Q4 2020 Xylem Inc Earnings Call
Welcome to the xylem fourth quarter and fiscal year end 'twenty 'twenty earnings conference call. At this time, all participants have been placed on listen only mode and the floor will be open for your questions. Following the presentation. If you would like to ask a question at that time. Please press star one on your test.
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Now I'd like to turn the call over to Matt Latino Vice President of Investor Relations.
Thank you Pasha.
Everyone and welcome to Xylem fourth quarter and full year 2020 earnings Conference call with me today are Chief Executive Officer, Patrick Decker, and Chief Financial Officer Sandy Rowland.
They will provide their perspective on xylem fourth quarter and full year 'twenty 'twenty results and discuss the first quarter and full year outlook for 'twenty 'twenty one.
Following our prepared remarks, we will address questions related to the information covered on the call.
I'll ask that you. Please keep to one question and a follow up and then return to the queue.
As a reminder, this call and our webcast are accompanied by a slide presentation available on the investors section of our website at Www Dot xylem Dot com.
A replay of today's call will be available until midnight on March 5th. Please note. The replay number is 805 858367 and the confirmation code is six to 83413.
Additionally, the call will be available for playback via the investors section of our website under the heading investor events.
Please turn to slide two.
We will make some forward looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future.
These statements are subject to future risks and uncertainties such as those factors described in the islands. Most recent annual report on form 10-K and in subsequent reports filed with the SEC.
Please note that the company undertakes no obligation to update any forward looking statements publicly to reflect subsequent events or circumstances and actual events or results could differ materially from those anticipated.
We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics in the appendix.
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 also included in the appendix section of the presentation.
Now please turn to slide three and I will turn the call over to our CEO Patrick Decker.
Thanks, Matt and good morning, everyone.
As you'll see from our release this morning, the team delivered a strong performance in the fourth quarter, giving us good momentum entering 2021.
Every segment and every end market made considerable gains on a quarter sequential basis.
And for xylem overall, the team outperformed expectations across the major metrics those being revenue earnings and cash.
As the year came to a close we took full advantage of stabilizing markets.
Both water infrastructure and applied water systems show quicker resilience and anticipated.
And we also affirmed our growth trajectory and measurement and control solutions building on the large project wins, we talked about last quarter by adding other headline am I deal in Houston, Texas.
We also gathered pace with our industry, leading digital portfolio as the pandemic accelerated customer adoption of digital transformation.
Revenue in the orders trends both improved significantly.
One caveat is that orders were still down slightly due to the scope reduction in our previous large win in India.
Otherwise orders grew in all three of our segments.
Xylem is large installed base of core products in established markets provided exceptional resilience on underlying demand for essential services.
At the same time, our global presence allowed us to capture the benefits of early recovery in places like China, which grew 18% in the quarter and also in Europe, where we grew 6%.
As a result of that positioning on a large and resilient installed base combined with a vibrant growth platform, we enter 2021 with healthy backlogs.
They're up 16% overall and up 30% shippable in 2022 and beyond.
We know growth really happens on a straight line.
And clearly the global challenges of 2020, you put a hedge in year on year numbers, including margin.
While I am very pleased with how we respond to given these conditions.
We took quick action on spending and on structural cost and we also made significant productivity improvements.
As a result, we returned to progress on margin in the third and fourth quarters, Although we didn't entirely offset COVID-19 effects.
Our supply chain execution and sure we kept customer served with the pandemic and we help them to deliver the central services their communities depend upon.
Our operational discipline delivered favorable bottom line outcomes, even in unfavorable market conditions strengthening our financial position through the year.
The team corrected for the volatile conditions. So quickly that in fact, we delivered free cash flow conversion north of 180%.
Looking ahead.
We're encouraged by early signs of market recovery the ramp up of vaccinations offers hope for an eventual return normalcy, but we're not there yet.
We are still in uncertain times.
We've nevertheless in our 2021 and a very strong position and we are on course to capitalize on our increased competitiveness financial strength and commercial momentum.
With that on one hand, it over to sandy for more detail on how our segments performed.
Thanks, Patrick we have continued to see steady quarter sequential growth improvement across our businesses since the low point on April and this quarter, we took another meaningful step forward.
Fourth quarter revenue growth was down 2% organically versus the same period last year.
This performance exceeded our expectations with upside in all of our end markets.
And geographically strong growth in China and Europe.
I will touch on revenue performance in more detail covering each of the segments, but it was short.
Charities and industrial are both down 3%.
Commercial was flat and residential was up 15 per se.
We also saw quarter sequential improvement in orders.
Organic orders were down 1% in the quarter as we delivered our second consecutive quarter of sequential orders improving.
This result, most notably reflects the return to growth in N C S orders, which delivered double digit gains.
Excluding the large win in Houston, which Patrick mentioned.
Applied water contributed solid mid single digit growth.
Water infrastructure orders grew mid single digits, excluding the scope production of a project in India.
We're still negotiating with the customer but felt it was most prudent to reflect the scope production now.
Otherwise orders growth would've been high single digits for xylem overall.
With orders accelerating and several large contract wins contributing to double digit growth in backlog, we have good visibility of future revenue streams heading into 'twenty and 'twenty one.
I'm very pleased with the team's operational execution and cost discipline.
Fourth quarter operating margin and EBITDA margin of $13, eight and 18, 8% respectively are above our forecasted range.
