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(Address
of principal executive offices) (Zip code)
(i914) i323-5700
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title
of each class
Trading Symbol(s)
Name of each exchange of which registered
iCommon Stock, par value $0.01 per share
iXYL
iNew
York Stock Exchange
i2.250% Senior Notes due 2023
iXYL23
iNew
York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☑ No ☐
Indicate
by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). iYes☑ No ☐
Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☑
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☑
As of October 25, 2019, there were i180,078,871
outstanding shares of the registrant’s common stock, par value $0.01 per share.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. iBackground
and Basis of Presentation
Background
Xylem Inc. (“Xylem” or the “Company”) is a leading equipment and service provider for water and wastewater applications with a broad portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment.
Xylem operates in ithree segments, Water Infrastructure, Applied Water and
Measurement & Control Solutions. See Note 20, "Segment Information" to the condensed consolidated financial statements for further segment background information.
Except as otherwise indicated or unless the context otherwise requires, "Xylem,""we,""us,""our" and the "Company" refer to Xylem Inc. and its subsidiaries.
i
Basis of Presentation
The interim condensed consolidated financial statements
reflect our financial position and results of operations in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All intercompany transactions between our businesses have been eliminated.
The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules. We believe that the disclosures made are adequate to make the information presented not misleading. We consistently
applied the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2018 ("2018 Annual Report") in preparing these unaudited condensed consolidated financial statements, with the exception of accounting standard updates described in Note 2. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes included in our 2018 Annual Report.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Estimates are revised as additional information becomes available. Estimates
and assumptions are used for, but not limited to, postretirement obligations and assets, revenue recognition, income tax contingency accruals and valuation allowances, goodwill and indefinite lived intangible impairment testing, contingent liabilities and lease accounting. Actual results could differ from these estimates.
Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends on December 31. For ease of presentation, the condensed consolidated financial statements included herein are described as ending on the last day of the calendar quarter.
In June 2016, the FASB issued guidance amending the accounting for the impairment of financial instruments, including trade receivables. Under current guidance, credit losses are recognized when the applicable losses have a probable likelihood of occurring and this assessment is based on past events and current conditions. The amended guidance eliminates the “probable” threshold and requires an entity to use a broader range of information, including forecast information when estimating expected credit losses. Generally, this should result in a more timely recognition of credit losses. This guidance is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted for interim and annual periods beginning after December
15, 2018. The requirements of the amended guidance should be applied using a modified retrospective approach
7
except for debt securities, which require a prospective transition approach. We are evaluating the impact of the guidance on our financial condition and results of operations.
Recently Adopted Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued guidance regarding the accounting for implementation costs of a hosting arrangement that is a service contract. The guidance establishes the requirement to capitalize certain implementation costs incurred in a hosting arrangement that
is a service contract, effectively aligning with the requirement to capitalize certain implementation costs incurred to develop or obtain internal-use software. This guidance is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted. The requirements of the amended guidance may be applied using either a retrospective or prospective approach. We adopted this guidance prospectively as of April 1, 2019. This guidance did not have a material impact on our financial condition and results of operations.
In February 2016, the FASB issued guidance amending the accounting for leases. Specifically, the amended guidance requires all lessees to record
a lease liability at lease inception, with a corresponding right of use ("ROU") asset, except for short-term leases. Lessor accounting is not fundamentally changed. This amended guidance is effective for interim and annual periods beginning after December 15, 2018 using a modified retrospective approach. Early adoption was permitted. We adopted this guidance as of January 1, 2019 using the modified retrospective approach whereby prior comparative periods were not retrospectively restated in the condensed consolidated financial statements. The adoption of the standard resulted in the recognition of ROU assets and lease liabilities of $i267
millioni and $i265 million, respectively, as well as deferred tax assets and deferred tax liabilities of $i68
million, as of January 1, 2019, the date of initial application. The guidance did not have a material impact on our Condensed Consolidated Income Statements and Statements of Cash Flow. See Note 9, "Leases" for further details./
Note 3. iAcquisitions
and Divestitures
2019 Acquisitions
During the three and nine months ended September 30, 2019 we spent approximately $i0 million and $i18
million, net of cash received on acquisition activity, respectively.
2018 Acquisitions and Divestitures
Pure Technologies Ltd.
On January 31, 2018, we acquired all the issued and outstanding shares of Pure Technologies Ltd. (“Pure”), a leader in intelligent leak detection and condition assessment solutions for water distribution networks for approximately $i420
million, net of cash received. Acquisition costs of $i4 million were reflected as a component of selling, general and administrative expenses in our Condensed Consolidated Income Statement for the year ended December 31, 2018.
Pure’s results of operations were consolidated with
the Company effective February 1, 2018 and are reflected in the Measurement & Control Solutions segment.
8
The Pure purchase price allocation as of January 31, 2018 is shown in the following table:
i
(in
millions)
Amount
Cash
$
i14
Receivables
i23
Inventories
i4
Prepaid
and other current assets
i2
Property, plant and equipment
i22
Intangible
assets
i149
Other long-term assets
i1
Accounts
payable
(i3
)
Accrued and other current liabilities
(i12
)
Deferred
income tax liabilities
(i25
)
Other non-current accrued liabilities
(i2
)
Total
identifiable net assets
i173
Goodwill
i261
Total
consideration
$
i434
/
The
fair values of Pure's assets and liabilities were determined based on estimates and assumptions which management believes are reasonable.
Goodwill arising from the acquisition consists largely of synergies and economies of scale expected from combining the operations of Pure and Xylem. All of the goodwill was assigned to the Measurement & Control Solutions segment and is not deductible for tax purposes.
The estimate of the fair value of Pure identifiable intangible assets was determined primarily using the “income approach,” which requires a forecast of all of the expected future cash flows either through the use of the multi-period excess earnings method or the relief-from-royalty method. Some of the more significant assumptions inherent in the development of intangible
asset values include: the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows, the assessment of the intangible asset’s life cycle, as well as other factors. The following table summarizes key information underlying identifiable intangible assets related to the Pure acquisition:
i
Category
Life
Amount (in
millions)
Customer Relationships
17 - 18 years
$
i84
Technology
3
- 10 years
i38
Tradenames
20
years
i21
Internally
Developed Software
3 years
i6
Total
$
i149
/
The
following table summarizes, on an unaudited pro forma basis, the condensed combined results of operations of the Company for the three and nine month periods ended September 30, 2018 assuming the acquisition of Pure was made on January 1, 2017:
The
foregoing unaudited pro forma results are for informational purposes only and are not necessarily indicative of the actual results of operations that might have occurred had the acquisition occurred on January 1, 2017, nor are they necessarily indicative of future results. The pro forma financial information includes the impact of purchase accounting and other nonrecurring items directly attributable to the acquisition, which include:
•Amortization expense of acquired intangibles
•
Adjustments to the depreciation of property, plant and equipment reflecting the impact of the calculated fair value
of those assets in accordance with purchase accounting
•
Adjustments to interest expense to remove historical Pure interest costs and reflect Xylem's current debt profile
•The related tax impact of the above referenced adjustments
The pro forma results do not include any cost savings or operational synergies that may be generated or realized due to the acquisition of Pure.
During the three months ended September 30, 2018 Pure
had revenue and an operating loss of $i25 million and $i2
million, respectively. During the eight months ended September 30, 2018 Pure had revenue and an operating loss of $i67 million and $i5
million, respectively.
Other Acquisition Activity
During the three and nine months ended September 30, 2018 we spent approximately $i3 million
and $i13 million net of cash received on other acquisition activity.
During the third quarter we divested our Precision Die Casting business for approximately $i22
million, net of cash assumed. The sale resulted in an immaterial gain for the three and nine months ended September 30, 2018, which is reflected in gain from sale of business in our Condensed Consolidated Income Statement. The business, which was part of our Measurement & Controls Solutions segment, provided aluminum die casting products primarily to customers in the automotive sector. The business reported 2017 annual revenue of approximately $i32
million.
Note 4. iRevenue
Disaggregation of Revenue
i
The
following table illustrates the sources of revenue:
We receive payments from customers based on a billing schedule as established in our contracts. Contract assets relate to costs incurred to perform in advance of scheduled billings. Contract liabilities relate to payments received in advance of performance under the contracts. Changes in contract assets and liabilities are due to our performance under the contract.
i
The
table below provides contract assets, contract liabilities, and significant changes in contract assets and liabilities:
Excludes
receivable balances which are disclosed on the balance sheet
Performance obligations
Delivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cycles and delays can occur from time to time. As of September 30, 2019, the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied for contracts with performance obligations, amount to $i388
million. We expect to recognize the majority of revenue upon the completion of satisfying these performance obligations in the following i60 months. The Company elects to apply the practical expedient to exclude from this disclosure revenue related to performance obligations that are part of a contract whose
original expected duration is less than one year.
Note 5. iRestructuring and Asset Impairment Charges
Restructuring
From time to time, the Company will incur costs related to restructuring actions in order
to optimize our cost base and more strategically position ourselves based on the economic environment and customer demand. During the three and nine months ended September 30,2019, we recognized restructuring charges of $i26 million and $i48
million, respectively. We incurred these charges primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment.
During the three and nine months ended September 30,2018, we recognized restructuring charges of $i4
million and $i19 million, respectively. We incurred these charges primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment.
