Q4 2019 Earnings Call
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I would not just trying to call over to Mr., Matt Latino senior director of Investor Relations.
[music]. Thank you Lisa good morning, everyone and welcome to Xylems fourth quarter and full year 2019 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 fourth quarter and full year, 2019 result, and discuss the full year outlook for 2020.
Following our prepared remarks, we will address questions related to the information covered on the call Oh, Let's say you. Please keep to one question and a follow up.
And then returned to the Q.
Reminder, this call and our webcast our accompanied by a slide presentation available in the Investor section of our website at Www Dot xylem Dot com.
A replay of today's call will be available until midnight March seven. Please note. The replay number is 805.
<unk> 58367, and the confirmation code is for 880 738.
Additionally, the call will be available for playback via the investors section of our web site under the heading investor about.
Please turn to slide two.
[music], 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 in his items. Most recent annual report on form 10-K, and subsequent reports filed with the FCC. 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 three.
We have provided you with a summary of our key performance metrics, including both GAAP 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 please turn to slide four and I will turn the call over to our C O Patrick Decker.
Thanks, Matt and good morning, everyone.
Let me start with some reflections on 2019 school, we're results and our progressed as a company.
Then I'll turn it over to Mark for additional detail on the fourth quarter.
Well around back to offer our 2020 outlook before taking questions.
Focusing first on 2019 in the first half we delivered solid growth mid single digits or better.
Across our segments in end markets.
But the year presented a dynamic market environment in second half conditions were clearly more challenging.
I was pleased with the agility of our teams and adapting to those changing conditions and we were able to deliver full year organic revenue growth almost 4%.
[laughter] solid performances and utilities.
And then our U.S. in emerging markets offset some of the second half softness in industrial and commercial end markets.
Our full year margin expansion was 20 basis points and we closed 2019 with an operating margin of 13.9%.
Earnings per share were up 5% year over year end up 9%, excluding the effects of foreign.
In exchange.
The fourth quarter unfold as much as we foresaw and our October earnings call and the teams agility and discipline deliberate overperformance on cash with free cash flow conversion of 124% against the target of 105% driven by significant working capital improvements.
That kind of.
Solid operational execution was also essential to delivering our earnings commitment in the quarter.
Because we focused on managing the things we can control while also maintaining our investment for growth, we're well positioned for 2020 and beyond.
We have good visibility of our pipeline of business and we've built strong.
Fundamentals over the last few years that give us confidence about continuing to deliver significant value creation from near term and long term growth margin expansion and cash generation.
So let's focus on those fundamentals for a moment.
We're a very different company today than we were just a few years ago.
We laid out our key.
It is to lift the growth profile of the company you back at our original Investor day in 2015.
At the time, the company with delivering low single digit growth.
Our emerging markets contributed roughly $750 million a total revenue.
Our vitality index, which is the proportion of sales comprised the.
Products launched in the last five years stood at just 18%.
And we weren't yet in the metrology or digital solutions businesses at all.
So now five years on.
Emerging markets are now well over $1 billion, with China going more than 50% and India more than doubling over that timeframe.
We've also please dial them at the cutting edge of innovation.
Our investments have brought many of the industry, leading technologies into our portfolio and the mncs business exposes us to market segments with higher growth rates.
Our vitality index has risen from 18% to 25%.
The digital transformation of.
Water networks, which wasn't till recently a fragmented proposition is now one executable reality for our customers.
Hey, I, a double digit orders growth in 2019 shows the customer enthusiasm and demand.
Job in 2020 is now to deliver on that reality and lead the sector in helping customers.
First caps to latent value and their networks.
Our annual revenue is now five in the quarter billion dollars and we have set a consistent pace of mid single digit organic growth over the last three years.
Of course, our emphasis on growth would be a double edged sword. If we had alluded margins along the way, but we've done the work to become more.
More profitable as we invested to ensure sustainable growth and margin expansion.
We clearly have more work to do here margin expansion continues to be one of our top priorities.
But we have so far deliberate approximately 250 basis points of EBITDA expansion in the last five years, even as we invested to reach into new geographies.
And new product segments.
And we've been able to deliver an average 13% compound annual growth in es over the last five years.
Significantly improved versus the previous for years.
EBITDA has increased by 65% over the same period.
As we digest the large deals at the front end.
New growth and as Capex shifts to aftermarket and recurring revenue streams and the next several years, we do expect the margin profile of our gross to become even more attractive.
At the same time, we bought focusing record to operational execution developing the capability I mentioned, a moment ago to deliver favorable bottomline.
Becomes even an unfavorable market conditions.
Just one example of that is there increased discipline and cash generation.
We've delivered average free cash flow conversion of 108% over the last five years.
Largely by driving down working capital from 23% to 17.5%.
I expect.
Just operational execution to continue being a key capability for us.
Any reflection of what we've been building over the last few years would be incomplete without considering sustainability, which is at the center of dialogues business strategy.
Not that long ago, our sustainability goals were sincere and ambitious but they were.
Certainly about reducing our own environmental footprint.
Today, we're equally focused on the sustainability outcomes, we create with our customers and in the communities in which they operate.
Because of the positive impact of our products and solutions. This is a much bigger opportunity.
So we don't aggressive industry, leading commitments into our.
Dan ability strategy targeting the downstream impact of the solutions we provide.
This is a far more meaningful approach to sustainability and one we believe is a clear differentiator.
The fundamentals, we built and the trajectory we've established give us a balanced view towards 2020 and beyond.
We're cautious in the face of near term uncertainty, but we're also well grounded and able to deliver sustained growth.
