賽莱默 (XYL) 2012 Q4 法說會逐字稿

Welcome to the Xylem fourth-quarter and full-year 2012 earnings conference call.

Hosting the call today from Xylem's headquarters in White Plains, New York, is Gretchen McClain, Xylem's President and Chief Executive Officer.

She is joined by Michael Speetzen, Xylem's Senior Vice President and Chief Financial Officer.

Today's call is being recorded and will be available for replay beginning at 12 p.m.

Eastern Standard Time.

At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation.

(Operator Instructions).

It is now my pleasure to turn the floor over to Phil De Sousa, Investor Relations Officer.

You may begin.

Thank you, Jackie.

Good morning, everyone.

Welcome to Xylem's fourth-quarter 2012 earnings conference call.

With me today are Chief Executive Officer, Gretchen McClain, and Chief Financial Officer, Michael Speetzen.

They will provide their perspective on Xylem's fourth-quarter and full-year results, and discuss the outlook for 2013.

Following their prepared remarks, they will address questions related to the information covered on the call.

I will ask that you please keep to one question, then return to the queue, so we will have enough time to address everyone on the call.

We anticipate that today's call will last approximately one hour.

As a reminder, this call and our webcast are accompanied by a slide presentation, available in the Investors section of our website at www.xyleminc.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 Thursday, February 21 at 6 p.m.

Please note that the replay number is 404-537-3406, and the confirmation code is 76727905.

Additionally, the call will be available for playback via the Investors section of our website under the heading Presentations.

With that said, please turn to slide 2. 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 Xylem's Annual Report on Form 10-K, and those described in subsequent reports as filed with the SEC.

These remarks constitute forward-looking statements for 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 3. And I will turn the call over to our CEO, Gretchen McClain.

Thank you, Phil.

Good morning and happy new year.

Thanks for joining the call.

We appreciate your interest in Xylem.

We made substantial progress in 2012, putting a foundation in place and defining a clear path to realizing our full potential.

We are confident in our course.

And we are moving forward this year with continued focus on leveraging our full power of our portfolio, our industry knowledge, and our customers' relationship to grow this business.

While we were disappointed from a topline perspective in 2012, we entered the new year with relative stable market conditions, a resilient portfolio, and plans to drive earnings growth centered on improving our competitive position, simplifying our business, and continuing our focus on cost-saving initiatives to provide flexibility to advance our growth strategy.

Later in the presentation, we will discuss how we see 2013 from a market perspective, and the actions we've been taking to deliver earnings growth, independent of these conditions.

Now I'd like to walk you through our fourth-quarter results.

We received orders of $926 million, up 3% in constant currency and 2% organically.

Revenue from the fourth quarter was $969 million, down 3% compared to prior-year, when we registered over $1 billion in revenue, an all-time record performance.

Revenue in the US and Europe was down 4% organically versus the prior-year.

While Superstorm Sandy provided a benefit of approximately $8 million, it did not offset weak industrial and public utility markets.

Within the emerging markets, which today represent approximately 20% of our revenue base, fourth-quarter revenues were down 2% organically.

However, when you exclude the timing of large project shipments in the fourth quarter of 2011, emerging markets grew 9%.

Investments made in key countries like Russia and China resulted in double-digit growth in the quarter.

We're reporting gross margins of 39.4% for the fourth quarter, up 150 basis points over the prior-year.

Adjusted operating margin expanded 140 basis points to 13.4%.

These results demonstrate our commitment and ability to drive operating performance from our business, even in a challenging growth environment.

Our strong operating performance during the quarter resulted in earnings per share of $0.47, up 21% on a normalized basis.

Overall, we delivered strong operating performance, delivering additional $0.01 of earnings relative to our guidance, despite lower-than-anticipated volume.

Our full-year 2012 financial highlights are as follows.

Orders of $3.8 billion were in line with revenue, and we are exiting the year with a backlog of $647 million, roughly in line with prior-year.

Revenues have increased 2.5% on a constant currency basis.

Gross margin was 39.6%, up 120 basis points over the prior-year.

Operating margin was 12.9%, up 100 basis points on a normalized basis.

To put this into perspective, our full-year margin came in right around the midpoint of our original guidance we set last February -- a significant achievement, given the impact of lower volume, and dilutive transaction and integration costs from the MJK and Heartland acquisitions.

It also includes the addition of incremental standalone costs of $28 million.

At the bottom line, we have reported EPS of $1.77, exceeding our previous guidance by $0.01.

And, finally, we delivered free cash flow of $312 million, a conversion ratio of 100%.

Now I'd like to provide you with an update on the business and the progress we've made on our strategic initiatives.

We continue our focus on acquiring businesses that fit our strategic objectives for growth and we believe will achieve attractive returns on invested capital.

During the third quarter of 2012, we acquired MJK, followed by the acquisition of Heartland Pump in the fourth quarter.

And earlier this week, we announced the acquisition of PIMS Group.

I'll spend some time on the next slide walking through the PIMS acquisition, but what I'll say for now is that our integration process is working -- both MJK and Heartland are already exceeding our expectations.

In fact, while we expected the impact of Heartland to have been $0.01 dilutive to the fourth quarter, it was neutral to earnings.

We are excited to have added these three acquisitions to what is already the world's broadest portfolio of water-focused solutions.

And we believe our pipeline provides opportunity to deploy our capital in a disciplined fashion in this fragmented market, to drive growth and returns for our shareholders.

Last year, we began several steps to better align ourselves to maximize our presence and efficiencies in Europe.

The European market is and will continue to be a critical region for us.

We've operated there successfully for more than 100 years, and have built a large install base with trusted customer relationships.

