Xylem - Earnings Call - Q4 2014
February 5, 2015
Transcript
Speaker 0
Welcome to the Xylem Fourth Quarter and Full Year twenty fourteen Earnings Conference Call. At this time, all participants have been placed on a listen only mode and the floor will be opened for your questions following the presentation. I would now like to turn the call over to Phil D'Souza, Vice President of Investor Relations.
Speaker 1
Thank you, Maria, and good morning, everyone, and welcome to Xylem's fourth quarter twenty fourteen earnings conference call. With me today are Chief Executive Officer, Patrick Decker and Chief Financial Officer, Michael Speedsen. They will provide their perspective on Xylem's fourth quarter and full year 2014 results and discuss the full year outlook for 2015. Following our prepared remarks, we will address questions related to the information covered on the call. At that time, I'll ask that you please keep to one question and a follow-up and then return to the queue so that we will have enough time to address everyone on the call.
We anticipate that today's call will last approximately one hour. As a reminder, this call and our webcast are accompanied by a slide presentation available in the Investors section of our website at www.silaminc.com. A replay of today's call will be available until midnight on February 19. Please note the replay number is (800) 585-8367 and the confirmation code is 6161428. Additionally, the call will be available for playback via the Investors section of our website under the heading Presentations.
All references today will be on an adjusted basis unless otherwise indicated. And non GAAP financials are reconciled for you in the appendix section of the presentation. With that said, 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 ZALLA's most recent annual report on Form 10 ks and in subsequent reports filed with
Speaker 2
the
Speaker 1
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. Now please turn to slide three. Now I'll turn the call over to our CEO, Patrick Decker.
Speaker 3
Thanks, Bill, and good morning, everyone. Thank you all for joining us today. This morning, I'll review the highlights of our fourth quarter and full year twenty fourteen results and provide a brief update on some of our major initiatives. Mike will provide additional details and then we'll discuss our 2015 outlook. So let's get started.
We closed out 2014 strong. The renewed focus on execution across our organization helped us to generate solid organic top line growth, the sixth consecutive quarter of margin expansion as well as double digit earnings growth. And I'd point out that these results were achieved in an environment with strong foreign exchange headwinds and a mixed economic environment conditions that we anticipate will continue throughout 2015. I'm pleased with our progress, but we are in the early stages of our journey. We continue to operate in an uncertain global macroeconomic environment.
We are encouraged by the bright spots such as an improving U. S. Market and solid opportunities in several emerging markets where we are poised to continue to grow and take share. But there remain many challenges, the most significant being the uncertainty in Europe given both the political and economic headwinds the region faces. We are also keenly aware of and closely monitoring the currency markets as foreign exchange translation does have a disproportionate effect on our reported results.
But let me be clear, this will not be a distraction for us. We remain focused on the factors we can control such as driving growth in our core business and operational improvements to drive out cost. Enhancing commercial excellence at Xylem is a strategic priority and critical in our efforts to accelerate profitable growth. And we're making good progress in rolling out the integrated technology solutions that are enabling stronger selling effectiveness and making it easier for our customers to do business with us. I anticipate measurable improvement in this area over the course of this year and look forward to sharing our progress.
With regard to cost reductions, opportunities remain to drive further business simplification and structural efficiencies. We are taking appropriate steps to achieve additional productivity gains and cost reductions, leveraging the lean and global sourcing capabilities we are building as well as other targeted cost actions. We expect these efforts to also enable us to overcome some of the headwinds including the unfavorable impacts of foreign exchange translation and slow growth in Europe. We are taking a balanced view towards 2015 in light of uncertain and challenging market conditions, but we remain committed to executing our plans to achieve faster than end of market growth and further expansion of our operating margins and returns on capital. But first, let's review the fourth quarter performance.
Orders grew organically 3% year over year. The sequential deceleration in growth in the previous quarter reflects the impact of some large water infrastructure project wins that closed in the third quarter and the push out of orders from the fourth quarter to the 2015. Taking a longer view, we saw orders grow 6% on an organic basis during the second half of the year with at least one point of growth attributable to our longer cycle infrastructure project business. Organic revenue increased 6% in the quarter, reflecting growing strength in the industrial and public utility sectors. We saw 8% growth in The U.
S. As that market continues to improve and the emerging markets were up 14% in the quarter including 25% growth in China. I'm encouraged by the resiliency of our business in Europe, which delivered 1% growth this quarter despite a very challenging environment. Our operating margin expanded 70 basis points in the quarter to a record 14.7%. This reflects continued progress on improving execution across Xylem.
To wrap up the fourth quarter results, volume growth and improved operating performance drove earnings per share of $0.62 an increase of 11% over the prior year. This result includes a $03 drag from the impact of foreign exchange translation. Now turn to slide four. For the full year, revenue increased 3% on an organic basis. We saw broad based growth in the industrial and public utility markets and benefited from the recovering U.
S. Commercial market. We generated the strongest growth in the emerging markets over the course of the year where we posted a 13% increase. Our operating margin expanded 110 basis points year over year including 100 basis point reduction in G and A cost, an area that continues to have room for further improvement. We delivered record earnings per share this year of $1.97 an increase of 18% and a solid indicator that we have set Xylem on the right path forward to improve financial returns.
Finally, we generated $297,000,000 of free cash flow in 2014, an increase of 50% year over year. We are continuing to make progress on our working capital performance across the business, which improved 40 basis points as a percent of revenue excluding the impact of foreign exchange translation. This improvement coupled with our increased profitability allowed us to increase the return of capital to shareholders by 45% in 2014. That includes a 10% increase in the dividend and $130,000,000 of share repurchases under our current program. As we announced in our press release this morning, our Board of Directors approved a 10% increase in our quarterly dividend.
