Xylem Inc. (XYL) Earnings

Management highlights

- Strategic Market Positioning • Management is positioning Xylem to capitalize on growing customer demand for comprehensive water solutions that improve operational resilience, efficiency, and regulatory compliance, expanding from the core resilient municipal business into high-growth industrial verticals. • Three core long-term growth drivers are identified: rising demand for water to support industrial quality and reliability, growing strategic importance of water for the expanding AI ecosystem, and portfolio optimization to prioritize high-value, high-growth markets. • The Avoqua acquisition has significantly expanded water treatment, reuse, and service capabilities, deepening the company's presence in attractive industrial end markets. The company has reshaped its portfolio via over $400 million of divestitures to sharpen focus, complemented by targeted acquisitions of high-growth relevant assets: the recently closed Trios acquisition advanced sensing and water quality capabilities for industrial customers, and the signed agreement to acquire Waterfleet adds mobile water treatment capabilities and expands exposure to AI-related infrastructure markets. - Operational Momentum & Customer Wins • Q2 2026 overall revenue grew 1% year-over-year in line with expectations, with strength in key core markets offsetting the 27% China decline and 2% 80-20 walkaway revenue. GAAP EPS reached a record $1.46, up 16% year-over-year, while overall adjusted EBITDA margin hit 23.3%, up 150 basis points year-over-year, driven by productivity, pricing, and mix. • Ending total company backlog reached $5.3 billion, with quarterly book-to-bill well above 1, and orders grew in three of four segments. Free cash flow was strong, and the company made opportunistic share repurchases in the quarter. • Notable recent large customer wins include a 20-year integrated water solutions contract with a top global chemical company (won against an incumbent), a wastewater treatment solution for the world's largest lithium battery cell manufacturer, and multiple data center projects for hyperscalers. AI-related data center revenue is expected to grow 200% year-over-year in 2026, representing ~2% of total annual revenue by year end. • Municipal market demand remains healthy, supported by strong infrastructure spending and backlog execution.

Guidance

- Full year 2026 organic revenue growth guidance was revised downward to 2% to 3%, from the prior 2% to 4% range, driven by near-term MCS electric metering project delays. Reported full year revenue is expected to be ~$9.2 billion, representing 2% total reported growth. - Full year 2026 adjusted EBITDA margin guidance was revised upward to 23.1% to 23.5%, from the prior 22.9% to 23.3% range, representing 90 to 130 basis points of margin expansion year-over-year. The improvement is driven by productivity, volume, and pricing that offset inflation and business investments. - Full year 2026 EPS guidance was raised to $5.55 to $5.70, from the prior $5.35 to $5.60 range, as stronger first half performance, share repurchase benefits, and higher margins more than offset the electric metering revenue impact. The company remains on track to hit its full year low double-digit free cash flow margin target. - For Q3 2026, management expects flat reported revenue growth and ~3% organic revenue growth. Adjusted EBITDA margin is projected to be 23.5% to 24%, up 30 to 80 basis points year-over-year, with Q3 EPS expected to fall between $1.42 and $1.47. - Management expects sequential quarterly growth momentum through the second half of 2026, with the fourth quarter exiting at mid-single-digit growth, building momentum for 2027.

