Xylem Inc. (XYL) Q1 2013 Earnings Report, Transcript and Summary

Good morning, everyone. I'm Phil De Sousa, Director of Investor Relations. Welcome to Xylem's 2013 Investor and Analyst Day, our first since spinning out of ITT in 2011. For those here with us at the historic New York Stock Exchange and those joining via webcast, I thank you for your time and interest in our company. As I look out into the audience, I see many familiar faces. A great number of investors and sell side analysts, a number of new faces, both buy side and sell side, which signals the continued interest in Xylem today. I am certain that today's presentation will cater to this broad audience. And I believe that you will leave today with a better understanding of our business, our industry, and the strategy the team has set forth as we continue to move forward. With that said, allow me to highlight today's agenda on Slide 2. We will have a series of speakers beginning with our CEO, Gretchen McClain, who will provide a brief update on the business and provide a Xylem overview. Following, we will turn to Xylem's Chief Strategy & Growth Officer, Colin Sabol, for a market update and a detailed discussion around how Xylem drives growth in the marketplace. We will then plan to take a short break, following which, we will begin a series of reviews led by our Business Presidents, Mike Kuchenbrod will cover our transport and treatment businesses, including an in-depth review of our dewatering transport platform; Chris Mcintire will follow with a deep dive into Xylem's Analytics business; and then we'll turn it to Ken Napolitano, who will cover Applied Water Systems. Finally, we will wrap up with Mike Speetzen, our Chief Financial Officer who will layout the strategic initiatives and capital deployment plans into financial context. Of course, we plan to take some time at the end of the day of the presentations to address questions from those here with us today. Turning to Slide 3. Everyone is quite familiar with this slide, but let me run through it, anyways. We will make some forward-looking statements today including references to future events or developments that we anticipate will or may occur in the future. These statements are subject to risks -- future risks and uncertainties, such as those outlined in our annual Form 10-K and those described in subsequent reports filed with the SEC. These remarks constitute forward-looking statements for purposes of the Safe Harbor Provision. Please note that the company undertakes no obligation to update such statements publicly to reflect events or circumstances, and actual results could differ materially from those anticipated. With that out of the way, I'll ask everyone to please turn off your BlackBerries, your iPhones, your iPads, your mobile devices, or at least please put them into silent mode. So it's time to start the program. Please help me welcome to the stage, Xylem's President and Chief Executive Officer, Gretchen McClain.

Thanks, Phil, and good morning. Thank you for joining us today. It's great to have you all here. And it's interesting, when you think about -- it's been 17 months since we separated from ITT and went out on our own as an independent company. In some ways, it seems like just yesterday, in other ways, it seems like it's been a long journey. We have been doing an enormous amount of work to separate and to step up a company on its own. And I will tell you, yesterday, really was an exciting day because it brought it all together. We got the opportunity to close the bell on our high for our stock, as well as a market new high. And so it was a great feeling. It was a great feeling from the perspective of, we've got the spin behind us, we've set a great foundation and we've got 4 new acquisitions with us. So we're on a journey. And I hope, this morning, what you will see is that strategy come alive as we all go through the presentation this morning. So let's go ahead and jump in with Slide 5. So as most of you know, last week, we announced another acquisition and it's part of our family, and that's privately held MultiTrode. And with 2012 revenue, we purchased it for $26 million. This is consistent with our bolt-on acquisition strategy that we have been executing. MultiTrode provides us with advanced monitoring and control technology. It's a state-of-the-art platform that enables us to provide smarter solutions including cloud-based services to our customers. It's also a scalable platform, which can easily be adapted to plug into our large installed base. It's also going to enable us to commercialize future products in our water and wastewater market…

Thanks, Gretchen, and good morning, everyone. I'm Colin Sabol. I'm responsible for driving strategy and growth at Xylem. Today, I'm going to talk to you about our markets and make sure you understand the economic framework that we are assuming as we underpin that long-term plan. I'm going to talk to you about how we are looking at our water markets that we serve and what we think the outlook for those are over the next 5 years. And I'm going to give you a deep dive into the portfolio of Xylem, so you understand it a bit more thoroughly. And then I'm going to wrap up my section talking about how Xylem will drive growth in any market environment, with a few key initiatives. So let's turn to Slide 36 and take a look at our geographic profile. 72% of Xylem's revenue comes from Europe and the U.S., and 20% comes from the emerging markets. Our 5-year outlook for these served markets is as follows: We expect 1% to 3% growth from the developed markets; a modest recovery in the U.S., including a commercial construction rebound that we're just beginning to see start; a European recession that continues and political uncertainty in that market that slows growth in Europe through 2014; emerging markets will grow at 6% to 8% over the 5-year period, driven primarily by a build out of infrastructure. And just an example of this, is China's 12th 5-year plan where they're focus on putting $60 billion into upgrading their urban wastewater network, that's 14% more than the prior 5-year plan. Turning to Slide 37, we'll take a look at the served markets cut by our end-market exposure. As Gretchen said, Xylem's largest end-market exposure is industrial, that's our number one exposure. Public utilities is number two…