12
i
The
following table presents the components of restructuring expense and asset impairment charges:
Three Months Ended
Nine Months Ended
September
30,
September 30,
(in millions)
2019
2018
2019
2018
By component:
Severance
and other charges
$
i26
$
i4
$
i46
$
i18
Lease
related charges
i—
i—
i1
i1
Other
restructuring charges
i—
i—
i1
i—
Total
restructuring charges
$
i26
$
i4
$
i48
$
i19
Asset
impairment
i7
i—
i10
i—
Total
restructuring and asset impairment charges
$
i33
$
i4
$
i58
$
i19
By
segment:
Water Infrastructure
$
i6
$
i2
$
i17
$
i8
Applied
Water
i2
i1
i4
i2
Measurement
& Control Solutions
i25
i1
i37
i9
/i
The
following table displays a roll-forward of the restructuring accruals, presented on our Condensed Consolidated Balance Sheets within accrued and other current liabilities, for the nine months ended September 30, 2019 and 2018:
(in millions)
2019
2018
Restructuring
accruals - January 1
$
i5
$
i7
Restructuring
charges
i48
i19
Cash
payments
(i21
)
(i18
)
Foreign
currency and other
(i2
)
(i1
)
Restructuring
accruals - September 30
$
i30
$
i7
By
segment:
Water Infrastructure
$
i1
$
i1
Applied
Water
i1
i1
Measurement
& Control Solutions
i21
i3
Regional
selling locations (a)
i7
i2
Corporate
and other
i—
i—
/
(a)
Regional
selling locations consist primarily of selling and marketing organizations and related support services that incurred restructuring expense which was allocated to the segments. The liabilities associated with restructuring expense were not allocated to the segments.
i
The following is a roll-forward for the nine months endedSeptember 30, 2019 and 2018
of employee position eliminations associated with restructuring activities:
2019
2018
Planned reductions - January 1
i69
i47
Additional
planned reductions
i621
i176
Actual
reductions and reversals
(i465
)
(i135
)
Planned
reductions - September 30
i225
i88
/
13
i
The
following table presents expected restructuring spend for actions commenced as of September 30, 2019:
(in millions)
Water Infrastructure
Applied
Water
Measurement & Control Solutions
Corporate
Total
Actions Commenced in 2019:
Total
expected costs
$
i18
$
i5
$
i27
$
i—
$
i50
Costs
incurred during Q1 2019
i3
i—
i3
i—
i6
Costs
incurred during Q2 2019
i7
i2
i5
i—
i14
Costs
incurred during Q3 2019
i6
i2
i18
i—
i26
Total
expected costs remaining
$
i2
$
i1
$
i1
$
i—
$
i4
Actions
Commenced in 2018:
Total expected costs
$
i8
$
i1
$
i7
$
i—
$
i16
Costs
incurred during 2018
i7
i1
i7
i—
i15
Costs
incurred during Q1 2019
i1
i—
i—
i—
i1
Costs
incurred during Q2 2019
i—
i—
i—
i—
i—
Costs
incurred during Q3 2019
i—
i—
i—
i—
i—
Total
expected costs remaining
$
i—
$
i—
$
i—
$
i—
$
i—
Actions
Commenced in 2017:
Total expected costs
$
i12
$
i7
$
i4
$
i—
$
i23
Costs
incurred during 2017
i5
i4
i2
i—
i11
Costs
incurred during 2018
i2
i1
i1
i—
i4
Costs
incurred during Q1 2019
i—
i—
i1
i—
i1
Costs
incurred during Q2 2019
i—
i—
i—
i—
i—
Costs
incurred during Q3 2019
i—
i—
i—
i—
i—
Total
expected costs remaining
$
i5
$
i2
$
i—
$
i—
$
i7
/
The
Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges and are expected to continue through the end of 2019. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2018 consist primarily of severance charges and are complete. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2017 consist primarily of severance charges and are expected to continue through the fourth quarter of 2020.
Asset Impairment
During the third quarter of 2019 we determined that certain assets within our Measurement & Control Solutions segment, including customer relationships, internally developed software, proprietary technology, and plant property & equipment, were impaired. Accordingly we recognized an impairment charge
of $i7 million. Refer to Note 10, "Goodwill and Other Intangible Assets," for additional information.
During the first quarter of 2019 we determined that certain assets within our Measurement & Control Solutions segment, including a customer relationship, were impaired. Accordingly we recognized an impairment charge of $i3
million. Refer to Note 10, "Goodwill and Other Intangible Assets," for additional information.
14
Note 6. iIncome Taxes
Our quarterly provision for income
taxes is measured using an estimated annual effective tax rate, adjusted for discrete items within periods presented. The comparison of our effective tax rate between periods is significantly impacted by the level and mix of earnings and losses by tax jurisdiction and discrete items.
The income tax provision for the three months ended September 30, 2019 was a benefit of $i77 million resulting
in an effective tax rate of i623.6% (on a pre-tax loss for the period), compared to a $i31 million
charge resulting in an effective tax rate of i19.0% for the same period in 2018. The income tax provision for the nine months ended September 30, 2019 was a benefit of $i45
million resulting in an effective tax rate of (i18.9)%, compared to an $i82
million charge resulting in an effective tax rate of i20.1% for the same period in 2018. The effective tax rates for the three and nine month periods ended September 30, 2019 differ from the United States federal statutory rate primarily due to the income tax benefit that resulted from changes in tax law in Switzerland and the impact of the goodwill impairment
charge on income before taxes in 2019.
Unrecognized Tax Benefits
We recognize tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities or litigation, based on the technical merits of the position. The tax benefits recognized in the condensed consolidated financial statements from such positions are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The amount of unrecognized tax benefits at September 30, 2019 was $i126
million, as compared to $i136 million at December 31, 2018, which if ultimately recognized will reduce our effective tax rate. We believe that it is reasonably possible that the unrecognized tax benefits will be reduced by approximately $i4
million within the next 12 months as a result of the expiration of certain statutes of limitations. We classify interest expense relating to unrecognized tax benefits as a component of other non-operating expense, net, and tax penalties as a component of income tax expense in our Condensed Consolidated Income Statements. As of September 30, 2019, we had $i8 million
of interest accrued for unrecognized tax benefits.
In June 2019, Xylem’s Swedish subsidiary received a tax assessment for the 2013 tax year related to the tax treatment of an intercompany transfer of certain intellectual property that was made in connection with a reorganization of our European businesses. The assessment asserts an aggregate amount of approximately $i80 million for tax, penalties and interest. In
July 2019, Xylem filed an appeal with the Administrative Court of Stockholm. Management, in consultation with external legal advisors, believes it is more likely than not that Xylem will prevail on the proposed assessment and intends to vigorously defend our position through litigation. At this time, we have not recorded any unrecognized tax benefits related to this uncertain tax position.
15
Note 7. iEarnings
Per Share
i
The following is a reconciliation of the shares used in calculating basic and diluted net earnings per share:
Weighted
average common shares outstanding — Basic
i180,072
i179,676
i179,938
i179,788
Plus
incremental shares from assumed conversions: (b)
Dilutive effect of stock options
i790
i895
i819
i903
Dilutive
effect of restricted stock units and performance share units
i350
i519
i402
i475
Weighted
average common shares outstanding — Diluted
i181,212
i181,090
i181,159
i181,166
Basic
earnings per share
$
i0.36
$
i0.73
$
i1.57
$
i1.80
Diluted
earnings per share
$
i0.36
$
i0.72
$
i1.56
$
i1.79
(a)
Restricted
stock unit awards containing rights to non-forfeitable dividends that participate in undistributed earnings with common shareholders are considered participating securities for purposes of computing earnings per share.
(b)
Incremental shares from stock options, restricted stock units and performance share units are computed by the treasury stock method. The weighted average shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented or were otherwise excluded under the treasury stock method. The treasury stock method calculates dilution assuming the exercise of all in-the-money options and vesting of restricted stock units and performance share
units, reduced by the repurchase of shares with the proceeds from the assumed exercises and unrecognized compensation expense for outstanding awards. Performance share units will be included in the treasury stock calculation of diluted earnings per share upon achievement of underlying performance or market conditions at the end of the reporting period. See Note 16, "Share-Based Compensation Plans" to the condensed consolidated financial statements for further detail on the performance share units.
Three
Months Ended
Nine Months Ended
September 30,
September 30,
(in thousands)
2019
2018
2019
2018
Stock
options
i1,390
i1,292
i1,401
i1,290
Restricted
stock units
i351
i334
i360
i338
Performance
share units
i391
i415
i439
i490
/
Note
8. iInventories
i
The components of total inventories are summarized as follows:
As discussed in Note 2, “Recently Issued Accounting Pronouncements,” Xylem adopted the new guidance on accounting for leases.
Leasing
Arrangements
We lease certain offices, manufacturing buildings, transportation equipment, machinery, computers and other equipment. Our most significant lease liabilities relate to real estate leases. These leases include renewal, termination or purchase options, and we have assessed these to determine whether it is reasonably certain for us to exercise any of the previously mentioned options. All periods relating to options that are reasonably certain to be exercised have been included in the lease term of the respective leases.
We have recorded ROU assets for lease arrangements that are reasonably certain to extend beyond 12 months. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments under the lease. ROU assets and liabilities are recognized at lease commencement date based on the present
value of lease payments over the lease term. The implicit rate within our leases is generally not determinable, and we use our incremental borrowing rate at the lease commencement date to determine the net present value of lease payments. The determination of the appropriate incremental borrowing rate requires judgment. We determine the appropriate incremental borrowing rate for each lease using our current borrowing rate, adjusted for various factors including geographic region, level of collateralization and term, to align with the term of the underlying lease.
Many of our leases are subject to payment adjustments to reflect annual changes in price indexes, such as the Consumer Price Index. While associated lease liabilities are not re-measured as a result of changes in the applicable price indexes, changes to required lease payments are treated as variable lease payments and recognized in the period in which the obligation
for those payments was incurred.
Leases with a lease term of 12 months or less, including renewal options that are reasonably certain to be exercised, that also do not include an option to purchase the underlying asset that is reasonably certain of exercise, are not recorded on the balance sheet. Instead, lease payments for these leases are recognized as a lease cost on a straight-line basis over the lease term.
We elected the package of practical expedients, which among other things, does not require reassessment of lease classification. Additionally, we have made an accounting policy election whereby we chose not to separate non-lease components from lease components in agreements in all leases which we are the lessee.
We did not identify any events or conditions during the three and nine
month periods ended September 30, 2019 to indicate that a reassessment or re-measurement of our existing leases was required. There were also no impairment indicators identified during the three and nine month periods ended September 30, 2019 that required an impairment test for the Company’s ROU assets or other long-lived assets in accordance with ASC 360-10.
Our current lease liabilities of $i60
million are included in "Accrued and other current liabilities" and our non-current lease liabilities of $i184 million are included in "Other non-current accrued liabilities" as of September 30, 2019. Our ROU asset balances are included in "Other non-current assets". The net balance of our ROU assets as of September 30,
2019 was $i247 million. These balances include an immaterial amount related to finance leases.
