Ladies and gentlemen, thank you for standing by, welcome to the Xylem first quarter 2013 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I will now turn the call over to Phil DeSousa, Investor Relations Officer. Please go ahead, sir.
Thank you, Laura. Good morning, everyone, welcome to Xylem's first quarter 2013 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 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 will ask that you please keep to one question and a follow-up, 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 in the investor section of our website at www.xyleminc.com. All references today will be on an adjusted basis unless otherwise indicated.
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 14th at 6:00 P.M. Please note the replay number is 404-537-3406, and the confirmation code is 29405041. Additionally, the call will be available for playback via the investor 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 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 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, actual results could differ materially from those anticipated. Now, please turn to slide three, and I will turn the call over to our CEO, Gretchen McClain.
Thank you, Phil, and good morning, everyone. We entered the year expecting a challenging first quarter, and it was. Delays in global treatment projects 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 gains in key 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. 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. We expect growth to accelerate through 2013. While Europe is clearly challenged, we are actively monitoring the situation, 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. Let's dig into the quarterly summary in more detail. We received orders of $962 million, down 4% in constant currency and 7% 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 million, up $76 million from year-end. Of our shippable backlog, we expect to deliver approximately $400 million in the second quarter and approximately $250 million in the second half. Revenue for the first quarter was $879 million, down 5% in constant currency and 7% organically. We are 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 and 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. Finally, free cash flow was a negative $10 million, driven primarily by lower income for the quarter, typical seasonality, timing of tax payments, and continued investments in growth platforms. 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 PIMS, 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 PIMS services has been 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, improve business sustainability.
We are focused on continually 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. 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 completed the transition of our European Water Solutions business to the newly formed European management structure. André Dewas is our new leader in the region. He is a seasoned executive with over 10 years of experience in our business, running key global operations and corporate strategy. We have 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 have already announced the closure of one facility and started integrating our sales organizations.
We are moving forward to phase 2, 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 million-$15 million of net savings from 2013 actions. This is in addition to the expected $12 million 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, N.Y. There, we produce 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 e-SV, 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%-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 shares 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, this is precisely what we are doing. All the while, we continue to execute on our operational performance in these tough market dynamics. Let me turn the call over to our CFO, Mike Speetzen, to walk you through the first quarter 2013 results. Mike?
Thanks, Gretchen. Please go to slide five. In the first quarter, Xylem revenues were $879 million, down 5% from our first quarter in 2012. Let me provide some perspective on our revenue 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-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.
We continued 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 $0.09 from the prior year. Core operations were down $0.08, 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 $0.01 benefit to EPS, and foreign exchange was unfavorable by $0.02. During the first quarter, we recorded a tax benefit of approximately $1 million related to a foreign tax refund. However, according to the terms of the Tax Matters Agreement, we're required to make payment of the refunded amount to ITT and therefore recorded an offsetting non-operating expense. Backing this out, our adjusted operating tax rate would have been approximately 22%, in line with our expectations. 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 million, 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 Superstorm 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 one quarter's 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 first quarter of 2012. 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 340 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 basis points. 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. 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 and the anticipated 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 million, reflecting the deployment of $78 million into acquisitions and $15 million 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 unutilized. Please turn to slide 10. We are affirming the guidance we provided at our 2013 Investor and Analyst Day. In the interest of time, here are the highlights.
We anticipate 2013 revenues of approximately $3.9 billion, which reflects total growth of 3%-4%, consisting of flat to 1% organic growth and 2 points of growth from acquisitions. We've prepared a revenue outlook summary on the next slide, providing insight to our planning assumptions. 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%-14.2%, and company operating margins are projected to be in the range of 12.2%-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-$1.89.
This range excludes one-time restructuring and realignment costs of approximately $60 million-$70 million pre-tax, but includes approximately $5 million of additional one-time separation costs and $5 million in higher pension costs. Free cash flow conversion is forecasted to be approximately 95%. 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. 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 2012 levels. We continue to expect stability in required operations and maintenance activities, as this spend is largely non-discretionary 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 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 Architecture Billings 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 and 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 are largely driven by replacement sales associated with our large installed base. We see potential for favorable performance in the U.S. market and have assumed that the European market stabilize. Agriculture remains a small market for us, and revenues are likely to be flat. Despite a strong start in the U.S. and Latin America 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, suggests 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.
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 margin. We expect a $0.01 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 integration 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 $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. Our European realignment led $0.03 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 13, and I'll turn it back over to Gretchen to wrap up.