We do see continued softness in some of our short cycle revenues in the first half.
The second half, we expect that to moderate in parallel with an increasingly solid position in our backlog.
We expect to be delivering.
Mid single digit growth in the back half of the error and enter 2021.
Well talk about that forward you shortly including some more detailed guidance on 2020.
I'll review the drivers of our 2019 full results is on slide five.
Im happy to address any of that in more detail in the latter part of the call during Q1 day.
But now I want to turn over to Mark to provide a deeper level of detail on how our segments ended the quarter.
Thanks, Patrick.
Revenue growth was flat in the fourth quarter as the market softness we began to experience in third quarter persisted.
And slightly worse than we expected.
Topline growth.
Needs to be affected by weakness in the shorter cycle industrial market.
As well as some softness related to timing of sales in the commercial end market.
Organic orders in the quarter also came in saw down 6% versus the prior year.
We did see some deceleration of order rates in the.
Quarter, although it is worth noting that we were lapping a 10% organic orders growth rate in the fourth quarter of 2018.
The soft orders intake at the ended the year certainly influences our view on top line growth for the first half of 2020.
As we look.
Net revenue performance across the end markets, we saw strength in utilities continue.
Up 4% in the quarter with growth reflected across most major geographies.
Industrial end markets were down 3%.
Weaker than expected and primarily impacted by the same short cycle.
Next we experienced at the end of third quarter.
Our commercial end market was down 5% with declines across most major geographies and the residential end market was down 2%, which was slightly better than expected.
Well cover end market dynamics in more detail as we move.
For the segment discussion.
Operating margin was 15% down 10 basis points versus the prior year.
Also review operating margin performance by segment in a moment.
But as we look across the businesses.
Weaker than expected volumes in.
So mix.
Particularly from the double digit declines in our high margin dewatering business negatively impacted the quarters margin performance compared to our expectations.
Well I'm disappointed in our revenue growth and margin performance in the quarter I am pleased with the teams operational execution.
And cost discipline to deliver strong cash flow and meet our commitment on earnings per share of 89 cents.
Please turn to slide seven and I'll review, our segment performance for the quarter.
Water infrastructure orders in the fourth quarter were down 8% versus last year.
Driven by declines in our de watering business as well as timing on large project wins.
Total shippable backlog in the segment exiting 2019 is up 7%.
Backlog shippable within 2020 is down 1%.
Well.
Shippable backlog in 2021 and beyond is up double digits.
Reflecting the near term softness expected in the first half of 2020, along with a strong backlog a large projects in hand to be delivered beginning in 2021.
Water infrastructure.
Revenue grew 1% organically in the quarter.
As the 11% decline in our North American dewatering business, largely offset mid single digit growth in the rest of the segment.
Well, we had expected the dewatering business to be down in the quarter.
Rental revenues in North America.
Slide 17%.
This was softer than expected.
Due to a sharp decline in rentals to oil and gas customers.
As well as lower year over year rentals related to storm events.
We expect this cycle to persist at least through the first half year.
Operating margin for the segment remained flat versus last year at 20.7% in the quarter.
Significant savings from net productivity and cost reductions were offset by volume declines in the negative mix impact from our North American dewatering business.
The segment delivered.
70 basis points of margin expansion for the full year ending at 18.2%.
This reflects continued gains across the year in price realization in productivity more than offsetting the second half volume declines and weaker revenue.
Thanks.
Please turn to slide.
Slide eight.
Applied water revenue declined 2% in the quarter.
By lower sales in commercial building services as well as modest declines in residential.
Segment orders and backlog were each down 1% in the fourth quarter.
Shippable backlog within 2020 is down 4% versus last year.
Both of these indicators are pointing to what we expect to be a softer first half of 2020 for segment revenues.
From an end market perspective commercial declined.
5% Mcwhorter with tough compares driven by the timing of prior year shipments related to price increases for tariffs in the U.S.
As well some slowing demand in western Europe.
Residential was down low single digits quarter.
Driven by economic softness in Europe.
US residential market was a bright spot up 6% in the fourth quarter and up 10% for the full year driven by modest share gains in some improvement in housing market activity.
Operating margin declined 60 basis points in the quarter to 16.6%.
Volume declines in the commercial business geographic mix and overall inflation, we're not fully offset by strong productivity.
And price realization in the quarter.
Despite the challenging fourth quarter for the year.
The team was able to deliver 50 basis points of margin.
The expansion.
Mid market headwinds in tariff impacts by driving 250 basis points of price realization in 400 basis points productivity across the business.
Now, let's turn to slide nine and I'll cover mncs.
I think control solutions orders declined 7% organically in the quarter.
Which primarily reflected a tough compare to 18% orders growth in the prior year.
Which included a large middle east metrology order and the timing of large North American energy orders.
Revenue increased 2%.
Driven by mid single digit growth in census, and partially offset by modest weakness in the analytics business in project timing.
Segment backlog exiting 2019 is up 8%.
Shippable backlog in 2020 are down 4%, reflecting the impact of the timing of large project deployments with most of the decline in the first half of the year.
However, shippable backlog for 2021 and beyond our up double digits, providing confidence on revenue growth momentum in the.
A back half of 2020.
Into 2021.
Census revenues in the quarter grew 4% driven by growth in water and energy metrology deployments in emerging markets, while well lapping a tough compare a 13% revenue growth last year.
Advanced infrastructure analytics revenues declined 3% in the quarter.
With several project push outs.
Quarters were also down in the quarter, although it's worth noting that this is coming to a third quarter with nearly 85% organic orders growth.