Welcome back, everybody. So what we're going to do now is take a quick break. We had scheduled it for 15 minutes, but in order to provide for a robust Q&A session at the end of the second half, we're going to shorten that up and ask that everybody come back to us here at 10:20, so we can get started with the second half of our presentation. And we'll allow the management team here to take a quick break, and we'll see you in about 10 minutes. [Break]

Okay. Welcome back, everyone. We're going to get started with the second half of our presentations here this morning. So with no further ado, let me please welcome to the stage Mike Kuchenbrod, our President of our Water Solutions Business.

Welcome. It's a great pleasure to be here today. And my name is Mike Kuchenbrod. I'm the President of Water Solutions. This includes our transport and treatment segments, and it is part of the Water Infrastructure segment. I'd like to show you what we're working on and how our business fits into the strategy and vision that Gretchen described. I'll take you through some strategic initiatives that we're focused on to give you a sense of where we see some of the best growth opportunities. I'll take you through a quick review of our dewatering business, which we've spoken about before, but it's an important topic and I think we should spend some more time on it today. And finally, I will wrap up with an overview of our focus and execution of operational excellence. So let's turn to Slide 50 and get started. Water Solutions participates in a 16 billion market with leading positions in the transport and treatment segments. Total revenue for the business in 2012 was $2.1 billion. We're different from our competitors in a number of areas, most importantly, our customer intimacy, footprint and proximity to the market and applications and engineering knowledge base. With over 40 direct sales companies, serving customers in more than 150 countries, there is no other water technology company in the market that match our sales and service capability. And there's no one else in the industry that has the breadth and experience in solving so many of our customer challenges. Please turn to Slide 51. Xylem is part -- is active in all parts of the water cycle. To help illustrate the Water Solutions business and our role in the water infrastructure network, I'd like to take a few minutes to ground you on some key application and technologies. Please…

Thanks, Mike. Good morning, everybody. It's a pleasure to be here. My name is Chris Mcintire and I'm going to talk to you about test or analytics, starting on Slide 71. I'll begin the discussion today with a description of analytics. This is a fantastic business that participates in an attractive and growing market. After the overview, I will move to a broader discussion about our technical and application capabilities. I'll share 2 specific examples of how we're helping customers with their measurement needs. These examples will help bring to life the deep application expertise and technology that we're bringing to bear on measurement challenges around the world. I'll also give you a glimpse of how our local experts are working directly with customers to put together solutions that meet their overall measurement needs. I'll then move to a discussion about growth, an important topic at Xylem. I'll cover geographic expansion, innovative offerings, acquisitions, and finally, operational excellence. I'll give you a quick look at our business and at how we're thinking about the future. Onto Slide 72. Our Analytics business today has reached nearly $300 million in revenue. For those of you that have been following the growth of Analytics, you'll be interested to hear that this represents a nearly 40% growth from 2011. Our Analytics business serves a $4 billion market, growing in the mid-single digits. This is a focused and attractive portion of the larger $6 billion analytical instrumentation market. We have a wide range of analytical instrumentation capability, focusing on both water quality and water quantity. This business has been built with a series of acquisitions over the past 10 years or so. This has provided us with several strong and well-known product brands: WTW, YSI and Aanderaa, our 3 great brand examples. The Analytics brands…

Thanks, Chris. Good morning, and thank you all for taking the time to be with us today. I started in this business when I was 18 years old, so I'm kind of the old dog on the team. I hate to admit it, but the numbers are the numbers, right? You guys can appreciate that, the numbers are the numbers. Over the past 30-plus years, I've seen a lot of change and a lot of progress in our industry. And I'm pleased to have the opportunity to share with you how we see and how I see the current dynamics in the Applied Water segment. So let's get started on Slide 84. Applied Water's strategy for profitable growth has 4 pillars: driving customer excellence, increasing our innovative offerings, expanding in emerging markets and delivering efficiency and productivity from our operations, 4 key points. Let's go to Slide 85. Applied Water Systems is centered in 3 large, attractive markets: building services, industrial water and irrigation. Inside of those, commercial building, HVAC and industrial water represent our strategic focus areas. We have a balanced geographic mix and focused investments to grow faster in the emerging markets. Our broad product technology and application expertise enable us to deliver superior solutions to our customers. Market-leading brands like Bell & Gossett, Goulds Water Technology, Lowara and FloJet, to name a few, coupled with our broad experience channels, position us to grow faster than the market. So let's talk about some of the market drivers, going to Slide 86. Macro drivers of urbanization and the growing middle class will be a catalyst for long-term growth, particularly in our target markets of commercial building services and industrial water. Water scarcity will demand smarter, more efficient solutions. We're rewarding those providers with system capabilities and application expertise. And…

