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spk06: Welcome to the Xylem fourth quarter and fiscal year-end 2020 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 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Matt Latino, Vice President of Investor Relations.
spk03: Thank you, Pasha. Good morning, everyone, and welcome to Xylem's 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's fourth quarter and full year 2020 results and discuss the first quarter and full year outlook for 2021. Following our prepared remarks, we will address questions related to the information covered on the call. I'll ask that you please keep to one question and a follow-up and then return to the queue. As a reminder, this call and our webcast are accompanied by a slide presentation available in the investor section of our website at www.xylem.com. A replay of today's call will be available until midnight on March 5th. Please note the replay number is 800-585-8367, and the confirmation code is 628-3413. Additionally, the call will be available for playback via the investor 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 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. 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.
spk12: 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 showed quicker resilience than anticipated. And we also affirmed our growth trajectory in measurement and control solutions, building on the large project wins we talked about last quarter by adding another headline AMI deal in Houston, Texas. We also gathered pace with our industry-leading digital portfolio, as the pandemic accelerated customer adoption of digital transformation. Revenue and orders trends both improved significantly. One caveat is that orders were still down slightly due to a scope reduction and a previous large win in India. Otherwise, orders grew in all three of our segments. Xylem's large installed base of core products and 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 rarely happens in a straight line, and clearly the global challenges of 2020 put a hitch in year-on-year numbers, including margin. But I am very pleased with how we responded given these conditions. We took quick action on spending and on structural costs, and we also made significant productivity improvements. As a result, we returned to progress on margins in the third and fourth quarters, although we didn't entirely offset COVID's effects. Our supply chain execution ensured we kept customers served through the pandemic, and we helped them to deliver the essential 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 percent. Looking ahead, We're encouraged by early signs of market recovery. The ramp up of vaccinations offers hope for an eventual return to normalcy. But we're not there yet. We are still in uncertain times. But we've nevertheless entered 2021 in a very strong position. And we are on course to capitalize on our increased competitiveness, financial strength, and commercial momentum. With that, I now want to hand it over to Sandy for more detail on how our seconds performed.
spk05: Thanks, Patrick. We have continued to see steady quarter sequential growth improvement across our businesses since the low point in April. And this quarter, we took another meaningful step forward. Fourth quarter revenue growth was down 2% organically versus the same period last year. That 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 in short, utilities and industrial were both down 3%, commercial was flat, and residential was up 15%. We also saw quarter sequential improvement in orders. Organic orders were down 1% in the quarter as we delivered a second consecutive quarter of sequential orders improvement. This result most notably reflects the return to growth in MNCS orders, which delivered double-digit gains, including the large one in Houston, which Patrick mentioned. Applied water contributed solid mid-single-digit growth, and water infrastructure orders grew mid-single digits, excluding the scope reduction of a project in India. We're still negotiating with the customer, but felt it was most prudent to reflect the scope reduction now. Otherwise, orders growth would have been high single digits for Xylem overall. With orders accelerating and several large contract wins contributing to double digit growth and backlog, we have good visibility of future revenue streams heading into 2021. I'm very pleased with the team's operational execution and cost discipline. Fourth quarter operating margin and EBITDA margin of 13.8 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. I'll review 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. 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 Descoped India project. Otherwise, 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 continued 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 US 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 residential growth that I just mentioned. Europe delivered high single-digit growth primarily driven by good pace in 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. volume declines in 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 MNCS, orders returned to growth in the quarter, up 13 percent organically. This was largely driven by double-digit growth in both water and energy. Orders in our test business 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 we finished the quarter down 5%. 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 US 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 deployments will resume toward 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 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 unfavorable 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 5% for the full year, exceeding our pre-pandemic free cash flow outlook, and delivered free cash flow conversion of 181%. Our team has been focused on driving continuous improvement on working capital for a number of years. In 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 collections. 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 1.5 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 9, and I'll turn the call back over to Patrick to look forward at 2021.