Full year.
There's revenue and backlog were up double digits.
We expect to continue to see relatively lumpy revenue in orders growth on a quarterly basis as we scale. This project driven business.
Segment, EBITDA margins in the quarter or up 80 basis points to 18.
0.1%.
Segment operating margin increased 20 basis points to 7.7%.
Net productivity benefits in price realization, partially offset by weaker revenue mix.
From a full year perspective.
EBITDA.
Margins declined 100 basis points to 18.2% and operating margins declined 90 basis points to 8.5%.
Unfavorable mix and the impact of strategic investments ahead of a slower than expected ramp of digital solutions revenues were partially offset by 390 basis points productivity.
I'd.
Volume leverage and 80 basis points of price realization.
Now, let's turn to slide 10 for an overview of cash flows in the Companys financial position.
We closed the quarter with a cash balance or $724 million.
We invested 51 million.
In dollars and Capex in the quarter and returned $43 million to shareholders through dividends.
Working capital also improved significantly versus 2018, indeed at 17.5% sales.
This is 150 basis point improvement from last.
Year, driven by the teams focus on operational efficiency significant reduction in inventories.
And solid improvements in accounts receivable collections in payables.
Our cash conversion cycle improved by five days in 2019.
With a strong second half push.
Which enabled us to grow free cash flow, 75% for the full year and delivered free cash flow conversion of 124%.
Lastly, we also announced annual dividend increase of 8%, representing our ninth consecutive annual dividend increase.
Please turn to slide 11, and Patrick will cover for 2020 outlook.
Thanks Mark.
Given the slower revenue growth and mixed outcome in the second half of 2019, we took an extremely close look at the forward profile of our business based on what we saw as we exited the year.
One of the lessons in 2019 is reminder of how.
Much the short cycle business still impacts our revenues and margins.
So we're being appropriately attentive to uncertainty in short cycle market conditions as we guide for 2020.
We're also taking into account the revenue profile of our highest growth businesses, including treatment census, and AA and our two fastest growing emerging markets, India and China.
Because these businesses deliver a higher proportion of large capex intensive projects weve been careful to account for timing effects in our guidance.
Several of you have heard me say that growth rarely happens in a straight line. This year is going to provide good evidence of that it's very much a story at two halves.
In the first half we see.
After down organic growth and utilities. This is primarily due to tough year over year comparisons you may recall U.S. utilities was up mid teens and the same half last year and we're also lapping several large projects in the same period.
And industrial end markets the music conditions experienced in the second half of two that 2019 are expected to.
Constrain our short cycle book and ship business at least through the second quarter.
Although we anticipate a discontinued softness as we exited the year. Since then events in China have further tempered our short term outlook.
The impact of the krona virus has for the time being essentially halted deliveries within China, which is our second largest and fastest.
Just growing market and it slowing trade in Asia more generally.
As of today, our best view that the first quarter impact of the krona virus to the company is likely to be approximately one to two points of revenue in the quarter and three to four cents of EPS.
It's obviously a dynamic situation and we are monitoring it very closely.
In light of US first half challenges, we're being cautious and further managing cost down in 2020 on top of realizing savings from the restructuring actions we took in 2019.
Those actions combined with the operational discipline, we demonstrated in the second half will enable us to maintain our investments for growth through this period of market.
Headwinds.
We see a return to momentum in the second half and into 2021.
And utilities, we have clear visibility of significant growth from deals in hand, and the second half of the year, including a half dozen large census, amite deployments.
We also expect double digit growth in the second half of the year.
Both China, and India, driven by project deployments.
And based on the information, we're receiving from our customers and distributors, we foresee a moderate recovery in industrial and commercial end markets and a return to modest revenue growth in the second half.
For good measure the third and fourth quarter will also be lapping the soft second half we.
Just experienced getting both quarters the opportunity to build on favorable year on year comparisons.
In short and the second half of 2020, we anticipate returning to mid single digit growth overall.
Now please turn to slide 12.
For the full year, we anticipate utilities will end 2000.
With low single digit organic growth benefiting from recovery in the second half the year as us opex spending normalizes to healthy levels and smart meter deployments continue to ramp up.
Industrial is expected to come in flattish despite modest recovery in the second half.
And we anticipate the first half softness in commercial will be largely.
Offset in the second half and the market to be up low single digits for the year.
For xylem overall, we foresee a combined picture a full year 2020 organic revenue growth and the low single digits.
And we expect to exit 2020 with momentum and increased visibility of committed revenues given the strong backlog position heading into two.
2021.
It's a dynamic environment. So we will continue to manage through elements of uncertainty by focusing on the things we can influence.
Effectively controlling our costs and driving productivity. So we can continue to invest to ensure sustainable growth over the long term.
We are fortunate to be well positioned with a balanced global portfolio.
So that we expect to continue delivering healthy cash generation through the year.
By the end of year, we foresee having approximately $1 billion in cash on hand.
Given the growth in our cash balance there has been understandable entered in our stance on capital allocation.
Alongside organic investment M&A remains a top.
Top priority and we do see opportunity for some investment this year.
Having said that we are considering all options for capital deployment, including additional returns to shareholders in 2020 under existing share repurchase authorizations, which have a remaining capacity of more than $300 million.
Now I'll turn it over to mark for a bit more detail.
Both the first quarter and the four year.
Thanks, Patrick.
On slide 13, we've provided our 2020 planning assumptions as well as a profile the first and second half markets in which Patrick just reviewed.
In the first half of 2020, we expect revenues to be down low.
And we'll digits and then return to mid single digit growth in the second half.
