As I discussed previously, we have rolled out our integrated commercial IT platforms in a couple of regions now. We're still in the early stages, but I'm very encouraged by the results I've seen. These tools are enabling our sales teams to increase lead generation across the portfolio, reduce the time required to produce a quote and simplify the administrative burden with a streamlined ERP system. For example, our CRM system, salesforce.com, was implemented across our Americas region and will be rolled out globally over the course of this year and next. This tool facilitates the immediate sharing of contacts and business leads across our commercial teams and growth centers. This is feeding our pipeline of projects, which over time we expect will result in a higher growth rate. A key component of our overall progress is our work in the area of continuous improvement. We are squarely focused on driving a continuous improvement mindset across the enterprise. In other words, broadening the deployment of lean beyond the four walls of the factory. Already, we see pockets of success across certain geographies as teams lean out various processes. So we know there’s more that can be achieved, and we have some high priority projects to advance this agenda. One example is an end-to-end supply chain project on one of our largest product lines that should yield a 25% reduction in inventory. And by centralizing our global sourcing activities, we now have visibility to identify meaningful savings on indirect spend, such as contingent labor and freight. These initiatives drive performance, and they generate measurable savings that can also be reinvested for growth. Last month, we announced that Steve Leung had joined Xylem as Senior Vice President and President of Emerging Markets. The emerging markets are particularly important to our growth strategy. They encompass some of the fastest growing areas of our business as development in these regions fuels the building of new infrastructure, which presents us with the opportunity to develop new installed bases of our water technology solutions. Steve is well-positioned to lead our efforts to capture and maximize those growth opportunities. One of his immediate areas of focus is to advance our strategy of further localizing our supply chain and R&D in critical growth markets, beginning with China and the Middle East. Steve brings more than two decades of management and commercial expertise as well as deep knowledge of the unique needs in these regions. I had the opportunity to work with Steve previously, and I know he will bring new ideas and perspective to the good work that's already underway. I also expect to be able to announce a new Innovation and Technology Officer in the coming weeks. This leader will help us coordinate and accelerate our R&D efforts, focusing on breakthrough technologies and innovation in services and business models. As I've said before, we intend to invest some of the productivity savings we generate back into growth opportunities, including innovation. Now let me quickly review our first quarter performance. Orders were flat organically, but they were up 4% in our Water Infrastructure segment. This growth reflects several key project wins with notable progress in our treatment business, which delivered order growth of 13% in the quarter. And while Applied Water orders were down 4%, we did expect a deceleration in this segment following the strong bookings generated during the fourth quarter of last year. One of our big wins in the quarter was a $16 million order for a major municipal project in Canada. The order for flight custom pumps along with accessories and spare parts is part of a multi-year project to upgrade this municipality's drinking water treatment plants and distribution systems. This win reflects both the superior quality of our products and the benefits accrued from strong customer relationships. In addition, our teams will be able to bring forth the applications expertise needed to craft a customized solution that met the unique requirements of this multi-faceted project. This comprehensive approach also helped lay the foundation for potential collaboration on future phases of this endeavor in the years ahead. This order contributed to a 10% year-over-year increase in total backlog in constant currency. Our teams are spending more time in the field, more time with customers understanding their needs, and the result is that we are building a richer pipeline of projects. Earlier this month, I had the opportunity to see some of that work in action on a visit to Southern California. As all of you know, the State of California is now into its fourth year of record drought conditions. The Governor recently issued an executive order that among other things imposed mandatory portable urban water use restrictions and accelerated funding for certain drought mitigation initiatives, including the development of water reuse projects. Xylem is very well-positioned to help the state and its many municipal viable water reuse projects. We have the leading technologies, the applications expertise, and the proven experience to develop solutions to create a sustainable source of water. In San Diego, I visited the Advanced Water Purification Facility at the North City Water Reclamation Center. This site is the focal strength of the city's demonstration project, which is a pilot study to determine the feasibility of water reuse technology to supplement local drinking water supply, both indirectly and directly. Our technologies are integrated throughout this pilot, and our team has worked closely with the customer on all phases of this venture. This along with other pilots in California is helping to feed our reuse pipeline. That said, even with accelerated state funding, these projects take time to develop to bring them to the point of an actual order. But our teams are working with the right people on the ground to influence and advance these initiatives. Now getting back to our results. Organic revenue grew 1% in the quarter, which was in line with the guidance we provided in February. Operating margin expanded 40 basis points year-over-year or 60 basis points, excluding the unfavorable impact of foreign exchange translation. This margin expansion was driven by productivity gains and cost reductions from our continuous improvement initiatives. It also reflects our disciplined approach to investments. We delivered earnings per share of $0.33, up 9% year-over-year before the impact of foreign exchange translation. Considering the muted top line growth, we're pleased with our team's ability to generate the strong bottom line performance. We also improved free cash flow generation after funding and increasing growth-enabling CapEx investments. And finally, on the capital deployment front, we increased our quarterly dividend by 10% and opportunistically repurchased $50 million in common stock. In total, we've returned $76 million in capital to our shareholders. As I mentioned previously, we do expect to execute on some bolt-on acquisition opportunities later in the year.

