Xylem Q3 2026 Earnings Call Transcript
Xylem (NYSE:XYL) reported third-quarter financial results on Tuesday. The transcript from the company’s third-quarter earnings call has been provided below.
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Summary
Xylem’s revenue fell short of expectations due to slower project movement and cautious utility spending, but strong order performance and solid earnings highlight resilience.
The company announced plans to divest Applied Water International and Specialty Flow Control to focus on high-growth, high-margin markets, and will consolidate from four to three segments in 2027.
Xylem adjusted its full-year 2026 guidance, lowering revenue expectations to a 1% decline year-over-year, with organic revenue flat and EPS reduced to $5.40 to $5.45.
Despite near-term volatility, orders grew 10% year-over-year, driven by strong demand in water and gas metering, with a 13% increase in backlog to $5.5 billion.
Data center orders increased by over 200%, indicating strong growth potential, and the company highlighted strategic wins, including a significant project in the semiconductor sector.
Management expressed confidence in long-term growth, emphasizing ongoing transformation efforts, portfolio optimization, and a commitment to margin expansion.
The planned divestiture will improve Xylem’s financial profile, reducing exposure to lower-margin and slower-growth segments, and enabling reinvestment in more lucrative markets.
Full Transcript
OPERATOR
Welcome to Xylem’s third quarter 2026 results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded.
I would now like to turn the conference over to Mr. Gregory Giametti, Senior Vice President, Investor Relations and FP&A. Please go ahead.
Gregory Giametti (Senior Vice President, Investor Relations and FP&A)
Thank you, operator. Good morning everyone and welcome to Xylem’s third quarter 2026 earnings call. With me today are Chief Executive Officer Matthew Pine and Chief Financial Officer Andrea Vanderburg. They will provide their perspectives on Xylem’s third quarter results and discuss the fourth quarter and full year 2026 outlook. Following our prepared remarks, we will address questions related to the information covered on the call. I’ll ask that you please keep to one question and a follow up and then return to the queue.
As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website. A replay of today’s call will be available until midnight November 10th and will be available for playback via the Investors section of our website under the heading Investor Events. Please turn to slide 2. We will make some forward-looking statements on today’s call, including references to future events or developments that we anticipate will or may occur in the future. 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 its 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 events or results could differ materially from those anticipated.
Please turn to Slide 3. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics. For the purposes of today’s call, all references will be made on an organic and or adjusted basis unless otherwise indicated and non-GAAP financials have been reconciled for you and are included in the Appendix section of the presentation. Now please turn to slide four and I will turn the call over to our CEO Matthew Pine.
Matthew Pine (President and Chief Executive Officer)
Thank you Greg and good morning everyone. Thank you for joining us. Before I begin, I’d like to welcome Andrea to her role as CFO of Xylem. Her deep knowledge of our business provides important continuity as we continue to execute our strategy the third quarter reflected a mixed operating environment. Demand for water infrastructure and technology remained strong, which was evident in our order performance during the quarter. Across the markets we serve, the long term drivers of water investment remained firmly in place.
Near term conditions were more challenging with revenue coming in below our expectations as certain projects moved more slowly than anticipated and utility customer spending decisions took longer to materialize and amid a more cautious and deliberate spending environment. While those near term factors affected revenue, our healthy order performance and solid earnings results reflect the greater resilience we built into Xylem. Through the operational excellence and portfolio actions we’ve been driving, we’re better positioned to navigate short term variability while staying focused on long term growth and value creation.
Today, we’re taking another step in focusing Xylem on growth. This morning we’re announcing our intent to divest Applied Water International and Specialty Flow Control, which is our beverage and marine business, while also moving from four segments to three beginning in 2027. These actions are rooted in a simple objective. Continue applying our 80/20 principles to sharpen Xylem’s focus around the businesses and end markets with the strongest growth and margin potential.
The assets we intend to divest are non-core to our long term strategy and or operate in markets that are less aligned with where we see the greatest opportunities for growth. We believe exiting these businesses strengthens the portfolio and increases our ability to invest in higher growth higher margin markets that are shaping Xylem’s future. At the same time, moving to 3 segments reflects the company we’re becoming. The 4 segment structure served us well as we integrated Evoqua and executed the first phase of our transformation.
