Q3 2019 Earnings Call
Welcome to design, one third quarter 2019 earnings conference call. At this time, all participants have been placed on the listen only mode and the four will be open for questions. Following the presentation.
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I would now like turn call over time that Latino senior director of Investor Relations.
[noise]. Thank you Nicole good morning, everyone and welcome to Xylems third quarter earnings Conference call with me today, our Chief Executive Officer, Patrick Decker, and Chief Financial Officer, Mark Rakowski.
They will provide their perspective on Xylems third quarter 2019 result, [laughter]. Following our prepared remarks, we will address questions related to the information covered on the call.
Oh, that's what you. Please keep to one question and a follow up and then return to the Q.
As a reminder, this call and our webcast our company by a slide presentation available in the Investor section of our website at Www Dot xylem Dot com.
A replay of todays call will be available until midnight on November Thirtyth 29 team. Please note. The replay number is 805 858367 and the confirmation code is 8669179 I.
Additionally, the call will be available for playback via the investors section of our web site under the heading investor events.
Please turn to slide two.
We will make some forward looking statements on todays 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 ins items. Most recent annual report on Form 10-K and.
In subsequent reports filed with the FCC.
We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics for purposes of today's call. All references will be on an adjusted basis, unless otherwise indicated and non-GAAP financials have been reconciled for you and are included in the appendix section of the presentation now.
Now please turn to slide four and I will turn the call over to our CEO Patrick Decker.
As you've seen from our released this morning, we delivered a solid quarter earnings performance and continued margin expansion.
Year over year earnings per share growth, excluding FX impact was in line with their expectation and represented an attractive year on year increase.
Margin expansion was quite strong at the top end of our guidance, reflecting disciplined cost management productivity gains and pricing.
And free cash flow conversion was particularly strong in the quarter.
However, in our end markets, we saw softer conditions than anticipated and that's clearly reflected in the quarters revenue performance, which came in below expectations.
Utilities demand remains solid globally, and we saw good performance across the portfolio, which delivered organic revenue growth in the mid single digits as expected.
However, we also saw a quicker than expected softening in our industrial and commercial demand, reflecting some uncertainties in these markets.
That slowdown with both more sudden and deeper than expected pulling overall revenue growth below our expectations for the quarter.
We expect this softness will persist through Q4 as a tight labor market continues to push back project timings and uncertainty around some industrial markets impacts capex spend.
Therefore weaker near term market outlooks have caused us to lower our full year guidance.
Despite that moderation in industrial and commercial demand, we have nevertheless continue to make progress on both productivity and price.
And that operational discipline enabled us to deliver on earnings and bring in margins at the higher end of our guidance.
Exiting Q3, we had strong bedding pipelines and shippable backlog is beyond 2019.
So we continue to see solid growth and margin expansion potential through 2020 and into the long term.
Looking at our regional mix, we saw strong North American utilities performance.
And robust emerging market growth.
Our investments in emerging markets continue to bear fruit.
China also turned in a performance of double digit orders growth in the quarter, giving at year to date orders and revenue growth and the double digits.
Mark will take us into the segment detail shortly but I want to take a moment to provide an update on our a business, where we took a noncash impairment charge in the quarter.
Hey, I his recent commercial momentum has been quite robust.
Orders grew more than 80% and the quarter.
Organic revenue grew by double digits.
The size and incremental margin profile of this business continues to be extremely attractive and accretive design.
All of which has to say that our growth pieces for the business has not changed.
That said the revenue ramp we're now seeing has taken longer to accelerate than we originally anticipated.
As we continue to invest in the business orders to sales conversion has been slower than expected moving cash returns at the right something we discussed in detail last quarter.
That extended timing of cash returns required an impairment charge against goodwill in accordance with accounting guidelines.
However, while the early pace to revenue growth lagged expectations, the orders sales and backlog growth. We're now saying is strong evidence of utilities market embracing digital transformation at an increasing pace.
In India. For example, we're deploying A's applications together with pumping solutions sensor and measurement technologies and other xylem services working across the portfolio to deliver our largest digital transformation project in India to date.
Increasingly we're also seeing the benefit of integrating our expertise with our commercial teams to take these solutions and to customers.
In Kansas for example, AI AG collaborated with our de watering sales team to win a large robotic condition assessment project, which will provide data driven insights to reduce our customers capital investment requirements.
These are just too many examples of the kinds of deals were saying as the market embraces digital transformation.
Now with that I'll turn over to Mark who will review our results by segment on slide six.
Thanks, Patrick.
Water infrastructure organic revenue grew 1% in the quarter.
The decline in this business impacted segment growth by more than 200 basis points in the quarter.
The strength in orders and backlog was driven by project wins in our utilities business.
Q4, shippable backlogs are up 3%.
Over year, despite the order declines in our industrial markets.
Yeah.
Perfectly us water infrastructure business was up 1%.
This was below expectations with solid utilities growth being largely offset by the unexpected mid single digit declines we saw in our dewatering business.
The dewatering business was most significantly impacted by double digit decline in equipment sales to our distributors largely served the oil and gas mining and construction markets.
These declines were partially offset by mid single digit growth in our rental services business.
