Xylem Inc. 2016 Form 10-K Summary
Business context and reporting period
Xylem filed an annual report for the fiscal year ended December 31, 2016. Xylem is a global water technology company with approximately 16,000 employees and operations serving customers in more than 150 countries. Its reportable segments are Water Infrastructure, Applied Water and Sensus.
The filing is annual rather than a standalone quarterly filing; fourth-quarter data is included in the unaudited quarterly information. Xylem acquired Sensus on October 31, 2016 for approximately $1.76 billion and consolidated its results beginning November 1, 2016.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $3,771 million | $3,653 million | 3.2% increase |
| Gross profit | $1,461 million | $1,404 million | 4.1% increase |
| Gross margin | 38.7% | 38.4% | Up 30 basis points |
| Operating income | $406 million | $449 million | 9.6% decrease |
| Operating margin | 10.8% | 12.3% | Down 150 basis points |
| Net income | $260 million | $340 million | 23.5% decrease |
| Diluted EPS | $1.45 | $1.87 | Decrease |
| Cash flow from operations | $497 million | $464 million | $33 million increase |
| Free cash flow | $373 million | $347 million | $26 million increase |
| Free cash flow excluding Sensus acquisition costs | $386 million | $347 million | Increase |
Adjusted net income was $364 million, or $2.03 per diluted share, compared with $336 million, or $1.85 per diluted share, in 2015. Adjusted operating income was $511 million, with a 13.6% adjusted operating margin, compared with $470 million and 12.9%, respectively, in 2015.
Revenue growth on a constant-currency basis was 5.3%, including $163 million from acquisitions and $29 million of organic growth. Unfavorable foreign currency translation reduced reported revenue by approximately $74 million, or 2.0%.
Segments and fourth-quarter results
| Segment | 2016 revenue | 2016 operating income |
|---|---|---|
| Water Infrastructure | $2,246 million | $308 million |
| Applied Water | $1,393 million | $188 million |
| Sensus | $132 million | $(17) million |
Sensus contributed $132 million of revenue during its final two months of 2016 and had a $17 million reported operating loss, including acquisition-related and restructuring costs. Excluding those costs, Sensus generated $9 million of adjusted operating income.
Fourth-quarter revenue was $1,095 million, compared with $994 million in the fourth quarter of 2015. Fourth-quarter operating income was $109 million, compared with $142 million, and net income was $50 million, compared with $114 million. Fourth-quarter diluted EPS was $0.28, compared with $0.63.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $308 million at December 31, 2016, compared with $680 million at December 31, 2015.
- Total debt increased to $2.368 billion from $1.274 billion, primarily to finance the Sensus acquisition and related refinancing.
- Long-term debt was $2.108 billion; short-term borrowings and current maturities were $260 million.
- Debt included $600 million of 4.875% senior notes due 2021, approximately $522 million of 2.250% senior notes due 2023, $500 million of 3.250% senior notes due 2026, $400 million of 4.375% senior notes due 2046, $65 million of commercial paper, and other borrowings.
- The $600 million revolving credit facility was undrawn at year-end, and the company stated that it was in compliance with applicable debt covenants.
- Capital expenditures were $124 million. Dividends paid were $112 million, and dividends declared per share increased to $0.6196 from $0.5632.
- No shares were repurchased under the principal $500 million repurchase authorization during 2016; approximately $420 million remained available at year-end.
Operating cash flow increased despite the Sensus acquisition. Investing activities used $1.886 billion, including $1.782 billion for acquisitions. Financing activities provided $1.034 billion, primarily through debt issuance and other acquisition financing.
Material changes versus the prior comparable period
- Reported revenue increased 3.2%, but operating income declined 9.6% and net income declined 23.5%.
- Reported profitability was affected by $53 million of Sensus acquisition-related charges, $47 million of restructuring and realignment costs, $5 million of special charges, higher interest expense, and a higher effective tax rate.
- The effective tax rate increased to 23.5% from 15.6%, driven principally by valuation allowance changes and the repatriation of foreign earnings, partly offset by a favorable tax settlement.
- Adjusted operating margin improved 70 basis points to 13.6%, reflecting productivity and cost-reduction initiatives that offset inflation, strategic investment spending and unfavorable mix.
- Backlog increased to $1.078 billion from $716 million, primarily because Sensus contributed $385 million. More than 70% of year-end backlog was expected to convert to revenue in 2017.
- Goodwill increased to $2.632 billion from $1.584 billion and net intangible assets increased to $1.201 billion from $435 million, largely reflecting the Sensus acquisition.
Guidance, outlook, risks and unusual items
Management expected 2017 revenue growth of 20% to 22%, consisting of low-single-digit organic growth plus the additional contribution from Sensus. Management expected approximately $24 million of incremental net savings in 2017 from restructuring actions and approximately $30 million of Sensus integration, restructuring and realignment costs during 2017.
Management expected 2017 growth in public utilities and modest growth in commercial, residential and industrial markets, while noting continued weakness in oil and gas, mixed emerging-market conditions and uncertain construction activity in portions of Europe.
- Principal risks include international operations, foreign currency fluctuations, economic and market conditions, pricing pressure, raw-material and supplier costs, cybersecurity and information technology disruptions, product liability, regulatory compliance, litigation and environmental matters.
- Integration of Sensus is a significant execution risk, including realizing expected synergies, retaining personnel, integrating systems and managing acquisition-related liabilities.
- Goodwill and indefinite-lived intangible assets totaled approximately $3 billion and are subject to future impairment risk. No impairment was identified in the 2016 annual assessment.
- Environmental liabilities accrued at year-end were $4 million. General legal matter accruals were $11 million, and product warranty liabilities were $99 million, including $66 million acquired with Sensus.
- Contractual commitments totaled $3.632 billion, including $2.393 billion of debt and capital lease obligations and $920 million of estimated interest payments.
- Standby letters of credit, bank guarantees and surety bonds totaled $218 million. The company also reported a $356 million funded-status deficit for pension and other postretirement plans.
- Foreign subsidiaries held $242 million of cash or marketable securities, while approximately $1.9 billion of foreign subsidiary basis differences was treated as indefinitely reinvested for tax purposes.
Most important facts for investors to verify
- Whether Sensus integration delivers the projected revenue growth, cost savings and margin contribution.
- The sustainability of the improvement in adjusted margins and free cash flow after acquisition and restructuring costs normalize.
- Debt reduction and refinancing capacity, including the October 2017 maturity of the $157 million term loan and compliance with leverage covenants.
- The effect of foreign exchange, interest rates, tax valuation allowances and foreign earnings repatriation on future earnings and cash flow.
- Conversion timing and quality of the $1.078 billion backlog, including the portion attributable to Sensus.
- Potential exposure from environmental, legal, product warranty, pension, cybersecurity and intellectual property contingencies.
- The filing states that management and Deloitte & Touche concluded internal control over financial reporting was effective, but Sensus was excluded from the 2016 assessment because it had been acquired late in the year.