Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through its Water Infrastructure and Applied Water segments. This unaudited Form 10-Q covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods.
Financial Performance and Liquidity
| Metric | Q2 2015 | Q2 2014 | Six Months 2015 | Six Months 2014 |
|---|---|---|---|---|
| Revenue | $920 million | $1,005 million | $1,757 million | $1,911 million |
| Gross profit | $348 million | $388 million | $663 million | $730 million |
| Gross margin | 37.8% | 38.6% | 37.7% | 38.2% |
| Operating income | $104 million | $116 million | $187 million | $192 million |
| Operating margin | 11.3% | 11.5% | 10.6% | 10.0% |
| Net income | $74 million | $86 million | $138 million | $135 million |
| Diluted EPS | $0.41 | $0.47 | $0.76 | $0.73 |
- Q2 revenue declined 8.5% as reported, but increased 0.4% on a constant-currency basis, including 1.0% organic growth. Six-month revenue declined 8.1% as reported and increased 0.4% on a constant-currency basis.
- Q2 orders were $944 million, down 8.4% reported and up 0.5% on a constant-currency basis. Backlog was $812 million at June 30, 2015, flat year over year and up 9.7% from December 31, 2014; management expected more than 70% to convert to revenue during the remainder of 2015.
- Q2 gross margin decreased 80 basis points, primarily because of foreign-currency translation. Management stated that gross margin excluding currency effects was consistent with the prior year.
- Six-month operating cash flow was $123 million versus $98 million in 2014. Free cash flow was $66 million versus $50 million, calculated as operating cash flow less $57 million of capital expenditures.
- Cash and cash equivalents were $600 million at June 30, 2015, compared with $663 million at year-end 2014. Total debt was $1.277 billion, including $1.196 billion of long-term debt and $77 million outstanding under the R&D Facility Agreement.
- The $600 million revolving credit facility was undrawn. Xylem reported compliance with applicable debt covenants, including a maximum 3.50-to-1.00 leverage ratio.
- Dividends declared were $0.1408 per share in Q2, versus $0.1280 in Q2 2014. The company repurchased $50 million of stock during the first six months and had approximately $20 million remaining under its primary repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Reported revenue was adversely affected by foreign-currency translation, particularly movements in the euro and other currencies, and by the 2014 divestiture of the Wolverhampton valves business.
- Water Infrastructure Q2 revenue declined 10.6% reported and was flat at constant currency; Applied Water revenue declined 5.1% reported but grew 1.0% at constant currency.
- Water Infrastructure operating income declined 14.5% in Q2, while Applied Water operating income declined 3.8%. For the first six months, Water Infrastructure operating income declined 8.2%, while Applied Water increased 3.2%.
- Operating income was pressured by cost inflation, unfavorable mix and currency effects, partially offset by restructuring, lean Six Sigma, sourcing and other cost savings.
- Restructuring charges were $1 million in Q2 and $4 million for the first six months, versus $3 million and $18 million, respectively, in 2014. Management also reported $6 million of Q2 restructuring and realignment costs under its non-GAAP presentation.
- Six-month net income increased 2.2% despite lower operating income, primarily reflecting the $9 million pretax gain from divestitures and lower restructuring costs. The gain related to two immaterial businesses sold for $1 million of cash.
- Other comprehensive income was $35 million in Q2, compared with an $8 million loss in the prior year, but the six-month OCI loss widened to $99 million from $9 million, primarily because of foreign-currency translation.
Guidance, Outlook, Risks and Unusual Items
- Management continued to expect low-single-digit organic revenue growth for 2015, offset by a high-single-digit negative foreign-exchange translation impact.
- Expected market trends included low-single-digit growth in public utilities, low- to mid-single-digit commercial growth, flat industrial and residential markets, and low-single-digit declines in agriculture.
- Management expected approximately $20 million of full-year restructuring and realignment costs, approximately $13 million of incremental net savings from 2014 actions and $3 million of additional net savings from 2015 actions. The filing separately states that full-year restructuring costs were expected to be approximately $10 million; investors should reconcile these differing scopes.
- Restructuring actions initiated in 2015 were expected to continue through the second quarter of 2016, with approximately $6 million of total expected costs and approximately $5 million of annual future net savings beginning in 2016.
- Key risks include foreign-currency volatility, economic and political conditions in international markets, industrial and oil-and-gas weakness, pricing and competition, customer order cancellations or delays, liquidity and refinancing needs, goodwill impairment, product liability, cybersecurity, litigation and governmental investigations.
- Xylem disclosed an internal investigation involving alleged antitrust and potential Foreign Corrupt Practices Act matters concerning its South Korean subsidiary. The Korean subsidiary was assessed an approximately $1.6 million fine; Xylem voluntarily contacted the SEC and DOJ and stated that potential liability could not yet be reasonably estimated.
- Legal, environmental and warranty accruals at June 30, 2015 included $6 million for general legal matters, $5 million for environmental matters and $31 million for product warranties. The company also reported $41 million of unrecognized tax benefits.
- Approximately 59% of revenue came from non-U.S. operations, and foreign subsidiaries held approximately $561 million in cash or marketable securities at June 30, 2015.
Most Important Facts to Verify
- Reconcile the reported $20 million full-year restructuring and realignment outlook with the separate $10 million restructuring-cost estimate.
- Monitor the SEC and DOJ investigation, including whether any material liability, penalties or remediation costs arise.
- Assess the effect of currency movements, especially the euro and Swedish krona, on revenue, margins, cash and accumulated other comprehensive income.
- Evaluate refinancing or repayment plans for the $600 million Senior Notes due in September 2016 and the $77 million R&D facility balance classified as short-term debt.
- Track conversion of the $812 million backlog, public-utility and commercial demand, and continuing weakness in industrial oil-and-gas and residential markets.
- Review non-GAAP organic growth, adjusted earnings and free cash flow reconciliations alongside GAAP results.