Xylem Inc. 2012 Q2 Form 10-Q Summary
Business Context and Reporting Period
Xylem provides water and wastewater equipment and services through its Water Infrastructure and Applied Water segments. The filing covers the three and six months ended June 30, 2012. Comparisons with 2011 require caution: 2012 reflects Xylem as a standalone company after its October 31, 2011 spin-off from ITT, while 2011 results are largely carve-out results of ITT’s former water businesses and include allocated corporate expenses.
Key Financial Metrics
| Metric | Q2 2012 | Q2 2011 | Six Months 2012 | Six Months 2011 |
|---|---|---|---|---|
| Revenue | $966 million | $971 million | $1,891 million | $1,861 million |
| Gross profit | $383 million | $379 million | $746 million | $716 million |
| Gross margin | 39.6% | 39.0% | 39.5% | 38.5% |
| Operating income | $129 million | $116 million | $228 million | $216 million |
| Operating margin | 13.4% | 11.9% | 12.1% | 11.6% |
| Net income | $89 million | $72 million | $152 million | $150 million |
| Diluted EPS | $0.48 | $0.39 | $0.82 | $0.82 |
| Net cash from operations | Not separately provided | Not separately provided | $125 million | $161 million |
| Free cash flow | Not separately provided | Not separately provided | $86 million | $134 million |
Q2 revenue declined 0.5% as reported but increased 4.5% on a constant-currency basis. Six-month revenue increased 1.6% as reported and 5.0% on a constant-currency basis. Foreign-currency translation reduced Q2 revenue by approximately $49 million and six-month revenue by approximately $63 million.
- Water Infrastructure revenue increased 1.2% in Q2 and 3.5% for the first six months as reported; constant-currency growth was 7.3% and 7.5%, respectively.
- Applied Water revenue decreased 3.1% in Q2 and 1.6% year to date as reported; constant-currency growth was 0.3% and 0.8%, respectively.
- Q2 orders were $970 million, down 2.8% as reported but up 2.3% at constant currency. Backlog was $720 million at June 30, 2012, down 5% from the prior-year period and up 10.6% from December 31, 2011.
- Q2 operating income excluding separation costs was $135 million versus $134 million in 2011. Adjusted net income was $92 million versus $103 million, and adjusted diluted EPS was $0.49 versus $0.56.
Material Changes Versus the Prior Comparable Period
- Gross margin improved 60 basis points in Q2 and 100 basis points for the six-month period, benefiting from pricing, factory productivity, material costs and the YSI acquisition.
- Reported operating income increased 11.2% in Q2 and 5.6% year to date, partly because separation costs declined to $6 million from $18 million in Q2 and to $11 million from $21 million year to date.
- SG&A increased 0.4% in Q2 and 5.1% year to date, while R&D increased 7.7% and 12%, respectively. Management attributed the increases primarily to standalone-company costs, YSI-related expenses and new-product development.
- Interest expense increased to $13 million in Q2 and $27 million year to date, primarily reflecting the $1.2 billion of senior notes issued in September 2011.
- The effective tax rate declined to 23.3% from 37.4% in Q2 and to 23.9% from 30.6% year to date, primarily due to lower separation costs and geographic earnings mix.
Cash Flow, Debt and Liquidity
Cash and cash equivalents were $358 million at June 30, 2012, compared with $318 million at December 31, 2011. Six-month operating cash flow was $125 million, capital expenditures were $57 million, and cash used in investing activities was $53 million. Financing cash outflows were $31 million, including $39 million of dividends, partly offset by $16 million of proceeds from employee stock-option exercises.
Total debt was $1.206 billion, 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 was undrawn at June 30, 2012. Xylem stated that it was in compliance with debt covenants and expected existing funds, operating cash flow and additional borrowing capacity to meet liquidity and capital needs over the next twelve months.
Outlook, Commentary, Risks and Unusual Items
- Management described global economic conditions, particularly in Europe, as difficult and expected weakness and financial-market and geopolitical instability to continue through the second half of 2012.
- Xylem planned restructuring and realignment actions, primarily in Europe, and expected approximately $15 million to $20 million of additional costs during the remainder of 2012.
- Approximately 80% of the June 30 backlog was expected to convert to revenue during the remainder of 2012.
- Approximately 63% of revenue was generated outside the United States, creating exposure to foreign-exchange volatility, especially involving the euro and other European and Asia-Pacific currencies.
- A proposed Swedish tax-law change could adversely affect the effective tax rate, although the company was evaluating mitigation opportunities.
- Separation-related cash costs remaining after June 30 were estimated at approximately $4 million to $9 million.
- Environmental liabilities accrued were $13 million. The company also maintained warranty accruals of $40 million and reported $6 million of unrecognized tax benefits.
- Legal proceedings were considered unlikely to have a material adverse effect. An ITT bondholder matter was resolved on July 10, 2012 without a material adverse effect. ITT indemnifies Xylem for specified legacy asbestos and silica claims under the separation agreements.
- After quarter-end, Xylem acquired MJK Automation for approximately $12.3 million and completed the exchange offer for registered senior notes.
Important Facts for Investors to Verify
- Assess comparability of 2011 carve-out results with 2012 standalone results, including differences in corporate-cost allocations and post-spin operating expenses.
- Verify whether planned European restructuring costs of $15 million to $20 million and remaining separation cash costs of $4 million to $9 million affect future earnings and cash flow.
- Monitor backlog conversion, order trends and exposure to economic weakness in Europe, especially in Water Infrastructure treatment and Applied Water building-services markets.
- Evaluate foreign-exchange sensitivity given the company’s substantial non-U.S. revenue and foreign-held cash.
- Review debt-service requirements, the 2016 and 2021 note maturities, covenant compliance and continued availability of the undrawn $600 million credit facility.
- Reconcile non-GAAP adjusted earnings and free cash flow to GAAP results and consider the year-to-date decline in operating cash flow and free cash flow.