Xylem Inc. Form 10-Q Summary
Business context and reporting period
Xylem provides equipment and services for water and wastewater applications through two segments: Water Infrastructure and Applied Water. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $897 million | $902 million | $2,676 million | $2,659 million |
| Gross profit | $357 million | $351 million | $1,055 million | $1,014 million |
| Gross margin | 39.8% | 38.9% | 39.4% | 38.1% |
| Operating income | $109 million | $120 million | $297 million | $307 million |
| Operating margin | 12.2% | 13.3% | 11.1% | 11.5% |
| Net income | $73 million | $88 million | $210 million | $226 million |
| Diluted EPS | $0.41 | $0.48 | $1.17 | $1.24 |
- Q3 revenue declined 0.6% year over year, but increased 1.0% on a constant-currency basis. Nine-month revenue increased 0.6%, or 2.7% on a constant-currency basis.
- Water Infrastructure revenue increased 0.5% in Q3 and 2.0% for nine months; Applied Water revenue declined 2.3% and 1.4%, respectively.
- Q3 orders were $946 million, up 0.7%; backlog was $775 million at September 30, 2016, down 4.6% from the prior year but up 8.2% from December 31, 2015. More than 55% of backlog was expected to convert to revenue during the remainder of 2016.
- Nine-month operating cash flow was $274 million versus $260 million. Free cash flow was $184 million versus $182 million, based on $90 million of capital expenditures.
- Cash and cash equivalents were $659 million at September 30, 2016, compared with $680 million at December 31, 2015. Total debt was $1.210 billion, including $62 million of short-term borrowings and current maturities.
- The $600 million revolving credit facility was undrawn, and the company reported compliance with applicable debt covenants. Commercial paper outstanding was $20 million.
- Total assets were $4.778 billion and stockholders’ equity was $2.227 billion at September 30, 2016.
Material changes versus the prior comparable period
- Gross margin improved 90 basis points in Q3 and 130 basis points for the nine-month period, primarily from global sourcing and continuous-improvement savings.
- Operating income declined 9.2% in Q3 and 3.3% for nine months. Reported results included higher restructuring and realignment costs, acquisition and integration costs, and other special charges.
- Adjusted Q3 operating income was $131 million, or a 14.6% margin, versus $124 million and 13.7% in 2015. Adjusted nine-month operating income was $344 million, or a 12.9% margin, versus $324 million and 12.2%.
- Adjusted Q3 EPS was $0.54 versus $0.49; adjusted nine-month EPS was $1.37 versus $1.25.
- Restructuring charges increased to $6 million in Q3 and $18 million for nine months, compared with $1 million and $5 million, respectively, in 2015. Management expected approximately $30 million of full-year restructuring costs and approximately $45 million of combined restructuring and realignment costs.
- Interest expense increased to $16 million in Q3 and $50 million for nine months, partly reflecting a $7 million make-whole payment related to the repayment of the 2016 senior notes and $4 million of bridge-facility fees.
- Xylem acquired Tideland Signal for $70 million on February 1, 2016. The company also announced the $1.7 billion Sensus acquisition, completed on October 31, 2016 after the reporting date.
- Foreign-currency effects reduced nine-month revenue by approximately $54 million. Other comprehensive loss improved to $17 million for nine months from $130 million in 2015, mainly because of more favorable currency translation.
Guidance, outlook, risks and unusual items
- Management continued to expect low-single-digit organic revenue growth for 2016.
- Management expected mid-single-digit declines in industrial markets, high-single-digit to low-double-digit growth in public utilities, low-single-digit commercial growth, low-single-digit residential declines and mid-single-digit agricultural declines.
- Management expected approximately $9 million of 2016 net savings from restructuring actions and approximately $23 million of annual future net savings beginning in 2017 from 2016 actions.
- The Sensus acquisition was a significant subsequent event. It was financed with cash, debt issuance, commercial paper and a €150 million term loan. Xylem issued $500 million of 3.250% senior notes due 2026 and $400 million of 4.375% senior notes due 2046 on October 11, 2016.
- Subsequent to quarter-end, Xylem acquired Visenti for $8 million, with contingent consideration of up to $4 million.
- Key disclosed risks include foreign-currency volatility, economic and market weakness, oil and gas and mining exposure, pricing pressure, order cancellations or delays, acquisition integration including Sensus, access to financing, leverage and liquidity, goodwill and intangible-asset impairment, product liability, cybersecurity, litigation, environmental obligations and governmental investigations.
- Standby letters of credit, bank guarantees and surety bonds totaled $177 million at September 30, 2016. Environmental liabilities accrued were $4 million, and product warranty accruals were $35 million.
- Management stated that asserted and unasserted legal claims were not expected to have a material adverse effect, and that liquidity was sufficient for the next twelve months. No material changes to previously disclosed risk factors were reported.
Most important facts to verify
- Post-quarter-end leverage, debt balances, covenant compliance and liquidity following completion and financing of the Sensus acquisition.
- The purchase accounting, goodwill, intangible assets and integration costs recorded for Sensus and Visenti.
- Whether expected organic growth and market-specific guidance were achieved, particularly in public utilities, industrial markets and Applied Water.
- Actual restructuring and realignment spending, timing of savings and impact on reported versus adjusted margins.
- Conversion of the $775 million backlog into revenue and any changes in orders, cancellations or project delays.
- Foreign-currency exposure, cash held by foreign subsidiaries and any potential tax cost of repatriation.