Xylem Inc. Form 10-Q Summary
Business context and reporting period
Xylem is a global water technology company serving the water cycle through three segments: Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $1,287 million | $1,195 million | $3,821 million | $3,430 million |
| Gross profit | $505 million | $471 million | $1,484 million | $1,340 million |
| Gross margin | 39.2% | 39.4% | 38.8% | 39.1% |
| Operating income | $176 million | $152 million | $460 million | $375 million |
| Operating margin | 13.7% | 12.7% | 12.0% | 10.9% |
| Net income attributable to Xylem | $130 million | $105 million | $324 million | $260 million |
| Diluted EPS | $0.72 | $0.58 | $1.79 | $1.44 |
| Operating cash flow | Not separately provided | Not separately provided | $388 million | $379 million |
| Free cash flow | Not separately provided | Not separately provided | $217 million | $260 million |
Q3 revenue increased 7.7%; constant-currency growth was 9.7%, including 7.9% organic growth. Nine-month revenue increased 11.4%, or 9.7% on a constant-currency basis, including 7.8% organic growth. Orders increased 8.6% in Q3 and 12.7% for the nine months. Backlog was $1.742 billion at September 30, 2018, up 12.0% year over year; management expected approximately 40% to convert to revenue in Q4 2018.
Adjusted operating income was $188 million in Q3, with a 14.6% adjusted margin, and $505 million for the nine months, with a 13.2% adjusted margin. Adjusted diluted EPS was $0.77 for Q3 and $2.00 for the nine months. These are non-GAAP measures and exclude specified restructuring, acquisition-related, special, tax, and divestiture items.
Liquidity, debt, and balance sheet
- Cash and cash equivalents were $404 million at September 30, 2018, compared with $414 million at December 31, 2017.
- Total debt was $2.531 billion, including $342 million classified as short-term borrowings and current maturities, versus $2.200 billion at year-end 2017.
- Debt included $78 million of commercial paper and a $264 million term loan used in part to fund the Pure Technologies acquisition. The $600 million revolving credit facility was undrawn, and the Company was in compliance with its debt covenants.
- Net cash used in investing activities was $579 million, primarily reflecting $433 million of acquisitions and $171 million of capital expenditures.
- Cash generated by financing activities was $195 million, principally because of $410 million of short-term debt issuance; the Company also paid $114 million of dividends and repurchased $58 million of common stock.
- Management stated that operating cash flow, cash balances, commercial paper access, committed credit facilities, and access to public debt markets should provide sufficient liquidity for the next twelve months.
Material changes versus the prior comparable period
- All three segments increased revenue and operating income. Q3 revenue rose to $541 million in Water Infrastructure, $378 million in Applied Water, and $368 million in Measurement & Control Solutions.
- Measurement & Control Solutions benefited from the January 2018 acquisition of Pure Technologies, which contributed approximately $30 million of Q3 revenue and $79 million for the nine months. Pure generated operating losses of $2 million in Q3 and $5 million for the eight months consolidated during the period.
- Xylem completed the divestiture of its Precision Die Casting business for approximately $22 million, recognizing an immaterial gain. The business had approximately $32 million of 2017 annual revenue.
- Operating margin improved despite a 20-basis-point Q3 and 30-basis-point nine-month decline in gross margin. Benefits from productivity, procurement, volume, and price realization outweighed inflation, unfavorable mix, strategic investment spending, currency effects, and purchase-accounting impacts.
- Restructuring charges were $4 million in Q3 and $19 million for the nine months, compared with $4 million and $22 million, respectively, including asset impairment, in the prior-year periods. The Company expected approximately $22 million of restructuring costs for full-year 2018.
- Other comprehensive income shifted to a $1 million loss in Q3 and a $68 million loss for the nine months, compared with income of $21 million and $119 million in the prior-year periods, primarily because of unfavorable foreign-currency translation.
- The Company adopted the new revenue recognition standard using the modified retrospective method; adoption did not materially affect financial condition or results of operations. It also adopted the period-cost method for future GILTI tax effects and recorded Tax Cuts and Jobs Act measurement-period adjustments.
Guidance, outlook, commentary, and risks
Management projected 2018 total revenue growth of 10% to 11%, with organic revenue growth of approximately 7% to 8%. Management expected high-single-digit organic growth in utilities and commercial markets, mid-single-digit industrial growth, and low-single-digit residential growth. The Company also expected approximately $12 million of incremental net savings from 2017 actions and $3 million from 2018 actions.
Management cited cost inflation, unfavorable mix, foreign exchange, strategic investment spending, purchase-accounting effects, and weaker residential conditions in certain markets as operating risks. Additional risks include economic and political conditions, trade restrictions, customer order cancellations or delays, competition and pricing pressure, housing-market weakness, weather, channel-partner performance, acquisition integration, refinancing and liquidity access, goodwill and intangible-asset impairment, product liability, cybersecurity, litigation, environmental matters, and regulatory compliance.
Xylem reported $8 million accrued for general litigation, $4 million for environmental matters, and $66 million for product warranty obligations at September 30, 2018. ITT LLC remains obligated to indemnify Xylem for specified legacy asbestos-related matters. Management did not expect asserted or unasserted legal claims, individually or in aggregate, to have a material adverse effect, although ultimate outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether 2018 revenue and organic-growth guidance was achieved, particularly given Q3 Water Infrastructure order declines and residential-market weakness.
- Whether the Pure Technologies acquisition delivers expected growth, synergies, and margin improvement after purchase-accounting effects.
- Whether cost inflation and unfavorable mix continue to offset procurement, productivity, and pricing benefits.
- Whether working-capital investment, capital expenditures, and acquisition spending improve or further pressure free cash flow.
- Debt maturities, short-term borrowings, commercial paper usage, interest costs, leverage-covenant compliance, and refinancing availability.
- The resolution of provisional Tax Cuts and Jobs Act accounting, including the $154 million Transition Tax obligation and $129 million of unrecognized tax benefits.
- Potential changes in foreign-currency exposure, including the highly inflationary classification of Argentina, and the effect on revenue, earnings, and accumulated other comprehensive income.