Thanks, Ken. Good morning. I'm Mike Speetzen, Xylem's Chief Financial Officer, I'm pleased to have the opportunity this morning to talk to you a little bit about our financial performance, touch about our capital deployment strategy, how we're doing on our acquisitions, and then cover off on our projections through 2017. So with that, why don't we get started by turning to Slide #98. As Gretchen mentioned, with the acquisition of MultiTrode, we've revised our full year guidance solely for this acquisition. We've increased our sales by just under $10 million and have maintained our midpoint of $3.9 billion. Margins are negatively impacted by 10 basis points, and we've reduced earnings per share by $0.01 to reflect normal transaction, step-up and integration costs associated with these acquisitions. Lastly, let me take a minute to remind you of some of the margin dynamics we're facing in 2013 that we discussed on our earnings call. With the addition of MultiTrode, we now see an additional negative 10 basis points versus 2012 impact from acquisitions and foreign exchange. Essentially, we've added over $100 million worth of revenue with slightly negative margins, driven by transaction cost, integration and purchase accounting, which obviously has a negative impact on operating margin rates. The costs associated with our European structure place 30 basis points of pressure on margins, but again, is accretive to earnings per share. And as we discussed, the small amount of onetime spin cost remaining in 2013, which we've included in our guidance, coupled with headwind from pension discount rates, places a negative impact of 20 basis points on our margins. Our core margin expansion is 50-plus basis points and is really masked by some of these items. The core operating margin expansion is driven by our restructuring actions that were executed in 2012…

Hands up. So I think we're going to hand out some mics, I believe, and get started so we can make sure that folks on the line can also hear as well. So Phil, we've got several folks here.

Allan Glick with First Manhattan. If I start at the end and go back with Slide 110, I just want to be clear, when you lay out the targets, what are your assumptions, if any, for restructuring going forward because to be fair, if you restructure every year, the numbers aren't quite as concise as one would like to be. So when you say core margins expand, I'm not really sure what that means. So maybe you could talk to us in a straight-ahead fashion.

Yes. So let me just talk about our restructuring and realignment and our thought process on how we include that in terms of our projections and so forth. As you know, this year we're doing a significant realignment and restructuring action, $60 million to $70 million, so we separated that and pulled that out of our earnings. Going forward, our intention is typical operation activities around restructuring the business will be embedded in it, but something large, substantially, that's truly a realignment will be outside. We'll obviously talk about that, give everyone a clear guidance of it. But typical, typical activity that we'd be including to change your business and operations we would be doing. An example of that would be, in 2010 -- no, actually 2011.

2011.

When we were closing the year, we saw economic issues, we went ahead and took activities. We baked that into our business. It wasn't a standalone activity. But coming into a year where we're doing significant realignment is just not part of your base.

Yes, so let me just reiterate. We're not counting on any future restructuring, number one. Number two, we talk core in terms of the core part of the business and then if you do the math, in terms of where we are today going forward, you'll see that you don't get 50 to 75 on a linear fashion, mainly because of dilution associated with the acquisitions. So we've pumped the size of the acquisitions from what we talked last year when we said 1% to 2% of revenue. We're now saying 2% to 4%, and that creates just a little bit more dilution as you look forward in terms of transaction cost, purchase accounting, those types of things. That's all built...

But that's in the numbers?

That's in the numbers.

That in the numbers.

Yes. So again, everybody -- so baked in your numbers is not any, like 2 years from now, doing a restructuring to get to the $2.50 to $3.40? I mean, as far as...

Right.

Correct.

Right. The only thing that's built in is the benefits from the restructuring executed in '12 and '13.

This is Cliff Ransom. My question for Ken and then a quick follow-up. When you start talking about services, how do you structure or discipline yourself to keeping away from simple wrench turning? I just get nervous when people talk about the demographics of the engineering life because on that demographic, we're all either dying or retiring, because you've got the same problem within your own company in terms of talent and wrench turning is typically very low margin. So how do you decide what you want to go after as you try to deepen your penetration of the operations of these customers?