Thanks, Patrick. Please turn to Slide 5. We generated revenues of $837 million, down $69 million for the prior year. The year-over-year decline reflects the anticipated foreign exchange translation headwind caused by stronger U.S. dollar and the impact of our valves divestiture in the third quarter of 2014. Excluding those items, organic revenue increased 1%, in line with our expectations and the outlook we provided during our last call. From an end market perspective, commercial led the way, up 9%, with both public utility and residential up 2%. Partial offsetting these gains were declines in the industrial and agricultural markets of 1% and 13% respectively. From a regional perspective, we continue to see strong growth in emerging markets, up 9% and modest growth in the U.S., up 2%. This was partially offset by declines in Canada and Australia, which were each down 12%. Lastly, Western Europe was flat for the quarter. Operating margin increased 40 basis points to 10.8%. Excluding the negative impact of foreign exchange translation, margins increased by 60 basis points, which demonstrates our improved cost base as this is a strong performance given the limited operating leverage on 1% organic growth. Focus and strong execution on continuous improvement and business simplification initiatives reduced costs by $23 million in the quarter and resulted in 270 basis points of margin expansion. Partially offsetting these reductions were inflation of nearly 2%, higher pension expense and the unfavorable impact from the divestiture of our valves business last year. Earnings per share declined by $0.01 to $0.33, however, excluding the foreign exchange translation headwind of $0.04, we grew EPS 9%. Now let me cover each of our reporting segments. Please turn to Slide 6. Water Infrastructure recorded orders of $562 million, up 4% organically, including a $16 million project win for transport custom pumps. Book-to-bill was 1.12, our strongest since the first quarter of 2010. As a result, we exit the quarter with total backlog of $585 million, up 12% on a constant currency basis. Of this amount, 75% is due to ship this year, with the balance of nearly $150 million expected to ship in 2016 and beyond. Revenue of $500 million was flat year-over-year on an organic basis. From an application perspective, we saw 3% growth in treatment while transport was flat and test was down 3% due to a tough compare. Regionally, we saw the most significant growth come from emerging markets, which were up 10%. The U.S. was also positive, up 1%. Offsetting these gains were declines in Canada, Australia and Western Europe. In summary, strength in emerging markets was driven by our ability to capitalize on the development of water and wastewater infrastructure in these regions. Treatment, for example, increased more than 40% in China, driven by the delivery of ozone and filtration projects. Transport applications also grew, up 9% in emerging markets, and test generated positive momentum but not enough to overcome a comparison to a $3 million project delivery in Brazil last year. The great news is that we expect to deliver on another sizable project to the same key account later this year. The U.S. contributed organic growth of 1%, driven by strength in test applications. Offsetting this favorable performance was lower public utility spend and lapping of prior year projects in Canada and Australia. Furthermore, we saw weakness in Canada, driven by the softening in the oil and gas market. Operating margin increased 10 basis points from 10.5% to 10.6% due to cost reductions and positive price realization. Restructuring savings of $4 million coupled with sourcing and lean initiatives more than offset the negative effects of inflation, pension and foreign exchange translation losses. Foreign exchange translation unfavorably impacted operating income by $6 million but was neutral to margin. Let me now turn to Slide 7. I'll talk through our Applied Water segment. Applied Water recorded orders of $353 million, down 4% organically. We do not believe this is an indication of any significant changes in this segment's end markets but rather due to timing, as Applied Water reported organic order growth of 9% in the fourth quarter of last year. As a result, we entered the second quarter with total backlog of $208 million, up 4% on a constant currency basis, more than 60% of which is expected to ship within the quarter. Revenue was $337 million, up 2% organically from the prior period. Building service applications were up 6%, irrigation was down 13%, and industrial water was down slightly of 1% year-over-year. Regionally, we generated growth in emerging markets and the U.S., which were up 7% and 2% respectively. Europe was flat overall for the quarter. To further summarize our revenue performance, I'll highlight growth in building services was driven by strength in U.S. commercial of 9%, where we have seen distributors restocking in advance of what we anticipate could be a recovery in the institutional building sector. Additionally, we continue to see growth in emerging market regions like the Middle East and Asia-Pacific. Residential was up 2% globally as our new energy-efficient ecocirc XL pump drove a 20% increase in Europe. U.S. residential was down 4% as cold weather negatively impacted construction and demand for well pumps. Both irrigation and industrial water applications were down from tough comparisons due to project shipments combined with overall softening market conditions. Operating margin expanded 60 basis points from 13.3% to 13.9% year-over-year. Excluding foreign exchange, margins were up 90 basis points. Margin improvement was driven by the favorable impact of cost reduction initiatives and volume leverage. These factors were partially offset by lower price, the unfavorable impact of last year's valves divestiture and nearly 2% cost inflation. Now let's turn to Slide 8, and I'll cover the company's financial position. Xylem maintains a strong cash position with a balance of $554 million at the end of Q1. Our net debt-to-net capital ratio is a healthy 27%, and our commercial paper and revolving credit facilities remain in place and continue to be unutilized. We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while enhancing shareholder returns through dividends and share repurchases. During the first quarter, we invested $37 million into capital expenditures and we returned $76 million to shareholders through dividends and share repurchases. The Q1 return of capital to shareholders included a 10% increase in dividends per share and $50 million of share repurchases. This leaves us with approximately $50 million of additional potential repurchases under our authorized programs. Free cash flow was $2 million, which marks an improvement of $5 million from the prior year and is driven by improved working capital performance.