Compared to the prior year lower volumes and unfavorable mix were partly offset by strong productivity and cost discipline.
Oh are you operating margin performance by segment in a moment.
Our EPS in the quarter was 81 cents due to higher than forecasted revenue and earnings and from a lower tax rate due to favorable jurisdictional mix.
Please turn to slide six and I'll review, our segment performance for the quarter.
Yeah.
Water infrastructure orders in the fourth quarter were down 16% organically versus last year.
As I mentioned, a moment ago that decline was driven by the day scope the India project.
Otherwise the orders would have been up mid single digits, reflecting healthy momentum in the segment as a whole, particularly in the wastewater utility businesses.
Notably treatment was up 10% as wastewater utility capex budgets continue to show resilience globally.
Water infrastructure revenue was flat organically in the quarter.
Modest growth in wastewater utilities was offset by modest declines in our industrial businesses.
Geographically results were mixed the U S was down high single digits, while Europe and emerging markets were up low single digits and mid single digits respectively.
These results generally reflect the stage of Covid recovery in each region.
Operating margin and EBITDA margin for the segment were down a modest 60 to 70 basis points respectively.
Significant savings from productivity and cost reductions were offset by inflation the recognition of reserves and negative mix from declines in our U S dewatering rental business.
Please turn to page six.
In the applied water segment orders were up 4% organically in the quarter driven by strong demand in Europe, and emerging markets, partly offset by modest softness in the U S.
Revenue declined 1% in the quarter.
Mid teens growth in residential was offset by softness in industrial.
Commercial revenue was flat.
From a geographic perspective, the U S was down mid single digits as Covid impacts drove declines in the industrial and commercial businesses offset by that strong resident residential growth that I just mentioned.
Europe delivered high single digit growth, primarily driven by good pace on commercial and modest growth in residential.
Emerging markets were down low single digits softness in industrial markets in the middle East were partially offset by strength in the residential and industrial markets in China.
Segment operating margin and EBITDA margin declined 90, and 170 basis points respectively.
I am declines on the industrial end market and overall inflation more than offset solid productivity gains favorable mix and some price realization in the quarter.
Now, let's turn to slide seven and I'll cover our measurement and control solutions business.
In M. C. S orders returned to growth in the quarter up 13% organically.
This was largely driven by double digit growth in both water and energy.
Orders in our test business were up low me were up low single digits.
Revenue improved considerably on a sequential basis from the mid teen declines we experienced in the second and third quarters. This quarter and we finished the quarter down five per cent.
While our core U S. Metrology business continued to experience COVID-19 related softness the largest decline is related to the timing of project deployments.
Large scale projects that were in process pre pandemic in both the U S and the middle East have been completed and new projects, which are part of our backlog have been temporarily delayed due to site access restrictions.
We expect that large project a point deployment well resume towards the end of the second quarter and further accelerate in the back half of the year.
These declines were partly offset by high single digit growth in our analytics and advanced digital solutions businesses.
Geographically the U S was down mid single digits for the reasons I just mentioned.
Emerging markets was down double digits due to the timing of prior year project deployments in the Middle East and Europe grew double digits from demand in the test business and from the start of the Anglian water of metrology project in the U K.
Segment operating income and EBITDA margins in the quarter were down 330, and 350 basis points respectively.
Lower volume inflation and favorable mix were partially offset by strong productivity and cost discipline.
Now, let's turn to slide eight for an overview of cash flows and the company's financial position.
I was particularly pleased with our strong cash performance for the year, we grew free cash flow by five per cent for the full year exceeding our pre pandemic free cash flow outlook and delivered free cash flow conversion of 181 per cent.
Our team has been focused on driving continuous improvement on working capital for a number of years and the difficult operating environment of 2020. They took that work another step forward, finishing at 17, 6% of revenue.
This is a 40 basis point improvement year on year, excluding foreign exchange impacts and reflects the team's progress in managing inventories and driving solid improvements in accounts receivable collection.
We benefited from favorable timing related to the settlement of restructuring tax interest and payroll liabilities.
Some of which will reverse in 2021.
Our balance sheet is well positioned and includes a $1 $9 billion cash balance.
Net debt to EBITDA leverage is one five times.
As a reminder, we'll take advantage of our cash position to repay one of our senior notes amounting to $600 million in the fourth quarter.
And lastly, we announced an annual dividend increase of 8%.
This is our 10th consecutive annual increase.
Please turn to page nine and I'll turn the call back over to Patrick to look forward at 'twenty 'twenty one.
Thanks Sandy too.
2020 reminded us all but it's prudent to be humble about the fidelity of our fore sight.
When Covid first began to spread around the world. We said, we would focus on managing what we can control, while maintaining our investment for growth and that's exactly what we've done.
So with 2021 still presenting some uncertainty we will apply the same kind of focus that guided us throughout 2020.
In our earnings call almost exactly a year ago, I said that I expected operational discipline would be a key capability for us I Couldnt have anticipated then how much we do benefit from that capability.
When 2000 Twenty's Big challenges arrived the team delivered on cost on working capital on free cash flow and on driving commercial value from our large installed base.
We're still on a challenging environment. So we will continue to face spending until we further see improvement in our markets.
We will keep executing the structural cost program began in 2020, which is going to deliver savings through 2021.
And given some of the inflationary headwinds were already saying we are redoubling, our efforts to manage the price cost dynamic.
