Xylem Inc. 2013 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water and wastewater equipment and services provider operating through Water Infrastructure and Applied Water. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods.
Financial Performance and Position
| Metric | Q2 2013 | Q2 2012 | Six Months 2013 | Six Months 2012 |
|---|---|---|---|---|
| Revenue | $960 million | $966 million | $1,839 million | $1,891 million |
| Gross profit | $371 million | $383 million | $705 million | $746 million |
| Gross margin | 38.6% | 39.6% | 38.3% | 39.5% |
| Operating income | $70 million | $129 million | $136 million | $228 million |
| Operating margin | 7.3% | 13.4% | 7.4% | 12.1% |
| Net income | $46 million | $89 million | $87 million | $152 million |
| Diluted EPS | $0.25 | $0.48 | $0.47 | $0.82 |
- Q2 revenue decreased 0.6% reported and 1.0% on a constant-currency basis. Six-month revenue decreased 2.7% reported and 2.9% constant currency.
- Orders increased 4.0% year over year in Q2 to $1.009 billion; six-month orders decreased 0.2% to $1.971 billion. Backlog was $759 million at June 30, 2013, with approximately 81% expected to convert to revenue during the remainder of 2013.
- Water Infrastructure Q2 revenue declined 2.1% and operating income declined 55.9%. Applied Water revenue increased 2.1%, while operating income declined 13.5%.
- Six-month operating cash flow was $62 million versus $125 million in 2012. Capital expenditures were $60 million, producing reported free cash flow of $2 million versus $86 million in 2012.
- Cash and cash equivalents were $360 million at June 30, 2013, compared with $504 million at December 31, 2012. Total debt was $1.204 billion, including $1.2 billion of senior notes.
- The $600 million revolving credit facility and approximately $157 million European Investment Bank research facility remained undrawn. Xylem stated that it was in compliance with applicable debt covenants and expected available liquidity to meet needs over the next twelve months.
- Dividends declared increased to $0.1164 per share in Q2 from $0.1012 in Q2 2012. Six-month dividends paid were $43 million, and share repurchases were $18 million.
Material Changes Versus the Prior Comparable Period
- Operating income fell $59 million, or 45.7%, in Q2 and $92 million, or 40.4%, for the first six months. Drivers included lower sales volumes, unfavorable mix, foreign-exchange headwinds, cost inflation, continued growth investments, and restructuring and realignment costs.
- Gross margin declined 100 basis points in Q2 and 120 basis points year to date. SG&A increased to 26.3% of revenue from 22.8% in Q2 2012 and to 26.5% from 23.8% for the first six months.
- Reported Q2 restructuring and realignment costs were $28 million, including $20 million of restructuring charges and $8 million of realignment costs. Six-month costs were $40 million. Adjusted Q2 EPS was $0.36 versus $0.49 in 2012, and adjusted six-month EPS was $0.62 versus $0.85.
- Xylem acquired PIMS, a United Kingdom wastewater services company, and MultiTrode, an Australian water and wastewater technology company. Six-month acquisition spending was $84 million, or $81 million net of cash acquired, and acquisitions contributed $46 million of revenue.
- Foreign currency translation reduced other comprehensive income by $21 million in Q2 and $64 million year to date, contributing to a decline in accumulated other comprehensive income to $55 million from $115 million at year-end 2012.
Outlook, Commentary, Risks, and Unusual Items
- Management described Europe and the United States as challenging markets, citing weak European conditions, U.S. market uncertainty, government-funding delays, industrial weakness, and delays in public utility projects.
- For full-year 2013, management continued to expect approximately $40 million to $50 million of restructuring costs and $20 million to $30 million of realignment costs. It anticipated approximately $13 million to $15 million of 2013 net savings from actions initiated in 2013, with approximately $28 million of annual future net savings beginning in 2014.
- Restructuring actions include headcount reductions and facility consolidation in Europe and North America and are expected to continue through the first quarter of 2014.
- Approximately 61% of revenue was generated outside the United States, exposing results and cash flows to foreign-exchange movements, particularly involving the euro, Swedish krona, British pound, Australian dollar, Canadian dollar, South African rand, Polish zloty, and Hungarian forint.
- Environmental liabilities accrued were $10 million at June 30, 2013. Product warranty accruals were $37 million. Management did not expect legal, environmental, or other proceedings to have a material adverse effect, although outcomes remain uncertain.
- A Spanish competition-law fine of €2.4 million was upheld by Spain’s High Court. Xylem appealed to the Supreme Court, and the appeal was admitted; proceedings were expected to last one to two years.
- ITT continues to indemnify Xylem for specified legacy asbestos and silica claims related to pre-spin-off products and facilities. Xylem reported no material liability for matters covered by those indemnifications.
- Management stated that disclosure controls and procedures were effective as of June 30, 2013 and that no material change had occurred in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether restructuring and realignment actions deliver the projected savings while avoiding further volume or execution-related deterioration.
- Whether Water Infrastructure revenue, margins, and orders recover amid European weakness, delayed public projects, and lower distributor inventories.
- Whether operating cash flow and free cash flow improve sufficiently to support acquisitions, dividends, capital expenditures, and debt obligations.
- The timing and execution risks associated with the PIMS and MultiTrode acquisitions.
- Foreign-exchange sensitivity, the concentration of cash in foreign subsidiaries, and potential tax consequences of repatriating foreign cash.
- The outcome of the Spanish Supreme Court appeal and developments in environmental, warranty, pension, tax, and other contingencies.
- Near-term refinancing considerations for the $600 million of senior notes due in 2016 and compliance with debt covenants.