賽莱默 (XYL) 2019 Q4 法說會逐字稿

Welcome to the Xylem Q4 2019 Earnings Conference Call.

(Operator Instructions)

I would now like to turn the call over to Mr. Matt Latino, Senior Director of Investor Relations.

Thank you, Lisa.

Good morning, everyone, and welcome to Xylem's Fourth Quarter and Full Year 2019 Earnings Conference Call.

With me today are Chief Executive Officer, Patrick Decker; and Chief Financial Officer, Mark Rajkowski.

They will provide their perspective on Xylem's Fourth Quarter and Full Year 2019 Results and discuss the full year outlook for 2020.

Following our prepared remarks, we will address questions related to the information covered on the call.

(Operator Instructions)

As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website at www.xylem.com.

A replay of today's call will be available until midnight on March 7. Please note the replay number is (800) 585-8367, and the confirmation code is 4880738.

Additionally, the call will be available for playback via the Investors section of our website under the heading investor events.

Please turn to Slide 2.

We'll make some forward-looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future.

These statements are subject to future risks and uncertainties, such as those factors described in Xylem's most recent annual report on Form 10-K and 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.

Please turn to Slide 3. We have provided you with a summary of our key performance metrics, including both GAAP and non-GAAP metrics.

For 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 4, and I will turn the call over to our CEO, Patrick Decker.

Thanks, Matt, and good morning, everyone.

Let me start with some reflections on 2019's full year results and our progress as a company.

Then I'll turn it over to Mark for additional detail on the fourth quarter, and we'll round 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 and end markets.

But the year presented a dynamic market environment, and second half conditions were clearly more challenging.

I was pleased with the agility of our teams in adapting to those changing conditions, and we were able to deliver full year organic revenue growth of almost 4%.

Solid performances in utilities and in our U.S. and 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 and up 9%, excluding the effects of foreign exchange.

The fourth quarter unfolded much as we foresaw in our October earnings call, and the team's agility and discipline delivered over performance on cash with free cash flow conversion of 124% against a 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 are well positioned for 2020 and beyond.

We have good visibility of our pipeline of business, and we 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 initiatives to lift the growth profile of the company back at our original Investor Day in 2015.

At the time, the company was delivering low single-digit growth.

Our emerging markets contribute roughly $750 million of total revenue.

Our Vitality Index, which is the proportion of sales comprise of new products launched in the last 5 years stood at just 18%, and we weren't yet in the metrology or digital solutions businesses at all.

So now 5 years on.

Emerging markets are now well over $1 billion with China growing more than 50% and India more than doubling over that time frame.

We've also placed Xylem at the cutting-edge of innovation.

Our investments have brought many of the industry's leading technologies into our portfolio.

And the M&CS 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 was until recently a fragmented proposition is now an executable reality for our customers.

AIA's double-digit orders growth in 2019 shows the customer enthusiasm and demand.

Our job in 2020 is now to deliver on that reality and lead this sector in helping customers capture latent value in their networks.

Our annual revenue is now $5.25 billion, and we have set a consistent pace of mid-single-digit organic growth over the last 3 years.

Of course, our emphasis on growth would be a double-edged sword if we had diluted margins along the way.

But we've done the work to become 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 delivered approximately 250 basis points of EBITDA expansion in the last 5 years, even as we invested to reach in the new geographies and new product segments.

And we've been able to deliver an average 13% compound annual growth in EPS over the last 5 years, significantly improved versus the previous 4 years.

EBITDA has increased by 65% over the same period.

As we digest the large deals at the front end of new growth, and as CapEx shifts to aftermarket and recurring revenue streams in the next several years, we do expect the margin profile of our growth to become even more attractive.

At the same time, we brought focus and rigor to operational execution, developing the capability I mentioned a moment ago to deliver favorable bottom line outcomes even in unfavorable market conditions.

Just 1 example of that is our increased discipline and cash generation.