spk12: Thanks, Sandy. 2020 reminded us all that it's prudent to be humble about the fidelity of our foresight. When COVID first began to spread around the world, we said we would focus on managing what we could 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 couldn't have anticipated then how much we'd soon benefit from that capability. When 2020'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 in a challenging environment, so we'll continue to face spending until we further see improvement in our markets. We'll keep executing the structural cost program begun in 2020, which is going to deliver savings through 2021. And given some of the inflationary headwinds we're already seeing, we are redoubling our efforts to manage the price-cost dynamic. We're keeping a very close eye on our supply chains and proactively managing potential inflationary and logistics impacts. Despite varying by market and geography, there are clearly opportunities for growth in a recovering environment. In 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 heroically to keep essential services running, the stresses of 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 it's from a small base, the trajectory is clear. It puts us in a very attractive position as we grow not only in software platforms, but in all of the digitally enabled parts of our portfolio. Geographically, India and China will continue to drive high growth. Despite experiencing COVID's earliest impacts, China actually grew last year. And in the three years leading up to 2020, India and China post a combined average annual growth rates in the double digits. With localization strategies well advanced in both countries, our China and India teams are set to continue delivering impressive growth. It's also worth mentioning the very solid financial foundation underpinning our growth. With a current cash balance of nearly $1.9 billion, capital employment is clearly top of mind for us. Even with some debt repayment due in the fourth quarter, that number still offers a lot of capacity. Alongside organic investment, M&A remains a 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 are 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 grain bond offering. And performance across these metrics continues to put us in a unique leadership position, both in the water sector and more broadly. The team's progress has strengthened our position on a number of sustainability indices. We were recently added to Bloomberg Barclay's 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 over to Sandy to provide in-market and segment outlook.
spk05: Thanks, Patrick. Through 2020, utilities have been reassuringly resilient, down only mid-single digits. As you see in the fourth quarter results, MNCS and water infrastructure revenues held up better than anticipated. Still, our outlook for 2021 reflects a tempered view 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 in the low to mid single digits in 2021. We expect that same growth rate on the wastewater side as utilities continue to focus on mission critical applications. And we expect modest recovery and OPEX growth on a global basis through the year. And the U.S. wastewater capex is likely to be down modestly However, the decline should reflect postponements rather than reductions in projects. As you would expect, we have kept close to our utility customers to understand how they are thinking about budgets and funding for this year. And while some uncertainty remains, their deepest concerns have largely abated since the low point of the pandemic. On the clean water side, we anticipate mid-single-digit growth. As I mentioned, large project deployments should begin ramping again from the second quarter, accelerating through the end of the year. The large multi-year 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 impacts in the near term. We expect industrial to be flattish to up low single digits. Our commercial end market outlook varies quite a bit by geography. The U.S. will continue to be sluggish. Europe, on the other hand, should 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. On slide 12, you will see that we are reinstating annual guidance. While 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 2021 organic revenue growth in the range of three to five percent 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 low 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. In 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 you with both the adjusted operating margin and adjusted 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 16.7 to 17.7 percent. For your convenience, we're also providing the equivalent adjusted operating margin here, which we expect to be in the range of 11.5 to 12.5 percent, up 70 to 170 basis points. This predominantly reflects the benefits from our restructuring savings combined with volume leverage and favorable price mix more than offsetting inflation and investments. This yields an adjusted EPS range of $2.35 to $2.60, an increase of 14 to 26 percent. Free cash flow conversion is expected to be in the range of 80 to 90 percent. following free cash flow conversion of 181 percent in 2020 and 124 percent in 2019. While we continue to drive continuous improvement, we expect to see increases in working capital as we return to growth, 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 1.22. FX can be volatile, and so an FX sensitivity table is included in the appendix, which will help you if we continue to see variations in the rates. Now, drilling down on the first quarter, we anticipate that total company organic revenues will grow in the range of 1 to 3 percent. This includes low single-digit growth in applied water and low to mid-single-digit growth in water infrastructure. MNCS is expected to decline low to mid single digits as we anticipate continuing delays from COVID before projects begin deployment in Q2. We expect first quarter adjusted EBITDA margin to be in the range of 14 to 15 percent, representing 170 to 270 basis points of expansion versus the prior year. With the largest expansion coming from MNCS, due to operational improvements and a prior year warranty charge. And with that, please turn to slide 13, and I'll turn the call back over to Patrick for closing comments.
