Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving the water and wastewater cycle through three segments: Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited report covers the three months ended March 31, 2018, compared with the corresponding 2017 period.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $1,217 million | $1,071 million | 13.6% increase |
| Gross profit | $460 million | $412 million | 11.7% increase |
| Gross margin | 37.8% | 38.5% | Down 70 basis points |
| Operating income | $113 million | $86 million | 31.4% increase |
| Operating margin | 9.3% | 8.0% | Up 130 basis points |
| Net income | $79 million | $56 million | 41.1% increase |
| Diluted EPS | $0.43 | $0.31 | 38.7% increase |
| Cash flow from operations | $63 million | $52 million | 21.2% increase |
| Capital expenditures | $61 million | $43 million | Increase of $18 million |
| Free cash flow | $2 million | $9 million | Decrease of $7 million |
Adjusted operating income was $135 million, or an 11.1% adjusted margin, versus $112 million, or a 10.5% adjusted margin, in the prior-year quarter. Adjusted net income was $93 million, or $0.51 per diluted share, compared with $71 million, or $0.39 per share.
- Revenue growth at constant currency was 8.6%, including 7.2% organic growth, $20 million of acquisition revenue, and a $5 million divestiture-related reduction.
- Segment revenue was $480 million for Water Infrastructure, $366 million for Applied Water, and $371 million for Measurement & Control Solutions.
- Orders increased 16.1% to $1,320 million; total backlog was $1,735 million at March 31, 2018, up 28.3% year over year. Management expected approximately 55% of backlog to convert to revenue during the remainder of 2018.
- Cash and cash equivalents were $297 million at March 31, 2018, compared with $414 million at December 31, 2017.
- Total debt was $2,599 million, including $371 million classified as short-term debt and current maturities, compared with $2,200 million at year-end 2017. The revolving credit facility was undrawn, and the company reported compliance with its debt covenants.
- The company declared quarterly dividends of $0.21 per share, compared with $0.18 in the prior-year quarter, and repurchased approximately $33 million of common stock.
Material Changes Versus the Prior Comparable Period
- Revenue benefited from organic growth across all three segments, favorable foreign currency translation, and acquisitions. Measurement & Control Solutions also benefited from the Pure Technologies acquisition.
- On January 31, 2018, Xylem acquired Pure Technologies for approximately $420 million net of cash received, with preliminary total consideration of $434 million. Pure contributed $16 million of revenue and a $3 million operating loss during its two months in Xylem’s results.
- Operating results benefited from productivity initiatives, favorable volume, lower Sensus acquisition-related costs, and lower Applied Water special charges. These benefits were partly offset by cost inflation, unfavorable mix and currency effects, strategic investment spending, purchase accounting impacts, and higher restructuring costs.
- Gross margin declined despite higher gross profit, primarily because of cost inflation and unfavorable mix.
- Investing cash outflow increased to $491 million, primarily due to $430 million of acquisition spending and higher capital expenditures. Financing cash flow was positive $302 million, principally reflecting $371 million of short-term debt issued to help fund the Pure acquisition.
- The effective tax rate declined to 17.1% from 20.4%, primarily reflecting the lower U.S. federal corporate tax rate and jurisdictional earnings mix, partly offset by GILTI.
- Xylem adopted the new revenue recognition standard using the modified retrospective method without a material impact on reported financial results. It also adopted guidance permitting reclassification of Tax Act-related stranded tax effects, reducing AOCI and increasing retained earnings by $17 million.
Guidance, Outlook, Risks and Unusual Items
Management expects 2018 total revenue growth of 8% to 10%, including approximately 2% from recently announced acquisitions, with organic revenue growth of 4% to 6%. The company expects approximately $35 million of integration, restructuring and realignment costs during 2018, approximately $10 million of incremental net savings from 2017 actions, and an additional $3 million of net savings from 2018 actions.
Management expects full-year restructuring costs of approximately $15 million and approximately $2 million of total net savings from actions taken or expected in 2018. Restructuring activities include headcount reductions and facility consolidation in North American and European operations.
- Key risks include economic and political conditions, international operations, foreign currency, pricing pressure, housing and related markets, weather, channel-partner performance, customer order cancellations or delays, acquisition integration, refinancing and liquidity, goodwill and intangible asset impairment, product liability, cybersecurity, litigation, environmental matters, and governmental investigations.
- Pure Technologies purchase accounting remains preliminary and may be revised, particularly for intangible assets, liabilities, and tax-related items.
- Unrecognized tax benefits were $131 million at March 31, 2018. The company had not completed its accounting for certain Tax Act provisions, including the transition tax and GILTI.
- Restructuring and asset impairment charges were $10 million in Q1 2018 versus $12 million in Q1 2017; the prior-year amount included $5 million of asset impairment charges.
- Legal, environmental, warranty, and other contingencies were not expected by management to have a material adverse effect, although outcomes cannot be predicted with certainty. Accrued general litigation matters were $10 million, environmental matters were $4 million, and warranty accruals were $81 million at March 31, 2018.
Investor Verification Items
- Verify the final purchase accounting and integration progress for Pure Technologies, including the $262 million preliminary goodwill allocation and expected synergies.
- Monitor acquisition-related leverage, the $371 million of short-term acquisition financing, and the company’s ability to reduce debt while funding capital expenditures, dividends, and repurchases.
- Assess whether organic growth remains within the 4% to 6% 2018 outlook and whether the substantial backlog converts as expected.
- Track gross-margin pressure from inflation and mix against productivity savings and pricing actions.
- Confirm the final accounting effects of the Tax Act, including GILTI and transition-tax measurements, as well as the impact of remaining accounting pronouncements.
- Evaluate cash conversion, since operating cash flow increased but free cash flow declined to $2 million after elevated capital expenditures and acquisition-related activity.