Xylem Inc. 2013 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Xylem is a water and wastewater equipment and services provider operating through Water Infrastructure and Applied Water segments. The unaudited report covers the three months ended March 31, 2013, compared with the three months ended March 31, 2012.
Financial Performance and Liquidity
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $879 million | $925 million | Down 5.0% |
| Gross profit | $334 million | $363 million | Down 8.0% |
| Gross margin | 38.0% | 39.2% | Down 120 basis points |
| Operating income | $66 million | $99 million | Down 33.3% |
| Operating margin | 7.5% | 10.7% | Down 320 basis points |
| Net income | $41 million | $63 million | Down 34.9% |
| Diluted EPS | $0.22 | $0.34 | Down $0.12 |
| Operating cash flow | $20 million | $61 million | Down $41 million |
| Free cash flow | $(10) million | $41 million | Down $51 million |
Adjusted net income was $50 million, or $0.27 adjusted diluted EPS, versus $67 million, or $0.36, in the prior-year period. The adjustment primarily excluded $12 million of 2013 restructuring and realignment costs; 2012 adjustments excluded $4 million of after-tax separation costs.
Water Infrastructure revenue declined 5.7% to $551 million and operating income declined 44.0% to $42 million. Applied Water revenue declined 2.8% to $345 million, while operating income remained $40 million. Orders were $962 million, down 4.2%, and backlog was $723 million at March 31, 2013, down 2.2% year over year but up 11.7% from December 31, 2012. Management expected approximately 88% of backlog to convert to revenue during the remainder of 2013.
Cash and cash equivalents were $375 million at March 31, 2013, compared with $504 million at December 31, 2012. Total debt was $1.205 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 and approximately $154 million European Investment Bank research and development facility were undrawn. The company stated that it was in compliance with applicable debt covenants and expected available funding sources to meet liquidity needs for the next twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue decreased primarily because of lower sales volumes across most applications, partly offset by pricing actions, new products and acquisitions.
- Constant-currency revenue declined 4.8%; organic revenue declined 7.2%, while acquisitions contributed $23 million of revenue.
- Gross margin contracted because of lower volume, higher material and labor costs, and acquisition-related costs.
- Operating expenses increased to $268 million from $264 million, including $5 million of restructuring charges and $7 million of realignment costs in 2013, compared with $5 million of separation costs in 2012.
- Operating cash flow declined because of lower earnings, working-capital use and higher tax payments. Investing cash outflow increased largely because of $78 million of acquisition spending.
- Two acquisitions were completed: PIMS Group in the United Kingdom for approximately $57 million and MultiTrode in Australia for approximately $26 million. Both were accounted for prospectively and were not material individually or in aggregate.
- The effective tax rate declined to 19.1% from 24.8%, primarily because of earnings mix and a discrete foreign tax refund. Under the Tax Matters Agreement, the related refund was payable to ITT, resulting in a $1 million expense and payable.
- Comprehensive income declined to a loss of $2 million from income of $118 million, mainly because of a $43 million unfavorable foreign-currency translation adjustment.
Guidance, Outlook, Risks and Unusual Items
Management stated that economic conditions in the United States and Europe, including weaker industrial and building-services markets, delayed government funding, construction weakness and lower fracking activity, were expected to remain challenging through the remainder of 2013. The company continued to expect approximately $40 million to $50 million of restructuring costs and approximately $20 million of realignment costs for the full year, with anticipated 2013 net savings of approximately $13 million to $15 million. Actions initiated in the first quarter were expected to be completed in the second half of 2013 and were expected to generate approximately $23 million of annual future net savings beginning in 2014.
Approximately 62% of revenue was generated outside the United States, exposing results to foreign-exchange movements, particularly involving the euro, Swedish krona, British pound, Australian dollar, Canadian dollar, Polish zloty and Hungarian forint. Other stated risks include market weakness, project timing, acquisition integration, cost pressures, pension and environmental obligations, product warranties, and potential goodwill or intangible-asset impairment.
The company accrued $11 million for environmental matters and maintained a $40 million product-warranty accrual at March 31, 2013. A Spanish competition-law fine of approximately €2.4 million was upheld by Spain’s High Court; Xylem filed a further appeal in April 2013. The company stated that it did not expect pending or unasserted legal matters to have a material adverse effect. ITT remained responsible under the separation agreement for specified legacy asbestos and silica liabilities.
Most Important Facts for Investors to Verify
- Whether revenue volume trends and orders improve after the first-quarter declines, particularly in Water Infrastructure and Europe.
- Progress against the $40 million to $50 million restructuring-cost expectation and the $13 million to $15 million 2013 net-savings target.
- Conversion of the $723 million backlog, including the expected 88% recognized during the rest of 2013.
- Cash generation, working-capital requirements and acquisition spending given the first-quarter $10 million negative free cash flow.
- Debt maturities, leverage-covenant compliance and continued availability of the undrawn credit facilities.
- Foreign-exchange exposure and the effect of currency movements on revenue, earnings and accumulated other comprehensive income.
- Resolution of the Spanish competition-law appeal and the adequacy of environmental, warranty, pension and other contingency accruals.