We've delivered average free cash flow conversion of 108% over the last 5 years, largely by driving down working capital from 23% to 17.5%.

I expect focused 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 Xylem's business strategy.

Not that long ago, our sustainability goals were sincere and ambitious but they were largely about reducing our own environmental footprint.

Today, we're equally focused on 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 built aggressive industry-leading commitments into our sustainability 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've built and the trajectory we've established give us a balanced view towards 2020 and beyond.

We are 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.

In 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 year and into 2021.

We'll talk about that forward view shortly, including some more detailed guidance on 2020.

Review to the drivers of our 2019 full year results is on Slide 5. I'm happy to address any of that in more detail in the latter part of the call during Q&A.

But now I want to turn it 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 the third quarter persisted and slightly worse than we expected.

Top line growth continued 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 soft, 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 end of the year certainly influences our view on top line growth for the first half of 2020.

As we look at 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 dynamics we experienced at the end of the 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.

I'll cover end market dynamics in more detail as we move through the segment discussion.

Operating margin was 15%, down 10 basis points versus the prior year.

I'll also review operating margin performance by segment in a moment.

But as we look across the businesses, weaker-than-expected volumes and unfavorable mix, particularly from the double-digit declines in our high-margin dewatering business, negatively impacted the quarter's margin performance compared to our expectations.

While disappointed in our revenue growth and margin performance in the quarter, I am pleased with the team's operational execution and cost discipline to deliver strong cash flow to meet our commitment on earnings per share of $0.89.

Please turn to Slide 7, 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 dewatering business as well as timing on large project wins.

Total shippable backlog in the segment exiting 2019 is up 7%.

Backlog shippable in 2020 is down 1%, while shippable backlog in 2021 and beyond is up double digits.

Reflecting a near-term softness expected in the first half of 2020, along with a strong backlog of 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.

While we expected the dewatering business to be down in the quarter, rental revenues in North America declined 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 of the 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 and 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 and productivity, more than offsetting the second half volume declines and weaker revenues.

Next, please turn to Slide 8. Applied Water revenue declined 2% in the quarter, driven 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% in the quarter with tough compares, driven by the timing of prior year shipments related to price increases for tariffs in the U.S. as well as some slowing demand in Western Europe.

Residential was down low single digits in the quarter, driven by economic softness in Europe.

The U.S. residential market was a bright spot up 6% in the fourth quarter and up 10% for the full year, driven by modest share gains and 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 were 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 expansion amid market headwinds and tariff impacts by driving 250 basis points of price realization and 400 basis points of productivity across the business.

Now let's turn to Slide 9, and I'll cover M&CS.

Measurement & 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 Sensus, and partially offset by modest weakness in the analytics business and project timing in AIA.

Segment backlog exiting 2019 is up 8%.

Shippable backlogs 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 are up double digits.

Providing confidence on revenue growth momentum in the back half of 2020 and into 2021.

Sensus revenues in the quarter grew 4%, driven by growth in Water and energy metrology deployments in emerging markets, all while lapping a tough compare, 13% revenue growth last year.

Advanced infrastructure analytics revenues declined 3% in the quarter with several project pushouts.

Orders were also down in the quarter.

Although, it's worth noting that this is coming off a third quarter with nearly 85% organic orders growth.

Full year orders, revenue and backlog were up double digits.

We expect to continue to see relatively lumpy revenue and orders growth on a quarterly basis as we scale this project-driven business.

Segment EBITDA margins in the quarter were up 80 basis points to 18.1%, and segment operating margin increased 20 basis points to 7.7%.

Net productivity benefits and price realization were 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 of productivity, volume leverage and 80 basis points of price realization.

Now let's turn to Slide 10 for an overview of cash flows and the company's financial position.

We closed the quarter with a cash balance of $724 million.

We invested $51 million in CapEx in the quarter and returned $43 million to shareholders through dividends.