Based on feedback we're getting from our distributors in direct customers. We expect the softness in equipment sales into these industrial verticals to continue into the fourth quarter.
These recent trends are having a significant impact on the segments outlook for fourth quarter revenue growth in margins.
Our water infrastructure business in us utilities continue to perform well growing 4% in the quarter.
However, we are seeing some delays in projects due to labor shortages and inflation in some markets.
The segments emerging markets business continues to perform very well overall and grew orders by double digits.
Segment operating margins grew 40 basis points, just to 19.6% driven by our teams continued good work on price realization in productivity.
This more than offset the impact of inflation lower volumes in a weaker mix of higher margin dewatering revenues.
Please turn to slide so.
The applied water systems segment delivered 1% organic revenue and orders growth in the quarter.
Higher price realization more than offset lower volumes in these markets.
This also reduced the segment's total backlog, which declined 3% year over year.
Growth in this segment was led by continuing strength in emerging markets with double digit growth in China, India and Eastern Europe .
This was largely driven by strong growth in the commercial building services market.
The us was flat with softening demand in the short cycle portions of the segments industrial end markets.
And while we continue to see good pace in quoting activity in our commercial business, we experienced a number of project delays in the quarter largely due to construction labor shortages in several markets.
Which we see as a sign of improving demand over the medium term.
Residential had a good quarter with 4% growth overall led by 8% growth in the U.S.
Western European revenues declined 6% in the quarter as demand further softened in the commercial and residential markets.
Our teams did a nice job managing through tougher than anticipated market conditions and were able to expand margins 90 basis points in the quarter to 17%.
Now please turn to slide eight.
The measurement and control solution segment delivered 8% organic revenue growth in the quarter.
Total Mncs segment backlog grew 10%, giving us continued confidence in the segments outlooks from next year and beyond.
The mncs water business continued to be the primary growth driver for the segment.
Energy grew 3%.
And the test business grew low single digits.
Census, in particular had a strong quarter growing organic revenue, 10% led by double digit growth in its water business.
Partially moderated by lower growth in energy applications as we lap the large alone electric meter deployment.
Our teams have done an excellent work expanding our metrology business internationally, where the water business grew roughly 30% in the quarter.
We are clearly seen the benefits of leveraging the globals xylem network and this will be an increasing source revenue growth in the fourth quarter and beyond.
We're also pleased with the strong commercial momentum we saw during the quarter across our platform.
In addition to double digit revenue growth, we had a meaningful acceleration in the conversion of pipeline opportunities, resulting in year over year orders growth of more than 80%. While also replenishing the pipeline, which continued to grow strong double digits in the quarter.
For the segment overall.
Operating margins expanded 50 basis points to 10%, which is in line with our expectations.
Volume and price gains plus 340 basis points in productivity more than offset moderating inflation and growth investments.
Our cash balance grew to over $450 million.
In Q3.
During the quarter, we returned $44 million to our shareholders through dividends.
We invested $46 million in capex, reflecting the expected moderating spend in the second half of the year and tracking to our full year capex forecast of $235 million to $240 million.
Our working capital in third quarter increased 80 basis points year over year to 20.6%.
Reflecting both the impact of last year's fourth quarter inventory build which we will burn off in this year's fourth quarter as well as timing of receivables collections.
Free cash flow increased almost 60% year over year and free cash flow conversion in the quarter was 162% in.
Improving substantially over the prior year in quarter sequentially.
This was primarily driven by an improvement working capital levels due to better inventory management, lower capex spend and lower contributions to our pension plans.
We remain fully committed to meeting our target of 105% free cash flow conversion for the full year.
Please turn to slide 10, and Patrick will cover our 2019 end market outlook.
Thanks Mark.
Our backlogs are healthy, indicating steady underlying demand growth, but that is offset somewhat by project timing effects.
In industrial we now expect flattish growth versus last year down slightly from our previous low single digit expectations.
We foresee the deceleration we experienced in the third quarter persisting ended the fourth.
We're also still saying mixed economic conditions across geographies, including areas in western Europe and parts of emerging markets.
Our outlook for the commercial market is low to mid single digit growth.
The U.S. commercial market in particular is likely to continue showing moderation to the fourth quarter due to project delays caused by a tight labor market.
Please turn to slide 11, and will provide guidance for the remainder of 2019.
Despite study topline growth in utility sector, we are lowering our overall organic revenue guidance to between three and 4% for the full year.
Two factors are driving this change in outlook first the impact of lower than expected volumes and our high margin short cycle businesses, particularly in industrial and commercial.
And second the impact of project timing and our high margin AA digital solutions business.
For these reasons.
We are adjusting our operating margin expectations to a range of between 13.8 and 14%.
Moving on to earnings per share.
We're adjusting our outlook to a range of $3.01 to $3.03 representing year over year growth of between seven and 8% excluding FX translation.
Slide 12, typically includes a seasonal profile of revenues and earnings by quarter.
However, given the expected slowdown in our Q4 revenue growth outlook, we've seen a meaningful change this year in the historical profile of our quarterly revenue and earnings.
So we'll take a moment to walk through the changes in our revenue expectation from our last earnings call to our current outlook and the impact on our fourth quarter implied margins and EPS.