We continue to make progress on our growth strategy through the acquisition of PIMS and Multitrode. 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?
At this time, I would like to remind everyone, if you'd like to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of Ryan Connors of Janney Montgomery Scott.
Great, thank you. I had a question relates to, you mentioned Sandy a couple of times in the prepared remarks. I wonder if there's 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.
In the first quarter, we saw revenue of Sandy at $3.5 million. 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.
Okay. 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 that pullback, in your opinion, and based on what you're seeing in the business? Thank you.
Sure. Good question. Mining really is impacting our dewatering business. Let me give you a little flavor of what we're seeing since April. 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. In mining, globally, there's still opportunity for us from a dewatering perspective. As I look at our dewatering business, which is the most impacted, it is in line with our expectations going forward.
Great. Thank you.
Your next question comes from the line of Mike Halloran of Robert W. Baird.
Morning, everyone.
Morning.
Morning.
Just to tack onto 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 have you seen any inflection points one way or another yet?
Sure. Let me give you some flavor on that. 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 2012 first quarter. What we did see is January, February, a little low. We had a pretty good March. 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 looks nice coming into the second quarter, which is obviously a good sign for us. 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. The areas that we're watching, as I mentioned, is Europe, some of the project delays, and any other uncertainty in terms of the market. Right now, more positive indicators.
Yeah, Mike, I guess the only thing I would add is relative to when we talked to everybody on 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. That was probably the one area that came out of the expectations that we had articulated at that point in time.
That makes sense. 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 basis to 2Q 2012, or the move from 1Q to 2Q would be comparable in 2012 versus 2013?
Yeah, the move. I think if you look at 2012 from Q1 to Q2, we saw about a 280, 290 basis point movement in margins. We see a very similar line of sight in the second quarter of 2013.
Great. Appreciate the time.
Thank you.
You bet.
Our next question comes from the line of Deane Dray of Citi Research.
Hey, what I'd like to get some more color on is the municipal market. You've said now that 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. Within the part that they are able to spend, which is OpEx, some of it's break and fix. There's no discretion. They have to fix those. 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 could 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, there's some discretion on push-outs.
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 would 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.
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 expenditure. As Mike said in his remarks, our capital expenditure, we're not assuming that's going to change substantially. The bidding activity, as we've continued to talk about, is still strong. Our funnel is strong, we're not seeing any signs of any kind of sustainable release of those orders at that point in time.
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 out in the first quarter.
I just add one more piece, which is tariffs continue to grow across the board. In the U.S., they're up around 6%. 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.
That's helpful. I didn't hear you use the term sequester. Is there any pressures from the sequester side that's affecting any expectations?
I would say mostly in our analytics business, our YSI business, where a lot of instrumentation goes through universities, colleges, and so forth. Right now, we still feel confident in our direction and the orders that we're getting in. That is an area that we are watching, and we'll keep a close eye on going forward.
Great. Just one follow-up. The comment on PIMS, the point of saying you're in Scotland and Northern Ireland. Was PIMS already in those regions? Maybe just some color there, and how do you scale up a business that does involve a lot of headcounts? What is the planned rollout there?
Great question. Let me just talk a little bit. If you looked at PIMS specifically, they were mostly in the U.K., and they played predominantly in the industrial side, which complemented us very well because we play in the public utility side. 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 them more robustly. In terms of scaling this out, let me tell you how we're working through that. PIMS 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, will actually allow us to run more quickly.
Great. Thank you.
The next question comes from the line of Kevin Maczka of BB&T Capital Markets.
Thanks. Good morning.
Morning.
Morning.
Can you touch on price cost briefly? It seems like in both segments, you had some price benefit, 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. Can you just talk about that bucket a little more, the material labor and overhead?
Yeah, let me just take the price question, then I'll let Mike walk through some of the details. 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 sure that we maintain the share in the markets that are important to us. 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.
Yeah, if you think about inflation, 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. You ought to be expecting around 2.5% from a full year. That'll become a bit of a tailwind, and 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.
Okay. Mike, second one from me. You mentioned pushouts a couple of times, some 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?
I guess there's a couple 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. 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. We've got about, as Gretchen mentioned, just over $400 million worth of backlog in the pipeline as we head into Q2. 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, et cetera.
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 a increasing basis. Versus last year, things were on a pretty steady decline through the year. 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 frack pad will obviously potentially benefit from that. 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. Overall, you've got the compares.