As of September 30, 2019,
the maturities of operating lease liabilities were as follows:
(in millions)
2019
$
i18
2020
i61
2021
i46
2022
i34
2023
i26
2024
i20
Thereafter
i59
Total
lease payments
i264
Less: Imputed interest
(i21
)
Total
$
i243
Disclosures
related to periods prior to adoption of the New Lease Standard as reported and provided in our 2018 Annual Report.
i
As of December 31, 2018, we were obligated to make minimum future rental payments under operating leases as follows:
(in millions)
2019
$
i76
2020
i61
2021
i43
2022
i33
2023
i22
Thereafter
i64
Total
lease payments
i299
/
Lessor arrangements
In addition to manufacturing and selling equipment, we also
lease out equipment to customers in exchange for consideration. These arrangements are generally short term in nature and predominantly involve the rental of pumps and accessories within the Water Infrastructure segment. Rental arrangements generally do not provide the customer the right to purchase the equipment as Xylem’s strategy is to rent these items over their useful lives. Customers may be billed based on daily, weekly or monthly rates depending on the expected rental period. We assessed that these arrangements constitute a lease under ASC 842, and have recognized them as operating leases. In situations where arrangements contain both the sale of products and a leasing component, contract consideration is allocated based on relative standalone selling price.
Total revenue from lease arrangements were $i65
million and $i188 million for the three and nine month periods ended September 30, 2019, respectively. Our gross assets available for rent and related accumulated amortization were $i262
million and $i171 million, respectively, as of September 30, 2019. Depreciation expense for these assets were $i7
million and $i21 million for the three and nine month periods ended September 30, 2019, respectively.
19
Note
10. iGoodwill and Other Intangible Assets
Goodwill
i
Changes in the carrying value of goodwill by reportable segment for the nine months ended September
30, 2019 are as follows:
During
the third quarter of 2019, the Company recorded a goodwill impairment charge of $148 million related to the Advanced Infrastructure Analytics (“AIA”) goodwill reporting unit. The impairment resulted from a downward revision of forecasted future cash flows. Factors that contributed to the revised forecast in the third quarter include lower than expected results as compared to prior forecasts, largely as a result of slower-than-expected conversion of pipeline opportunities to revenue. Additionally, we have continued to invest in the AIA platform ahead of the adoption curve, which has also impacted the near term profitability of the business. These factors drove the decrease in forecasted cash flows, and as such, the calculated fair value of the AIA reporting unit below its carrying value as of the third quarter.
To determine the fair
value of the AIA reporting unit, the Company used the income approach. Under the income approach, the fair value of the AIA reporting unit was based on the present value of the estimated cash flows that the reporting unit is expected to generate over its remaining life. Cash flow projections were based on management’s estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate was based on the weighted average cost of capital appropriate for the AIA reporting unit.
Other Intangible Assets
i
Information
regarding our other intangible assets is as follows:
Amortization
expense related to finite-lived intangible assets was $i35 million and $i104 million for the three
and nine months ended September 30, 2019, respectively, and $i34 million and $i108
million for the three and nine months ended September 30, 2018, respectively.
During the third quarter of 2019, the Company also assessed whether the carrying amounts of the AIA reporting unit’s long-lived assets may not be recoverable based on the revised forecasted cash flows, and therefore impaired. Our assessment resulted in an impairment charge of $i7
million, primarily related to customer relationships, proprietary technology, software and property, plant and equipment. The charge was calculated
20
using an income approach, which is considered a Level 3 input for fair value measurement, and is reflected in “Restructuring and asset impairment charges” in our Condensed Consolidated Income Statements.
During the first quarter of 2019, we determined that the intended use of a finite lived customer relationship within the test application of our Measurement & Control Solutions segment had changed. Accordingly we recorded a $i3
million impairment charge. The charge was also calculated using the income approach and is reflected in “Restructuring and asset impairment charges” in our Condensed Consolidated Income Statements.
Note 11. iDerivative Financial Instruments
Risk Management Objective of Using Derivatives
We
are exposed to certain risks arising from both our business operations and economic conditions, and we principally manage our exposures to these risks through management of our core business activities. Certain of our foreign operations expose us to fluctuations of foreign interest rates and exchange rates that may impact revenue, expenses, cash receipts, cash payments, and the value of our stockholders' equity. We enter into derivative financial instruments to protect the value or fix the amount of certain cash flows in terms of the functional currency of the business unit with that exposure and reduce the volatility in stockholders' equity.
Cash Flow Hedges of Foreign Exchange Risk
We are exposed to fluctuations in various foreign currencies against our functional currencies. We use foreign currency derivatives, including currency forward agreements, to manage our exposure to
fluctuations in the various exchange rates. Currency forward agreements involve fixing the foreign currency exchange rate for delivery of a specified amount of foreign currency on a specified date.
Certain business units with exposure to foreign currency exchange risks have designated certain currency forward agreements as cash flow hedges of forecasted intercompany inventory purchases and sales. Our principal currency exposures relate to the Euro, Swedish Krona, British Pound, Canadian Dollar, Polish Zloty and Australian Dollar. We had foreign exchange contracts with purchased notional amounts totaling $i117
million and $i506 million as of September 30, 2019 and December 31, 2018, respectively. As of September 30, 2019, our most significant foreign currency derivatives included
contracts to sell U.S. Dollar and purchase Euro, purchase Swedish Krona and sell Euro, sell British Pound and purchase Euro, purchase Polish Zloty and sell Euro, purchase U.S. Dollar and sell Canadian Dollar, and to sell Canadian Dollar and purchase Euro. The purchased notional amounts associated with these currency derivatives are $i45 million,
$i39 million, $i11
million, $i9 million, $i7
million and $i5 million, respectively. As of December 31, 2018, the purchased notional amounts associated with these currency derivatives were $i191
million, $i168 million, $i52
million, $i37 million, $i29
million and $i22 million, respectively.
Hedges of Net Investments in Foreign Operations
We are exposed to changes in foreign currencies impacting our net investments held in foreign subsidiaries.
Cross
Currency Swaps
Beginning in 2015, we entered into cross currency swaps to manage our exposure to fluctuations in the Euro-U.S. Dollar exchange rate. During the second quarter of 2019 we entered into additional cross currency swaps. The total notional amount of derivative instruments designated as net investment hedges was $i702 million and $i426
million as of September 30, 2019 and December 31, 2018, respectively.
Foreign Currency Denominated Debt
On March 11, 2016, we issued i2.250%
Senior Notes of €i500 million aggregate principal amount due March 2023. We designated the entirety of the outstanding balance, or $i544
million and $i566 million as of September 30, 2019 and December 31, 2018, respectively, net of unamortized discount, as a hedge of a
net investment in certain foreign subsidiaries.
21
i
The table below presents the effect of our derivative financial instruments on the Condensed Consolidated Income Statements and Statements of Comprehensive Income:
Amount
of (gain) loss reclassified from OCI into revenue (a)
i2
i1
i4
(i1
)
Amount
of loss reclassified from OCI into cost of revenue (a)
i1
i2
i3
i2
Net
Investment Hedges
Cross Currency Swaps
Amount
of gain (loss) recognized in OCI (a)
$
i31
$
(i5
)
$
i30
$
i8
Amount
of income recognized in Interest Expense
i4
i—
$
i11
$
i—
Foreign
Currency Denominated Debt
Amount of gain (loss) recognized in OCI (a)
$
i22
$
(i8
)
$
i23
$
i11
/
(a)
Effective
portion
As of September 30, 2019, $i8 million of net losses on cash flow hedges are expected to be reclassified into earnings in the next 12 months. The ineffective portion of a cash flow hedge is recognized immediately in Selling, general and administrative expenses in the Condensed Consolidated
Income Statements and was not material for the three and nine months ended September 30,2019 and 2018.
As of September 30, 2019, no gains or losses on the net investment hedges are expected to be reclassified into earnings over their duration. The net investment hedges did not experience any ineffectiveness for the three and nine months ended September 30,2019.
The fair values of our derivative assets and liabilities
are measured on a recurring basis using Level 2 inputs and are determined through the use of models that consider various assumptions including yield curves, time value and other measurements.
i
The fair values of our foreign exchange contracts currently included in our hedging program designated as hedging instruments were as follows:
The
fair value of our long-term debt, due in 2023, designated as a net investment hedge was $i583 million and $i599
million as of September 30, 2019 and December 31, 2018, respectively.
22
Note 12. iAccrued
and Other Current Liabilities
i
The components of total accrued and other current liabilities are as follows:
Less:
short-term borrowings and current maturities of long-term debt
i306
i257
Total
long-term debt
$
i2,030
$
i2,051
(a)
The
fair value of our Senior Notes was determined using quoted prices in active markets for identical securities, which are considered Level 1 inputs. The fair value of our Senior Notes due 2021 was $i631 million and $i620
million as of September 30, 2019 and December 31, 2018, respectively. The fair value of our Senior Notes due 2023 was $i583 million and $599 million as of September 30,
2019 and December 31, 2018, respectively. The fair value of our Senior Notes due 2026 was $i515 million and $i476
million as of September 30, 2019 and December 31, 2018, respectively. The fair value of our Senior Notes due 2046 was $i455 million and $i397
million as of September 30, 2019 and December 31, 2018, respectively.
/
(b)
The debt issuance costs and unamortized discount are recognized as a reduction in the carrying value of the Senior Notes in the Condensed Consolidated Balance Sheets and are being amortized to interest expense in our Condensed Consolidated Income Statements over the expected remaining terms of the Senior Notes.
Senior
Notes
On September 20, 2011, we issued i4.875% Senior Notes of $i600
million aggregate principal amount due October 2021 (the "Senior Notes due 2021"). On March 11, 2016, we issued i2.250% Senior Notes of €i500
million aggregate principal amount due March 2023 (the "Senior Notes due 2023"). On October 11, 2016, we issued i3.250% Senior Notes of $i500
million aggregate principal amount due October 2026 (the “Senior Notes due 2026”) and i4.375% Senior Notes of $i400
million aggregate principal amount due October 2046 (the “Senior Notes due 2046” and, together with the Senior Notes due 2021, the Senior Notes due 2023 and the Senior Notes due 2026, the “Senior Notes”).
