Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving utility, industrial, residential and commercial markets across the water cycle. Its four reportable segments are Water Infrastructure, Applied Water, Measurement & Control Solutions, and Integrated Solutions & Services.
This report covers the quarter and six months ended June 30, 2023. On May 24, 2023, Xylem completed its acquisition of Evoqua Water Technologies, adding the Integrated Solutions & Services segment. Evoqua results are included from the acquisition date.
Financial Performance and Liquidity
| Metric | Three months ended June 30, 2023 | Year-over-year | Six months ended June 30, 2023 | Year-over-year |
|---|---|---|---|---|
| Revenue | $1,722 million | Up 26.2% | $3,170 million | Up 20.3% |
| Gross profit | $651 million | Up 25.2% | $1,197 million | Up 21.3% |
| Gross margin | 37.8% | Down 30 bps | 37.8% | Up 40 bps |
| Operating income | $119 million | Down 18.5% | $250 million | Down 2.7% |
| Operating margin | 6.9% | Down 380 bps | 7.9% | Down 180 bps |
| Net income | $92 million | Down 17.9% | $191 million | Down 1.5% |
| Diluted EPS | $0.45 | Down from $0.62 | $0.98 | Down from $1.07 |
- Second-quarter organic revenue increased 14.6%; acquisition contribution was 13.0% and foreign-currency translation reduced growth by 1.4%.
- Adjusted operating income was $259 million, or a 15.0% margin, versus $173 million, or 12.7%, in the prior-year quarter. Adjusted EBITDA was $329 million, or a 19.1% margin, versus $226 million, or 16.6%.
- Six-month adjusted operating income was $444 million, with a 14.0% margin, and adjusted EBITDA was $565 million, with a 17.8% margin.
- Orders were $1,856 million in the quarter, up 10.2% overall but down 1.6% organically. Six-month orders were $3,426 million, up 0.8% overall but down 3.5% organically.
- Backlog was $5,271 million at June 30, 2023, up 40.3% from June 30, 2022; approximately 39% was expected to convert to revenue during the remainder of 2023.
- Net cash provided by operating activities was $9 million for the six months, versus $32 million in the prior-year period. Free cash flow was negative $61 million versus negative $63 million.
- Capital expenditures were $103 million, and acquisition spending was $476 million. Cash and cash equivalents were $708 million at June 30, 2023, down from $944 million at December 31, 2022.
- Total debt was $2.507 billion, including $240 million classified as short-term debt or current maturities. Long-term debt was $2.267 billion.
- The $1 billion revolving credit facility was undrawn, with $925 million available after commercial paper borrowings. Management reported total available liquidity of approximately $1.6 billion, including cash.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected strong organic performance across all major regions and segments, improved component availability, price realization and backlog execution, supplemented by the Evoqua acquisition.
- Reported profitability declined because of acquisition and integration costs, higher restructuring and realignment costs, increased acquired-intangible amortization, inflation, strategic investment spending and unfavorable mix.
- Special charges increased to $67 million in the second quarter and $92 million for the six-month period, primarily related to the Evoqua transaction and integration.
- Restructuring and realignment costs were $37 million in the second quarter and $48 million for the six-month period, compared with $8 million and $12 million, respectively, in the prior-year periods.
- SG&A increased 42.0% in the quarter, substantially faster than revenue, reflecting acquisition-related expenses, special charges, restructuring costs and inflation.
- Applied Water operating income increased 37.7% in the quarter, while Measurement & Control Solutions returned to operating profit. Water Infrastructure operating income declined 1.9%, and Integrated Solutions & Services reported a $7 million operating loss.
- The acquisition was funded through stock issuance valued at approximately $6.121 billion, replacement equity awards of $160 million and debt repayment of $619 million. Legacy Evoqua shareholders owned approximately 25% of the combined company after closing.
Guidance, Outlook, Risks and Unusual Items
- Management updated 2023 total revenue growth guidance to approximately 30% and organic revenue growth guidance to 9% to 10%.
- For the remainder of 2023, management expects utility organic growth in the mid-teens, industrial organic growth in the mid-single digits and building-solutions organic growth in the mid-single digits. Residential demand, particularly in the United States, remained soft.
- Management expects approximately $90 million to $95 million of restructuring and realignment costs during 2023, including approximately $55 million to $60 million of restructuring costs. Actions are expected to continue through the end of 2024.
- Key risks include integration of Evoqua, realization of expected synergies, acquisition-related costs, supply-chain and component availability, inflation, interest rates, foreign exchange, demand and pricing pressure, cybersecurity, project execution, product liability, environmental compliance and potential goodwill or intangible-asset impairments.
- The filing identifies additional risks associated with wastewater treatment and hazardous materials, including contamination, environmental liabilities, reputational harm and costs exceeding insurance coverage. Large projects also carry risks of delays, cost overruns, performance-guarantee claims and safety requirements.
- A Swedish tax dispute related to a 2013 intellectual-property transfer remains under appeal. The adverse lower-court decision was approximately $74 million, but management believes it is more likely than not that Xylem will prevail; no unrecognized tax benefit was recorded for this position.
- The company sold Evoqua’s former carbon reactivation and slurry operations for approximately $91 million on June 15, 2023. The Evoqua receivables securitization program was terminated and paid in full on July 20, 2023.
- Legal and environmental accruals were $12 million and $4 million, respectively, at June 30, 2023. Guarantees, letters of credit and similar instruments totaled $716 million.
- Disclosure controls and procedures were determined to be effective, and no material change in internal control over financial reporting was reported.
Important Facts for Investors to Verify
- Whether Evoqua integration delivers the expected revenue, cost synergies and margin improvement without further material charges.
- Conversion of the $5.271 billion backlog into revenue and cash, including the timing and profitability of large projects.
- Organic order trends, particularly the declines reported for Applied Water and Measurement & Control Solutions for the six-month period.
- Progress toward the 2023 revenue and organic-growth guidance and the expected $90 million to $95 million of restructuring and realignment costs.
- Operating cash flow and free cash flow conversion, which were weak in the first half despite higher adjusted earnings.
- Debt levels, leverage-covenant compliance and liquidity after acquisition financing and integration spending.
- Exposure to environmental, wastewater-treatment, performance-guarantee, tax and other contingent liabilities.
- The impact of acquisition-related amortization, special charges and other non-GAAP adjustments when comparing reported and adjusted performance.