Working capital also improved significantly versus 2018, ending at 17.5% of sales.

This is a 150 basis point improvement from last year driven by the team's focus on operational efficiency, significant reduction in inventories and solid improvements in accounts receivable, collections and payables.

Our cash conversion cycle improved by 5 days in 2019 with a strong second half push, which enabled us to grow free cash flow 75% for the full year and deliver free cash flow conversion of 124%.

Lastly, we also announced an annual dividend increase of 8%, representing our ninth consecutive annual dividend increase.

Please turn to Slide 11, and Patrick will cover our 2020 outlook.

Thanks, Mark.

Given the slower revenue growth and mixed outcomes 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 of 2019 is a 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 are also taking into account the revenue profile of our highest growth businesses, including treatment, Sensus and AIA and our 2 fastest-growing emerging markets, India and China.

Because these businesses deliver a higher proportion of large CapEx-intensive products, we've 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 of 2 halves.

In the first half, we see flat to down organic growth in utilities.

This is primarily due to tough year-over-year comparisons.

You may recall, U.S. utilities was up mid-teens in the same half last year, and we're also lapping several large projects in the same period.

In industrial end markets, the muted conditions experienced in the second half of 2019 are expected to constrain our short-cycle book and ship business at least through the second quarter.

Although, we anticipate this continued softness as we exited the year.

Since then, events in China have further hampered our short-term outlook.

The impact of the coronavirus has, for the time being, essentially halted deliveries within China, which is our second largest and fastest-growing market, and it's slowing trade in Asia more generally.

As of today, our best view is that the first quarter impact of the coronavirus to the company is likely to be approximately 1 to 2 points of revenue in the quarter and $0.03 to $0.04 of EPS.

It's obviously a dynamic situation, and we are monitoring it very closely.

In light of those first half challenges, we're being cautious in 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 momentum in the second half and into 2021.

In utilities, we have clear visibility of significant growth from deals in hand in the second half of the year, including a half dozen large Sensus AMI deployments.

We also expect double-digit growth in the second half of the year in 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 quarters will also be lapping the soft second half we've just experienced, getting both quarters the opportunity to build on favorable year-on-year comparisons.

In short, in 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 2020 with low single-digit organic growth, benefiting from a recovery in the second half of the year, as U.S. 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 of full year 2020 organic revenue growth in 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 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 cost 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 that we expect to continue delivering healthy cash generation through the year.

By the end of the year, we foresee having approximately $1 billion in cash on hand.

Given the growth in our cash balance, there has been understandable interest in our stance on capital allocation.

Alongside organic investment, M&A remains a top priority, and we do see opportunity for some investments 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 on both the first quarter and the full year.

Thanks, Patrick.

On Slide 13, we've provided our 2020 planning assumptions as well as the profile of the first and second half market dynamics, which Patrick just reviewed.

In the first half of 2020, we expect revenues to be down low single 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 the segment enters 2020 with weak order trends and lower shippable backlog.

In the Measurement & Control Solutions, we expect 4% to 6% growth with strong second half revenues related to project deployments, offsetting lower first half growth against tough prior year compares of 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 1.11 which was the average for the month of January.

Our FX sensitivity table is included in the appendix.

Our estimated tax rate for 2020 is 19.5%.

Noncash pension income is expected to decline by $15 million or $0.07 per share due to the planned buyout of our U.K. pension plan.

Expected 2020 EPS of $2.96 to $3.16 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 backlogs down 3% and at least 1 to 2 points of revenue growth impact from the coronavirus 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 180 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 Sensus North American metering business in China.

EBITDA margins are expected to be in the range of 14.1% to 15%.

We see EBITDA margins breaking 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 of 16.2% to 17.1%; and M&CS 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 to 2020 sees us emerging from 1 year of 2 halves and entering another year of 2 halves.

Despite near term uncertainty, 2020 presents a balanced picture.

There are still some muted market conditions in the short term.