Sure. You said Ken, but that's really more of a question for Mike. In the AWS business, it's more of a replacement business than it is a repairing issue. So for Mike, the TotalCare initiative, I think, is what you're referring to.

And you're absolutely right that the whole goal of going to advanced services is enabling us to actually get more value because if you do a typical time and material type contract, and you're really just supplying the labor. Although that's valued for maybe a retrofit of pump, it's not really where we're going. If you think about going in and doing these audits in some of the examples that I've given, you actually bring value into optimization of the plant. You have follow-up maintenance contracts that go with that, which helps make sure that the plant runs at its peak performance. So those things are absolutely great enablers for us, not only to provide service that our customers value, but also some of the equipment upgrades that then are necessary to take place such that the plant operates at the right level. So that's where the value comes from, and that's where the service is actually a great vehicle to actually have the conversation with the customer about the problem that they're facing.

And just -- I would add, when we bought the PIMS Group, when you look at their model and how it's working, I mean, they make profit in what they're doing and it gets back to getting maintenance contracts, serving upfront, getting that return. And in that situation, they're seeing greater than 90% of reassignment of those maintenance contracts going forward. We've learned in terms of what do we need to do in regions where we are getting great return with our services capability. And in the U.S., just last year, Mike's business improved its profitability in the services applications by really putting a focus and a discipline around processes and services.

If I could, I just want to ask a follow-on, Gretchen, to the question that I asked you last week. It's kind of turning on its head. The Water business is, as you commented, highly fragmented. You're still highly silo-ed as an enterprise. You're working to break down those silos and integrate yourselves as you approach these verticals. But that's a big change. You gave us some color on that today, but for those who are most involved in that process, could you just add a little flesh to it? And then the last question related to that a little bit downstream is, it's one thing to have lots of sensors. How difficult will it be to take that installed base and turn them into control elements so that you can maximize the efficiency of a system as opposed to add one point in the pipe?

Cliff, all great questions. And let me just comment a little bit, and I'll ask my team to jump in, especially since some have come new to the Xylem team and through acquisitions and others who have seen the migration that we've been trying to drive throughout the organization. We were very separate businesses, and I can tell you, when I came to ITT in 2005, very silo-ed, very brand oriented and so forth. Still important. I want to make sure it's important everyone understands, that brand to the market is critically important. That's what our customers know. But as we've been able to break down the barriers and really share the expertise and the knowledge across the organization, it's helped us actually penetrate and be able to position ourselves differently than our competition with that customer. Now by no means are we going to be a company that everything's integrated into the future. The market's not going to move in that direction. But there are, clearly, water challenges that are interrelated and ultimately needs you to understand the different technologies, that expertise, and in many cases, bring them together to optimize your system solution. And I think you've got a highlight of some of that behind us as we went through that today. So I think that's just making us stronger as we go forward. Getting back to your question around the aftermarket, when you play in the aftermarket, now you can bring the opportunity of monitoring control into the market, and then you ultimately then can bring in new equipment because you know of the new opportunities that they're expanding. You can help bring what today is not a smart water industry. We can drive it to what I believe is a smart industry that ultimately now gets more proactive in solving its issues rather than reactive. So Chris, do you want to comment on the analytics prospect?

Yes, yes, good question. So selling analytics just by itself, it's all about not just having sensors because a sensor by itself doesn't provide information you can take action on. So we've always historically focused on systems that give our customers reliable information that they can decide on and take action. And before we had the connection with treatment businesses and deep application knowledge, we typically would rely on others to try and draw those monitoring and control links. And they don't have the expertise and the application. But by coming together with the treatment business and by coming together with the experts in Mike's business, we can take those folks that know how to do the treatment, they know how to do the analytics and can put together a real combined monitoring and control that can bring real value to the customer. And Mike, do you want to add to that?

Control would be [indiscernible] it's one thing to measure it, it's another thing [indiscernible] on the control [indiscernible]. Is that a fair statement to say?

In different applications. Again, I'd invite you to look at the Flygt Experior example. That is a control element that demonstrated where you actually have a controller that's looking at the application and then optimizing the pump to be able to make sure that it's doing the job at the right level. That is a control aspect. So we absolutely have that. I would suggest that some of these advanced process control that Chris talked about where you link the measurement of water quality and feed back that information into treatment optimization, that is the area that we're advancing into today. But we have had -- we have a sizable piece of our business that's in controls today around pump management.

