Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a water and wastewater equipment and services provider operating through Water Infrastructure and Applied Water. This unaudited report covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Financial Performance and Liquidity
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $902 million | $963 million | $2,659 million | $2,874 million |
| Gross profit | $351 million | $376 million | $1,014 million | $1,106 million |
| Gross margin | 38.9% | 39.0% | 38.1% | 38.5% |
| Operating income | $120 million | $130 million | $307 million | $322 million |
| Operating margin | 13.3% | 13.5% | 11.5% | 11.2% |
| Net income | $88 million | $106 million | $226 million | $241 million |
| Diluted EPS | $0.48 | $0.58 | $1.24 | $1.31 |
- Reported Q3 revenue declined 6.3%, but increased 2.1% on a constant-currency basis. Nine-month revenue declined 7.5%, while constant-currency revenue increased 1.0%.
- Foreign currency translation reduced Q3 revenue by approximately $81 million and nine-month revenue by approximately $243 million.
- Water Infrastructure revenue declined 8.5% in Q3 and 9.5% for nine months as reported, while constant-currency revenue increased 1.7% and 0.7%, respectively. Applied Water revenue declined 2.8% and 4.3% as reported, while constant-currency revenue increased 2.8% and 1.4%.
- Orders were $939 million in Q3, down 8.6% reported but flat organically. Nine-month orders were $2,798 million, down 8.3% reported and up 0.5% organically.
- Operating cash flow was $260 million for the first nine months, versus $253 million in 2014. Free cash flow was $182 million, versus $176 million.
- Capital expenditures were $78 million. Financing cash outflows were $194 million, including $128 million of share repurchases and $77 million of dividends paid.
- Cash and cash equivalents were $611 million at September 30, 2015, compared with $663 million at December 31, 2014. Foreign subsidiaries held approximately $593 million in cash or marketable securities.
- Total debt was $1.275 billion, including $1.2 billion of senior notes and $77 million outstanding under the R&D facility. The $600 million revolving credit facility was undrawn, and the company reported compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Net income decreased 17.0% in Q3 and 6.2% for the nine-month period. Reported diluted EPS decreased from $0.58 to $0.48 in Q3 and from $1.31 to $1.24 for nine months.
- Q3 operating income was pressured by cost inflation, foreign exchange, and unfavorable mix. Cost savings from continuous improvement, procurement, lean Six Sigma, and restructuring actions provided partial offsets.
- Nine-month gross margin declined 40 basis points, primarily because of currency translation. Management stated that gross margin excluding currency effects was slightly better than the prior year.
- Restructuring charges declined to $5 million for nine months from $18 million. The company expects approximately $8 million of restructuring costs for full-year 2015 and approximately $2 million of 2015 net savings from all actions.
- The 2014 Wolverhampton valves divestiture reduced nine-month 2015 revenue by approximately $11 million and contributed to the prior-year gain from sale of businesses. In 2015, two immaterial businesses were sold for $1 million, generating a $9 million gain.
- Other comprehensive loss was $31 million in Q3 and $130 million for nine months, primarily due to foreign currency translation. Accumulated other comprehensive loss increased to $229 million at September 30, 2015.
- The company repurchased $128 million of common stock during the first nine months and had $470 million remaining under a new $500 million authorization at quarter-end.
Guidance, Outlook, Risks, and Unusual Items
- Management continued to expect low-single-digit organic revenue growth for 2015, offset by a high-single-digit negative foreign-exchange translation impact, primarily from the weaker euro.
- Management expected 2015 performance to be flat in industrial markets, up low-to-mid-single digits in public utilities, up mid-single digits in commercial markets, up low-single digits in residential markets, and down mid-to-high single digits in agriculture.
- Backlog was $812 million at September 30, 2015, down 3.8% from the prior year but up 9.7% from December 31, 2014. Management expected 56% of backlog to convert to revenue during the remainder of 2015.
- Restructuring actions focused on European and North American cost structures and were expected to continue through the second quarter of 2016.
- Xylem disclosed an internal investigation involving alleged bid-rigging and potential Foreign Corrupt Practices Act issues at its South Korean subsidiary. The Korea Fair Trade Commission imposed an approximately $1.6 million fine; the SEC informed the company it would not bring an enforcement action regarding the events. The company stated that potential liability could not yet be reasonably estimated but was not expected to have a material adverse effect.
- Accrued liabilities included $6 million for general legal matters, $5 million for environmental matters, and $31 million for product warranties.
- Key risks include foreign exchange, international operations, economic and end-market weakness, oil and gas exposure, order cancellations or delays, pricing pressure, liquidity and refinancing needs, goodwill impairment, product liability, regulatory investigations, litigation, and cybersecurity disruptions.
- On October 22, 2015, after quarter-end, Xylem acquired substantially all assets of Hypack, Inc. for approximately $18 million. Hypack provides hydrographic software and had approximately $8 million of annual revenue.
- Management stated that available operating cash flow and additional borrowing capacity should provide sufficient liquidity for the next twelve months, although future financing availability and terms are not assured.
Important Facts for Investors to Verify
- Whether organic growth and cost savings offset continuing currency pressure, inflation, and weakness in oil and gas and agriculture markets.
- The refinancing plan and terms for the $600 million senior notes due September 2016, classified as long-term based on management’s intent and ability to refinance.
- Actual restructuring and realignment spending, savings realization, and completion timing through 2016.
- Cash deployment among share repurchases, dividends, acquisitions, capital expenditures, and debt repayment.
- Developments in the South Korea compliance matter, environmental obligations, legal claims, warranty costs, and other contingencies.
- Conversion timing and margin quality of the $812 million backlog, including the expected 56% revenue recognition in the remainder of 2015.
- The financial impact and integration of the post-quarter-end Hypack acquisition.