Xylem Inc. 2022 Q2 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 Form 10-Q covers the three and six months ended June 30, 2022, compared with the corresponding 2021 periods.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Revenue | $1,364 million | $1,351 million | $2,636 million | $2,607 million |
| Gross profit | $520 million | $520 million | $987 million | $1,010 million |
| Gross margin | 38.1% | 38.5% | 37.4% | 38.7% |
| Operating income | $146 million | $160 million | $257 million | $293 million |
| Operating margin | 10.7% | 11.8% | 9.7% | 11.2% |
| Net income | $112 million | $113 million | $194 million | $200 million |
| Diluted EPS | $0.62 | $0.62 | $1.07 | $1.10 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $32 million | $206 million |
| Free cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $(63) million | $126 million |
- Q2 revenue increased 1.0% reported and 5.4% on a constant-currency basis. Organic growth was led by Water Infrastructure and Applied Water, while Measurement & Control Solutions declined.
- Q2 adjusted operating income was $155 million, with an adjusted operating margin of 11.4%, versus $166 million and 12.3% in the prior-year quarter. Adjusted EBITDA was $226 million, or 16.6% of revenue, versus $234 million, or 17.3%.
- Six-month operating cash flow fell $174 million year over year, primarily because of higher receivables, inventory and supplier advances related to supply-chain volatility. Capital expenditures were $95 million, producing negative free cash flow of $63 million.
- Cash and cash equivalents were $1.113 billion at June 30, 2022, compared with $1.349 billion at December 31, 2021. Management reported approximately $1.9 billion of available liquidity, including cash and $800 million of available credit facilities.
- Total debt was $2.400 billion, including $521 million classified as short-term borrowings and current maturities. The next long-term debt maturity is the €500 million senior notes due March 2023. The revolving credit facility was undrawn, and the company reported compliance with applicable debt covenants.
- Six-month dividends paid were $110 million, and share repurchases were $52 million. Up to $182 million remained available under the repurchase authorization at June 30, 2022.
Material changes versus the prior comparable period
- Reported revenue growth was limited by foreign exchange translation, which reduced Q2 revenue by approximately $60 million and first-half revenue by approximately $93 million.
- Gross margin declined 40 basis points in Q2 and 130 basis points year to date, reflecting inflation, logistics and strategic investment spending, and unfavorable mix. Price realization and productivity savings partially offset these pressures.
- Q2 operating income declined 8.8%; first-half operating income declined 12.3%. Measurement & Control Solutions moved to a $5 million operating loss in Q2 and a $15 million loss year to date, compared with operating income of $13 million and $22 million, respectively, in 2021.
- Q2 segment revenue increased 3.5% in Water Infrastructure and 3.6% in Applied Water, while Measurement & Control Solutions declined 6.0%. First-half revenue increased 4.1% and 5.8% in the first two segments and declined 8.6% in Measurement & Control Solutions.
- Backlog increased to $3.757 billion at June 30, 2022, up 35.2% from June 30, 2021 and 16.0% from December 31, 2021. Approximately 40% was expected to convert to revenue during the remainder of 2022.
- Interest expense declined to $12 million in Q2 and $25 million year to date, primarily because a senior note paid in October 2021 no longer generated interest expense.
Guidance, outlook, commentary and risks
- Management updated 2022 reported revenue growth guidance to 3%–5% and organic revenue growth guidance to 8%–10%.
- Expected 2022 organic growth is mid-single-digit for utilities, high-single-digit to low-double-digit for industrial, mid-single-digit to high-single-digit for commercial, and double-digit for residential markets.
- The company expects approximately $20 million–$25 million of 2022 restructuring and realignment costs, including approximately $10 million–$15 million of restructuring costs.
- Management expects chip supply to improve modestly in each successive quarter of 2022, but continues to cite semiconductor and other component shortages, China COVID lockdowns, inflation, freight and logistics costs, tight labor markets, and foreign-exchange volatility.
- A Swedish tax assessment related to a 2013 intercompany intellectual-property transfer was decided adversely in June 2022 for approximately $80 million including penalties and interest. Xylem intends to appeal and has not recorded an unrecognized tax benefit because management believes it is more likely than not to prevail.
- The company expects a settlement charge of approximately £125 million, or about $150 million, when it completes the expected 2022 buy-out of its largest U.K. defined-benefit pension plan, primarily for previously unrecognized actuarial losses.
- Management identified potential future impairment risk for goodwill associated with the Advanced Infrastructure Analytics reporting unit if forecast cash flows deteriorate. Other principal risks include geopolitical events, the Russia-Ukraine war, cybersecurity, product liability, regulatory matters, refinancing and liquidity, tax changes, environmental obligations and further macroeconomic disruption.
Most important facts for investors to verify
- Whether price realization and productivity savings can offset inflation, logistics costs and strategic investment spending.
- The pace of semiconductor and component availability, particularly its effect on Measurement & Control Solutions and backlog conversion.
- Cash-flow normalization as inventory, receivables and supplier advances unwind.
- Refinancing or repayment plans for the €500 million senior notes due March 2023.
- The outcome and timing of the Swedish tax appeal and the expected U.K. pension-plan settlement charge.
- Progress against the 2022 revenue outlook, organic growth targets, restructuring-cost expectations and the $3.757 billion backlog.