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 segments. The filing covers the three months ended March 31, 2016, compared with the same period in 2015. The interim financial statements are unaudited and prepared under U.S. GAAP.
Financial Performance and Key Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $847 million | $837 million | Up 1.2%; up 4.4% constant currency |
| Gross profit | $329 million | $315 million | Up 4.4% |
| Gross margin | 38.8% | 37.6% | Up 120 basis points |
| Operating income | $79 million | $83 million | Down 4.8% |
| Operating margin | 9.3% | 9.9% | Down 60 basis points |
| Net income | $66 million | $64 million | Up 3.1% |
| Diluted EPS | $0.37 | $0.35 | Up 5.7% |
| Operating cash flow | $41 million | $39 million | Up $2 million |
| Free cash flow | $4 million | $2 million | Up $2 million |
- Adjusted operating income was $92 million, with a 10.9% adjusted operating margin, compared with $90 million and 10.8% in the prior-year quarter.
- Adjusted net income was $62 million, or $0.35 adjusted diluted EPS, compared with $60 million, or $0.33, in Q1 2015.
- Orders were $888 million, down 3.0% as reported and approximately flat organically. Backlog was $776 million at March 31, 2016, up 8.4% from December 31, 2015 but down 2.1% year over year; management expected 78% of backlog to convert to revenue during the remainder of 2016.
- Water Infrastructure revenue increased 2.8% as reported and 7.0% on a constant-currency basis. Applied Water revenue declined 1.2% as reported but increased 0.6% on a constant-currency basis.
- Cash and cash equivalents were $1.193 billion at March 31, 2016, compared with $680 million at December 31, 2015.
- Total debt was $1.873 billion, including $720 million classified as short-term debt and $1.153 billion as long-term debt. The revolving credit facility was undrawn, and the company reported compliance with applicable debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected $31 million of organic growth and $6 million from acquisitions, partly offset by a $27 million foreign-currency translation headwind.
- Gross margin improved from cost savings, global sourcing, continuous improvement initiatives and higher volume, partially offset by cost inflation and currency effects.
- Operating income declined because higher SG&A, research and development, restructuring and special charges more than offset gross-profit improvement.
- Applied Water operating income declined 15.2%, primarily due to strategic investments and unfavorable mix. Water Infrastructure operating income increased 14.9%, supported by volume, mix and cost savings.
- The effective tax rate improved to a 1.6% benefit from a 17.3% expense, primarily due to the recognition of previously unrecognized tax benefits following the effective settlement of a tax examination.
- Other comprehensive income was $26 million versus a $134 million loss in Q1 2015, mainly because of favorable foreign-currency translation.
- Xylem acquired Tideland Signal Corporation on February 1, 2016 for $70 million. Tideland had approximately $48 million of annual revenue and was included in Water Infrastructure results from the acquisition date.
- On March 11, 2016, Xylem issued €500 million of 2.250% senior notes due 2023. On April 11, 2016, after the reporting period, it settled its $600 million senior notes due 2016 for $607 million, including $7 million of make-whole interest; the related loss was to be recorded in Q2 2016.
Guidance, Outlook, Risks and Unusual Items
- Management continued to expect low-to-mid-single-digit organic revenue growth for full-year 2016.
- Public utilities and commercial markets were expected to provide the strongest growth. Residential markets were expected to be approximately flat, while oil and gas and mining remained sources of weakness.
- Management planned continued restructuring and realignment actions to improve the cost structure. The filing contains differing full-year restructuring cost references: approximately $25 million in the executive summary and approximately $15 million in the detailed restructuring discussion. This discrepancy should be verified against subsequent filings or management disclosures.
- Management expected approximately $5 million of total net savings during 2016 from actions taken and planned, with additional annual savings beginning in 2017.
- Key risks include foreign-currency volatility, international political and regulatory conditions, economic weakness in oil and gas and mining, customer order cancellations or delays, competition and pricing pressure, housing and weather conditions, acquisition integration, liquidity and refinancing, goodwill and intangible-asset impairment, product liability, cybersecurity, litigation and environmental obligations.
- Legal proceedings were described as incidental to operations and not expected to have a material adverse effect based on information available at filing. The Spanish competition matter was closed after payment of a €2.4 million fine in March 2016.
- Environmental liabilities accrued were $4 million. Standby letters of credit, bank guarantees and surety bonds totaled $174 million at March 31, 2016. The company also disclosed ongoing product warranty and postretirement obligations.
- Foreign subsidiaries held $719 million in cash or marketable securities. Management stated that current cash, operating cash flow, borrowing capacity and capital-market access were expected to provide sufficient liquidity for the next twelve months.
- Recently issued accounting guidance regarding share-based payments, leases, inventory, and revenue recognition had not yet been fully adopted; the company was evaluating the impacts of the applicable standards.
Important Facts for Investors to Verify
- Reconcile the conflicting full-year restructuring cost outlook of $25 million versus $15 million.
- Assess the effect of the April 11, 2016 debt settlement and its $7 million make-whole charge on Q2 results, leverage and interest expense.
- Monitor whether Water Infrastructure momentum offsets continued weakness in Applied Water residential, oil and gas, and mining markets.
- Evaluate cash conversion, given $41 million of operating cash flow, $4 million of free cash flow and significant working-capital movements.
- Track acquisition integration and contribution from Tideland Signal, including purchase accounting effects and expected synergies.
- Review foreign-currency exposure, hedging activities and the concentration of cash held by foreign subsidiaries.
- Confirm the treatment and timing of restructuring savings, postretirement contributions, environmental matters, guarantees and other contingencies.