Xylem Inc. 2021 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 applications. This unaudited Form 10-Q covers the three and nine months ended September 30, 2021, compared with the corresponding 2020 periods.
Financial performance and key metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Revenue | $1,265 million | $1,220 million | $3,872 million | $3,503 million |
| Gross profit | $472 million | $461 million | $1,482 million | $1,304 million |
| Gross margin | 37.3% | 37.8% | 38.3% | 37.2% |
| Operating income | $152 million | $73 million | $445 million | $188 million |
| Operating margin | 12.0% | 6.0% | 11.5% | 5.4% |
| Net income | $114 million | $37 million | $314 million | $106 million |
| Diluted EPS | $0.63 | $0.20 | $1.73 | $0.58 |
| Operating cash flow | Not separately provided | Not separately provided | $318 million | $454 million |
| Free cash flow | Not separately provided | Not separately provided | $191 million | $318 million |
- Q3 revenue increased 3.7%; constant-currency revenue increased 2.0%. Nine-month revenue increased 10.5%, or 6.8% in constant currency.
- Orders increased 21.8% in Q3 to $1,518 million and 26.1% for the nine months to $4,716 million. Backlog was $2,964 million at September 30, 2021, up 35.2% from September 30, 2020.
- Adjusted Q3 operating income was $155 million, with a 12.3% adjusted margin, compared with $158 million and 13.0% in the prior year. Adjusted EBITDA margin was 17.9% versus 18.2%.
- Q3 gross margin declined 50 basis points because of cost inflation and higher logistics costs. The nine-month gross margin improved 110 basis points, supported by productivity and restructuring savings and favorable volume.
- Cash and cash equivalents were $1,255 million at September 30, 2021, compared with $1,875 million at December 31, 2020. Total debt was $2,455 million versus $3,084 million at year-end 2020.
- Liquidity was approximately $2.1 billion, consisting of approximately $1.3 billion of cash and $800 million of available revolving credit capacity. The revolving facility was undrawn, and the company reported compliance with debt covenants.
- On October 1, 2021, after quarter-end, Xylem repaid the $600 million senior notes due 2021 using cash on hand. The next long-term debt maturity is in March 2023.
Material changes versus the prior comparable period
- Operating income and net income benefited substantially from the absence of the prior-year $58 million goodwill impairment charge and lower restructuring and other special charges.
- Q3 2021 restructuring and asset impairment charges were a net recovery of $2 million, compared with $19 million of charges in Q3 2020. Nine-month charges were $7 million versus $69 million.
- Measurement & Control Solutions revenue declined 4.2% in Q3, primarily because of utility-market weakness and electronic component constraints. Its operating income improved to $7 million from a $62 million loss, largely because prior-year impairment and other special charges did not recur.
- Water Infrastructure revenue increased 4.4% in Q3 and Applied Water revenue increased 9.9%. Their Q3 operating margins were 18.5% and 15.0%, respectively.
- Working capital reduced operating cash flow: receivables increased $78 million and inventories increased $135 million during the nine months. Higher interest, income-tax, payroll-tax, freight, and logistics payments also affected cash generation.
- Financing activities used $806 million in the first nine months, principally reflecting repayment of the $600 million senior notes due 2021, compared with $550 million of financing cash inflow in 2020.
Guidance, outlook, commentary, risks, and unusual items
- Management updated 2021 total revenue growth guidance to 5% to 7% and organic revenue growth guidance to 3% to 4%, including expected negative supply-chain effects.
- Management expected utilities revenue to be essentially flat organically, industrial revenue growth in the high-single-digit range, commercial revenue growth in the mid- to high-single-digit range, and residential revenue growth in the low-teens.
- Approximately 35% of September 30 backlog was expected to convert to revenue during the remainder of 2021, subject to supply constraints.
- Management identified shortages of electronics, parts, and raw materials; port congestion; delivery delays; freight and logistics cost inflation; broader cost inflation; unfavorable mix; and project timing as key operating pressures.
- The filing contains differing restructuring outlook references: one section states approximately $20 million of 2021 restructuring and realignment costs and approximately $35 million of net savings, while a later MD&A section states approximately $8 million of full-year restructuring costs and approximately $33 million of incremental savings. This discrepancy should be reconciled.
- COVID-19 continues to create uncertainty affecting demand, supply chains, costs, operations, estimates, and asset valuations. Management stated that current liquidity should be sufficient to meet funding needs and service debt during the year.
- Xylem disclosed an approximately $80 million Swedish tax assessment, including tax, penalties, and interest, related to a 2013 intercompany intellectual-property transfer. The company is appealing and has not recorded unrecognized tax benefits, believing it is more likely than not to prevail.
- Legal, environmental, warranty, product liability, cybersecurity, foreign-exchange, regulatory, impairment, and acquisition-integration risks remain relevant. The company accrued $5 million for general legal matters, $3 million for environmental matters, and $62 million for product warranties at September 30, 2021.
- The remaining goodwill balance in the Advanced Infrastructure Analytics reporting unit was $112 million after the 2020 impairment. Failure to achieve forecasts could result in future impairment.
Important facts for investors to verify
- Reconcile the inconsistent 2021 restructuring-cost and savings guidance within the MD&A.
- Confirm the post-quarter-end repayment of the $600 million notes due 2021 and the resulting cash and debt balances.
- Monitor whether supply-chain shortages, inflation, freight costs, and component constraints affect backlog conversion, margins, and the 2021 revenue outlook.
- Assess the sustainability of adjusted margins after excluding unusually high 2020 impairment and special charges.
- Track Measurement & Control Solutions revenue recovery and profitability, including the risk of additional goodwill or intangible-asset impairments.
- Review developments in the Swedish tax litigation and the company’s ability to maintain its stated liquidity and debt-covenant position.