We're keeping a very close eye on our supply chain and proactively managing potential inflationary and logistics impacts.
Despite varying by market and geography, there are clearly opportunities for growth in a recovering environment.
And digital transformation, the pandemic demonstrated the imperative of operational and financial resilience for utilities, which is precisely the value proposition of our advanced digital solutions.
Pre pandemic the business case was already very compelling.
But as utility operators worked her role locally to keep essential services running the stresses on the pandemic made it clear that new approaches are required.
Remote monitoring automated operations and smart infrastructure more broadly continue to see increased demand.
Backlog in our advanced digital solutions grew 70% year on year.
Although its from a small base the trajectory is clear.
It puts us on a very attractive position as we grow not only in software platforms, but in all will be digitally enabled parts of our portfolio.
Geographically, India, and China will continue to drive high growth.
Despite experiencing COVID-19 earliest impacts China actually grew last year.
And in the three years, leading up to 2020, India and China posted combined average annual growth rates in the double digits.
With localization strategy is well advanced and book countries are China, and India teams are set to continue delivering impressive growth.
Okay.
It's also worth mentioning the very solid financial foundation underpinning our growth.
With our current cash balance of nearly $1 $9 billion capital deployment is clearly top of mind for us.
Even with some debt repayment during the fourth quarter that number still offers a lot of capacity.
Alongside organic investment M&A remains the top priority.
And we intend to be proactive in our deployment of capital wherever the investment case warrants.
We remain disciplined about valuations, but we do see opportunity for additional investments over the next 18 months.
Growth is also important to our creation of social value.
We're in the very privileged position that sustainability is baked into our business model and strategy.
Our portfolio of solutions has a net positive impact not only on water, but on a wide range of sustainability outcomes.
We took several bold steps on sustainability in 2020.
Most notably our green bond offering.
And performance across these metrics continues to put us in a unique leadership position both on the water sector and more broadly.
The team's progress has strengthen our position on a number of sustainability indices.
We were recently added to Bloomberg Barclays MSCI Green Bond index.
Despite that gratifying recognition, we have so much more work to do to achieve our 2025 sustainability goals and to deliver on our mission.
I'm now going to turn it over to sandy to provide end market and segment outlook.
Yeah.
Thanks, Patrick.
20 utilities had been reassuringly resilient.
Only mid single digits.
As you see in the fourth quarter results, and then C S and water infrastructure revenues held up better than anticipated.
Still our outlook for 2021 reflects a temporary deal that utilities have not seen the end of the pandemic impacts quite yet.
We anticipate our utility business overall, which is just north of 50% of xylem revenues will grow on the low to mid single digits in 'twenty and 'twenty one.
We expect that same growth rate on the wastewater side as utilities continue to focus on mission critical application.
And we expect modest recovery in Opex growth on a global basis through the year.
In the U S wastewater capex is likely to be down modestly. However, the declines should reflect postponements rather than reductions in projects.
As you would expect if kept close to our utility customers to understand how they are thinking about budgets and funding for this year.
While some uncertainty remains their deepest concerns have largely abated abated since the low point of the pandemic.
On the water side, we anticipate mid single digit growth as I mentioned large project deployment should begin ramping again from the second quarter accelerating through the end of the year.
The large multiyear metrology deals that we won in 2020 set us up for solid growth this year and beyond.
In industrial markets, we've seen good sequential improvement.
Short cycle orders and project activity are definitely beginning to pick up but are still likely to be limited by COVID-19 impacts in the near term.
We expect industrial to be flattish to up low single digits.
Our commercial end market outlooks varies quite a bit by geography.
The U S will continue to be sluggish Europe on the other hand should can continue recovering although not at the double digit pace, we saw in the fourth quarter.
And overall, we anticipate the commercial market to be flattish to down slightly for the year.
Yeah.
On Slide 12, you will see that we are reinstating annual guidance well.
Uncertainty remains especially regarding the timing and cadence of recovery. We are confident our team will deliver results in line with the following framework.
For xylem overall, we foresee full year 'twenty 'twenty, one organic revenue growth in the range of 3% to 5%.
This breaks down by segment as follows low to mid single digit growth in water infrastructure with solid growth in wastewater utilities being partially offset by flattish performance in the industrial markets predominantly in our dewatering business.
Most single digit growth in applied water, while we see pockets of recovery in this segment globally, particularly in residential the outlook for growth in the commercial building and market is more muted.
On top of that our exposure to North America is heavier and the region has lagged on pandemic recovery.
And measurement and control solutions, we expect mid single digit growth customers indicate project deployments will likely resume late in the second quarter and further accelerate through the second half of the year.
We also expect to see our test assessment services and advanced digital solutions businesses building on the momentum they delivered finishing 2020.
While we have typically provided deal with both the adjusted operating margin and adjusted margin EBITDA margin in the past you will notice that we are increasing our focus and reporting around adjusted EBITDA.
We believe that this measure more accurately reflects the cash performance of our businesses and will enable us to more transparently report margin performance after M&A without purchase accounting impacts.
For 2021, we expect adjusted EBITDA to be up 40 to 140 basis points to a range of $16 seven to 17, 7%.
For your convenience, we're also providing the equivalent adjusted operating margin here, which we expect to be in the range of 11, and a half to 12, 5% up 70 to 102 hundred 70 basis points.
This predominantly reflects the benefits from our restructuring savings combined with volume leverage and favorable price mix more than offsetting inflation and investment.
