Xylem - Earnings Call - Q1 2013
April 30, 2013
Transcript
Speaker 0
Ladies and gentlemen, thank you for standing by and welcome to the Xylem First Quarter twenty thirteen Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. I will now turn the call over to Phil D'Souza, Investor Relations Officer.
Please go ahead, sir.
Speaker 1
Thank you, Laura. Good morning, everyone, and welcome to Xylem's first quarter twenty thirteen earnings conference call. With me today are Chief Executive Officer, Gretchen McLean and Chief Financial Officer, Michael Speedsen. They will provide their perspective on Xylem's first quarter results and discuss the full year outlook for 2013. Following their prepared remarks, they will address questions related to the information covered on the call.
I'll ask that you please keep to one question and a follow-up and then return to the queue, so we will have enough time to address everyone on the call today. We anticipate that the call will last approximately one hour. As a reminder, this call and our webcast are accompanied by a slide presentation available on the Investors section of our website at www.xylaminec.com. All references today will be on an adjusted basis unless otherwise indicated and non GAAP financials are reconciled for you in the appendix section of the presentation. A replay of today's call will be available until Tuesday, May 14 at six p.
M. Please note the replay number is 4045373406 and the confirmation code is 2945041. Additionally, the call will be available for playback via the Investors section of our website under the headings Presentations. With that said, please turn to slide two. We will make some forward looking statements on today's call, including references to future events or developments that we anticipate will or may occur in the future.
These statements are subject to future risks and uncertainties such as those outlined in Zion's Annual Report on Form 10 ks and those described in subsequent reports as filed with the SEC. These remarks constitute forward looking statements for the purposes of the Safe Harbor provision. Please note that the company undertakes no obligation to update such statements publicly to reflect subsequent events or circumstances and actual results could differ materially from those anticipated. Now please turn to slide three and I'll turn the call over to our CEO, Gretchen McLeay.
Speaker 2
Thank you, Phil and good morning everyone. We ended the year expecting a challenging first quarter and it was. Delays in global treatment project and tough year over year comparisons for our U. S. Industrial dewatering business drove our revenue expectations to be down mid single digits.
As we progressed through the first quarter, we saw additional weakness in Europe. And as a result, our top line was 1% weaker than expected. While the top line was disappointing, we gained strength in key areas of the business. Exciting new product launches are winning in the marketplace and are leading to share markets. Acquisitions added 2% to the top line, including contributions from our two most recent acquisitions, which we closed during the first quarter, PIMs and Multitrode.
Looking at our operating performance, we had better than expected segment margins. And as a result, we are reporting EPS of $0.27 for the first quarter in line with expectations. As we look forward, we are maintaining our full year guidance. The U. S.
Is a region where we have seen and expect to see growth in 2013 across various end markets. Emerging market conditions remain favorable and we are well positioned and we expect growth to accelerate through 2013. While Europe is clearly challenged, we are actively monitoring the situation and we are expecting a significant and we are not expecting a significant recovery. We are aggressively taking actions to improve our cost base and reposition ourselves for growth in this region. Now let's dig into the quarterly summary in more detail.
We received orders of $962,000,000 down 4% in constant currency and organically. Sequentially, relative to the fourth quarter, organic orders were up modestly by 2%. For the first quarter, our book to bill ratio is in line with seasonal trends at 1.09. We exit the quarter with backlog of $723,000,000 up $76,000,000 from year end. Of our shippable backlog, we expect to deliver approximately $400,000,000 in the second quarter and approximately $250,000,000 in the second half.
Revenue for the first quarter was $879,000,000 down 5% in constant currency and 7% organically. We're reporting gross margins of 38% for the first quarter and operating margin of 8.9%. These results primarily reflect lower volume, one time acquisition costs and continued investments. We are funding these investments partially offsetting margin dilution with the contributions of new products, restructuring savings from actions taken in 2012 and cost reductions resulting from Lean Six Sigma and global sourcing initiatives. As I mentioned earlier, EPS was $0.27 for the first quarter.
And finally, free cash flow was a negative $10,000,000 driven primarily by lower income for the quarter, typical seasonality, timing of tax payments and continued investment in growth platforms. Now I'd like to provide you with an update on the business and the progress that we've made on our strategic initiatives. Please turn to slide four. I want to spend a few minutes providing you with an update on the decisions that we have made and the actions that we've already taken against the strategies we discussed at our recent Investor and Analyst Day. First, an incredible focus on delivering customer value.
As a reminder, approximately 40% of our annual revenue comes from our large installed base. We pride ourselves on our relationships with our customers and our goal is to continue to earn their loyalty. Our Total Care program is all about providing a suite of advanced aftermarket services to create customer value over the long term. With the recent acquisition of PIMMS, a U. K.
Services market leader, we are adding firepower and extending our competitive advantage. Second, drive profitable growth. We continue to make solid advancements in our disciplined acquisition strategy. Most recently, we completed the acquisition of Multitrode, which enhances our global water and wastewater monitoring and control capabilities. During the first quarter, we began selling the innovative product lines of MJK into China through our in region analytics sales office.
And our PIM services has extended to existing customers in Scotland and Northern Ireland. These are simple examples of how our global presence is driving revenue synergies from our bolt on acquisitions and how we are accelerating our geographic growth. Third, improved business sustainability. We are focused on continually improving the efficiency and effectiveness in all we do, which translates into greater competitive advantage and builds sustainable cycle of financial stability and flexibility. During the quarter, we made substantial progress against our restructuring and realignment initiatives.
In January, we opened our new EMEA headquarters office in Schaffhausen, Switzerland. We've completed the transition of our European Water Solutions business to the newly formed European management structure. Andre Duan is our new leader in the region. He's a seasoned executive with over ten years of experience in our business, running key global operations and corporate strategy. We've communicated to employees the new organization and the rationale behind our changes.
This is a more competitive organization and is designed to create more value for our customers. As part of the transition, we've already announced the closure of one facility and started integrating our sales organizations. We are moving forward to Phase two, which is anticipated to be completed later this summer. This will move the European applied water systems business under the newly formed European structure. Let me wrap up this point by saying that we are on track to deliver the targeted 13,000,000 to $15,000,000 of net savings from actions.