By capitalizing on our entire portfolio of products and services, and leveraging our scale and expertise more efficiently, we not only preserve, but enhance our competitive position.

We've made significant progress on this initiative, beginning with the establishment of a new European headquarters in Schaffhausen, Switzerland.

We also initiated some restructuring steps in 2012.

And this year, we will be taking additional restructuring and realignment actions targeted at advancing this new European management structure for growth.

By driving our strategic and operating decision-making in an aligned Xylem in Europe, we will be best positioned to take a more focused view of our customers' needs and optimize our cost base, differentiating Xylem in the marketplace.

We made good progress in delivering customer value.

For the year, we achieved a vitality index of 15%, which is our internal measurement for our new products as a percent of total revenue.

This is up from 12% in 2011, and reflects the successful deployment of innovative new product applications and services for the relevant customer segment.

This means we generated over $0.5 billion in revenue from new innovative product launches, including more than one-third from applications focused on reducing the energy consumption of our customers' processes.

During the quarter, we announced plans to open a new office in Saudi Arabia, to continue to build our already strong position in the Middle East and Africa region, which today represents approximately 5% of total Xylem revenues.

Accelerating our presence and market penetration in emerging markets will continue to be a key focus area for Xylem.

And I'm pleased to announce that we recently proposed and achieved Board approval to increase our first-quarter dividend by 15%.

Our annual dividend payout will be approximately $86 million, assuming the Board approves each of the next three quarter of dividends at the same amount as the first quarter.

This reflects our confidence in continuing to generate strong free cash flow from the business.

Beyond 2013, our dividend policy will be to propose dividend increases in line with earnings growth.

Turning to slide 4. This week, we announced the acquisition of privately-held PIMS Group, with fiscal year 2012 revenues of $38 million, for a purchase price of $57 million.

This acquisition is consistent with our strategy to expand our aftermarket service business and accelerates our expansion into contract services.

Located in and servicing more than 10,000 locations in the UK, PIMS specializes in the installation and maintenance of water and wastewater pumping systems, sewers and drains, and wastewater treatment plants.

The business provides municipal, industrial, and private customers with 24/7 support services.

We expect to leverage its market-leading business processes throughout our global footprint with minimal additional capital investment, while enhancing the services we already provide today.

With Xylem's large install base, PIMS is a perfect match to ensure customers are provided with industry-leading products, application solutions, and enhanced aftermarket support services.

We expect to generate cost synergies with the acquisition, and to generate revenue synergies in the UK and as we expand globally.

We expect the PIMS to be margin-dilutive during 2013, as we get through the normal purchase accounting step-up adjustments and integration costs.

And we expect that PIMS will be EPS neutral in 2013 and accretive in 2014.

Now let me turn the call over to our CFO, Mike Speetzen, to walk you through the 2012 detailed results.

Mike?

Thanks, Gretchen.

Please go to slide 5. In the fourth quarter, Xylem revenues were $969 million, down 3% from our record fourth quarter in 2011.

Let me provide some perspective on our fourth-quarter and full-year revenue performance by end market and by region.

First, in our largest end market, industrial, organic revenue was down low-single digits year-over-year in the fourth quarter.

Despite the impact from Superstorm Sandy, the US continued to be negatively impacted by dry weather conditions and the slowdown in water transporter applications supporting natural gas fracking.

European industrial market weakness continued in the fourth quarter, down mid-single digits.

Industrial performance in emerging markets was robust, with Latin America and the Middle East and Africa regions posting double-digit gains over the prior year.

On a sequential basis, industrial grew mid-single digits in the fourth quarter, driven by Europe, reflecting normal seasonal patterns.

Overall, full-year organic revenues for industrial were up low-single digits.

Fourth-quarter revenue from the public utility market declined high-single digits year-over-year.

This was weaker than our expectation of a low-single digit decline.

As we mentioned on last quarter's call, we saw the acceleration of some deliveries into the third quarter, and we knew we were facing a difficult comp, given the sizable projects we delivered in 2011.

The varying levels of uncertainty among public utilities, both in the US and Europe, resulted in the delay of smaller projects and discretionary maintenance, and drove the additional weakness in this market.

Overall, full-year organic revenues for public utilities were down approximately 1%.

Commercial building services were up low-single digits.

In the US, we saw market conditions weaken in the back-half of the year.

Superstorm Sandy partially offset this weakness, providing approximately $1.5 million in revenue for the quarter.

Outside of the US, we saw strength in Latin America, driven by several small project shipments.

And Europe was flat year-over-year.

Overall, full-year organic revenues were flat for the commercial end market, in line with our expectations.

Residential was up low-single digits in the fourth quarter.

The US market was up mid-single digits, driven by seasonal promotions and the benefit of approximately $0.5 million attributable to Superstorm Sandy.

Despite the contribution from our recently launched, high-energy efficient Ecocirc circulator, Europe was down low-single digits, given continued weakness in the housing market.

Overall, full-year organic revenues were down low-single digits for the residential end market, in line with our previous expectations.

And as for agriculture, we were up mid-single digits for the fourth quarter, driven by better-than-expected results out of Europe.

Overall, full-year organic revenues were up low-single digits, in line with our previous expectations.

Let me spend just a few minutes on our overall geographic performance.

The US was down 4% on an organic basis in the fourth quarter and flat for the year, in line with our previous expectations.

Europe was down 4% in the fourth quarter and was down 1% for year, slightly below our expectations of flat year-over-year performance, driven by weakness in the residential market.

Emerging market organic revenue declined 2% for the fourth quarter, primarily due to the timing of several large project shipments, which we delivered during the fourth quarter of 2011.

Excluding these projects, emerging market revenue was up approximately 9%.