Now turning to Slide 4. There's no change to the operational outlook in our guidance. Given the deterioration of the dollar since we last provided guidance and the ongoing volatility in the currency markets, we believe it's prudent to update our 2015 full year guidance only to reflect additional foreign exchange translation headwinds. To recap, consistent with the guidance we provided in February, we anticipate 2015 organic revenue growth of 1% to 3%. Similarly, we continue to expect our adjusted operating margin to grow in the range of 50 to 90 basis points, reflecting a carryover benefit of our broad-based restructuring efforts last year as well as additional efficiencies we expect to drive in 2015. We are updating our adjusted earnings per share guidance to a $1.80 to a $1.90 for the full year, which includes $0.26 of negative foreign currency translation impact. This is a little more than we previously anticipated. Excluding this headwind, year-over-year EPS growth is still expected to be in the range of 5% to 10%. Finally, we will continue to execute a disciplined approach to capital deployment, which is expected to result in 100% free cash flow conversion. With that, let me now turn the call over to our CFO, Mike Speetzen, to walk you through the results and full year guidance in more detail. Mike?

Thanks, Patrick. Please turn to Slide 5. We generated revenues of $837 million, down $69 million for the prior year. The year-over-year decline reflects the anticipated foreign exchange translation headwind caused by a stronger U.S. dollar and the impact of our valves divestiture in the third quarter of 2014. Excluding those items, organic revenue increased 1%, in line with our expectations and the outlook we provided during our last call. From an end market perspective, commercial led the way, up 9%, with both public utility and residential up 2%. Partial offsetting these gains were declines in the industrial and agricultural markets of 1% and 13% respectively. From a regional perspective, we continue to see strong growth in emerging markets, up 9% and modest growth in the U.S., up 2%. This was partially offset by declines in Canada and Australia, which were each down 12%. Lastly, Western Europe was flat for the quarter. Operating margin increased 40 basis points to 10.8%. Excluding the negative impact of foreign exchange translation, margins increased by 60 basis points, which demonstrates our improved cost base as this is a strong performance given the limited operating leverage on 1% organic growth. Focus and strong execution on continuous improvement and business simplification initiatives reduced costs by $23 million in the quarter and resulted in 270 basis points of margin expansion. Partially offsetting these reductions were inflation of nearly 2%, higher pension expense and the unfavorable impact from the divestiture of our valves business last year. Earnings per share declined by $0.01 to $0.33, however, excluding the foreign exchange translation headwind of $0.04, we grew EPS 9%. Now let me cover each of our reporting segments. Please turn to Slide 6. Water Infrastructure recorded orders of $562 million, up 4% organically, including a $16 million project win for transport custom pumps. Book-to-bill was 1.12, our strongest since the first quarter of 2010. As a result, we exit the quarter with total backlog of $585 million, up 12% on a constant currency basis. Of this amount, 75% is due to ship this year, with the balance of nearly $150 million expected to ship in 2016 and beyond. Revenue of $500 million was flat year-over-year on an organic basis. From an application perspective, we saw 3% growth in treatment while transport was flat and test was down 3% due to a tough compare. Regionally, we saw the most significant growth come from emerging markets, which were up 10%. The U.S. was also positive, up 1%. Offsetting these gains were declines in Canada, Australia and Western Europe. In summary, strength in emerging markets was driven by our ability to capitalize on the development of water and wastewater infrastructure in these regions. Treatment, for example, increased more than 40% in China, driven by the delivery of ozone and filtration projects. Transport applications also grew, up 9% in emerging markets, and test generated positive momentum but not enough to overcome a comparison to a $3 million project delivery in Brazil last year. The great news is that we expect to deliver on another sizable project to the same key account later this year. The U.S. contributed organic growth of 1%, driven by strength in test applications. Offsetting this favorable performance was lower public utility spend and lapping of prior year projects in Canada and Australia. Furthermore, we saw weakness in Canada, driven by the softening in the oil and gas market. Operating margin increased 10 basis points from 10.5% to 10.6% due to cost reductions and positive price realization. Restructuring savings of $4 million coupled with sourcing and lean initiatives more than offset the negative effects of inflation, pension and foreign exchange translation losses. Foreign exchange translation unfavorably impacted operating income by $6 million but was neutral to margin. Let me now turn to Slide 7. I'll talk through our Applied Water segment. Applied Water recorded orders of $353 million, down 4% organically. We do not believe this is an indication of any significant changes in this segment's end markets but rather due to timing, as Applied Water reported organic order growth of 9% in the fourth quarter of last year. As a result, we entered the second quarter with total backlog of $208 million, up 4% on a constant currency basis, more than 60% of which is expected to ship within the quarter. Revenue was $337 million, up 2% organically from the prior period. Building service applications were up 6%, irrigation was down 13%, and industrial water was down slightly of 1% year-over-year. Regionally, we generated growth in emerging markets and the U.S., which were up 7% and 2% respectively. Europe was flat overall for the quarter. To further summarize our revenue performance, I'll highlight growth in building services was driven by strength in U.S. commercial of 9%, where we have seen distributors restocking in advance of what we anticipate could be a recovery in the institutional building sector. Additionally, we continue to see growth in emerging market regions like the Middle East and Asia-Pacific. Residential was up 2% globally as our new energy-efficient ecocirc XL pump drove a 20% increase in Europe. U.S. residential was down 4% as cold weather negatively impacted construction and demand for well pumps. Both irrigation and industrial water applications were down from tough comparisons due to project shipments combined with overall softening market conditions. Operating margin expanded 60 basis points from 13.3% to 13.9% year-over-year. Excluding foreign exchange, margins were up 90 basis points. Margin improvement was driven by the favorable impact of cost reduction initiatives and volume leverage. These factors were partially offset by lower price, the unfavorable impact of last year's valves divestiture and nearly 2% cost inflation. Now let's turn to Slide 8, and I'll cover the company's financial position. Xylem maintains a strong cash position with a balance of $554 million at the end of Q1. Our net debt-to-net capital ratio is a healthy 27%, and our commercial paper and revolving credit facilities remain in place and continue to be unutilized. We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while enhancing shareholder returns through dividends and share repurchases. During the first quarter, we invested $37 million into capital expenditures and we returned $76 million to shareholders through dividends and share repurchases. The Q1 return of capital to shareholders included a 10% increase in dividends per share and $50 million in share repurchases.