This is in addition to the expected $12,000,000 of savings from the actions we executed in 2012. Let me illustrate how these three strategies on this page come to life. Two weeks ago, I visited our facility in Auburn, New York. There we produced the Goulds water technology brand for products in our residential, commercial and industrial markets. We have been investing in new products and technologies in our Applied Water segment.
Our energy leading ESB, which is produced in this plant, saw double digit growth in North America in the first quarter and is now in its third year of strong double digit growth. Over the past two years, this facility has undergone a complete transformation. Our lean efforts have resulted in cycle time reductions of 20% to 40%, higher on time performance and 25% reduction in floor space. This site was also the first to implement our new ERP platform in the first quarter, which will further improve operational efficiency and our response time and accuracy. In Europe, our Hungary facility has completed a similar lean transformation.
There we are producing our new EcoCirc heating pump, which is growing more than 20%. In both cases, we are taking share through a combination of product and factory innovation and creating value for our customers. As I continue to share with you, we are gaining traction against our most critical strategies that advance customer value, new product launches, our Total Care Services program and expanding our portfolio with acquisitions. This is the best way to drive growth and this is precisely what we are doing. All the while, we continue to execute on our operational performance in these tough market dynamics.
Now let me turn the call over to our CFO, Mike Spietzen to walk you through the first quarter twenty thirteen results. Mike?
Speaker 3
Thanks, Gretchen. Please go to slide five. In the first quarter, Xylem revenues were $879,000,000 down 5% from our first quarter in 2012. Let me provide some perspective performance by end market and by region. First, in our largest end market industrial, organic revenue was down 10% year over year in the first quarter performing worse than anticipated.
In The U. S, we continue to be negatively impacted by year over year comparisons of water transport applications supporting natural gas fracking and destocking by some distributors particularly those serving The U. S. Mining industry. We also saw some weakness in niche markets like marine which was unfavorably impacted by a cooler start to the season.
European industrial market weakness continued in the first quarter down mid single digits. Project timing in emerging markets drove a year over year decline in industrial markets, particularly in The Middle East and Asia Pac, which were both down double digits. First quarter revenue from the public utility market declined high single digits year over year. Overall, this was in line with our expectations for the quarter. In The U.
S. Where we were up low single digits, we saw an acceleration of activity driven primarily by previously delayed replacement and maintenance work. We continue to see stability in Northern Europe. However, year to year year over year project timing, spending cuts in Southern Europe and funding challenges in Eastern Europe resulted in a double digit decline for the first quarter. Commercial building services were down low single digits, primarily driven by weak institutional construction market conditions in The U.
S. And slowing retrofit opportunities. Outside of The U. S, we continue to see strong results particularly from emerging markets. For example, fire pumps and integrated commercial building packages drove double digit growth in Latin America and China.
While year over year sales were flat for the quarter, we saw conditions improving in The Middle East and are cautiously optimistic about construction growth in the region moving forward. Residential was down low single digits in the first quarter. In The U. S, we were up low single digits with performance driven by seasonal promotions and improving market conditions for new and existing home sales. Europe was down double digits driven primarily by weaker market conditions in Southern Europe.
As for agriculture, we were up high single digits for the first quarter driven by better than expected results in The U. S. And project shipments into Latin America. Let me spend just a few minutes on our overall geographic performance. The U.
S. Was down 6% on an organic basis in the first quarter in line with our expectations. Relative to our expectations, we saw weaker industrial market conditions. These were partially offset by a pickup in public utility maintenance and repair activity after a slowdown in the fourth quarter and strength in residential. Europe was down 8% for the first quarter, below our expectations of a mid single digit year over year decline, driven by weaker industrial and residential market conditions, particularly in Southern Europe.
Emerging market organic revenue declined 9% for the first quarter, reflecting the impact of year over year project timing in our Water Infrastructure segment. China and Russia continued their upward trajectory both posting double digit growth in the quarter. Gross margin was 38% and operating margin was 8.9% for the quarter. Margins were negatively impacted by year over year volume declines and associated leverage loss. Additionally, we continue to invest in the business which impacted margins by 70 basis points.
Partially offsetting these headwinds were benefits from cost reduction initiatives including the benefit from restructuring actions executed in 2012 and price. As we indicated at Investor and Analyst Day, we anticipate that acquisitions and foreign exchange will have an unfavorable impact on margins this year. In the first quarter, we saw 40 basis points of headwind from acquisitions, primarily reflecting the impact of purchase accounting, integration and transaction costs. In addition, foreign exchange translation and transaction unfavorably impacted operating margins by 30 basis points. Please turn to slide six.
This slide shows our EPS walk for the first quarter. We're reporting $0.27 of EPS, down $09 from the prior year. Core operations were down $08 driven primarily by volume decline, continued investment in strategic initiatives and costs associated with acquisitions. Restructuring savings and net cost reductions driven by our Lean Six Sigma and global sourcing initiatives partially offset these impacts. As planned, the completion of Phase one of our European realignment actions provided a $01 benefit to EPS and foreign exchange was unfavorable by $02 During the first quarter, we recorded a tax benefit of approximately $1,000,000 related to a foreign tax refund.
However, according to the terms of the tax matter agreement, we're required to make payment of the refunded amount to ITT and therefore recorded offsetting non operating expense. Backing this out, our adjusted operating tax rate would have been approximately 22% in line with our expectations. Now let me provide more detail for each of our reporting segments. Please turn to slide seven. For the first quarter, Water Infrastructure reported revenue of $551,000,000 down 5% over prior year on a constant currency basis and down 9% organically.
Acquisitions contributed four points to the top line growth. Transport declined 7% for the first quarter. In The U. S, transport declined high single digits, primarily due to a significant decline in industrial dewatering applications. This decline was driven by tough year over year comparisons for natural gas fracking related applications and lower distributor sales, which we attribute primarily to a decline in mining.
