Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through two segments: Water Infrastructure and Applied Water. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, with comparisons to the corresponding 2012 periods.
Financial Performance and Key Metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $965 million | $931 million | $2,804 million | $2,822 million |
| Gross profit | $384 million | $374 million | $1,089 million | $1,120 million |
| Gross margin | 39.8% | 40.2% | 38.8% | 39.7% |
| Operating income | $98 million | $111 million | $234 million | $339 million |
| Operating margin | 10.2% | 11.9% | 8.3% | 12.0% |
| Net income | $73 million | $72 million | $160 million | $224 million |
| Diluted EPS | $0.39 | $0.38 | $0.86 | $1.20 |
- Third-quarter revenue increased 3.7%, with constant-currency growth also 3.7%. Nine-month revenue declined 0.6%.
- Third-quarter orders were $955 million, up 8.3%; nine-month orders were $2,926 million, up 2.5%.
- Backlog was $752 million at September 30, 2013, up 9.0% year over year and 16.2% from December 31, 2012. Management expected approximately 62% of backlog to convert to revenue during the remainder of 2013.
- Water Infrastructure revenue rose 4.0% in the quarter but declined 1.2% year to date. Applied Water revenue rose 2.9% in the quarter and 0.7% year to date.
- Operating cash flow for the first nine months was $163 million, compared with $230 million in 2012. Capital expenditures were $91 million, producing reported free cash flow of $72 million versus $171 million in 2012.
- Cash and cash equivalents were $394 million at September 30, 2013, compared with $504 million at December 31, 2012.
- Total debt was $1,202 million, consisting primarily of $600 million of 3.550% senior notes due 2016 and $600 million of 4.875% senior notes due 2021. The $600 million revolving credit facility and approximately $163 million European Investment Bank R&D facility were undrawn.
- Dividends declared per share increased to $0.1164 in the quarter from $0.1012 in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- Operating income declined 11.7% in the quarter and 31.0% year to date, despite higher third-quarter revenue.
- Margins were pressured by unfavorable price realization, geographic and product mix, inflation, higher pension costs, acquisition-related costs, and continued investment in growth initiatives.
- Restructuring charges increased to $5 million in the quarter and $30 million year to date, compared with $4 million in each prior-year period. The actions primarily affected Europe and North America and included headcount reductions and facility consolidation.
- Realignment costs and $20 million of special charges related primarily to the Xylem Group LLC legal settlement and costs associated with the change in chief executive officer reduced reported operating results.
- Net income was broadly stable in the quarter because the effective tax rate fell to 12.1% from 27.8%, but declined 28.6% year to date. The lower tax rate reflected earnings mix, special charges, and CEO-transition-related costs.
- Operating cash flow declined because of increased receivables and inventories, longer European collection times, support for higher backlog, restructuring payments, and lower first-half revenue volumes. Investing cash use increased primarily because of acquisitions.
- Xylem acquired MultiTrode and PIMS for approximately $84 million in aggregate consideration, or $81 million net of cash acquired, adding primarily to Water Infrastructure.
Guidance, Outlook, Risks, and Unusual Items
- Management expected European conditions to remain stabilized overall but continued to anticipate weakness and uncertainty in southern Europe. U.S. industrial markets and public utility projects were affected by economic uncertainty, delayed government funding, and project delays.
- For full-year 2013, management continued to expect approximately $40 million to $50 million of restructuring costs and $25 million to $30 million of realignment costs.
- Management expected approximately $14 million to $15 million of 2013 net savings from restructuring, with annual future net savings of approximately $34 million to $36 million beginning in 2014. Restructuring actions were expected to continue through 2014.
- Approximately 63% of quarterly and 62% of year-to-date revenue came from non-U.S. operations, creating exposure to foreign-exchange movements, regional economic conditions, and cash held by foreign subsidiaries. Foreign subsidiaries held $325 million in cash or marketable securities at September 30, 2013.
- The company authorized a $250 million share-repurchase program in August 2013. It repurchased $25 million of shares during the quarter and had approximately $225 million remaining under that program at September 30.
- The Xylem Group LLC trademark litigation was settled on October 4, 2013, with mutual releases and dismissal with prejudice. The related obligation was accrued in the September 30 balance sheet.
- Accrued general legal matters were $21 million, environmental liabilities were $9 million, and warranty accruals were $38 million at September 30, 2013. Management did not expect these matters to have a material adverse effect, although outcomes remain uncertain.
- The company reported effective disclosure controls and procedures and no material changes to internal control over financial reporting. Management reported no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether higher orders and backlog convert into revenue as expected, particularly the projected 62% conversion during the remainder of 2013.
- The sustainability of operating-margin performance after restructuring, realignment, special charges, price and mix pressure, inflation, and pension costs.
- Actual restructuring and realignment spending versus the $40 million to $50 million and $25 million to $30 million full-year expectations.
- Working-capital trends, especially European receivables, inventories, and the resulting decline in operating cash flow and free cash flow.
- Liquidity and refinancing requirements associated with the $600 million senior notes due in 2016, as well as compliance with the 3.50 maximum leverage covenant.
- The financial impact of acquisitions, foreign-exchange movements, legal and environmental contingencies, and the CEO-transition-related charges.