Now turning to Slide 4. There's no change to the operational outlook in our guidance. Given the deterioration of the dollar since we last provided guidance and the ongoing volatility in the currency markets, we believe it's prudent to update our 2015 full year guidance only to reflect additional foreign exchange translation headwinds. To recap, consistent with the guidance we provided in February, we anticipate 2015 organic revenue growth of 1% to 3%. Similarly, we continue to expect our adjusted operating margin to grow in the range of 50 to 90 basis points, reflecting a carryover benefit of our broad-based restructuring efforts last year as well as additional efficiencies we expect to drive in 2015. We are updating our adjusted earnings per share guidance to a $1.80 to a $1.90 for the full year, which includes $0.26 of negative foreign currency translation impact. This is a little more than we previously anticipated. Excluding this headwind, year-over-year EPS growth is still expected to be in the range of 5% to 10%. Finally, we will continue to execute a disciplined approach to capital deployment, which is expected to result in 100% free cash flow conversion. With that, let me now turn the call over to our CFO, Mike Speetzen, to walk you through the results and full year guidance in more detail.

Thanks, Patrick. Please turn to Slide 5. We generated revenues of $837 million, down $69 million for the prior year. The year-over-year decline reflects the anticipated foreign exchange translation headwind caused by a stronger U.S. dollar and the impact of our valves divestiture in the third quarter of 2014. Excluding those items, organic revenue increased 1%, in line with our expectations and the outlook we provided during our last call. From an end market perspective, commercial led the way, up 9%, with both public utility and residential up 2%. Partial offsetting these gains were declines in the industrial and agricultural markets of 1% and 13% respectively. From a regional perspective, we continue to see strong growth in emerging markets, up 9% and modest growth in the U.S., up 2%. This was partially offset by declines in Canada and Australia, which were each down 12%. Lastly, Western Europe was flat for the quarter. Operating margin increased 40 basis points to 10.8%. Excluding the negative impact of foreign exchange translation, margins increased by 60 basis points, which demonstrates our improved cost base as this is a strong performance given the limited operating leverage on 1% organic growth. Focus and strong execution on continuous improvement and business simplification initiatives reduced costs by $23 million in the quarter and resulted in 270 basis points of margin expansion. Partially offsetting these reductions were inflation of nearly 2%, higher pension expense and the unfavorable impact from the divestiture of our valves business last year. Earnings per share declined by $0.01 to $0.33, however, excluding the foreign exchange translation headwind of $0.04, we grew EPS 9%. Now let me cover each of our reporting segments. Please turn to Slide 6. Water Infrastructure recorded orders of $562 million, up 4% organically, including a $16 million project win for transport custom pumps. Book-to-bill was 1.12, our strongest since the first quarter of 2010. As a result, we exit the quarter with total backlog of $585 million, up 12% on a constant currency basis. Of this amount, 75% is due to ship this year, with the balance of nearly $150 million expected to ship in 2016 and beyond. Revenue of $500 million was flat year-over-year on an organic basis. From an application perspective, we saw 3% growth in treatment while transport was flat and test was down 3% due to a tough compare. Regionally, we saw the most significant growth come from emerging markets, which were up 10%. The U.S. was also positive, up 1%. Offsetting these gains were declines in Canada, Australia and Western Europe. In summary, strength in emerging markets was driven by our ability to capitalize on the development of water and wastewater infrastructure in these regions. Treatment, for example, increased more than 40% in China, driven by the delivery of ozone and filtration projects. Transport applications also grew, up 9% in emerging markets, and test generated positive momentum but not enough to overcome a comparison to a $3 million project delivery in Brazil last year. The great news is that we expect to deliver on another sizable project to the same key account later this year. The U.S. contributed organic growth of 1%, driven by strength in test applications. Offsetting this favorable performance was lower public utility spend and lapping of prior year projects in Canada and Australia. Furthermore, we saw weakness in Canada, driven by the softening in the oil and gas market. Operating margin increased 10 basis points from 10.5% to 10.6% due to cost reductions and positive price realization. Restructuring savings of $4 million coupled with sourcing and lean initiatives more than offset the negative effects of inflation, pension and foreign exchange translation losses. Foreign exchange translation unfavorably impacted operating income by $6 million but was neutral to margin. Let me now turn to Slide 7. I'll talk through our Applied Water segment. Applied Water recorded orders of $353 million, down 4% organically. We do not believe this is an indication of any significant changes in this segment's end markets but rather due to timing, as Applied Water reported organic order growth of 9% in the fourth quarter of last year. As a result, we entered the second quarter with total backlog of $208 million, up 4% on a constant currency basis, more than 60% of which is expected to ship within the quarter. Revenue was $337 million, up 2% organically from the prior period. Building service applications were up 6%, irrigation was down 13%, and industrial water was down slightly of 1% year-over-year. Regionally, we generated growth in emerging markets and the U.S., which were up 7% and 2% respectively. Europe was flat overall for the quarter. To further summarize our revenue performance, I'll highlight growth in building services was driven by strength in U.S. commercial of 9%, where we have seen distributors restocking in advance of what we anticipate could be a recovery in the institutional building sector. Additionally, we continue to see growth in emerging market regions like the Middle East and Asia-Pacific. Residential was up 2% globally as our new energy-efficient ecocirc XL pump drove a 20% increase in Europe. U.S. residential was down 4% as cold weather negatively impacted construction and demand for well pumps. Both irrigation and industrial water applications were down from tough comparisons due to project shipments combined with overall softening market conditions. Operating margin expanded 60 basis points from 13.3% to 13.9% year-over-year. Excluding foreign exchange, margins were up 90 basis points. Margin improvement was driven by the favorable impact of cost reduction initiatives and volume leverage. These factors were partially offset by lower price, the unfavorable impact of last year's valves divestiture and nearly 2% cost inflation. Now let's turn to Slide 8, and I'll cover the company's financial position. Xylem maintains a strong cash position with a balance of $554 million at the end of Q1. Our net debt-to-net capital ratio is a healthy 27%, and our commercial paper and revolving credit facilities remain in place and continue to be unutilized. We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while enhancing shareholder returns through dividends and share repurchases. During the first quarter, we invested $37 million into capital expenditures and we returned $76 million to shareholders through dividends and share repurchases. The Q1 return of capital to shareholders included a 10% increase in dividends per share and $50 million of share repurchases.