These declines were partially offset by favorable public utility performance driven by an acceleration of operating activities and a continuation of Sandy disaster recovery dewatering projects. In Europe, transport declined in the mid single digits, driven by funding constraints and project execution delays and broad based spending cuts in Southern Europe. While market conditions in most of Europe continue to be challenged, conditions in Northern Europe remain stable. Treatment revenues declined 22% for the first quarter driven by two factors. First, in the developed markets, we continue to see market softness.
As an example, water and wastewater capital spending in The U. S. Remains down and we continue to see municipal funding constraints in Europe. We anticipate that these regions will continue to lag in performance at least until confidence is restored and project orders are released. Secondly, the first quarter also reflects how project timing can impact any performance.
For example, The Middle East and Asia Pac were down double digits year over year due to a few large projects that shipped in the 2012. And lastly, test revenues were down 8% due to the timing of European project shipments in 2012. First quarter operating margins came in at 9.4%. Operating excellence and restructuring actions drove three forty basis points of margin expansion. As you can see from the slide, these cost reductions coupled with favorable price of 30 basis points slightly offset the organic volume decline and continued investment in the business by 20 bps.
Our margins were negatively impacted by 60 basis points of acquisition dilution and 50 basis points from foreign exchange. Let me now turn to slide number eight and talk through Applied Water. Applied Water's first quarter revenue was down 3% on both a constant currency and organic basis. Building Services was down 3% driven by the commercial and residential performance I covered earlier. Industrial Water was down 6% and was primarily attributable to weakness in The U.
S. And Europe. In The U. S, we were down approximately 10%. Our results were unfavorably impacted by weakness in marine and a weaker general industrial market.
Europe was down mid single digits due to continued weakness in Southern Europe. Partially offsetting these headwinds, we continue to see favorable results in emerging market regions. For example, Latin America and Asia Pac both posted double digit growth in beverage dispensing applications and Russia also posted favorable performance. And lastly, Irrigation was up 7% with The U. S.
And Latin America up double digits, partially offset by Europe being down high single digits. Applied Water posted strong operating performance during the first quarter with margins up 170 basis points to 12.2%. Price and productivity actions including the benefit of restructuring actions taken in 2012 coupled with new product sales more than offset the impact of lower volume and inflation enabling continued investment in the segment. Now let me turn to slide nine and review our financial position. Free cash flow was slightly negative in the first quarter.
Our performance is in line with our expectations and reflects the impact of lower volume increase in tax payments. These tax payments were related to extensions provided by taxing authorities following Superstorm Sandy. Our available cash on hand was $375,000,000 reflecting the deployment of $78,000,000 into acquisitions and $15,000,000 in share repurchases. Our net debt to net capital ratio remains at a healthy 29% and our credit metrics are in line with expectations and our credit ratings. Our commercial paper and revolving credit facilities remain in place and continue to be underutilized.
Please turn to slide number 10. We are affirming the guidance we provided at our twenty thirteen Investor and Analyst Day. So in the interest of time, here are the highlights. We anticipate 2013 revenues of approximately $3,900,000,000 which reflects total growth of 3% to 4% consisting of flat to 1% organic growth and two points of growth from acquisitions. We've prepared a revenue outlook summary on the next slide providing insight to our planning assumptions.
But before we move on, let me make just a few more points. While foreign exchange rate fluctuations could impact our performance in 2013, we have not seen any significant movements that would require adjustment to our guidance. Segment margins are anticipated to be in the range of 13.7% to 14.2% and company operating margins are projected to be in the range of 12.2% to 12.7%. We anticipate second quarter segment and operating margins to improve sequentially similar to 2012. We anticipate full year earnings per share of $1.79 to $1.89 This range excludes one time restructuring and realignment costs of approximately 60,000,000 to $70,000,000 pretax, but includes approximately $5,000,000 of additional one time separation costs and $5,000,000 in higher pension costs.
Free cash flow conversion is forecasted to be approximately 95%. Our operating tax rate is expected to approximately 21%, a reduction from 24% in 2012. This rate reflects a sustainable benefit from the establishment of our new European headquarters in Schaffhausen, Switzerland. Please note because of certain milestones including the rollout structure across our regional businesses, we expect the operating tax rate to average approximately 22% over the first half of twenty thirteen and twenty percent over the second half. Please turn to slide 11, which illustrates our revenue outlook by end market and outlines a few of the related planning assumptions around the balance of the year.
Industrial is our largest end market, representing 43% of our revenues. For the full year, we expect flat to up low single digit organic growth. We expect challenging market conditions to continue in Europe, but have not factored further declines into our outlook. We do anticipate The U. S.
Industrial markets will improve sequentially for the second half of the year. It's also important to note that our performance will be against relatively easy prior year comparisons. Revenues from public utilities, now 35% of our total revenue are expected to be flat with twenty twelve levels. We continue to expect stability in required operations and maintenance activities as this spend is largely non discretionary and is funded by tariffs end users. As we have discussed during previous quarters, the portion of public utility revenue that is derived from CapEx project spending continues to be constrained by project delays.
Given the longer lead times for such projects and the absence of any significant change in CapEx spending levels, our forecast for 2013 assumes that this continues to be the case. We expect that demand for emerging market public utility infrastructure will be a source of growth for Xylem in 2013. Our revenues from commercial markets are expected to be flat to up low single digits. Indicators such as the commercial architectural billing index have improved through the first quarter, which could lead to a recovery in the second half. We've assumed a modest improvement in The U.
S, offsetting the weakness we saw in Europe during the first quarter. Additionally, we expect that new products in emerging market revenues will continue to grow at a faster than developed market rate. Residential markets support flat to low single digit growth as our product sales associated with our large installed base. We see potential for favorable performance in The U. S.
Market and have assumed that the European markets stabilize. Agriculture remains a small market for us and revenues are likely to be flat. Despite a strong start regions, we expect flat year over year performance primarily due to the difficult comparison from 2012. Taken together, the low growth economic environment along with the relative stability of demand for the critical types of products we sell across a variety of end markets suggest flat to low growth in 2013. Please turn to slide 12.