Our growth rates last year were on a sequential declining basis, and by the time we got to the fourth quarter, we had essentially a negative 3, I think -3.4% organic growth. There's some of that that from a compare standpoint helps from a growth perspective.
I would just add a couple 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, 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.
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'll obviously become a tailwind for us as we go through the year. We made great progress from a restructuring standpoint. We recorded about $5 million worth of cost in the first quarter, but I think it's important to understand that we essentially initiated about 70% of our actions. We're going to have a substantial benefit in the back half of the year, well over $10 million-$11 million worth of benefit coming from the actions initiated in 2013. We're already seeing the benefits from 2012 play out.
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.
Very helpful. Thank you.
Yep.
Your next question comes from the line of David Rose of Wedbush Securities.
Good morning. If I may follow up on the inflation question briefly, and then I have one other one. On the inflation question, 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? 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.
Yeah. Labor definitely plays into it. As a factor relative to the total inflation number that we provide, labor contributes about a point to that. 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. 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. 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. 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.
Okay. That's helpful. On your treatment business, I'm trying to reconcile some of the commentary around project delays and then regulation. Maybe you can give us a little bit more 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.
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. The funnel is getting stronger in the Middle East. It's getting stronger in Asia Pacific. Even in the developed regions, Europe and in the U.S., while there is bidding activity, given the funding is just not there in the public utilities, it's not being released. Let me give you two dynamics. In first quarter of 2012, we had a substantial amount of large orders. In this quarter, we saw a little less. 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 orders are filled, and so it's continuation going forward.
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 you have in terms of the year-over-year compares as well.
Okay. It's going to be lumpy throughout the remainder of the year, but you feel comfortable because you have projects in hand.
I'd say it's going to 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. We'll be watching our treatment business as we go forward.
Okay, great. Thank you.
Your next question comes from the line of Matt Summerville of KeyBanc.
Hi, good morning. This is Joe Radigan on for Matt. Had a follow-up on the seasonality question. As we model the balance of the year, you're going to see stronger seasonal trends in the second quarter, what do you expect the linearity to look like through the back half? You're getting the benefits from the cost takeout in the back half of the year. Do you expect the fourth quarter to be the high water mark in terms of operating income and EPS? How do you expect that to fall throughout the course of the year?
Yeah. 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. I'd expect Q3 to be relatively consistent with the second quarter. 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. Those dynamics will play out and support a higher margin level in the fourth quarter.
Okay. On the MRO side, did you recapture any of the push-out you saw in the fourth quarter, or was it just a return to sort of the normal buying patterns there? On the de-stocking that you talked about last quarter and again this quarter, has that abated now, or do you anticipate that further headwind going forward?
I think on the maintenance side, the public utilities, we definitely saw that play back out. In the U.S., we were essentially up about 6%. We've seen that come back in line. I think as it relates to the de-stocking, the most recent activity we've seen is more around the dewatering. Again, it's relative to the first quarter of last year when we still saw strength from a mining standpoint. Most of the de-stocking 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. They're really looking for us to be able to react to that. 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. Aside from the dewatering, we didn't see a big change.
Great. Thanks, Mike.
You bet.
Our next question comes from the line of Chip Moore of Canaccord.
Morning.
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 is driven by some of the newer products and services, and then how that could set you up for next year?
Yeah. 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. Our growth margins, our pricing situation around those new projects, I feel very confident about. That is helping. As I highlighted, a couple of our new products that we are launching are seeing double-digit type of advancement. 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%. 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.
Great. One more. We've talked about dewatering quite a bit, but maybe you could touch on some of the asset utilization trends just by geography, whether you had to make any significant adjustments there. Thanks.
Yeah. We manage this business very different than we do the rest of the portfolio. Really starting back in first half of 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. 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. 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.
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. It's a pretty complicated and detailed analysis. I'd say overall, we've seen a pullback in the U.S. in terms of where our investment is, but we're still moving geographically where we're seeing the growth.
I just add to this, is our whole dewatering model. We bought a leading number 1 position in the U.S. with Godwin, and our goal here was ultimately to be able internationally to expand ourselves. 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 into India, so we are expanding nicely in terms of our opportunity and reach. I feel very confident about our growth opportunity for dewatering going forward internationally.
Thank you.
Your next question comes from the line of Brent Thielman of D.A. Davidson.
Hi, good morning.
Good morning.
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?
Can you say your question again because you came in very low?
