Xylem Inc. 2018 Form 10-K Summary
Business context and reporting period
Xylem is a global water technology company serving utility, industrial, residential and commercial customers through three segments: Water Infrastructure, Applied Water, and Measurement & Control Solutions. The filing covers the fiscal year ended December 31, 2018; the fourth quarter ended December 31, 2018.
Revenue was generated in approximately 150 countries. The United States represented 47% of revenue, Europe 28%, Asia Pacific 13% and other regions 12%. Xylem had approximately 17,000 employees.
Key financial metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $5,207 million | $4,707 million | +10.6% |
| Gross profit | $2,026 million | $1,847 million | +9.7% |
| Gross margin | 38.9% | 39.2% | -30 bps |
| Operating income | $654 million | $552 million | +18.5% |
| Operating margin | 12.6% | 11.7% | +90 bps |
| Net income attributable to Xylem | $549 million | $331 million | +65.9% |
| Diluted EPS | $3.03 | $1.83 | +65.6% |
| Cash flow from operations | $586 million | $686 million | -14.6% |
| Free cash flow | $349 million | $516 million | -32.4% |
| Cash and equivalents | $296 million | $414 million | -$118 million |
| Total debt | $2,308 million | $2,200 million | +$108 million |
Adjusted operating income was $714 million, with an adjusted operating margin of 13.7%, compared with $626 million and 13.3% in 2017. Adjusted net income was $522 million, or $2.88 per diluted share, compared with $433 million, or $2.40 per diluted share, in 2017.
Fourth-quarter 2018 revenue was $1,386 million, operating income was $194 million, net income attributable to Xylem was $225 million, and diluted EPS was $1.24. Fourth-quarter 2017 revenue was $1,277 million, operating income was $177 million, net income was $71 million, and diluted EPS was $0.40.
Segments and material changes
- Water Infrastructure: Revenue increased 8.6% to $2,176 million; operating income increased 15.1% to $359 million; operating margin rose to 16.5% from 15.6%.
- Applied Water: Revenue increased 8.0% to $1,534 million; operating income increased 21.6% to $236 million; operating margin rose to 15.4% from 13.7%.
- Measurement & Control Solutions: Revenue increased 16.8% to $1,497 million; operating income increased 7.3% to $118 million, while operating margin declined to 7.9% from 8.6%. Higher restructuring and special charges, cost inflation, strategic investment spending and unfavorable mix pressured margins.
Organic revenue increased 8.3%, acquisition revenue contributed $111 million, divestitures reduced revenue by $24 million, and favorable currency translation contributed $23 million. Orders increased 11.7% to $5,437 million, including 9.3% organic growth. Backlog increased 11.6% to $1,689 million, of which approximately 65% was expected to convert to revenue in 2019.
Xylem acquired Pure Technologies Ltd. on January 31, 2018, for approximately $420 million net of cash received. Pure contributed $96 million of revenue during the eleven months ended December 31, 2018. Xylem also divested its Precision Die Casting business for approximately $22 million.
Cash flow, liquidity and debt
- Operating cash flow declined primarily because of increased inventory and receivables. Inventory was built to address component shortages, maintain service levels and manage tariff impacts.
- Capital expenditures were $237 million, compared with $170 million in 2017. Acquisition spending was $433 million, primarily for Pure.
- Total debt was $2.308 billion, including $257 million of short-term borrowings and current maturities. Long-term debt was $2.051 billion.
- The $600 million revolving credit facility was undrawn at year-end, and Xylem reported compliance with its debt covenants. Management stated that available cash, operating cash flow, commercial paper access and committed facilities were sufficient for expected needs over the next twelve months.
- Dividends declared increased to $0.84 per share from $0.72 per share. Xylem repurchased approximately $59 million of common stock during 2018; $363 million remained available under the principal repurchase authorization at year-end.
Guidance, outlook and unusual items
- Management forecast 2019 total revenue growth of 2% to 4%, including organic revenue growth of 4% to 6%.
- Management expected mid-single-digit organic growth in utilities, low- to mid-single-digit growth in industrial and commercial markets, and low-single-digit growth in residential markets.
- Restructuring and realignment costs were expected to be approximately $30 million in 2019. Management expected approximately $8 million of incremental net savings in 2019 and beyond from prior actions.
- The 2018 effective tax rate was 6.1%, compared with 29.2% in 2017, primarily reflecting the U.S. Tax Cuts and Jobs Act, an intercompany asset sale and related tax adjustments. The filing states that the Tax Act accounting was complete.
- Xylem recorded $22 million of restructuring and asset impairment charges in 2018, including a $2 million fourth-quarter impairment of Water Infrastructure software assets.
- Key risks include economic and geopolitical conditions, tariffs and supply-chain costs, foreign currency exposure, cyber and information-technology disruptions, acquisitions and integration, restructuring execution, product liability, regulatory compliance, litigation, environmental obligations, pension funding, goodwill impairment and debt refinancing.
- Goodwill and other indefinite-lived intangible assets totaled approximately $3 billion. The AIA goodwill reporting unit had fair value less than 10% above carrying value, increasing sensitivity to future impairment.
Investor verification checklist
- Verify the sustainability of organic growth and the conversion of the $1.689 billion backlog into 2019 revenue.
- Assess whether the decline in operating cash flow and free cash flow reverses as inventory and receivables normalize.
- Monitor leverage, the $257 million term loan, refinancing requirements and compliance with debt covenants.
- Separate recurring operating performance from tax benefits, restructuring charges, acquisition accounting and other adjusted items.
- Evaluate Measurement & Control Solutions margin recovery following the Pure acquisition and integration spending.
- Review exposure to tariffs, inflation, foreign exchange, cyber incidents, environmental liabilities and potential goodwill impairment.
- Note that management’s internal-control assessment excluded Pure during its first year of ownership, although management and the external auditor reported effective controls overall.