This further illustrates the confidence we have in our execution and the cash generation ability of this company and it marks the third consecutive year of dividend increases. So with that, let me turn the call over to our CFO, Mike Speetzen to walk you through the results and the company's financial position in more detail. Mike? Thanks Patrick. Please turn
Speaker 2
to slide five. During the fourth quarter, we generated revenue of $1,000,000,000 essentially flat to the prior year including a $50,000,000 headwind from foreign exchange translation. On an organic basis, revenue was up 6% which includes the benefit of one extra business day or roughly 1.5% when compared with the 2013. From an end market perspective, we saw strength across the board. Industrial was up 6% with growth in all regions including mid single digit growth in The United States and double digit growth in both Latin America and The Middle East.
As a reminder, Xylem serves a wide variety of industrial customers and in the quarter we generated industrial growth in both our water infrastructure and applied water segments. I'll cover both of these in more detail in the next two slides. Revenue from the public utility end market was up 5% with mid single digit growth in both The U. S. And Europe.
We generated even stronger growth in the emerging markets where we continue to see public utility investment to build out water and wastewater infrastructure. Revenue from our commercial end market was up 8% with 14% growth in our U. S. Business, which represents more than 50% of our overall sales in this end market. Operating income of $153,000,000 was up $8,000,000 over last year despite $7,000,000 of headwind from foreign exchange translation.
Operating margin increased by 70 basis points to a record 14.7%. Cost reductions including Lean Six Sigma, global sourcing and restructuring savings more than offset inflation driving a 30 basis point improvement in segment margins. Corporate expense was $3,000,000 lower than the prior year when we incurred one time costs associated with the relocation of our corporate headquarters. Wrapping up on the consolidated results, strong organic revenue growth and execution across our cost reduction initiatives resulted in record EPS of $0.62 an increase of 16% before the unfavorable impact of foreign exchange or 11% overall. Now let me provide more details on each of our reporting segments.
Please turn to slide six. In our Water Infrastructure segment, we reported revenue of $672,000,000 up 6% on an organic basis. We grew across all major regions with emerging markets leading the way up 13%. U. S.
Revenue increased 6% while Europe grew 3%. I'd further summarize our revenue performance as follows Transport was up 6% overall with broad based strength. In Europe, the business was up high single digits driven by public utility demand for our flight pumps, aftermarket parts and prepackaged pump stations as well as timing of shipments from Q3 to Q4. It's important to note that performance within Europe was mixed. For example, France our second largest market in Europe was down low teens.
In The U. S, we continue to see strong performance in industrial transport driven by dewatering applications related to natural gas extraction related activities. Treatment revenue was up 4% as we delivered a large water filtration project in Brazil and continue to see strong demand for filtration and disinfection products in China. Finally, test applications finished a record year with another strong quarter of 5% with strength in The U. S.
Driven by continued success of new products and cross selling of our European based technologies. While strong revenue growth in the quarter was balanced across the region and applications, order performance for Water Infrastructure was mixed. For the fourth quarter, we booked orders of $596,000,000 flat on an organic basis. This was down from the 10% organic growth we experienced in the prior quarter. While transport orders grew, treatment orders were weaker in the quarter as we saw some project delays in The U.
S, Europe and The Middle East. For the fourth quarter, we're reporting record operating income of $113,000,000 and a record operating margin of 16.8%. Performance was driven by the increase in organic volume and cost reductions of $26,000,000 driven by sourcing and lean initiatives as well as $6,000,000 in restructuring savings. In addition, we saw the benefit of a slightly improved pricing environment and the favorable impact of foreign exchange translation. Partially offsetting these tailwinds was inflation of approximately 3% unfavorable mix and increased spend on strategic initiatives.
Please turn to slide seven. Applied Water reported revenue of $370,000,000 up 7% on an organic basis. Regionally, we saw strong growth in The U. S. Up 9% organically and emerging markets grew 18%.
Latin America and The Middle East were both up more than 40%. Growth in China moderated from earlier in the year, but was still up 10%. Europe remained a weak spot however declining 3% as construction and industrial demand was soft. I'd further summarize our revenue performance as follows. Building services grew percent as we benefited from a long awaited recovery in The U.
S. Institutional building market and associated distributor restocking as well as success with marketing and promotional activities. Industrial water grew 7% with strength exhibited across most regions. And lastly, Irrigation which represents less than 10% of Applied Water revenue grew 25% driven by the timing of several project shipments against a relatively small revenue base. Operating margin expanded 40 basis points year over year to 13.5%.
However, this headline masked a strong 70 basis point improvement in operations as foreign exchange translation negatively impacted results by 30 basis points. Our strong operational performance was driven by volume and cost reductions from sourcing and Lean Six Sigma activities and to a lesser extent restructuring savings. Partially offsetting these tailwinds was inflation of nearly 3% and the impact of divesting our valves business earlier 2014 and pricing was neutral in the fourth quarter. Now let's turn to slide eight to cover the company's full year performance by segment. Looking back at full year 2014 results, let me first start with Water Infrastructure.
Revenue was $2,400,000,000 up 4% organically including double digit emerging market growth driven by the build out of public utility infrastructure and industrial growth. In addition, we saw low single digit growth in the public utility market for developed regions overall and strength in The U. S. Industrial market driven by demand for dewatering applications. Operating margin was also up strongly increasing 110 basis points year over year to 14.3% due to volume leverage and the impact of cost reductions that initiated in 2013 and 2014.
Moving on to Applied Water. Revenue was $1,500,000,000 up 2% organically. We delivered 9% growth markets including double digit growth in industrial water applications in The Middle East and Latin America. We saw U. S.
Strength across all applications including signs of a slowly recovering commercial building market. The weak macroeconomic environment in Europe particularly in Southern Europe was a consistent headwind throughout the year. For the year, Europe was down 2%. Operating margin increased 90 basis points year over year to a full year record of 14%, primarily reflecting positive price, strong productivity improvements and the impact of cost actions from 2013 and 2014. Overall, our focus on productivity and cost efficiency against the backdrop of a slow global growth and currency volatility has enabled us to generate strong segment margin expansion over the course of the year.