At the end of last quarter, we expected approximately 5% organic revenue growth roughly 180 basis points margin expansion and earnings per share of approximately $1.02.
Given significant changes in the market dynamic we saw in Q3 and continuing into Q4, we've moderated our expectations for revenue growth.
And therefore margin expansion and EPS as well.
And while we're entering the fourth quarter with healthy shippable backlog.
Based on current order trends, we expect the book and ship revenues for our short cycle businesses in the us to decline in the quarter.
Overall, we expect this will have a 300 basis point impact on organic revenue growth in a 90 basis point impact on margin applying our typical fourth quarter incremental margin rate of 35%.
Second we're being impacted by weaker margin mix as we expect to have lower revenues from our highest margin businesses, which deliver well above our average asylum incremental margins, particularly our dewatering rental and yes businesses.
This mix effect further impacts margins by about 60 basis points.
Together these changes have lowered our margin expectations to a range of 15.3% to 15.5%.
Representing a 20 to 40 basis point expansion versus the prior year.
While there is modest negative impact expected from foreign exchange headwind.
This is largely offset by lower interest expense, bringing our updated earnings per share expectations to a range of 80 to 90 cents for the fourth quarter.
These changes in our full year revenue outlook for the company are also broken down by segment as shown on the slot.
Just a couple of other items to note.
We're maintaining our full year estimated effective tax rate at 19%.
And we are adjusting our full year euro rate slightly downward to 111.
Our FX sensitivity table is located in the appendix.
Finally, we're increasing the full year estimate for restructuring and realignment costs to a range of $75 million to $85 million.
This reflects the cost of additional actions we took during the third quarter to optimize the census, European manufacturing and commercial operations to better support our customers and improved profitability.
Savings from these actions will begin to materialize in 2020 with a long term run rate benefit of $13 million.
Clearly the sudden and pronounced slowing in our industrial and commercial end markets has presented some near term challenges putting pressure on margins and our short cycle businesses.
And based on our current assessment, we expect some of that market uncertainty to continue through the balance of this year.
Their actions in the face of evolving market conditions enabled us to meet some of our most important commitments.
We have the advantage of an extremely strong portfolio of market, leading products and we built on that foundation with genuinely disruptive digital technologies, giving us momentum as the sector embraces digital transformation.
That's strong market position is particularly reflected in our utilities growth, which continued to the steady pace across both water infrastructure and measurement and control solutions.
And our investments in emerging markets are also delivering impressive growth and both orders and revenues.
All of which gives confidence in the medium and longer term growth profile of our business despite near term headwind.
We have a resilient business that will continue to expand margins at attractive rate.
And we will deliver strong cash generation alongside sustainable mid single digit growth over the long term.
We look forward to you joining us at our 2020 Investor day to hear more about our strategy, our long term targets and growth profile.
And I'm pleased to announce the date of our Investor day, we'll be in the spring on March 30, Onest when will gather in Atlanta, Georgia at our data analytics center of excellence.
And I look forward to hosting as many of you there as possible them.
With that operator, we're now happy to take questions.
Please now open for questions at this time, if you have a question or comment. Please press star one on your Touchtone phone if at any point your questions answered you may when loop yourself from the Q by pressing the pound key.
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Thank you.
Our first question is coming from the line of Deane Dray with RBC capital markets.
Thank you good morning, everyone.
Good morning.
Maybe just start with the making sure we've calibrated the which businesses are feeling most of the slowdown.
And then frankly, we're just seeing this everywhere across the industrials with.
Industrial commercial short cycle weakness.
Loading oil and gas so god win by our calculations, that's about 8% of total revenues and last calibrated there.
Total xylem oil and gas was about 5%. So what else would then godwin maybe it's the construction markets are soft there. So just are those are the right numbers and then what kinds of end markets and activities are you seeing.
Reduced in terms of demand here.
Yes, so god bless there'd be.
A little bit more little bit higher percentage, maybe maybe 10%.
And to your point.
During the oil and gas is.
It's not a big piece of it maybe.
For four or 5%, but what were what we saw in the quarter.
Was a big slowdown in sales into our distributors.
And they are heavily.
Oriented towards oil and gas, but also.
Mining construction, so that was really where we felt it the most rental was still.
Pretty solid up.
Mid single digits.
But as we work through the.
The first part here of October .
We have seen.
Downward trends in our rental business as well and it's a lot of it is we believe just a function of what is some slowing cap ex spends in the broader industrial space.
On the distributors and this is again comment with other industrial Levered companies are you distributors de stocking as near as you can tell how do you have a sense of the sell in versus sell through.
Yes, our sense Dean and speaking with the distributors is it's less of a destocking and it's really more of just holding back on further investment just given the uncertainty and the capex budget, they're selling into.
There there is still somewhat confident around bidding activity and things that are out there, but it's such a short cycle business for them that there has been there being conservative right now.
It's hard to its hard to tell how long that last through the quarter right. Now we're saying we assume it lasted Q4, we'll know more about how far goes into 2000 2020, I'd say over the next couple months, but I.
Early results in October our fairly consistent with what we saw the third quarter as well on the distributor side.
Got it Thats really helpful and then on the FAA.
