Xylem Inc.
Q1 2014 Earnings Call Transcript

Published: 29 Apr 2014

[Operator:]

Welcome to Xylem's First Quarter 2014 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Phil De Sousa, Vice President of Investor Relations.

[Phil De Sousa:]

Thank you, Susan. Good morning, everyone, and welcome to Xylem's First Quarter 2014 Earnings Conference Call. With me today are Chief Executive Officer, Patrick Decker; and Chief Financial Officer, Michael Speetzen. They will provide their perspective on Xylem's quarterly results and discuss the full year outlook for 2014. Following our prepared remarks, we will address questions related to the information covered on the call. [Operator Instructions] We anticipate that today's call will last approximately 1 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.xyleminc.com. 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. A replay of today's call will be available until midnight on May 13. Please note the replay number [phone] and the confirmation code is 22345240. Additionally, the call will be available for playback via the Investors section of our website under the heading Presentations. With that said, please turn to Slide 2. 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. Now please to turn to Slide 3. And I'll turn the call over to our CEO, Patrick Decker.

[Patrick K. Decker:]

Thanks, Phil, and thank you all for joining us this morning. Today, we announced our first quarter 2014 results. In a moment, I'll give you some headline comments and perspective on the quarter. I will then share some perspective on what I've seen and heard thus far, since join the company 6 weeks ago, and then I'll turn it over to Mike to share more details on the quarter and our full-year outlook. Given the slow start to the year, which was driven in large part by severe winter weather conditions in North America, the team certainly closed the quarter strong and delivered a solid performance. Heading into the last month of the quarter, we understood it would be critical to drive hard to recover from the slow January and February to get back on track. I'm very pleased with the way the team embraced the challenge, particularly during a CEO leadership transition and challenging market conditions. During the quarter, orders and revenue grew 3% overall and organically, with strong performance coming from emerging markets. We entered the second quarter with backlog of $793 million and 2014 shippable backlog of $679 million, which is up 6% year-over-year. We continue to invest for growth. During the first quarter, we spent $27 million in R&D, up 4% from the prior year and we expect those spend levels to continue through the year. And we see prior year's investments in product development paying off. For example, sales of Flight Experior embedded with new smart run technologies grew approximately 50%. This demonstrates the continued adoption of smart technology and flights capability in market-leading product development. Additionally, our investment in MultiTrode is also a driving growth. For example, we just recently completed the release of our Multismart Controller in 12 additional languages, enabling us to expand sales of this line to approximately 20 new countries. Just as critical are our ongoing cost-reduction initiatives, such as the $18 million of restructuring and realignment costs in the quarter, targeted at reducing our overall cost base. We'll see the benefit from those actions in the latter half of the year, and we continue to realize significant savings from the actions the team completed last year, which resulted in a 150 basis point improvement in operating margins in the first quarter. To wrap up the first quarter results, volume growth and improved operating performance drove earnings per share of $0.34, up 26% over the prior year. Free cash flow is negative $3 million, primarily reflecting typical seasonality and working capital dynamics. We are confident in achieving our full year free cash flow target of 100% conversion of net income. Finally, on the capital deployment front, we increased our first quarter dividend by 10% and opportunistically repurchased $50 million in common stock. We will cover some of my initial observations since joining the company on the next slide, but I'll highlight one message I've already stressed

[Michael T. Speetzen:]