spk12: Thanks, Sandy. We recognize both that the marketplace is stabilizing and that it's still likely to be unsettled for some time, 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 have vital products at the heart of essential services, and we have differentiated 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'll 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.
spk06: The floor is now open for questions at this time. If you have a question or comment, please press star 1 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 while 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 Holleran with Bayard.
spk09: Good morning, everyone. Let's start on the MNCS side. You know, margins up a little bit as you work through the year here. As we get through next year, it 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're thinking about You know, whether it's 2022 kind of timeframe, getting back to that normal range you've been in historically, or there are other factors that play that can move that around and just kind of latest, greatest thoughts on that side.
spk05: Yeah, Mike, thanks for the question. You know, obviously, as we work through the pandemic, the MNCS 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 strong action throughout 2020 to make structural cost-saving changes that are permanent. And we think that as we move through 2021, that is the segment where you're going to see the largest part of our margin expansion. And 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 greatest margin expansion. And that comes from operational efficiencies from the restructuring, as well as we did have a one-time item last year.
spk12: Yeah, Mike, we've got, you know, we've got a number of these large deal deployments. You know, I think recently we've won as much as north of $300 million of large deals in 2020. Those are going to begin to ramp as side access returns. And we just continue to have some really good commercial wins here. And when I say good, meaning they come with very attractive accretive margins in those deals.
spk09: But basically what I'm hearing, though, is as you get those deployments out and you get to more normalized site access. There's no reason to think that that normalized range from CS isn't back on the table whenever that time period starts That is correct.
spk05: Mike, the 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, you know, we would expect that we will be back at 2021, I'm sorry, we'll be back at 19 margin levels and we'll be on good pace for margin expansion.
spk09: Great. That's helpful there. And then second one on the capital deployment side. obviously highlighted M&A and focus on that. Maybe just talk about the actionability of the supply of the funnel right now and if there's really any change to the focus in what you're interested in bringing in relative to what's in that funnel.
spk12: Yeah. So, Mike, no real change in our focus areas in the M&A funnel. I mean, we've got a number of kind of smaller bolt-on tuck-ins that we'll be executing this year. But we're staying very close to a couple of larger actionable items as well. So, you know, again, we're going to, you know, we've got a keen eye on valuations. And, you know, we do understand the value of inorganic growth. And, again, you know, we're going to continue to remain disciplined. But we're optimistic.
spk09: Great. Appreciate the time as always.
spk12: Thanks, Mike.
spk06: Our next question is from the line of DeAndre with RBC Capital Markets.
spk04: Thank you. Good morning, everyone. Hey, good morning, Dean. 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 order. Things are changing really fast there. I get it. They're in basically crisis mode. But just what went on there? And what's the outlook? Because there's still so much to do there in India. So start there and then some color on that Houston project, please.
spk12: 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 India, Dean. You know, we've seen double-digit growth the last few years. We've got a great backlog there. Obviously, you know, top top policy mandate by Prime Minister Modi, you know, continues to be the case there. This was a unique to 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 just wanted to be appropriately conservative to reflect a reduction now in our orders. We'll see how it plays out. But no change in our view at all, Dean, on India.
spk04: Great. And Dean Miguel- Go ahead, Sandy, on Houston.
spk05: Yeah. Yeah. Thanks, Dean, for the question. You know, this is another project that we're very, very excited about. And, you know, it builds on the $250 million of awards that we announced earlier in the year. So this deal is about a $40 million deal. It's primarily a water deal, and it's with a really powerful water utility. So it's one that we're quite pleased to bring into our backlog.
spk04: And how much of the digital offerings is embedded in the Houston project? I know it's meters, but anything else that you would highlight?