Although I have covered this slide in the past, let me walk you through it again as it highlights important margin and EPS dynamics impacting 2013. First, we are incorporating the remaining required one time separation costs for IT systems and corporate headquarters relocation into our guidance. These costs result in a $02 reduction to EPS and a decrease of 10 basis points to our operating margin. We expect a $01 dilutive impact to EPS for foreign exchange and acquisitions. At the operating margin line, these drivers will have an unfavorable impact of 50 basis points.
Operating margins related to the acquisitions are unfavorably impacted by certain purchase accounting adjustments and transaction costs. Excluding these impacts, operating margins for these acquisitions would be accretive to Xylem's operating margin. Cost savings initiatives, restructuring savings and productivity are expected to drive a $7 benefit to EPS and 50 basis points of margin improvement more than offsetting the unfavorable impact of higher pension costs of approximately $02 continued investment in growth initiatives and the headwind from a low organic growth environment. Finally, our European realignment will add $03 to EPS. The lower tax rate discussed earlier will more than offset the higher run rate costs associated with the new European organizational structure.
At the segment and operating margin lines, this is expected to have a 30 basis point negative impact. The combination of all these items results in an EPS of $1.84 and an operating margin of 12.5% consistent with our guidance midpoint for 2013. Please turn to slide number 13 and I'll turn it back over to Gretchen to wrap up.
Speaker 2
In summary, we continue to make progress on our growth strategy through the acquisition of PIMs and Multitrodes. We delivered solid operating performance despite macro challenges, which resulted in a softer top line performance than we expected at the beginning of the year. As we move forward in 2013, we are continuing our investments for growth, launching new products and solutions to better serve our customers, driving lean Six Sigma and global sourcing initiatives, executing on our restructuring and realignment plans and advancing our acquisition strategy by executing against a robust pipeline of opportunities. While market conditions remain challenging, the fundamentals of our business are strong. The macro trends in Water are compelling and we are advancing our growth strategy.
I am confident in the Xylem team, our technologies and solutions and our direction. With that, we'll be happy to take your questions. Laura?
Speaker 0
Your first question comes from the line of Brian Connors of Janney Montgomery Scott.
Speaker 4
Great. Thank you. I had a question relates to you mentioned Sandy a couple of times in the prepared remarks. I wonder if you could is there any way you can quantify the impact there whether it be in terms of top line or margin or EPS? Any kind of granularity you can give us on what impact that had on the quarter would be helpful.
Speaker 2
Yes. So in first quarter, we saw revenue of Sandy at $3,500,000 You've got a couple of dynamics going on with Sandy. One, we've had our dewatering pumps there longer than we had actually anticipated. The release of disaster funding has been slower than anticipated. So some of the work that we were hoping would start has been delayed, but obviously opportunities as we go into second quarter and the remaining of the year.
Speaker 4
Okay. And then second, I guess, follow-up question. You mentioned mining as a headwind to your industrial business. Can you give us a little more color there specifically on where we stand there in terms of bookings and backlog as we've moved into April here? And what inning you think we are in in that pullback in your opinion and based on what you're seeing in the business?
Thank you.
Speaker 2
Sure. Good question. So mining really is impacting our dewatering business. But let me give you a little flavor of what we're seeing since April. So April is giving us some good indications, a little bit more confidence in a few areas.
Dewatering, we are seeing some order pickup from the natural gas activity. And in mining, globally, there's still opportunity for us from a dewatering perspective. So as I look at our dewatering business, which is the most impacted, it is in line with our expectations going forward.
Speaker 4
Great. Thank you.
Speaker 0
Your next question comes from the line of Mike Halloran of Robert W. Baird.
Speaker 5
Good morning, everyone.
Speaker 6
Good morning. So just to tack on to that last one when you started talking about the trends in April that you've seen on the dewatering side. Could you maybe talk about more broadly through the whole platform how trends track through the quarter? I know at the Analyst Day you talked about a little bit weaker February. How did March end up?
And then what have you seen so far through April more broadly? And are you seeing any inflection points one way or another yet?
Speaker 2
Sure. Let me give you some flavor on that. So as we went through the first quarter, we knew we were coming into a low growth environment. We knew we had some tough compares from a previous very strong twenty twelve first quarter. So what we did see is January, February a little low.
We had a pretty good March. It wasn't a great March, but had a pretty good March. As we've come now into April, as I mentioned, I'd say April has a couple of good indicators for us. Some more confidence in a few areas dewatering as I mentioned natural gas as well as the disaster that we're all seeing in the Midwest flooding that's helping. The other area I would say is our orders in Europe is in line with our expectations.
So we're seeing some progress there. Again, we're watching that closely. Our loading program and our building services area has looks nice coming into the second quarter, which is obviously a good sign for us. So overall, in line with our expectations at this point. When I look at the opportunities in front of us natural gas, the flooding, The U.
S. Residential market is positive. And the areas that we're watching as I mentioned is Europe, some of project delays and any other uncertainty in terms of the market. But right now more positive indicators.
Speaker 3
Yes. Mike, I guess the only thing I would add is relative to when we talked to everybody at Investor Day, we had some projects push out of the first quarter that the good thing is that they're rescheduled later in the year. So we've got good line of sight to that. But that was probably the one area that came out of the expectations that we had articulated at that point in time.
Speaker 6
That makes sense. And then Mike a point of clarification on one of your comments. When you said that you're expecting second quarter margins to be comparable to 2012, I just want to make sure were you saying comparable on a year over year to 2Q twenty twelve or the move from 1Q to 2Q would be comparable in 2012 versus 2013?
Speaker 3
Yes, the move. I think if you look at 2012 from Q1 to Q2, we saw about 80 basis two ninety basis point movement in margins. We see a very similar line of sight in the 2013.
Speaker 5
Great. Appreciate the time. Thank you. You bet.
Speaker 0
Your next question comes from the line of Deane Dray of Citi Research.
Speaker 2
Hi, Deane.
Speaker 7
Hi, like to Deane.
