Xylem Inc. — Q1 2019 Form 10-Q 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. This filing covers the unaudited three months ended March 31, 2019, compared with the same period in 2018.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $1,237 million | $1,217 million | +1.6% |
| Gross profit | $474 million | $460 million | +3.0% |
| Gross margin | 38.3% | 37.8% | +50 bps |
| Operating income | $109 million | $113 million | -3.5% |
| Operating margin | 8.8% | 9.3% | -50 bps |
| Net income | $79 million | $79 million | Flat |
| Diluted EPS | $0.43 | $0.43 | Flat |
| Cash flow from operations | $83 million | $63 million | +31.7% |
| Free cash flow | $14 million | $2 million | +$12 million |
- Constant-currency revenue increased 5.8%, comprising 6.2% organic growth, $5 million of acquisition revenue and a $10 million divestiture headwind.
- Adjusted operating income was $133 million, with a 10.8% adjusted margin, versus $135 million and 11.1% in the prior-year quarter.
- Adjusted net income was $94 million, or $0.52 adjusted diluted EPS, versus $93 million and $0.51, respectively.
- Orders were $1,315 million, down 0.4% reported but up 3.9% on a constant-currency basis and 4.0% organically. Backlog was $1,833 million, up 5.6% year over year; approximately 57% was expected to convert to revenue during the remainder of 2019.
Segment performance
| Segment | Q1 2019 revenue | Revenue change | Q1 2019 operating income | Operating margin |
|---|---|---|---|---|
| Water Infrastructure | $482 million | +0.4% reported; +6.7% constant currency | $51 million | 10.6% |
| Applied Water | $379 million | +3.6% reported; +6.8% constant currency | $56 million | 14.8% |
| Measurement & Control Solutions | $376 million | +1.3% reported; +3.8% constant currency | $16 million | 4.3% |
Measurement & Control Solutions was the principal operating weakness. Its operating income declined 51.5%, reflecting cost inflation, unfavorable mix, strategic investment spending, prior-year purchase-accounting impacts and higher special charges. Water Infrastructure and Applied Water improved on both reported operating income and margin.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $275 million at March 31, 2019, compared with $296 million at December 31, 2018.
- Total debt was $2.348 billion, including $304 million of short-term borrowings and current maturities and $2.044 billion of long-term debt. Debt increased from $2.308 billion at year-end.
- Debt included $85 million of commercial paper, $141 million under the term loan and $78 million under a revolving line of credit. The $800 million 2019 five-year revolving credit facility was undrawn.
- The company stated that it was in compliance with debt covenants and believed existing cash, operating cash flow, commercial paper access and committed facilities were sufficient for the next twelve months.
- Capital expenditures were $69 million; dividends paid were $44 million; and share repurchases totaled $39 million, including $25 million under the authorized repurchase program.
- Lease accounting adoption on January 1, 2019 added $267 million of right-of-use assets and $265 million of lease liabilities. At quarter-end, lease liabilities totaled $255 million.
Material changes versus the prior comparable period
- Reported revenue increased modestly, while currency-adjusted and organic growth were substantially stronger; foreign-currency translation reduced revenue by approximately $51 million.
- Gross margin improved 50 basis points, but operating margin declined 50 basis points because of higher restructuring and realignment costs, inflation, strategic investments, lower overhead absorption and unfavorable mix.
- Research and development expense increased 24.4% to $51 million, or 4.1% of revenue, from $41 million, or 3.4%.
- Operating cash flow increased by $20 million, while investing cash use fell sharply because Q1 2018 included approximately $430 million of acquisition spending, primarily for Pure Technologies; Q1 2019 acquisition spending was $5 million.
- Interest expense declined to $18 million from $21 million, primarily because of acquisition-related debt costs incurred in Q1 2018.
- The company recognized $11 million of restructuring and asset impairment charges, including $8 million of restructuring charges and a $3 million impairment in Measurement & Control Solutions, compared with $10 million in the prior-year quarter.
- Xylem replaced its prior revolving credit facility with an $800 million 2019 five-year facility, with an accordion option for up to $1 billion in total commitments.
Guidance, outlook, risks and unusual items
- Management forecast 2019 total revenue growth of 2% to 4% and organic revenue growth of 4% to 6%.
- Management expects utilities to grow organically in the mid-single digits, industrial markets in the low-to-mid single digits, commercial markets in the mid-single digits and residential markets in the low-single digits.
- Management expects $60 million to $70 million of restructuring and realignment costs during 2019, while a separate discussion identifies expected full-year restructuring costs of $35 million to $45 million. The filing distinguishes broader realignment costs from restructuring costs.
- Management expects approximately $15 million of total net savings during 2019 from actions taken and planned, including approximately $7 million of incremental savings from 2018 actions and $16 million from 2019 actions as described in the outlook discussion.
- Key risks include currency volatility, tariffs and geopolitical conditions, economic and housing-market weakness, order cancellations or delays, competition and pricing pressure, acquisition integration, liquidity and refinancing access, goodwill and intangible-asset impairment, product liability, cybersecurity, regulatory investigations, litigation and environmental liabilities.
- Accrued liabilities included $6 million for general litigation, $3 million for environmental matters and $52 million for product warranties. The company stated that no asserted or unasserted legal matters were reasonably expected to have a material adverse effect, and ITT remained responsible for specified legacy asbestos liabilities under indemnification arrangements.
- Unrecognized tax benefits were $132 million, with approximately $8 million potentially reducing within the next twelve months. The company also expects $10 million to $20 million of additional pension contributions during the remainder of 2019.
Most important facts for investors to verify
- Whether organic growth and backlog conversion support the 2019 revenue outlook despite foreign-exchange, regional and end-market pressure.
- Whether Measurement & Control Solutions can recover margins after its significant year-over-year operating-income decline.
- The precise distinction and reconciliation between the $60 million–$70 million restructuring and realignment outlook and the separately stated $35 million–$45 million restructuring-cost estimate.
- Progress toward the targeted cost savings and the effect of restructuring spending on reported and adjusted earnings.
- Debt reduction, commercial-paper usage, covenant headroom and liquidity under changing interest rates or weaker operating cash flow.
- Potential exposure from tax uncertainties, environmental matters, product warranties, litigation and legacy indemnification obligations.
- The effect of the 2019 lease-accounting adoption and continuing capital allocation to dividends, repurchases, acquisitions and capital expenditures.