But as we look towards the second half of the year, our backlog and our line of sight to the timing of 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 tenets of our investment thesis.

We expect to continue to deliver attractive top line growth from our investments in the capabilities and solutions that enable our customers to transform their businesses.

We remain committed to 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 increase 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 31.

We look forward to sharing more detail on our technology and solution capabilities, discussing our growth plans and hearing directly from some of our business leaders and customers.

I'm hoping to host as many of you as possible then at our Data Analytics Center of Excellence in Atlanta, Georgia.

Now, operator, we'll turn the call over to you for questions.

(Operator Instructions)

Your first question comes from the line of Ryan Connors with Boenning and Scattergood.

I think you covered a lot of the details pretty well.

I had a couple of bigger picture questions, actually.

Now the first 1 is, just strategically, obviously, you're transitioning here to a bit of a different period headwinds may, in fact, be transitory, but cost control and restructuring is becoming a more important part of the story right now, especially in the near term.

So obviously, you've 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 in cost control and restructuring relative to R&D investments and other things?

You talked about the Vitality Index?

And how you ensure that you don't lose that momentum on innovation and R&D and product development as you kind of rationalize things?

Go ahead.

Yes.

Ryan, it's Mark.

I mean, it's a great point, and it's certainly something that we pay close attention to.

At the end of the day we're going to create the most value by growing.

We need 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 -- are going to be roughly $40 million.

We're continuing to look at opportunities.

We continue to drive cost out through great work that all of the teams are doing through Tony Milando's leadership and -- are under continuous improvement.

There's savings that, while a little bit late 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 at all.

Yes, Ryan, I -- it's a great point.

And I think that, first of all, we still see there to be a high level of continuous improvement opportunities across the company as we've deployed Lean Six Sigma starting -- handful of years ago, but we're still in the early stages, quite frankly, from my perspective on where the opportunities are, especially beyond the 4 walls of the factory but across the rest of our P&L.

But we are definitely going to be investing through this near-term noise.

We adopted a handful years ago, what we call a productivity for growth mindset, where a meaningful portion of our productivity has been invested for growth because we believe this is a long-term game to your point.

Okay.

And then my other was -- my follow-on was related in that.

If you look across the industrial landscape the last few years, it seems that this sort of portfolio pruning kind of targeted divestitures have become a popular strategy for companies in the facing tougher times.

Lots of peer companies going that route, whether they call it realignment or pruning.

Is that something that's on your radar?

Or are there any lower margin brands or businesses that they -- you would consider offloading?

Or is everything you have considered kind of core?

Yes, Ryan.

So we take at least an annual review, if not even more frequent than that.

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, there really are -- while there are in businesses that might be dilutive at times and cycles to growth.

There's nothing right now that is anywhere close to not delivering its return on capital above the cost of capital, so everything clears the hurdle at this point in time.

But it is something that we look at on an annual basis at a minimum.

Your next question comes from the line of Deane Dray with RBC Capital Markets.

Patrick, I was hoping you could give us some high-level thoughts on guidance here.

I think you've done a good job explaining the dynamics first half, second half.

But I'd be interested in hearing if you've taken any different approach this year to setting guidance, maybe along the lines of embedding some more conservativism, some -- maybe some implied contingency because there is variability to your earnings stream, especially with the short-cycle dewatering business.

But has there been any change in terms of how you're approaching guidance?

Yes, I think that Deane, as we -- as I look back and reflect on kind of what we learned in 2019.

And as I mentioned before, you just reiterated, a meaningful portion of our business is still short-cycled.

Heading into 2019, we were still feeling pretty bullish based on what we were seeing in the marketplace.

But quite frankly, we should have built in more contingency into that view.

We think this guide is a balance view.

We clearly see near-term headwinds that we laid out, orders soft in Q4, lower shippable backlog coming into the year.

Clearly, the uncertainty with the China coronavirus and some tough comps.