Speaker 8
Some more color on is the municipal market. You said now this is 35% of the mix. And I'm trying to bridge some of the comments about you're seeing some stability in The U. S. Muni, but you're also saying there's no capital spending, big projects releases and we know that this has been an ongoing position for the municipalities.
So within the part that they are able to spend, which is OpEx, some of it's break and fix. There's no discretion to have to fix those. But it sounds as though there's an element of business that falls under OpEx where there is some discretion and there had been some push outs. And maybe you can just give us some color as to what those projects are. They're not the big CapEx, they're not break and fix, but they are falling into that OpEx.
And in some cases, they there's some discretion on push outs.
Speaker 2
Yes, Deane, let me just kind of step back on the muni market. As you mentioned, there's the CapEx and there's the OpEx. What we saw and I'll talk very specifically about The U. S. First is last fall, we actually saw with the uncertainty in the market, the fiscal cliff concern, we actually saw some pullback in some of what I would say is maintenance operations that typically be done in expanding cycles.
When we came into the first quarter of the year, we saw the OpEx, our transport side of the business see some positive effects because of that. We're also seeing a couple areas where we have advanced new products and services. So we are working with our public utilities to bring solutions around energy efficiency, helping them with from a maintenance cost, bring their cost down so that they can free up dollars to go towards capital expenditures. As Mike said in his remarks, our capital expenditure, we're not assuming that's substantially. However, the bidding activity as we've continued to talk about is still strong.
The portfolio I mean our funnel is strong, but we're not seeing any signs of any
Speaker 5
kind
Speaker 2
of sustainable release of those orders at that point in time.
Speaker 3
And Deane, I think it's evidenced by the strength we saw in The U. S. Where we were up essentially 6% relative to those delays from an operational standpoint can't happen for a long period of time. And I think you saw that play in the first quarter.
Speaker 2
I'd just add one more piece, is tariffs continue to grow across the board. In The U. S. They're up around 6%. And you've also got regulatory type requirements that are ultimately driving the implementation of some projects both maintenance as well as CapEx as the funding gets released.
Speaker 8
That's helpful. And I didn't hear you use the term sequester. So is there any pressures from the sequester side that's I meeting any
Speaker 2
would say mostly in our analytics business, our YSI business, where a lot of instrumentation goes through universities, colleges and so forth. But right now, we still feel confident in our direction and the orders that we're getting in. But that is an area that we are watching and we'll keep a close eye on going forward.
Speaker 8
Great. Just one follow-up. The comment on PIMMS, the point of saying you're in Scotland and Northern Ireland. Now was PIMMS already in those regions? And maybe just some color there.
And how do you scale up a business that does involve a lot of headcount? And so what is the planned rollout there?
Speaker 2
Yes, great question. Let me just talk a little bit. If you looked at PIM specifically, they were mostly in The U. Industrial side, which complemented us very well because we play in the public utility side. Where they were not where we are entering in Northern Ireland and in Scotland, it's specifically through our existing sales channel going to see the public utilities and actually being able to service robustly.
In terms of scaling this out, let me tell you how we're working through that. Tim's had a very good set of tools and documentation that we are actually now being able to deploy out through our seasoned sales companies to be able to drive that. We're also using some of their core talent to help us train those teams so that they can get up and running. There's no question you'll need people in each of the regions. But in terms of the core competencies, the business models, the dos, the don'ts, actually allow us to run more quickly.
Speaker 5
Great. Thank you.
Speaker 0
Your next question comes from the line of Kevin Maxa of BB and T Capital Markets.
Speaker 5
Thanks. Good morning. Good morning.
Speaker 2
Good morning.
Speaker 5
Can you touch on price cost briefly? It seems like in both segments you had some price benefit, but yet you call out a pretty sizable hit here on the material labor and overhead inflation. I would imagine the material side gets much easier for you going forward with what's happening in commodities. But can you just talk about that bucket a little more the material labor and overhead?
Speaker 2
Yes. Let me just take the price question and I'll let Mike walk through some of the details. But overall, we saw in the first quarter 60 basis points from price. We've been talking about driving strategic pricing across the organization and we have been very successful in doing that. This year we are in a competitive environment and we want to make maintain the share in the markets that are important to us.
And so we've talked about one to two points that we are driving across the organization. In 2013, we will be at the low end of that.
Speaker 3
Yeah. And so if you think about inflation, mean our inflation in the first quarter was about 2.8%. The way we've got that factored in for the balance of the year is definitely on a declining basis. So you ought to be expecting around 2.5% from a full year. So that will become a bit of a tailwind.
I think that plays to some of the dynamics we're seeing on the front end from a pricing standpoint as well as just the year over year compares relative to commodity pricing and input costs.
Speaker 5
Okay. And then Mike second one from me. You mentioned push outs a couple of times and things moving out of Q1 maybe into Q2 or the back half. Is that what really gives you the confidence to stick with a zero to one organic after a negative seven in Q1?
Speaker 3
Yes. I guess there's a couple of things that play into that. Definitely with some of the projects pushing out, they pushed out beyond essentially Q2. There's some underlying dynamics that play out as we go into the year. One is you've got seasonality.
So if you look from Q1 to Q2, the percentage of our backlog that's shippable within the current quarter is pretty consistent as we go into Q2 as it was in Q1. And so we've got about as Gretchen mentioned just over $400,000,000 worth of backlog in the pipeline as we head into Q2. And from a seasonal standpoint, we do typically ramp up into the second quarter. There's a number of things that happen in our business around loading programs that go into the Applied Water segment etcetera. As we look out through the balance of the year, we haven't seen anything yet that tells us that things are going to be dramatically different.
I think people are still projecting that the industrial production level in The U. S. Although it's down versus last year slightly from a growth standpoint, it's on an increasing basis versus last year things were on a pretty steady decline through the year. So that's a dynamic that works in our favor. Certainly natural gas pricing now over $4 gives us a good view relative to fracking pads coming back online and our business that delivers water to the frac pad will obviously potentially benefit from that.