The Senior Notes include covenants that restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale and leaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/or customary grace and cure periods). We may redeem the Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal to the principal amount of the Senior Notes to be redeemed, plus a make-whole premium. We may also redeem the Senior Notes in certain
23
other
circumstances, as set forth in the applicable Senior Notes indenture.
If a change of control triggering event (as defined in the applicable Senior Notes indenture) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to i101% of their principal
amount plus accrued and unpaid interest to the date of repurchase.
Interest on the Senior Notes due 2021 is payable on April 1 and October 1 of each year. Interest on the Senior Notes due 2023 is payable on March 11 of each year. Interest on the Senior Notes due 2026 and the Senior Notes due 2046 is payable on May 1 and November 1 of each year beginning on May 1, 2017. As of September 30, 2019, we are in compliance with all covenants for the Senior Notes.
Credit Facilities
2015 Five-Year Revolving Credit Facility
Effective March 27, 2015, Xylem entered
into a Five-Year Revolving Credit Facility (the "2015 Credit Facility") with Citibank, N.A., as Administrative Agent, and a syndicate of lenders. The 2015 Credit Facility provided for an aggregate principal amount of up to $i600 million of: (i) revolving extensions of credit (the "revolving loans") outstanding at any time and (ii) the issuance of letters of
credit in a face amount not in excess of $i100 million outstanding at any time. The 2015 Credit Facility provided for increases of up to $i200
million for a maximum aggregate principle amount of $i800 million in aggregate principal amount at our request and with the consent of the institutions providing such increased commitments. On March 5, 2019 Xylem terminated the 2015 Credit Facility among the
Company, certain lenders and Citibank, N.A. as Administrative Agent.
2019 Five-Year Revolving Credit Facility
On March 5, 2019, Xylem entered into a Five-Year Revolving Credit Facility (the “2019 Credit Facility”) with Citibank, N.A., as Administrative Agent, and a syndicate of lenders. The 2019 Credit Facility provides for an aggregate principal amount of up to $i800
million (available in U.S. Dollars and in Euros), with increases of up to $i200 million for a maximum aggregate principal amount of $i1
billion at the request of Xylem and with the consent of the institutions providing such increased commitments.
Interest on all loans under the 2019 Credit Facility is payable either quarterly or at the expiration of any LIBOR or EURIBOR interest period applicable thereto. Borrowings accrue interest at a rate equal to, at Xylem's election, a base rate or an adjusted LIBOR or EURIBOR rate plus an applicable margin. The 2019 Credit Facility includes customary provisions for implementation of replacement rates for LIBOR-based and EURIBOR-based loans. The 2019 Credit Facility also includes a pricing grid that determines the applicable margin based on Xylem's credit rating, with a further adjustment depending on Xylem's annual Sustainalytics Environmental, Social and Governance score. Xylem will also pay quarterly fees to each lender for such lender’s
commitment to lend accruing on such commitment at a rate based on our credit rating, whether such commitment is used or unused, as well as a quarterly letter of credit fee accruing on the letter of credit exposure of such lender during the preceding quarter at a rate based on the credit rating of Xylem (as adjusted for the Environmental, Social and Governance score).
The 2019 Credit facility requires that Xylem maintain a consolidated total debt to consolidated EBITDA ratio, which will be based on the last four fiscal quarters, and in addition a number of customary covenants, including limitations on the incurrence of secured debt and debt of subsidiaries, liens, sale and lease-back transactions, mergers, consolidations, liquidations, dissolutions and sales of assets. The 2019 Credit
Agreement also contains customary events of default. Finally, Xylem has the ability to designate subsidiaries that can borrow under the 2019 Credit Facility, subject to certain requirements and conditions set forth in the 2019 Credit Agreement. As of September 30, 2019, the 2019 Credit Facility was undrawn and we are in compliance with all covenants.
Commercial Paper
U.S. Dollar Commercial Paper Program
Our U.S. Dollar commercial paper program generally serves as a means of short-term funding with a $i600
million maximum issuing balance and a combined limit of $i800 million inclusive of the 2019 Five-Year Revolving Credit Facility. As of September 30, 2019 and December 31,
2018, none of the Company's $i600 million U.S. Dollar commercial paper program was outstanding. We have the ability to continue borrowing under this program going forward in in future periods.
24
Euro Commercial
Paper Program
On June 3, 2019 Xylem entered into a Euro commercial paper program with ING Bank N.V., as administrative agent, and a syndicate of dealers. The Euro commercial paper program provides for a maximum issuing balance of up to €i500 million (approximately $i547
million) which may be denominated in a variety of currencies. The maximum issuing balance may be increased in accordance with the Dealer Agreement. As of September 30, 2019, $i306 million of the Company's Euro commercial paper program was outstanding at a weighted average interest rate of (i0.20)%. We
have the ability to continue borrowing under this program going forward in future periods.
Term Loan Facility
On January 26, 2018, the Company’s subsidiary, Xylem Europe GmbH (the “borrower”) entered into a 12-month €i225 million (approximately $i246
million) term loan facility (the “Term Facility”) at an interest rate of i0.45% in which the terms are set forth in a Term Loan Agreement, among the borrower, the Company, as parent guarantor and ING Bank. The Company entered into a parental
guarantee in favor of ING Bank also dated January 26, 2018 to secure all present and future obligations of the borrower under the Term Loan Agreement. The Term Facility was used to partially fund the acquisition of Pure Technologies Ltd in 2018 and the maturity date has since been extended through February 2020. As of September 30, 2019 and December 31, 2018, $i0
million and $i257 million were outstanding under the Term Facility, respectively.
Note 14. iPostretirement
Benefit Plans
i
The components of net periodic benefit cost for our defined benefit pension plans are as follows:
Three
Months Ended
Nine Months Ended
September 30,
September 30,
(in millions)
2019
2018
2019
2018
Domestic
defined benefit pension plans:
Service cost
$
i1
$
—
$
i2
$
i2
Interest
cost
i1
i1
i3
i3
Expected
return on plan assets
(i2
)
(i2
)
(i6
)
(i5
)
Amortization
of net actuarial loss
i—
i1
i1
i2
Net
periodic benefit cost
$
i—
$
—
$
i—
$
i2
International
defined benefit pension plans:
Service cost
$
i2
$
i3
$
i7
$
i8
Interest
cost
i4
i5
i14
i15
Expected
return on plan assets
(i4
)
(i9
)
(i22
)
(i28
)
Amortization
of net actuarial loss
i2
i2
i6
i7
Settlement/Curtailment
i8
i—
i8
i1
Net
periodic benefit cost
$
i12
$
i1
$
i13
$
i3
Total
net periodic benefit cost
$
i12
$
i1
$
i13
$
i5
/
The
components of net periodic benefit cost other than the service cost component are included in the line item "Other non-operating income, net" in the Condensed Consolidated Income Statements.
The total net periodic benefit cost for other postretirement employee benefit plans was less than $i1 million for both the three and nine months ended September 30, 2019,
including net credits recognized into other comprehensive income ("OCI") of $i1 million and $i2
million, respectively, for the three and nine months ended September 30,2019. The total net periodic benefit cost for other postretirement employee benefit plans was less than $i1 million for both the three and nine months ended September 30, 2018, including net credits
recognized in OCI of $i1 million and $i2
million, respectively, for the three and nine months ended September 30,2018.
25
We contributed $i14 million and $i37
million to our defined benefit plans during the nine months ended September 30, 2019 and 2018, respectively. Discretionary contributions of $i19 million were made to the U.S. Plan in the third quarter of 2018, to increase the funding ratio and reduce regulatory fees. Additional contributions
ranging between approximately $i4 million and $i8
million are expected during the remainder of 2019.
The Company has initiated the process for a full buy-out of its largest defined benefit plan in the UK. In order to prepare for a buy-out, the plan’s assets were converted to cash, cash equivalents or other highly liquid assets as of the third quarter. In addition, the Company completed an enhanced transfer value (“ETV”) exercise for the deferred vested participants of the plan. The ETV offered the participants an enhanced lump sum to transfer their full pension rights out of the plan. Lump sum payments of $i21
million were paid out of the plan assets, and the Company recorded a settlement charge of $i8 million during the quarter. Prior to the settlement accounting, the plan was re-measured as of July
31, 2019, resulting in an increase in the plan’s projected benefit obligation of $i37 million, an increase in plan assets of $i26
million and an increase to losses in accumulated other comprehensive income of $i11 million. The assumptions used to re-measure the plan were developed in the same manner as at December
31, 2018. However, due to the recent change in the investment assets, the expected rate of return on assets was changed from i7.25% to i0.70%. The
discount rate used in the re-measurement was i2.00%, down from i3.00%
at December 31, 2018. The Company recorded incremental net periodic benefit cost of $i3 million in the third quarter as a result of the re-measurement.
26
Note
15. iEquity
i
The following table shows the changes in stockholders' equity for the nine months ended
September 30, 2019:
Share-based compensation expense was $i7
million and $i23 million during the three and nine months ended September 30, 2019, respectively, and $i7
million and $i23 million during the three and nine months ended September 30,2018, respectively. The unrecognized compensation expense related to our stock options, restricted stock units and performance share units was $i7
million, $i26 million and $i18
million, respectively, at September 30, 2019 and is expected to be recognized over a weighted average period of i1.9, i2
and i1.9 years, respectively. The amount of cash received from the exercise of stock options was $i10
million and $i7 million for the nine months endedSeptember 30, 2019 and 2018, respectively.
28
Stock
Option Grants
i
The following is a summary of the changes in outstanding stock options for the nine months ended September 30, 2019:
The
total intrinsic value of options exercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during the nine months ended September 30, 2019 was $i11.9 million.
Stock Option
Fair Value
The fair value of each option grant was estimated on the date of grant using the binomial lattice pricing model which incorporates multiple and variable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility and changes in dividends. iThe following are weighted-average assumptions for 2019 grants:
Volatility
i24.10
%
Risk-free
interest rate
i2.55
%
Dividend yield
i1.30
%
Expected
term (in years)
i5.4
Weighted-average fair value / share
$
i17.04
Expected
volatility is calculated based on a weighted analysis of historic and implied volatility measures for a set of peer companies and Xylem. We use historical data to estimate option exercise and employee termination behavior within the valuation model. Employee groups and option characteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options are expected to remain outstanding. The risk-free rate is based on the United States Treasury yield curve in effect at the time of option grant.