But what gives us confidence about the second half of the year is the projects and backlog that we have already in hand for second half.

And just assuming to get a modest return to growth in the short cycle, again, not a miracle is required in the second half here.

So we do feel it's achievable, but it's appropriately risk adjusted.

Got it.

And then you all are 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 coronavirus.

We appreciate the fact that you've taken this approach.

Maybe just give us some real-time color in terms of how your businesses are being impacted?

You've got $0.03 or $0.04 negative impact.

But is there any other lasting effects that you see in terms of relationships or the types of demand fall off that you're seeing today?

Sure.

Great question, Deane.

Appreciate that you appreciate that we try to be transparent here.

We felt it would be disingenuous not to lay out real-time, as of what we see right now, impacts on the business, given that it is, our second largest business outside of the U.S.

So first, as you all appreciate, the safety of our people is absolutely paramount.

Secondly, we are -- although, we're not advertising it.

We are heavily involved in the humanitarian response in Wuhan, we've been delivering pumps and offering to build water towers there at some of the pop up hospitals.

So that's been very important.

If you say, this is very fluid.

And so what we do know right now is that there would be impact on the shutdown of our factories because right now, we have halted our deliveries.

Again, we don't know how much of that is simply delays versus it will 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's 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 this very closely.

And certainly, we're in a position to give you all updates, no later than Investor Day.

Appreciate that.

And then can then I also ask 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 cut?

We look at -- I see CapEx is up, so that explains some of it.

But I'm concerned, there might be some giveback in the working capital improvements that you did, especially in the fourth quarter.

So give us some context there, please.

Yes, Dean, and thanks for that note.

I -- we were certainly looking to syndicate ourselves after last year.

But a chunk of that was timing, as we discussed.

We had built up inventories.

We had a big ramp-up in sales at the end of the year, high single-digit growth.

And to some extent, while 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 in prepared comments, a ramping up of revenues in the second half.

So there will be, instead of a 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 conversion cycle.

In reducing days, both in inventories, receivables and payables.

And I would just add, Deane, I think -- so there -- 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 spot that we're in with working capital now than we were a few years ago.

I think to your question also on conversion, you picked up on the CapEx, the modest increase there.

And that really is driven predominantly by some expansion plans that we've laid out for India to support the really breakout growth there as well as continued investment in some of the software in the M&CS, but also where other segments -- where much of that gets capitalized.

And so those are really the 2 big drivers for CapEx increase in 2020.

Your next question comes from the line of Nathan Jones with Stifel.

I'd like to go back to some of the guidance, specifically the mid-single-digit expectation in the second half.

I mean, clearly, you're going to have easier comps.

It sounds like you have some shippable backlog there.

Primarily around the MCS kind of stuff.

But I mean, I think there clearly has to be an expectation here that you're going to see short-cycle improvement?

You probably need to see the orders start rolling in, in about the second quarter to ship those in the back half.

Can you talk about where -- for that mid-single-digit growth rate in the back half, what you have in hand?

What's in backlog in terms of these projects versus what kind of improvement you need to see in the underlying environment?

What kind of growth you need to see in order rates over the next couple of quarters to support that outlook in the back half?

Sure.

Yes.

Nate, it's Mark.

I think, it starts with the confidence that we've got, certainly, in the utility space broadly but accentuated in our M&CS business.

There are -- the way the projects work in terms of deliveries year-over-year, they -- the backlogs are much stronger in the second half of the year.

We also -- we're not looking, as Patrick said, for a miracle in terms of recovery in the short-cycle businesses, but they are going up against much tougher compares.

Or easier compare.

Yes, I mean, easier compare.

So 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 as we stay close to our channel partners as well, Nate, especially here in the U.S. that they feel quite good right now about bidding and quoting activity that they're involved in.

And part of the softness they saw in the second half was working down some of their inventory that they bought in ahead of the price increases that we've done, so there's a bit of that.