Please turn to slide nine and I'll cover the company's financial position. Xylem maintains a strong cash position with a balance of $663,000,000 at the end of Q4 with approximately 21% held outside of The U. S. We remain committed to our balanced capital deployment strategy, which is to maintain and grow the business while also enhancing shareholder returns through dividends and share repurchases. During 2014, we invested $119,000,000 in capital expenditures and we returned $224,000,000 to shareholders.
This includes a 10% increase in our dividend and $130,000,000 under our share repurchase program. We also generated $297,000,000 of free cash flow, largely reflecting higher income and lower CapEx spend. Relative to the prior year, our free cash flow performance improved by $99,000,000 Free cash flow conversion finished the year at 91% up from 87% last year. That said, we fell short of our 100% conversion rate target primarily due to working capital performance. We're disappointed with our performance in this regard and as you'll hear Patrick address in a few minutes improving working capital performance is one of our top priorities in 2015.
Lastly, increased the return on invested capital by 90 basis points to 10.9% in line with our expectations. Please turn to slide 10 and I'll turn it back over to Patrick to cover the CEO
Speaker 3
update. Thanks Mike. So please turn to slide 10. As we look ahead, we have a clear vision to achieve our goal of establishing Xylem as the definitive market leader in the water space. These long term strategic initiatives will enable us to grow our business, establish stronger commercial partnerships and build a culture in which excellence across all functions is fostered and delivered.
Let me briefly discuss our 2015 strategic priorities. We continue to see increased growth opportunities in the emerging markets. As I mentioned last quarter, we are focusing additional resources in China and The Middle East this year, building more robust capabilities and growing our presence in each market. Globally, we are already beginning to develop deeper, more distinctive industry vertical marketing capabilities. One of Xylem's unique strengths is the breadth of products and services we offer customers across the water cycle.
Positioning Xylem as a total solution provider for certain industries and large key accounts will enhance our ability to solve our customers' challenges and drive efficiencies along the way. As I've said before, I believe the opportunity to drive continuous improvement and business simplification across the company can and will be a significant lever for long term value creation. This is the fundamental thread in the productivity for growth mindset that we are driving into our day to day activities. Last month, we announced that Tony Milando would be joining us as our Senior Vice President of Continuous Improvement and Business Transformation. Tony just started this week and he brings a wealth of experience in business integration and simplification.
Given the challenging macroeconomic environment we face today, we are looking to accelerate certain lean and global sourcing initiatives as well as some other targeted cost actions. We will continue pushing the cost levers and Tony now will help accelerate the execution of our continuous improvement roadmap. In addition, we will invest some of those productivity savings back into the business to build new and stronger organization capabilities that drive faster to market growth and margin expansion that is sustainable over time. As Mike mentioned, improving our working capital performance is also a top priority and we anticipate at least 100 basis point improvement as a percentage of revenue excluding the impacts of foreign exchange translation. Finally, as I've mentioned before, we intend to initially pursue bolt on acquisitions.
While timing is always difficult to predict, we aim to be more active in this area in the latter part of the year. So now please turn to slide 11. As I review this slide, the growth rates I refer to all exclude the foreign exchange headwinds that we expect to negatively impact our results. Looking at the year ahead, we anticipate 2015 organic revenue growth of 1% to 3%. Our adjusted operating margin is expected to grow in the range of 50 to 90 basis points, reflecting the carryover benefit of our broad based restructuring efforts last year as well as additional efficiencies we expect to drive in 2015.
We anticipate generating earnings per share of $1.85 to $1.95 which includes zero two one dollars of negative foreign currency translation impact. Excluding this headwind, EPS growth is expected to be in the range of 5% to 10%. Finally, we will continue to execute a disciplined approach to capital deployment, which is expected to result in 100% free cash flow conversion. Please turn to slide 12. This slide outlines our expectations for 2015 organic revenue by end market.
Industrial, which represents 44% of our total revenue is expected to grow at a low single digit rate. This projection assumes continued growth in The U. S, but slightly slower growth in the emerging markets. The public utility sector, which constitutes a third of our total revenue is anticipated to grow at a low single digit rate. Here we anticipate continued growth in the emerging markets as well as in The U.
S. Where we see encouraging signs in terms of municipal funding. For the commercial market, we see growth in the low to mid single digit range. Again, The U. S.
Market appears to be improving and the emerging markets are anticipated to have continued strength, but we expect Europe to remain soft. The residential sector remains challenged and we anticipate we will be flat to down low single digits as Europe continues to be a drag. And finally, our smallest sector agriculture will likely be flat for the year. Please turn now to slide 13 and Mike will walk you through a few more details on our expectations.
Speaker 2
Thanks again Patrick. Given the recent focus on foreign exchange and the potential impact on many companies' financial performance, we thought it would be appropriate to help provide transparency as it relates to our company. So first, let's begin by discussing Xylem's foreign exchange transaction exposure. This is true economic exposure and we have in place a comprehensive hedging program that substantially mitigates our overall transaction exposure. Our strategy is to proactively hedge and mitigate up to 75% of net cash flows for our seven largest currency pairs.
Furthermore, we hedge the monthly mark to market exposure on our balance sheet as well. We do this on a rolling twelve month basis and all of our hedging activity utilizes forward instruments. Finally, as it relates to foreign currency transaction exposure, I would highlight that any residual impact not offset by our hedging program is reflected in our underlying operational performance. Now let me address foreign currency translation exposure, which is the impact resulting from translating financial statements of foreign entities back in the U. S.
Dollars for financial reporting purposes. Given the nature of this exposure and the anticipated impact on our financial results in 2015, we will isolate the impact so that you will be able to better judge the operational performance of our company and progress against strategic initiatives. This table illustrates the top five translation currency exposures for Xylem. It provides you with the average exchange rate for each currency last year and the twenty fifteen rate assumed in our guidance which was based on the spot rate for each currency last Friday. To summarize based on these rates used for guidance, revenue will be negatively impacted by approximately $280,000,000 and operating income by 48,000,000 which results in a $0.21 EPS headwind.