Segment performance

1. Water Infrastructure: Achieved 480 basis points of EBITDA margin expansion year-over-year, driven by productivity, pricing, product mix, and volume that offset inflation and business investments. The segment saw strong leverage from North American transport growth, with 80-20 portfolio simplification actions contributing approximately 2% of walkaway revenue this year, alongside a 27% year-over-year revenue decline in China. 2. Measurement and Control Solutions (MCS): Orders grew 2% year-over-year, ending backlog held steady at roughly $1.2 billion, and book-to-bill was below 1. Near-term electric metering project delays have pressured performance, driven by slowed utility capital spending. The water side of the segment saw double-digit order growth in both Q1 and Q2 2026, with the sales pipeline up 30% year-over-year. 3. Applied Water: Orders grew 9% year-over-year, with book-to-bill well above 1, boosted by over 300% year-over-year growth in data center orders. Revenue grew 3% year-over-year, driven by strength in U.S. commercial buildings that offset weakness in residential markets and China. EBITDA margin was down 50 basis points year-over-year, slightly below expectations, as inflation and lower volume were mostly offset by productivity and pricing. 4. Water Solutions and Services (WSS): Orders grew significantly year-over-year, driven by the company's largest ever order: an approximately $850 million 23-year outsourced water project with Dow. Revenue grew 1% year-over-year, driven by capital projects (including the Dow contract) and strength in dewatering. Segment EBITDA margin reached 25.3%, up 90 basis points year-over-year, as pricing, mix, and productivity offset inflation and lower volume.

Risks & headwinds

- Near-term MCS performance is pressured by slowed electric metering investment, driven by utility affordability concerns and a more cautious capital spending environment ahead of upcoming U.S. elections, as politicians have taken hard stances on electricity rate increases leading to near-term pullbacks in utility spending. - The China market remains challenging, with Q2 2026 orders and revenue both down almost 30% year-over-year, driven by broader economic weakness, reduced Chinese government infrastructure investment, significant local competition, and ongoing 80-20 portfolio selectivity. - Broader macro risks include ongoing market volatility, the Middle East conflict, changing tariff policies, and persistent inflationary pressures. Newly announced tariff changes and refunds did not have a material impact to projected 2026 results. - WSS revenue growth is inherently lumpy due to the timing of large outsourced contract wins, which can create quarterly variability in results.

Analyst Q&A

• Q: What are the key non-municipal drivers behind Applied Water's 9% organic order growth, what is the outlook for outsourced water contract pipeline after the historic Dow win, and how does this align with the Avoqua acquisition strategy? /

  A: Applied Water's 9% order growth was primarily driven by data center demand, with additional strength from North American commercial building services across multiple verticals. Data center exposure will continue increasing, with 200% 2026 revenue growth bringing it to 2% of total annual revenue by year end. The Avoqua acquisition expanded capabilities to win large build-operate outsourced contracts in high-growth industrial verticals including lithium battery manufacturing, where the company recently won a full-cycle novel wastewater treatment contract leveraging its zero liquid discharge assets, as well as data center water treatment projects. This industrial growth is complementary to the company's core stable municipal business.

• Q: What is driving the near-term slowdown in MCS electric metering, and how does the water side of the segment perform to offset this? /

  A: The full year organic guidance revision is entirely attributable to near-term electric metering deployment delays, caused by slowed utility capital spending from affordability concerns and political caution around rate hikes ahead of elections. Xylem continues to gain market share in electric metering, and the long-term growth outlook for the sector remains healthy driven by ongoing AMI 2.0 meter refresh cycles. The water side of MCS continues to see strength, with double-digit order growth in both Q1 and Q2, a 30% year-over-year increase in pipeline volume, and full year low single-digit growth expected with a strong second half that partially offsets electric declines.

• Q: How will the 80-20 simplification strategy evolve after 2026, and what does this mean for walkaway revenue and future growth? /

  A: 2026 will see the peak of walkaway revenue from 80-20 actions, at close to 2% of total revenue, and walkaway volume will be significantly lower in 2027 as the majority of the portfolio review has been completed. After 2026, 80-20 will shift from being primarily a margin expansion lever driven by walking away from low-value business to a growth enabler, with resources reallocated from low-value projects to high-priority underpenetrated growth areas including U.S. water transport, data centers, mining, and outsourced water solutions.

• Q: Have valuations for water sector acquisition targets fallen enough to create attractive opportunities for Xylem's M&A program? /

  A: Valuations have started to soften slightly for some targets, but private market valuations have not fully aligned with the lower public market valuations for water assets. Xylem maintains a healthy M&A pipeline and remains on track to deploy $1 billion of capital annually for accretive acquisitions that align with its strategic growth priorities.