The new orders.
At more than 80% that's impressive and it just seems so yes. The timing of this seems a little inconsistent that you're also taking an impairment and I know the impairment is more backward looking but the idea here is that on the impairment is that related to the pure technologies.
Give us a sense is that it was the timing cash was the factor, but some more color there would be helpful.
Yes, so Dan this is Patrick I would say it so it is largely pure.
And it is largely a function of.
US having had more aggressive assumptions around how quickly one we get some of the but some of the revenue synergy benefits of that integration.
It is also some of the other digital solutions that we brought onboard because the goodwill had to be looked at.
Across the entire platform.
And the reality is even though.
Even though we are seeing good momentum here. It was short of what our original assumptions were.
Even though we're now gaining the momentum that we had originally expected the timing was delayed of what was originally assumed.
And the and the deal financial some so following accounting guidelines, we were required to take an impairment in the quarter.
But I think it's important for people to read through and pick up on the comment you're making in that is what we're seeing in terms of the bidding activity at this point in time, we talked about 60% increase in the bidding pipeline last quarter. We saw continued growth the bidding pipeline. This past quarter and then it really is punctuated with the.
Nearly 85%.
Orders growth in the quarter and double digit revenue growth. So.
We.
Disappointing it took longer to get ramped up than we expected.
But we feel we're in a much stronger position now than we were even a quarter ago.
Great. Just last question for me just if we could get some more context or color within that 85% order growth I just want to make sure. Those are just like pilot programs, but is there some real substance around them and then related there was news that you all had some a successful non revenue water.
Project in China in Shanghai.
We learned about that at the Westech program.
Tradeshow and can you give us some color around that as well thanks, Yes yep.
Sure Dan So yes, the orders in Q.
Q3 of north of 80%.
Our not just a whole bunch pilots I mean this is substantive business that we're getting we still do pilots.
Many times utilities in order to get through their procurement processes, which three business by and oftentimes there aren't too other bids to be had given the new to the technology. They need to go through a pilot to be able to demonstrate proprietary nature of what we're doing and so.
The reality is we do see some of that pilot activity, but the large majority of the orders we had here we're actually in the pure piece of AI.
The second part of your question, which was.
The non revenue water when in China, We were now seeing a number of leads.
Tenders coming out where the utilities are especially the more thought leading utilities are not looking at this as well, let's do a leak detection project or let's do a metering project, they're looking at in saying, we don't necessarily know which of these levers are going to improve our non revenue water issue.
Most.
And so the reality is.
They are going out now and saying, let's do a tender to bring someone and to look at our pipeline overall, all and determine where are the losses coming from and therefore, how do we optimize that deployment. So.
This was the one specifically in China was driven predominately by Arpus Cindy.
Leak detection capabilities, but it pulls through other parts of the business.
And it was a non revenue water project that we're doing across several districts.
In Shanghai.
And so we're very encouraged by that because the more we get to these days as you can appreciate.
The more reference wins, we have for other utilities around the world and Thats what were seeing happening right now it just takes momentum.
Thank you.
Thank you.
Your next question comes from the line of Scott Davis with My list research.
Good morning, guys.
Good morning, Scott.
I imagine you guys and Dean would be a lot of funded a cocktail party talking about [laughter], we would not be both.
Right.
Anyways.
I had to pick on pick on them.
Yeah.
[laughter] looking to get back online.
[laughter] Republican to come down in my office, a quick math.
Yes I.
Pretty tall Guy anyways.
I want to take a step backwards because.
Not really in that Nitty gritty here, but the how much visibility do you guys have when you look out to like 2020 on.
On the.
On the China infrastructure spend.
I mean given the.
The five year planning cycles do they give you pretty good visibility on that kind of stuff or you walk into each.
Quarter, just kind of.
Rating for the phone to rain, how does that work.
Yes, great question Scott.
I think let me start in the top and say.
Roughly two thirds, a little more than two thirds of our business in China is in the utility sector.
And the remainder than commercial buildings and industrial for the most part.
I would say on.
The commercial and industrial piece that is a short cycle business not very much different from what we see in rest of world.
But for that little north of two thirds of our business in China.
It is very much long visibility.
It's long lead time.
Heavy capex.
It's very heavily oriented towards treatment.
And so we have good visibility into that bidding pipeline.
And our conversion and win rates, so and that very much is tied to the fact that this is a.
Central government led all kind of mandate around clean water and environmental I'll pick up and it is part of a kind of rolling five year plan. So that part I would say of our business. We've got some of the greatest visibility.
Going into 2020 and of course, we're also now saying the increased appetite to implement some of these.
Digital solutions that we're talking about around non revenue water, it's after which gives us greater confidence.
Okay, that's really helpful and at a fascinated by this whole labor shortage thing and.
It just seems so.
Strange as if thats cutting rates and everybody is starting to worry about the macro in such an extreme but it's a skilled labor non skilled labor is or some sort of dynamic thats changed meaningfully in the last year as it relates to people that can actually execute on these projects.
Yes, we're seeing it largely as non skilled labor.
Particularly in the.
In the construction areas and kind of short project businesses, where a lot of this also is where they often times rely on temporary labor.