Restricted Stock Unit Grants
i
The
following is a summary of restricted stock unit activity for the nine months ended September 30, 2019. The fair value of the restricted share unit awards is determined using the closing price of our common stock on date of grant.
The following is a summary of Return on Invested Capital ("ROIC") performance share unit grants for the nine months ended September 30, 2019. The fair value of the ROIC performance share units is equal to the closing share price on the date of the grant.
(a)
Represents an increase in the number of original ROIC performance share units awarded based on the final performance criteria achievement at the end of the performance period of such awards.
TSR Performance Share Unit Grants
The following is a summary of our Total Shareholder Return ("TSR") performance share unit grants for the nine months ended September 30, 2019:
(a)
Represents an increase in the number of original TSR performance share units awarded based on the final market condition achievement at the end of the performance period of such awards.
i
The fair value of TSR performance share units was calculated on the date of grant using a Monte Carlo simulation model utilizing several key assumptions, including expected Company and peer company share price volatility, correlation coefficients between peers, the risk-free rate of return, the expected dividend
yield and other award design features. The following are weighted-average assumptions for 2019 grants:
Volatility
i20.9
%
Risk-free
interest rate
i2.52
%
/
Note
17. iCapital Stock
For the three and nine months ended September 30, 2019the Company repurchased common stock of less than i0.1
million shares for less than $i1 million and approximately i0.5
million shares for $i39 million, respectively. Repurchases include both share repurchase programs approved by the Board of Directors and repurchases in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock units. The details of repurchases by each program are as follows:
30
On
August 24, 2015, our Board of Directors authorized the repurchase of up to $i500 million in shares with no expiration date. The program's objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. There were ino
shares repurchased under this program for the three months ended September 30, 2019. For the nine months endedSeptember 30, 2019, we repurchased approximately i0.3 million shares for $i25
million. There were ino shares repurchased under this program for the three months ended September 30, 2018. For the nine months ended September 30, 2018, we repurchased approximately i0.7
million shares for $i50 million. There are up to $i338
million in shares that may still be purchased under this plan as of September 30, 2019.
Aside from the aforementioned repurchase program, we repurchased less than i0.1 million shares and approximately i0.2
million shares for less than $i1 million and approximately $i14
million for the three and nine months ended September 30,2019, respectively, in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock units. Likewise, we repurchased less than i0.1 million shares and approximately i0.1
million shares for less than $i1 million and approximately $i8
million for the three and nine months ended September 30, 2018, respectively.
31
Note 18. iAccumulated Other
Comprehensive Loss
i
The following table provides the components of accumulated other comprehensive loss for the nine months endedSeptember 30, 2019:
From time to time we are involved in legal and regulatory proceedings that are incidental to the operation of our businesses (or the business operations of previously owned entities). These proceedings may seek remedies relating to environmental matters, tax, intellectual property matters, acquisitions or divestitures, product liability and personal injury claims, privacy, employment, labor and pension matters,
government contract issues and commercial or contractual disputes.
From time to time claims may be asserted against Xylem alleging injury caused by any of our products resulting from asbestos exposure. We believe there are numerous legal defenses available for such claims and would defend ourselves vigorously. Pursuant to the Distribution Agreement among ITT Corporation (now ITT LLC),
33
Exelis and Xylem, ITT Corporation (now ITT LLC) has an obligation to indemnify, defend and hold Xylem harmless for asbestos product liability matters, including settlements, judgments, and legal defense costs associated with all pending and future claims that may arise from past sales of
ITT’s legacy products. We believe ITT Corporation (now ITT LLC) remains a substantial entity with sufficient financial resources to honor its obligations to us.
See Note 6 "Income Taxes", of our condensed consolidated financial statements for a description of a pending tax litigation matter.
Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claims, we do not believe it is reasonably possible that any asserted or unasserted legal claims or proceedings, individually or in aggregate, will have a material adverse effect on our results of operations, or financial condition. We have estimated and accrued $i6
million and $i7 million as of September 30, 2019 and December 31, 2018, respectively, for these general litigation matters.
Indemnifications
As part of our 2011 spin-off from our former parent, ITT Corporation (now ITT
LLC), Exelis Inc. and Xylem will indemnify, defend and hold harmless each of the other parties with respect to such parties’ assumed or retained liabilities under the Distribution Agreement and breaches of the Distribution Agreement or related spin agreements. The former parent’s indemnification obligations include asserted and unasserted asbestos and silica liability claims that relate to the presence or alleged presence of asbestos or silica in products manufactured, repaired or sold prior to October 31, 2011, the Distribution Date, subject to limited exceptions with respect to certain employee claims, or in the structure or material of any building or facility, subject to exceptions with respect to employee claims relating to Xylem buildings or facilities. The indemnification associated with pending and future asbestos claims does not expire. Xylem has not recorded a liability for material matters for which we expect
to be indemnified by the former parent or Exelis Inc. through the Distribution Agreement and we are not aware of any claims or other circumstances that would give rise to material payments from us under such indemnifications. On May 29, 2015, Harris Inc. acquired Exelis. As the parent of Exelis, Harris Inc. is responsible for Exelis’ indemnification obligations under the Distribution Agreement.
Guarantees
We obtain certain stand-by letters of credit, bank guarantees, surety bonds and insurance letters of credit from third-party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance related requirements. As of September 30,
2019 and December 31, 2018, the amount of stand-by letters of credit, bank guarantees and surety bonds was $i302 million and $i275
million, respectively.
Environmental
In the ordinary course of business, we are subject to federal, state, local, and foreign environmental laws and regulations. We are responsible, or are alleged to be responsible, for ongoing environmental investigation and remediation of sites in various countries. These sites are in various stages of investigation and/or remediation and in many of these proceedings our liability is considered de minimis. We have received notification from the United States Environmental Protection Agency, and from similar state and foreign environmental agencies, that a number of sites formerly or currently owned and/or operated by Xylem or for which we are responsible under the Distribution Agreement, and other properties or water supplies that may be or have been impacted from those operations, contain disposed or recycled materials
or wastes and require environmental investigation and/or remediation. These sites include instances where we have been identified as a potentially responsible party under federal and state environmental laws and regulations.
Accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. Our accrued liabilities for these environmental matters represent our best estimates related to the investigation and remediation of environmental media such as water, soil, soil vapor, air and structures, as well as related legal fees. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on
an undiscounted basis. We have estimated and accrued $i3 million and $i4
million as of September 30, 2019 and December 31, 2018, respectively, for environmental matters.
34
It is difficult to estimate the final costs of investigation and remediation due to various factors, including incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the extent of investigation or remediation and our share, if any, of liability for such conditions, the selection of alternative remedial approaches, and changes in environmental standards and regulatory requirements. We believe the total amount accrued is reasonable based
on existing facts and circumstances.
Warranties
i
We warrant numerous products, the terms of which vary widely. In general, we warrant products against defect and specific non-performance. The table below provides the changes in our product warranty accrual:
(in
millions)
2019
2018
Warranty accrual – January 1
$
i60
$
i82
Net
charges for product warranties in the period
i20
i16
Settlement
of warranty claims
(i32
)
(i33
)
Foreign
currency and other
(i2
)
i1
Warranty
accrual - September 30
$
i46
$
i66
/
Note
20. iSegment Information
Our business has three reportable segments: Water Infrastructure, Applied Water and Measurement & Control Solutions. When determining the reportable segments, the Company aggregated operating segments based on their similar economic and operating characteristics. The Water Infrastructure segment focuses on the transportation and treatment of water, offering a range of products including water and wastewater pumps, treatment equipment,
and controls and systems. The Applied Water segment serves many of the primary uses of water and focuses on the residential, commercial and industrial markets. The Applied Water segment's major products include pumps, valves, heat exchangers, controls and dispensing equipment. The Measurement & Control Solutions segment focuses on developing advanced technology solutions that enable intelligent use and conservation of critical water and energy resources as well as analytical instrumentation used in the testing of water. The Measurement & Control Solutions segment's major products include smart metering, networked communications, measurement and control technologies, critical infrastructure technologies, software and services including cloud-based analytics, remote monitoring and data management, leak detection and pressure monitoring solutions and testing equipment.
i
Additionally,
we have Regional selling locations, which consist primarily of selling and marketing organizations and related support services, that offer products and services across our reportable segments. Corporate and other consists of corporate office expenses including compensation, benefits, occupancy, depreciation, and other administrative costs, as well as charges related to certain matters, such as environmental matters, that are managed at a corporate level and are not included in the business segments in evaluating performance or allocating resources.
35
The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1 in the 2018
Annual Report). The following tables contain financial information for each reportable segment:
Three Months Ended
Nine Months Ended
September
30,
September 30,
(in millions)
2019
2018
2019
2018
Revenue:
Water
Infrastructure
$
i531
$
i541
$
i1,574
$
i1,567
Applied
Water
i376
i378
i1,149
i1,132
Measurement
& Control Solutions
i389
i368
i1,155
i1,122
Total
$
i1,296
$
i1,287
$
i3,878
$
i3,821
Operating
Income:
Water Infrastructure
$
i97
$
i99
$
i246
$
i240
Applied
Water
i61
i59
i179
i170
Measurement
& Control Solutions
(i136
)
i31
(i94
)
i95
Corporate
and other
(i11
)
(i13
)
(i40
)
(i45
)
Total
operating income
$
i11
$
i176
$
i291
$
i460
Interest
expense
$
i16
i21
$
i52
$
i63
Other
non-operating (expense) income, net
(i7
)
i4
(i2
)
i9
Gain
from sale of business
i—
i2
i1
i—
Income
before taxes
$
(i12
)
$
i161
$
i238
$
i406
Depreciation
and Amortization:
Water Infrastructure
$
i15
$
i17
$
i46
$
i50
Applied
Water
i5
i5
i17
i16
Measurement
& Control Solutions
i36
i34
i107
i107
Regional
selling locations (a)
i6
i5
i14
i15
Corporate
and other
i3
i2
i8
i7
Total
$
i65
$
i63
$
i192
$
i195
Capital
Expenditures:
Water Infrastructure
$
i14
$
i20
$
i65
$
i60
Applied
Water
i5
i5
i15
i19
Measurement
& Control Solutions
i21
i26
i74
i72
Regional
selling locations (b)
i4
i3
i13
i11
Corporate
and other
i2
i6
i8
i9
Total
$
i46
$
i60
$
i175
$
i171
(a)
Depreciation
and amortization expense incurred by the Regional selling locations was included in an overall allocation of Regional selling location costs to the segments; however, a certain portion of that expense was not specifically identified to a segment. That expense is captured in this Regional selling location line.