Thanks, Mike. As I said, we're off to a solid start to the year. We're excited about the direction Xylem is headed and look forward to sharing more details about our future plans at an Investor Day meeting later this year. For now, let me reiterate that we remain focused on driving stronger operating performance even as we face some uncertainty in the marketplace. I'm pleased with the progress the team has made in that regard and the continued momentum of that work. We do see some positive signs ahead, and we will continue to invest to ensure that we are well-positioned to capture new growth opportunities later this year and into 2016. We remain committed to delivering on our financial commitments and executing a broad-based capital deployment strategy. Our operational outlook remains unchanged, and we're on the right path to realizing the full potential that this company is capable of delivering. So operator, we can now begin the Q&A session.

Given all the macro anxiety, that's an awfully nice clean quarter from you guys. First question is help me understand the order cadence for the past 2 quarters. So it looked like Applied was up nicely in the fourth quarter, but now I'm looking at flat organic orders starting off the year. And does that in any way challenge you to hit this 1% to 3% organic revenue growth for 2015?

Yes, Deane, this is Mike. I think from an Applied Water - and I'd made a couple of comments in my prepared remarks. We had order growth in the fourth quarter about 9%, and we think that the performance in the first quarter is just indicative that a lot of folks, given some of the promotional programs and things that are underway probably did quite a bit of restocking, ordering back in the fourth quarter. And so as we look at what the projection for the balance of the year is, as it relates to Applied Water, we don't see anything from an end market standpoint that says we're going to see anything play out any different. It looks like the commercial market is in a recovery mode. The Architectural Billing Index, specifically around institutional, has remained above 50 now for some time, and so we think that's driving some of the advanced ordering that we saw in the latter part of last year.

Regarding your comments about oil and gas, I'm not surprised that your exposure is less than 5%. However, the expectation that this business could decline by 40% is significantly higher than what our sensitivity model suggests. Could you elaborate on your comment that this is one of your higher-margin businesses?

Yes. We have some exposure to oil and gas within our Applied Water business, but most of it comes from our dewatering business, which is involved in frac pads for both oil and gas in roughly equal proportions. That business experienced a decline of about 25% in the first quarter, and according to our current projections, we expect a further decline of around 40% for the remainder of the year. We have considered this in our guidance and ensured that our teams are taking necessary actions to mitigate that risk. The positive aspect is that our dewatering business has a diverse portfolio, covering areas like construction, municipal bypass, and disaster recovery. This allows us to mobilize and redeploy resources effectively, which is a primary focus for our team right now.

And just if I can have one last question. Just to clarify, your comments on the increased business in China on the treatment side. You cited ozone and filtration. And is the filtration piece, is that part of your licensing agreement with GE?

No. This would not be related to the Zenon membrane. This is around our Leopold gravity filtration business.

I wanted to ask about the announcement of a new Chief Innovation Officer. I found that comment intriguing. Our understanding is that the product development pipeline has started to gain some momentum, which is a positive aspect of the situation. Can you provide more details on what prompted the decision to formalize this role? What will be the responsibilities of this individual, and what specific goals are set to achieve substantial improvements in this area?