We're guiding to 1% to 3% organic revenue growth for 2020.
This breaks down by segment as follows.
We expect flat to 2% growth in water infrastructure.
With solid growth in utilities being partially offset by continued weakness in our north American dewatering business, which will be lapping double digit growth compares through the first half of the year.
In applied water, we expect flat to 2% growth through the full year as this segment enters 2000.
20, with weak order trends and lower shippable backlog.
And it measurement and control solutions, we expect 46% growth with strong second half revenues related to project deployments offsetting lower first half growth against tough prior year compares a 15%.
Growth in North America, driven by double digit growth in water as well as large energy project deployments.
We're assuming a euro rate of 111, which was the average for the month of January.
Our FX sensitivity table is included in the appendix.
Our.
The tax rate for 2020 is 19.5%.
Non cash pension income is expected to two declined by $15 million or seven cents per share due to the planned by out of our UK pension plan.
Expected 2020.
$2, a 96 cents to $3 in 16 cents is an increase of 1% to 8% excluding the impact of foreign exchange translation and the reduction in noncash pension income.
Moving to the first quarter.
With shippable backlog is down 3%.
And at least one to two points of revenue growth impact from the Corona virus in the quarter.
We anticipate total company organic revenues will decline in the range of 3% to 5%.
We expect first quarter adjusted operating margins to be in the range of 8% to 9% representing 100.
80 to 280 basis points of contraction versus the prior year.
At the xylem level, this will be driven by unfavorable mix and lower volumes largely in our North American dewatering business, the census, North American metering business and in China.
EBITDA margins are expected to be in the range of 14.1% to 15%.
We see EBITDA margins break down by segment as follows.
We expect water infrastructure to be in the range of 13% to 13.9%.
Applied water to be in the range.
From 16.2% to 17.1%.
And mncs to be in the range of 14.8% to 15.5%.
With that please turn to slide 14, and I'll turn the call back over to Patrick for some closing comments.
Thanks, Mark the transition from 2019 into 2020 sees us.
Merging from one year to have than entering another year of two halves.
Despite near term uncertainty 2020 presents a balance picture.
There are still some good market conditions in the short term, but as we look toward the second half of the year our backlog in our line of sight to the timing a major projects provide a high degree of confidence both about our guidance for 2020.
And about the momentum to which we will return as we exit this year.
And both now and over the longer term, we remain grounded in the tenants of our investment thesis.
We expect to continue to deliver attractive topline growth from our investments in the capabilities and solutions that enable our customers to transform their businesses.
We remain committed.
Ongoing margin expansion, while maintaining our investments in future growth by pursuing the productivity cost and simplification initiatives that will make those margin gains sustainable.
And we will continue driving disciplined cash generation to enhance our capacity for attractive capital deployment, including investment in organic and inorganic growth and increased.
If returns to shareholders.
We'll provide an update on our strategic priorities and our long term plans at our upcoming Investor and analyst day on March 30 Onest.
Well look forward to sharing more detailed in our technology in solution capabilities.
Focusing our growth plans and hearing directly from some of our business leaders and customers.
Im hoping to host as many of you as possible then at our data analytics Center of Excellence and Atlanta, Georgia now operator, we'll turn the call over to you for questions.
Ed.
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Your first question comes from the line of Ryan Connors with Boenning <unk> Scattergood.
Great. Thanks for taking my questions.
I think you covered a lot of the details pretty well I had a couple of bigger picture question is actually the first one is.
Just strategically you know obviously, you're transitioning here a bit of a different period headwinds may in fact, we transitory, but good cost control and restructuring is becoming a more important part of the story right now.
Especially in the near term.
So obviously you said in the past you don't want to cut into bone, but can you just talk about how you look at the things you're doing and cost control and restructuring relative to R&D investments and other things you're talking about the vitality index and how you view you ensure that you don't lose that momentum on.
Innovation, and R&D and product development as you kind of rationalize things.
Yes go ahead, yes, Hey, Ryan Good morning, Yes, it's mark.
It's a it's a great point and it's certainly something that we played close attention to at the end of the day, we're going to create the most value by.
Growing we.
To continue to maintain our investments in R&D.
We are continuing to invest to grow out our digital solutions platform. So we're really focused on those areas of spend where we've got too much complexity, where we've got redundancy in the organization.
And.
Last year, we launched.
A series of restructuring efforts to get after that very thing.
And the savings.
Coming from those programs.
All in are going to be roughly $40 million, we're continuing to look at.
Annuities.
We continue to drive cost out through great work that all of the teams are doing through Tony will onto his leadership and are under continuous improvement.
You know there's.
Savings that ball a little bit laid in GBS. This past year will provide opportunities to reduce.
Complexity and take out cost as well so we're not looking at cutting back on investment Paul Yes.
It's a great point and I think that first of all in we still see there'd be a high level of continuous improvement opportunities across the company as we've deployed lean six sigma starting handful years ago.
But we're still in the early stages quite frankly from my perspective on where the opportunities are especially beyond the four walls of the factory, but across the rest of our LPL, but we're definitely going to be investing through this near term noise.
We adopted a handful years ago will be caught a productivity for growth mindset, where a meaningful portion of our.
Activity has been invested for growth.
Because we believe this is a long term game to your point.
Okay and then my my other was of my follow on was related and that.
You look across the industrial landscape. The last few years it seems that this sort of portfolio pruning.
Kind of targeted divestitures of become a popular.
Energy companies went into facing.
Tougher times lots of peer companies going that route where they call it realignment or pruning and that's something that's on your radar in or are there any lower margin brands or businesses that you would consider offloading or is everything you have considered kind of core.