spk03: Yeah, so, Dean, it's an AMI deal. It is new. It's a share gain, you know, for us and displacing someone that was there before. And so it will fit in that digital landscape as you think about, you know, the communications offering from FlexNet on the census side.
spk04: Great. And, Patrick, just it looks like you're exiting the year with more momentum in 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 digital?
spk12: yeah i think it's we're still early innings here dean i i would say there are two two dynamics at play uh one is as you pointed out uh you know the the utilities are moving now from these things being nice to have to must-haves uh especially with remote monitoring uh you know restricted uh you know uh uh labor deployment capabilities uh but secondly we're in the early still in terms of you know we've we put new structure in place uh early last year we put new incentives in place to really drive uh synergies more broadly so it's not just about you know the the you know the artist known as xylem view you know our digital uh you know revenant uh it's also the impact that has on pulling through uh you know other deals you know houston being a good example of that uh you know we talked about columbus winston-salem late last year so we're taking a broader view on this theme than just
spk04: the digital revenue component it really is the impact it has on our broader portfolio that's great and um just last one for me and it's for sandy uh 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 um you know maybe you can comment on working capital sales because you know it's it's been improving but You know, my sense is there's still lots more you can do there, but I would love to hear your thoughts.
spk05: Yeah, you know, Dean, thanks for the question. I've been here now for four months and, you know, it's been really interesting. I'm still very excited about the opportunity for growth, particularly by scaling our digital portfolio. And 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 portfolio. Also think 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 opportunity there. Turning to your question on working capital, I think that the team did a terrific job on that this year. 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 past dues. And we need to shout out and recognize our operations team on how they effectively managed and controlled inventory. So 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 you know, some of our financing programs with our suppliers and other efforts. But I think we're, you know, we're exiting in a pretty good spot there.
spk12: Male Speaker And, Jane, not to belabor it, but just to remind all of our investors that our three primary annual incentive plan metrics are organic revenue growth, it's operating, you know, margin, operating income and its free cash flow conversion of which, you know, the single biggest driver there is working capital as a percentage of revenue. So I just want to make sure we, you know, reminded all of our investors that, you know, we're not, you know, we're not taking our foot off of working capital in any way, shape or form.
spk04: Great. Thank you.
spk12: Thank you.
spk06: Our next question is from the line of Andy Keplowitz with Citigroup.
spk00: Hey, good morning, guys. Morning. Morning. Patrick, so I think we can all understand why Zion is performing so well in China, given the relative strength in that economy. But what's a little more difficult to understand is why you are performing so much better consistently in Western Europe than you are in the U.S. I mean, COVID interruption in 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.? ?
spk12: Yeah, I think, you know, part of this is a timing issue for the U.S. You know, we're in the early stages of recovery there. You know, it also is as, you know, Europe traditionally has been more stable in terms of how utilities focus on their spending and how they plan their budgets accordingly. We also benefit from a very strong share position. in Europe. And so when that's the case, the level of aftermarket recurring revenue benefits us quite significantly there. But I wouldn't read too much into the – I wouldn't suggest that Europe is going to outpace the U.S. over time. I think really just more a matter of timing right now.
spk05: The other thing I would add to that is a little bit is mixed, 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 2021, we are expecting to see progress on clean water, especially as we can start rolling out those deployments.
spk00: That's helpful. And then this is probably for Patrick or Sandy. You had talked about $80 million, I think, of permanent cost savings in 2021. there is $60 million of temporary cost savings that would come back in some way. Maybe you could talk about the buckets of savings that are implied in that 21 forecast that you now have. What are you assuming for inflation? Because if I look at the incremental margin that you're forecasting, it doesn't look like it's equal to gross margin even. So there must be a sizable inflation component in there.
spk05: Yeah, so I think there's multiple elements to that question. Let me try to, you know, break it down for you in a 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 2021, 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 focused on. And as we look year over year, we took about $60 million of costs out from discretionary categories like travel and entertainment, services, marketing, et cetera. And our 2021 plan contemplates that about 40% of those costs will return. And then I would say that, you know, the third part of your question, you're starting to touch on inflation, which is probably the most challenging part of the equation. You know, as you know, we saw a very stable inflationary environment for most of 2020. Did start to see that pick up at the end of 2020. And, you know, we're seeing 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.