This yields an adjusted EPS range of $2 35 to $2 60, an increase of 14 to 26 per cent.
Free cash flow conversion is expected to be in the range of 80 to 90 per cent following free cash flow conversion of 181% in 2020 and 124% in 2019.
While we continue to drive continuous improvement, we expect to see increases in working capital as we returned to growth and.
And some of the timing benefits, we realized in 2020 related to the settlement of liabilities will reverse in 2021.
We believe this is purely a dynamic related to 2021, and we expect to drive 100% cash conversion in 2022 and beyond.
We've provided you with a number of other full year assumptions on the slide to supplement your models.
One key item that I do want to draw your attention to is foreign exchange, we're assuming a euro to dollar conversion rate of one point to two.
FX can be volatile and so on FX sensitivity table is included in the appendix well, which will help you. If we continue to see variations in the race.
Now drilling down on the first quarter, we anticipate that total company organic revenues will grow in the range of 1% to three per cent.
This includes low single digit growth in applied water and low to mid single digit growth in water infrastructure.
M. A C. S is expected to decline low to mid single digits as we anticipate continuing delays from COVID-19 before projects begin to deployment in Q2.
We expect first quarter adjusted EBITDA margin to be in the range of 14% to 15%, representing a 170 to 270 basis points of expansion versus the prior year.
With the largest expansion coming from M. A C S due to operational improvements and a prior year warranty charge.
With that please turn to slide 13, and I'll turn the call back over to Patrick for closing comments.
Thanks, Andy.
We recognize both of the marketplace is stabilizing and that it is still likely to be on settled for some time, but.
But we come into the new year with good momentum and an even stronger position emerging from the pandemic than when we entered it.
That position is built on a durable business model.
We are vital products at the heart of the Central services and we have different differentiator technology that provides a multiyear runway for attractive growth.
Our mission has perhaps never been more relevant.
And our underlying investment thesis remains robust.
Our near term performance is delivering results and we continue to invest for sustainable growth.
That's in line with our long term strategy to create both economic and social value for our shareholders, our customers and our communities.
We will provide an update on our key strategic priorities and our long term plans at a virtual investor and analyst day planned for later this year.
Where I look forward to sharing more detail on our technology and solution capabilities and to discussing our growth strategies.
So now operator with that we'll turn the call over to you for questions.
The floor is 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 question is answered you may remove yourself from the queue by pressing the pound key again, we do ask that you pose your question that you pick up your handset to provide optimal sound quality.
Thank you.
Our first question is coming from the line of Mike Halloran with Baird.
Hey, good morning, everyone.
Morning, Mike.
But let's start on the Mcs side, you know margins up a little bit as you work through the year here I mean, as we get through next year feels like there's a correlation with how margins are tracking in the deployment curve. So when you take all the cost efforts that you've done and you get towards some normalization as you get these deployments out is.
At that point in time, you were thinking about you know, whether it's 2022 kind of timeframe getting back to that normal range you've been in historically or are there. Other factors at play that can move that around and just kind of latest greatest thoughts on that side.
Yeah, Mike Thanks for thanks for the thanks for the question you know obviously as we work through the pandemic on the M&A and then C. S segment was our segment that was most impacted.
And we saw that with you know steeper revenue declines, which also impacted the margins.
The business team took you know strong action throughout 2020 to make structural cost saving changes that are that are permanent.
And you know, we think that as we move through 'twenty 'twenty. One that is the segment, where you're going to see the largest part of our margin expansion and and you know Mike you're going to see that right from the get go out of the gate. When we look at Q1. That's also the segment that's going to have the <unk>.
Greatest margin margin expansion and you know that comes from operational efficiencies from the restructuring as well as we did have a onetime item less last year, Yeah, Mike We've got.
We've got a number of beads large deal deployments I think recently, we've won as many as much as north of $300 million of larger deals in 2020.
Those are going to begin to ramp as THAAD excess returns.
And we just continue to have some really good commercial wins here.
When I say, good meaning they come with very attractive accretive margins.
In those deals.
So really what I'm hearing.
Go ahead, and so basically what I'm hearing, though is as you get those deployments out and you get to a more normalized state access. There is no reason to think that the normalized range for them. It's yes isn't back on the table whenever that time period starches.
That is correct.
Okay.
One thing that I would add as we look out through 2021, you're going to see the strongest performance in Q4 from a margin perspective and at that point in time, we would expect debt we will be back at 2021, I'm sorry, we're back at 19 margin levels.
And we'll be on on good pace for margin expansion.
That's helpful. There and then second one on the on the capital deployment side obviously.
Obviously highlighted M&A and focus on that and maybe just talk about the action ability of the supply of the funnel right now and if there's really any change to the focus.
And what youre interested in bringing in relative to what's in that funnel.
Yes, so Mike no no no real change in our focus areas and the M&A funnel I mean, we've got a number of kind of smaller bolt on tuck ins.
That will be executing this year.
But we're staying very close to a couple of larger actionable items as well.
No.
You know again, we're going on.
We've got a keen eye on valuations.
We do understand the value of inorganic growth.
And again.
You know, we're going to continue to remain disciplined but we're optimistic.
Great appreciate the time as always.
Thanks, Mike.
Our next question is from the line of Dan Dray with RBC capital markets.
Thank you good morning, everyone.
