Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for the water cycle through its Water Infrastructure and Applied Water segments. This Form 10-Q covers the three and nine months ended September 30, 2012, filed November 1, 2012.
Xylem was spun off from ITT on October 31, 2011. The 2012 results are stand-alone Xylem results, while the 2011 comparative results are carve-out results derived from ITT records; therefore, comparability is affected by corporate cost allocations and separation activities.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $931 million | $939 million | $2,822 million | $2,800 million |
| Gross profit | $374 million | $365 million | $1,120 million | $1,081 million |
| Gross margin | 40.2% | 38.9% | 39.7% | 38.6% |
| Operating income | $111 million | $79 million | $339 million | $296 million |
| Operating margin | 11.9% | 8.4% | 12.0% | 10.6% |
| Net income | $72 million | $77 million | $224 million | $227 million |
| Diluted EPS | $0.38 | $0.42 | $1.20 | $1.23 |
- Q3 revenue declined 0.9% as reported but increased 3.2% on a constant-currency basis. Nine-month revenue increased 0.8% as reported and 4.4% in constant currency.
- Gross margin expanded 130 basis points in Q3 and 110 basis points year to date, reflecting pricing, productivity, favorable material costs and acquired businesses.
- Operating income increased 40.5% in Q3 and 14.5% year to date, primarily because separation costs fell to $4 million from $46 million in Q3 2011 and to $15 million from $67 million year to date.
- Net income and EPS declined despite higher operating income because interest expense increased to $14 million from $1 million in Q3 and taxes increased to $28 million from $5 million. The Q3 effective tax rate was 27.8% versus 6.3%.
- Adjusted net income was $83 million, or $0.44 adjusted diluted EPS, in Q3, compared with $101 million, or $0.54, in the prior-year quarter. Year-to-date adjusted net income was $242 million versus $284 million.
Segments, Orders and Backlog
- Water Infrastructure: Q3 revenue increased 1.9% to $595 million, or 6.7% in constant currency. Nine-month revenue increased 2.9% to $1,788 million. Q3 operating income declined 2.3% to $85 million, while nine-month operating income increased 3.3% to $253 million.
- Applied Water: Q3 revenue declined 4.9% to $350 million, or 1.6% at constant currency. Nine-month revenue declined 2.7% to $1,078 million. Q3 operating income increased 16.2% to $43 million, primarily because of lower separation costs and the absence of a prior-year impairment charge; excluding separation costs, segment operating income declined.
- Q3 orders were $882 million, down 8.7% year over year, or 4.7% in constant currency. Nine-month orders were $2,856 million, down 2.9% as reported but up 0.7% in constant currency.
- Backlog was $690 million at September 30, 2012, down 8.5% from September 30, 2011 and up 6.0% from December 31, 2011. Management expected approximately 70% of backlog to convert to revenue during the remainder of 2012.
Cash Flow, Debt and Liquidity
| Cash flow or balance | September 30, 2012 | Comparable period or December 31, 2011 |
|---|---|---|
| Operating cash flow, 9M | $230 million | $252 million in 9M 2011 |
| Capital expenditures, 9M | $81 million | $79 million in 9M 2011 |
| Free cash flow, 9M | $171 million | $235 million in 9M 2011 |
| Cash and equivalents | $424 million | $318 million at December 31, 2011 |
| Total debt | $1,212 million | $1,206 million at December 31, 2011 |
| Net debt, calculated | $788 million | Not provided |
- Operating cash flow fell $22 million year over year, primarily because of $38 million of interest payments and higher tax payments, partly offset by lower separation cash payments and improved receivable collections.
- Investing cash outflow was $89 million versus $377 million in the prior-year period, largely because acquisition spending declined from $309 million to $12 million.
- Financing cash outflow was $41 million, including $56 million of dividends, partly offset by $22 million of stock-option exercise proceeds.
- The $600 million revolving and competitive advance credit facility was undrawn at September 30, 2012. It includes a maximum leverage ratio of 3.50; the company reported compliance with its debt covenants.
- Debt consisted primarily of $600 million of 3.550% senior notes due 2016 and $600 million of 4.875% senior notes due 2021. Credit ratings were unchanged: S&P BBB/A-2, Moody’s Baa2/P-2 and Fitch BBB/F-2.
Material Changes, Outlook and Risks
- Management cited difficult market conditions from dry U.S. weather, weaker U.S. dewatering, mining and construction activity, European economic uncertainty, softer residential and commercial markets, and foreign-exchange volatility.
- Xylem began restructuring and realignment actions, primarily in Europe, and expected approximately $15 million of additional restructuring and realignment costs during the remainder of 2012. Year-to-date 2012 restructuring and realignment costs were $5 million pre-tax, with estimated annual savings of approximately $3 million beginning in 2013.
- Management estimated approximately $5 million of additional pre-tax spin-off-related costs for the remainder of 2012.
- Approximately 62% of nine-month revenue came from non-U.S. operations. Foreign subsidiaries held $308 million of cash or marketable securities, and management intended to indefinitely reinvest all but $100 million of foreign funds outside the United States.
- On October 26, 2012, Xylem acquired Heartland Pump Rental & Sales for approximately $29 million. Heartland reported approximately $33 million of 2011 revenue and employed approximately 100 people.
- Environmental liabilities accrued were $12 million at September 30, 2012. Management did not expect current legal, environmental or other proceedings to have a material adverse effect, but acknowledged that final environmental costs are uncertain.
- ITT agreed to indemnify Xylem for specified legacy asbestos and silica liabilities. Xylem had not recorded liabilities for material matters expected to be indemnified.
- The company stated that no material changes had occurred in previously disclosed risk factors or market-risk information. Disclosure controls and procedures were considered effective.
Important Facts for Investors to Verify
- Assess the comparability of 2012 stand-alone results with 2011 ITT carve-out results, including allocated corporate expenses.
- Separate underlying operating performance from separation, restructuring, realignment, impairment and tax-related items.
- Monitor declining orders and backlog, especially in Water Infrastructure, and the conversion of approximately 70% of backlog expected in late 2012.
- Evaluate the effect of higher interest expense, $1.212 billion of debt and the 3.50 maximum leverage covenant.
- Track foreign-exchange exposure, European economic conditions, U.S. weather-driven demand and potential Swedish tax-law effects.
- Review the integration and financial contribution of MJK, YSI and the subsequent Heartland acquisition.
- Confirm the adequacy of environmental accruals and the financial strength and scope of ITT indemnifications.