However, the new structure better aligns the company around how customers move water, treat water and measure and optimize water systems. It enables us to accelerate value creation, capture synergies across the portfolio and operate with greater speed and accountability. Together, these actions reflect our determination to proactively advance our transformation plan and position Xylem to accelerate growth while continuing to expand margins over time. Most importantly, we’re rotating our exposure to higher growth higher margin opportunities. Over the last few years, we’ve deliberately reshaped our portfolio towards markets with stronger underlying growth, more attractive economics and compelling long term demand drivers.
Businesses like Cornell, Roper, Water Fleet and Trios have historically grown at rates above our target growth rate and their additions expand our presence in attractive high growth industrial verticals. As we continue rotating the portfolio, proceeds from divestitures and other capital sources will provide additional capacity to execute against our capital allocation priorities and help to further increase our exposure to these higher growth higher margin markets.
We’re already seeing tangible evidence of that momentum. Amazon provides a strong example. What began with digital water replenishment efforts through Xylem View in Mexico is now being commercialized globally and more recently treatment solutions for data center infrastructure projects at scale. Today, the relationship engages multiple parts of our portfolio and demonstrates the value of our differentiated platform. And recently we secured a significant win with a new customer in one of the world’s leading semiconductor manufacturers providing advanced ultra pure water treatment technology for a critical U.S. fabrication facility.
This breakthrough win demonstrates our competitiveness in the high growth microelectronics sector. These are the types of opportunities that validate our strategy and reinforce our confidence in where we’re headed. The long term demand drivers for water remain intact. Our portfolio is becoming more focused. Our exposure to higher growth end markets continues to increase. Any actions we’re announcing today positions Xylem to accelerate organic growth while creating additional opportunities for margin expansion and value creation in the years ahead. With that, let me turn the call over to Andrea to discuss the quarter in more detail.
Andrea van der Berg (EVP and Chief Financial Officer)
Thanks Matthew. Please turn to Slide 5. As Matthew mentioned, revenue results fell short of our expectations largely due to lower MCS book and ship volume and timing of WSF capital projects. However, the strength of our operating model enabled us to deliver earnings in line with our guidelines. Despite some near term volatility, overall demand remains healthy. Orders were strong up 10% versus prior year driven by water and gas metering strength in MCS and data center orders in AW.
Our ending backlog grew 13% to $5.5 billion versus prior year sequentially up roughly 200 million and our book to bill for the quarter was above 1. Revenue was roughly flat to last year on an organic basis, largely driven by lower MCS metering, WI treatment and wss. Together these more than offset continued strength in North America transport and data center execution. Through productivity improvements in price we more than offset the impact of inflation, lower sales volumes and mix to deliver earnings in line with our guidance, the team’s operational execution delivered quarterly EBITDA margin of 23.9% up 70 basis points versus the prior year.
We also grew EPS 5% compared to last year to $1.44 excluding any benefit from Ievoteric refund year to date. Free cash flow was $444 million slightly below last year, mainly because of working capital and investments in outsourced water contracts. We expect working capital improvements in the fourth quarter. Net debt to adjusted EBITDA increased to 1.1 times driven by our opportunistic share repurchases in the quarter. Let’s turn to slide 6 across the segments. A common theme was healthy underlying demand with different revenue conversion dynamics by business for measurement and control solutions. Demand remains healthy supported by strong customer engagement. A book to bill of 1.16 and backlog of approximately 1.3 billion orders increased 30% in the quarter driven by large water and gas metering awards, with deployments largely scheduled for the second half of 2027 and into 2028.
While these orders reinforce our confidence in the long term growth outlook, we are seeing greater caution than shorter cycle demand. The affordability pressures that have weighed on electric metering are now extending into water metering purchases. Although these purchases are generally funded through utility operating budgets, replacement timing is more discretionary in mission critical repair and maintenance activity and water infrastructure. As utilities continue to manage inflation, interest rates and affordability concerns, some customers have slowed the pace of these purchases.
We continue to believe the issue is pace rather than demand. Customers remain committed to these investments and our strong value proposition, but are progressing more deliberately than prior periods. Revenue was down 5% on a tough compare with 11% growth last year driven by softness in electric metering and analytics. EBITDA margin of 24.5% was 270 basis points higher than the prior year driven by favorable productivity price and the divestiture of international metrology partially offset by inflation volume and mix in water infrastructure orders were down 1% a quarter driven by delays in treatment order intake and continued China headwinds, partly offset by strength in transport orders. In the Americas where OPEX funded demand remained healthy. Revenue was down 1% as growth in transport was more than offset by lower treatment revenue reflecting 80/20 walkaway actions and China headwinds.