Hey, good morning, David Good morning, Dean Hey, maybe we can start with some of the dynamics within the business and Patrick just give us some sense of that change in scope on the India pump water.
Things are changing really fast there I got out there and basically crisis mode, but just Oh what went on there.
And what's the outlook.
Because there's still so much to do the ore in India. So I'll start there and then some color on debt.
Houston project please.
Sure.
So I'll, let I'll let.
Sandy take the Houston project question I'll focus here on India.
So we still remain very positive on on India Dean.
We've seen double digit growth the last few years, we've got a great backlog there.
Obviously the.
Top top policy mandate by Prime Minister Modi continues to be the case. There. This was a unique day scoping on one project, where it was a little bit driven by an element of nationalism.
And so we're still.
Going back and negotiating on that.
We don't see that as part of a broader trend. It was very unique very localized in one particular state.
And again, we're going on we just wanted to be appropriately conservative to reflect a reduction now in our orders are well, we'll see how it plays out but no no change in our view at all Dean on India.
Great.
Go ahead sandy on on Houston.
Yeah, Yeah. Thanks, Deane for the for that question. This is another project that we're very very excited about and it builds on the $250 million of awards that we that we announced earlier in the in the year. So this deal is about a 40 million 40 million.
<unk> deal if it's primarily a water deal and it's with a really powerful water utility. So it's it's one that we're quite well quite pleased to bring into our backlog.
And how much of the digital offerings is embedded in this.
Houston project I know its meters, but anything else that you would highlight.
Yeah. So deane, it's a it's an am I deal.
It is new it's a share gain.
For us in displacing someone that was there before and.
And so it will fit in that digital landscape as you think about the communications offering from from flex net on the on the sensor side.
Great and Patrick just it looks like you're exiting the year with more momentum on your digital offerings and this was the expectation that the reaction of the utilities in Covid was they did need to do more remote monitoring they didn't need to do more automation.
And so just your sense of that demand are we seeing what inning are we so far in this what I think is a big conversion here on on digital.
Yes, I think we're still early innings here Deane I would say there are two dynamics at play.
One is as you pointed out.
The the.
Utilities are moving now from these things being nice to have day must haves.
Besley with remote monitoring.
On a restricted.
Labor deployment capabilities.
But secondly, we're in the early innings still on terms of.
We put new structure in place.
Early last year, we put new incentives in place to really drive.
Synergies more broadly so it's not just about.
The you know the artist known as Xylem view, our digital revenue. It's also the impact that has on pulling through.
Other deals Houston being a good example of that we.
We talked about Columbus, Winston Salem late last year. So we're taking a broader view on this theme than just the digital revenue component. It really is the impact it has on our broader portfolio.
That's great and just last one for me is for Sandy.
You've had the opportunity to be in the role now for enough time to maybe you can share with us where do you see yourself, making the biggest impact or the biggest focus and.
Maybe you can comment on working capital to sales because it's it's been improving but you know my sense is there's still lots more you can do there, but would love to hear your thoughts.
Yeah.
Dean Thanks for the question I've been here now for four months and.
It's been really interesting I think.
I'm still very excited about the opportunity for growth.
Typically by scaling our digital portfolio.
And that's you know that's a journey that I think we're making good progress on and very encouraged about the collaboration across the organization that there are digital opportunities that span the full full portfolio.
Also thank you.
Your net your work is never done around continuous improvement and so there certainly is opportunity for us to continue to drive margin expansion, whether it's through conversion cost projects further optimizing our footprint, there's there's opportunity opportunity.
There.
Turning to your question on working capital you know I think that the team did a terrific job on that this year in in.
In years, where your revenue growth declines, it's difficult to make improvements on a percentage basis and the team did a super job on collections, bringing down our our past dues.
And we need to shout out and recognize our operations team on how they effectively managed and controlled controlled inventory. So you know as we as we return to growth next year working capital will be a little bit of a headwind we're going to continue to drive continuous improvement initiatives.
Whether it's scaling our some of our financing programs with our suppliers and other efforts, but I think we're you know we're exiting in the in a pretty good spot there and.
Good day and thrill.
And not to not to belabor it but.
Just to remind all of our investors debt our three primary.
<unk> annual incentive.
Plan metrics, our organic revenue growth.
Operating margin operating income and it's free cash flow conversion of which the.
The single biggest driver there is working capital.
As a percentage of revenue so I just want to make sure we.
It reminded all of our investors that we're not you know.
We're not taking our foot off of working capital in any way share perform.
Great. Thank you.
Thank you.
Yeah.
Our next question is from the line of Andy Kaplowitz with Citigroup.
Hey, good morning, guys.
Good morning on this morning.
Patrick So I think we can all understand why xylem is performing so well in China, given the relative strength on that economy, but what's a little more difficult to understand why you are performing so much better consistently in western Europe than you are in the U S. I mean COVID-19 interruption.
Some parts of Europe is just as bad as here. So what is it about your business, that's allowing you to outperform in Europe versus the U S.
Yeah.
Part of this is.
On a timing issue for the U S.
We're in the early stages of recovery there.
It also is as.
As you know Europe traditionally has been more stable.
In terms of how utilities are focused on their spending and how they how they plan on.
Their budgets accordingly.
We also benefit from.
A very strong share position.
In Europe, and so when that's the case you know the level of aftermarket recurring revenue.
That's us.
No quite significantly there.