Turning to slide 14, I'll further illustrate this impact. As you can see here, we expect organic revenue growth of 1% to 3% before approximately seven percentage points of negative foreign exchange translation impact. Operating income is expected to be in the range of $528,000,000 to $553,000,000 resulting in margin expansion of 50 to 90 basis the negative impact of foreign exchange translation noted on this slide. Please turn to slide 15. Just a few more points around our full year 2015 outlook.
On this slide, each of the projected margin and EPS growth rates exclude the negative impact of foreign exchange translation. At the segment level, we expect Water Infrastructure revenue of $2,300,000,000 reflecting organic growth of 1% to 3%. And for Applied Water, we expect revenue of $1,400,000,000 with organic revenue flat to up 2%. Segment margins are anticipated to be in the range of 14.5% to 14.9% and operating margins are projected to be in the range of 13.1% to 13.5% reflecting margin expansion of 50 to 90 basis points. At the bottom line, we anticipate earnings per share of $1.85 to $1.95 excluding restructuring and realignment costs of $20,000,000 As noted on the slide, EPS growth is expected to be 5% to 10%.
As mentioned earlier, we're driving 100% free cash flow conversion of net income and this takes into consideration expected CapEx in the range of 120,000,000 to $130,000,000 We expect return on invested capital to remain at approximately 11% given the unfavorable impact of foreign exchange translation on operating income. Excluding this anticipated impact of foreign exchange translation, we would expect approximately 50 basis points of improvement in 2015. Our operating tax rate is expected to be 21 approximately one point higher than in 2014 given the expected mix in regional revenue specifically higher growth in The U. S. Where we have our highest effective tax rates.
Lastly, fully diluted share count is expected to be 183,000,000. With that said, please turn to slide 16. As we've done in prior years, I'd like to spend just a few minutes highlighting the seasonal profile of our business, which you can see on the left side of the chart. For the 2015, we expect 1% organic growth due in part to the fact that we have one less day in the 2015 and an extra day in the fourth quarter later in the year. On average one day represents $15,000,000 of revenue which would impact year over year growth by 1.5.
I'd also note that we expect foreign exchange translation headwind of approximately $75,000,000 in the first quarter. We operating income to be down year over year due primarily to $12,000,000 in expected foreign exchange translation. While we anticipate our annual corporate expense to be held flat with 2014, we expect corporate expenses in Q1 to be in the range of 12,000,000 to $13,000,000 slightly higher than last year. And lastly, we anticipate the continuous improvement activities and restructuring savings will fund strategic initiatives. With that, I'll turn
Speaker 3
the call back over to Patrick for closing comments. Thanks Mike. Let me conclude by reiterating that we are pleased with our results in 2014. We made significant progress last year delivering strong financial results, refining our operating model and raising our execution game. We entered 2015 with solid momentum and we intend to build on our achievements.
I am confident that we have the right strategy in place and we're building the right team to move Xylem forward and to increase the value of our shareholders' investments. Operator, we can now open up for Q and A.
Speaker 0
The floor is now open for questions. Our first question comes from the line of Deane Dray of RBC Capital Markets.
Speaker 4
Thank you. Good morning, everyone.
Speaker 2
Good morning, Deane.
Speaker 4
Hey, just to start off, really appreciate that slide 13 you provided on your FX exposure. We recognize that this is a not one of the elements necessarily within your control, but this additional detail is a big help. And so a couple
Speaker 5
of questions for
Speaker 4
starters. And just so everyone is clear, I know some initial worries about the Swiss franc and being your tax center in Switzerland. I know it's a non issue, but Mike if you could just take us through why it's not an issue? And then also address please within the hedging why 75% on the transaction hedging? Why not 100%?
And where would we see the mark to market adjustments on a quarterly basis? Are those in your operating results? So I know just I grouped up all my FX questions there.
Speaker 2
Okay. All right, Dean. So let me take a shot at this. So I think as it relates to the Swiss franc, we do have some impact from that because we have local cost. But relative to the total size of the company, they're very small and not material.
I think the key element to understand is although we are in Switzerland the functional currency within Switzerland is the euro since we're transacting primarily with euro denominated countries. And so again it gets back to the majority of our foreign exchange impact is heavily weighted and you can see that on slide 13 in terms of the amount of profit that we capture in Switzerland, but it's denominated in euros. As it relates to the hedging program, it's a bit of a call from a company perspective. We have picked 75% because what that does is that essentially gives us some cushion for any variability we have in our forecast. It's all about qualifying for hedge accounting so that we avoid the second part of your question mark to market variation.
As long as we can demonstrate that we're effectively hedging predicted cash flows with a high degree of accuracy, essentially all the mark to market gets caught in basically a balance sheet account and then is released as we incur the gain or the loss on the actual transaction. So it takes the variability out of the P and L and it gives us a little bit of cushion from a financial projection perspective.
Speaker 4
Great. And just one follow-up within the currency exposure. Mike, how would you characterize your natural hedge with having manufacturing in let's say Sweden and just outside The U. S. How you balance on the revenue and cost side?
Speaker 2
Yes, I'd say probably not as much
Speaker 4
as we'd like to be.
Speaker 2
And I think that shows up in the fact that our hedging program covers about $500,000,000 in net cost and cash movements. And I think for the European exposure, we're pretty well offset given that most of our manufacturing is done in either Italy or in Sweden. But we do deal with some of the cross currency effects. And with our applied water business, we have a pretty heavy manufacturing base in
Speaker 6
The U. S. And that gives
Speaker 2
us a little bit of a disadvantage, especially when we see the U. S. Dollar appreciating. But again, we look to try and use the foreign exchange transaction program to put us in a better position in terms of hedging that off.