EBITDA margin for water infrastructure of 26.2% increased 180 basis points with productivity and price more than offsetting inflation volume and investment in Applied water orders grew 15% and booked to bill was above 1 listed by data center wins and strength in America’s commercial business. Data center orders in Q3 were again up over 200%. Revenue grew 9% versus the prior year, primarily driven by strength in US commercial buildings including data centers.
EBITDA margin declined 40 basis points against the strong prior year quarter as inflation mix and growth investments more than offset productivity volume and price. Our planned divestiture of applied Water International and Specialty Flow Control will strengthen the financial profile and durability of Xylem as these two businesses represent roughly 9% of Xylem revenue on a run rate basis but less than 5% of company EBITDA and reduces our exposure from China from approximately 2% of Xylem revenue to 1%. This divestiture supports our continued strategic portfolio rotation towards margin accretive high growth industrial verticals In Water Solutions and Services. Demand remains healthy. Orders increased 6% in the quarter, led by continued strength in capital. Funnel activity remains strong across capital and services. Revenue declined 2% year over year. Certain large capital projects ramped more slowly than anticipated, and we’re comparing against a prior-year quarter that grew double digits on one-time service and capital work. We view this as an issue of timing rather than demand.
Segment EBITDA margin was 24.9%, down 140 basis points versus the prior year, driven by inflation, lower volume and mix, partially offset by price and productivity. Now let’s turn to Slide 7 for our updated full-year and fourth-quarter guidance. As we’ve discussed, underlying demand remains healthy, as reflected in our orders and backlog. In the near term, however, demand is converting to revenue more slowly than anticipated. In municipal markets, affordability pressures are leading some utilities to defer more discretionary purchases. We’ve stayed close with our utility customers and remain confident that federal funding is not a major factor.
In industrial markets, demand is solid, but some large capital projects are ramping more slowly than we anticipated. As a result, more of our backlog is now scheduled to ship in later periods. With that, we’re lowering our full-year revenue guidance to reflect lower revenue conversion in MCS and WSS. Based on our current visibility in both water and electric metering markets, MCS is expected to decline modestly on a sequential basis in the fourth quarter and stabilize at that level for the near term. In WSS, we expect a return to low-single-digit growth in the fourth quarter, an improvement from the third quarter but below our prior expectations, as large project timing continues to weigh on revenue.
Full-year reported revenue is now expected to be down roughly 1% year over year at $8.95 billion, with organic revenue roughly flat to last year versus prior guidance of 2% to 3% growth. Despite the top-line challenge, our disciplined execution is still expected to result in EBITDA margin of roughly 23.2%, or 100 basis points expansion versus the prior year, driven by productivity and price more than offsetting inflation as well as investments for growth.
As a result, we now expect full-year EPS of $5.40 to $5.45, compared to $5.55 to $5.70 previously. The reduction reflects lower volume as we continue to hold margin and remains within our original EPS guidance framework for the year. We now expect free cash flow margin of about 10.2% at the low end of our prior range, driven by higher interest costs from financing the Cornell and Roper acquisition and our opportunistic share repurchases. Now drilling down on the fourth quarter, we anticipate revenue will be down roughly 5% on a reported basis and down 1% to 2% organically. We expect fourth-quarter EBITDA margin to be roughly 24.5%, which is up 130 basis points, driven by price realization and productivity gains. We expect these results to yield fourth-quarter EPS of $1.39 to $1.44. While more of our backlog is now scheduled to ship in later periods, we exited the third quarter with strong demand indicators and remain confident in our competitive position.
With that, please turn to Slide 8, and I’ll turn the call back over to Matthew for closing comments.
Matthew Pine (President and Chief Executive Officer)
Thanks, Andrea. The long-term demand drivers for our business remain strong. Water challenges continue to intensify, infrastructure needs continue to grow, and customers remain focused on reliability, resilience and sustainability. While near-term spending decisions have become more cautious, our customers continue to tell us the same thing: the need to invest in water infrastructure, resilience and efficiency has not changed. At the same time, Xylem is a fundamentally stronger company than it was just a few short years ago.
We strengthened operations, sharpened the portfolio and built greater resilience across the business. The actions we’re announcing today represent the next step in that journey. They further focus Xylem on the businesses, technologies and end markets where we see the strongest opportunities for growth and value creation. We remain confident in our strategy, confident in our positioning and confident in our ability to create long-term value as these opportunities continue to unfold. With that, let’s open up the call for your questions.