I wouldn't read too much into.
The I wouldn't suggest that Europe is going to outpace the U S overtime on it really just more a matter of timing right now.
So Matt one.
And then our guidance that is a little bit is mix too. So in Europe. Our concentration is heavier on the wastewater side and that has been especially resilient during the pandemic and as we move through 'twenty and 'twenty. One we are expecting to see progress on clean water, especially as we can start rolling out those deployments.
That's helpful. And then this is probably for Patrick or San Diego, you had talked about $80 million I think of permanent cost savings in 'twenty. One there was $60 million of temporary cost savings that would come back in some way maybe you could talk about the buckets of savings day, you know our implied in that 'twenty. One forecast that you now have what are you assuming for inflation.
Cause if I look at the incremental margin that you are forecasting it doesn't look like it's equal to gross margin, even so there must be a sizeable inflation component in there.
Yeah. So I think there is there's multiple elements to that cash.
That question, let me try to break it down down for you in a couple of different couple of different pieces.
So you know I'll start with restructuring this year, we did take aggressive restructuring actions and.
We realized about $70 million of savings from those structural programs as we look forward into 'twenty 'twenty, one we're expecting a similar level.
We have some further programs in Europe that haven't been completed yet both related to footprint migration as well as overall efficiencies.
But we do certainly expect to get those done in 2021 and that will help us from a year over year perspective.
Discretionary costs is another bucket that we are we are focused on and as we look you know year over year, we took about $60 million of cost out from discretionary categories like travel and entertainment services marketing et cetera.
And our 'twenty 'twenty, one plan contemplates that about 40% of those costs will return.
And then I would say that you know the third third part of your question Youre starting to touch on inflation, which is probably the most challenging part of the the equation.
As you know we saw a very stable inflationary environment for most of 2020.
Do you start to see that pick up at the end of 2020, and you know we're seeing that debt that pressure continue in 2021.
Our teams have gotten a little bit in front of that so we have announced price actions that have been implemented in the first quarter.
But the inflation around materials is something that we are watching very very closely.
And I would just add that.
You know it.
We're clearly looking at the level of uncertainty here in terms of what inflation is likely to be and we're trying to be appropriately kind.
Kind of measured.
And how we are reflecting that in our guide for the year.
You know this is not unchartered territory for us in terms of the whole price cost dynamic.
We've been here before.
Back to the tariff.
Time frame.
Our price realization were expecting that along with productivity will offset material and.
And labor inflation.
We've got a very strong improvement procurement team.
And they are in lockstep with our commercial teams on making sure that we've got that debt.
Matt highlighted.
So again as Sandy said, we're already using pricing actions on the impacts are different across each one of the segments.
Based upon the impact on commodities, but we just felt it would be prudent.
Two to guidance that we've done.
Patrick you had 60 basis points in Q4, I would assume that you get a lot more price on that you know for the for 'twenty 'twenty one share.
Yeah, I think that's I think that's a fair fair assumption.
Thanks, guys.
Thank you.
Our next question is from the line of Scott Davis with Melius research.
Hi, Good morning, everyone, Patrick Sandy on Hey, Scott how are you doing 20 Scott.
Good.
Most of my questions have been asked but if you look at your Capex guidance looks like up about 20% were.
Where's the dollar.
Where's the money being prioritized maybe just.
Some examples of projects or geographies or areas that you're focused on right now.
Yeah. Thanks. Thanks, Scott you know I think as we move through the pandemic, we certainly clamped down on our spending around capex in in 2020, and our outlook for Capex for 2021 is very much in line with our historical historical spend levels.
You know I think that a lot of our capex deployment is tied to our growth strategies and we're making investments on the digital side, we're making investments in emerging markets, we're making some investments in our manufacturing centers to drive continuous in improved.
Link and so you know, it's something that we're going to watch closely throughout the year and make sure. We phased that increase accordingly, you know as we see recovery will we'll start to release incremental capex dollars to position us for growth in 2022 and beyond yes, Scott I would say.
Just add to Sandys point, we're going to continue to.
To manage the phasing on Capex, we will see how the year plays out in terms of market recovery. There is no there's no one or two big Bang on.
Capex projects that are in there.
Its pretty well distributed.
Very much is tied to growth. So I would just reinforce what sandy said its localization within emerging markets.
It's some upgrade in terms of continuous improvement and a few of our factories, but it also is a paramount tied to all the work that has to be done to support some of the large deal wins that we have within Mcs.
Okay. That's really helpful. And then I know working capital has been kind of beat to death, but sandy since you're relatively new its.
Fresh set of eyes on this stuff, but is there any on us.
Structural reason why I always think of working capital being a percent.
China sales on the kind of 14 per cent or lower being getting them into.
The territory of the best run companies is there any structural reason why that number can't be down towards kind of.
Because I said more best in class levels.
Yeah, you know I don't think there's any structural reason I think we're going to continue to work at dish and I think that the company made steady progress over the over the years and it's definitely something that we're not losing focus on where we're not satisfied.
But you know we're going to continue to drive that that journey are.
Our biggest challenge Scott.
It is kind of within the water sector.
Is.
We still have work to do to simplify our supply chain.
And that has an impact on inventory levels.
So I would say if you look at our receivable book performance on payable performance.
Pretty much in line there theres some opportunities there, but it's not that's not really going to move the needle. It really is structurally on the inventory side and that's work that Tony Melinda on our supply chain team have been very much focused on it made good improvement, but there's still in my view a fair ways to go.