Yes, so we.
We take at least an annual review if not even more frequent than that of the growth profile, but also the returns on capital economic value creation is the criteria that we apply across each of our business lines.
As we sit here today are there really are while there are some businesses that might be dilutive at times and.
Cycles to growth our Theres nothing right now that is all anywhere close to not delivering its return on capital above the cost of capital. So.
Turning cleared the hurdle at this point in time, and it's something that we look at on on on an annual basis had a minimum.
Okay, great. Thanks for your time.
Thank you Sean.
Your next question comes on line of game Dray with RBC capital markets.
Thank you good morning, everyone.
Good morning day.
Patrick I was hoping you could give us some high level thoughts on guidance here.
Good job, explaining the dynamics first half second half.
For Sydney hearing.
You've taken any different approach this year to setting guidance, maybe along the lines of embedding some more conservative is some maybe some implied contingency because there is variability to your earnings stream, especially with a short cycle do you watering business, but has there been any change.
In terms of how you're approaching guidance.
Yeah, I think that.
D. and as we as I look back and reflect on what we learned in 2019.
I mentioned before and you just.
Reiterated a meaningful portion of our business is still short cycle.
Heading into 2019, we were still feeling pretty bullish all.
On what we are seeing the marketplace, but quite frankly, we should have built in working tendency into that view. We think this guide as a balanced view.
Clearly seen your near term headwinds that we laid out or soft in Q4, lower shippable backlog coming into the year clearly the uncertainty with China can run.
The virus and some tough comps.
But what gives us confidence about the second half of the here is the projects in backlog that we have already in hand for two for second half.
And just assuming a modest returned to growth in the short cycle again, not a miracle is required in the second half year. So we do feel it's achievable, but its appropriately risk adjusted.
Got it and then you wall or one of the only companies in the industrials and certainly ones that we follow that have actually.
Embedded a.
Revenue and EPS impact from the Corona virus.
We appreciate the fact that you.
Taking this approach maybe.
Just give us some real time color in terms of how your businesses are being impacted you've got three or four cents negative impact but is there any other.
Lasting effects that you see in terms of relationships or.
So demand fall off that Youre seeing today.
Sure Great question.
Dan appreciate that you appreciate that we've tried to be transparent here. We we were deltic will be disingenuous not too.
Layout real time as what we see right now impacting the business given that it is.
Second largest business outside the us.
So first as you all appreciate the safety.
Our people is absolutely Paramount.
Secondly, we are although we're not advertising that we are heavily involved in the humanitarian response and will on how we did but we've been delivering pumps and offering to build water towers. There at some of the pop hospitals. So thats been very important as you said this is.
Very fluid and so.
What we do know right now is that there would be impact on the shutdown of our factories, all because right now we have halted deliveries.
Again, we don't know how much of that is simply delays versus it would get recovered either in the quarter or in Q2. So we're monitoring that very closely.
There clearly is an impact on our supply chain in terms of our suppliers being down as well.
And so there is that kind of knock on effect that again, we think would be recovered over the course of the year, but we're trying to keep a handle on what that is for certainly Q1.
And that's really the basis on which we laid out the impact on revenue.
And earnings per share.
Again, we're going to keep monitoring it very closely and certainly in a position ought to give you all updates no later than Investor day.
Appreciate that and then given I also asked some questions on the free cash flow guide. So first of all great work. This year, so that was a vindication year.
If you will mark for the team.
Cash flow performance. So we appreciate that just is there any other color you can give us on the guide of 95%.
Is that also a conservative cod, we look at.
Capex is up so that explains some of that but im concerned there might be some good.
And the working capital improvements that you did.
Especially in the fourth quarter, so give us some context there please.
Yes, teen and and thanks for that note I'd, we were certainly looking to educate ourselves after last year, but you know a chunk of that was timing as we discussed we've built up inventory.
Whereas we had a big ramp up in sales at the end of the year high single digit growth.
You know to some extent well the teams did a great job driving down inventories there was a lot of inventory to drive down we had softer volumes and we maintained a good discipline around our inventory build.
We've done a better job on collecting cash managing payables and I would say that.
We're certainly expecting.
As we took you through and prepare comps.
Hey, ramping up of revenues in the second half so there will be instead of a.
[music].
Working capital being a source it won't be as big a source of cash flow.
In 2020, however, we're still looking at improving our cash cash conversion cycle and reducing days both in inventories.
Receivables and payables.
And I'd just add Dean I think so we think it's a very balanced view on working capital there's really no major movement built into our guide here on working capital. Obviously, we'll have some of the pressure that mark alluded to here, but there's still opportunities to try to mitigate that as well we feel much better about the software with working capital now than we were a few years ago I.
I think to your question also on conversion you picked up on the Capex. The modest increase there and that really is driven predominately by some expansion plans that we've laid out for India to support the really break out growth there.
Well as continued investment in some of the software in the Mcs, but.
Also were other segments, where much of that gets capitalized and so those are really the two big drivers for Capex increase in 2020.
Thank you.
Thank you Hi, Steve.
Your next question comes from the line of Nathan Jones with Stifel.
Good morning, everyone.
Good morning.
I'd like to go back to some of the guidance specifically the mid single digit expectation in the second off I mean, clearly you're going to have easier comps. It sounds like you had some shippable backlog there.
Primarily around the Mcs kind of stuff.
But I mean, I think that clearly has to be an expectation here that you're going to say.
Short cycle improvement you probably need to see the ought to start rolling in about second quarter.
The to ship does in the back half can you talk about.