What I thought was really interesting was Mike's speech in Slide 102 that shows the migration on the gross margin side because that, in it's essence, is a good progress report in terms of the value creation that's going on. And the 3 elements that you put in there, price portfolio and productivity, those drivers, I'd like to ask 3 questions and you can divide it up because that will tell us how sensitive it is in terms of what that migration and how much higher gross margin we can expect. So for Colin, on the price side of it, just think about the questions, I'm going to ask all 3, but for you, it's going to be the 1 to 2 percentage points of price realization, just what are the levers that you're pulling? How much of this is new product? How much of this is moving up the technology scale? So where is that 1 to 2? For, Ken, the Slide 91 on the reverse osmosis skid systems, really interesting. How much of Xylem content is there today? How much might it be down the road. As you move up the technology scale, that's really the sweet spot where you'll be leveraging the technology know-how, the systems integration and solving a solution as opposed to providing components. And then back to Mike Speetzen, 7 to 1 ERP, going from 7 to 1, seems almost too ambitious. So just tell us, are there diseconomies at all as you force some of the businesses like systems -- or service into an ERP system where it may not fit. But -- all right, so I apologize, but here we go, 3 different answers that get us to gross margin. Let's start with you, Colin.

So we can start with price. As I laid out in some of the materials I spoke about today, we have this initiative called customer excellence, and we've gotten $110 million of price over the last couple of years by driving it. While we've touched 80% of our sales force, I still think there's a lot more than just 20% to go. So in other words, we've rolled it out across 80% of the company, but driving it more deeply and embedding it into the way we act is certainly still an opportunity for us in customer excellence. I would target both strategic pricing and tactical pricing. There's -- we used to take our price lists from the previous year and multiply it times 1.03 to set next year's stock -- price for our products. We don't do that anymore. We use great data analysis to understand where are we differentiated, where can we get more than our fair share of price and where are we competitively challenged and we price our products lower, maybe, than what they were the previous year to drive volume. So it's a very data-driven analysis, and there's certainly room in that. I also think there's a lot of room in the behavior of our commercial leaders, making sure that they are pricing and eliminating leakage from the price waterfalls. So there's still some opportunity there. I think you mentioned one thing that I think is really relevant, and that is we're on a journey to improve our vitality index across the company. We are at approximately 15% now. We'll get to 25% or better over the 5-year period. And every time we launch a new product, we're very careful to launch a product that is significantly better than the previous product we had and better than the competition. And that gives us an opportunity to gain price. And so if you just do some simple math of taking our 15% vitality index to 25 and getting a significant price premium on each of those, that's a very large contributor to our price impact as we go forward.

Yes, Dean, on the RO skids, really there's 2 pieces to this. There's 2 pieces of our business. One is an RO package business that's based out of Dallas, Texas. And another piece is a tubular membrane business, PCI business in Poland. You may recall that earlier in the beginning -- middle of 2012, we combined the former RCW, Residential & Commercial Water, and flow control into one value center. And those 2 pieces resided in each piece. PCI was in flow control, and RO skid business was in RCW. And so we have now combined those groups as one. They do different things. The tubular membrane is a specific membrane technology that has a great value proposition in certain applications that we're focused on. The package systems business, there are a number of components in the RO skid business which have been commoditized. Right, so it isn't necessarily about producing all the individual components that go on in RO skid. It's about really applications. It's understanding where your portfolio in terms of the scope of what you produced and what applications are attractive in terms of the growth. So we're working with Mike's team, as well as with Chris's team in terms of industrial -- not just desal. I mean, there is still a lot of desal work going on. So your ability to come up with modular designs that you can produce sufficiently and to have very good control schemes that eke out a little bit better energy consumption because ultimately, those are expensive systems to provide, that's where a lot of the value creation is. And then in the consultative services, working with the customer in terms of the application. So it's -- in that piece, it's not about we're not in the standard RO membrane technology business today. I mean, that's not where we are. But it's about understanding the application and how to produce a cost-effective and energy-efficient system for the application. That's a relatively small piece of our business today but a big growth opportunity for us.

So the 7 to 1. It's a lot of work. Some of it we had to do coming out of the spin because we shared some systems with ITT. But we really stepped back and said, "We don't want to just get off a system and go to something without really having a strategy." So we laid out a pretty comprehensive roadmap. And what I'd say is we've got it in stages. So this is not an attempt to do some sort of a Big Bang. You heard Ken talk about we've done one ERP implementation that went live in January. Until we get that stabilized, we won't be on to the next one. We're going through the process right now of coming off of a shared general ledger system with ITT for some of our business. In the process of determining what we wanted to do, we decided to go with Oracle, mainly from the standpoint of we had another portion of the business that was already set up on that. So we really stood back and made sure that we were aligning with systems that we use today and use this opportunity in every staged fashion to be able to get our business up on the same system but also recognizing it's key to have that ability to talk within businesses that need to versus trying to force it where it doesn't make a lot of sense. It's part of our capital deployment. So as we look forward, Ken, as he looks at his roadmap, he's juggling the ERP implementations against investment in new products, facility rationalization and such. So...