Sorry about that. Just on building services side of Applied Water. Obviously, some 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 of 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?
Sure. When I look at building service, couple things. As I mentioned earlier in April, we saw our loading program around the building services come in very nicely. 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 our 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 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. recover in the second part of the year. I feel pretty good about the direction of the new products the teams are launching.
Okay. Just on the Water Infrastructure segment, you mentioned difficult comps for the emerging market regions. When do those start to ease? 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?
When we came out of first quarter, our book-to-bill in our Water Infrastructure is about 1.09, consistent with what we said Xylem. Our book-to-bill is in line with where we are and in line with what we saw historically. I feel good about that. When I look at the Water Infrastructure 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. Flygt Experior 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. 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.
Okay. Thank you.
Once again, if you'd like to ask a question, please press star one. Your next question comes from the line of Jim Kratochvil of Morningstar.
Thank you. Good morning, everyone.
Morning.
Morning.
What was the growth rate of total aftermarket revenue the past couple of quarters? Where do you see that growth for the rest of the year? How much does that presumed revenue mix shift towards aftermarket contribute to your expected margin performance in 2013?
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, and that drives the use of a lot of your products and services there. Applied Water, up 1%. 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. We believe we'll see a positive growth in the aftermarket by the end of the year.
Yeah, I guess the one thing I'd add, Jim, is with the project business being down, one of the things that goes along with project business is initial provisioning of spare parts. That obviously is a knock-on effect that we're seeing playing out, as well as we see headwind from a project business.
Okay, thank you. That's all I had.
Okay.
Thank you.
Your next question comes from the line of Stuart Scharf of S&P IQ.
Good morning. Thank you.
Morning.
Morning, Stuart.
Could you talk a little about the M&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?
Yeah, great question. Clearly M&A and inorganic growth is a key strategy for us as we go forward. I feel very good about our pipeline probably it's as robust as I think we've ever had it. If you look at our track record, the last several quarters we've been able to announce a new acquisition, 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. Those are the key areas. We haven't moved off of that. They're a substantial fragmented market that we work within, and we feel good. The multiples continue to stay stable.
We're in the game, and we hope to continue to play hard.
Okay. Regarding Venezuela, what is your position there? Have you changed your thinking about that area with the currency devaluation and geopolitical situation?
Yeah, very small presence, limited currency exposure. Most of the currency is utilized within country, so it's really a non-issue for us.
Okay, thank you very much.
Thank you.
Yeah.
Our next question comes from the line of Brian Konigsberg of Vertical Research.
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 gonna be down low single digits. We talked about the sequential improvement of margins similar to what we saw last year between Q1 and Q2, around 270 basis points. Just plugging it in and assuming stable corporate costs and interest expense and everything else, I see the contribution relative to the midpoint of your full-year guidance closer to 20%, not 25%. You were saying that Q3 is probably gonna be a similar level to Q2, and then you'll see a bump in Q4, which actually would require a fairly substantial increase. I know you're getting more restructuring and other items, but it just seems unusually large.
Maybe I kind of misunderstood the comments, can you just walk through that a little bit more, just to make sure we're all clear on what you're saying?
Yeah. Let me maybe back up a step. When you look at the sequential growth we'll have from the first to the second quarter, you do the math, it's over $100 million 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, you have stable revenue between the third and fourth quarter, you get a pretty sizable pickup in the fourth quarter. It does have high drop rates when you do the top-level math.
We would expect to see that in terms of the different markets that we're seeing, you've also got the benefits from the restructuring actions that are gonna hit heavy in the second half of the year. 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%-40% given the volume lift that we're getting, you tack on restructuring on top of that'll get you there.
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.
No, there's definitely some impact there. We talked when we issued our guidance 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, 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.
Okay. Just lastly, on kind of the fracking comments that you were making, you expect that to start to improve. 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 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 just market trends improving in that?
There's certainly some of that at play, but you have to also remember, most of that business is service-related. They may have equipment sitting there, but they need personnel there to run it. When you think about the activities that we have from a frack 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.
Right. It's rental. 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.
Okay, that makes sense. Great. Thank you very much.
Thank you.
Yeah.
Thank you. That does conclude the Q&A portion of today's call. I will now turn the floor to Gretchen McClain for closing remarks.
Yeah, 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. We've got great activities going on in terms of advancing the business around growth. 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.
Thank you for participating in the Xylem First Quarter 2013 Earnings Conference Call. You may now disconnect.