Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through its Water Infrastructure and Applied Water segments. This unaudited quarterly report covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods.
Financial Performance and Position
| Metric | Q2 2016 | Q2 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Revenue | $932 million | $920 million | $1,779 million | $1,757 million |
| Gross profit | $369 million | $348 million | $698 million | $663 million |
| Gross margin | 39.6% | 37.8% | 39.2% | 37.7% |
| Operating income | $109 million | $104 million | $188 million | $187 million |
| Operating margin | 11.7% | 11.3% | 10.6% | 10.6% |
| Net income | $71 million | $74 million | $137 million | $138 million |
| Diluted EPS | $0.39 | $0.41 | $0.76 | $0.76 |
- Q2 revenue increased 1.3%; constant-currency growth was 2.7%, comprising 1.5% organic growth and 1.2% from acquisitions. Six-month revenue increased 1.3%, or 3.5% on a constant-currency basis.
- Water Infrastructure revenue increased 2.7% in Q2 and 2.8% for the first half; Applied Water revenue declined 0.8% and 1.0%, respectively.
- Adjusted operating income was $121 million in Q2, with a 13.0% adjusted margin, versus $110 million and 12.0% in the prior-year quarter. Six-month adjusted operating income was $213 million, with a 12.0% margin, versus $200 million and 11.4%.
- Orders declined 2.2% in Q2 to $923 million and 2.6% for the first six months to $1.811 billion. Backlog was $727 million at June 30, down 10.5% year over year but up 1.5% from December 31, 2015; management expected 72% to convert to revenue during the remainder of 2016.
- Net cash provided by operating activities was $125 million for the first six months, versus $123 million in 2015. Capital expenditures were $62 million, producing reported free cash flow of $63 million versus $66 million.
- Cash and cash equivalents were $586 million at June 30, 2016, compared with $680 million at year-end 2015. Total debt was $1.234 billion, including $91 million classified as short-term and $1.143 billion long-term.
- The $600 million Senior Notes due 2016 were settled for $607 million, including a $7 million make-whole premium. Xylem issued €500 million of 2.250% Senior Notes due 2023 and had $50 million of commercial paper outstanding.
- The $600 million revolving credit facility was undrawn. Xylem reported compliance with its debt covenants and stated that available liquidity was sufficient for anticipated needs over the next twelve months.
Material Changes Versus the Prior Comparable Period
- Gross margin improved 180 basis points in Q2 and 150 basis points for the first half, primarily from sourcing, continuous-improvement initiatives and volume leverage.
- Operating income rose 4.8% in Q2 but was essentially flat for the first half because of higher restructuring costs, increased strategic investment and higher interest expense.
- Interest expense increased to $20 million in Q2 and $34 million for the first half, compared with $14 million and $28 million, respectively, primarily because of the debt refinancing and the make-whole premium.
- Restructuring charges increased to $6 million in Q2 and $12 million for the first half, compared with $1 million and $4 million in the prior-year periods. Actions included headcount reductions and facility consolidation in North America and Europe.
- Xylem acquired Tideland Signal Corporation on February 1, 2016 for $70 million. Tideland contributed approximately $11 million of Q2 revenue and $17 million of first-half revenue, according to the acquisition analysis.
- Six-month net income included no gain from business sales, compared with a $9 million gain in 2015. Foreign-currency translation produced a $40 million Q2 comprehensive loss, versus $35 million of comprehensive income in 2015.
- The company early adopted new share-based-payment accounting in Q2, recording a $2 million tax benefit in income tax expense and changing the presentation of excess tax benefits in cash flows.
Guidance, Outlook, Risks and Unusual Items
- Management continued to expect low-single-digit organic revenue growth for full-year 2016.
- Expected market performance was flat for industrial markets, high-single-digit growth for public utilities, mid-single-digit growth for commercial markets, and mid-single-digit declines for residential and agriculture markets.
- Management planned continued restructuring and realignment actions, with approximately $25 million of 2016 costs cited in the outlook section. Elsewhere in the filing, management stated that approximately $15 million of full-year restructuring costs were expected; this difference should be reconciled.
- Management estimated approximately $7 million of 2016 net savings from 2016 actions and approximately $22 million of annual future net savings beginning in 2017.
- Key risks include foreign-exchange volatility, weak oil and gas and mining demand, pricing pressure, economic and political conditions, order cancellations or delays, acquisition integration, liquidity and refinancing access, product liability, environmental matters, litigation, cybersecurity and impairment of goodwill or intangible assets.
- The filing states that there were no material changes to previously disclosed risk factors and no material adverse effect was expected from asserted or unasserted legal claims. Xylem paid a €2.4 million Spanish competition fine in March 2016, closing that matter.
- Environmental liabilities were accrued at $4 million, warranty accruals were $32 million, and stand-by letters of credit, bank guarantees and surety bonds totaled $176 million at June 30, 2016.
Important Facts for Investors to Verify
- Reconcile the conflicting full-year restructuring-cost estimates of approximately $25 million and $15 million.
- Assess whether declining orders and the 10.5% year-over-year backlog reduction could pressure revenue after 2016.
- Monitor the effect of higher interest expense and the refinancing of the 2016 Senior Notes on earnings and cash flow.
- Evaluate the sustainability of gross-margin improvement after restructuring costs, inflation and strategic investments.
- Review foreign-currency exposure, including the company’s substantial non-U.S. revenue and foreign cash holdings.
- Assess Tideland’s integration, contribution to growth and related acquisition costs.
- Track restructuring execution, expected savings and remaining employee reductions through 2017.