Emerging market organic revenue grew mid-single digits over the full year in 2012.

Adjusted operating income was up 8%.

Despite lower-than-expected organic revenue, fourth-quarter operating margins came in at 13.4%, up 140 basis points after absorbing the minimal impact of incremental standalone ramp-up costs.

Gross margin was 39.4% for the fourth quarter, up 150 basis points versus the prior-year, as price and cost improvements more than offset inflation and unfavorable mix.

By driving gross margin performance, we were able to continue to invest in our business while expanding operating margins.

Investments in the fourth quarter impacted operating margins by 30 basis points.

For this quarter, our operating margin contribution for price offset material cost inflation.

The MJK and Heartland Pump acquisitions were a 10 basis point headwind to operating margins for the quarter, reflecting the impact of purchase accounting and integration costs.

The impact of foreign exchange translation and transaction favorably impacted operating margins by 20 basis points.

Please turn to slide 6. This slide shows our EPS walk for the fourth quarter.

This has been a transition year for Xylem.

And as such, there were a lot of moving parts.

So I want to spend some time this morning, as we have on previous calls, describing the components of our performance.

As the middle section of the chart depicts, we have adjusted both 2011 and 2012 EPS to a normalized basis to provide a clear picture of how we performed operationally versus last year.

The walk starts with GAAP EPS for 2011, and ends with GAAP EPS for 2012.

In between, we make two sets of adjustments.

For the fourth quarter, on the left side of the chart -- we increased 2011 GAAP EPS of $0.28 by $0.11 to show 2011 on a comparable basis.

For the fourth quarter of 2012 on the right side of the chart, we adjusted GAAP EPS of $0.39 by adding back the net negative impact of 2012 one-time separation costs, restructuring and realignment costs, and special tax items.

Making these adjustments puts both fourth quarters on a comparable normalized basis to allow for a better view of operational performance.

This analysis shows that normalized EPS increased 21% or $0.08, and was completely driven by core operations, including actions taken to reduce costs and restructuring activities initiated in the third and fourth quarters of 2012.

Acquisition impacts, foreign exchange translation, and our operating tax rate were neutral to our EPS performance.

We previously provided a range of restructuring and realignment costs of $15 million to $20 million, with related savings of approximately $10 million.

For the year, restructuring and realignment came in at $24 million and will yield savings of approximately $12 million in 2013.

Now let me provide more detail for each of our reporting segments.

Please turn to slide 7. For the fourth quarter, Water Infrastructure reported revenue of $637 million, down 5% over prior-year on a constant currency basis, and down 7% organically.

The MJK and Heartland Pump acquisitions contributed 2 points to topline growth, and foreign exchange was a 1 point headwind.

Transport declined 5% for the fourth quarter, driven by weakness in both public utility and industrial markets, where we saw mid-single digit declines.

Despite approximately $6 million of revenue due to Superstorm Sandy, our US dewatering business was down significantly from the prior year, due to ongoing drought conditions, lack of public utility funding for projects, and lower industrial rentals, particularly for natural gas fracking applications, which peaked in the fourth quarter of 2011.

Treatment revenues declined 18% for the fourth quarter, driven by the general decline of project activity and the delay of project shipments into 2013.

Additionally, in the fourth quarter of 2011, we saw a 21% increase in treatment, driven by the timing of large shipments into Latin America, which did not repeat in 2012.

Test revenues were up 1%, due to strength in emerging markets, partially offset by continued weakness in Europe.

Fourth-quarter operating margins came in at 16.5%, up 120 basis points from 2011.

Operational excellence and restructuring savings expanded operating margins by 380 basis points, while our customer excellence initiative drove price to the tune of 70 basis points, and as a result, more than offset the impact of inflation and provided flexibility to continue to invest in the business.

Our margins were, however, negatively impacted by the previously mentioned lower rental dewatering volume, and acquisition headwind from purchase accounting and integration costs.

Let me now turn to slide 8 and talk to our Applied Water segment.

Applied Water's fourth-quarter revenue was up 4% on both a constant currency and organic basis.

Foreign exchange was a 1% headwind, bringing our total growth in the segment 3%.

Building services was up 2%, driven by commercial and residential performance I covered earlier.

Industrial water was up 6%, due to favorable general industrial market conditions across most regions.

In the US, our results were favorably impacted by the timing of shipments we mentioned during the last-quarter call.

Excluding these dynamics, US industrial water applications were slightly weaker than expected.

Europe was up low single digits, driven by growth in Russia, and we continue to see favorable results in Asia-Pac.

And, lastly, irrigation was up 4%, with Europe up mid-single digits, partially offset by the US, which was down low-single digits.

Fourth-quarter operating margins came in at 11.6%, up 240 basis points from 2011.

Price and productivity actions, and benefits from severance actions taken in the fourth quarter of 2011, more than offset the impact of lower volume, unfavorable mix and inflation, enabling continued investment in the segment.

Now let me turn to slide 9 and review our financial position.

We generated $312 million of free cash flow for the year, a conversion on adjusted net income of 100%.

Our cash flow is down from 2011, as anticipated, driven primarily by interest payments of $53 million related to the debt put in place as a result of the spin-off from ITT.

In addition, we had incremental US federal and state tax payments in 2012.

As a reminder, the 2011 figures are a result of the carve-out financials provided in the Form 10, and reflected in an allocated portion of US tax payments that were deemed a Xylem obligation for the purposes of the Form 10 statement.

Note that adjusting for these tax payments would bring the 2011 conversion in line with our current-year performance.

As you can see from the slide, working capital as a percent of revenue increased 80 basis points year-over-year.

Foreign exchange had an unfavorable impact of 100 basis points and was partially offset by 20 basis points of operational improvements.