Deane, I'd just add, I mean, we've brought on Nick, who's here with us today, as our CIO, to really think about what's our end state, where do we want to go. So as we need to upgrade certain businesses and plants and we're going in a direction that drives us to one solution ultimately rather than disparate solutions or things where it makes sense to be leveraged. We're not going to do it all overnight. It doesn't make sense. But ultimately, it drives us in a direction that we have governance around the organization, driving us where we can all get access to our information. We've got a lot of old legacy systems, which take a lot of folks that are retiring to keep them up and grade -- upgraded. And so the idea here is to get more modernized, think about the relationship and the interface with our customer first and then ultimately making sure that it's going to streamline the back end of our business so we can move more quickly but it's disciplined.

Just to pull it all together, do you have a 2017 gross margin target that you can talk about today?

I'd just say it's north of 40.

It's Ryan Connors with Janney Montgomery. One of the things that makes your business a little bit unique versus some of your peers is the prevalence of the rental business that you talked about it a little bit. And it's something, I think, that we struggle to understand because we don't run across it too often. Can you just talk a little bit about the capital needs of that business and the capital commitment and how it impacts the ROIC of that business relative to your manufacturing businesses? And any kind of capital commitments you see on the horizon in that pocket of the business?

Yes. So let me talk just a little bit about -- first of all, it was very different to us as well. And in recognizing that, we carve it off and look at it from a very different perspective. So we use some different measures in terms of how we look at the effectiveness of that business. Key indicator, for example, is asset utilization by geography so that we can determine where we want to invest and where we may need to redeploy assets to another region that may need them more. We spend time with Mike each month, looking at a set of measures around return on assets. The business is accretive to our ROIC. We're careful about how much money we do invest. It's hard to give you an exact number because there's a couple things that happen. One is you spend money refurbing the existing fleet or replacing equipment that actually gets sold coming off of rental. And then there's a portion that we have been investing over the past couple of years as we look to expand geographically. So we've talked about going into Australia, making some inroads in China and Latin America, as well as expanding our depot network within the U.S. So we fit all that in with the CapEx numbers that I talked about earlier in terms of about 2.5% to 3% of revenue and try and manage it in a very disciplined manner so that we're very careful about the asset utilization and making sure that we get the highest return off of that business.

I would just add to it, and that's what I tried to communicate earlier, which is that the utilization metric is really critical because it gives you a flavor for how you're utilizing that asset. The other thing I would say is I mentioned a European rental bank, because there's different types of mix of what customer demands are. In some cases, on the smaller end pumps, if they're not there that day, that second, you're not going to get it. So you have to have that very local and available, where others on the larger side, there's a little bit longer lead time because the project design and construction allows for that. So you can have a bank that you can use in a region rather than just in a local area. So we look at all of those things to make sure that we're optimizing that investment.

One example would be just with Sandy. I mean, we had equipment coming from west to be able to be brought here, to be able to help because we didn't have that number of pumps sitting around. But ultimately, we were able to redeploy and be able to help support in a situation where when you're monitoring the weather in that situation, you had a little bit of visibility.

I made a comment during the acquisition process. We look for key management talent that comes with the business to retain. One of the things that we got from Godwin was that capability to manage the asset base, something that we had not done a good job of within our existing dewatering business where we tended to have these pools all localized. Godwin had a very disciplined process for being able to quickly move assets. And that way, you didn't have to have as many, and you were efficiently able to move them where you needed them. We've now started putting that into our European business where we have more of the electrical submersible solutions. So that's a good example of how that's played to our benefit.

So just a quick question on margins. On this part of the thesis on Xylem's margin expansion, you demonstrated you were able to expand margins from '08 to '12. Essentially, organic growth was flat during that time period. If you just look at the revenue base, flat over that period. And I just don't understand your margin guidance looking forward because in a period of flat organic growth, you had 27% incremental margins. If you look forward to 2017, you're projecting 3% to 5% revenue growth. So higher organic revenue growth, but yet, your incremental margins are only 19%. So just help us understand exactly what's happening here with the incremental margins.