spk12: And I would just add that, you know, we're clearly looking at a level of uncertainty here in terms of what inflation is likely to be. And we're trying to be appropriately kind of measured in how we're 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. You know, think back to the tariff timeframe. Our price realization, we're expecting that, along with productivity, will offset material and labor inflation. We've got a very strong and proven procurement team, and they are in lockstep with our commercial teams on making sure that we've got that highlighted. So, again, as Sandy said, we're already using pricing actions. The impacts are different. across each one of the segments based upon, you know, the impact on commodities. But we just felt it would be prudent to guide as we've done.
spk00: Patrick, you had 60 basic points in Q4. I would assume that you get a lot more price than that, you know, for 2021 there.
spk05: Yeah, I think that's a fair assumption.
spk00: Thanks, guys. Thank you.
spk06: Our next question is from the line of Scott Davis with Milius Research.
spk10: Hi. Good morning, everyone. Patrick, Sandy, and Matt.
spk05: Hey, Scott. How are you doing? Morning, Scott.
spk10: Good. Most of my questions have been asked, but if you look at your CapEx guide, it looks like up about 20%. Where's the money being prioritized? Maybe just some examples of projects or geographies or areas that you're focused on right now.
spk05: Yeah, thanks, Scott. You know, I think as we move through the pandemic, you know, we certainly clamp down on our spending around CapEx in 2020, and our outlook for CapEx for 2021 is very much in line with our 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 improvement. And so, you know, it's something that we're going to watch closely throughout the year and make sure we phase that increase accordingly. You know, as we see recovery, we'll start to release incremental CapEx dollars to position us for growth in 2022 and beyond.
spk12: Yeah, Scott, I would just add to Sandy's point. You know, we're going to continue to, you know, to manage the phasing. on CapEx, we'll see how the year plays out in terms of market recovery. There's no one or two big bang CapEx projects that are in there. It's pretty well distributed and it very much is tied to growth. So I would just reinforce what Sandy said, it's localization within emerging markets. It's some upgrade in terms of continuous improvement in a few of our factories, but it also is a fair amount tied to the work that has to be done to support some of the large deal wins that we have within MNCS.
spk10: Okay, that's really helpful. And then I know working capital has been kind of beaten to death, but Sandy, since you're relatively new, it's a fresh set of eyes on this stuff. Is there any kind of structural reason why, you know, I always think of working capital being percent of sales, again, 14% or lower, getting into the territory of the best-run companies. Is there any structural reason why that number can't be down towards, as I said, more best-in-class levels?
spk05: I don't think there's any structural reason. I think we're going to continue to work at this, and I think the company's made steady progress over the years. And it's definitely something that we're not losing focus of. We're not satisfied. But, you know, we're going to continue to drive that journey.
spk12: Our biggest challenge, Scott, and it is kind of endemic within the water sector, is, you know, we still have work to do to simplify our supply chain. And that has an impact on inventory levels. So I would say, you know, if you look at our receivable performance, our payable performance, you know, we're pretty much in line there. There's some opportunities there, but that's not really going to move the needle. It really is structurally on the inventory side. And that's work that Tony Milando and our supply chain team have been very much focused on. They've made good improvement, but there's still, in my view, a fair ways to go.
spk10: That makes a lot of sense, too. So thank you. Good luck for 2021. Thanks, Scott. I'll pass it on. Thank you.
spk06: Our next question is from the line of Nathan Jones with Stifel.
spk11: Good morning, everyone. Hey, good morning, Nate.
spk06: Morning.
spk11: A couple questions, a follow-up really on the margin side of this. If I look at your guidance, the top end of revenue guidance is about where you were in revenue in 2019, and the top end of the margin guidance is still about 100 basis points below where you were in 2019. 140 million of structural costs taken out of the business during that time. You said price and productivity offset inflation. So can you fill in the blanks there on where the gap is between where margins are expected to be in 21 versus where they were in 19 on roughly the same revenue level?