So more of the pressure that will linger in the second half would be in the industrial business.

And that's the one that we're staying closest to in terms of seeing what that order rate looks like in Q2.

Okay, fair enough.

I'd like to then talk a little bit about mix, both here in 2020 and longer term.

I mean, clearly, you've got some headwinds from stuff like dewatering, it's very high margin.

You're going to have some mix headwinds on these MCS projects as you roll out the hardware initially.

Can you talk about what you anticipate the impact of mix to be, whether it's basis point of margin or however you want to couch it in 2020?

And then if you look forward, I would think, let's say, dewatering recovers and these MCS projects, I guess, the hardware installed move to software.

You should see an improving mix as we go forward over the next few years.

Can you talk a little bit more about what kind of impact we should expect to see that have on margins as you go forward, qualitatively or quantitatively?

Yes.

Nate, it's Mark.

We're going to lay out a lot more of this when we get together in March.

But clearly, it gets back to the story -- it is a story of 2 halves, right?

And our mix, it's really tough given compares in our dewatering business in the first half of the year.

And also, certainly, in the first quarter plus the compares with our Sensus North American water growth.

But that does turn around in the second half, given the project deployments that we see in M&CS, a -- just an easier set of compares in our short-cycle businesses, a little bit more robust growth, as Patrick mentioned, given some of the timing in commercial business services.

And we are expecting to see a better ramp in our digital solutions business.

So it will -- first half, tough, second half better.

But all in, it's probably not a big contributor to overall margin expansion.

Yes.

So Nate, this is Patrick.

You've raised a very important point here, I think, for investors to look at and understand, and 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 recovery in dewatering.

It is very high incremental margins.

But on top of that, we will see the adoption of AIA and MCS overall, which will have very nice accretive margins, higher growth profile.

So that mix is going to be part of our story at Investor Day, but that does not remove us from focusing on what we control, and that is productivity, cost and our investments.

Your next question comes from the line of Scott Davis with Melius Research.

Lisa, maybe we'll come back to him and.

We'll go into the next one.

Your next question comes from the line of John Walsh with Credit Suisse.

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.

I'm just trying to put everything together and looking at what your implied Q1 decrementals are?

And then how we get positive?

Obviously, you highlighted a lot of stuff already around volume, et cetera.

But maybe you can talk about how the savings flow 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 primarily around business simplification, it's GBS 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.

And I mean, any way to kind of quantify an H1 versus an H2 benefit, just so we can kind of help for the modeling purposes.

There's about $6 million of restructuring savings in Q1, John.

Okay.

And then, obviously, I appreciate you gave the details around the backlog shippable into 2020 and also visibility in 2021.

Can you just remind us how firm those orders are?

Like once a customer decides to place an order are there either progress payments or cancellation fees?

Just wanted to understand that a little bit better.

Yes, John.

They are -- these are commitments.

Now in some cases, particularly in some of our larger infrastructure projects, particularly in emerging markets, but not limited to emerging markets.

We do look to get advanced payments.

The -- while the orders are in hand, as long as there's a commitment.

Some of these -- the timing of them can move out from quarter-to-quarter, so that's always something that we need to pay close attention to.

But these are -- certainly, these are things that -- there're commitments for but timing can shift in any given quarter.

Yes.

Very rare, this is Patrick, very rarely would they be canceled.

And when you think about even our metrology deals that we do, especially the AMI side, the economics on these things, the returns on capital for utility, once we got these things approved in their rate case by the regulator are so attractive for them that they -- it would be rare for them to ever cancel one of these, and that's a big part of what we see in the shippable backlog beyond 2020.

Your next question comes from Pavel Molchanov with Raymond James.

You guys alluded to the hefty cash balance that you're expecting by the end of the year.

And in that context, let me ask about the M&A landscape.

You guys are seeing the headwinds, presumably, many smaller players in the water tech space are seeing as much, if not more.