Yes, so there's a couple of dynamics. One is we're looking to step up the acquisitions on more of a recurring basis. And relative to the discussion we had about 1.5 years ago and what we're seeing in the environment relative to what we need to pay for the acquisitions, although they're still below the highs, they are ahead of where they were historically for us. So there's going to be a little bit of dilution coming from that piece. The other piece is we obviously are going to continue to expand, consistent with the message, I think, you heard this morning, around the geographic reach, as well as innovation. I mean, getting product vitality up to 25% or more percent requires us to continue to put money in, which essentially dilutes your incremental drop. A lot of the increase we had in R&D thus far really came as a result of some of the businesses we acquired and the structure that they had. As we look forward, we're actually going to be redeploying more of our own direct cash into that. And I would also say the selling channel. That's one of our biggest differentiators, and as we look to go more global than we are today, that means putting people on the ground in these different locations. And so that's a part of our cost base that I don't want to call it variable, but it's going to be more variable than, say, G&A cost as we look into the future.

I mean, I thought a lot of these investments you guys had already done when you were a part of ITT, and now you're going to enter a period of nice robust margin expansion. I mean, the average industrial company talks about 25%, 30%, maybe 35%, incremental margins, and here, it's just a lot lower. So I'm just trying to understand those dynamics a little better.

So I would just say, so in terms of the investment in the sales channel and so forth, we have made substantial investment across the emerging market and base facilities. But as you go and you bring analytics into it, you need a unique applications knowledge, sales team that's working with it. Now we won't have to build the infrastructure because we will leverage the footprint that we've got in that installed base and the IT systems and so forth that are already there. But you will have an investment to be out and able to continue to expand in terms of the market.

A couple of questions. One is there's a lot of change going on in the organization, sales force consolidation and facility consolidation, particularly in Europe where some of the Flygt and some of your strong brands reside. Can you talk a little bit about your ability to retain key talent as you're doing all these things? How are you getting people to move where you need them to move? And where are they going if you're losing them? And then the second thing is you're stepping up the acquisition pace. Can you talk about the competition for these acquisitions? Number one. And number two, your ability, if -- I guess it can be challenging, too, if you're doing lots of little acquisitions, can you do that? And if you're doing a few big ones, can you pull those off? And do you have an M&A team in place to do that?

Okay. Let me first talk a little bit about the change, the dynamics, the restructuring that we're doing. If you look at where we've been and where we've come over quite a few years, there's been a constant change in the organization. And it's part of our culture in terms of to stay competitive, to be out in front. You've got to continue to adapt and to be flexible and modify yourselves. And clearly, Europe, a wonderful location for us, strong position. We need to make sure we're maximizing the investment we've already made and be able to bring a unique value to our customer. And so we are making substantial changes, but our turnover rate is extremely, extremely low. I'd say the commitment and the excitement and the spirit that's in our organization is quite high. I've had a chance to be able to travel, be out to our fields and so forth, and there's high energy. Now you do in some cases, when you move someone's location and their job, you're going to lose some folks. But I would say the top talent we've got have been flexible and as adaptive as they can to be able to move with us, and we're not seeing that to be an issue at this point in time. Mike, you can probably comment on it more than anyone.

Yes, we're into this process, and I would say there's also the other side to it. With the change comes opportunity because some of the jobs on how you do business provide an opportunity for people to grow and expand their capabilities. So there's also the opportunity side that goes with that. But I think so far, for the people that we've reached out to in key roles relative to the -- and I'm specifically talking about the European structure, it's going well. People are excited about it, and they see the benefit that it can bring in terms of being able to represent Xylem to our customers in a more holistic way.

The way we approach Europe, too, is we've got to the top leaders in Europe and said, "We want you to be a part of it. We want you to help us make sure we design this correctly because we want you to be the leaders of the organization and help make sure we can execute it." So their engagement, I think, has been key and is ultimately helping us maintain, attract that talent and to be able to go forward. Now onto your second question which was around acquisitions and speeding up our acquisition strategy and so forth, how we've done that. We do have a robust acquisition team, and we've been focused on it. So I'll comment in 2 ways. First of all, when we first did the acquisition of Nova, which got us the start of our analytics platform, when we brought Chris in and his team, one of the things we wanted to do is we knew this is an area we wanted to grow through acquisitions. And so we invested in a team, not only that would do well in executing the business that we bought, but was prepared to be able to continue that strategy of acquisitions. So we brought on the right talent. So his team has been very key in terms of how we played this out. Under Colin, we've got a great team that is really looking at our strategic opportunities. And then within each of the business, we have folks that are really driving what are the candidates that are out there that would help position us strategically faster than organic investments, and we've got a robust pipeline. And we have a good team that's executing and so forth. So I feel good about our process, lots of bolt-on we've done for in the last 3 quarters. We've got a strong pipeline. But as we deploy that, we've got to make sure we got the right team and we will go at the pace with the right team and not make a mistake. It's too important. And our scorecard back here and our discipline, it's critically important to keep that at the right levels so that we get the right returns to our shareowners.