OPERATOR
We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you’re using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Mike Halloran with Baird. Please go ahead.
Mike Halloran (Analyst at Baird)
Good morning, everyone.
Matthew Pine (President and Chief Executive Officer)
Hey, good morning, Mike.
Mike Halloran (Analyst at Baird)
Hey, thanks and welcome back, Andrea. So a couple questions here. First, maybe help just drill in more with the dichotomy you’re seeing between what was good order patterns, the more broad-based commentary of decent underlying strength with some of the air pockets you’re seeing in the short term in terms of whether it’s conversion timing or just some of the softness in utility spend. Given some of the inflation and spend challenges, how does that play out as we work into next year?
Are we going to be seeing some softness emerge in the front half versus back half? When does this type of thing normalize as far as you’re concerned, and just kind of any context on the contrast between those two points that you’ve been making.
Andrea van der Berg (EVP and Chief Financial Officer)
Thanks, Mike. As you mentioned, we had really strong orders in Q3, and that was primarily driven by MCS as well as data centers and Applied Water. Overall, though, because of the timing that we’re seeing on MCS orders, especially in the book-to-bill portion of the metering business that tends to be more discretionary. Although we won significant projects in Q3 that drove that orders growth, those projects are slated for the end of 2027 going into 2028 as well.
With WSS we saw great demand. We had a strong funnel, 6% orders growth in WSS, and WSS drove the biggest portion of that $200 million of sequential backlog growth. However, WSS tends to be lumpier, and some of those projects were booked at the end of Q3, and we still have a strong funnel going into Q4. So, in general, it’s about timing of when those WSS capital projects support growth going into next year. I’ll hand it over to Matthew to give a broader view of revenue going into 2027.
Matthew Pine (President and Chief Executive Officer)
Thanks for the question, Mike. So yeah, just elevating into thinking about 27 from a revenue perspective, I’d frame revenue into two buckets: the areas where we have strong visibility to growth, and I would say the other areas where timing is the main variable. On the growth side, we continue to see momentum in AI-related infrastructure and data center orders, still relatively small but growing quickly, supported by a stronger growth profile in Applied Water than we’ve historically described.
So you can think about that in 27 as being Applied Water historically above where we’ve typically been. Also, we feel really good about Water Infrastructure. Transport remains very durable given the break-fix nature of the business. And in Treatment we’re lapping much of the 80/20 headwind in China from this year, and that really disproportionately affected 2026. The second bucket, as we think about 2027, where the watch item is and remains variable, is primarily in MCS and WSS, as Andrea was talking about in Q4. In MCS we have strong order activity; projects were scheduled for the back half of 27 and into 28, but the shorter-cycle water metering business remains a little softer. In WSS, the funnel and orders are strong. The pace of large project conversion will really determine the growth cadence. We have a nice step up from Q3 to Q4, and we expect that momentum to carry into 27 as we exit Q4 of this year.
So, in general, I’d say we like the underlying setup for 27, but we’re going to give you a more precise framework when we provide guidance in February.
Mike Halloran (Analyst at Baird)
Thanks for that. And then maybe just some thoughts on where you are in terms of the portfolio journey from here. Obviously a couple non-core divestitures. Resegmenting the resegmentation actually makes a lot of sense. But let’s break that into two buckets. One, how much more larger-scale divestiture opportunity do you see from here? And two, when you think about the more run-rate 80/20 revenue work that you’ve done, the two points of headwind this year, how does that second bucket then translate on a forward basis?
Are we towards the end of the journey on either of those two different buckets? Maybe just kind of help with the thought process from here?
Matthew Pine (President and Chief Executive Officer)
Yeah, maybe on the first. Just at a high level, we continue to evaluate the portfolio to make sure it aligns with our long-term strategy and the needs of our customers. And I would say at the moment we’re focused on the divestitures we announced this morning around Applied Water International, especially Flow Control. But it’s something that we obviously look at pretty consistently. Obviously we look at that with the board and we’ll continue to do that as good hygiene.
In terms of 80/20, maybe I’ll just elevate and talk about the broader transformation of Xylem first and then get a little bit more double click into the details. But 80/20 is really part of a broader transformation of Xylem. Phase one has really been about executing over the past three and a half years on improving our operating model. And I’ve talked a lot about that’s very comprehensive. That’s our culture, our processes, systems and structure.
And maybe just a couple of things I’d like to point out that are I think really good testament to our success there is. I’ll start with safety because we always start with safety and quality. Our safety injury frequency rate is down 34%, very significant and approaching world class. Our on-time performance is 700 basis points of improvement. Our days of inventory outstanding has improved by 22%. Our margins are up 600 and our SKU count is down 40%.