Thanks, Patrick. Please turn to Slide 5. We generated revenues of $906 million, up 3% from the prior quarter. It's worth noting that we're comparing the first quarter of last year, where we experienced 7% organic revenue contraction. The public utility industrial and residential end-market showed strength relative to poor performance last year. The public utility end market was up 5%, driven by continued infrastructure investment in emerging markets and while we did have some sizable projects deliver in Europe and the U.S., customers remain focused on operational expenditures and small project activities. Growth of 1% in industrial stemmed primarily from emerging market demand, including the delivery of several projects for the power market in Korea and heavy industry in China. While the commercial market came in flat for the quarter, residential continues to demonstrate growth, up 6% over the prior year, driven by growth in both the U.S. and emerging markets. I'll cover up more specifics by segment, but generally speaking, we saw strong growth from emerging markets, up 18%, modest growth of 1% and the U.S. was down 1%, most significantly impacted by weather. We delivered strong operational performance. Operating income of $94 million was up $16 million or 21% over last year, and operating margins increased 150 basis points or 10.4%. The first quarter performance was driven by the increase in organic volume and savings from cost reduction initiatives across our businesses. Cost reductions totaled $31 million and included approximately $10 million of restructuring savings and the balance coming from sourcing and Lean initiatives. Partially offsetting these tailwinds was inflation of nearly 2% and unfavorable mix due to lower dewatering rental revenue, which stemmed from the severe weather conditions experienced early in the quarter. Incremental margins were 59%, including the benefit from restructuring savings and unfavorable foreign exchange. Excluding these items, incremental margins were still strong at 42%. EPS expanded 26% to $0.34, better than we anticipated, driven by favorable revenue performance and accelerated cost actions given the slow start to the year. Core operations drove the year-over-year EPS improvement, contributing $0.10 driven by organic volume growth combined with execution on productivity and cost management, including restructuring savings of $0.04. Now let me provide more detail on each of our reporting segments. Please turn to Slide 6. Water Infrastructure reported revenue of $568 million, up 4% organically. Additionally, we had 1 percentage point of growth from acquisitions and foreign exchange was a 2-point headwind. We experienced organic growth in all of our applications, with transport up 3%, treatment up 9% and test up 5%, year-over-year. Regionally, we saw the most significant growth come from emerging markets, which were up 24%. Europe was positive, up 2% and slightly better than our expectations, but was more than offset by the U.S., which was down 6%. I'll summarize our revenue performance as follows

[Patrick K. Decker:]

Thanks, Mike. We delivered a solid first quarter, which gets us off to a good start to the year and we're very excited by the direction Xylem is headed. As Mike indicated, we see stable market conditions and are gaining momentum in orders activity. Operational performance is improving. While we are not where we need to be yet, I am pleased with the progress the team has made and the trajectory we are in. And as I mentioned in my opening comments, we are clear about our focus areas and remain committed to delivering on our financial commitments and recognizing the full potential this company is capable of delivering. Operator, we can now begin the Q&A session.

[Operator:]

[Operator Instructions] Our first question comes from the line of Deane Dray with Citi Research.

[Deane M. Dray:]

That was a nice clean quarter. I had a couple of questions. The first will be on the emerging markets. Seeing an 18% organic revenue is very impressive, as well as the 50% up in China. So if you could just give us some additional color, how much of that -- is it a lumpy business? Are these big projects? Is there any MRO associated with them and then how does that play out the balance of the year?

[Michael T. Speetzen:]

Yes. So thanks, Deane. The 18% growth was terrific and as you indicated, there's definitely project activity that comes with that. And it was pretty balanced across various regions. I think the key point I'd make is that we are anticipating that it will decelerate. We anticipate the full year emerging markets would be in the high single-digits. And so although it will continue to be very positive for the business, we do see it moderating a bit. And as you indicated, we are dealing with some of the project deliveries and saw a couple of those accelerate into the first quarter, which created a little bit of a distortion on growth rate.

[Patrick K. Decker:]

And Deane, I would only -- I would just add that the emerging markets, that whole area in my mind from a strategic standpoint is, I think, a big area of opportunity for us. I'm actually going to be traveling over to Asia for the first couple of weeks of June, to get a number of our markets over there and just get a better feel for the pulse of the business, but I'm very pleased with the quarter. But I'm also very much focused on what the long-term potential is for us in those markets.

[Deane M. Dray:]

And I should have also added, it's -- you'd rather be in a position of explaining why the emerging markets are up so much, rather than the other way around. And the second question, for Mike, I know you alluded the fact that corporate expense came in late this quarter. Maybe if you could calibrate for us what's some of the puts and takes were. I know, from our estimates, it came in like by about $0.025 favorable. So was there some discretionary spending that you pullback and what other puts and takes might there be?

[Michael T. Speetzen:]

Yes, I mean, look there's always puts and takes relative to things like compensation accruals and things like that. But I think, given that we saw the year starting off slow and saw the weather having a pretty heavy impact on our very profitable dewatering business, we made some discretionary decisions around deferring certain costs out of corporate. And that was really consistent with what you've seen us do in the past, where we're keeping a very quick pulse on the business and reacting quickly as well. We do anticipate some of that coming back into the business. So as I mentioned in my prepared remarks, we see corporate being in the range of $55 million to $60 million for the year. So you ought to anticipate us being around $15 million to $16 million per quarter.

[Deane M. Dray:]

And then -- perfect. Just last one for me, is maybe you can address how the cadence of the quarter played out. You said January and February were light, March came in strong. Can you give it to us on organic revenue growth basis by chance?

