Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through two reportable segments: Water Infrastructure and Applied Water. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Financial Performance and Position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $963 million | $965 million | $2,874 million | $2,804 million |
| Gross profit | $376 million | $384 million | $1,106 million | $1,089 million |
| Gross margin | 39.0% | 39.8% | 38.5% | 38.8% |
| Operating income | $130 million | $98 million | $322 million | $234 million |
| Operating margin | 13.5% | 10.2% | 11.2% | 8.3% |
| Net income | $106 million | $73 million | $241 million | $160 million |
| Diluted EPS | $0.58 | $0.39 | $1.31 | $0.86 |
- Orders were $1,027 million in the third quarter, up 7.5%, and $3,051 million for the first nine months, up 4.3%.
- Backlog was $844 million at September 30, 2014, up 12.2% year over year and 19.4% from December 31, 2013; management expected approximately 60% to convert to revenue during the remainder of 2014.
- Operating cash flow for the first nine months was $253 million, up from $163 million. Free cash flow was $176 million versus $72 million.
- Capital expenditures were $77 million, compared with $91 million in the prior-year period.
- Cash and cash equivalents were $529 million at September 30, 2014, versus $533 million at December 31, 2013.
- Total debt was $1,240 million, including $1,199 million of long-term debt. The $600 million revolving credit facility was undrawn, and $36 million was outstanding under the European Investment Bank research and development facility.
- Foreign subsidiaries held $474 million in cash or marketable securities. Management stated that available funding sources should satisfy liquidity and capital requirements over the next twelve months.
Material Changes Versus Prior Comparable Period
- Third-quarter revenue declined 0.2%, while nine-month revenue increased 2.5%. Constant-currency revenue was flat in the quarter and up 2.5% year to date.
- Water Infrastructure revenue was flat in the quarter and increased 3.2% for the first nine months. Applied Water revenue increased 0.6% in the quarter and 1.7% year to date on a reported basis.
- Profitability improved substantially due to lean Six Sigma, global sourcing, restructuring savings, lower corporate costs, and the absence of approximately $20 million of 2013 special charges related to a legal settlement and the chief executive officer transition.
- Gross margin declined 80 basis points in the quarter and 30 basis points year to date, reflecting unfavorable geographic and product mix, pricing pressure, foreign-exchange effects, and cost inflation.
- Restructuring charges declined to less than $1 million in the quarter and $18 million year to date, compared with $5 million and $30 million, respectively, in 2013. Restructuring accruals were $11 million at September 30.
- On July 2, 2014, Xylem sold its Wolverhampton, U.K. pneumatic and hydraulic valves business for approximately $30 million and recognized an $11 million gain. The divested business had approximately $25 million of 2013 annual revenue.
- Net comprehensive income was adversely affected by a $114 million third-quarter foreign-currency translation loss, resulting in comprehensive loss of $3 million despite net income of $106 million.
- Xylem repurchased $130 million of common stock during the first nine months and paid $71 million in dividends. Up to $70 million remained available under the principal repurchase authorization at quarter-end.
Guidance, Outlook, Risks, and Unusual Items
- Management expected modest U.S. industrial recovery, continued emerging-market strength, marginal European improvement, and mixed mining conditions. Utilities were expected to be flat to slightly higher, while residential building applications were expected to be flat to slightly negative.
- For 2014, management continued to expect restructuring costs of approximately $30 million to $35 million and realignment costs of approximately $10 million to $15 million. Expected 2014 net savings were approximately $15 million to $17 million, with approximately $20 million of annual future net savings from 2014 actions beginning in 2015.
- Restructuring activity was expected to continue through 2015, including European and North American headcount reductions and facility consolidations.
- Key operating risks include foreign-exchange volatility, European weakness, cost inflation, unfavorable pricing and product mix, project timing, market conditions in industrial, residential, mining and utility end markets, and execution of restructuring initiatives.
- Legal, environmental, product warranty, asbestos, pension, tax, and indemnification matters remain contingencies. Xylem accrued $17 million for general legal matters, $6 million for environmental matters, and $32 million for product warranties at September 30, 2014. Management did not expect asserted or unasserted legal matters to have a material adverse effect, but ultimate outcomes are uncertain.
- The company was in compliance with debt covenants, including a maximum leverage ratio of 3.50, and reported no material changes to previously disclosed risk factors or market-risk information.
- Unrecognized tax benefits were $30 million at September 30, 2014; management did not expect a significant change within the following twelve months.
Most Important Facts for Investors to Verify
- Whether strong orders and backlog convert into revenue, particularly the expected 60% conversion during the remainder of 2014.
- Whether restructuring, sourcing, and lean Six Sigma savings offset gross-margin pressure from pricing, mix, inflation, and foreign exchange.
- The sustainability of improved operating margins after excluding prior-year special charges and current restructuring benefits.
- Liquidity and refinancing plans for the $600 million senior notes due in 2016, together with the status of the undrawn revolving facility.
- The effect of currency movements and the concentration of cash in foreign subsidiaries.
- Progress and remaining cash costs of restructuring and realignment actions through 2015.
- Potential changes in legal, environmental, warranty, pension, tax, and indemnification exposures.