Improved collection performance and favorable supplier terms more than offset investment inventory to support shorter lead-times expected from customers.

As it relates to our capital structure, we ended the year in a strong position.

Our available cash on hand was $504 million.

We have a solid net debt to net capital ratio of 25%, 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 unutilized.

Before we turn to the guidance details, let me turn the call back over to Gretchen to provide you with the framework we are working with in 2013.

Gretchen?

Please turn to slide 11.

I want to spend a few minutes providing you with our strategic framework that guides and drives our decisions and actions.

We will spend more time in our upcoming Investor Day on March 7 framing this for you.

But simply put, these are our key goals and initiatives, and from here we develop plans for change and ways to measure the change.

It's our business model to drive excellence throughout the business.

In 2012, we made substantial progress putting a foundation in place as a pure-play water technology company.

Taking it to the next level and positioning Xylem for the long-term requires a few things.

First, an incredible focus on delivering customer value.

We prize customer intimacy above all.

And working to meet customer needs and deliver unique value is part of our Company DNA.

We will continue to deliver value across our portfolio of products and services, and actively seek new ways to create more value through bringing together our applications expertise and integrated processes across the business, to help solve the complex water challenges our customers confront.

Through our Xylem TotalCare program, coupled with the benefits of the PIMS acquisition, we are enhancing our aftermarket capability to protect and expand our large installed base.

Our applications knowledge gives us the ability to provide energy audits, system upgrades, and solutions focused on reducing our customers' total cost of ownership.

Second, drive profitable growth.

We are balancing growing our main lines of business with pursuing dynamic new opportunities, both through organic investments and our disciplined acquisition strategy.

We will accomplish this by investing in innovative offerings in high potential areas like smart products, energy efficiency and re-use; expanding our growth platforms, analytics and dewatering; and extending our geographic position in key markets, both emerging and underserved mature markets.

And we will maximize revenue and profitability, and carefully manage how we use our capital to invest in our business, balance risks and opportunities, and return to our shareholders.

Third, improve business sustainability.

We are focused on continuously improving the efficiency and effectiveness in all we do, which translates into greater competitive advantage, and builds a sustainable cycle of financial stability and flexibility.

We will continue our focus on optimizing our cost structure.

We plan to invest $60 million to $70 million in restructuring and realignment in 2013.

As I discussed earlier, in Europe we are repositioning our business, as well as taking other targeted actions to better position us in the future.

And we are driving a robust operating rhythm throughout the organization.

These changes will lead to achieving our goals and enabling innovation, agility and speed, which are necessary to address the long-term market drivers of demand in the water industry.

So let me set the stage for our 2013 guidance before I hand it over to Mike to walk through the details.

Turn to slide 12.

This slide shows our revenue profile on a trailing four-quarter basis since 2011, and highlights some of the key major drivers that have influenced our actual performance and our forecast for 2013.

As the chart illustrates, we experienced strong growth in 2011, driven by the delivery of large project orders received in 2010; strong performance from our Godwin dewatering and analytical businesses acquired in 2010; and general strength across all end markets, driven by the recovering global economy.

We started to see order rates for large public utility CapEx projects slow in the second half of 2011, impacting public utilities revenue growth in 2012.

Compared to the strong performance in 2011, the US dewatering business was impacted by drought conditions along with a slowdown in natural gas-related fracking activities.

While European political and economies concerns made headlines in 2012, our European business remained resilient, down only 1%.

Like most other companies, we saw a general slowdown in US and European industrial markets in the latter half of 2012.

Taken together, this led to a flat organic revenue growth with a more difficult second half of the year.

Looking forward to 2013, we expect the second-half slowdown experienced in 2012 continue to impact the first half of 2013.

Compared with relative prior-year periods, we expect revenue will be down mid-single digits in the first quarter of 2013, down low-single digits in the first half of 2013, and up low-single digits through the balance of the year.

We expect Europe to remain relatively stable, and expect the US to strengthen in the second half, along with re-acceleration in emerging market growth.

This assumes a sequential improvement in underlying demand for our business as the year progresses.

Please turn to slide 13, where Mike will walk you through each of the end markets and our 2013 guidance.

Thanks, Gretchen.

On a global basis, industrial remains our largest end market, representing 43% of our revenues in 2012.

In this market, we provide products which are critical to running our customers' base operations, where energy-efficient products and total cost of ownership are valued by our customers.

In addition, the majority of our dewatering revenues are associated with industrial end markets.

With some uncertainty around where US industrial demand will go, and European industrial production expected to remain challenged, we anticipate our revenues will be flat to up low-single digits organically in 2013.

In addition to slightly improving economic conditions in the US and emerging markets, we see additional expansion of our treatment solutions into industrial applications, and a return to more normal weather patterns for our dewatering business in the US.

Revenues from public utilities, now 35% of our total revenue, are expected to be flat with 2012 levels.

We continue to expect stability in required operations and maintenance activities, as this spend is largely nondiscretionary and is funded by tariffs to 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, in the absence of any significant change in CapEx spending levels, our forecast for 2013 assumes that this continues to be the case this year.

We expect that demand for emerging market public utility infrastructure will drive growth for Xylem in 2013.

Our revenues from commercial markets are expected to be flat to up low-single digits.

While indicators such as the commercial Architectural Billing Index have improved slightly in recent months, we expect market demand in the US to remain flat through at least the first three quarters.

European commercial construction is expected to remain challenged, offset by growth in emerging markets.

Residential markets support flat to low-single digit growth, as our product sales are largely driven by replacement sales associated with our large installed base.

Agriculture remains a small market for us, and revenues are likely to be flat, given the benefit we received from drought conditions in the US in 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, suggests flat to low growth in 2013.