[Michael T. Speetzen:]

Yes, so I guess, maybe I'll put it in these terms. When we looked at February, as I mentioned in Patrick's introduction call, we were actually flat year-over-year. And when we looked at how much we had delivered through that point, we were at about roughly $500 million worth of revenue. We were anywhere from 2 to 3 percentage points behind where we have historically been. So by default, March came through a couple of points better than we had originally anticipated and I really give a lot of credit to the teams, given the weather conditions improved into and back out of it. Dewatering, for example, we had seen utilization rates in the low 40s, 40% range in January and February and we saw these utilization rates improve back up into the high 40s. We did not recover the January and February missed revenue, particularly in that business, but the teams really took advantage of the weather being back. We didn't run special promotions or anything like that. The teams just went out and made sure that we were executing on the business.

[Patrick K. Decker:]

Now I would just add, Deane, that I -- having come in the middle of the month and knowing and seeing firsthand the level of focus and intensity the team was placing on this, I was very impressed by how they came together and rather than making excuses, we're really going out and just as Mike said, doubling down and the teamwork across the organization was very impressive, those last 3 to 4 weeks of the month.

[Operator:]

Your next question comes from the line of Ryan Connors with Janney Montgomery Scott.

[Ryan M. Connors:]

This question is for Patrick. Patrick, you mentioned the top 3 focus areas on Slide 4 and the #1 focus area there is putting customers at the center. And there's been some level of chatter in the marketplace, maybe some of it opportunistic by your competitors that given the last few years, there's been a lot of distraction, the spinout, multiple changes at the top. Is the fact that, that goes at the top of your list any reflection that you think there is merit to that distraction and now this needs to refocus? Or is something else that you saw on your travels that led you to put that at the top?

[Patrick K. Decker:]

Yes. Well, I appreciate the question. I had to say, first of all, throughout my entire career, it's always been very clear to me that keeping customers at the center is got to be at the forefront for any organization and company. I will then add that I think any organization that is going through a number of changes and transition a company like Xylem has done, naturally, they're going to be magnetic forces that pull people away sometimes from focusing on the customer. But I have been very impressed by what I've seen out at the local level in terms of people's passion for the customer. The whole passion for being very entrepreneurial at a local level and all I'm trying to do here is to really elevate that. You've heard Steve talk in previous calls about the importance of us investing in innovation and that also is very much a centerpiece for me. Because I do think we have opportunities here to again leverage our productivity to invest even more in innovation over time.

[Ryan M. Connors:]

And then kind of a related follow-up is just in terms of compensation structures and incentives, both for I guess, in the -- both the manufacturing side of the house and maybe more importantly in the customer-facing side of the house. As you look at the way things are structured, are there any changes or tweaks do you think that need to be made in terms of how the teams are incentivized to drive the business?

[Patrick K. Decker:]

Well, I would say, again, good question. It's early days for me. I mean, it's my seventh week in the organization. Obviously, making sure that we've got the right organizational model in place, which I feel good about in terms of the changes been made here, making sure that the incentive structure is aligned with that, are clearly very much on my radar screen. But I think it's premature for me to comment right now on that.

[Operator:]

Your next question comes from the line of Mike Halloran with Robert W. Baird.

[Michael Halloran:]

So could we just go through the puts and takes, when looking at the front half of the year versus the guidance for the back half of the year? Obviously, a large portion a little over half of that's going to be just sequential volume uptick that you guys are projecting, but what are some of the other puts and takes there sequentially from a mix perspective, as you see restructuring layering in and any other items like that?

[Michael T. Speetzen:]

Yes, so I think a couple of things, Mike. Restructuring is going to be pretty even throughout the year, it's going to be about $20 million in the first half and the second half. What you really sees is a couple of things and you hit it, it's the volume leverage, as we get into the back half of the year. We're going to end up delivering, call it another $150 million worth of revenue and it's going to have a pretty hard mix in our Water Infrastructure segment, which is we've indicated drops at a pretty high rate. In addition to that, as we laid out in our guidance, we talked about the $100 million worth of cost reductions. It's a little more biased towards the back end of the year. If you look at our first quarter, we got about 22% of the total savings including restructuring. So we're going to end up picking up another $15 million to $20 million in the back half, which is really the work we're doing to accelerate a lot of the sourcing savings that we think the business has the potential to recognize, as well as just getting the Lean projects up and going. So you've got the volume leverage, coupled with higher level of the profitability coming through on the productivity savings.