And then you just have some of the other seasonal characteristics. You've got the flooding in the Midwest that's obviously going to play to that. And then overall you've got the compares. So our growth rates last year were on a sequential declining basis. And by the time we get into the fourth quarter we had essentially a negative 3% I think negative 3.4% organic growth.
So there's some of that that from a compare standpoint helps from a growth perspective.
Speaker 2
And I would just add a couple of points which is we had new products that we're launching. We're expanding geographically even with the acquisitions that we've acquired and gives us confidence as we go through the rest of the year. We've got a short cycle. As I think about quarter two, we've got when you look at quarter two, it's going to ramp up, which is seasonally aligned. It's about 25% of our revenue.
And we're basically expecting second quarter to be down low single digits.
Speaker 3
Yes. And then I guess the only other piece I'd add is the question was probably more around revenue. But I think from a margin standpoint, it's also important to think about obviously, we've got the sequential improvement from revenue. You can see the impact from a volume leverage perspective. It played out against us in Q1, but that will obviously become a tailwind for us as we go through the year.
We made great progress from a restructuring standpoint. We recorded about $5,000,000 worth of cost in the first quarter. But I think it's important to understand that we essentially initiated about 70% of our actions. So we're going to have a substantial benefit in the back half of the year well over 10,000,000 to $11,000,000 worth of benefit coming from the actions initiated in 2013. We're already seeing the benefits from 2012 play out.
And then we've obviously got the continued focus around cost and the fact that inflation should be moderating as we get into the back half of the year.
Speaker 5
Okay. Very helpful. Thank you. You bet.
Speaker 0
Your next question comes from the line of David Rose of Wedbush Securities.
Speaker 5
Good morning. If I may follow-up on the inflation question briefly and then I have one other one. On the inflation question is there other than raw materials coming in, can you give us a little bit more dynamic of what your expectations are for labor? And why inflation is so high versus the headline numbers that we see? Mean I is it geographical differences?
Is it labor? Maybe you can give us a little bit more color. And then I'll have a follow-up.
Speaker 3
Yes. So labor definitely plays into it. As a factor relative to inflation number that we provide labor contributes about one point to that. So throughout the globe we see obviously different inflation rates in terms of what the various labor forces are looking for and it's obviously a little bit higher in some of our developing regions. But I do think that plays out quite a bit.
We see the material component moderating as I mentioned earlier. That takes time to work itself through the system. We have very little direct commodity exposure. So most of what we're exposed to ultimately comes through some sort of a component that's had some value associated with it. That takes time to work itself through from an inventory standpoint.
And then really our manufacturing overhead it contributes some. We're seeing normal levels of inflation there. I think the biggest single component starts with labor and then it moves quickly to material.
Speaker 5
Okay. That's helpful. And then on your treatment business, I'm trying to reconcile some of the commentary around project delays and then regulation. And maybe you can give us a little bit color in terms of why the treatment business is down as much as it is and your expectations going forward outside of simply project delays?
Speaker 2
Yes, David. Let me take that in terms of the treatment. Treatment is driven primarily from the capital expenditures and the budgets around the globe. We see significant opportunity in the emerging markets as they're building infrastructure to be able to have the economies of the future. We see that as an opportunity going forward.
Funnel is getting stronger in The Middle East. It's getting stronger in Asia Pacific. But even in the developed regions, Europe and in The U. S, while there is bidding activity, given the funding is just not there in public utilities, it's not being released. Let me give you a couple of dynamics.
In 2012, we had a substantial amount of large orders. Second in this quarter, we saw a little less, but we also saw about some of those projects slipping throughout the rest of the year. The good thing we have those in hand, it's a matter of them shipping later this year. So I feel good about that. In the treatment, half of our funnel is I mean, half of our orders are filled.
And so it's continuation going forward.
Speaker 3
David, I'd also add, we saw some dynamics in Europe that played out last year where there were biogas regulations that played out in Germany, a little bit in Italy as well. Those have since essentially dissipated and so there's a little bit of that that you have in terms of the year over year compares as well.
Speaker 5
Okay. So it's going to be lumpy throughout the remainder of the year, but you feel comfortable because you have projects in hand?
Speaker 2
I'd say it's going be lumpy. We've got projects in hand. Like I said, half of them we've got book to bill that we can still go after and so forth. But we'll be watching our treatment business as we go forward.
Speaker 5
Okay, great. Thank you.
Speaker 0
Your next question comes from the line of Matt Summerville of KeyBanc.
Speaker 9
Hi, good morning. This is Joe Radigan on for Matt. Just had a follow-up on seasonality question. As we model the balance of the year, I mean, you're going to see stronger seasonal trends in the second quarter. But
Speaker 7
what do
Speaker 9
you expect the linearity to look like through the back half? Should we expect I mean, you're getting the cost the benefits from the cost takeout in the back half of the year. Do you expect fourth quarter to be the high watermark in terms of operating income and EPS? Or how do you expect that to fall throughout the course of the year?
Speaker 3
Yes. So from a it all starts obviously with the top line. We see our linearity playing out pretty similar to what we've seen if you looked at an average over the past several years. So I'd expect Q3 to be relatively consistent with the second quarter and obviously fourth quarter will be the height and that's pretty consistent with what we've seen historically. That is typically when we see our highest margin performance.
That obviously gets somewhat accentuated by the fact that we're executing a bunch of restructuring actions primarily. We obviously made great progress in Q1 and in Q2 and we'll be seeing the full benefit in the back half. And so those dynamics will play out and support a higher margin level in the fourth quarter.
Speaker 9
Okay. And then on the MRO side, did you recapture any of the push out you saw in the fourth quarter? Was it just a return to sort of the normal buying patterns there? And then on destocking that you talked about last quarter and again this quarter, has that abated now? Or do you anticipate that further headwind going forward?
Speaker 3
Yes. Think on the maintenance side, the public utilities, we definitely saw that play back out. I mean, U. S, we were essentially up about 6%. So we've seen that come back in line.