And the temporary labor market has really tightened up at this point in time and I know you've been yesterday I think the fed chair talked about tightening labor markets.
Despite the discussion around softening or the lessing interest rates.
So we saw that on the commercial side.
Of the business.
We think its transitory because we still see strong quoting activity.
This is feedback we're getting from our channel partners, where we rely heavily on our indirect channel for this market in the US. It is they use specific issue that we're saying and what we're also seeing it show up Scott to a lesser extent, but we we talk about project delays and utilities, even though we've got strong growth. There we are seeing some.
Projects.
Being delayed through our engineering consulting firms whereby their initial budgetary quotes are coming in well above what the utilities have been expecting so they're pushing back on them to go back and reengineer the quote.
The projects will still go through we still see them the bidding pipeline, but we're also seeing that little bit of an air pocket.
People go back and have to re kind of redo their their budget assumptions on some of these projects due to higher labor costs.
That's amazing okay. Thanks for the color guys. Good luck to thank you. Thank you.
The next question comes from lining Nathan Jones.
Good morning, everyone.
When we won eight.
Good luck to follow up on the goodwill write down first in pure on I think you've explained yes pretty thoroughly that things haven't ramped up here as fast as you'd anticipated.
Fuel for about a year and a half now maybe you could comment.
On the changes in your view of where you end up in the long time, rather than whatever has happened to your initial time.
After year, and a half of having that and putting together these AA platform.
Expectations for the long time revenue potential out of this platform increase decrease.
Okay.
Yes, I would say Nate.
Very good question and appropriate when obviously.
Our our view over the long term and I would say now over the meeting over the near and medium term as we stand here today things remain unchanged from our original assumption it took us longer to get the ramp going.
And what was originally assumed.
And so if I look if I look at what parts what aspects of AI broadly because we really are looking now at its AI broadly rather than just pure and quite frankly, we're now looking at it in terms of.
The broader impact and pull through potential for xylem.
In terms of really deploying these digital solutions and new technologies, hence the reference to the win and China the win in India.
The win in Kansas is these are pull through opportunities for our four also the rest of the company I would say, we feel as good if not better about that potential and opportunity than we did at that time that we built this platform I would say what what have we learned.
I think what we've learned what I certainly a permanent learned.
Is that the conversion cycle for the utilities has simply been longer than we had originally anticipated.
In some cases as sales cycles been up to a year on the digital solutions because of the need to run pilots.
The the procurement process that I talked about earlier.
And just the fact that this is we're bringing disruptive solutions to a sector and.
What I've certainly learned as well.
Is that this was not going to be a straight line.
Disruptions never straight line. So it's taken longer than we had originally anticipated, but we feel very good about where we are down I'm very proud of what the team's doing.
What do utilities are well known for that pace of adoption of new technologies.
[laughter].
Maybe just talking a little bit more about this China project you said it was largely the Sanjay that won that project dissent days pretty as being a pretty small business.
You talked there about the ability to pull through technologies from the other parts of the business. Maybe you could you talk about whether it's just the specific project or more general.
Kind of what are the content.
Non revenue water project, one by the Sanjay can pull through for the rest of saw them.
Sure, Yes, it's a great question, so and in China. Just one example, we've got a number of these examples around around the world and what we're really talking about here is this something it just happens to be one of our number of digital solutions whereby in this case it happens to be.
Specific type of leak detection capability.
They were able to go when and if this but other examples as well.
India, Australia. We can example here in the us where they were able to go in and start off they were the ones that opened the door.
Where the customer looks at this as my non revenue water issue is I got a salt weeks.
But as the team goes in and assess the situation they see a bigger opportunity than just doing a leak detection opportunity. It can flow into the fact that there may be a metering.
Need a metering opportunity.
There may be a metering replacement opportunity that we pull through one of our other capabilities. It could be it can be a range of things that happen, it's no different than whenever.
Our amnet team goes in.
And our team applies that Amnet technology around stormwater overflow for combined Super overflows.
There's the project around doing getting the data and doing the analysis.
And that might be an ongoing SaaS contract, but there are just as many opportunities to then go in and say Hey, there's a problem in the treatment plant there is a problem in the.
The waste water pumping network backing them pull through our flight submersible waste water pumps into that so there are number of examples where one of our digital solutions are applied.
They get the signature wind, but they pull through.
The rest of the business and then other revenues not showing up in AI is showing up in our other our other segments.
Yes, one quick one on industrial we talked a lot about that drop in industrial demand.
Related a lot to de watering related to heavy industry oil and gas that kind of stuff. The light industrial business is supposed to be a lot most stable on a lot less subject to these kind of rapid fluctuations can you talk about.
The light industrial during Threeq, you and your outlook for light industrial in Fourq you.
Yes Nate.
We.
You're right with that that observation Nevertheless.
We did see decelerating order growth in our.
Lighter industrial applications lot of that being in our applied water.
Segment so.
Just like you know were seen in general Capex spend you know Oems are just a little bit more cautious in some other spend and were our order trends are are down we expected to be flattish maybe down low single digit.
Going into the fourth quarter it's.
And I think some of its just general.