[Michael Halloran:]

Makes sense. And then on the dewatering platform, obviously, mining is a little bit of a headwind, weather was a headwind in the first quarter. Maybe you could just talk a little bit by end market, what you're seeing there as weather and trends start normalizing and which of these areas or strength are improvement, which areas are still soft?

[Michael T. Speetzen:]

Yes, so and I think you're right. The mining is going to continue to be a headwind, especially in the first half because then we'll start to lap some of other things, we saw playing out last year. For us, the first quarter, and whether it was public utilities or construction, given the freezing conditions, the fact we had, I think over 20 Godwin branches that were shut down due to weather and construction sites being down, we saw that part of the dewatering business down kind of call it mid-single digits. As we go through the balance of the year, we're not anticipating the recovery in mining. We definitely see the construction markets improving, and we'll definitely see public utilities getting back to a more stable environment. I think that will really help, from a mix perspective, back to your first question with the rental business, picking up momentum through the course of the year.

[Operator:]

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

[Nathan Jones:]

Patrick, hearing your prepared comments, you spent a fair bit of time talking about your philosophy in your approach to management in terms of Lean Six Sigma, voice of the customer. It's probably unfair to ask you about where the opportunities are within Xylem at this point, but could you just expand on that a little bit more and how you intend to draw those changes down through the organization?

[Patrick K. Decker:]

Sure. Again, thanks for the question. I would summarize it as this. As I've traveled around, I've clearly seen some pockets of real strength and excellence, as it relates to the application of Lean Six Sigma and also even in the area of sourcing activity. But I do believe that there's an opportunity for us to make that more consistent in its application to also make it deeper in its application. So, for example, what I've not seen as much of is the application of Lean Six Sigma kind of beyond the 4 walls of the factory. So when you start getting into the sales and marketing area, the R&D area, I've seen pockets of it, but I think, there's more opportunity for us in that area, that will also help us enable to drive growth. In terms of how I go about doing it, again, I think messaging across the organization and making sure that people understand that it is a #1 priority for me is where it starts and also making sure that we are investing adequate resources in terms of training, certification, but also how we deploy the resources across the organization. So there's a multitude of things that I'll be driving in that area, as we go forward. As you know, very well, this is a journey. It's a journey that's never ended, and I think that we are well on the path to realizing it, but there's still opportunity in front of us.

[Nathan Jones:]

Okay. And my follow-up is on the test, strong growth there. You did call out some large projects shipments in that business. Is that something that you're expecting to recur or we expecting to see a moderation of the growth rates there?

[Patrick K. Decker:]

Yes. I think there'll be a little bit of a moderation, as I commented overall from around the emerging markets, with us, up 18% in the first quarter. We're going to see that moderating down into what I'll say is the high single-digits as we move forward. And again, it could move around within the quarters, but at this point, I don't anticipate anything significant for that particular business unit anyway.

[Operator:]

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

[Scott R. Davis:]

Patrick, I know it's early days, so it's kind of hard to answer some of these questions, I'm guessing. But I wanted to touch on a couple of topics. And first is just the cost base. It was always our understanding at least that the high fixed cost base in Europe needed to be chipped down at. I mean, have you dug into that or at least, have any early read on whether that cost out -- take out the past restructuring, that's already done, but whether that cost base can, in fact, be brought down to better levels? Or do you just need volumes to come back to make that business look better? I guess, it's -- I'll just open it up to that.

[Patrick K. Decker:]

Sure. Yes, well, volume always helps certainly, and we shown, certainly this quarter, that leverage in that volume growth is a great way to expand margins. But my assessment right now is that I think the commentary that's been made in the past around there being a couple of hundred basis points or so of SG&A opportunity that's still in front of us, I think, is very fair. I've seen opportunities as I've traveled around that I do believe, we can drive that number down. In terms of margin expansion, again, I still believe that through, again, some of the Lean work that we can do, there'll be opportunities in that area, as well as we go forward. In terms of any other kind of cost takeout actions, I think, again, there's opportunities there in terms of helping us get this business to that mid-teen margin that's been put out there in the past as a long-term goal.

[Scott R. Davis:]

Okay, fair enough. And then as a follow-up, one thing that was missing in your slides, and again, early days, is really the portfolio and M&A. I mean, how do you think of driving the M&A organization? I mean, do you have to take a backseat for a while, until you make the cultural changes you're looking for, or can you proceed on continuing to look at assets and maybe even potentially getting more aggressive?