I'm happy to share, Ryan. I'm very pleased with the progress that our five growth centers have made in revitalizing the pipeline over the past few years. You've likely noticed our new products hitting the market. This initiative is not solely about a leader overseeing what each business unit is doing. There are still efficiency gains to pursue, particularly by localizing more of our product design and innovation in fast-growing emerging markets, rather than focusing mostly on the heritage markets where those brands originated. A significant part of this role will involve driving efforts toward emerging markets. Additionally, we have conducted value mapping work recently, engaging in a fact-based assessment of our customers' needs across various end markets, including municipal, oil and gas, power, mining, and food and beverage sectors. This individual will collaborate with our marketing teams to identify opportunities for both organic innovation and technology, as well as to inform our M&A strategies. M&A often serves as a substitute for R&D, particularly in an industry where intellectual property is fragmented. These will be the key focus areas for our innovation and technology lead.

Okay. And I guess my related follow-up would be related to your last point there, which is as you look at the M&A environment, I mean, you mentioned that the company will likely become more active there over the balance of the year. What is the core? Obviously, you can't share with us any specifics, but are you more looking at acquisitions that add to your distribution or product portfolio in developed markets? Or is it more of a technology M&A? Is that really the focus?

I think it will be a combination of the two. I would say our predominant interest will be in adding new technology and capabilities to the portfolio, but certainly, where there are opportunities for us to strengthen the core, we'll certainly take advantage of that.

I have a couple of questions. First, I wanted to discuss pricing. How would you assess that in the first quarter across different segments, or would it be better to look at it by geography? Additionally, how do you view this moving forward? There seems to be some industry concern about how much of the revenue decline is due to pricing and what the associated decrementals might be.

For the quarter, pricing remained largely unchanged overall, but there are variations across segments. In our Water Infrastructure segment, as mentioned last year, we have been actively working to enhance our pricing capabilities, and we began to see some positive results in the fourth quarter, which continued into the first quarter where we achieved approximately 40 basis points. While it's not a significant increase, it indicates progress. However, we are experiencing considerable pressure in the Applied Water segment, which reflects some common trends noted by many of our peers. We faced nearly 90 basis points of headwinds in that market due to heightened competition and certain dynamics related to end markets and weather conditions. We are managing this situation carefully and our teams are implementing strategies to address it. Looking ahead at our full-year guidance, we anticipate pricing to be less than 50 basis points, though there is a possibility of further pressure. It's still early in the year and we will encourage our teams to work on mitigating this and ensuring that we present the right value proposition to justify our pricing for the products we offer.

I would just add that two other areas that I think we're very much focusing on in helping mitigate this is, again, you heard us talk about ramping up our global procurement and sourcing efforts. So taking advantage of this low growth and kind of deflationary environment to put that pressure back on our suppliers. Secondly, this is an area where, again, rolling out new products is very helpful to us in terms of arresting the price declines, if not even driving some level of increase. So all the more reason for us to be bringing new products to market.

Yes, that's fair. On the emerging markets side, that's been up double digits, high singles for quite a bit now. When do we start rolling into comps that become a little bit more challenging to keep that kind of pace?

Yes, we actually had our most difficult comp in the first quarter, where we had 18% growth last year. And as we indicated in our initial guidance and obviously what we've reiterated today, we expect strong growth in the emerging markets, high single digits. We just don't anticipate it being at the level that we recognized last year, where we were up about 13%. So we've kind of lapped the most difficult compare, but obviously, there’s dynamics going on in China around the commercial markets and so we think the guidance level that we've put out there is pretty consistent with what we experienced in the first quarter and is driving quite a bit of the growth for the company.

I would just add that I do want to just remind everyone that we're still very much in the building installed base mode, and so it's heavy project activity. It will be choppy and lumpy from quarter-to-quarter, but we do see a steady stream of new products coming.

Yes, that's good to hear. Maybe my last point. Regarding the industrial outlook, there's a decrease of 1% for the quarter, which includes significant drops in oil and gas, yet you are still anticipating growth for the full year. There has been considerable variability in earnings during this season, particularly concerning industrial segment guidance. What leads you to believe that your products are more resilient in this environment, and what reassures you that growth is still possible despite the 40% decline in oil and gas?

Yes. So I'd say it's a couple of things. One, within the segment that shown about oil and gas dewatering, as I mentioned earlier, even though we are facing significant headwind from that particular vertical, that business serves a variety of other end markets that we do see continued strength in. So I think from a dewatering standpoint, we certainly have the diversity of the portfolio. From a more broad-based industrial perspective, I would say the geographic and ultimate end market breadth that we have. So if you remember some of the charts we've displayed in the past, our industrial segment is very diverse in terms of general industrial, food and beverage, construction, et cetera. And so we think by that diversity, that's given us a little bit of insulation relative to the low single-digit growth rate that we're expecting for the year.

And this is also where we, I think, are very well-positioned from an emerging market standpoint, especially with the install build in the Middle East and China. And so while we're doubling down our efforts in those areas, I certainly don't want to diminish the great work the teams have already done historically to build our base there.

I had a couple of questions on the margin profile, both, you know, from kind of above the unit level. So first of all, the R&D reduction that you had year-over-year, is that something that you see as structural what you've done to improve the productivity and return on investment in R&D? Or was this more discretionary?

Yes. I'll take that one. I would say it's largely timing of spend within the quarter. It certainly is not a trend line that we're focusing to continue. If anything, over time, we'll be marginally increasing the amount of investment we spend in R&D. There is also the opportunity we've been driving here to be more efficient and effective in our R&D spend. So as we again further move to localize more and more of our R&D investment in some of the emerging markets, that's a more efficient spend that we're going to get because that will be able to support not only those local markets but also some of our global activity. So it will be a mixed bag going forward, but I wouldn't read anything into the modest decline in the quarter.