Just general concerns and then managing their their operating budgets, yes, I mean, I think I think the our comments in the past I wouldn't want them to be interpreted as they every single quarter I think our view is over the course of any given year.
That that whole sector of light industrial typically is in that low single digit that's what we're saying certainly when the year seven down as we look ahead. The next year, we still expect that to be generally in line with with GDP growth.
But there can be a quarter here or there where you get some skittishness skittishness on the part of our distributors to hold back a little bit we also.
In the quarter and even through the second half, we had pretty tough comp.
Versus last year, I mean, we were up I think close to 9%.
Last year in the quarter, so that we didn't kind of called that out in our comments, but thats an important point to make here.
Okay. Thanks, very much for taking my questions I'll pass it on.
Okay. Thank you thanks Nate.
The next question comes from the line and John Walsh with credit Credit Suisse.
Hi, good morning.
Good morning.
Just wanted to kind to go back to.
Thinking about calibrating the forward look here and obviously you remain very confident here.
Single digit.
Organic look going forward.
This sounds cyclical right. Some of these pressures that you're feeling so there will be transitory and I think as Steve alluded to most companies are feeling this.
But consensus does have 5% I know its.
Early to kind of be putting point estimates down for next year, but how would you think given.
This kind of short cycle pressure feeling in the backlog what kind of visibility do you have to actually put a potential range out there for next year.
Sure John Sorry, Yes, I mean to your point, obviously, it's early for us to to really be giving any specific guide and we will give a full guide with their Q4 earnings report.
Early next year I would say, we look at it really in a few different dimensions.
First of all and I think to your point. Most importantly here, we feel good about the steady growth and utilities.
Most notably within our Mcs segment as well as that part of the water infrastructure business, where.
Shippable backlog in 2020 is up high single digits in both of those segments.
We think China, and India still have a lot of runway based upon bidding activity of backlog, we see there.
And we are saying our am I metering.
Project deployments ramping up in 2020.
And so and then lastly, the conversion of the AI funnel.
We expect to be ramping up in 2028 and beyond as well having said all that to your point, we do have a.
Somewhat of a cyclical downturn here right now in our commercial and industrial businesses.
And we're not going to try to.
Prognosticate here in terms of what how long that's going to ROE.
We will have a better feel for that I'm sure as we get through the end of Q4.
But that that uncertainty in my view, probably will linger through certainly the first half of the year end. The fact that we had some tough comps.
That we're going to be lapping I mean again first half of this year.
Industrial was up 3% not a lot to write home about but.
About where normally as but commercial was up 9% in the first half so we're going a little bit the tough comp in the first half.
The last thing I would say is but we continue to be confident in our margin expansion.
And we still have meaningful productivity opportunities out there we've talked before about the mix of Im CNS.
Coming to our favour now given the heavy water project roll out there and also the continued strong performance in water infrastructure from a margin standpoint.
We have the next question please.
Next question comes from the line of Brian Lee with Goldman Sachs.
Hey, guys. Good morning, Thanks for taking my question Ed Good morning.
Good morning, maybe too.
Jump off of that topic.
Patrick since you bring up the productivity at 400 basis points to so I think it was the best you've seen year to date and then on the flip side volume mix was maybe a bit worse than you've been tracking at so.
Two questions here can you maybe talk to the puts and takes here. This is the near term trend we should be expecting.
Going forward for these margin drivers and then second question just given the additional reset in operating margins here for fiscal 2019, I'm wondering if the.
The 100 basis point expansion view that you outlined earlier in the year for 2020 is that still intact.
I should be anticipating an update to that as well thanks guys.
Let me let me take the the first part of that question relative to some of what we saw in third quarter I mentioned in mind.
Prepared remarks.
The teams really did.
Nice job continuing to drive.
Productivity, we continue to fund.
Places to take out.
Cost in our manufacturing supply chain operations.
In in as you'll recall, we did take some restructuring actions as well in.
In the first part of this year, that's really started to ramp up.
Q3, we'd expect that.
To continue into into Q4 as well.
We've seen as we expected.
So moderating.
Inflation.
In the third quarter as well certainly in.
In our.
Mncs segment as expected as we lap some of those.
On shortages.
Higher costs, we had to deal with some of the.
Moves that we've made on.
Address Terence.
And also we saw a lower inflation.
And applied water for the for the third quarter as well and we'd expect that to continue into into the fourth quarter full so.
And on your question around.
Kind of looking at 2020, and the 100 basis point of margin expansion.
I would say.
Brian our view on that as we center today is that the productivity.
Pricing piece, all the levers that we have in our control remain intact.
I think the big the Big question in terms of what any kind of delta might be versus that is all going to come down to what we believe our volume growth profile is going to be in 2020 relative to what we've said before in terms of a mid single digit I'm not signaling anything there I'm simply saying that will be the one factor.
That will make sure we get comfortable with as we give a guide for 2020.
Okay, Great I appreciate the color thanks, guys.
Thank you Brian .
Your next question comes from the line for Rebar IDEXX with Jefferies.
Good morning.
Good morning.
Oh, you mean pretty positive and Alex for 2020 for Mcs and I guess could you comment on the visibility that you haven't to the project timing and is there any risk that some of these projects get pushed out.