[Patrick K. Decker:]

Sure. Yes, well, I think that acquisitions are and definitely will be a key element of our growth strategy in terms of getting our growth rate up to where we have stated we wanted to be. We continued and I've seen the teams continue to cultivate opportunities, even while we've been in this slight pause for a while. And so I think now we've made a lot of progress on the operating improvement actions, obviously, we still have work to do there. That gives me increased confidence in execution. Obviously, we no longer have the lingering questions around CEO change. I'm very pleased the team has maintained a pipeline of candidates and continue to have a strong balance sheet that we can obviously leverage when the time is right. So again, little bit more time for me to spend with the team and of course, the market factors always come in play here and when the right opportunity is available. But I can reinforce that acquisitions will be a key element of our growth strategy.

[Operator:]

Your next question comes from the line of Matt Summerville with KeyBanc.

[Joseph K. Radigan:]

This is Joe Radigan on for Matt. My first question is just a follow-up on an earlier answer. Have you seen the pickup in March? Has that carried through into April so far? I mean, what are you seeing more up-to-date trends?

[Michael T. Speetzen:]

Yes, so we're actually right on the forefront of getting results for the month of April. But based on what we've seen and heard and there's a little bit of softness, some of that's the project deliveries that accelerated into March. But otherwise, we really haven't seen any significant deviation from the trends that we saw in the month of March.

[Joseph K. Radigan:]

Okay. And then Mike, I think you said in your prepared comments that you've seen some early signs of the CapEx-related business improving. Was that a U.S. comment or a global comment, and what are you seeing there that kind of gives you more confidence that maybe we could be seen recovery at some point of the horizon here?

[Michael T. Speetzen:]

Yes, I mean, I think, it's between both regions and as you know, Europe is a number of different regions. So we tend to see more of the strength in the, call it, Western and Northern part of Europe. But the reason that we have, I guess, increased confidence is when you look at the backlog that shippable for 2015, it's up 34%. And then when you look at it between the 2 segments, it's actually up over 40% in Water Infrastructure. And so that obviously has some projects that are in emerging markets, but it does also contain the work that we see going on and we've seen it. I'll comment more specifically around the treatment market in the U.S., where last year as you know, we continued to see declines in the order rates. That's impacting our revenues as we get into 2014. But we are seeing order rates starting to pick up that will obviously bode well for 2015. So we're not ready to call that we're out of the woods yet, but it certainly feels like things are moving in the right direction. The bid pipeline is still very active, and we feel like, we're competitively positioned to take advantage of that.

[Operator:]

Your next question comes from the line of Brian Konigsberg with Vertical Research.

[Brian Konigsberg:]

Mike, maybe can you just touch a little bit more on price cost, so it was a little bit mixed in the quarter. I know you -- I think, you had some decent opportunities in the second half of '13, maybe it decelerated a little bit in Q1. I just wanted to know what your thoughts were for the remainder of the year, particularly through the channel.

[Michael T. Speetzen:]

Yes. So I think, we saw little price, about 20 basis points in Q1 and it was actually more biased towards Applied Water. Water Infrastructure was essentially flat. It was better than we were anticipating slightly. But I do expect that the competitive pressures that we see in the market are going to still weigh on us through the balance of the year. So the discussion that we had around pricing gain, where from 25 to 50 basis point, headwind for the year still holds. But from a cost standpoint, we're actively pushing from a productivity standpoint. So even though pricing isn't pulling its share of the weight that it was in the past, we've made up for that with not only the restructuring, but also pushing forward more on the sourcing and the Lean savings in the business and creating a nice spread that's going to give us the margin uplift that we need for the year.

[Brian Konigsberg:]

All right. And this just going over to the customer relationship management system. Where are you in that installation process? Are those costs embedded in Q1 numbers and if not, I guess, maybe just touch on the cadence of the spending and potentially even the benefits?

[Patrick K. Decker:]

Yes. So the implementation is really right at the beginning, at the early stages right now. And so the team have been studying alternatives for a while, certainly before I joined and I'm very supportive of the decision that we've made to move forward. It's a big enabler to our whole integrated front-end, getting our sales organizations able to talk to each other, get visibility to what our opportunities are with customers across the portfolio and sharing those leads. Again, the money itself, again, is not going to be incremental to what we've got into before. It's all been embedded in our outlook for the year. But again, at the end of the day, we expect that this is going to have a pretty meaningful impact for us over time in terms of driving top line growth and as well, obviously, margin expansion.

[Brian Konigsberg:]

If I could just ask one more, maybe I'm reading this incorrectly, but it looks like the FX headwind, it was $0.03 headwind in the quarter, but now, it was only a $4 million revenue headwind? How do I reconcile those 2 things?