So 80/20 is a part of a broader operating system, but it’s not all that we do to execute on our transformation. Now, we’ll obviously continue to do that, but we’re really focused on phase two and three of our journey, and that’s about building the growth engine of the company and it’s about optimizing our portfolio, and you can see that in the actions that we announced today. As far as 80/20 goes specifically, it’s well embedded into the functions, the segments and divisions of our company. Now going into year four, that’s led centrally by Tom Pettit, our Chief Operations Officer.
And we plan to be at our peak walkaway this year at 2%, and into 27 we see it as probably 50 to no more than 100 basis points of headwind. And obviously we’ll continue to see margin improvement from that.
Mike Halloran (Analyst at Baird)
Thank you. Appreciate it.
Matthew Pine (President and Chief Executive Officer)
Thanks, Mike.
OPERATOR
The next question comes from Andy Kaplowitz with Citigroup. Please go ahead.
Andy Kaplowitz (Analyst at Citigroup)
Good morning, everyone.
Matthew Pine (President and Chief Executive Officer)
Morning, Andy.
Andy Kaplowitz (Analyst at Citigroup)
Andrea, congrats on the role. Maybe just back to MCS and how to think about as you go into 27. I think, Andrea, you mentioned a lot of MCS projects should burn later in 27. That’s fine, but obviously, as you talked about, you have a pretty big backlog. So if we break down water versus electric metering, any more color you can give on the respective end markets and when you might see that book-and-ship start to re-accelerate? Is it some of this maybe election uncertainty?
How do you think about all that?
Andrea van der Berg (EVP and Chief Financial Officer)
Yeah, thanks, Andy. So as we mentioned, we had really strong orders in MCS, up 30%, but the backlog is down year over year. But when you peel that back, water metering within our backlog is up by 13% and it sequentially increased as well. So we’re seeing really good strength in our water metering business. But the book-and-bill portion of that business has been softer, and it’s for projects that are more later-dated at the end of 2027 into 2028. So we’ll continue to monitor the book-and-ship portion of the business and how those projects, whether they accelerate earlier or are deferred later. Which is why we said overall it’s strong demand, but it’s pushing out, and to look to MCS revenue as sequentially around Q3 and Q4 levels going into the first half of next year. And then it will all be about whether those projects stay on track and the book-and-ship business recovers and accelerates from there.
Andy Kaplowitz (Analyst at Citigroup)
That’s helpful. And then Matt, Andrea, maybe a similar question on WSS. I know you’ve mentioned delays, but obviously a lot of that business seems to be well positioned given the markets it serves. So why are you seeing these delays, and what’s the unlock to sort of get these larger projects going to go forward? Is it rates? I mean, what’s going on in these industrial markets? I think you should see acceleration at some point here.
Andrea van der Berg (EVP and Chief Financial Officer)
Thanks, Andy. So we are seeing benefits from the industrial cycle. It shows up first in our pipeline and then orders and then later in revenue. Our WSS business has a portion of capital projects that tend to be lumpier. The majority, as I mentioned, of our sequential backlog improvement was within WSS. It’s just all about whether those orders get converted into revenue, as well as some of the later pushouts of some of these projects in Q3 also impact Q4, which is why we previously guided WSS high single digits in Q4 and now that will be low single digits because of the timing of these larger capital projects.
But overall we’re still seeing very strong demand. As Matthew mentioned, we highlighted two large customer projects, and we expect WSS over the long term or in the short to medium term to be at a mid-single-digit growth rate.
Andy Kaplowitz (Analyst at Citigroup)
Helpful, thank you.
OPERATOR
The next question comes from Joe Giordano with TD Cowen. Please go ahead.
Joe Giordano (Analyst at TD Cowen)
Hey guys, good morning.
Matthew Pine (President and Chief Executive Officer)
Hey, good morning, Joe.
Joe Giordano (Analyst at TD Cowen)
Maybe a start on just the re-segmentation. So we’ve had a bunch, you know, we’ve had some moves in the past. I just want to understand, like, from a customer standpoint versus like a Xylem internal standpoint, because I felt like moving the rental, like the dewatering stuff, into WSS was to keep that whole segment kind of run on this service rental-type basis. And now bringing in, like, the treatment stuff, you know, which is more capital sales, seems a little bit against that.
