Xylem Inc. Form 10-Q Summary
Business Context and Reporting Period
Xylem provides equipment and services for water and wastewater applications through two reportable segments: Water Infrastructure and Applied Water. This unaudited Form 10-Q covers the three months ended March 31, 2015, compared with the three months ended March 31, 2014.
First-quarter 2014 segment information was recast to reflect the company’s geographic commercial-organization redesign; the recast did not affect consolidated historical results.
Financial Performance and Key Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $837 million | $906 million | Down 7.6% |
| Gross profit | $315 million | $342 million | Down 7.9% |
| Gross margin | 37.6% | 37.7% | Down 10 basis points |
| Operating income | $83 million | $76 million | Up 9.2% |
| Operating margin | 9.9% | 8.4% | Up 150 basis points |
| Net income | $64 million | $49 million | Up 30.6% |
| Diluted EPS | $0.35 | $0.27 | Up 29.6% |
| Operating cash flow | $39 million | $22 million | Up $17 million |
| Free cash flow | $2 million | $(3) million | Improved $5 million |
- Reported revenue was reduced primarily by a $73 million foreign-currency translation impact and a $5 million divestiture impact. Revenue increased 0.4% on a constant-currency basis, including 1.0% organic growth.
- Water Infrastructure revenue was $500 million, down 9.4% reported but up 0.4% at constant currency. Applied Water revenue was $337 million, down 4.8% reported but up 0.6% at constant currency.
- Orders were $915 million, down 7.9% year over year, or down 0.1% at constant currency. Backlog was $793 million at March 31, 2015, up 7.2% from December 31, 2014 and flat versus March 31, 2014; approximately 78% was expected to convert to revenue during the remainder of 2015.
- Operating income benefited from cost-saving initiatives, restructuring savings and lower restructuring charges. Restructuring and realignment costs were $6 million versus $18 million in the prior-year quarter; special charges were $1 million.
- Adjusted net income was $60 million versus $63 million, and adjusted diluted EPS was $0.33 versus $0.34. Reported net income included a $9 million gain from the sale of two nonmaterial businesses.
- The effective tax rate was 17.3% versus 19.1%, primarily reflecting the geographic mix of earnings.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $554 million at March 31, 2015, down from $663 million at December 31, 2014. The $109 million decrease reflected operating cash flow of $39 million, capital expenditures of $37 million, financing uses of $71 million and a $41 million foreign-exchange impact.
- Capital expenditures increased to $37 million from $25 million, primarily for manufacturing-facility improvements.
- Total debt was $1.276 billion, comprising $1.195 billion of long-term debt and $81 million of short-term borrowings and current maturities. The company had $600 million of 3.550% senior notes due in 2016 and $600 million of 4.875% senior notes due in 2021.
- A new five-year revolving credit facility provides $600 million of capacity, expandable to $800 million with lender consent, and was undrawn at quarter-end. The company was in compliance with all debt covenants.
- $76 million was outstanding under the European Investment Bank research and development facility and was classified as short-term debt because management intended to repay it within one year.
- Management stated that existing operating funds and borrowing capacity were expected to provide sufficient liquidity for the next twelve months. Foreign subsidiaries held $505 million in cash or marketable securities.
Material Changes Versus the Prior Comparable Period
- Revenue declined 7.6% on a reported basis, but was broadly stable on a constant-currency basis because organic growth offset divestiture effects.
- Operating margin improved by 150 basis points despite foreign-exchange, cost-inflation and pricing pressures.
- Reported net income and EPS increased, but adjusted net income and adjusted EPS declined modestly after excluding restructuring, special items and the divestiture gain.
- Operating cash flow improved substantially, while capital expenditures, share repurchases and dividends continued to consume cash.
- Other comprehensive loss increased to $134 million from $1 million, driven primarily by foreign-currency translation, particularly the weakening of the euro against the U.S. dollar.
- Restructuring accruals declined to $8 million from $19 million, and the company continued actions involving headcount reductions and facility consolidation.
- The company entered into the new $600 million revolving credit facility effective March 27, 2015.
Outlook, Commentary, Risks and Unusual Items
- Management continued to expect low-single-digit organic revenue growth for 2015, offset by a high-single-digit negative foreign-exchange translation impact.
- Expected market trends included strength in U.S. industrial markets excluding oil and gas, continued emerging-market and public-utility demand, low-to-mid-single-digit commercial growth, and flat-to-down low-single-digit residential growth.
- Management expected approximately $20 million of restructuring and realignment costs in 2015, approximately $16 million of incremental net savings from 2014 actions and an additional $2 million of net savings from 2015 actions. The filing separately states that approximately $10 million of restructuring costs were expected for the full year.
- The company recognized a $9 million gain on the sale of two businesses for $1 million of cash. The businesses were not material individually or in aggregate.
- Xylem South Korea was assessed an approximately $1.6 million fine by the Korea Fair Trade Commission for bid-rigging violations. Xylem broadened an internal investigation to include potential Foreign Corrupt Practices Act issues, voluntarily contacted the SEC and Department of Justice, and stated that potential liability could not yet be reasonably estimated.
- General legal matters were accrued at $6 million, environmental matters at $5 million and product warranty obligations at $30 million at March 31, 2015.
- Principal risks include foreign-currency exposure, international operations and compliance, order cancellations or delays, competition and pricing pressure, oil-and-gas weakness, housing and weather conditions, liquidity and refinancing needs, goodwill impairment, product liability, cybersecurity, litigation and governmental investigations.
- The company reported effective disclosure controls and procedures and no material change in internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether organic growth and backlog conversion offset the expected foreign-exchange headwinds during the remainder of 2015.
- The timing and refinancing plan for the $600 million of senior notes due in September 2016.
- Actual restructuring and realignment spending, savings realization and the apparent distinction between the $20 million combined outlook and the separately stated $10 million restructuring estimate.
- Developments, potential financial exposure and disclosure changes related to the Korea investigation and any SEC or DOJ actions.
- Whether operating cash flow remains sufficient to fund capital expenditures, dividends, share repurchases, pension contributions and the planned repayment of the $76 million EIB facility.
- The effect of currency movements, pricing pressure, oil-and-gas weakness and geographic mix on gross margin and adjusted earnings.