Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem is a global water technology company serving the water cycle through three segments: Water Infrastructure, Applied Water, and Measurement & Control Solutions. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Financial Performance and Key Metrics
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Revenue | $1,317 million | $1,164 million | $2,534 million | $2,235 million |
| Gross profit | $519 million | $457 million | $979 million | $869 million |
| Gross margin | 39.4% | 39.3% | 38.6% | 38.9% |
| Operating income | $171 million | $137 million | $284 million | $223 million |
| Operating margin | 13.0% | 11.8% | 11.2% | 10.0% |
| Net income attributable to Xylem | $115 million | $99 million | $194 million | $155 million |
| Diluted EPS | $0.64 | $0.55 | $1.07 | $0.86 |
| Operating cash flow | Not separately provided | Not separately provided | $201 million | $151 million |
- Q2 revenue increased 13.1%; constant-currency revenue increased 10.7%, including 8.4% organic growth and $29 million of acquisition revenue.
- Six-month revenue increased 13.4%; constant-currency revenue increased 9.7%, including 7.8% organic growth and $49 million of acquisition revenue.
- Adjusted Q2 operating income was $182 million, with a 13.8% adjusted operating margin, compared with $153 million and 13.1% in 2017.
- Adjusted six-month operating income was $317 million, with a 12.5% adjusted operating margin, compared with $265 million and 11.9% in 2017.
- Six-month free cash flow was $90 million, or $91 million excluding Sensus acquisition-related costs, versus $74 million and $96 million, respectively, in 2017.
- Cash and cash equivalents were $321 million at June 30, 2018, compared with $414 million at December 31, 2017.
- Total debt was $2.54 billion, including $361 million classified as short-term borrowings and current maturities, compared with $2.20 billion at year-end 2017.
- The $600 million revolving credit facility was undrawn, and the company reported compliance with applicable debt covenants.
- Dividends declared were $0.21 per share in Q2 and $0.42 per share for the first six months. Xylem repurchased $58 million of common stock during the first half.
Material Changes Versus the Prior Comparable Period
- Revenue growth was broad-based: Q2 segment revenue increased 13.3% in Water Infrastructure, 7.5% in Applied Water, and 19.3% in Measurement & Control Solutions.
- Q2 operating margin expanded 120 basis points, supported by procurement and productivity savings, favorable volume, and price realization. Cost inflation, strategic investment spending, unfavorable mix, and purchase accounting effects were offsets.
- Six-month gross margin declined 30 basis points because of cost inflation, unfavorable mix, purchase accounting, and currency effects.
- Xylem acquired Pure Technologies on January 31, 2018, for approximately $420 million net of cash received. Pure contributed $29 million of Q2 revenue and $49 million for the first six months; its six-month operating loss was $2 million.
- Acquisition spending and higher capital expenditures drove investing cash outflows to $537 million, versus $69 million in the prior-year period. Capital expenditures were $111 million versus $77 million.
- Short-term debt increased substantially to fund the Pure acquisition, including a $261 million term loan and $98 million of commercial paper at June 30, 2018.
- Other comprehensive loss was $87 million in Q2 and $67 million for the first six months, compared with comprehensive income of $56 million and $98 million, respectively, in 2017. The principal driver was unfavorable foreign-currency translation.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2018 total revenue growth of 10% to 11%, including approximately 6% to 7% organic growth.
- Management expected approximately $45 million of 2018 integration, restructuring, and realignment costs, including approximately $23 million of restructuring costs, with approximately $2 million of total net savings expected during 2018.
- Backlog was $1.707 billion at June 30, 2018, up 11.5% from June 30, 2017. More than 50% was expected to convert to revenue during the remainder of 2018. Approximately $69 million of backlog related to acquisitions.
- Orders increased 13.7% in Q2 and 14.9% for the first six months. Management cited strength in utility, industrial, commercial, emerging-market, and infrastructure-related demand, while residential markets remained comparatively weaker.
- The Q2 effective tax rate increased to 23.2% from 16.8%; the six-month rate increased to 20.8% from 18.1%, primarily reflecting tax examination settlements and GILTI, partly offset by the lower U.S. federal tax rate.
- The company continued evaluating the Tax Cuts and Jobs Act, including GILTI and transition-tax accounting. The filing states that the accounting was not complete at quarter-end.
- Reported risks include foreign-exchange volatility, economic and geopolitical conditions, trade barriers, customer order cancellations or delays, competition and pricing pressure, housing-market weakness, acquisition integration, liquidity and refinancing, goodwill and intangible-asset impairment, product liability, cybersecurity, litigation, environmental matters, and regulatory compliance.
- General litigation accruals were $10 million, environmental accruals were $4 million, and product warranty accruals were $72 million at June 30, 2018. Xylem stated that it did not expect asserted or unasserted legal claims to have a material adverse effect, and that ITT remained responsible for specified legacy asbestos liabilities under indemnification arrangements.
Important Facts for Investors to Verify
- Whether the Pure Technologies acquisition achieves expected growth, synergies, and margin improvement, given its reported six-month operating loss and related purchase-accounting effects.
- The company’s ability to reduce working capital and sustain operating cash flow while funding acquisitions, capital expenditures, dividends, and share repurchases.
- Debt reduction, refinancing requirements, interest-rate exposure, and compliance with leverage and other covenants as the term loan and commercial paper mature.
- Progress against 2018 revenue, organic-growth, restructuring-cost, and savings expectations.
- Whether cost inflation, unfavorable mix, currency movements, and strategic investments continue to pressure margins, particularly in Measurement & Control Solutions.
- Final accounting for the Tax Cuts and Jobs Act and the resulting effect on future tax expense, cash taxes, and deferred taxes.
- Potential exposure from product warranties, environmental matters, litigation, indemnification obligations, and foreign-exchange movements.