Speaker 4
Okay. And then away from FX and first of all I appreciate all that additional disclosure and detail on the FX side. And then just if you would characterize the benefit potential benefit from lower fuel costs and is that included in your guidance? And just update us on any direct or indirect oil exposures on your revenue side? I know there's some a bit in transport, but how would you characterize those?
And that's Yes.
Speaker 2
I guess sorry about that. I guess I'd characterize not only energy costs, but I would say overall commodity impact. We saw inflation rates that had averaged out around 2.8% throughout the course of 2014. Right now built into our guidance is inflation that's just around 2%. So we are certainly seeing the benefits coming through across the board in the business.
And I would say in terms of exposure, we have less than 5% of our revenue that's exposed to oil and gas and it's primarily Dean as you well know in our dewatering business. And I would say the majority of that exposure is actually against natural gas. We've taken a view that we are likely to be down and that is obviously built into the guidance range of 1% to 3%.
Speaker 6
Thank you.
Speaker 2
Thanks, Deane. Thanks, Deane.
Speaker 6
Our next question comes from the
Speaker 0
line of Scott Davis of Barclays.
Speaker 5
Hi. Good morning, Hey, Scott. Hey, Scott. Just trying to get a sense of your level of conservativeness in the guide on top line. And the 1% to 3%, looks like from slide three, I guess it is orders up 3%.
Are you seeing something in January that causes concern? Is this a just a lack of visibility and just trying to remain reasonably conservative?
Speaker 3
Yes, Scott. Let me this is Pat. Let me take that one. I mean, I'd say first of all, we were pleased with solid second half growth in the business. I would say though we need to recognize that we're still operating in a pretty low growth environment.
And so we do feel that we're taking share, but it's in a low growth environment. And while we are seeing some pockets of improving conditions, they are balanced with other markets where there's greater levels of uncertainty, especially in parts of Europe. We do have good visibility into Q1 both revenue and earnings. Obviously, we're being impacted as Mike indicated by a number of shipping days. So don't want to get into the hair on that one, but it does have some impact for us.
So there's no real concern as we go into Q1 from a revenue standpoint. But as you pointed out, it's a very short cycle business. And while we do see a number of bright spots, there are challenges. And so we want to be appropriately balanced in our look for the full year, given that short cycle nature. And therefore, we just think it's a good balanced outlook for the year.
Speaker 2
And Scott that one I would add to supplement Patrick's comment around the short cycle. Our backlog is up as we head into 2015, but it only represents 17% of our anticipated shipments for the year. So just gives you a sense of how much is left to go. And even when you look at the first quarter, I've got roughly 40% sitting in backlog. So we're kind of watching things on a day to day basis.
Speaker 5
Sure, sure. Understood. Following question just relates to the balance sheet. And there's things you can and can't control. The one thing you can control is your capital structure.
And the comments of bolt on acquisitions, but more back end of the year variety. It just leads me to believe I mean, is the risk we're sitting here kind of twelve months from now and cash balances are again building on the balance sheet and we're leaving a key lever that you guys can use on the table. So I guess my question is that why not step up repurchases or think about a more aggressive use of the balance sheet to try to control some drive some earnings growth here?
Speaker 3
Sure. So Scott, this is Patrick again. We do have $70,000,000 left in our authorized share repo program. And so whenever we sit back and talk about and think about our capital deployment framework, we still see our top opportunities here being to continue to invest in the growth of the core business. And so we are making investments in CapEx and R and D consistently in the past.
We did have the increase in the dividend and we'll continue to pull that lever. We are very actively looking at and pursuing the development of our M and A pipeline. So we're going to continue to remain focused on that area. Obviously, we want to balance that between execution there and our own internal operating execution, but I'm feeling better and better about that and the pipeline is looking more and more attractive. And we will use that remaining repo that we've got authorized if we find that things are not moving as fast on the M and A front as we'd like for it to.
But I'm confident that you're going to see us be pretty active here in the back 2015 on the M and A front, again focused on bolt ons.
Speaker 5
Okay. Thanks. I'll pass it on.
Speaker 6
Thanks, Scott. Thanks, Scott. Our
Speaker 0
next question comes from the line of Nathan Jones of Stifel.
Speaker 7
Good morning, Patrick, Mike, Phil.
Speaker 3
Good morning, Nathan.
Speaker 7
Morning. A question I guess as it relates to currency again, you do have a significant amount of manufacturing in Sweden and the kroner has also taken a big dive. It's actually even worse than the euro at the moment. What kind of impact could that have in terms of a potential competitive advantage for you there with the manufacturing in Sweden?
Speaker 2
Yes, mean it certainly plays in especially as we start thinking about the pumps that are manufactured in Sweden and export into The U. S. And Latin America. And I would say this has been a pretty fluid environment. I mean given the fact that the rates really fell hard in the latter part of December and then constructively throughout January.
We've got our teams obviously taking a hard look at what some of the competitive implications are across the board.
Speaker 3
Yes. And I would just add to that Nathan. Mean you're absolutely spot on that as things move fast here, I think our folks in the field are pretty savvy and we're very much focused on not just relying on hedging strategies to try to mitigate this FX impact, but really whether it's an advantage to take full advantage of that. But it's fluid and we'll move as fast as we can.
Speaker 7
And we've seen some of your competitors and some folks in adjacent markets talk pretty constructively recently on The U. S. Municipal market. Can you talk about what you're seeing in that market and what your expectations are for potentially accelerating orders as we go through the year?
Speaker 2
Yes. Mean we Nathan as we talked about through course of 2014, we definitely saw a pickup and it was more on the construction side specifically around what we saw in our treatment business which had orders that were up double digits. As we go into 2015, we're looking at the public utility market overall
Speaker 4
to be
Speaker 2
up low single digits. We do think The U. S. Is an area of opportunity. We continue to be very balanced in how we're looking at that.