For that mid single digit growth rate in the back half.
You having had what's in backlog in terms of these projects versus what kind of improvement you need to see the underlying and.
What kind of growth you need to see an order rates over the next couple of quarters to support that outlook in the back half.
Sure, Yes, it's mark.
I think.
It starts with the confidence that we've got.
Certainly in the utility space.
Broadly but.
But.
Accentuated in our.
Mncs business there are the way the the projects work in terms of deliveries year over year. They the backlogs are.
Much stronger.
In the second half of.
Of the year.
We also we're not looking as Patrick said for medical and in terms of.
Recovery in the short cycle businesses, but they are going up against much tougher.
Much tougher compares or easier compares I mean easier.
Compare so I.
I would say the what really gives us confidence is more in terms of.
Projects in hand in the back half of the year versus a strong recovery in our short cycle business and we've been hearing we've been hearing as we stay close to our channel partners as well Nate, especially here in the us that.
They feel quite good right now about bidding and quoting activity to date that they're involved in.
And part of the softness they saw in the second half was working down some of their inventory. They bought in ahead of the price increases that we've done so there's no theres a bit of that so more of the more of the pressure that will linger in the second half would be in the industrial business and Thats.
Thats the one that we're staying close is too in terms of saying what that order rate looks like in Q2.
Okay Fair enough I'd love to talk a little bit about mix.
Here in 2020 and longer time, I mean, clearly you've got some headwinds for and stuff like de watering, it's very high margin, you're going to absent make headwinds on that.
The Mcs projects as you roll out the hardware. Initially can you talk about what you anticipate the impact of mix to be whether its basis points of margin. However, you want to catch it in 2020.
And then if you look forward I would think.
That said de watering recovers.
MTS projects.
Get the hardware installed move to software you should see any proving mix as we go forward over the next few years can you talk a little bit more about what kinds of impacts we should expect to see that have on margins as you go forward qualitatively or quantitatively.
Yes, Hey.
Nate its mark.
You know, we're going to lay out a lot more of this.
When we get together in March, but clearly you know it gets back to the store. It is a story of two apps right and.
Our next it's really tough given.
Pairs in our dewatering business in the first half of the year.
And.
And also certainly in the in the first quarter plus the the compares with our senses North American water growth.
But that does turn around.
In the second half given you know the project deployments that we see an mncs.
Yes, a just an easier set of compares in.
In our short cycle businesses.
A little bit more robust growth as Patrick mentioned, given some of the timing and commercial business services and we are expecting to see a better ramp.
In in our digital solutions business so.
Yeah.
First half tough second half better, but all in its probably not a big contributor to overall margin expansion. Yeah. So Nate this is Patrick your you've you've raised the very.
A very important point here I think for investors to.
I'll look at an understanding we will go into much more detail on this at Investor day is the impact that we see from the shifting growth profile of the company.
To the higher margin, we will see a recovering de watering it is very high incremental margins, but on top of that we will see the adoption of AI and MTS overall.
Which will have very nice accretive margins higher growth profile. So that mix is going to be part of our store in investor day, but that does not remove us from focusing on what we control and that is productivity cost and in our investments.
Okay. Thanks, very much I'll pass it on.
Thank you.
Your next question comes from the line of Scott Davis with nucleus research.
Okay.
Mr. Davis your line is open.
With that maybe we will come back to them and go to the next one.
Next question comes from the line of John Walsh with Credit Suisse.
Hi, good morning.
Okay.
Hi, yes.
Thanks for all that detail.
All in the prepared remarks I guess following on the last question just wondering if we could have a conversation about how some of the restructuring and realignment savings flow through.
Trying to put everything together and looking at what your implied Q1 Decrementals are and then how we get positive obviously.
Highlighted a lot of stuff already around volume et cetera, but maybe you can talk about how the savings flows through into 2020 and I'm, assuming some of that stuff has a tail into 2021 as well.
Yes, yes so.
The 2020 restructuring and realignment is.
You know primarily around.
Business simplification.
Yes related so we are seeing benefits coming from our procurement tower finance as we've talked about is going to be delayed into later into 2020.
But we did.
Initiate some programs last year in terms of simplification in Europe.
Additional actions in North America.
And.
As we look at those benefits, we're certainly expecting them.
To ramp up.
Through.
The year.
Particularly those actions in Europe, which were.
Just take longer to work through the works Council.
Yes, I mean any way to kind of quantify in each one versus in each to benefit just so we can kind of help for the modeling purposes.
It was about 6 million.
No restructuring savings in in Q1 John.
Okay.
And then obviously appreciate you gave the details around the backlog shippable into 2020 and also visibility into 2021 can you just remind us how from those orders are.
Once a customer decides to place an order or are there other progress payments or cancellation fees, just wanted to understand that a little bit better.
Yes.
They are you know these are.
Vince.
Now.
In some cases.
Filling some of our larger.
Infrastructure projects, particularly in emerging markets, but not limited to emerging markets, we do look to get advance payments.
The.
While the orders are in hand as long as there is a commitment some of these.
The timing of them can move outs from quarter to quarter.
So thats, that's always something that we need to pay close attention to but these are.
Certainly these are things that are commitments for but the timing can shift in any given quarter, yes, very rare lift as Patrick very rarely.
I would they be cancelled and when you think about even our metrology deals that we do especially in the PMI side.
The economics on these things are returns on capital for utility once had gotten these things approved and they're in their rate case.
By the regulator or so attractive for them today, it would be rare for them to ever canceled.
Dave.
And that's a big part of what we see in the shippable backlog beyond 2020.