Please turn to slide 14, and I'll walk you through the guidance details.

We anticipate 2013 revenues of approximately $3.9 billion, which reflects total growth of 3% to 4%, consisting of flat to 1% organic growth, 2 points of growth from acquisitions of MJK, Heartland and PIMS, and a 1 point benefit from foreign exchange.

For Water Infrastructure, we expect 2013 revenue of approximately $2.5 billion, reflecting total growth of 4% to 5%.

Organic growth for Water Infrastructure is expected to be flat to 1%.

The previously mentioned acquisitions will contribute 3 points of growth, while foreign exchange has a 1 point benefit.

Finally, for Applied Water, we expect revenues of approximately $1.4 billion.

This reflects growth of 1% to 2%, driven by organic growth of flat to 1%, and 1 point benefit from foreign exchange.

Segment margins are anticipated to be in the range of 13.8% to 14.3%, and Company operating margins are projected to be in the range of 12.3% to 12.8%.

We anticipate earnings per share of $1.80 to $1.90.

This range excludes one-time restructuring and realignment costs of approximately $60 million to $70 million pretax, but includes approximately $5 million pretax of additional one-time separation costs and $5 million pretax of higher pension costs.

Of the $60 million to $70 million, we plan to execute restructuring actions in 2013, which will cost approximately $40 million to $50 million, with an expected payback of approximately two years.

And we expect approximately $13 million to $15 million of net savings to be realized in 2013.

This is in addition to the $12 million of savings resulting from the actions executed in 2012.

Free cash flow conversion is forecast to be approximately 95%, slightly lower than 2012, after taking into account restructuring payments and capital expenditures related to the European realignment and targeted expansion of dewatering.

We also have the remaining actions required to separate from ITT, including IT systems to exit service agreements, as well as the required relocation of our corporate headquarters.

Our operating tax rate is expected to be 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 of the European structure across our regional businesses, we expect the operating tax rate to average approximately 22% over the first half of 2013, and 20% over the second half.

Our fully diluted share count is expected to be 186.4 million, which takes into account our share repurchase program, targeted at offsetting dilution associated with the various Xylem employee stock plans.

Finally, let me summarize our capital deployment plans.

Our first priority remains organic investment, as this is the highest returning investment we can make.

To this end, we see investing 2.5% to 3% of revenue in CapEx, 3% into R&D, and just under 2% into restructuring and realignment to enhance our competitive position.

Inorganic growth remains a top priority.

Our acquisition capacity and pipeline support continued investment.

As Gretchen mentioned, we are increasing our dividend by 15% and have the intention to grow it in future years in line with earnings.

Please turn to slide 15, which illustrates our EPS and operating margin walk from 2012 to the midpoint of 2013 guidance.

For 2013, 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 $0.02 reduction to EPS and a decrease of 10 basis points to our operating margins in 2013.

The impact of foreign exchange, and the acquisitions of MJK, Heartland and PIMS, are neutral to EPS, but reduces our 2013 operating margin by 40 basis points.

Operating margins related to the acquisitions are unfavorably impacted by certain purchase accounting adjustments, and integration and transaction costs.

Excluding these impacts, operating margins for all three acquisitions would be accretive to Xylem's operating margin.

Cost savings initiatives and productivity are expected to drive a $0.07 benefit to EPS and 50 basis points of margin improvement, more than offsetting the unfavorable impact of higher pension costs of approximately $0.02, continued investment in growth initiatives, and the headwind from a low organic growth environment.

Finally, our European realignment will add $0.03 to EPS.

The lower tax rate discussed on the previous slide 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 resulted in adjusted EPS of $1.85 and adjusted operating margin of 12.6%, consistent with our guidance midpoint for 2013.

Please turn to slide number 16.

And I'll turn it back over to Gretchen to wrap up.

In summary, 2012 was certainly a challenging but rewarding first full year.

Looking back, we established an organization with the ability to handle adversity, adapt to changing market dynamics, and deliver strong performance.

We've discussed in detail how we've advanced our strategic position over the past 12 months, launched new innovative products and services, and were recognized by organizations and customers as best-in-class.

We delivered strong financial and operational performance despite macro challenges, which resulted in softer topline performance than we expected at the beginning of the year.

We drove significant gross margin and operating margin expansion, in line with our original guidance.

And we are taking actions to protect our progress and continue our efforts we initiated in 2012.

As we move forward to 2013, we will focus and maintain our focus on improving our competitive position, investing for long-term growth, and increasing our efficiency and effectiveness.

We entered the year well positioned in the marketplace with a strong balance sheet and an organization built to succeed.

With that, we're happy to take your questions.

Operator?

(Operator Instructions).

Deane Dray, Citi Research.

I was interested in hearing more about the PIMS acquisition.

The move into services does complement the equipment model, but could you comment on how you scale a service business?

There's a lot of headcount intensive in terms of that business model.

So how much has it been growing?

And how do you scale it?

And do you get a flow-through of your aftermarket products through a service organization like PIMS?

Yes, Deane, let me step back a little bit.

We've been talking about our aftermarket strategy for quite some time.

We've been spending enormous amount of time driving what we call our TotalCare program is.

And so in all of our businesses where we have a large install base, our sales teams have been working aggressively to make sure that we're capturing the parts and services, but also bringing advanced services where we can bring the broad portfolio of products that we have, and our ability to go in and do energy audits and so forth.

What we get with PIMS is, one, some very nice processes.

We also get a very talented group of folks that have a core competency, that we can help train geographically our teams that are positioned very well.

So not only do we get a great position in the UK, which complements where, today, we play in the public utilities, and 90% of their customer base is non-public utilities.