I think one of the general concerns is, are we truly in a recovery or are we simply just catching up on the backlog of work? And I don't know that the jury's come back on that one. So, I'd sure hope that it would represent additional opportunity, but we're playing it kind of right down the middle right now.
Speaker 3
I mean, I would add that we are seeing the project funnel grow, particularly in our treatment business, which is being driven by that. But again, the timing of these things, many of them are longer term multiyear projects. And so again, we're just trying to take a balanced view here as to what to bake into 2015.
Speaker 7
And on the $20,000,000 of restructuring expense you're planning this year, can you talk about where that's targeted and what the potential impacts are? And that's excluded from your EPS guidance this year correct?
Speaker 2
Correct. I would say a fair amount of the restructuring component is actually associated with the actions that we undertook in 2014. So it's really tied into the $18,000,000 worth of restructuring benefit that carries over into 2015. We also have additional realignment which is a continuation of some of the ongoing transformation activity we have within the business and then some smaller elements that are related to what I'll call a little bit longer term restructuring activities that are within the business.
Speaker 3
I would add that, I mean we are absolutely committed to taking actions to improve the operating efficiency. As I've indicated before, I still stand behind the fact that we see a couple of 100 basis points at least of opportunity there in terms of cost out. I'd say this is on the heels of a good job by the team over the past few years in terms of taking cost out. But I would say that we're in the middle innings of developing what I would see as a multiyear and multifaceted plan. It's going to include lean and global sourcing, much of which is already baked into our plan and it's really the driver behind the 50 to 90 basis point operating margin expansion that we're talking about before FX.
But in addition to that, we have identified some strategic actions that are centered around business simplification that we think can reduce our structural cost. And lastly, would say with Tony Milando coming on board now, together he and I will be developing and executing a plan that's focused on strategic opportunities to reduce costs that cut across the businesses as opposed to the recent activity the last couple of years, which was really centered on business unit by business unit. Now the opportunity is to look across the businesses.
Speaker 7
I'll be looking forward to more details on that in the next couple of quarters. Thanks very much.
Speaker 2
Thank you. We will.
Speaker 6
Our next question comes from the
Speaker 0
line of Chip Moore of Canaccord.
Speaker 6
Thanks. I was hoping you could touch on Europe a bit more, I guess, particularly for the Water Infrastructure business. Sounded like it was pretty mixed France down. Just talk about country by country a little bit confidence that that business stays stable? Thanks.
Speaker 2
Yes. I think Chip, we've taken a I'd say a fairly conservative view relative to Europe. I mean, Europe was a little bit better in the fourth quarter than we had anticipated. We were essentially looking for it to be flat and we were up about 1%. As we look out into 2015, we're essentially counting on Europe to be call it flat.
The Nordics continue to be strong economically in the way they develop their water systems. We feel confident there. We're confident from a U. K. Standpoint because we track with the AMP cycle and we know that that's going to be into a more of a downturn here for the next year and then moving into an upswing.
I'd say where the question mark start to come is around Western and Southern. We pointed out the fact that France was down. France is one of our larger end markets and so we've seen a little bit of volatility there and we're keeping a close eye to make sure that we can understand and track that. Germany has remained relatively balanced and Southern Europe continues to be a net drag for us. And so at this point, I wouldn't say we're going to expect to see something that occurs through 2015.
In our view that's going to be dramatically different than that and as a result that becomes more of a drag on the top line growth.
Speaker 6
Okay. Yes. That's helpful Mike. And if we shift it to emerging markets, obviously great results. Looks like that strategy is starting to pay off.
Maybe you can just detail out a little bit where you're funneling some investments there?
Speaker 3
Sure. So let me take this one. We've identified I certainly don't want to suggest that we're only focused in on China and The Middle East. I mean, we're certainly sowing the seeds and building the capabilities in other critical emerging markets as well and we're seeing good growth there. But we're taking a very focused strategy in 2015 and making investments both in China and Middle East.
They're largely driven by the need to further localize our manufacturing, some of our R and D work, the innovation that we're doing around the products and services that are tailored for those markets. And we're also putting some more feet on the street in those markets as well. So it really is more about localization and transferring some of the responsibilities and capabilities to those markets away from some of our core developed markets where the activity occurs today.
Speaker 6
Great. Congratulations guys. Thanks.
Speaker 3
Thank you.
Speaker 0
next question comes from the line of Robert Barry of Susquehanna.
Speaker 6
Good morning.
Speaker 8
Good morning. Good Robert.
Speaker 6
Wanted to just start by following up on some of the comments you made about accelerating some of the sourcing lean actions, perhaps accelerating some structural cost actions. Do you mean imply that there could be some upside to that $20,000,000 a bucket of restructuring that's currently in the plan?
Speaker 3
I think these are actions that, first of all would likely not benefit us until late twenty fifteen predominantly into 2016 and onward, because they are going to be a bit more difficult to get at structurally than some of the things that we've done in the last couple of years. And we're in the middle innings of developing and finalizing that plan. And so I wouldn't necessarily see it as straight up upside to what we're guiding to right now. Obviously, we're going to accelerate and get these things as quickly as we can. And as I mentioned earlier, we'll certainly be keeping you guys apprised of progress over the course of the year.
Speaker 6
Okay. Fair enough. And then I was wondering if you could just unpack a little bit the expectation within infrastructure, a growth of 1% to 3%. Anything there that stands out as maybe within the businesses is a little bit stronger or weaker? It sounds like maybe treatment with some of the push out might be weaker transport stronger, but just curious your views across transport treatment test.
And within transport dewatering I think has been stronger. Is that still the expectation?
Speaker 2
Yes. I think as it relates to dewatering, we certainly expect to continue to see growth with the exception of the oil and gas exposure where we do anticipate getting a little bit of headwind. I'd say as it relates to treatment, probably not as strong a growth as you would expect mainly because the project sequence out over time. These can be nine, twelve, eighteen month projects. I'd really look at the core transport and test businesses as being kind of the key drivers.