Great. Thank you for the color.
Appreciate it.
So.
Your next question comes from Pavel Molchanov with Raymond James.
Thanks for taking the question you you guys.
I alluded to the hefty cash balance that you're expecting but by the end of the year and in that context, let me ask about theme.
M&A landscape.
You are seeing the headwinds, presumably many smaller players in the water tech space or are seeing as much if not more.
It is the kind of valuation opportunity, becoming more interesting from a consolidation angle.
I would say we've not seen.
Any meaningful change in valuations to date, obviously that that could that could change based upon the.
You know the volatility you alluded to.
And so we are always evaluating we think we have a very attractive pipeline of opportunities. We will always remain discipline on valuations and again make sure that these things are critical to really enabling these strategic growth of the portfolio. So.
Again, we mentioned earlier, we think.
Some opportunities out there this year.
But again, we'll have more of an update on that at Investor day in terms of what that pipeline looks like at least directionally.
Okay.
Your next question comes from the line of cell Superior Donna with Cowen.
Good morning, guys, just Francisco Amador in for Joe.
Do you expect you expect good morning could you expand on why you expect the NPS margins to be solo two started the year and just what your longer term margin target is for Mcs and how you get there.
Yes Francisco.
Market, it's there's a couple of things.
No. One you volumes are are down and.
We'll see we'll see some impact on that relative to leverage.
But also mix.
I had mentioned in our prepared remarks are.
Our north American water business have really tough compare year over year very high margins.
And also just given some of the timing we see in our high margin.
Digital solutions business Theres, some mixed pack mix impact there as well in the last point and Patrick.
Mentioned this.
Despite the.
The.
Soft patch in terms of volumes and mix in Q1, we are continuing to invest we've got customer commitments, we need to.
We also.
We're excited about where the opportunities in the digital.
A little side, so we're actually increasing our investment year over year and I would say just to punctuate the investment comment the couple of areas that are really our priority you invest in that segment right now are predominantly again, meaning from the customer commitments on some product modification for some of the large deals. We do have some new products that were looking to.
Due to roll out this year in the in the metrology space that we think are going to be very exciting and then lastly, continuing to invest in building out the I'll go to market infrastructure for the digital solutions capabilities that we've got and that's not just in the U.S. that's on a global scale.
Okay, great. Thank you and then just as a follow up are you seeing any aggressive aggressive pricing by competitors and the dewatering market, having an impact on margins and do you have any color just on the competitive landscape here.
Yeah, I think you know the dewatering space. It has always been quite competitive from a pricing standpoint.
Although obviously the margins are very attractive.
I'd, probably rather not comment too much on competitive pricing.
At this stage, but I would say, we don't really I don't think we see a major sea change in that area, but it's always been a competitive market that we.
And what what really help slip margins in that business is just.
The emergency nature of it and how critical.
The services, our two customers when they are in need and obviously as volumes are softer its.
Even more competitive.
Great appreciate it thank you.
Yep.
Your next question comes from line of Brett.
Please proceed with vertical research partners.
Hi, good morning.
Hey, good morning.
Just wanted to come back to the second half guide could you just put a finer point on the size of those specific Mcs deployments that you expect and then thinking about the delivery timetables. There is is it pretty balanced between Q3.
In Q4 or is it pretty loaded up in the tail end of the year.
No it's fairly it's fairly balanced and.
No.
It is certainly a component, but we we have a global businesses.
We see continued improvement in.
And just.
Recurring revenue in replacement of meters as well, so, but but the thing that really makes the difference is a little bit little bit easier compare and.
More robust.
Backlogs.
That are pretty much even play.
You know expected to deploy across Q3 in Q4.
Okay is there any way you could quantify the size of the projects or.
Points to the year or.
Absolute dollars.
Yes, the growth in the deployment of these these larger projects is.
It's mid single digit plus impact.
Okay got it thanks.
Then just shifting back to the restructuring question go ahead.
Go ahead.
Okay shifting.
Getting back to the restructuring question I am a bit surprised given the softness and in some catch up on the simplification efforts you're doing more.
Structuring standpoint this year.
Maybe just the thought process there and then.
How you're thinking about that the drop through on savings and payback timing.
Yes.
The savings.
We discussed have always been phase it doesn't happen all at once.
The the programs that we undertook from a simplification perspective last year and in Europe, and North America.
We're really rolled out as we saw things moving in the back in the back half of the.
So we start to see that ramp up in throughout.
Throughout this year, we saw some benefits at the end of last year, but we'll see we'll see more this year. Yes. We had this is Patrick we.
Again, you think about anytime you've got restructuring programs, you've got some that are rolling off.
As you're lapping and so we had taken restructuring in the first half.
Last year than we had announced that really begin to benefit second half the year and trails, a little bit into this year that phase was down that was kind of phase one in Europe, we had a phase two in Europe.
That we that we launched and the second half of last year and just given the lead times involved in getting things like works Council approval.
There's some factory implications so these things happen.
To be manage we expect those to happen in the second half of the year. So no. There is always amid a phasing here in terms of when a program gets launched versus when it gets rolled out and deliver savings.
Got it no I appreciate the color thanks a lot.
You're welcome.
Your next question comes from the line of Brian Lee with Goldman Sachs.
Hey, guys. Good morning, Thanks for taking the questions. Thanks Bye.
Good morning.
I guess, just first stuff on the margin front I know this has been something you guys. It's obviously been highly focused on couple moving parts here.
But if you could just help US you had been talking about.
