Xylem Inc. 2014 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through its Water Infrastructure and Applied Water segments. This unaudited Form 10-Q covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013.
Financial Performance and Liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $906 million | $879 million | +3.1% |
| Gross profit | $342 million | $334 million | +2.4% |
| Gross margin | 37.7% | 38.0% | Down 30 bp |
| Operating income | $76 million | $66 million | +15.2% |
| Operating margin | 8.4% | 7.5% | Up 90 bp |
| Net income | $49 million | $41 million | +19.5% |
| Diluted EPS | $0.27 | $0.22 | +22.7% |
| Operating cash flow | $22 million | $20 million | +$2 million |
| Free cash flow | $(3) million | $(10) million | Improved by $7 million |
- Constant-currency revenue increased 3.5%, consisting of 3.0% organic growth and $5 million of acquisition contribution, partly offset by a $4 million foreign-currency translation headwind.
- Water Infrastructure revenue increased 3.1% to $568 million; Applied Water revenue increased 2.9% to $355 million.
- Orders increased 3.2% to $993 million. Backlog was $793 million at March 31, 2014, up 9.7% year over year and 12.2% from December 31, 2013; management expected approximately 86% to convert to revenue during the remainder of 2014.
- Cash and cash equivalents declined to $466 million from $533 million at December 31, 2013, primarily reflecting share repurchases, dividends, capital expenditures and foreign-exchange effects.
- Total debt was $1.243 billion, including $1.199 billion of long-term debt and $39 million outstanding under the European Investment Bank research and development facility. The $600 million revolving credit facility remained undrawn, and the company reported compliance with debt covenants.
- Capital expenditures were $25 million. Financing uses included $51 million of common-stock repurchases and $24 million of dividends paid.
Material Changes Versus the Prior Comparable Period
- Operating income benefited from lean Six Sigma, global sourcing, restructuring savings and higher volume, which more than offset cost inflation, foreign exchange and unfavorable sales mix.
- SG&A declined to $224 million from $237 million, reducing SG&A as a percentage of revenue to 24.7% from 27.0%.
- Gross margin declined because of lower-margin Water Infrastructure dewatering rental revenue and increased emerging-market sales mix.
- Reported restructuring charges increased to $15 million from $5 million. Including realignment costs, management reported $18 million of restructuring and realignment costs versus $12 million in the prior year.
- Adjusted net income was $63 million versus $50 million, and adjusted diluted EPS was $0.34 versus $0.27, excluding restructuring and realignment costs and tax-related special items.
- Net cash used in investing activities improved to $24 million from $105 million because the prior-year period included $78 million of acquisition spending.
- Other comprehensive loss improved to $1 million from $43 million, primarily because foreign-currency translation was substantially less unfavorable.
Guidance, Outlook, Risks and Unusual Items
- Management expected a slow recovery in U.S. industrial markets, modest improvement in European industrial markets, modest public-utility growth and continued weakness in mining. Developed-market recovery was expected to remain slow, while emerging markets were expected to grow modestly.
- For 2014, management expected approximately $30 million to $35 million of restructuring costs and $10 million to $15 million of realignment costs. It expected approximately $15 million of total net savings in 2014, including $25 million from 2013 actions and $15 million from 2014 actions on a gross incremental basis as described in the filing.
- Restructuring actions focused on European and North American cost structures, including headcount reductions and facility consolidation, and were expected to continue through the third quarter of 2014.
- Potential risks included weak industrial, mining, utility capital-spending and institutional-building markets; foreign-exchange movements; cost inflation; project delays; working-capital requirements; reliance on non-U.S. operations; and availability and cost of future financing.
- The company accrued $17 million for general legal matters and $7 million for environmental matters. Reasonably possible losses in excess of accrued environmental and legal amounts were estimated at approximately $29 million.
- A purchase-price dispute involving minority shareholders of a historical acquisition was being appealed by both sides. The company stated that asserted and unasserted legal claims were not expected to have a material adverse effect, individually or in aggregate.
- Former parent ITT remained obligated to indemnify Xylem for specified legacy asbestos and silica liabilities. Xylem had not recorded a liability for material matters expected to be indemnified.
- Patrick K. Decker was named president and chief executive officer effective March 17, 2014. His equity award was subject to shareholder approval and was excluded from first-quarter 2014 activity.
- The filing reported no material changes to previously disclosed risk factors, no defaults, and effective disclosure controls and procedures.
Most Important Facts for Investors to Verify
- Whether restructuring and realignment savings are realized as projected and whether additional charges remain within the 2014 outlook.
- Backlog conversion, order trends and the durability of organic growth across both segments.
- Working-capital performance, particularly the increase in inventories and receivables, and the company’s ability to convert earnings into operating and free cash flow.
- Debt maturities, covenant compliance and the planned repayment of the $39 million EIB facility classified as short-term debt.
- Exposure to foreign-currency movements, emerging-market mix, weak mining and utility capital spending, and adverse industrial-market conditions.
- Developments in the purchase-price litigation, environmental matters and other contingencies, including potential losses beyond recorded accruals.