But again looking at Europe as potentially drag on the overall performance. And I think from a pricing environment perspective although we did see a little bit of positive price 20 basis points in the fourth quarter, we're not anticipating that to be a significant driver. We are anticipating some positive price, but it's going to be below 50 basis points throughout 2015.
Speaker 6
Is mining expected to be a headwind or tailwind or neutral? I think it's been a pretty big headwind, but Yes.
Speaker 2
For us, I think in 2015, it's about net neutral. Saw most of the impact this past year or so.
Speaker 6
Fair enough. And then just maybe one final one housekeeping item. You talked about resi weakness in calling out Europe. Just how much of that 7% of the business that's resi is in Europe? It's about a quarter.
A quarter of the 7%?
Speaker 2
Yes.
Speaker 6
Okay, great. Thank you.
Speaker 3
You bet. Thank you.
Speaker 6
Our next question comes from the
Speaker 0
line of Joe Giordano of Cowen.
Speaker 3
Hey, guys. Hi, Good morning.
Speaker 8
Question first on the restructuring. At what point do we start taking that into operations and not call it out specifically if it's more tailored towards like a continuous improvement type of initiative?
Speaker 2
Yes. I think I'll give you my perspective and then Patrick can certainly weigh in. I think we've got to get through what I'll call this next wave of transformation, which obviously we have not fully detailed out yet and need to understand the impact. But I do think philosophically we agree that at a point here in the not too distant future we need to start to
Speaker 3
incorporate that into the earnings profile of the business. And I totally agree with that. We've talked about that internally and it's really been myself that said, let's make sure that we have this window here in front of us where we know that we're going be doing some more transformative things and I want to make sure that we're able to be as transparent as possible with all of you as to what that looks like. But we definitely want to get to a level of normalcy here in terms of just baking it into our results.
Speaker 8
Okay. And then more of a high level question. I'm just curious to hear what comments you had or what potential implications you think about some of the tax proposals being discussed in Washington now regarding accrued foreign income and things like that? And where is your cash position relative to U. S.
Versus overseas things of that nature?
Speaker 2
Yes. So a couple of comments. One, tough to comment because nobody knows what's actually going to make it through. I think obviously we're supportive of any proposal that would enable us to get our cash back from overseas in an efficient manner given the fact that we have 80% outside of The U. S.
That said, we don't wait for tax changes. We've got a pretty active strategy from a planning standpoint. We've been pretty effective since we spun off being able to repatriate cash in a very tax efficient manner. So we'll obviously continue to watch it. We've got a strong tax team here that stays pretty plugged into what's going on in the regulatory environment and we have demonstrated in the past that we can react pretty quickly to regulatory changes.
Speaker 8
Okay. And then just lastly for me on M and A just real quick. Where are you looking to increase I'm assuming Europe is where valuations have declined the most. Are you looking to increase your exposure there if the opportunity is presented so?
Speaker 3
We certainly wouldn't rule it out. I comment right now on a preference as to one geography versus another. I think that we're going through some very attractive kind of value mapping work as we speak in terms of laying out really leveraging this industry vertical marketing capability we're building to really understand what the full range of water management needs are for our customers in different industries. And we're really doing that work along with pursuing some deals in the pipeline already. So probably wouldn't want to comment on geographies at this stage.
Speaker 8
Okay. That does it for me. Thanks for taking it guys.
Speaker 2
Thanks, Joe. Thank you.
Speaker 6
Our next question comes from the
Speaker 0
line of David Rose of Wedbush Securities. Good morning.
Speaker 3
I Hey,
Speaker 9
just wanted to follow-up first of all just on the restructuring realignment just to be clear. So the $20,000,000 is not included in the numbers. You have $18,000,000 of savings from the 14 actions. And is that and is it $20,000,000 in total that's an additional $38,000,000 coming through?
Speaker 2
No. It's 20,000,000 in total, dollars 18,000,000 of which is from the actions we executed Some of that cost carries over into $2,015,000,000 and then we have $2,000,000 of extra benefit from actions that are occurring in 2015.
Speaker 9
And so the $20,000,000 in restructuring and realignment costs, what sort of benefit should we see in 2016?
Speaker 2
Yes. Like I said about half of that $20,000,000 in cost is actually related to the actions that started in 2014. But from an accounting standpoint, we weren't able to accrue for that. So if you look what we incurred in 2014 which was about $26,000,000 that was below what we had originally guided to and it mainly had to do with the cutoff of what is accrual or not accrual under restructuring. The balance has to do with realignment.
So it's a variety of things associated with getting the lean deployment manufacturing footprint those types of things underway.
Speaker 9
Okay. All right. That's clear for me. Thank you. And then just a couple of follow ups.
Just on the commentary around your residential assumptions, I mean you've got just a quarter of that really is in Europe. So vast majority is in The U. S. So why wouldn't you see higher growth rates? I mean what sort of assumptions are you do you have embedded in Europe for resi?
Speaker 5
I mean, if we can Yes.
Speaker 2
Definitely, David, the headwind in Europe, it is just a quarter, but it does carry kind of a mid single digit decline with it. The thing that I think we always need to point out with our resi business as it relates to our U. S. Exposure given it is about half of what our residential business is. It is primarily a replacement market, and it's primarily around borehole pumps.
So while we do anticipate the residential market will be in an upswing in 2015, our ability to participate in that is really more in a replacement. Not to say that we don't participate in new builds where they're putting in ground wells and things like that, but it's just not as big opportunity as all the new construction going on.
Speaker 1
David, I actually highlight to the extent that there's a recovery here or a continued if you would progress in residential market that's actually going to benefit more that U. S. Public utility infrastructure. Public utility.
Speaker 3
Yeah.