I think as it relates to the destocking, the most recent activity we've seen is more around the dewatering. And again, it's relative to the first quarter of last year when we still saw strength from a mining standpoint. And most of the destocking is in the channel where the mining activity has come down and the distributors are essentially not wanting to carry as much stock. The other parts of the business, I'd say, there really hasn't been a big change. As we've mentioned in the past, we're carrying more inventory to supplement the fact that our customers are looking for very short lead times now and they're really looking for us to be able to react to that.
So we're obviously pushing hard to have the factories be responsive as well as making sure we're carrying safety stock to meet those requirements. But aside from the dewatering, didn't see a big change.
Speaker 9
Great. Thanks Mike.
Speaker 5
You bet.
Speaker 0
Our next question comes from the line of Chip Moore of Canaccord.
Speaker 5
Good morning. Back to pricing, understandable that driving price gets a little tougher just given some of the end market uncertainty. Can you talk about how much of that one point in 13,000,000 is driven by some of the newer products and services? And then how that could set you up for next year?
Speaker 2
Yes. As we've been investing in new product launches, we've been putting a lot of effort into making sure that we have a value proposition that we really position ourselves differently and can bring something different to the customer that they value. So our gross margins, pricing situation around those new projects, I feel very confident about. So that is helping. As I highlighted a couple of our new products that we are launching are seeing double digit type of advancements.
So I feel good. Our vitality index as I've talked about in terms of the robustness of our new products is at about 16% this year. Just a couple of years ago it was 12%. So we continue to advance. We continue to see them penetrate the market.
And that also gives us the confidence that we've got the right position and the right portfolio going forward to address the water issues in the market.
Speaker 5
Great. And then one more. We've talked about dewatering quite a bit, but maybe you can touch on some of the asset utilization trends just by geography whether you had to make any significant adjustments there? Thanks.
Speaker 3
Yes. I mean, we clearly we manage this business very different than we do the rest of the portfolio. And really starting back in 2012, we started making adjustments. The good thing for us is the equipment is movable between different end markets and so that gives us some flexibility. We did dial back our capital expenditures in line with the revenue decline we saw coming into 2012 as well as into 2013.
But we're still focused on expanding. We're going into new markets. Obviously, we've talked a lot about Australia, but we're also going to Latin America and into Asia. And so we see areas where we're continuing to invest. In those markets, we've actually seen growth, where we've essentially had to pull back in certain areas of asset investment has really been primarily in The U.
S. And it's a generic statement to make because there's actually some parts of the business where we've had to invest because the dewatering equipment is being utilized for example to support the Superstorm Sandy recovery and some of the activities going on in the Midwest. There's other models where we've obviously had to dial back. So it's a pretty complicated and detailed analysis. But I'd say overall, we've seen a pullback in The U.
S. In terms of where investment is, but we're still moving geographically where we're seeing the growth.
Speaker 2
I'd just add to this. As you know our whole dewatering model, we bought the leading number one position in The U. S. With Godwin. And our goal here was ultimately internationally to expand ourselves.
So we're trying to have that right balance in terms of pulling back where it makes sense, but also making sure that we're investing for the global opportunity in front of us. I think last year I mentioned that we had our first dewatering order into China. We now have our first dewatering order in into India. And so we are expanding nicely in terms of our opportunity and reach. So I feel very confident about our growth opportunities for dewatering going forward internationally.
Speaker 5
Thank you.
Speaker 0
Your next question comes from the line of Brent Thielman of D. A. Davidson.
Speaker 5
Hi. Good morning. Good morning. On the Building Services side of Applied Water, as we're starting to see planning for new non res projects picking up, can you elaborate a little more on maybe some of the incremental signs you may be seeing within your own business that gives you confidence in that improvement in commercial in the second half?
Speaker 2
Can you say your question again, because you came in very, very
Speaker 5
low? Sorry about that. Yes, just on Building Services side of Applied Water. Obviously, of the leading indicators seeming to show non res projects picking up or at least planning around it. Can you elaborate a little bit more on some the incremental signs you might be seeing within your own business that gives you some confidence in that improvement in commercial for the second half?
Speaker 2
Yes, sure. When I look at building service, couple of things. As I mentioned earlier in April, we saw our loading program around the building services come in very nicely. So that gives us good confidence. We're also seeing in The U.
S. Residential playing out nicely. But typically that's before you see commercial and we're seeing architecture billing increasing, which is a good indicator that in the future here that we'll see nice projects. When I look at it from a geographic perspective, we're seeing nice growth in Southern I mean in Latin America. We're also seeing nice growth in Asia Pacific and The Middle East.
We see that's going to show signs of improvement. We had political unrest there for quite a while. I think we've got the right team and the right position there to continue to go forward. U. S.
Recovering in the second part of the year and I feel pretty good about the direction of the new products the teams are launching.
Speaker 5
Okay. And then just on the Water Infrastructure segment. You mentioned difficult comps for the emerging market regions. When did those start And it sounded like you were expecting some improvement going forward.
Is that due to higher quotation levels? Or you've actually starting to see some orders received?
Speaker 2
So when we came out of first quarter, our book to bill in our Water Infrastructure is about 1.09% consistent with what we said in Xylem. So our book to bill is in line with where we are and in line with what we saw historically. So I feel good about that. When I look and public utilities, again, you're seeing the need for the infrastructure in the emerging markets and our position is playing out nicely. Where I feel confident, I'll go back to new product launches.
Xperior has been has had a nice launch into the market. We have worked with many of our customers to pilot our products and ultimately that's leading them to see energy efficiency and ultimately to buy as we go forward. So I feel pretty confident about our base operations side of the house. CapEx is the area where we got to watch in terms of the funding and how that flows.
Speaker 5
Okay. Thank you.
Speaker 0
Your next question comes from the line of Jim Krapfel of Morningstar.
Speaker 10
Thank you. Good morning, everyone.
Speaker 3
Good morning. What
Speaker 10
was the growth rate of total aftermarket revenue in the past couple of quarters? Where do you see that growth for the rest of the year? And how much does that presumed revenue mix shift towards aftermarket contribute to your expected margin performance in 2013?