We also get a core competence of talent that we can actually use to help our teams geographically expand.

Great.

And then just a quick follow-up for Mike.

Can you comment on the lower tax guidance, what's driving that and sustainability?

Yes, good question, Deane.

We do quite a bit of work around the tax planning.

As we've mentioned in prior discussions, we actually were fortunate to take the tax leader that was at ITT with us, given the global footprint that we have.

So we've been doing a lot of work around the planning aspects.

I think the key element is, this is a sustained tax rate improvement from some of the restructuring that we're doing in Europe.

And we look at it as a great position, not only to leverage, including other parts of our current portfolio, but as we look to bring new acquisitions into the fold; it will give us a good leverage point in terms of building sustainability around further improvements in that tax rate.

Great, thank you.

Matt Summerville, KeyBanc.

Can you talk a little bit more -- I understand the relocation of the headquarters, but just what you're doing from a heavy lifting perspective in terms of restructuring?

Are you taking out facilities, people?

Can you put other numbers behind that?

And then what do you expect the payback to be on the $60 million to $70 million you're investing in '13, as we think about '14?

Sure, Matt.

Let me first talk a little bit about what we're trying to do in Europe.

You know, we've been positioned in Europe for quite some time.

And as separate, independent companies, we have not really been fully utilizing or leveraging our unique and broad capabilities as a total Xylem in the water industry.

And so our objective here is to set up a headquarters, one headquarters -- today, we have three headquarters -- in Switzerland.

We will be aligning our strategies around our end markets that we go to.

And so a couple of the restructuring actions will lead to consolidating multiple sales companies in one country.

We will be able to leverage our back office more efficiently and effectively.

We'll be able to set up shared services that support the teams across Europe, and have centers of excellence.

And, ultimately, be able to get some opportunity to leverage manufacturing and our supply chain leverage commodity buys across the whole organization.

So I feel like we're going to be able to position ourselves to be able to work more effectively and efficiently in the market, but ultimately, be able to bring more value to our customer.

Mike, you can walk through the (multiple speakers) -- the numbers.

Yes.

So, Matt, let me just kind of step back and hit some of the numbers.

So, in 2012, we executed about $17 million from a cost perspective of restructuring.

We got about $1 million of benefit in 2012.

The remaining $12 million will be a benefit in 2013.

Out of the $60 million to $70 million of restructuring and realignment, $40 million to $50 million of that is restructuring.

And we see that giving us a benefit in 2013 of about $13 million to $15 million.

So think about the total restructuring benefit from actions done in 2012, as well as 2013, in a range of $25 million to $27 million.

The payback period on these, like we've articulated before, given the fact that we're focused primarily around Europe, is going to be approximately two years.

Okay, so then what we should think about that -- if you're getting a 1-to-1 dollar payback, that they're somewhere in the range of $35 million to be -- that will benefit you in '14.

Is that the right way to think about it, Mike?

Yes.

We're essentially, from an execution standpoint, for the actions being done in 2013, planning in Q1, execution in Q2, and then we'll be looking for run rate savings to have achieved in Q3 and Q4.

Thank you.

Ryan Connors, Janney Montgomery Scott.

I had a question in regards to foreign exchange.

Last year, you all made a downward guidance revision based on the euro and translation.

And given how strongly the euro, in particular, has rebounded, and look at the guidance assumptions, a little bit surprised that ForEx is as little a tailwind as it is in there, 100 basis points.

So can you just talk us through, Mike, the assumptions you're making around currency and the euro in particular?

Thanks.

You bet.

Euro is clearly the largest driver we have.

In the guidance, we used $1.32.

Rates have been trading slightly higher than that.

But just from a modeling perspective, if you look back, the average rate that we had during the 2012 time period was about $1.2[8].

And so as we look at that, it's about a 1% pickup from a topline perspective.

Obviously, if the rate were to hold at $1.35, you would see some incremental pickup.

It's anybody's shot in terms of where the euro is going to go.

I mean, if you look at what the projections are through the balance of the year, the euro is supposed to moderate some, based on what they're projecting with interest rates.

But, certainly, if it were to hold at the levels it is today, we would see a potential upside from where we're at today.

But again, it's all translation and has a minimal impact on the bottom line.

Great, thank you.

Chip Moore, Canaccord.

On the repositioning, I was wondering if maybe you could talk a little longer-term once you get through the actions in Europe, how much more runway you think you have on streamlining the business and where you're at?

So we've been making actions as we establish Xylem.

And so if you were to look at our Asian organization today, we have aligned around a Xylem organization across our Asian region.

We've been making some moves in Europe.

A couple of our countries have already integrated and so that has been positive.

And so we'll be making actions.

Europe is critical.

You know, it's a market that's challenged right now.

It's an important customer base.

And so those are the first major steps.

But I do feel overall, we've got a nice alignment in the organization.

And then we're trying to take those big steps now to position ourselves for the long-term.

We'll give you a little bit more color in March at our Investor Day, but the big step is in Europe.

Great.

Thanks.

David Rose, Wedbush Securities.

A couple quick questions.

On the spin costs, can you elaborate a little bit more of what we're seeing and why we're still seeing that cost, a year-and-a-half after the spin?

And then maybe a little bit more on differentiating the orders for the fourth quarter, given that they were up so much and your commentary about public utilities being down.

I'm assuming that the order growth is more industrial than public utility.

Maybe you can break that down for us.

Yes, let me, David, take the one-time spin costs.

Obviously, at the time of the spin, we did our best to estimate what it would take to effectively separate ourselves from ITT.

When you look at the total amount of money that was spent to exit, the remaining $5 million that we're talking about in the guidance is relatively small.

