Xylem Inc. 2012 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Xylem reported results for the three months ended March 31, 2012. The company provides equipment and services for water and wastewater applications through two segments: Water Infrastructure and Applied Water.
Xylem was spun off from ITT on October 31, 2011. The 2012 results are stand-alone Xylem results, while the 2011 comparable period consists of carve-out results of ITT’s former water businesses. Comparability may therefore be affected by historical allocations of corporate costs and the transition to stand-alone operations.
Financial and Operating Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $925 million | $890 million | Up 3.9% |
| Gross profit | $363 million | $337 million | Up 7.7% |
| Gross margin | 39.2% | 37.9% | Up 130 basis points |
| Operating income | $99 million | $100 million | Down 1.0% |
| Operating margin | 10.7% | 11.2% | Down 50 basis points |
| Net income | $63 million | $78 million | Down 19.2% |
| Diluted EPS | $0.34 | $0.42 | Down $0.08 |
| Net cash from operating activities | $61 million | $71 million | Down $10 million |
| Free cash flow | $41 million | $54 million | Down $13 million |
Adjusted operating income, excluding separation costs, was $104 million versus $103 million. Adjusted net income was $67 million versus $80 million, and adjusted diluted EPS was $0.36 versus $0.43.
- Water Infrastructure revenue increased 6.0% to $584 million; operating income increased 17.2% to $75 million.
- Applied Water revenue was flat at $355 million; operating income declined 13.0% to $40 million.
- Orders increased 2.7% to $1.004 billion, while organic orders increased 0.7%.
- Backlog was $739 million at March 31, 2012, up 13.5% from December 31, 2011 and 2.4% from March 31, 2011. More than 85% was expected to convert to revenue during the remainder of 2012.
Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $347 million at March 31, 2012, compared with $318 million at December 31, 2011.
- Total debt was $1.206 billion, consisting primarily of $600 million of 3.55% senior notes due 2016 and $600 million of 4.875% senior notes due 2021.
- The $600 million revolving credit facility was undrawn at quarter-end. Xylem was in compliance with its debt covenants.
- Capital expenditures were $31 million versus $19 million in the prior-year quarter.
- Cash flow from operations was reduced by interest and higher tax payments. Inventory increased to $465 million from $426 million at year-end.
- Foreign subsidiaries held $238 million in cash or marketable securities. Management stated that existing operating cash flows and additional borrowing capacity were expected to satisfy liquidity needs for the next twelve months.
Material Changes and Management Commentary
- Revenue growth reflected $34 million of incremental YSI acquisition revenue and $15 million of organic growth, partly offset by a $14 million foreign-currency translation impact.
- Water Infrastructure benefited from YSI, industrial dewatering demand, price realization, and operating leverage. Treatment activity was pressured by slower public-utility funding in developed markets.
- Applied Water faced residential weakness from unfavorable North American weather, European economic uncertainty, and Middle East political instability. General industrial, beverage, and commercial activity provided offsets.
- Gross margin improved through YSI contributions, factory productivity, and pricing initiatives, partly offset by commodity and labor inflation.
- Stand-alone SG&A increased to $231 million from $210 million, primarily due to information technology, regulatory compliance, and corporate governance investments. R&D increased to $28 million from $24 million.
- Separation costs were $5 million pretax, or $4 million after tax, versus $3 million pretax, or $2 million after tax. Remaining separation-related cash costs were estimated at approximately $10 million to $15 million.
Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide a clear quantitative full-year revenue, earnings, or margin guidance target. Management expressed expectations that current liquidity sources would meet capital and liquidity needs over the next twelve months.
- Key operating risks include foreign-currency volatility, residential-market weakness, economic conditions in Europe and emerging markets, commodity and labor inflation, public-utility funding levels, and project-delivery timing.
- Environmental liabilities accrued were $14 million at March 31, 2012. Management stated that legal and environmental matters were not expected to have a material adverse effect, although ultimate outcomes cannot be predicted with certainty.
- ITT bondholder litigation alleged damages exceeding $5 million, potentially exceeding $15 million for all affected holders. Xylem’s share of related costs is 40% under the Distribution Agreement.
- ITT indemnifies Xylem for legacy asbestos and silica liabilities, subject to specified exceptions. Xylem had not recorded liabilities for material matters expected to be indemnified.
- The company identified corrected operating-lease disclosures from its prior annual report; the correction did not affect the income statement, balance sheet, cash flows, or equity statements.
- Disclosure controls were assessed as effective, with no material changes to internal control over financial reporting.
Investor Verification Checklist
- Assess comparability between stand-alone 2012 results and carve-out 2011 results, including corporate-cost allocations.
- Verify whether YSI acquisition benefits, pricing, productivity, and backlog conversion offset Applied Water weakness and inflationary pressures.
- Monitor operating cash conversion, inventory growth, capital spending, and the decline in free cash flow.
- Review debt maturities, covenant compliance, interest burden, and access to the undrawn revolving facility.
- Track the remaining separation costs, environmental accruals, litigation exposure, and reliance on ITT indemnification.
- Confirm subsequent filings for any formal full-year guidance, changes in market conditions, or developments in the ITT bondholder litigation.