I believe a 100 basis points of EBIT margin expansion in 2020, originally now that target midpoint is more like 30 to 40 basis points year on year. Appreciate there's a lot of moving parts here, but to the extent that you can.
Any sense that you can provide it's kind of the bridge between the old and new views how much is lower.
And how much is mix operational savings, maybe falling short and then any other items as we think about how you can.
Again kind of bridge back to the faster margin expansion trajectory you had been targeting before.
Yes. This is Patrick I mean, I would say first of all clearly we plan to spend.
Fair amount of time on this at Investor Day, it's really kind of lay out how we're thinking about margin expansion.
Clearly, we are still deeply committed to margin expansion through productivity shifting.
In our revenue portfolio and still some other cost takeout opportunity. So we will walk through that certainly I.
At Investor day in a bit more depth.
I think the biggest drivers here domestically are the challenges in our two highest margin businesses that being dewatering and simply the slower the slower ramp up of conversion of orders to revenue on digital solutions.
We believe those are simply transitory, but will walk you through that at Investor day.
Mark talked about some execution delays that we talked about last year as it related to the finance tower, we're still deeply committed to that we're moving that forward, but there it had been a shift to the right and that's certainly impacting parked in 2020.
We've also continued to invest for growth so we've not pull back on R&D.
Or other investments to grow these these these faster.
Growing businesses, but again will walk you through in more depth on that in terms of how we're thinking about longer term margin expansion and how we're going to guide to that each year.
Okay Fair enough I look forward to that and then maybe just a housekeeping.
And from Mark I noticed the the interest expense assumption for 2020, it's coming down about.
$10 million year on year, any assumptions, there embedded on refinancing or paying down debt due to the or what else might be driving that year on year change outside of just additional cash on the balance sheet.
Yes, well.
Part of it is you know we manage our interest rate risk.
Through swaps and other programs that.
Our certainly benefiting us.
A little bit this year in the in the back back part of the year as well as a full year.
Benefit into 2020.
So that's that's just the effects of that interest rate risk management program.
All right I got it thank you.
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Your next question comes from the line of Andrew Kaplowitz with Citi.
Hey, good morning, guys.
Good morning, Patrick Patrick Good morning, your rental business was starting to weekend. When you reported last October I think you said it was down 17% in Q4, you mentioned top storm comparisons weakness in oil and gas have you seen the rate of decline in rental to stabilize at all yet and what are your rental teens, telling you about.
Incremental weakness in that market and when it might subside.
Yes, so the if I follow your question correctly.
You know the you haven't really break dewatering out between the rental piece of the business and our equipment sale.
And actually we did see growth in.
Our rental business.
By mid single digits. It was really the equipment sales that we saw the big the big drop there and that was largely driven by reaction on the part of our distributors they were saying Oh, what they saw capex uncertainty.
Run the cash they're small distributors typically.
So they got skittish understood understandably and pull back our rental piece continued to grow modestly during that timeframe up now we have again scene that weakness continue.
In that part of de watering for.
Heading into this year, that's why we're trying to be cautious in terms of how we guide that.
Yes, I think the at this point in time, we are still saying broad based industrial weakness in so that does temper our view on how we view this and because it has such a large decremental impact when it goes the wrong way, we want to be cautious in terms of how we how we guide here, yes, I'd just add a little more.
In terms of so what what changed in the fourth quarter.
The.
Until we expected some rental weakness just based upon what we're seeing in our distributor channels.
Sales side in the fourth quarter. It was it was weaker than we expected and really for two reasons one.
We you know the our shipments into customers in the oil and gas space.
Were down more than we expected in some of that had to do with bankruptcies and oil refinery.
Explosions.
And then there was.
Big year over year.
The decline in rentals related to storm events. So both of those were.
More than we expected.
But to Patrick's point, we do expect some of the weakness in rental to persist, particularly as we sell into the oil and gas.
And other heavy industry in the first half of.
2020, but some normalization as we get out of that get out of that period, particularly when you look at the tough compares that we had in the first to the first half inch.
29 team.
Great. Thanks for that color guys and then just I wanted to ask.
Yes in the context of timing.
Revenue growth in Q4 was up to I think you said shipping shippable backlog into 2020 was down 4%, but double digits for 2021, Phil you mentioned difficult comparisons, but as something happening either in the quarter over the last couple of.
Quarters could sort of further slowed down in decision, making our customers just more hesitant to take on these digital projects given they're worried about the economy is that what it is.
Labor availability, what is that that's slowing it down.
Yes, I think we have to break we have to break it down between we it's hard to talk about mncs is one.
It's not one business line, so the projects or they are very different projects. So.
The digital solutions piece, how what we're talking about those kind of project needs are things that typically start off in a pilot phase.
Then make move into orders.
And then Theres a lot there always subject to weather events.
It's not it's.
Not a reflection of there being a lack of funding or a lack of interest or they're pulling off on those it's simply a matter of time in that regard based upon the orders we add on hand coming out of Q3 in Q4 and for the Oh no for the census for metrology piece of Mncs.
We've not really seen any.
Page in dynamics in terms of decision, making length of time it takes.
That's that's not really been a driver here in terms of why we see that backlog. It's just you know these are these are large.
Several large implementations that it takes a while for those utilities to get case approved.
And get the get the specs finalized.
And get the RFP is out and finalized and so there's always going to be a level of lumpiness there and that's why it's important in our view that we look at these things over a longer timeframe than a couple of quarters or even from one year to the next.
Appreciate it guys.
Thank you.
Thank you. This does conclude today's xylem Q4 2019 earnings conference call. Please disconnect your lines at this time and have a wonderful day.
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