And I’m thinking, like, from a utility standpoint you were probably buying Flygt pumps and then treatment stuff, and now you’re buying it from two different segments. And does it, like, complicate it in some ways as well, even though it streamlines down to three segments from four?
Matthew Pine (President and Chief Executive Officer)
No, I think it’s a natural evolution, Joe, of what we’ve been working on. We were highly matrixed before and you’d have a lot of finger-pointing and not a lot of accountability into, like I said in my prepared remarks, four segments, 16 divisions, with much more accountability. And that’s worked well for us as we integrated Evoqua. And we did, to your point, make the dewatering business integrate into WSS. That will not change. So really taking a step back too, when we looked at that transformation, 80% of our customers buy from one division and so 20% buy from multiple divisions, but a lot of them don’t even know it. So when you think about water infrastructure, transport and treatment are very different. You’ve got mechanical, kind of electromechanical pumping, and then you’ve got biological treatment. And those are very different customers within a utility. And sometimes they’re not even the same utility in a market.
So we have a process, when we do have overlap, where we do have internal lead sharing. We built an enterprise selling team over the past two years that also works at kind of an enterprise level, calling on these types of customers when we can have a more holistic, solution-driven conversation. But that’s really the 20 of our business, if you kind of put it in 80/20 terms. The new structure really just better aligns the company on how customers move water, treat water, measure water, optimize water systems. For me, it’s about bringing together shared technologies, end markets, and enables us to unlock greater value across the portfolio and operate with greater speed and accountability and a sharper focus on growth. And maybe just a couple of examples as I wrap this up: as we pivot to more industrial exposure, we do see a lot of overlap in WSS and WI today and within WI and Applied Water.
And a good maybe example of this, it’s evidenced in the Cornell Roper deal. I’d walk into meetings and we would have two and sometimes three segment presidents in the meeting. And as we look at our pipeline, we are cultivating targets where there’s multiple segments involved. And by aligning this way, it’s just going to make us much more efficient as we execute on our portfolio and get better focus. And the second thing I would say is there are significant R&D synergies when you think about a treatment portfolio and a transport flow portfolio where we align pumping and treatment into discrete segments. And there are operating synergies as well. For example, our castings — a lot of that is outsourced in Applied Water today — by bringing flow together in our pumping business, we think there’s a lot of insource opportunities to give us more economies of scale.
And so, you know, the last thing which is a benefit from this as well is eliminating the WI segment support cost. So there’s a lot of, I would say, outweighing — very positive — than any of the negative of moving this way. And our customers actually will be, you know, much more benefited by this structure.
Joe Giordano (Analyst at TD Cowen)
Matthew, you mentioned you’re excited about the former Water Infrastructure growth into 2027. Orders look like they’re going to be flat to down this year, so that kind of surprises me. Like what? Historically, normally, like, orders kind of at that rate this year, it kind of means growth pressure next year. And then, Andrea, if you could just comment on the margin profile of the stuff you’re booking into MCS now versus what you’re currently putting up in margins for that segment.
Thanks, guys.
Matthew Pine (President and Chief Executive Officer)
Yeah, no problem. I mean, in terms of Water Infrastructure, transport remains very healthy. I mean, you know, I talked about 80/20 walk-away in China. That’s been a big drag on some of the orders. We lapped that in Q4, and, you know, I have meetings with the treatment team and looking at our backlog, you know, coming into Q4, we feel really confident that we can get WI to mid-single-digit growth, but even treatment into potentially mid- to high-single digits as we exit the year.
So I think there’s really good momentum. There have been some delays in terms of those projects maybe being pushed out four, six, eight months. Some of that has to do with how the utilities are bidding this project, kind of contractor-manager-at-risk, which is kind of making them go a little bit slower. But in general we see momentum there as we exit the year.
Andrea van der Berg (EVP and Chief Financial Officer)
And Joe, on the MCS margin profile, one of the biggest drivers of the margin profile that will benefit MCS is on the international metrology divestiture. And then also, as I mentioned on water projects, the water metering backlog was up sequentially and it’s up year over year. So we continue to see strength in water metering. It’s just that book-and-ship business in the near-term mix will be the biggest driver or variable for our 2027 margin because of the strong incrementals in water.
But again, we have strength in our backlog year over year and sequentially within MCS and the water metering business.
Joe Giordano (Analyst at TD Cowen)
Thank you.
Andrea van der Berg (EVP and Chief Financial Officer)
Thank you.
OPERATOR
The next question comes from Nathan Jones with Stifel. Please go ahead.