[Michael T. Speetzen:]

So there's -- so Brian, there's 2 components. There's the translation, which is the smaller impact this quarter. And as we anticipated, we saw a heavier transaction impact and what we do hedge, that only ends up smoothing out the eventual impact that you have from a foreign exchange perspective and we're only hedging about 75% to 80% of the total. For us, it's really around the mix of where you derive revenue and where your costs are based. So not to get into a lot of the details, but we've got a lot of euro base revenue, but a cost base based in Sweden. So you end up with some differential there and then we obviously have a bunch of cross-currency issues with Australia and the Canadian dollar, which have both had been heavily impacted this past quarter. But I think, the key message is this is consistent with we what built into the guidance. We don't see any issues as we go through the balance of the year either.

[Brian Konigsberg:]

Just curious, I imagine these are hedges that are put in place, but do you have an offset that hits gross margin a couple of quarters down the line as these things are delivered or is that not really play?

[Michael T. Speetzen:]

No. This is more what actually lives through and what is what I'll call a differential in the cost base. So the hedging handles all the transactional pieces, but over time all that does is smooth you out and if you end up with the imbalance between 2 regions, you're ultimately going to have that impact to your P&L and that's essentially what this is.

[Operator:]

Your last question comes from the line of David Rose with Wedbush.

[David L. Rose:]

This is a follow-up question on the margin side. I mean, the SG&A was, I think, lower than many of us anticipated. Given the gross margins were essentially flat, how should we think about the gross margin pressure going forward? I think the implication is it's pretty hard to get the leverage there, if sales are flat, on the gross margin side, given what you talked about in terms of pricing. Am I missing something there? And that's I guess, the first part and the second part is, if we think about sort of the, I wouldn't call it aggressiveness, but I think there was, Steve had put it before in a prior call, that the team is more aggressive in seeking out orders and I guess, you're going to be a little bit more competitive on pricing. What is it in terms of comfort level and the backlog, how do you get comfort with that backlog and maybe that question is for both of you, Patrick and Mike, that you don't see further margin pressure in and what's in the backlog?

[Michael T. Speetzen:]

Yes. So on the gross margin, I guess, a couple of comments. One, Q1 was heavily impacted by the fact that we came up a bit short on the dewatering rental and we were a bit overweight to the emerging markets, where we tend to see a little bit lower gross margin in terms of what that revenue comes through. As you know, it's project-based, so it tends to be on the lower end of the margin scale. As we progress through the year, though, a couple of things. One, there is improving mix, as we see the Water Infrastructure business ramp up, that starts as we get into the second quarter. But we're also working on number of initiatives that I've talked to in prior call around the Lean, but also sourcing, where we think that there is more capability to drive sourcing savings throughout the business. And so that would tell you that our gross margin will improve on the year-over-year basis at the full year level, probably around 50-plus basis points, despite what we anticipate as some pricing headwind. On your second question around the orders, it's a good question and it's something that we're pretty active in reviewing all the bid activities. So when you think about that improvement in the backlog that's shippable going out beyond the next year. The review process we have is to make sure that we're bidding at the right level of margins. So given that there is project activity, there's going to be some pricing pressure there relative to what we would see coming through some more of the developed regions. But not a surprise and it's something that we build in, as we think about our cost plans and our margin improvement plans as we go forward. So we're adjusting our cost base accordingly, and I think there is plenty of opportunity for us to continue to see the margin expansion.

[Patrick K. Decker:]

I would just reinforce what Mike said here around, again, the opportunities in global sourcing are very real. And that really has been underleveraged in my view. And so again, the commentary Steven made in past quarters, I think is spot on and we're working hard in that area. And then again, the opportunities around Lean deployment, while those tend to be longer-term, I think there are some near-term opportunities there for the team. The team is working as hard as Mike pointed out, we own the pricing environment that we're operating in and we, again, want to do we can do to really use our productivity to drive growth, both investment, as well as being competitive from a margin standpoint.

[Operator:]

And 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.

[Patrick K. Decker:]

Thank you. Well, as I mentioned in my opening comments, we're very clear about our focus areas and remain committed to delivering our financial commitments and recognizing the full potential of the company is capable of delivering. We are pleased with our performance in Q1. We have a lot of work yet to do to deliver 2014, but we're confident the plans and actions are in place to do exactly that. So again, I want to thank you all for joining today and for your support interest and look forward to connecting to you again in the near future.

[Operator:]

Thank you. This does conclude today's Xylem's First Quarter 2014 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.