(b)
Represents capital expenditures incurred by the Regional selling locations not allocated to the segments.
36
ITEM 2.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed consolidated financial statements, including the notes, included elsewhere in this report on Form 10-Q (this "Report"). Except as otherwise indicated or unless the context otherwise requires, "Xylem,""we,""us,""our" and the "Company" refer to Xylem Inc. and its subsidiaries.
This Report contains information that may constitute “forward-looking statements" within the meaning of the Private Securities Litigation Act of 1995. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. Generally, the words “anticipate,”“estimate,”“expect,”“project,”“intend,”“plan,”“forecast,”“believe,”“target,”“will,”“could,”“would,”“should” and similar expressions identify forward-looking statements. However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. These forward-looking statements include any statements that are not historical in nature, including any statements about the capitalization of the Company, the Company’s restructuring and realignment, future strategic plans and other statements that describe the Company’s business strategy, outlook, objectives, plans, intentions or goals. All statements that
address operating or financial performance, events or developments that we expect or anticipate will occur in the future - including statements relating to orders, revenues, operating margins and earnings per share growth, and statements expressing general views about future operating results - are forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such forward-looking statements.
Factors that could cause results to differ materially from those anticipated include: overall economic and business conditions, political and other risks associated with our international operations, including military actions, economic sanctions or trade barriers including tariffs and embargoes that could affect customer markets and our business, and non-compliance
with laws, including foreign corrupt practice laws, data privacy, export and import laws and competition laws; potential for unexpected cancellations or delays of customer orders in our reported backlog; our exposure to fluctuations in foreign currency exchange rates; competition and pricing pressures in the markets we serve; the strength of housing and related markets; weather conditions; ability to retain and attract talent and key members of management; our relationship with and the performance of our channel partners; our ability to successfully identify, complete and integrate acquisitions; our ability to borrow or to refinance our existing indebtedness and availability of liquidity sufficient to meet our needs; uncertainty from the expected discontinuance of LIBOR and transition to any other interest rate benchmark; changes in the value of goodwill or intangible assets; risks relating to product defects, product liability and recalls; claims or investigations by
governmental or regulatory bodies; security breaches or other disruptions of our information technology systems; litigation and contingent liabilities; and other factors set forth under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 ("2018 Annual Report") and with subsequent filings we make with the Securities and Exchange Commission ("SEC").
All forward-looking statements made herein are based on information currently available to the Company as of the date of this Report. The Company undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise, except as required by law.
Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends on December 31. For ease of presentation, the reporting periods included herein are described as ending on the last day of the calendar quarter.
Overview
Xylem is a leading global water technology company. We design, manufacture and service highly engineered products and solutions ranging across a wide variety of critical applications in utility, industrial, residential and commercial building services settings. Our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery, measurement and use of drinking water to the collection, test and treatment of wastewater
to the return of water to the environment. Our product and service offerings are organized into three reportable segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Measurement & Control Solutions.
•
Water Infrastructure serves the water infrastructure sector with pump systems that transport water from aquifers, lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumping solutions that move the wastewater to treatment facilities where our mixers, biological treatment, monitoring and control systems provide the primary functions in
37
the
treatment process. We also provide sales and rental of specialty dewatering pumps and related equipment and services. Additionally, our offerings use monitoring and control, smart and connected technologies to allow for remote monitoring of performance and enable products to self-optimize pump operations maximizing energy efficiency and minimizing unplanned downtime and maintenance for our customers. In the Water Infrastructure segment, we provide the majority of our sales directly to customers along with strong applications expertise, while the remaining amount is through distribution partners.
•
Applied Water serves the usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning, and for
fire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers and controls provide cooling to power plants and manufacturing facilities, circulation for food and beverage processing, as well as boosting systems for agricultural irrigation. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with many of the leading independent distributors in the markets we serve, with the remainder going directly to customers.
•
Measurement & Control Solutions primarilyserves the utility infrastructure solutions and services sector by delivering communications, smart metering,
measurement and control technologies and critical infrastructure technologies that allow customers to more effectively use their distribution networks for the delivery, monitoring and control of critical resources such as water, electricity and natural gas. We also provide analytical instrumentation used to measure water quality, flow and level in clean water, wastewater, surface water and coastal environments. Additionally, we offer software and services including cloud-based analytics, remote monitoring and data management, leak detection, condition assessment, asset management and pressure monitoring solutions. We also offer smart lighting solutions that improve efficiency and public safety efforts across communities. In the Measurement & Control Solutions segment, we generate our sales through a combination of long-standing relationships with leading distributors and dedicated channel partners as well as direct sales depending on the regional availability
of distribution channels and the type of product.
Executive Summary
Xylem reported revenue for the third quarter of 2019 of $1,296 million, an increase of 0.7% compared to $1,287 million reported in the third quarter of 2018. On a constant currency basis, revenue increased by $33 million, or 2.6%, primarily consisting of organic revenue growth of $37 million, or 2.9%,
driven by growth across all segments and in the utility, residential and commercial end markets, which was marginally offset by a slight decline in the industrial end market. A decrease from revenue related to divestitures of $4 million partially offset the revenue growth during the quarter.
We generated operating income of $11 million (margin of 0.8%) during the third quarter of 2019, as compared to $176 million (margin of 13.7%) in 2018. Operating income in the third quarter of 2019 included unfavorable impacts from
increased special charges of $154 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $19 million during the period. Excluding the impact of these items, adjusted operating income was $196 million (adjusted margin of 15.1%) during the third quarter of 2019 as compared to $188 million (adjusted margin of 14.6%) in 2018. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives, including restructuring savings, and price realization, which were partially offset by cost inflation, increased cost of quality, unfavorable
mix and increased spending on strategic investments.
38
Additional financial highlights for the quarter ended September 30, 2019 include the following:
•
Orders of $1,346 million, down 0.7% from $1,356 million in the prior year, up 1.3% on an organic basis
•
Earnings
per share of $0.36, down 50% when compared to the prior year ($0.82, up 6.5% on an adjusted basis)
•
Cash flow from operating activities of $451 million for the nine months ended September 30, 2019, up 16.2% from the prior year. Free cash flow, excluding Sensus acquisition related costs, of $276 million increased $58 million over the
prior year, as higher operating cash flows were slightly offset by increased spending on capital investments.
Key Performance Indicators and Non-GAAP Measures
Management reviews key performance indicators including revenue, gross margins, segment operating income and margins, orders growth, working capital and backlog, among others. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases
and debt repayment. Excluding revenue, Xylem provides guidance only on a non-GAAP basis due to the inherent difficulty in forecasting certain amounts that would be included in GAAP earnings, such as discrete tax items, without unreasonable effort. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following items to represent non-GAAP measures as well as the related reconciling items to the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures may not be comparable to similarly titled measures reported by other companies, to be key performance
indicators:
•
"organic revenue" and "organic orders" defined as revenue and orders, respectively, excluding the impact of fluctuations in foreign currency translation and contributions from acquisitions and divestitures. Divestitures include sales of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate.
•
"constant
currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not the U.S. Dollar.
•
"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude, as applicable, restructuring and realignment costs, special charges, gains and losses from the sale of a business and tax-related special items. A reconciliation of adjusted net income is provided below.
Three
Months Ended
Nine Months Ended
September 30,
September 30,
(In millions, except for per share data)
2019
2018
2019
2018
Net
income & Earnings per share
$
65
$
0.36
$
130
$
0.72
$
283
$
1.56
$
324
$
1.79
Restructuring
and realignment, net of tax of $9 and $17 for 2019 and $3 and $10 for 2018
21
0.11
8
0.04
54
0.3
27
0.15
Special
charges, net of tax of $2 and $2 for 2019 and net of tax of $0 and $1 for 2018
164
0.91
1
0.01
168
0.93
7
0.04
Tax-related
special items
(101
)
(0.56
)
2
0.01
(118
)
(0.65
)
5
0.02
(Gain)
loss from sale of business, net of tax of $0 for 2019 and $0 for 2018
—
—
(2
)
(0.01
)
(1
)
(0.01
)
—
—
Adjusted
net income & Adjusted earnings per share
$
149
$
0.82
$
139
$
0.77
$
386
$
2.13
$
363
$
2.00
39
•
"adjusted
operating expenses" defined as operating expenses adjusted to exclude restructuring and realignment costs and special charges.
•
"adjusted operating income" defined as operating income, adjusted to exclude restructuring and realignment costs and special charges, and "adjusted operating margin" defined as adjusted operating income divided by total revenue.
•
“realignment costs” defined as costs not included in restructuring costs that are incurred as part of actions taken to reposition our business,
including items such as professional fees, severance, relocation, travel, facility set-up and other costs.
•
"Sensus acquisition related costs" defined as costs incurred by the Company associated with the acquisition of Sensus that are being reported within operating income. These costs include integration costs, acquisition costs, costs related to the recognition of the backlog intangible asset amortization recorded in purchase accounting.
•
“special
charges" defined as costs incurred by the Company, such as acquisition and integration related costs not included in "Sensus acquisition related costs", non-cash impairment charges and other special non-operating items, such as pension adjustments.
•
"tax-related special items" defined as tax items, such as tax return versus tax provision adjustments, tax exam impacts, tax law change impacts, significant reserves for cash repatriation, excess tax benefits/losses and other discrete tax adjustments.
•
"free
cash flow" defined as net cash from operating activities, as reported in the Statement of Cash Flows, less capital expenditures as well as adjustments for other significant items that impact current results which management believes are not related to our ongoing operations and performance. Our definition of "free cash flow" does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow.