It's not related to anything that we did not know about.

We spent the better part of 2012 trying to make sure that we had a good effective strategy for the IT systems exits, as well as exiting our current location for our new corporate headquarters.

So it's nothing that wasn't anticipated.

It was tough to put a number around.

At the end of the day, we weren't going to compromise an effective and efficient exit.

I do not see anything beyond this.

This effectively ends all the interlinks that we have with ITT this year.

So this is -- the reason we've called it out is to ensure that, as you think of the margin going forward, it's not an ongoing cost.

Yes, let me talk a little bit about the fourth-quarter dynamics.

As we all saw, the confidence level in Europe and some of the confidence level around the US fiscal cliff, had people pulling back tight on their budgets.

So we saw that both in public utilities and industrial.

And the public utilities part of that was driven by some of the orders that were pulled forward in third quarter, but we did see some pulling back.

We've done a lot of discussion with our customers to understand what's going on and what to expect going forward.

We did see them extending some of their [maintenance] activities; it's not something we think is a trend or difficult.

And we also had some very difficult compares in the fourth quarter.

As I mentioned earlier, it was our all-time record fourth quarter in 2011 at $1 billion.

And a significant part of that growth was tied to treatment orders in the fourth quarter of 2011 -- I mean, sales in 2011, which didn't, of course, repeat.

The good thing is we saw some nice orders in the fourth quarter of 2012 around treatment, so we're feeling good about that.

Let me just comment in terms of the order rates and what we've seen.

We've talked about bidding activity still being strong.

Bidding activity is still good.

Our pipeline, or I should say our funnel, is very full.

But there's not a significant change in terms of the release of those bids into orders.

But we did see something happen in fourth quarter.

Not sure that's a trend.

It's too early to say that at this point in time.

And so we have not baked that in.

We think we're going to still see that market very challenged going forward.

Okay, great.

Thank you.

John Moore, CL King.

Can you quantify any benefit Sandy had on the order rate in the fourth quarter?

And do you expect to have any more benefit from any Sandy-related demand in the first quarter or longer-term?

Yes, let me comment.

On fourth quarter, we saw $8 million from Sandy.

That came from both of our segments, the largest portion of it from our dewatering business.

The team did a remarkable job in executing and being there helping our customers.

In terms of 2013, we all know that the disaster spending bill has been approved.

Projects are being worked.

We're working very closely with our customers.

I think we're well positioned to be able to benefit when you look at the portfolio that we have, the expertise that we've got.

But again, it's early in the stages of those projects getting laid out.

That should be something that falls out later.

So it's tough to quantify 2013 impact at this point.

Okay, great.

The $8 million was to revenue, but was there a -- was it a similar benefit to orders in the quarter?

Yes.

Thanks.

Jim Krapfel, Morningstar.

I think you partially answered this question already, but what do you think is driving the weakness you've seen from your public utility customers?

Do you sense it's more due to weaker electricity usage trends that don't necessitate the need for new power plants?

Or do you think it's more due to continued low power prices, making utilities more conservative with available cash flow?

Just trying to get a better sense of whether the utility end market weakness is more secular in nature versus cyclical.

Well, I think you have two dynamics.

The public utilities have been down in the CapEx expenditure for quite some time.

They're at a low end, I think, [six] years.

That's not changing.

We don't see any indication of that changing.

So that's a big piece from the CapEx perspective.

From the operational OpEx side of the house, as I said, we saw some dynamics where we pulled some things into the third quarter.

We still think the aftermarket is a very strong market, and given our large installed base, that we will be positioned very well.

I also think public utilities are looking at how they can reduce their total cost of ownership.

That, again, positions it extremely well to be able to bring solutions to help them take their costs down.

Okay.

And then how is the acquisition pipeline looking?

And what valuations are you encountering, especially relative to the past few quarters?

So, our acquisition pipeline is quite strong.

We continue to cultivate a lot of different businesses.

As we know, the water industry is quite fragmented.

And feel good that we have a healthy acquisition pipeline and that it's working.

I mean, we've had three acquisitions over the last three quarters, and we feel very good about that.

I also feel very good about our acquisition pipeline and integration process.

Each one of our acquisitions that we've acquired are getting well integrated with the businesses, are performing quite well.

In terms of valuations, in the fragmented market you still have various different acquisitions.

We have been looking primarily on bolt-ons, smaller; many of those are private companies.

And it varies whether you're going after a business that's in the services area versus whether you're at more of a high attractive value in the analytics or treatment area.

Okay, thank you so much.

Matt Summerville, KeyBanc.

I just have a couple follow-ups.

Can you talk about -- putting Sandy aside for a minute, what was the magnitude of drop-off you saw throughout 2012 in your dewatering business?

And given that some of the longer-term kind of drought-related statistics, that at least we look at, are still indicating a pretty severe situation here in early '13, where are you driving the confidence that that business gets better?

Yes.

So, dewatering saw two dynamics, two very significant dynamics.

One, an all-time drought in the US, which brought that down.

And then the other area where we saw 2011 slow is the pickup that we saw in 2011 around the natural gas fracking activity.

The positive things about our dewatering.

We bought a dewatering that's well positioned in the US.

We have been able to take that business model and expand ourselves in Australia, now into Brazil.

And we intend to take that business model into other regions around the world.

We think that will ultimately be significant in terms of growth for us, and it also helps cycles there when you do have some kind of a drought activity.

Overall, our position in dewatering does serve many multiple different end markets, but we did see a spike in natural gas, which makes it tough for a compare.

But we were flat for the year.

Your global dewatering was flat?

Our overall business.

Got it.

