Xylem Inc. 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving utility, industrial, residential and commercial markets across the water cycle. Its three reportable segments are Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $1,296 million | $1,287 million | $3,878 million | $3,821 million |
| Gross profit | $509 million | $505 million | $1,509 million | $1,484 million |
| Gross margin | 39.3% | 39.2% | 38.9% | 38.8% |
| Operating income | $11 million | $176 million | $291 million | $460 million |
| Operating margin | 0.8% | 13.7% | 7.5% | 12.0% |
| Net income | $65 million | $130 million | $283 million | $324 million |
| Diluted EPS | $0.36 | $0.72 | $1.56 | $1.79 |
| Operating cash flow | Not separately reported | Not separately reported | $451 million | $388 million |
| Free cash flow | Not separately reported | Not separately reported | $276 million | $217 million |
- Q3 revenue increased 0.7%; constant-currency revenue increased 2.6%, including 2.9% organic growth. Nine-month revenue increased 1.5%; constant-currency revenue increased 4.3%, including 4.8% organic growth.
- Adjusted Q3 operating income was $196 million, with a 15.1% adjusted operating margin, versus $188 million and 14.6% in the prior-year quarter. Adjusted nine-month operating income was $521 million, with a 13.4% margin, versus $505 million and 13.2%.
- Q3 orders were $1,346 million, down 0.7% reported but up 1.3% organically. Backlog was $1,868 million at September 30, 2019, up 7.2% year over year; approximately 40% was expected to convert to revenue during the remainder of 2019.
- Cash and cash equivalents were $453 million versus $296 million at December 31, 2018. Total debt was $2.336 billion, including $306 million of commercial paper; net debt was approximately $1.883 billion.
- The $800 million five-year revolving credit facility was undrawn, and the company reported compliance with its debt covenants. Approximately $298 million of cash or marketable securities was held by foreign subsidiaries.
Material Changes Versus the Prior Comparable Period
- Operating income declined sharply because of $148 million of goodwill impairment related to the Advanced Infrastructure Analytics reporting unit, $7 million of additional long-lived asset impairment, and higher restructuring and realignment costs.
- Total Q3 restructuring and asset impairment charges were $33 million versus $4 million in Q3 2018; nine-month charges were $58 million versus $19 million. Restructuring actions primarily involve headcount reductions and facility consolidation in North American and European operations.
- Measurement & Control Solutions revenue increased 5.7% in Q3, but reported operating income fell to a $136 million loss from $31 million of income because of impairment and restructuring charges. Its adjusted operating income increased to $39 million from $35 million.
- Water Infrastructure Q3 revenue declined 1.8% on a reported basis, while Applied Water revenue declined 0.5%; both segments grew on a constant-currency basis. Water Infrastructure and Applied Water reported Q3 operating margins of 18.3% and 16.2%, respectively.
- Net income declined 50% in Q3 and 12.7% for the nine-month period. The reported tax benefit of $77 million in Q3 and $45 million for nine months reflected tax-law changes in Switzerland and the effect of the goodwill impairment on pretax income.
- The company adopted the new lease standard on January 1, 2019, recognizing $267 million of right-of-use assets and $265 million of lease liabilities. The adoption did not materially affect income statements or cash flows.
Guidance, Outlook, Risks and Unusual Items
- Management expected approximately 1% total revenue growth for 2019 and organic revenue growth of 3% to 4%. Expected organic growth was mid-single-digit for utilities, flat to low-single-digit for industrial markets, low to mid-single-digit for commercial markets, and flat to low-single-digit for residential markets.
- Management expected $50 million to $60 million of restructuring costs for the full year and approximately $15 million of 2019 net savings from restructuring and realignment actions. Actions initiated in 2017 were expected to continue through the fourth quarter of 2020.
- The AIA impairment reflected slower-than-expected conversion of pipeline opportunities, lower forecast results and continued investment ahead of market adoption. Remaining AIA goodwill was $170 million, and management stated that additional impairment could occur if forecasts are not achieved.
- Xylem faced an approximately $80 million Swedish tax assessment, including tax, penalties and interest, related to a 2013 intercompany intellectual-property transfer. The company appealed and believes it is more likely than not to prevail; no related unrecognized tax benefit was recorded.
- Other risks include foreign-exchange exposure, tariffs and trade barriers, economic and market conditions, order cancellations or delays, competition and pricing pressure, acquisitions and integration, liquidity and refinancing, LIBOR transition, cybersecurity, product liability, litigation, environmental matters and impairment of goodwill or intangible assets.
- Stand-by letters of credit, bank guarantees and surety bonds totaled $302 million at September 30, 2019. General litigation and environmental accruals were $6 million and $3 million, respectively. The company stated that no asserted or unasserted legal matters were reasonably expected to have a material adverse effect.
Important Facts for Investors to Verify
- Whether AIA achieves revised revenue and profitability forecasts and whether further goodwill or long-lived-asset impairment is required.
- Conversion of the $1.868 billion backlog, including the timing and cancellation risk of long-term customer contracts.
- Progress and realized savings from restructuring actions, compared with the $50 million to $60 million cost expectation and approximately $15 million net savings target.
- Cash generation, working-capital trends, commercial-paper refinancing needs and compliance with the consolidated debt-to-EBITDA covenant.
- Resolution and potential cash exposure from the approximately $80 million Swedish tax assessment and other tax uncertainties, including $126 million of unrecognized tax benefits.
- Measurement & Control Solutions’ underlying operating performance excluding impairment charges, particularly AIA pipeline conversion and order trends.