Nine Months Ended
September
30,
(In millions)
2019
2018
Net cash provided by operating activities
$
451
$
388
Capital expenditures
(175
)
(171
)
Free
cash flow
$
276
$
217
Cash paid for Sensus acquisition related costs
$
—
$
(1
)
Free
cash flow, excluding Sensus acquisition related costs
$
276
$
218
•
“EBITDA” defined as earnings before interest, taxes, depreciation and amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to exclude share-based compensation, restructuring and
realignment costs, special charges and gain or loss from sale of businesses.
Three Months Ended
Nine Months Ended
September
30,
September 30,
(in millions)
2019
2018
2019
2018
Net Income
$
65
$
130
$
283
$
324
Income
tax (benefit) expense
(77
)
31
(45
)
82
Interest expense (income), net
14
20
49
60
Depreciation
30
29
88
87
Amortization
35
34
104
108
EBITDA
$
67
$
244
$
479
$
661
Share-based
compensation
$
7
$
7
23
23
Restructuring
and realignment
30
11
71
36
Special charges
166
1
170
8
(Gain)
loss from sale of business
—
(2
)
(1
)
—
Adjusted EBITDA
$
270
$
261
$
742
$
728
40
2019
Outlook
We anticipate total revenue growth of approximately 1% in 2019, with organic revenue growth anticipated to be in the range of 3% to 4%. The following is a summary of our organic revenue outlook by end market.
•
Utilities increased by approximately 6% organically through the third quarter driven by strength in the United States and the emerging markets, with the exception of Latin America, partially offset by weakness in Canada. For 2019, we expect organic growth in the mid-single-digit range (versus mid to high-single-digits) driven by healthy water and wastewater spending in the United States and smart meter and infrastructure
analytics growth opportunities. We also anticipate that a healthy infrastructure investment focus in the emerging markets will continue in China and India, offset by softer than anticipated conditions in Europe.
•
Industrial increased by approximately 2% organically through the third quarter driven by strength in the United States and Asia Pacific. For 2019, we expect flat to low-single-digit growth (versus low-single-digits) driven by softer than anticipated industrial conditions in North America as the oil and gas markets begin to decline after a strong 2018. We anticipate mixed market conditions outside of the United States with strength in Australia and India, offset by slowing growth in China
and softer than anticipated conditions in Europe and Latin America.
•
In the commercial markets, organic growth was approximately 6% through the third quarter driven bystrength in the emerging markets and North America, partially offset by weakness in western Europe. For 2019, we expect organic growth in the low to mid-single-digit range (versus mid-single-digits) as the overall market will begin to moderate after two years of strong performance. Organic growth will be driven by continued strength in the United States, moderating in the second half of the year, and the emerging markets led by initiatives in the China and India building markets, offset
by softness in Europe.
•
In the residential markets, organic growth was approximately 3% through the third quarter driven by strength in the United States and Asia Pacific, partially offset by weakness in western Europe and the Middle East and Africa. For 2019, we expect flat to low-single-digit growth primarily driven by continued competition in the United States replacement market as the housing market begins to stabilize. We also anticipate modest growth opportunities in China and other Asia Pacific countries for second water supply, offset by soft performance in Europe from weaker than anticipated economic conditions.
We will continue
to strategically execute restructuring and realignment actions primarily to reposition our European and North American businesses in an effort to optimize our cost structure and improve our operational efficiency and effectiveness. During 2019, we expect to incur between $75 million and $85 million in restructuring and realignment costs. We expect to realize approximately $7 million of incremental net savings in 2019 from actions initiated in 2018, and an additional $16 million of net savings from our 2019 actions.
We plan to continue to take actions and focus spending in 2019 on actions that allow us to make progress on our top strategic priorities. The priority of accelerating profitable growth
encompasses our initiatives to drive commercial excellence, grow in emerging markets and strengthen innovation and technology through creation of new centers of excellence, a streamlined approach to product development and strategic acquisitions. The priority of driving continuous improvement is an area where we will continue to work to create new opportunities to unlock savings by eliminating waste and increasing efficiencies, which is supported by efforts to expand and further deepen our talent pool. We plan to continue to deploy capital in smart, disciplined ways to develop and acquire solutions to address our customers’ challenges. Finally, we continue to work to improve cash performance and generate capital to return to our shareholders.
41
Results
of Operations
Three Months Ended
Nine Months Ended
September
30,
September 30,
(In millions)
2019
2018
Change
2019
2018
Change
Revenue
$
1,296
$
1,287
0.7
%
$
3,878
$
3,821
1.5
%
Gross
profit
509
505
0.8
%
1,509
1,484
1.7
%
Gross
margin
39.3
%
39.2
%
10
bp
38.9
%
38.8
%
10
bp
Total
operating expenses
498
329
51.4
%
1,218
1,024
18.9
%
Expense
to revenue ratio
38.4
%
25.6
%
1,280
bp
31.4
%
26.8
%
460
bp
Restructuring
and realignment costs
30
11
172.7
%
71
37
91.9
%
Special
charges
155
1
NM
159
8
NM
Adjusted
operating expenses
313
317
(1.3
)
%
988
979
0.9
%
Adjusted
operating expenses to revenue ratio
24.2
%
24.6
%
(40
)
bp
25.5
%
25.6
%
(10
)
bp
Operating
income
11
176
(93.8
)
%
291
460
(36.7
)
%
Operating
margin
0.8
%
13.7
%
(1,290
)
bp
7.5
%
12.0
%
(450
)
bp
Interest
and other non-operating expense, net
23
17
35.3
%
54
54
—
%
Gain
(loss) from sale of business
—
2
NM
1
—
NM
Income
tax (benefit) expense
(77
)
31
(348.4
)
%
(45
)
82
(154.9
)
%
Tax
rate
623.6
%
19.0
%
NM
(18.9
)%
20.1
%
(3,900
)
bp
Net
income
$
65
$
130
(50.0
)
%
$
283
$
324
(12.7
)
%
NM
- Not meaningful change
Revenue
Revenue generated during the three and nine months ended September 30,2019 was $1,296 million and $3,878 million, reflecting increases of $9 million, or 0.7%, and $57 million, or 1.5%, respectively, compared to the same prior year periods. On a constant currency basis, revenue grew 2.6% and 4.3% for the three and nine months
ended September 30,2019. The increases at constant currency consisted primarily of increases in organic revenue of $37 million, or 2.9%, and $182 million, or 4.8%, respectively, reflecting strong organic growth in the United States and all of our emerging market regions, except for Latin America, where organic revenue declined. There was a decrease in revenue related to divestitures of $4 million during the third quarter of 2019 and a net decrease in revenue related to acquisition and divestiture impacts of $18 million for the nine months ended September 30,
2019.
42
The following tables illustrate the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during the three and nine months ended September 30,2019:
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Total Xylem
(In millions)
$ Change
% Change
$ Change
% Change
$
Change
% Change
$ Change
% Change
2018 Revenue
$
541
$
378
$
368
$
1,287
Organic
growth
3
0.6
%
4
1.1
%
30
8.2
%
37
2.9
%
Acquisitions/Divestitures
—
—
%
—
—
%
(4
)
(1.1
)%
(4
)
(0.3
)%
Constant
currency
3
0.6
%
4
1.1
%
26
7.1
%
33
2.6
%
Foreign
currency translation (a)
(13
)
(2.4
)%
(6
)
(1.6
)%
(5
)
(1.4
)%
(24
)
(1.9
)%
Total
change in revenue
(10
)
(1.8
)%
(2
)
(0.5
)%
21
5.7
%
9
0.7
%
2019
Revenue
$
531
$
376
$
389
$
1,296
(a)
Foreign
currency translation impact for the quarter due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Chinese Yuan, the Australian Dollar and the Swedish Krona.
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Total Xylem
$ Change
% Change
$ Change
% Change
$
Change
% Change
$ Change
% Change
2018 Revenue
$
1,567
$
1,132
$
1,122
$
3,821
Organic
growth
66
4.2
%
43
3.8
%
73
6.5
%
182
4.8
%
Acquisitions/Divestitures
—
—
%
—
—
%
(18
)
(1.6
)%
(18
)
(0.5
)%
Constant
currency
66
4.2
%
43
3.8
%
55
4.9
%
164
4.3
%
Foreign
currency translation (a)
(59
)
(3.8
)%
(26
)
(2.3
)%
(22
)
(2.0
)%
(107
)
(2.8
)%
Total
change in revenue
7
0.4
%
17
1.5
%
33
2.9
%
57
1.5
%
2019
Revenue
$
1,574
$
1,149
$
1,155
$
3,878
(a)
Foreign
currency translation impact for the year due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Chinese Yuan, the Swedish Krona and the Australian Dollar.
Water Infrastructure
Water Infrastructure revenue decreased $10 million, or 1.8%, for the third quarter of 2019 (0.6% increase at constant currency) compared to the same period in 2018. Revenue growth was negatively impacted by $13 million of foreign currency translation, with the change at constant currency coming entirely
from organic growth of $3 million. Organic growth for the quarter was driven by strength in the utility end market, particularly in the United States, where we benefited from healthy order intake and strong market conditions and in western Europe from strong customer wins and project execution. Organic growth in the utility end market was partially offset by weakness in the industrial end market, particularly in North America where declines in the dewatering transport applications were only partially offset by growth in Asia Pacific during the quarter. Price realization also contributed to the organic growth in both end markets during the quarter.
From an application perspective, organic revenue growth for the third quarter was driven primarily by growth in our treatment application in the United States and western Europe, where we
benefited from strong project execution and healthy order intake during those regions. This growth was partially offset by declines in the emerging markets, primarily due to the lapping of a large Middle East project delivery in the prior year. Organic revenue from our transport application remained relatively flat compared to the prior year period as project revenues increased from deployments across Europe and the emerging markets, but were offset by soft market conditions in North America in the dewatering applications.
For the nine months endedSeptember 30, 2019, revenue increased $7 million, or 0.4% (4.2% increase at constant currency) as compared
to 2018. Revenue growth was negatively impacted by $59 million of foreign currency translation, with the change at constant currency coming entirely from organic growth of $66 million.