Sure. So we've got we've got pretty good visibility into into the emptiness segment based upon our shippable backlog and 2020 beyond the typical shippable backlog in 2020 and beyond is is quite healthy.
I think we're looking at like 7% growth.
You know versus last year.
Which is that was coming out of the quarter.
We've got.
No. There is a portion of that business that is day to day replacement meters and so I wouldn't want anybody to think that everything's locked in the back of base. So all large projects, but there is a meaningful piece of that business that that definitely adds up it's probably about half of the revenue for the segment.
Is sitting in backlog right now and that's pretty solid for for any one of our business is going in.
I think secondly, what we're saying there is just again good.
Healthy conversion to am I.
And those projects have very good returns on them economically not just for us but for the utilities, that's why they make the investment.
I'd say, there's always a risk that depending upon what the broader economy was to do.
If we were to go into a recessionary environment than of course, there's always some risks there that project can move to the right.
But thats not historically been the case based upon the diligence that weve that we've done lastly, although again, it's only a it's right now it's only $120 million. So business again, we were seeing good ramp up now in AA.
Which is very helpful in terms of.
Helping spike that.
That growth rate for the segment.
And then the lastly, I would say is.
We've we've integrated.
The AI business and the census business now into our commercial teams.
And Europe , and emerging markets and Thats, given the team already a bump up in increasing bidding pipeline and visibility into the market in terms opportunities and so I do expect there to be opportunity there as well.
That's helpful and then it seemed like a growth in western Europe picked up slightly from last quarter.
Some of the macro trends so could you provide some color.
That market.
Yes, it did actually.
It was actually a little bit better than than we had seen in the first part of the year a lot of that was driven by.
Utilities and and it was.
We saw it relative strength.
Low single digits plus in some some parts of Europe , but it was it was fairly broad based.
In where we were wasn't as strong was.
On the industrial side, but that was in the quarter, probably one of the good surprises.
Yes.
And we expect can I know, we are expecting that too.
To continue into Q4.
I appreciate the color. Thank you.
Thank you.
The next question comes from the line up Alamo cannot with Raymond James.
Thanks for taking the question.
Given the industrial headwinds that we've been talking but for the past our I'm curious if the smaller more focus private players in your value chain, our presumably feeling this to a greater extent and if so.
This this perhaps create an opportunity for you guys to kind of re reaccelerate the M&A trend from several years ago.
That's good question I mean, I think where we remain disciplined on our approach to M&A.
We do have a healthy pipeline right now of.
Targets, we look at all different shapes and sizes.
We haven't seen a meaningful move as of yet in terms of valuation expectations.
But I do believe that could certainly change.
Depending upon how prolong the the industrial commercial thing could be.
But we'll play that buyer will remain disciplined.
And our priorities remain unchanged, we've talked about before we think we have a really good platform and utilities at this point in time, so anything we do there would be.
We're likely continue tuck ins and bolt ons of digital solutions.
And then the second.
Nine second our other biggest priority is building out a more robust industrial franchise and so we continue to look those opportunities and hopefully some things will come along here, but we're going to we're going to be disciplined.
And then follow up on on the balance sheet. Your net debt to cap went below 40% this quarter.
The lowest level since the since before that the census acquisition are you pretty happy with where leverage is at the moment.
Yes, we are I mean, we're you know.
We had.
Post the pure.
Acquisition gotten a little bit of ahead of our target, but we knew we'd be able to bring that down relatively quickly we have and it was just this quarter really where we've seen really strong cash flow that we were we were pleased with so we're now moving it into.
Our targeted range, which is two and a half to three times Moody's.
Okay understood appreciate it guys.
Thank you.
The next question comes from the line of George Teradata with Cowen.
Hey, guys, George Joe Hi, George you are here.
Hey.
Hey, George [laughter].
No.
So it's it's hard to give guidance I think we all appreciate that.
Seen a couple of cuts in a row, if you're looking at it just optically it looks like it's a bit reactionary rather than anticipatory. So I was wondering if you can kind of reconcile that with how you are actually learning the business internally like getting ahead of slowdown in terms of restructuring actions and and looking at cost structures and has that have you feel like you've.
In a little bit faster to react on that are rather than maybe the publicly discussed numbers that are out there.
Yes, I think so Joe it's a good it's a it's a good in fair point to make I mean, we do have we do still have a meaningful part of our business, which is roughly somewhere probably between 40, 45%.
Especially non utility that is short cycle business.
And so to your point that there are thing.
Obviously that we look at we don't just kind of weighing it and ticket gas off on outlooks and forecast. The point is things can change quickly within a quarter.
And that's what we saw in this quarter was things really change late in the quarter.
And it happened pretty suddenly.
And through distribution et cetera. So.
I would say.
We had not been anticipatory around that being a possibility than we would not have been able to pull the levers that we did to deliver on our EPS at high end of our margin.
Guidance in a range for the quarter.
Obviously, we're looking into Q4 and now even in 2020. There are other actions that we've taken both from a cost out but also just leaning in even harder on productivity.
And then otherwise anticipated.
Lastly, I would say, though we are it's important that everyone knows that we have been focused also on preserving investments.
And the key elements of our portfolio and we'll do so both in Q4 as well as going into 2020.