Speaker 2
So let's so I'll take it from an aftermarket perspective. In first quarter, overall aftermarket was down. That plays to the dynamics of the industrial market being down. You've got mining down. You've got and that drives the use of a lot of your products and services there.
Applied water, up 1%. And so you're seeing where there is growth you're continuing to see that aftermarket. Going forward, we do see the aftermarket still playing as we think the industrial market plays out. And so we believe we'll see a positive growth in the aftermarket by the end of the year.
Speaker 3
Yeah. And I guess the one thing I'd add Jim is with the project being I'm sorry project business being down, one of the things that goes along with project business is initial provisioning of spare parts. And so that obviously is a knock on effect that we're seeing playing out as well as we see headwind from a project business.
Speaker 10
Okay. Thank you. That's all I had.
Speaker 2
Thank you.
Speaker 0
Your next question comes from the line of Stuart Scharf of SMP IQ.
Speaker 7
Good morning. Thank you. Good morning.
Speaker 1
Good morning.
Speaker 7
Could you talk a little about the M and A? And has anything changed? Or what are the multiples? And are you looking more in one direction or just being opportunistic at this point?
Speaker 2
Yes. Great question. And clearly M and A and inorganic growth is a key strategy for us as we go forward. I feel very good about our pipeline probably as robust it's as robust as I think we've ever had it. If you look at our track record, last several quarters we've been able to announce a new acquisition.
So the team is aggressively working hard. We're working in terms of candidates, working in terms of the same areas that we've talked about. Analytics is clearly a key area as we go forward. Dewatering continues to be an opportunity for us. Services, as we look at how we can support our large infrastructure and the customers that we currently have.
And so those are the key areas. We haven't kind of moved off of that. There's substantial fragmented market that we work within and we feel good. The multiples continue to stay stable. And so we're in the game and we hope to continue to play hard.
Speaker 7
Okay. And regarding Venezuela, what is your position there? And have you changed your thinking about that area with the currency devaluation and geopolitical situation?
Speaker 3
Yes, very small presence, limited currency exposure. Most of the currency is utilized within countries. So it's really a non issue for us.
Speaker 7
Okay. Thank you very much.
Speaker 2
Thank you. Our
Speaker 0
next question comes from the line of Ryan Konigsberg of Vertical Research.
Speaker 5
Yes. Hi. Good morning. Just a point of clarification. Q2 guidance and just how it relates to the year.
Gretchen, I think you said that Q2 is going to be down low single digits. We talked about the sequential improvement at margins similar to what we saw last year between Q1 and Q2 around two seventy basis points. Just kind of plugging it in and assuming kind of stable corporate costs and interest expense and everything else, I mean, see the contribution relative to the midpoint of your full year guidance close to 20% not 25%. And then you were saying that Q3 is probably going to be a similar level to Q2 and then you'll see a bump in Q4, which actually would require a fairly substantial increase. And I know you're getting more restructuring and other items, but it just seems unusually large.
Maybe I kind of misunderstood the comments, but can you just walk through that a little bit more just to make sure we're all clear on what you're saying?
Speaker 3
Yes. So let me maybe back up a step. So when you look at the sequential growth we'll have from the first and second quarter, you do the math it's over $100,000,000 of top line. And essentially we're getting in the mid-30s from a drop rate, which it's supported by normal volume leverage. I think you can see how sensitive the business is to that from the first quarter results.
Plus you've got the incremental restructuring kicking in from the actions that were initiated in the first quarter. As you get into the back half, have stable revenue between the third and fourth quarter and then you get a pretty sizable pickup in the fourth quarter. It does have high drop rates when you do the top level math. One, we would expect to see that in terms of the different markets that we're seeing, but you've also got the benefits from the restructuring actions that are going to hit heavy in the second half of the year. And so when you play all that math through, I think you can get yourself pretty close to the incrementals.
The base business is dropping anywhere from 35% to 40% given the volume lift that we're getting and then you tack on restructuring on top of that and that will get you there.
Speaker 5
So on the project work that you have line of sight on, I typically would think of those as kind of lower margin type of projects. Is that not necessarily the case? It sounds like maybe not if you think the drop through is so high.
Speaker 3
No, there's definitely some impact there. And we talked when we issued our guidance in the first round that for us this year we've essentially said mix is somewhat neutral. You've got a little bit of headwind coming from some of the projects, but you've also got a pickup coming from the mix for dewatering and some of the activities we have going on from a price to cost ratio.
Speaker 5
Okay. And then just lastly on kind of the fracking comments that you were making and you expect that to start to improve. I mean a lot of the equipment guys in the market are discussing while there may be some incremental improvement given some of the higher gas prices, there is a ton of equipment that's just sitting idle that needs to be absorbed before equipment actually or equipment orders actually start to improve. Do you not see similar dynamics? Do you not need to see I guess a period of absorption before you would see the benefits of I guess just market trends improving in that?
Speaker 3
Well, there's certainly some of that at play, but you have to also remember most of that business is service related. So they may have equipment sitting there, but they need personnel there to run it. So when you think about the activities that we have from a frac pad perspective, there's certainly equipment rental, but there's also the folks that are there monitoring and ensuring that the water flow is consistent and reliable.
Speaker 2
Right. So it's rental. I mean a lot of times they're renting this equipment the more they're using their mine as compared to just necessarily expanding out to another drill site.
Speaker 5
Okay. That makes sense. Great. Thank you very much.
Speaker 2
Thank you. Thank
Speaker 0
you. That does conclude the Q and A portion of today's call. I will now turn the floor to Gretchen McLean for closing remarks.
Speaker 2
Okay. Let me just close with a thank you. Thank you for your time and your support for the business. We're looking forward to our next call and showing you where we are. But we've got great activities going on in terms of advancing the business
Our new product launches, our services, our acquisition strategy, are taking traction in the marketplace and we feel confident in the direction that we're going. Again, thank you very much for your time.
Speaker 0
Thank you for participating in the Xylem first quarter twenty thirteen earnings conference call. You may now disconnect.