That makes a lot of sense to so thank you and good luck for 'twenty cash. Thank you Scott and highest Patrick thank.
Thank you.
Our next question is from the line of Nathan Jones with Stifel.
Good morning, everyone.
Hey, good morning day Corning.
A couple of questions a follow up really on on the margin side of this if I look at your guidance. The top end of revenue guidance and the talk is about where you were in revenue in 2019 on the top end of the margin guidance is still about 100 basis points below where you were in 2019.
140 million of structural cost taken out of the business during that time, you said price and productivity offsetting inflation. So can you fill in the blanks there on on where the gap is between where margins are expected to be in 'twenty, one buses, where they were in 19 on roughly the same revenue level.
Yeah.
Yeah, you know I think I think Nate you you know you hit on a lot of the points there and you know as we've modeled out 'twenty 'twenty. One we are modeling in good incremental margins to the to the portfolio.
Some mix differences as we as we exit them.
M. A C S has been a.
A little bit delayed from a pandemic recovery perspective, and once we get that back on track and growing youre going to see margin expansion ramp ramp back up.
You know I think the other thing is we're continuing to make investments on the on the digital side and.
Those are prudent investments and we're phasing them throughout the year I'm in line with the recovery, but I would I think that's probably the one the one piece that you may be overlooking in the in the model data I think the other piece I would I would I would say is it's really important.
To focus on and we can certainly give more clarity on this.
Second half versus first half what the what the exit.
Rates are in terms on both topline growth and margin.
And what can it looks like Youre looking at the full year average.
I'll take that color then maybe you can talk about the differences in growth rates and margins in the first off on second half.
[laughter], Yeah, let me, let me take the first crack at that and then Patrick can chime chime in you know I think as we think about the quarter sequential trends through 2021, Yeah, you almost have to think about how the pandemic.
Packed at our businesses and regions throughout the throughout the year and you know so I think right out of the gate in Q1, I think what's important is that we're going to return to growth and youre going to see meaningful margin expansion you know from a margin perspective, the biggest growth happened.
In the first half of the year because as you saw our margins were much stronger in Q3 and Q4 than they were in the earlier part of the part of the year.
And then you know I think as we focus on drill down on them and so yes. It's it's the deployments in the second half that from a dollar a dollar value perspective starts to accelerate and you know as we exit 2021 again, I think our revenue and margin levels will be very much in line with what we experienced in 2019.
<unk>.
Do you think Mcs exit the year at double digit margin.
Operating margin.
I you know I wouldn't I wouldn't I would say, Matt can probably more high single digits.
Again, we're talking operating margin not yep yep.
On the lot of day in any of that one okay.
Okay.
Is it on.
Okay.
Net.
Our next question comes from the line of salary for a day ski with Jefferies.
Thanks for taking my questions just a follow up on them on the previous question for you on margins for 2019 levels. I would've also thought you would have had an FX benefit to margin. So you could just quantify or how youre thinking about this.
Yeah.
Yeah. You know you know FX is one of our key key variables and you know a.
Key assumptions and you know we've guided to a one point to two.
On Euro to dollar conversion rate you know I think the way that I think about FX. In particular is that you know you're always the most incur most important currency pair for us and you know a 5% variation in the euro drives about $50 million of revenue.
From and about $20 million on margin.
So I think that's that's a good way to frame it.
Great. Thanks, that's helpful. And then could you provide some color on what you saw on the dewatering business in the quarter on whats driving the expectation for an acceleration through the year and she does drive improvement in the margin performance in water infrastructure as we go through the year as well.
Yeah. So we do expect the activity and dewatering to ramp in the second half of 'twenty one.
Part of that is.
We put some more <unk>.
Just to get a price models in place that are going to be driving high margin rental.
Because we went through really is a key focus area there for us.
It really also is tied to what we're expecting in terms of the North America industrial and commercial.
Business.
We've seen quite encouraging performance in January.
With opportunities not only in the U S. But also growing in western.
And southern markets.
Three we'd expect about flattish to low single digit growth for for 'twenty one.
Your last point.
Great. Thanks on the color.
Thanks, Thank you.
Okay.
Yeah.
Your next question is from the line of Pablo Bullshot marching on.
With Raymond James.
Yeah, Thanks for our fleet.
Taking the question you referenced the appetite for M&A, but you also said youre going to be disciplined.
Suppose as we're getting out of the crisis phase of the pandemic, Inc into a recovery.
Uh huh.
At night, all else being equal make valuations in water Tac even higher.
Then a.
Have been in recent years.
Uh huh.
It depends on on the sector within the water space, obviously things that are of a higher digital nature.
That has more of a recurring revenue SaaS nature of the model across any sector. Those are always going to have higher multiples on premiums.
I think we're we're proud of the work the teams done and a number of these areas that we look at our relationships that we built over a number of years.
And so a number of these things don't actually go through an auction process.
And that's really where I think.
The seller fine Xylem, Inc to be an attractive partner.
Because of our global breadth of our channels to market.
Net of our portfolio.
And again, we tend to look at.
Some of the smaller M&A to be really a proxy for R&D.
And so on.
Again, we're going to be we're going to be disciplined.
In this regard, but no I'm still very encouraged by what we see in the pipeline.
Okay.
That's kind of a broader question.