Thats an area that we do not want to be seen as being purely reactive.
To the near term.
We've talked about this as a team going into the beginning of this year relative to at some point. These the cycle will turn we need to be prepared for that and we you know there as every business has or opportunities for us to get more streamlined and leaner and we've been doing that throughout the course of year. So I think the Joe the.
Challenge that we've been facing here near the end of this last quarter and through Q4 is again really just getting as much visibility as possible into is this an air pocket up for commercial and industrial in the us for and.
How long does that pocket run.
Before you see some return.
Normalization because.
If it were not for this softness that we saw in this particular part of the business, which does tend to be more cyclical, but it does rebound.
We saw very solid and strong growth in the rest of our portfolio inline with what we've been talking about both in the near term and longer term.
Sure.
Thanks.
On a on that on the impairment look I get the port I think the portfolio that you are building there is interesting and its unique and it's almost by definition going to take a long time to kind of figure this out within market, but does it does.
Does this kind of development kind of.
Change the way you think about how much to pay for smaller bolt ons or maybe not maybe not real small bolt ons the ones that have like some half to them does it do you have to like recalibrate, what what the appropriate multiple and some of those businesses are as you go forward.
I think it's I think the most important thing Joe the way we look at it is I would say first of all I certainly wouldn't want to have any of these businesses in somebody else's hands.
They need to be was item okay.
And as we and I think that as we have integrated the ones that we now have over the course of the past number of months here because you know we've only had the non core business that we've only had those over the course of last year.
And so we've been integrating those as we speak we've learned we've learned a lot during that timeframe I've learned a lot by being out with a lot customers and understanding even better kind of how they think now that we have C suite level conversations because we have the credibility to go in and talk to customers at a broad enterprise level that.
Well, certainly inform and educate as we look at any future bolt on acquisitions, both from a valuation standpoint, but you know you're never going to be able to perfectly time.
An acquisition and perfectly layer the price on what you are paying.
You don't want to overpay of course.
And we'll always be discipline that regard.
So those are our learnings, but no. We're now we're not gun shy about going on and continue to build out in this portfolio not at all.
And just last one just on sneak one last one here.
As we get into like a slower kind of pocket in some of your cyclical businesses. Your infrastructure segment has done a really nice job on margin that's been definitely a bright spot.
What's the what's the potential there it's it's extended a lot over the last couple of years, you've had good volume to help drive that if you get into like a slower growth market how much how much more potential is in that segment.
Yeah listen that the there's there's always opportunity and it doesn't come just from.
Cost cutting in more productivity that's important.
We do that and we'll continue to do that.
No.
Month in month now I think the other part of it is also continue to innovate and bringing new.
Leading edge products solutions.
To the to the forms of Patrick's point earlier this whole notion of.
Opening the door with our.
Platform and digital solutions.
The pool in in bringing new higher end pumps and equipment in aftermarket is you know.
Theres a lot of potential there relative to the margin profile I think the I think the beyond just normal volume driven leverage and productivity that we get.
In any one of our businesses and certainly most notably in water infrastructure given.
Our strong market positions there in terms of leadership.
By definition drops through.
The strong incrementals when you've got growth, even if it's slower growth, but I think the really big deal here is on the innovation side, it's a new the new product development pipeline.
By definition.
As we continue to grow that pipeline I think right now as a company we're up to 25% in our vitality index, that's up from 22% in the first quarter up and so there's a continued ramp there that we're saying and that pipeline drops through it.
And our experience because products that not only grow faster or technology to grow faster than the average, but they bring with them higher margins than the average.
And so thats, a very meaningful part here of the story across each one of the three segments, including water infrastructure.
Great. Thanks, guys.
Thank you thanks, Joe.
The final question will come from the line Walter Liptak with Seaport Global.
Hi, Thanks for taking my question.
Good morning.
So my question is pretty.
Pretty quick and easy I, just wanted to drill into that.
Mncs business.
You mentioned that the visibility is good you've got nice backlogs.
But I wonder if you could delineate that between water gas and electric is it sounds like the water was strong this quarter and you've got some tough comps.
In some of the others wonder about the visibility for 2020 with that.
With that.
Funnel for gas and electric.
Yes, we had.
Well, we had some big wins.
You know a year.
Year to half ago that were.
Electric gas and.
No, they're starting to roll off in where we've seen good success recently, both domestically and internationally is in our water business. So.
Most of that is on the water side.
Now the good news that also we just launched a.
Branded product in the energy side as well. So we we expect that to get momentum in the market I think we just announced that a few days ago publicly.
So we still feel good about the electric and gas side of the market, but certainly we're very encouraged by the momentum were seeing on the water side with which brings with higher margins.
Okay got it alright, thank you very much.
Thank you.
No further questions I'll hand for back to Patrick Decker for closing remarks.
Great. Thank you. So thanks, everybody for your time and attention this morning, and patients and we ran a little bit long here. Thanks for your continued support interest and look forward to seeing many of you out in the field otherwise we'll be back in touch for Q4 earnings call. Thank you all.
Thank you. This does conclude today's solid third quarter earnings conference call. Please disconnect. Your lines at this time it have a wonderful day.