Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving water infrastructure, applied water, and measurement and control markets. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Financial Performance and Key Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Revenue | $1,345 million | $1,317 million | $2,582 million | $2,534 million |
| Gross profit | $526 million | $519 million | $1,000 million | $979 million |
| Gross margin | 39.1% | 39.4% | 38.7% | 38.6% |
| Operating income | $171 million | $171 million | $280 million | $284 million |
| Operating margin | 12.7% | 13.0% | 10.8% | 11.2% |
| Net income | $139 million | $115 million | $218 million | $194 million |
| Diluted EPS | $0.77 | $0.64 | $1.20 | $1.07 |
| Operating cash flow | Not separately provided | Not separately provided | $206 million | $201 million |
| Free cash flow | Not separately provided | Not separately provided | $77 million | $90 million |
Q2 adjusted operating income was $192 million, with an adjusted operating margin of 14.3%, versus $182 million and 13.8% in the prior-year quarter. Q2 adjusted net income was $143 million and adjusted diluted EPS was $0.79, compared with $131 million and $0.73, respectively, in 2018.
- Q2 organic revenue increased 5.2% and constant-currency revenue increased 4.6%; reported revenue growth was reduced by foreign exchange and divestitures.
- Q2 orders were $1,392 million, up 1.0% reported and 3.9% organically. Backlog was $1,865 million at June 30, 2019, up 9.3% from June 30, 2018.
- Segment Q2 revenue was $561 million for Water Infrastructure, $394 million for Applied Water, and $390 million for Measurement & Control Solutions.
- Q2 segment operating income was $98 million, $62 million, and $26 million, respectively.
- Cash and cash equivalents were $383 million at June 30, 2019, compared with $296 million at December 31, 2018.
- Total debt was $2,453 million, including $402 million of short-term borrowings and current maturities and $2,051 million of long-term debt.
- The company had $259 million outstanding under its Euro commercial paper program, while its $800 million revolving credit facility was undrawn.
Material Changes Versus the Prior Comparable Period
- Q2 revenue increased 2.1%, while six-month revenue increased 1.9%. Organic growth was broad-based, led by the United States and Asia Pacific, particularly China and India.
- Q2 operating income was unchanged despite higher revenue; operating margin declined 30 basis points because of inflation, unfavorable mix, strategic investment spending, and higher restructuring and realignment costs.
- Six-month operating income declined 1.4% and operating margin declined 40 basis points, primarily due to higher restructuring costs, inflation, unfavorable mix, lower overhead absorption, and strategic investments.
- Net income and diluted EPS increased materially, helped by lower interest expense and a lower effective tax rate. The Q2 tax rate fell to 10.5% from 23.2%; the six-month rate fell to 12.8% from 20.8%, primarily due to Swiss tax-law changes and the prior-year settlement of tax examinations.
- Measurement & Control Solutions was the principal segment weakness: Q2 operating income declined 16.1% and six-month operating income declined 34.4%. Adjusted six-month operating income declined 20.5%.
- Operating cash flow increased modestly, but free cash flow declined to $77 million from $90 million because capital expenditures increased to $129 million from $111 million.
- Investing cash outflows declined substantially to $146 million from $537 million, primarily because the prior-year period included approximately $430 million of acquisition spending, principally for Pure Technologies.
Guidance, Outlook, Risks, and Unusual Items
Management expects 2019 total revenue growth of 2% to 3% and organic revenue growth of 5% to 6%. Utilities are expected to grow in the mid- to high-single digits, industrial markets in the low-single digits, commercial markets in the mid-single digits, and residential markets at flat to low-single-digit rates.
Management expects $60 million to $70 million of 2019 restructuring and realignment costs and approximately $15 million of total net savings during 2019. The filing separately states that full-year restructuring costs are expected to be $35 million to $45 million; investors should reconcile the differing definitions and amounts. More than 50% of June 30 backlog is expected to convert to revenue during the remainder of 2019.
- The company recognized $14 million of restructuring and asset impairment charges in Q2 and $25 million for the six-month period, including a $3 million asset impairment charge in the first quarter.
- Actions include headcount reductions, facility consolidation, and implementation of a Global Business Services platform. Approximately $21 million of Q2 restructuring and realignment costs were used in the adjusted operating income reconciliation.
- A Swedish subsidiary received an approximately $80 million tax assessment, including tax, penalties, and interest, related to a 2013 intercompany intellectual-property transfer. Xylem appealed in July 2019 and has not recorded unrecognized tax benefits for the assessment.
- Unrecognized tax benefits totaled $127 million, with approximately $3 million potentially reducible within the next 12 months.
- Key risks include foreign currency, tariffs and trade barriers, economic and housing conditions, order cancellations or delays, competition and pricing pressure, acquisitions, liquidity and refinancing, LIBOR transition, cybersecurity, product liability, litigation, environmental matters, and impairment of goodwill or intangible assets.
- General litigation accruals were $6 million and environmental accruals were $3 million at June 30, 2019. Standby letters of credit, bank guarantees, and surety bonds totaled $305 million.
- The company adopted the new lease standard in 2019, recognizing approximately $267 million of right-of-use assets and $265 million of lease liabilities at adoption. June 30 lease liabilities totaled $256 million.
Most Important Facts for Investors to Verify
- Reconcile reported restructuring and realignment guidance of $60 million to $70 million with the separately stated $35 million to $45 million restructuring-cost estimate.
- Assess whether the ongoing weakness in Measurement & Control Solutions is temporary or reflects sustained margin pressure, including the impact of strategic investment and purchase accounting.
- Monitor conversion of the $1.865 billion backlog and the company’s expectation that more than half will be recognized in the second half of 2019.
- Evaluate the potential financial and tax impact of the approximately $80 million Swedish tax assessment and the company’s appeal.
- Track liquidity, commercial paper usage, the $143 million term loan due to mature in February 2020, and total debt relative to EBITDA covenant requirements.
- Confirm the sustainability of earnings growth given the lower tax rate, lower interest expense, higher restructuring costs, and declining free cash flow.