We're seeing or hearing lots of talk in Washington about infrastructure and in your on the next generation E U.
Has an infrastructure program.
One of its components.
I'm curious kind of to what extent you expect as a company to benefit as these infrastructure stimulus.
You should begin to actually materialize.
Yeah. So I mean, we're generally positive on the early indications from the New administration.
Having said that it's far too early to know anything beyond intentions and policy outlines.
<unk>.
We're not assuming or.
We are building into our forecast anything for an infrastructure bill.
Because we really need to see what ultimately is scoped in.
But again discussions and indications on plans thus far.
Do seem to include water.
As part of that focus, which we find obviously very encouraging.
But our utility customers have also make clear with us that they are not assuming or planning for it and.
And again, they would say we've seen that moving before with.
With previous new administering new administrations that came in but clearly if and when we do see something on infrastructure, that's going to be a big net positive for us.
Given that our portfolio touches nearly all parts of the water cycle.
Right.
Got it.
Thank you.
Yeah.
Our next question is from the line of Joe Giordano with Cowen.
Hey, guys good morning.
Good morning, Joe Good morning.
Patrick has touched on M&A, a couple of times I'm just curious like.
M. CNS is a business for you guys that youre trying on arguably less complicated.
And like how you feel about adding.
To that business and making it at least near term more complicated.
Yeah.
I wouldn't look at it in terms of adding complexity to MMC up I think the way that we the way we think about it is just adding to the portfolio of solutions that we can bring to most notably the clean water side of the utilities.
And so as we are in there and doing complicated work week.
We continue to see areas of opportunity, where we can bring more digital.
To the portfolio. So I wouldn't look at it is adding complexity I take your point obviously.
Anytime that we look at smaller startups that we add to the portfolio.
Selling them.
Getting channel the market, obviously is one of the big synergies that we bring.
But we do that with great confidence.
And then last for me just on dewatering.
Can you just talk about what's going on underlying in that market I know, there's been a lot of competition on the on the construction element you guys, maybe trying to reposition how does that maybe a little bit away from that into more I'd like to mining and stuff like that but what how is that playing out because I feel like they're within energy and mining and you had to shut down quarter with.
With construction activity, so I thought the comps would be pretty good in that business, that's relative to like the flattish guide there.
Yeah, Yeah, I think you're right Joe I mean, I think we're expecting that the business is going to start to come back and be positive for us. This year I think we're a little cautious on calling that we have also seen that movie play out before and so that's that's one that we'd like to see.
The activity really come back I think the.
There is normal seasonality in some of the North America side in the in terms of weather and doing some of that construction and industrial activity.
Part of it's lagged a little bit because of Covid to Joe because if you think about this as a very much a people driven business. It's it's very much hand to hand.
Out in construction.
Construction yards, and so forth and so as they're not able to get out.
On site and do some of that work then you know theres been some some noise. There we expect it's going to come back though.
And in in 'twenty, one yeah, Q there'll still be some pressure in Q1.
From a from a COVID-19 perspective.
But in the second half of the year, where we're expecting that it's it's it's more neutral.
Thanks, guys.
Thanks, Joe Thanks.
Okay.
Our final question is from the line of John Walsh with Credit Suisse.
Hi, good morning.
Good morning, John.
A lot of ground covered obviously very strong cash performance.
In 2020, I just had a question about.
How to think about the absolute free cash flow for next year.
You gave the conversion ratio I think there's usually some adjustments obviously to net income that you provide in the reconciliation.
Is it as simple as doing the math on the adjusted net income or are there some items that we need to think about in terms of a pad.
Add backs when we do the conversion ratio.
Yeah Yeah.
I think that we did we did give you an outlook on what we expect to spend from our restructuring and realignment perspective, and you know we also provided you with the with the tax rate.
So I think we've given you all the inputs to Tim to model, but you know I think big picture.
If you look at 2019 through 'twenty and 'twenty, one we expect free cash flow conversion to be 130%, which is which is very healthy I think there's you know there's three discrete headwinds for 2021. The first one we talked about earlier on the on the call is as we return to growth will be.
Some add back from from working capital, we talked about resuming capex to be more in line with historical levels and you know I think the third one is more unique to 'twenty and 'twenty and 'twenty 'twenty, one and that is you know there were a number of liability categories.
On that we benefited from the timing on and you know that benefit was about $75 million in 2020.
Two thirds of that will reverse next next year, but I think that that's largely a one time phenomenon and so yeah 80 to 90 is lower than our historical target, but three years being at 130 I think it is a good spot.
Great Yeah, no that's very helpful color on those those moving pieces.
That's all I had appreciate you taking the question. Thank you.
Thank you.
I would now like to turn the call back over to.
Patrick Decker for closing remarks.
Thanks, Phil.
I appreciate we all appreciate the continued support and interest.
Thanks for joining the call today.
I want to wish you, all a happy and healthy new year Oh I.
I know we're already it's hard to believe we're already more than a month into it but again hopefully it all your families and friends are safe and sound.
Look forward to catching up with you.
Sure.
And in our next earnings call and as we said earlier, we'll be we'll be scheduling and planning an investor and analyst day sometime later this year and we'll get back to you all on Matt. So thank you all very much and have a great weekend.
Thank you. This does conclude today's xylem fourth quarter and fiscal year end 'twenty 'twenty earnings Conference call. Please disconnect. Your line at this time and have a wonderful day.
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