And then as we think about the margin dynamics, your core business flat to up 1%, Mike talked to my last question about the anticipated cost savings from the '12 actions, what's going to happen in '13 following through for the year.

I guess I'm having a hard time reconciling to your operating margins being down as much as 50 basis points.

And I would assume you're looking to take more prices here?

Yes.

So let me come at it from a couple different angles, Matt.

From a price standpoint, we've talked historically about having a target of 100 to 200 basis points.

We're obviously entering a -- continue to be in a tough economic cycle.

And pricing is going to be towards the lower end of that range, versus this year, we ended up at about 150 basis points.

So there's going to be a little bit of headwind there, although we do still see positive contributions from price.

But I think, the slide we put together in the deck hit some of the key points.

I mean, first of all, we've got a pretty substantial pickup from foreign exchange and acquisitions.

And while they're not dilutive from an EPS standpoint, they're not bringing any income, for the most part, to the bottom line.

And that ends up diluting the margins by about 40 basis points.

And the foreign exchange piece is more just translation effect of the currency change.

The acquisitions, it's more the short-term impact of the upfront purchase accounting and some of the transaction costs.

The European realignment, while it's a pickup from an EPS standpoint and drives a substantial portion of the tax benefit, we do have to set up infrastructure in Europe to support that.

And that's a 30 basis point headwind.

Now the good news is, over time, that's going to give us a platform to drive future benefit to the business from an operating (technical difficulty) standpoint.

And then we've articulated, really, two of the -- what I'd say is out of the norm adjustments.

One is the pension discount rate came down about 75 basis points.

And for us, that's about a $5 million impact.

And then the one-time separation costs, which are about just really trying to make sure we exit the connections with ITT in the right way.

And then you look at our core operations.

We're doing a lot of the same things that we did in 2012, dealing with a low growth environment.

We have very robust, lean and sourcing initiatives to ensure we're driving productivity to not only offset inflation, but give us a little bit of room to continue to invest in the key parts of our business.

And I think that's a critical element, is, we have not backed off making sure that we're investing in the future of the Company.

And then the restructuring savings, obviously, add to that, to help offset what is some headwind from the other cost increases that I had mentioned a little bit earlier.

Appreciate that walk.

Thanks, Mike.

(Operator Instructions).

Brian Konigsberg, Vertical Research.

I just had one question really on public utility.

You hit on some of it, but I'm just curious what you think it actually is going to take to get the capital projects part of the business to turn upwards?

I mean, if you think about historically, how things are funded, it seems like the healthy municipality is able to issue debt.

Now that we're seeing some improvements in the residential market, you would think the health of the municipalities are improving.

But I'm curious, is there a period of absorption that needs to occur?

Or the municipalities coalescing before they're able to get to a point where they're able to improve the bond issuances at the municipal level, to start doing these capital projects on a more significant level?

We know there's no shortage of demand for new projects; it's really a matter of getting that capital into the system, I think.

Can you -- if you could address that?

Sure, it's a great question.

Here's how I think about it.

I mean, the economy is down.

Until the economy gets addressed in some of the key issues that we're talking about in the US and other areas, it's going to be a challenged area.

Now that's not stopping us ultimately in terms of strategically looking how we position ourselves in working with our customers, to get after cutting -- to reducing their operating costs, so that they can actually invest in those areas.

There are a lot of builds that are out there that are being kicked around and addressed.

There are indicators that will say later this year or into 2014 you will see activity taking place.

But right now, the trends and the orders don't reflect that.

Our teams are aggressively investing in the right technology, so we are well positioned once that opens up.

Okay, thank you very much.

Your final question comes from the line of Stewart Scharf with S&P Capital IQ.

Can you talk a little about the mix, based on new products and end markets?

Is there one area you're focusing on more or where the mix generally is better, and the margins?

Or is it just pretty even, based on various new products and end markets?

I would say one thing.

When I talked about our vitality index, we are getting a large percentage of our revenue coming from our new product launches, which is a good indication that we have the right technology going into the markets.

I feel good about that.

When I look at mix, going into '13, we think our mix is going to be net neutral.

You've got emerging markets that is pulling down on it.

And that's an area that is growing and an area that we continue to expand in.

Analytics and dewatering is positive.

Yes.

And maybe just from a financial standpoint, I mean, 2012, we saw a lot of negative mix, and we hit a lot of the drivers around the dewatering business being the primary impact.

As we look into 2013, as Gretchen stated, we see mix being less of a factor for us, where we see positive upticks in areas like dewatering and analytics.

We'll see a little bit of an offset from an emerging market standpoint, but nothing that's significant at this point.

Okay.

And just on your cash allocation, is it pretty much the same?

You focused on the strategic acquisitions; you just raised your dividend.

Any change in planning for use of cash, share buybacks and so forth?

No, I mean, we have a share repurchase program.

As we've stated in the past, it's primarily aimed at managing that dilution from the equity programs.

At this point, we have a very robust acquisition pipeline and an ample supply of internal investments.

And our strategy is going to be to focus on those two areas and continue to reevaluate, as time goes on.

Okay, thank you very much.

You bet.

That was our final question.

I'd now like to turn the floor back over to Gretchen for any closing remarks.

Yes, I just want to say thank you for joining us.

It's been a great year.

We've got a great plan laid out.

We are watching the economy very closely.

We're sizing our business to ensure that we've got the flexibility for growth.

We're driving, of course, for growth in our strategic activities.

So if we (technical difficulty) sit and the market changes, that's a positive thing that we will see in the future.

I look forward to seeing you at our Investor Day on March 7. So thank you very much for your time.

Thank you.

This does conclude today's Xylem fourth-quarter and full-year 2012 earnings conference call.

Please disconnect your lines at this time and have a wonderful day.