Nathan Jones (Analyst at Stifel)
Good morning everyone.
Matthew Pine (President and Chief Executive Officer)
Hey, good morning, Nathan.
Nathan Jones (Analyst at Stifel)
I guess I’ll do the data center questions. I think you talked about 3Q revenue or 3Q orders being up 200% year over year. I think, Matthew, you’ve talked about exiting the year at 2% of revenue from data centers. Can you just talk about, I guess, what the expected growth there is in 2027? Can this add a point of growth, a couple points of growth to the 2027 outlook?
Matthew Pine (President and Chief Executive Officer)
Yeah, maybe just at a high level. I mean we’re definitely excited about the opportunity. We’re staying disciplined in terms of how we’re investing. We’re trying to invest behind demand versus way in front of it. So we’re not building a ton of capacity ahead of what we see, but we are adding capacity, and that’s going to have a little impact on margins in the short term, but normalizing back to kind of our standard margins for the company. As you said, the data center orders are up 200% for Applied Water again in the quarter, and we’re seeing broader opportunities across the entire portfolio, especially with our expanding relationship with Amazon there that we mentioned in the prepared remarks. We do, to your point, expect data centers to exit at 2% of Xylem revenue on a run-rate basis. And we clearly see it as an attractive growth opportunity in 2027. I think we’ll be able to size that better in February.
But just as I was making my comments around our 2027 revenue just a moment ago, you know, Applied Water is definitely going to be at a much higher growth rate than we’ve been signaling in the past, and that business is benefited by the data centers.
Nathan Jones (Analyst at Stifel)
Follow-up on data centers. It appears to me that a bigger opportunity over time would be around recycling, reuse of water, and potentially build-own-operate projects at data centers. Are you at a point where you’re having discussions with customers about things like that? And can you talk about any of the opportunities over what I would imagine would be a few years? You could go retrofit existing data centers that are liquid-cooled.
Matthew Pine (President and Chief Executive Officer)
Just any thoughts you’ve got around that? Yeah, I mean at a high level there’s not a lot of water consumption at the data center itself — the direct usage — especially as a lot of those are being converted to air-cooled chillers. And so that’s not really a huge benefit. Now there are opportunities that we’ve seen and we’re taking advantage of where a data center can’t get municipal water because, for whatever reason — could be location, it could be that the municipal water doesn’t give them a permit because they expect to use too much water — but we would take surface water into the data center and treat that.
That’s more an exception than the rule. Really, where we’re seeing the benefit of, I’d say, the broader AI ecosystem buildout is on semiconductor chip fabs, and I mentioned we’ve had a few wins here recently with some new customers in that area. And the one that is on the horizon — it’s probably not 2027, but for sure it’s going to be 2028, 2029, and 2030 — is power. Power is where the most water is used in the AI ecosystem. And we’re positioned very well there from the legacy Evoqua business, especially on nuclear.
And so as those projects come online both in Europe and the U.S., we’re well positioned to take advantage of that growth. Thanks for the questions.
OPERATOR
The next question comes from William Gripen with Barclays. Please go ahead.
William Gripen (Analyst at Barclays)
Excellent. Thank you for the time and the opportunity. Just wanted to dig in here a bit more on Andrea, I think you mentioned affordability concerns. What product segments, I guess within that context, do you really consider or sort of see as being more discretionary? And then you did reference funding in your prepared remarks. As we look into next year, what are you seeing in terms of the overall funding picture and what have you been hearing from your municipal customers?
Matthew Pine (President and Chief Executive Officer)
Yeah, thanks for the question. I’ll take that. So I would say in general, let me just elevate at a high level. I would say that municipal demand remains fundamentally healthy and there’s obviously all of the secular drivers that are driving that. I would say at the same time, though, we are seeing caution in some areas on muni spending. I wouldn’t characterize it as a broad-based slowdown per se, but I do have several conversations with CEOs over the course of each quarter.
In my recent conversations with utility CEOs here in the U.S., I would say that they are more cautious about the general economy than they were a quarter or two quarters ago. And they’re seeing increases in construction costs, energy costs, financing costs, along with a little bit of spillover from energy, of pushback on customer rate increases in some areas. I wouldn’t say it’s holistic, and that is leading to deferred spending on things that are not immediately operational in need.