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David Rose with Wedbush Securities. About 1/3 of your growth is coming from some of your energy-efficient products. I mean, you've highlighted about $500 million in some of your new product introductions coming from energy efficiency. So with that said, maybe this is a 2-part question. But if you could give us some color on the impact of EU regulation on energy-efficient growth or growth in energy-efficient products in the EU. And given what appears to be an increasing likelihood of that regulation pass through here in the U.S. in a couple of years, what are your expectations? And maybe you can give us some color on your considerations of using your balance sheet to help fuel growth in that, particularly given the success in Jefferson Parish.

Okay. So let me just ask Ken. Why don't you talk about it a little bit more? I know you touched on it in terms of Hydraulic Institute, and his leadership there, but very active in terms of the activity here in the U.S.

Yes, so there's a couple of dynamics. So in the EU, there's kind of stages of legislation that's just rolling out. So the first couple of big ones hit in January 1, 2013. And they're in 2 spaces, they're in the circulator pump space where hydronic heating in Europe is prevalent. It's the predominant way both in small residences and in large building that heating happens. That's different than in U.S. So that's actually a much bigger market in Europe, and hence, there was a lot more energy at stake. And so the EU went first at essentially heating circulators. So that went into effect January 1 and at the primary energy efficiency level. They also then just expanded into a much broader water pump category. That's a wide range of pumps that go all the way up to -- from 1 to a couple of hundred horsepowers, so a pretty big range. And that also went into effect January 2013, but it was all only an initial step, a small efficiency standard, if you will, to give the industry some time to adapt. So the more stringent standard goes into effect on January 1, 2015. So the whole industry, depending on where your current state is, is investing to get their products there. We're already 100% compliant to the legislation and the regulations that are in place already, and we have a clear path. The global water platform was one example where we're not only doing that modularization to increase the simplicity and the productivity of the product lines but we're also redesigning the efficiencies to exceed those 2015 regulations. So I mean, ultimately, it's hard to put an exact number on it, but clearly, in Europe, it's the law. So I mean, if you don't have a circulator that hits that efficiency, you can't sell it. It's not a soft regulation. So those products sell for about double the price of the old ones. So you can kind of do the math on just what the revenue impact on the growth is going to be, even if the unit volume doesn't change, and that's going to transpire over the next 2 years. So we're playing in that market. That was why we bought Laing. They had that technology, and that's a key technology for us that we're now leveraging across other portfolios. The U.S. is going to take a little longer. I mean, the DOE -- I'm not going to make any editorial comments about the speed of government, but the reality is there are several more years before that legislation is actually in place in the U.S. But as I mentioned, manufacturers are running to get their products, and not everybody is going to have the wherewithal to do this. So I would say we already are put -- using a lot of our balance sheet leverage to take advantage of those opportunities over the next, call it, 3 to 7 years.

Okay. So let me just -- I'd just like to say a few comments. First of all, thank you. Thank you for your time, your attention. I know this morning was a lot of data and a lot of detail, but I hope what you walked away with is a couple of key points that I want to summarize. First of all, I'm confident on our course. We are evolving this company, and you can see it from some of the numbers from 2008 and directionally where we're headed. We come from a very strong core business. We've got unique global assets that are critically important when you look at the macro trends around the world, around the issues we all know around water, whether it's in the U.S., whether it's in Europe, whether it's ultimately in the emerging markets, which are the economies of the future. So we're positioned extremely, extremely well. We've also continued to strengthen that with the new product launches that we've talked about and advancing our strategic acquisition strategy, as demonstrated with the 4 new acquisitions that we've just announced over the last several months. And I'm really excited about being separated at this point in time. We've got that strong base, and last year, when we were faced with a tough economic situation, there's clearly uncertainty in the marketplace, we had operational strength. We stayed focused on what we needed to do, but we did it as well while we were investing in the long-term growth of this company because that's critically important. And we are committed and we continue to execute to make sure that we're improving our customer delivery and our focus with them. And I hope you saw that today, that our applications expertise is broad. And the more that we…

Ladies and gentlemen, that concludes the webcast portion of today's Investor and Analyst Day. For all of you who joined us here today at the New York Stock Exchange, we invite you to join us here for the next 1.5 hours or so. We'll be serving a passed lunch, and certainly, we'll be making our senior management team available to follow on with. I'd also like to take the time just to introduce some of our value center business leaders who are joining us, who will be...