spk05: Yeah, you know, I think, Nate, you know, you hit on a lot of the points there. And, you know, as we've modeled out 2021, we are modeling in good incremental margins through the portfolio. You know, there's still some mixed differences as we exit. You know, MNCS has been – a little bit delayed from a pandemic recovery perspective. And once we get that back on track and growing, you're going to see margin expansion ramp back up. You know, I think the other thing is we're continuing to make investments on the digital front, and those are prudent investments, and we're phasing them throughout the year 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.
spk12: Male Speaker Yeah, Nate, 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, you know, second half versus first half, what the, what the exit, you know, rates are in terms of both top line growth and margin. You're looking at a full year average.
spk11: I'll take that color then. Maybe you can talk about the differences in growth rates and margins in the first half and second half.
spk05: Yeah. Let me take the first crack at that, and then Patrick can 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 impacted our businesses and regions 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 you're going to see meaningful margin expansion. You know, from a margin perspective, the biggest growth happens 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 year. And then, you know, I think as we focus and drill down on MNCS, it's the deployments in the second half that, from 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.
spk11: Do you think MCS exits the year at double-digit margins, operating margins?
spk05: You know, I would say it's probably more high single digits.
spk12: Again, we're talking operating margins, not even that.
spk11: Yeah, not even that, I know. There's a lot of DNA in that one. Okay, thanks. I'll pass it on.
spk03: Okay, thanks, Nate. Thanks, Nate.
spk06: Our next question comes from the line of Sari Bordisky with Jefferies.
spk01: Thanks for taking my questions. Just to follow up on the previous question on margins versus 2019 levels, I would have also thought you would have had an FX benefit to margins. So you could just quantify how you're thinking about this.
spk05: Yeah, you know, FX is one of our key variables and, you know, key assumptions. And, you know, we've guided to a 1.22 euro to dollar conversion rate. You know, I think the way that I think about FX in particular is that, you know, the euro is the most important currency pair for us. And, you know, a 5% percent variation in the euro drives about $50 million of revenue and about $20 million of margin. So I think that's a good way to frame it.
spk01: Great. Thanks. That's helpful. And then could you provide some color on what you saw in the dewatering business in the quarter and what's driving the expectations for an acceleration through the year? And should this drive improvement in the margin performance in water infrastructure as we go through the year as well?
spk12: Yeah, so, you know, we do expect the activity and the watering to ramp in the second half of 21. Part of that is, you know, we put some more sophisticated pricing models in place that are going to be driving high margin rental, because rental really is the key focus here and there for us. It really also is tied to what we're expecting in terms of the North America industrial and commercial, you know, 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.
spk03: Male Speaker 3, we'd expect about flattish to low single-digit growth for 21. Just your last point. Female Speaker 1 Great. Thanks for the call.
spk01: Male Speaker 2 Thanks.
spk10: Male Speaker 3 Thank you.
spk06: Your next question is from the line of Pavel Molchanov with Raymond James.
spk08: Yeah, thanks for taking the question. You referenced the appetite for M&A, but you also said you're going to be disciplined. I suppose as we're getting out of the crisis phase of the pandemic into a recovery phase, Would it not, all else being equal, make valuations in water tech even higher than they, you know, have been in recent years?
spk12: You know, it depends on, you know, the sector within the water space. Obviously, things that are of a higher digital nature, that has more of a recurring revenue kind of SAS value, nature of the model across any sector. Those are always going to have higher multiples and premiums. I think we're proud of the work the team's done in a number of these areas that we look at are relationships that we've 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 you know, the seller finds Xylem to be an attractive partner because of our global breadth, our channels to market, you know, the breadth of our portfolio. You know, and again, you know, we tend to look at some of the smaller M&A to be really a proxy for R&D. And so that, you know, again, we're going to be disciplined in this regard. But no, I'm still very encouraged by what we see in the pipeline.