And for us, that really shows up mainly in metering, both the short-cycle replacement nature of the metering that we do, as well as some project pushouts where utilities have flexibility on timing. I would say treatment demand remains really strong. But as I mentioned earlier to Joe, projects are taking just a little bit longer, in some cases due to contractor availability—they’re tied up on AI jobs, for example—or they’re rescoping them due to inflation or, I mentioned before, they’re bidding them as contractor manager at risk, which takes more time.
The last thing I would wrap up on—there’s been some commentary that I’d like to get out in front of here—I think it’s important to keep in context that the Xylem U.S. utility capex exposure is less than 10% of our revenue, and the majority of our utility exposure is repair and replace demand, and that can’t be deferred. So you really see that show up in our transport orders and our transport business. So that’s a little bit of a state of the muni business in the U.S. as we see it.
William Gripen (Analyst at Barclays)
Great. Appreciate that color, and just wanted to ask my follow-up here on if you could provide a bit more color on the customer mix and exposure for the two divested, or the two businesses that you announced planned divestiture for today, and could you sort of scope or quantify to what extent those could be margin-accretive divestments?
Andrea van der Berg (EVP and Chief Financial Officer)
Thanks, Will. Overall, the planned divestiture will improve our portfolio’s mix, resilience, growth, and margin profile, while again sharpening our focus on higher growth and more attractive verticals as part of our portfolio rotation. So as we highlighted, these two businesses represent 9% of Xylem revenue but less than 5% of Xylem EBITDA. From a revenue growth profile, they are negative this year with our forward expectation that they’ll be well below our target framework.
It also reduces our exposure to China. This year China is 2% of Xylem revenue and after the divestiture, China will be 1% of revenue. And from an EBITDA margin perspective, these two businesses are dilutive to EBITDA margin, while Applied Water Americas’ margin is accretive to Xylem overall margin.
William Gripen (Analyst at Barclays)
Very helpful. Thanks very much. That’s all for me.
OPERATOR
Thank you. The next question comes from Steve Volkmann with Jefferies. Please go ahead. Steve, your line may be muted.
Steve Volkmann (Analyst at Jefferies)
Yes, it was. Thank you. So I just want to follow up on that last question. Are there also some opportunities—sort of stranded costs—for these two businesses that you might be able to get at over time, and what might that look like?
Andrea van der Berg (EVP and Chief Financial Officer)
No, great question. And as a reminder as well, we’ll be closing the Cornell Roper acquisition in Q4 too, which will be adding additional revenue and that’s accretive to growth and margin as well. And then we continue on our transformation, so we will still continue to have benefits from structural cost actions as 80:20 continues to be embedded in our operating model.
Steve Volkmann (Analyst at Jefferies)
Okay, great. And then Matthew, I think you mentioned this in your prepared remarks around having capital to deploy, but I’m curious how you’re thinking about replacing the EBITDA that’s lost from these divestitures. Do you already have stuff in the pipeline? Are you going to be looking for something and you’ll maybe just take your time on that, or maybe you buy back some stock in the meantime? Just curious how you’re thinking about that kind of EBITDA impact as you divest these things.
Matthew Pine (President and Chief Executive Officer)
Yeah, maybe just elevate to our priorities in terms of capital deployment. The first is going to be organic investment. Then, to your point on M&A and looking from a bolt-on perspective, looking to move that more towards high-growth verticals. We’re going to grow dividend in line with earnings, and then at the end we’re going to use what’s left for opportunistic buybacks. And so, after—to Andrea’s point—we’re going to close on Cornell Roper here by the end of the year, and by then we’ll be managing about one and a half to two times the leverage. And from a proceeds perspective, we’ll take the proceeds from Applied Water, especially flow control divestitures, and it’ll give us some more capacity to execute against the healthy pipeline, which will allow us to accelerate the strategic rotation of our portfolio. So those proceeds are not going to come into play until the end of ’27, beginning of ’28.
So we have time to, A, work on the business—to your first question—and then we’ve got time to plan and continue to execute against our healthy pipeline on acquisitions.
Steve Volkmann (Analyst at Jefferies)
Super, thanks. I’ll pass it on.
OPERATOR
Thank you. This concludes our question and answer session. I would like to turn the conference back over to Matthew Pine for any closing remarks.
Matthew Pine (President and Chief Executive Officer)
We’ll wrap it up there. Thanks for your questions today and thanks to everybody who joined on the call. A lot of our colleagues joined these calls, and just want to say to our colleagues, really appreciate all you’re doing to transform Xylem and make it a best-in-class company. As always, we appreciate your interest in Xylem. All the very best.
OPERATOR
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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