Xylem Inc. 2020 Q3 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. The filing covers the unaudited three and nine months ended September 30, 2020. Results were materially affected by the COVID-19 pandemic, including lower demand, project delays, supply-chain disruption, and reduced operating capacity.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $1,220 million | $1,296 million | $3,503 million | $3,878 million |
| Gross profit | $461 million | $509 million | $1,304 million | $1,509 million |
| Gross margin | 37.8% | 39.3% | 37.2% | 38.9% |
| Operating income | $73 million | $11 million | $188 million | $291 million |
| Operating margin | 6.0% | 0.8% | 5.4% | 7.5% |
| Net income | $37 million | $65 million | $106 million | $283 million |
| Diluted EPS | $0.20 | $0.36 | $0.58 | $1.56 |
| Adjusted EPS | $0.62 | $0.82 | $1.25 | $2.13 |
- Q3 revenue decreased 5.9%; constant-currency revenue decreased 6.6%, entirely from organic declines. Nine-month revenue decreased 9.7%, or 8.8% on a constant-currency basis.
- Q3 adjusted operating income was $158 million, with a 13.0% adjusted margin, compared with $196 million and 15.1% in the prior-year quarter. Nine-month adjusted operating income was $336 million, with a 9.6% margin, versus $521 million and 13.4%.
- Operating cash flow was $454 million for the nine months, compared with $451 million in 2019. Free cash flow was $318 million, up from $276 million.
- Capital expenditures were $136 million, down from $175 million. Dividends paid were $142 million and share repurchases were $61 million.
- At September 30, 2020, cash and cash equivalents were $1.402 billion, short-term investments were $200 million, and total debt was $3.093 billion, including $3.053 billion of long-term debt.
- Available liquidity was approximately $2.4 billion, consisting of cash, short-term investments, and approximately $800 million of available credit facilities. The revolving credit facility was undrawn.
Material changes versus the prior comparable period
- All segments experienced lower Q3 revenue: Water Infrastructure declined 1.3% to $524 million, Applied Water declined 3.2% to $364 million, and Measurement & Control Solutions declined 14.7% to $332 million.
- Measurement & Control Solutions reported a Q3 operating loss of $62 million and a nine-month operating loss of $120 million. Its nine-month adjusted operating income declined to a $3 million loss from $101 million.
- Gross margin declined 150 basis points in Q3 and 170 basis points for the nine months, driven by cost inflation, unfavorable volume and mix, COVID-19 effects, and higher inventory-management costs.
- Reported Q3 operating income improved because the prior-year period included substantially higher special charges and restructuring costs. Underlying adjusted profitability declined.
- Xylem recorded a $58 million goodwill impairment charge and an $11 million intangible-asset impairment charge in Q3, both related primarily to the Advanced Infrastructure Analytics reporting unit within Measurement & Control Solutions.
- The company issued $1 billion of Green Bonds in June 2020, consisting of $500 million due 2028 and $500 million due 2031. Total debt increased from $2.316 billion at December 31, 2019.
- Backlog was $2.192 billion at September 30, 2020, up 21.7% from December 31, 2019; approximately 32% was expected to convert to revenue during the remainder of 2020.
Guidance, outlook, commentary, risks, and unusual items
- Management withdrew full-year 2020 guidance on March 31, 2020 because of COVID-19 uncertainty. It expected Q4 revenue to decline 5% to 7%, or 6% to 8% organically.
- Management expected COVID-19 to continue adversely affecting results beyond September 30, 2020. Operating capacity was just over 90% globally at the end of Q3, with all production facilities operational.
- Management expected full-year 2020 restructuring and realignment costs of $75 million to $85 million, including approximately $25 million of non-cash charges, and approximately $67 million of net savings. The MD&A separately described expected restructuring costs of $55 million to $60 million; investors should reconcile these disclosures.
- The 2020 restructuring plan includes headcount reductions, operational simplification, and asset impairments; actions are expected to continue through 2021. Approximately 262 planned reductions remained at September 30, 2020.
- Liquidity remained strong, and management stated that it expected to meet funding needs and comply with debt covenants. The credit facility covenant was amended through September 30, 2021 to use net leverage, and stock repurchases were restricted through March 31, 2021 subject to exceptions.
- Key risks include the duration and severity of COVID-19, demand and project delays, order cancellations, supply-chain disruption, foreign-exchange exposure, cybersecurity, goodwill and intangible-asset impairment, restructuring execution, refinancing and liquidity access, tax litigation, environmental matters, warranty claims, and the transition away from LIBOR.
- A Swedish tax assessment related to a 2013 intercompany intellectual-property transfer asserted approximately $80 million of tax, penalties, and interest. Management believes it is more likely than not to prevail and has not recorded unrecognized tax benefits for this matter.
- Warranty accruals increased to $62 million from $46 million at September 30, 2019. The Measurement & Control Solutions segment also recorded a $15 million warranty charge during the first quarter related to a firmware issue in certain meters.
Most important facts for investors to verify
- Whether COVID-19-related demand weakness, project delays, and the Q4 revenue decline range were consistent with subsequent results.
- Whether the AIA reporting unit required additional goodwill or intangible-asset impairments after the $69 million of Q3 charges.
- Progress, costs, timing, and realized savings from the global restructuring program.
- Compliance with debt covenants, refinancing of the $600 million debt maturity due in October 2021, and the effect of the Green Bond issuance on interest expense and leverage.
- Conversion of the $2.192 billion backlog into revenue and the level of cancellations or rescheduling.
- Resolution of the Swedish tax assessment and changes in other legal, environmental, warranty, and contingent liabilities.