And, David, there is also some foreign exchange translation tied up in this. If you remember, we have overweight in terms of our engineering that's outside of the U.S., in areas like Stockholm, where we're benefiting from a translation standpoint. Even if we pull that out, we are down, so the comments that Patrick highlighted absolutely apply, but it's being amplified by foreign exchange rate now.

Okay. So in Q2, that will be set back to a normalized level?

That has declined, yes.

Okay. And then, lastly, within the margin context, on the Water Infrastructure side, you seem to make some pretty good progress despite the FX headwinds and some of the sluggish commentary you made about the overall market. Where did you see most of the traction front end or within the four walls? Maybe you can provide just a little bit more perspective on that?

Yes. I think, David...

I'm sorry, but could you provide some insight on how the pipeline looks within the backlog moving forward?

Sure. I think from a margin standpoint, certainly the continued effort and focus that we have across the business on making sure that we're driving the lean and the global sourcing productivity. And I would say for Water Infrastructure, you don't see all of the margin leverage come through because as we indicated, as we're growing in emerging markets, which for that segment, we're up 10%, while there are attractive margins, they're obviously at a lower rate because it's primarily OEM business versus having the after-market content. We are getting that volume leverage off of the growth within the platform and so that's obviously aiding to the margin profile.

So then the backlog...

Yes. So the backlog for Water Infrastructure, so orders were up 4%. The backlogs, it's one of the strongest levels we've had. As I indicated in some of my remarks, when you look at our shipments for 2016 and beyond, we are up over 50% and so we're continuing to see the strength. Our treatment business was up about 13% from an order standpoint and that was pretty evenly spread across the globe. So at this point, we're not calling a full-on municipal recovery, but we are certainly seeing continued growth and order strength for that business, not only in treatment, but also in our large transport business.

I think we've also been pleased. We've seen our win rate improve in the treatment business as well, which is a leading indicator for the rest of the business. It's gone now from 40%, up to 45%, driven by a number of factors, but it's a pretty encouraging sign for us.

As you get ready to roll out the new sales tools globally here, can you talk a little bit about what you've seen so far in the U.S.? And then when you couple that with some of the newer energy efficiency products, et cetera, how are you thinking about potential share gains?

Sure. I'll address the first part of that and then let Mike add on to the second part. We're very pleased with the collaboration that our new sales tools are facilitating. The benefits are noticeable in several areas. One major advantage is that it simplifies the process for our commercial teams to share leads across the portfolio. As you're aware, our businesses have often targeted the same customers, but we haven't always approached these customers in a coordinated manner. The salesforce.com tool is definitely helping with that. It also provides us with better visibility into existing projects. The combination of enhanced visibility and improved win rates is obviously very beneficial. Ultimately, this effort is about making things easier for our sales teams by reducing their administrative workload. We're still in the very early stages of this initiative, which presents a great opportunity for our teams to spend more time engaging with customers. Regarding our product rollout, our vitality index is about 20%, which dipped slightly in the first quarter due to mix, but we're optimistic about several new products we've already launched and others that we plan to announce in the coming months. Mike, would you like to add to that?

Chip, I assume your question was in relation to the deployment of salesforce.com in terms of the shipping?

That's right.

Yes. So I think, when we look at things like the ecocirc that I talked about in my prepared remarks, we obviously are taking share in the European markets. And as we look at having a tool that enables, as Patrick said, our sales force to be able to communicate opportunities and execute on those, we think that, coupled with the energy-efficient proposition that we have in our products or that we're developing for our products, and given the climate we're dealing with with our customers in terms of trying to reduce costs, we think that's going to give us a very strong platform. As we've talked in the past, being able to outperform the market by 1 point or 2, that's going to be a key part of that equation.

You've had a few quarters now of strength in the commercial nonresidential product area, and it seems to be some momentum in that market. Is this a group that can be as meaningful as 20% or more of your sales mix, if the market gives you enough tailwind all else kind of generally equal in the other applications?

I don't think so. I mean, it's 13% of our revenue today. And when I think about the growth potential that we have, say, in industrial and even public utility growing at a moderate rate, it's going to be tough for it to surpass that. I mean, we had 9% growth in the first quarter, but as I indicated in my comments, we think that's going to moderate to kind of low to mid-single digits. Some of that is being driven by advanced stocking. But it is going to be a great part of the portfolio for sustained growth as that market continues through over the next several years.

Okay. And then in terms of your guidance, are you expecting cost inflation to kind of stay a headwind throughout this year? It seems some of the movement in commodities last several months would help in that regard.

At this stage, we are indicating it's less than 2%. Compared to last year, we actually observed a slight decline toward the end of last year. However, relative to the previous year, it's a net benefit for us. There's also a significant element of wage inflation that needs to be considered. As Patrick mentioned earlier regarding the strategic sourcing organization, we are strongly focusing on continuing our solid performance to counteract that. So to reiterate, even if we begin to experience some downward pricing pressure alongside inflation, we remain confident in our ability to achieve margin expansion in that situation.

Question on restructuring. So you kept that at $20 million. Correct me if I'm wrong, I think that there was maybe, what, $17 million, $18 million that wasn't done in '14 that actually you're just doing in '15 and you added a couple of million more when you provided your initial outlook. I guess I was under the impression there that, that could become more aggressive. Can you just maybe talk about where that stands? Is there an opportunity to maybe kind of hit the gas pedal on that this year? And where those opportunities might be, if you could?

