Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving utility, industrial, residential and commercial markets through Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods.
Financial Highlights
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $1,380 million | $1,265 million | $4,016 million | $3,872 million |
| Gross profit / margin | $524 million / 38.0% | $472 million / 37.3% | $1,511 million / 37.6% | $1,482 million / 38.3% |
| Operating income / margin | $168 million / 12.2% | $152 million / 12.0% | $425 million / 10.6% | $445 million / 11.5% |
| Net income | $12 million | $114 million | $206 million | $314 million |
| Diluted EPS | $0.07 | $0.63 | $1.14 | $1.73 |
| Adjusted operating income | $187 million | $155 million | $458 million | $464 million |
| Adjusted operating margin | 13.6% | 12.3% | 11.4% | 12.0% |
| Adjusted EBITDA / margin | $252 million / 18.3% | $227 million / 17.9% | $659 million / 16.4% | $676 million / 17.5% |
- Third-quarter revenue increased 9.1%; constant-currency revenue increased 15.4%, supported by organic growth across all segments and end markets. Nine-month revenue increased 3.7%, or 8.2% on a constant-currency basis.
- Quarterly gross margin expanded 70 basis points because of price realization and productivity savings, partly offset by inflation, strategic investment spending and unfavorable mix. Nine-month gross margin declined 70 basis points.
- Operating income increased 10.5% in the quarter but declined 4.5% year to date. Nine-month results reflected inflation and higher strategic investment spending.
- Operating cash flow was $234 million for the first nine months, down from $318 million. Free cash flow was $86 million, down from $191 million, after $148 million of capital expenditures.
- Cash and equivalents were $1.186 billion at September 30, 2022, compared with $1.349 billion at December 31, 2021. Total debt was $2.363 billion, including $483 million of notes due in 2023 and classified as current.
- The $800 million revolving credit facility was undrawn. Management reported approximately $2.0 billion of available liquidity, consisting of cash and available credit facilities.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by Applied Water, up 14.5% in the quarter, Water Infrastructure, up 4.9%, and Measurement & Control Solutions, up 9.4%. Foreign-currency translation reduced quarterly revenue by approximately $80 million.
- Measurement & Control Solutions recorded a $2 million operating loss in the quarter and a $17 million operating loss for the nine months, compared with operating income of $7 million and $29 million, respectively, in 2021. The nine-month decline was driven by inflation, unfavorable volume and mix, restructuring and a $12 million asset impairment charge.
- Orders declined 6.5% in the quarter to $1.419 billion, or 1.1% on a constant-currency basis, but increased 2.2% for the first nine months to $4.818 billion. Backlog was $3.667 billion at September 30, up 23.7% from the prior-year period.
- The U.K. pension plan buyout was completed in September 2022. Xylem recorded a $140 million pension settlement expense and a related $23 million net tax benefit; the settlement did not reduce cash.
- Restructuring and realignment costs were $6 million in the quarter and $18 million year to date, compared with $2 million and $16 million, respectively, in 2021. The company also recorded $15 million of special charges year to date, primarily the pension settlement and asset impairment.
- Debt declined from $2.440 billion at year-end 2021, while the 2023 euro-denominated notes were reclassified to current maturities. Xylem intended to repay those notes in December 2022 using cash on hand.
Guidance, Outlook, Commentary and Risks
- Management updated 2022 total revenue growth guidance to approximately 4% and organic revenue growth guidance to 9% to 10%.
- Expected 2022 organic growth was mid-single-digit for utilities, low-double-digit for industrial markets, high-single to low-double-digit for commercial markets, and high-teens for residential markets.
- Management expected approximately $25 million to $30 million of 2022 restructuring and realignment costs, including $10 million to $15 million of restructuring costs.
- Management cited continued semiconductor and component shortages, inflation in materials, labor, energy, freight and logistics, tight labor markets, and supply-chain disruptions. Chip availability had modestly improved sequentially, but remained constrained.
- Other identified risks include foreign-currency volatility, the Russia-Ukraine war, COVID-19 impacts, demand and pricing pressure, cybersecurity and information-technology disruptions, product liability and warranty claims, future goodwill or intangible impairments, refinancing and liquidity risk, regulatory matters, and tax uncertainty.
- Xylem disclosed a Swedish tax assessment of approximately $70 million related to a 2013 intercompany intellectual-property transfer. The company appealed an adverse lower-court decision, believes it is more likely than not to prevail, and had not recorded an unrecognized tax benefit as of September 30, 2022.
- The company reported that its disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the 2022 revenue and organic-growth outlook was achieved and how much growth was offset by foreign-currency translation.
- The repayment and refinancing treatment of the $483 million equivalent of senior notes due in 2023.
- Cash conversion, working-capital requirements and free cash flow, particularly as inventories increased to $837 million from $700 million at year-end 2021.
- Recovery of Measurement & Control Solutions profitability and any further impairment or restructuring charges.
- Actual inflation, supply-chain and semiconductor effects on margins, backlog conversion and orders.
- The outcome and potential financial exposure of the Swedish tax litigation and other environmental, warranty, legal and guarantee obligations.