spk08: Okay. Let me ask kind of a broader question. You know, we're seeing or hearing lots of talk in Washington about infrastructure and in Europe, the next generation EU has an infrastructure program as one of its components. I'm curious kind of to what extent you expect as a company to benefit as these infrastructure stimulus initiatives begin to actually materialize?
spk12: Yeah, so, you know, I mean, we're generally positive on the early indications from the new administration. You know, having said that, it's far too early to know anything beyond intentions and policy outlines. You know, we're not assuming or 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 made clear with us that they are not assuming or planning for it. And, again, you know, they would say we've seen that movie before with previous new administrations that came in. You know, 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.
spk08: Right. Appreciate it, guys.
spk12: Thank you.
spk06: Our next question is from the line of Joe Giordano with Cowan.
spk02: Hey, guys. Good morning. Good morning, Joe.
spk05: Morning.
spk02: Hey. Patrick, you touched on M&A a couple times. I'm just curious, like, MC&S is a business for you guys that you're trying to, you know, arguably make less complicated. And, like, how you feel about adding more to that business and making it, you know, at least near term, more complicated?
spk12: Yeah, I wouldn't look at it in terms of adding complexity to MNCS. I think 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 consultative work, we continue to see areas of opportunity where we can bring more digital you know, to the portfolio. So I wouldn't look at it as adding complexity. I take your point. Obviously, any time that we look at smaller startups that we add to the portfolio, scaling them and getting channeled to market obviously is one of the big synergies that we bring. But, you know, we do that with great confidence.
spk02: And then last for me, just on dewatering, you know, Can you just talk about what's going on, like, underlying in that market? I know, like, there's been a lot of competition on the construction element. You guys may be trying to reposition out of that, maybe a little bit away from that into more of, like, the mining and stuff like that. How is that playing out? Because I feel like they're within energy and mining and, you know, you had a shutdown quarter with construction activity. So I thought the comps would be pretty good in that business just relative to, like, the flattish guy there.
spk03: Yeah, I think you're right, Joe. 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 one that we'd like to see the activity really come back. I think the There's normal seasonality in some of the North America side in terms of weather and doing some of that construction and industrial activity. Part of it's lagged a little bit because of COVID, too, Joe, because think about this as very much a people-driven business. It's very much hand-to-hand. out in, you know, 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, there's been some noise there. We expect it's going to come back, though, you know, here in 21.
spk05: Yeah. There will still be some pressure in Q1 from a COVID perspective. But in the second half of the year, we're expecting that it's more neutral.
spk02: Thanks, guys. Thanks, Joe. Thanks.
spk06: Our final question is from the line of John Walsh with Credit Suisse.
spk07: Hi. Good morning.
spk05: Morning, John.
spk07: Good morning, John. A lot of ground covered, obviously very strong cash performance in 2020. 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 add-backs when we do the conversion ratio?
spk05: Yeah. You know, I think that we did give you an outlook on what we expect to spend from a restructuring and realignment perspective. And, you know, we also provided you with the tax rate. So, I think we've given you all the inputs to model. But I think big picture, if you look at 2019 through 2021, we expect free cash flow conversion to be 130%, which is very healthy. I think there's three discrete headwinds for 2021. The first one we talked about earlier on the call is inflation. As we return to growth, there'll be some add back 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 2020 and 2021. And that is, you know, there were a number of liability categories 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 year. But I think 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, is a good spot.
spk07: Great. Yeah, no, that's very helpful color on those moving pieces. That's all I had. Appreciate you taking the question. Thank you.
spk03: Thank you.
spk06: I would now like to turn the call back over to Patrick Decker for closing remarks.
spk12: Thanks. So again, I appreciate, you know, 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. I know we're already, it's hard to believe we're already more than a month into it, but again, hopefully all your families and friends are safe and sound. Look forward to catching up with you. and in our next earnings call. And as we said earlier, we'll be scheduling and planning an investor and analyst day sometime later this year, and we'll get back to you all on that. So thank you all very much, and have a great weekend.
spk06: Thank you. This does conclude today's Xylem fourth quarter and fiscal year-end 2020 earnings conference call. Please disconnect your line at this time and have a wonderful day.
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