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 its Water Infrastructure, Applied Water, and Measurement & Control Solutions segments. This unaudited filing covers the three months ended March 31, 2020, with comparison to the first quarter of 2019.
Financial Performance and Position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $1,123 million | $1,237 million | Down 9.2% |
| Gross profit / margin | $409 million / 36.4% | $474 million / 38.3% | Margin down 190 bps |
| Operating income / margin | $61 million / 5.4% | $109 million / 8.8% | Down 44.0%; margin down 340 bps |
| Adjusted operating income / margin | $70 million / 6.2% | $133 million / 10.8% | Margin down 460 bps |
| Net income | $38 million | $79 million | Down 51.9% |
| Diluted EPS | $0.21 | $0.43 | Down 51.2% |
| Operating cash flow | $(2) million | $83 million | Down $85 million |
| Free cash flow | $(53) million | $14 million | Down $67 million |
- Segment revenue was $438 million for Water Infrastructure, $338 million for Applied Water, and $347 million for Measurement & Control Solutions.
- All segments experienced organic revenue declines. On a constant-currency basis, revenue declined 7.7%, entirely from a $95 million organic decrease; foreign currency translation reduced revenue by an additional $19 million.
- Measurement & Control Solutions reported a $12 million operating loss versus $16 million of operating income in the prior-year quarter. Results included a $15 million warranty charge related to a firmware issue in certain meters.
- Cash and cash equivalents were $739 million at March 31, 2020, compared with $724 million at December 31, 2019. Inventory increased to $573 million from $539 million.
- Total debt was $2.490 billion, including $459 million of short-term borrowings and current maturities. Long-term debt was $2.031 billion. The $800 million revolving credit facility was undrawn, and the company reported approximately $1.7 billion of available liquidity, including cash and available credit facilities.
- Backlog was $1.887 billion, up 4.8% from December 31, 2019; approximately 56% was expected to convert to revenue during the remainder of 2020.
Material Changes Versus the Prior Comparable Period
- Revenue, operating income, net income, earnings per share, and cash generation declined materially as COVID-19 reduced demand, disrupted production and supply chains, and delayed customer projects.
- Gross margin declined because of unfavorable volume, cost inflation, increased cost of quality, unfavorable mix, and the meter warranty issue. Procurement and productivity savings and price realization provided partial offsets.
- SG&A declined modestly in dollars but increased to 26.4% of revenue from 24.5%; adjusted operating expenses increased to 30.2% of revenue from 27.6%.
- Restructuring and asset impairment charges declined to $2 million from $11 million. The prior-year period included a $3 million impairment charge and higher restructuring costs.
- Operating cash flow turned negative primarily because of lower earnings and working-capital usage, including a $54 million inventory increase in cash-flow terms and a $68 million decrease in accounts payable.
- Financing activities provided $87 million, primarily from increased short-term borrowings. The company repurchased $60 million of common stock and paid $48 million in dividends.
- Other comprehensive loss was $87 million, largely reflecting foreign-currency translation losses, compared with $20 million of other comprehensive income in Q1 2019.
Guidance, Outlook, Risks and Unusual Items
- Xylem withdrew full-year 2020 guidance on March 31, 2020. It projected second-quarter organic revenue to decline 20% to 30% because of COVID-19 and had not reinstated full-year guidance.
- Management identified approximately $100 million of net reductions to planned operating and capital spending for the remainder of 2020 and was reevaluating capital expenditures, strategic investments, restructuring actions, and dividends.
- The company expected COVID-19 impacts to continue beyond the first quarter through reduced demand, project delays, production constraints, supplier interruptions, customer payment changes, and economic weakness.
- On April 25, 2020, Xylem Europe GmbH entered into a 12-month €100 million term loan facility that was undrawn as of the filing. On April 30, 2020, Xylem drew $50 million under a 12-month term loan facility.
- Short-term debt included $268 million of Euro commercial paper and $191 million of other borrowings. The next long-term debt maturity was October 2021, when $600 million of senior notes mature.
- The company reported an approximately $80 million Swedish tax assessment, including tax, penalties and interest, related to a 2013 intercompany intellectual-property transfer. Management believes it is more likely than not to prevail and has not recorded unrecognized tax benefits for this matter.
- Goodwill and intangible assets remain exposed to impairment risk if COVID-19 causes further deterioration in projected cash flows. The Advanced Infrastructure Analytics reporting unit had a fair value less than 20% above carrying value in the 2019 assessment.
- General legal and environmental accruals were $3 million each at March 31, 2020. Product warranty accruals increased to $55 million from $52 million at December 31, 2019.
Important Facts for Investors to Verify
- Whether COVID-19-driven volume declines, project delays, supply-chain constraints, and customer payment trends persist or worsen after March 31, 2020.
- Execution of the approximately $100 million spending reductions and the potential effect on future revenue growth, margins, capital expenditures, strategic investments, and dividends.
- Cash conversion and working-capital performance, particularly inventory, accounts payable, and operating cash flow.
- Debt refinancing and liquidity requirements, including the $268 million of commercial paper, $191 million of other borrowings, and the October 2021 long-term debt maturity.
- Potential additional warranty costs related to the Sensus meter firmware issue and any effects on product liability or customer relationships.
- Progress and outcome of the Swedish tax litigation and any resulting tax, penalty, interest, or cash exposure.
- Goodwill and intangible-asset valuation, especially for the Advanced Infrastructure Analytics reporting unit.
- Management’s future full-year guidance and the extent to which the second-quarter organic revenue outlook is realized.