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 could change based upon 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 disciplined on valuations.

And again, make sure that these things are critical to really enabling the strategic growth of the portfolio.

So again, we mentioned earlier, we think there are 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.

Your next question comes from the line of Joseph Giordano with Cowen.

This is Francisco Amador in for Joe.

Could you expand on why you expect the MCS margins to be so low through the start of the year?

And what -- just what your longer-term margin target is for MCS and how you get there?

Yes, Francisco, it's Mark.

It's -- there's a couple of things.

One, your volumes are down, and we'll see some impact on that relative to leverage.

But also mix, as I mentioned in our prepared remarks.

Our North American Water business had a 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.

There's some mix packed -- mix impact there as well.

And the last point, and Patrick mentioned this, despite the soft patch in terms of volumes and mix in Q1, we are continuing to invest.

We've got customer commitments we need to meet.

We also -- we're excited about what the opportunities in the digital 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 to invest in that segment right now, are predominantly again, meeting some of the customer commitments on some product modification for some of the large deals.

We do have some new products that we're looking to roll out this year in the metrology space that we think are going to be very exciting.

And then lastly, continuing to invest in building out the 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.

And then just as a follow-up, are you seeing any aggressive pricing by competitors in the dewatering market, having an impact on margins?

And do you have any color just on the competitive landscape here?

Yes, I think the dewatering space is -- 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 really helps lift margins in that business is just the emergency nature of it, and how critical the services are to customers when they are in need.

And obviously, as volumes are softer, it's even more competitive.

Your next question comes from the line of Brett Linzey with Vertical Research Partners.

I 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 it pretty balanced between Q3 and Q4, or is it pretty loaded up in the tail end of the year?

No, it's fairly balanced.

And it is certainly a component, but we have a global business, and we see continued improvement in just recurring revenue in replacement of meters as well.

So -- but the thing that really makes the difference is a little bit easier compare and more robust backlogs that are pretty much evenly expected to deploy across Q3 and Q4.

Okay.

Is there any way you could quantify the size of the projects and, let's call it, what we know points to the year or absolute dollars?

Yes.

The growth in the deployment of these larger projects is it's mid-single-digit plus impact.

Okay.

Got it.

And then just shifting back to the restructuring question.

Go ahead.

Go ahead.

Yes.

Okay.

Yes.

Shifting back to the restructuring question.

I am a bit surprised given the softness and some catch-up on the simplification efforts here and doing more from a restructuring standpoint this year?

Maybe just the thought process there?

And then how you're thinking about the drop-through on savings and payback timing?

Yes.

The savings, we discussed -- have always been phased.

It doesn't happen all at once.

The programs that we undertook from a simplification perspective last year in Europe and North America.

We're really rolled out as we saw things moving in the back half of the year.

So we start to see that ramp up in -- throughout this year.

We saw some benefits at the end of last year, but 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 of last year that we had announced that really began to benefit second half of the year and trails a little bit into this year.

That phase was done, that was kind of Phase 1 in Europe.

We had a Phase 2 in Europe that we launched in 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 have to be managed.

We expect those to happen in the second half of the year.

So there's always a bit of phasing here in terms of when a program gets launched versus when it gets rolled out and deliver savings.

Your next question comes from the line of Brian Lee with Goldman Sachs.

I guess, just first off on the margin front.

I know this has been something you guys have, obviously, been highly focused on -- a couple of moving parts here.

But if you could just help us -- you had been talking about, I believe, 100 basis points of EBIT margin expansion in 2020, originally.

Now the target midpoint is more like 30 to 40 basis points year-on-year.

I appreciate there's a lot of moving parts here.

But to the extent that you can, any sense that you can provide on kind of the bridge between the old and new views, how much is lower volume?

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 a fair amount of time on this at Investor Day to really kind of lay out how we're thinking about margin expansion.