Sure, Brian. We have indicated that there are still several hundred points of opportunity as a percentage of revenue to cut costs. This is especially evident in our general and administrative expenses, but there are also hidden costs within our gross margin structure. We're taking a very strategic and proactive approach that aligns with our broader strategy. We plan to provide more details on this multi-year, multi-faceted plan later this year at our Investor Day.

So not likely much more this year, is that takeaway?

Still remains open. We'll have more to share. We're in the late stages of developing those plans. As you saw, we announced a few months ago, we appointed Tony Milando as our Head of CI and Business Transformation. So Tony's working very closely with Mike, myself and the leadership team to finalize those plans.

I had a couple of questions on the margin profile, both, you know, from kind of above the unit level. So first of all, the R&D reduction that you had year-over-year, is that something that you see as structural what you've done to improve the productivity and return on investment in R&D? Or was this more discretionary?

Yes. I'll take that one. I would say it's largely timing of spend within the quarter. It certainly is not a trend line that we're focusing to continue. If anything, over time, we'll be marginally increasing the amount of investment we spend in R&D. There is also the opportunity we've been driving here to be more efficient and effective in our R&D spend. So as we again further move to localize more and more of our R&D investment in some of the emerging markets, that's a more efficient spend that we're going to get because that will be able to support not only those local markets but also some of our global activity. So it will be a mixed bag going forward, but I wouldn't read anything into the modest decline in the quarter.

And, David, there is also some foreign exchange translation tied up in this. If you remember, we have overweight in terms of our engineering that's outside of the U.S., in areas like Stockholm, where we're benefiting from a translation standpoint. Even if we pull that out, we are down, so the comments that Patrick highlighted absolutely apply, but it's being amplified by foreign exchange rate now.

Okay. So in Q2, that will be set back to a normalized level?

That has declined, yes.

Okay. And then, lastly, within the margin context, on the Water Infrastructure side, you seem to make some pretty good progress despite the FX headwinds and some of the sluggish commentary you made about the overall market. Where did you see most of the traction front end or within the four walls? Maybe you can provide just a little bit more perspective on that?

Yes. I think, David...

I'm sorry, but could you also provide some information on how the pipeline looks within the backlog going forward?

Sure. I think from a margin standpoint, certainly the continued effort and focus that we have across the business on making sure that we're driving the lean and the global sourcing productivity. And I would say for Water Infrastructure, you don't see all of the margin leverage come through because as we indicated, as we're growing in emerging markets, which for that segment, we're up 10%, while there are attractive margins, they're obviously at a lower rate because it's primarily OEM business versus having the after-market content. We are getting that volume leverage off of the growth within the platform and so that's obviously aiding to the margin profile.

So then the backlog...

Yes. So the backlog for Water Infrastructure, so orders were up 4%. The backlogs, it's one of the strongest levels we've had. As I indicated in some of my remarks, when you look at our shipments for 2016 and beyond, we are up over 50% and so we're continuing to see the strength. Our treatment business was up about 13% from an order standpoint and that was pretty evenly spread across the globe. So at this point, we're not calling a full-on municipal recovery, but we are certainly seeing continued growth and order strength for that business, not only in treatment, but also in our large transport business.

I think we've also been pleased. We've seen our win rate improve in the treatment business as well, which is a leading indicator for the rest of the business. It's gone now from 40%, up to 45%, driven by a number of factors, but it's a pretty encouraging sign for us.

As you get ready to roll out the new sales tools globally here, can you talk a little bit about what you've seen so far in the U.S.? And then when you couple that with some of the newer energy efficiency products, et cetera, how are you thinking about potential share gains?

Sure. I'll take the first part of that and maybe let Mike comment on the second piece. I mean, we're very pleased with what we've seen in terms of the collaboration that our new sales tools drive. I think the benefits are in a few areas. One is it does make it easier for our commercial teams to get visibility as to sharing leads across the portfolio. As you've known for a while, we oftentimes have served the same customers, but we haven't always glanced at those customers in a coordinated fashion. So the salesforce.com tool is certainly helping in that regard. I think it's also getting us more visibility to projects that are out there. So the combination of better visibility and improving our win rate is obviously a powerful combination. I think ultimately, over time, this is also about simplifying the lives of our sales teams and taking a lot of the administrative burden off of them. We are in the very, very early innings of that. So that's all opportunity in front of us to allow them to be able to spend even more time out in the field in front of customers. In terms of again rolling out new products, our vitality index is roughly around 20%. And that dipped down a little bit in the first quarter just by way of mix, but we do feel good about a number of the new products that we have that we've already rolled out and some others that we're going to be announcing here over the coming few months. And if you might add, Mike, on the...

Chip, I assume your question was in relation to the deployment of salesforce.com in terms of the shipping?

That's right.

Yes. So I think, when we look at things like the ecocirc that I talked about in my prepared remarks, we obviously are taking share in the European markets. And as we look at having a tool that enables, as Patrick said, our sales force to be able to communicate opportunities and execute on those, we think that, coupled with the energy-efficient proposition that we have in our products or that we're developing for our products, and given the climate we're dealing with with our customers in terms of trying to reduce costs, we think that's going to give us a very strong platform. As we've talked in the past, being able to outperform the market by 1 point or 2, that's going to be a key part of that equation.