Speaker 9
Sure. Just looking at some of the peers that have had much more positive commentary around residential. And maybe if you could lastly on the treatment side, you've made a lot of changes in terms of product development on the treatment side coming up with small system solutions. Does that change the nature of the cycle, I mean, greater short cycle where you have less visibility. And I'm really kind of thinking about water reuse as an example.
Does that sort of change your visibility in that market? I mean, the opportunity seems to increase, but you have less visibility. Is that fair?
Speaker 3
I don't I think it's a fair question. I don't we certainly don't have a sense or a feel that it's necessarily going to reduce our visibility in terms of shipping mix that much. Actually part of the work, that we benefited from in terms of one having integrated our front end commercially as well as the implementations of CRM solution, is that we our teams especially in North America where we were implementing it first, are actually getting more visibility to building out the project funnel. So we've actually grown our project funnel pretty significantly here over the past number of months, as well as having improved our win rate, as a result of that. So I think there are going to be things that we do internally from an execution standpoint and getting better visibility and expanding the funnel that would mitigate any of the offset that you're referring to in terms of change in mix of short cycle.
Speaker 9
Okay, great. Thank you very much.
Speaker 2
Thanks,
Speaker 0
final question comes from the line of Brian Koenigsberg of Vertical Research.
Speaker 9
Yes. Hi. Good morning.
Speaker 3
Good morning.
Speaker 9
Maybe touching a little bit more on just oil and gas. I understand it's 5% of your revenue exposure. Can you tell us what the contribution to operating profit is? I suspect that dewatering higher margins is it maybe closer to 10% of operating profit?
Speaker 2
Yes. Brian, I want to stay away from getting into the details. But the couple of points I give you is, it is dewatering, it is rental. But I would tell you it's in the lower end of the value add spectrum on that. So I wouldn't anticipate the type of drop rates that we've seen in the past on rental.
But as we indicated, it's less than 5% of our revenue. We do think that the team has some pretty good options in front of them to try and offset some of the potential headwinds through branch expansion and some of the activities that they have underway just given the size of player we are in the market. But at this point, we really didn't call it out because we don't anticipate being a significant headwind at this point.
Speaker 9
But I guess just following on that point, I understand you said the exposure is more kind of on the gas production side, which gives you a little bit more comfort. Do you have a guess a sense of the exposure to gas production. I mean is it on associated wells or is it dry gas wells? Because obviously there's been a ton of production of gas coming from wells that are targeting oil and it's a byproduct. So if we're going get a pullback on that type of production, have you done that type of analysis and is that incorporated in your outlook?
Speaker 2
The team has definitely done that. And what I would tell you is that the majority of our exposure is going to be direct not residual. And at this point, it's about watching what's going on with natural gas pricing and rig counts. And at this point, the thing I'd point out to you is we actually had very strong performance in the fourth quarter. So we have not seen any initial signs, but obviously it can change relatively quickly.
Speaker 9
Yes. I mean I'd say that obviously we took a fairly big leg down since Q4, but okay. Just moving on. Maybe just on inflation. So I think you said in water infrastructure up 3% from an inflation standpoint.
I mean so just with the commodity prices coming off, mean where is most of that inflation coming from? Is it wage and I guess other sorts of inflation? And shouldn't that start to moderate maybe?
Speaker 2
Yes. So the 3% that I spoke to was relative to 2014. And as I think I answered earlier question, we think inflation is going to be closer to two. A big portion of that obviously is what we do from a wage perspective which has not come down year over year in terms of what we give folks in terms of merit increases on an annual basis. And then there are parts of the component base that have not moderated as much from a commodity pricing standpoint.
So we've got a great strategic sourcing team. They've done a lot over the past several years to drive savings and we're pretty confident that whatever residual inflation we see we've got the ability to more than offset it.
Speaker 9
Got it. Thank you very much.
Speaker 2
You bet. Thanks, Brian. And
Speaker 0
we have a question from the line of Jim Gianacoris of Oppenheimer.
Speaker 10
Hey, Jim. Hey, good morning.
Speaker 9
Good morning, Jim.
Speaker 10
Thanks for taking my question. Yeah. Just a quick one on and I'm sorry if I
Speaker 9
missed it. If you can
Speaker 10
talk about the competitive landscape in both of your segments or by end market? You mentioned that you don't think price is going be a headwind this year. Just some color around that. Is that reflective of more rational players out there or reflective of your value proposition relative to other products out there? Any color would be helpful.
Speaker 2
Yes. So I think as it relates to applied water, there's probably going be a little bit of downward price bias. It's probably less about the competitive environment. It's more about what we've seen in the underlying commodities. That business tends to track more closely.
We do anticipate getting positive price, but may not be at the same level that we've gotten over the past couple of years as commodity prices are settling down. I think within water infrastructure, it's probably a bit of the market calibration and we're now entering a period where the market is growing albeit at a very low rate and that is taking a little bit of the pressure off. But I don't want to suggest that those competitive pressures have diminished dramatically. I think it's going to be about how do we make sure our teams fully understand and have the capability internally to do the right value proposition selling to make sure that we're getting paid the premium that we deserve given the performance of our products.
Speaker 3
I would also add that one of the other things that the team is working hard to do is one of the benefits from a pricing standpoint is when you're able to ramp up your launch of new products. And we have had a number of new products that we've launched recently and a number teed up for $20.15. So it's always easier to go talk price when you've got something new to talk about in terms of technology and solutions. So that's going to be another lever for us to pull as well.
Speaker 10
Very helpful. Thank you.
Speaker 2
Thank you. Thanks, Jim. Thanks.
Speaker 0
There are no further questions at this time. I would now like to turn the floor back over to Patrick Decker for any additional or closing remarks.
Speaker 3
Great. Well, thanks everybody for your time on the call today and we appreciate your continued interest. And we look forward to updating you on our next call. So safe travels and we'll talk to you soon. Thank you.
Speaker 0
Thank you. This does conclude today's Xylem's fourth quarter and full year twenty fourteen earnings conference call. Please disconnect your lines at this time and have a wonderful day.