Clearly, we are still deeply committed to margin expansion through productivity, shifting mix in our revenue portfolio and still some other cost takeout opportunities, so we'll walk through that certainly at Investor Day in a bit more depth.

I think the biggest drivers here, thematically are the challenges in our 2 highest margin businesses, that being dewatering, and certainly, the slower -- the slow ramp-up of conversion of orders to revenue on digital solutions.

We believe those are simply transitory, but we'll walk you through that at Investor Day.

Mark talked about some execution delay that we had 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 parts of 2020.

We've also continued to invest for growth.

So we've not pulled back on R&D or other investments to grow these faster growing businesses.

But again, we'll 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'll look forward to that.

And then maybe just a housekeeping question for Mark on -- I noticed the interest expense assumption for 2020, it's coming down about close to $10 million year-on-year.

Any assumptions there embedded on refinancing or paying down debt through the year?

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, we've managed our interest rate risk through swaps and other programs that are certainly benefiting us a little bit this year in the back part of the year as well as a full year benefit into 2020.

So that's just the effects of that interest rate risk management program.

Your next question comes from the line of Andrew Kaplowitz with Citi.

Patrick, Patrick or Mark.

Your rental business was starting to weaken when you reported last October, I think you said it was down 17% in Q4.

You mentioned tough storm comparisons, weakness in oil and gas.

Have you seen the rate of decline in rental stabilize at all yet?

And what are your rental teams telling you about the incremental weakness in that market and when it might subside?

Yes.

So the -- if I follow your question correctly, the -- you have to really break the watering 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 drop there.

And that was largely driven by reaction on the part of our distributors, they were seeing -- what they saw CapEx uncertainty -- they run to cash.

They are small distributors typically, and so they got skittish understandably and pulled back.

Our rental piece continue to grow modestly during that time frame.

Now we have, again, seen that weakness continue in that part of dewatering for -- heading into this year, that's why we're trying to be cautious in terms of how we guide that business.

I think the -- at this point in time, we are still seeing broad-based industrial weakness, and 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 guide here.

Yes, and I just add a little more color in terms of so what changed in the fourth quarter.

The rental -- we expected some rental weakness just based upon what we were seeing in our distributor channels and on the sales side.

In the fourth quarter, it was weaker than we expected and really for 2 reasons.

One, we -- that the -- our shipments into customers in the oil and gas space were down more than we expected and some of that had to do with bankruptcies and oil refinery explosions.

And then there was a big year-over-year decline in rentals related to storm events, so both of those were more than we expected.

We -- 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 period, particularly when you look at the tough compares that we had in the first -- to the first half of 2019.

Great.

And then just -- I wanted to ask you about MCS in the context of the timing.

Revenue growth in Q4 was up 2. I think you said shippable backlog in the 2020 was down 4%, but up double digits for 2021.

So you mentioned difficult comparisons, but has something been happening either in the quarter over the last couple of quarters to, sort of, further slow down decision making, or customers just more hesitant to take on these digital projects, given they're worried about the economy?

Is that what it is?

Is it labor availability?

What is it that's slowing it down?

Yes.

Well, I think we have to break it down between -- it's hard to talk about M&CS as one, it's not 1 business line.

So the projects, they're very different kind of projects.

So -- but the digital solutions piece, we're talking about those kind of projects.

These are things that typically start off in a pilot phase, then they move into orders.

And then they're always subject to weather events.

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 timing in that regard based upon the orders that we had on hand coming out of Q3 and Q4.

And then for the Sensus for metrology piece of M&CS.

We've not really seen any change in dynamics in terms of decision-making, length of time it takes, that's not really been a driver here in terms of why we see a backlog.

It's just -- these are large -- several large implementations that it takes a while for those utilities to get their case approved get the specs finalized and get the RFPs 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 time frame than a couple of quarters or even from 1 year to the next.

This does conclude today's Xylem Q4 2019 Earnings Conference Call, please disconnect your lines at this time, and have a wonderful day.