Xylem Inc. Form 10-Q Summary
Business context and reporting period
Xylem is a global water technology company serving utility, industrial, residential and commercial customers across the water cycle. Its reportable segments are Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited filing covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022.
Financial performance and position
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $1,448 million | $1,272 million | 13.8% |
| Gross profit | $546 million | $467 million | 16.9% |
| Gross margin | 37.7% | 36.7% | +100 bps |
| Operating income | $131 million | $111 million | 18.0% |
| Operating margin | 9.0% | 8.7% | +30 bps |
| Net income | $99 million | $82 million | 20.7% |
| Diluted EPS | $0.54 | $0.45 | 20.0% |
| Net cash used in operating activities | $(19) million | $(81) million | Improved $62 million |
| Free cash flow | $(35) million | $(130) million | Improved $95 million |
Constant-currency revenue increased 17.4%, including organic growth of $221 million, while foreign-currency translation reduced reported revenue by $45 million. Adjusted operating income was $167 million, or an 11.5% margin, compared with $116 million, or 9.1%, in the prior-year quarter. Adjusted EBITDA was $236 million, or a 16.3% margin, compared with $181 million, or 14.2%.
- Water Infrastructure revenue was $589 million, up 10.5% reported and 15.2% on a constant-currency basis; operating income declined to $70 million from $74 million.
- Applied Water revenue was $453 million, up 6.6% reported and 9.6% on a constant-currency basis; operating income increased to $83 million from $59 million.
- Measurement & Control Solutions revenue was $406 million, up 29.3% reported and 31.5% on a constant-currency basis; operating income improved to $20 million from a $10 million loss.
Cash and cash equivalents were $837 million at March 31, 2023, compared with $944 million at December 31, 2022. Total debt was $1.881 billion, consisting of long-term senior notes; there were no short-term borrowings or current maturities. The new $1 billion five-year revolving credit facility was undrawn, and management reported approximately $1.8 billion of available liquidity, including cash and available credit facilities.
Material changes versus the prior comparable period
- Revenue growth was broad-based, with particularly strong performance in Measurement & Control Solutions, reflecting backlog execution, improved component availability and price realization.
- Gross margin improved by 100 basis points, primarily from price realization, productivity savings and favorable volume. These benefits were partly offset by inflation, unfavorable mix, strategic investment spending and inventory management costs.
- Operating results included $11 million of restructuring and realignment costs and $25 million of special charges in Q1 2023, compared with $4 million and $1 million, respectively, in Q1 2022. The special charges primarily related to the pending Evoqua acquisition and integration activities.
- Orders declined 8.5% to $1.570 billion, or 5.4% on an organic basis, largely because Measurement & Control Solutions was lapping unusually strong prior-year orders related to electronic component shortages. Backlog increased 5.4% year over year to $3.743 billion.
- Operating cash flow remained negative but improved substantially, reflecting lower inventory purchases, better collections, higher earnings and lower interest payments.
- Interest expense declined to $9 million from $13 million, principally because euro-denominated notes were repaid in December 2022 and net investment hedges generated interest income.
- The effective tax rate increased to 21.7% from 16.4%, primarily due to earnings mix and nondeductible transaction costs.
Guidance, outlook, commentary and risks
Xylem updated its 2023 total revenue growth and organic revenue growth outlook to 8%–9%. Management expects low-teens organic growth in utilities, mid-single-digit growth in industrial and commercial markets, and a low-single-digit organic decline in residential markets. The company expects approximately $25 million–$35 million of restructuring and realignment costs during 2023, including approximately $6 million–$10 million of restructuring costs.
The company expects approximately 50% of its March 31, 2023 backlog to convert to revenue during the remainder of 2023. Management cited aging infrastructure, utility capital spending, dewatering demand, replacement activity and improved component availability as positive factors, while noting inflation, supply-chain constraints, interest rates, labor costs, market moderation and foreign exchange as pressures.
Xylem agreed to acquire Evoqua Water Technologies in an all-stock transaction with an implied enterprise value of approximately $7.5 billion. The transaction was anticipated to close in mid-2023 and remained subject to shareholder, regulatory and other customary approvals at the filing date. The filing identifies risks relating to closing conditions, litigation, integration costs, employee retention, customer and supplier reactions, dilution and achievement of expected synergies.
On April 26, 2023, after the quarter end, Xylem funded an approximately $110 million minority investment in Global Omnium Idrica, S.L. with cash on hand and entered into a global distribution agreement for Idrica’s GoAigua technology.
Other notable matters include a Swedish tax assessment and appeal involving approximately $77 million, for which management believes it is more likely than not that Xylem will prevail; restructuring and a $2 million software impairment charge; $426 million of guarantees and similar commitments; and $4 million accrued for environmental matters. Management stated that no material changes occurred to previously disclosed risk factors and that disclosure controls were effective.
Important facts for investors to verify
- Confirm the closing status, financing, share issuance, accounting treatment and integration progress of the Evoqua acquisition.
- Assess whether the 8%–9% 2023 revenue outlook remains achievable given lower orders and potential macroeconomic or supply-chain pressure.
- Monitor conversion of the $3.743 billion backlog and the sustainability of Measurement & Control Solutions’ margin recovery.
- Evaluate cash generation, working-capital requirements and liquidity after the Idrica investment, dividends and any Evoqua-related costs.
- Review the outcome and potential exposure from the Swedish tax appeal and other legal, environmental, warranty and guarantee obligations.
- Distinguish GAAP results from adjusted measures, particularly the $25 million of special charges and $11 million of restructuring and realignment costs included in Q1 2023.