43
Organic growth for the nine month period was primarily driven by strength in the utility end market, particularly in the United States, where we benefited from healthy order intake and strong market conditions across all applications. The utility end market also saw growth in western Europe and Asia Pacific driven by strong project deployments during the period. Organic growth during the nine month
period was also driven by strength in the industrial end market, particularly in Asia Pacific and the United States over the first half of the year, where we benefited from healthy order intake and a strong mining market. Organic growth in the industrial end market was partially offset by declines in western Europe due to the timing of project deployments in the prior year. Organic growth in both end markets also benefited from price realization year over year.
From an application perspective, organic revenue growth for the nine months ended September 30, 2019 was driven primarily by our transport application. The transport application had strong organic revenue growth driven by project deliveries and price realization in the United States and the emerging markets. Transport also had strong organic growth from the global dewatering
rental business over the first half of the year, coming from strength in construction and mining in the United States and Australia. Organic revenue from our treatment application also contributed to the segment's growth driven by project deliveries in the United States and Asia Pacific where we benefited from healthy order intake coming into the year. This organic growth was partially offset by declines in the Middle East, Europe and Latin America, primarily due to the lapping of large treatment project deliveries in these regions in the prior year.
Applied Water
Applied Water revenue decreased $2 million, or 0.5%, for the third quarter of 2019 (1.1% increase
at constant currency) as compared to the prior year. Revenue was negatively impacted by $6 million of foreign currency translation for the quarter. Revenue growth at constant currency consisted of organic growth of $4 million, or 1.1%, which was driven by modest strength across all end markets. From an application perspective, organic revenue growth in the third quarter was led by strength in the building services application in the residential market in the United States and strong second water supply business in China, which was offset by declines in western Europe during the quarter. The industrial water application revenue grew modestly on an organic basis, primarily driven by market growth in Europe, while the building services application in the commercial market contributed modest
organic growth during the quarter. Price realization also contributed to the organic growth within the segment during the quarter.
For the nine months ended September 30, 2019, revenue increased $17 million, or 1.5% (3.8% increase at constant currency) as compared to the prior year period. Revenue was negatively impacted by $26 million of foreign currency translation for the period. Revenue growth at constant currency consisted of organic growth of $43 million, or 3.8%, which was primarily driven by strength in the commercial end market, as well as growth
in the industrial and residential end markets. From an application perspective, organic revenue growth during the nine month period was led by growth in the commercial building services application which was driven by market expansion in the emerging markets, primarily in the Middle East & Africa, strong price realization and healthy industry demand in the United States and product localization in China. The industrial water application revenue also grew organically, primarily driven by market growth in western Europe, coupled with customers stocking orders due to geopolitical concerns, and strength in the United States. Organic growth in residential building services came primarily from market growth in the Unites States and strong second water supply business in China, which was partially offset by declines in western Europe and the Middle East during the period. Organic growth within the segment also benefited
from price realization year over year.
Measurement & Control Solutions
Measurement & Control Solutions revenue increased $21 million, or 5.7%, for the third quarter of 2019 (7.1% at constant currency) as compared to the prior year. Revenue was negatively impacted by $5 million of foreign currency translation for the quarter. Revenue growth at constant currency was made up of organic revenue growth of $30 million, or 8.2%, which was partially offset by $4 million of
divestiture activity. Organic revenue growth for the quarter was driven by strength in the utility end market, primarily in the United States, the Middle East and western Europe. From an application perspective, organic revenue from the water application contributed very strong organic growth for the segment, with large project deployments in the Middle East, the United States and western Europe during the quarter. The energy application in the United States also contributed to the organic growth during the quarter, driven by gas project deployments which more than offset the lapping of large electric project deployments in the prior year. The test application had modest organic revenue growth during the quarter, while the software as a service ("SaaS") and other application remained relatively flat as compared to the prior year.
44
For
the nine months ended September 30, 2019, revenue increased $33 million, or 2.9%, (4.9% at constant currency) as compared to the prior year. Revenue was negatively impacted by $22 million of foreign currency translation during the nine month period. Revenue growth at constant currency was made up of organic revenue growth of $73 million, or 6.5%, partially offset by $18 million of reduced revenue related to the net acquisition and divestiture activity. Organic revenue growth for the period was driven by strength
in the utility end market, primarily in the United States, the Middle East and India, partially offset by declines in the United Kingdom and Canada. From an application perspective, organic revenue from the water application contributed the majority of the organic growth for the segment, with project deployments in the United States, the Middle East, western Europe and India during the period. The strong organic growth in the water application was partially offset by a slight decline in the SaaS and other application primarily due to the timing of a large software sale in the prior year in the United Kingdom. The energy application remained relatively flat as gas project deployments in the United States during the period were offset by the timing of a large electric project deployment in the prior year. The test application had modest organic growth as compared to the prior year.
Orders / Backlog
Orders
received during the third quarter of 2019 were $1,346 million, a decrease of $10 million, or 0.7%, over the prior year (1.0% increase at constant currency). Orders received during the nine months ended September 30, 2019 were $4,053 million, a slight decease of $1 million over the prior year (2.8% increase at constant currency). The order growth was negatively impacted by $24 million and $113 million
of foreign currency translation for the three and nine months ended September 30, 2019, respectively. The order growth at constant currency primarily consisted of organic order growth of 1.3% and 3.1% for the three and nine months ended September 30, 2019, respectively. Orders related to divestitures of $4 million reduced order growth during the third quarter of 2019 and net acquisition and divestiture activity of $13 million
reduced order growth during the nine months endedSeptember 30, 2019.
The following tables illustrate the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to orders during the three and nine months ended September 30,2019:
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Total Xylem
(in millions)
$ Change
% Change
$ Change
% Change
$ Change
% Change
$ Change
% Change
2018
Orders
$
537
$
377
$
442
$
1,356
Organic
Growth
62
11.5
%
5
1.3
%
(49
)
(11.1
)%
18
1.3
%
Acquisitions/(Divestitures)
—
—
%
—
—
%
(4
)
(0.9
)%
(4
)
(0.3
)%
Constant
Currency
62
11.5
%
5
1.3
%
(53
)
(12.0
)%
14
1.0
%
Foreign
currency translation (a)
(13
)
(2.4
)%
(6
)
(1.6
)%
(5
)
(1.1
)%
(24
)
(1.8
)%
Total
change in orders
49
9.1
%
(1
)
(0.3
)%
(58
)
(13.1
)%
(10
)
(0.7
)%
2019
Orders
$
586
$
376
$
384
$
1,346
(a)
Foreign
currency translation impact for the quarter due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Chinese Yuan, the Australian Dollar and the Swedish Krona.
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Total Xylem
(in millions)
$ Change
% Change
$ Change
% Change
$ Change
% Change
$ Change
% Change
2018
Orders
$
1,671
$
1,162
$
1,221
$
4,054
Organic
Growth
97
5.8
%
33
2.8
%
(5
)
(0.4
)%
125
3.1
%
Acquisitions/(Divestitures)
—
—
%
—
—
%
(13
)
(1.1
)%
(13
)
(0.3
)%
Constant
Currency
97
5.8
%
33
2.8
%
(18
)
(1.5
)%
112
2.8
%
Foreign
currency translation (a)
(64
)
(3.8
)%
(26
)
(2.2
)%
(23
)
(1.9
)%
(113
)
(2.8
)%
Total
change in orders
33
2.0
%
7
0.6
%
(41
)
(3.4
)%
(1
)
—
%
2019
Orders
$
1,704
$
1,169
$
1,180
$
4,053
(b)
Foreign
currency translation impact for the year due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Chinese Yuan, the Swedish Krona and the Australian Dollar.
45
Water Infrastructure
Water Infrastructure segment orders increased $49 million, or 9.1%, to $586 million (11.5% increase at constant currency) for the third quarter as compared to the prior year. Order growth for the segment was negatively impacted by $13 million
of foreign currency translation. The order increase on a constant currency basis was driven by organic order growth in the transport application. Transport organic order growth was primarily driven by a large smart city project order secured in India during the quarter, as well as strong pump order intake in North America and across Europe, partially offset by dewatering transport applications in Europe. Organic orders for the treatment application increased slightly during the quarter, primarily driven by order intake in China and North America, which were partially offset by a reduction of orders in Oceania and Europe during the quarter.
For the nine months ended September 30, 2019, orders increased $33 million, or 2.0%, to $1,704 million
(5.8% increase at constant currency) as compared to the same prior year period. Order growth for the segment was negatively impacted by $64 million of foreign currency translation. The order increase on a constant currency basis was driven by organic order growth in the transport application. Transport organic order growth was primarily driven by a large smart city project order secured in India during the quarter and strong market conditions, coupled with some price realization, in Europe, North America and China. Organic orders for the treatment application declined during the period, primarily driven by project timing in North America and the emerging markets due to the timing of large project orders in the prior year.
Applied Water
Applied Water segment orders decreased $1
million, or 0.3%, to $376 million (1.3% increase at constant currency) for the third quarter of 2019 as compared to the prior year. Order growth for the quarter was negatively impacted by $6 million of foreign currency translation. The order increase on a constant currency basis was primarily driven by strong commercial order intake in North America during the quarter.
For the nine months endedSeptember 30, 2019, orders increased $7 million,
or 0.6%, to $1,169 million (2.8% increase at constant currency) as compared to the same prior year period. Order growth for the period was negatively impacted by $26 million of foreign currency translation. The order increase on a constant currency basis was driven by strong order intake in the United States and China across all applications, which were partially offset by a reduction of orders in the Middle East.
Measurement & Control Solutions
Measurement & Control Solutions segment orders decreased $58 million, or 13.1%, to $384 million (12.0%
decrease at constant currency) for the third quarter of 2019 as compared to the third quarter of 2018, which had order growth in excess of 30%. Order intake during the quarter was negatively impacted by $5 million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline of $49 million, or 11.1%, and $4 million of divestiture activity. Over half the decrease in organic orders during the quarter was driven by the energy application, which had a few significant gas and electric deployment orders in the prior year that did not repeat. The water application saw a more modest decline in organic orders during the quarter as the lapping of large
prior year projects, coupled with some softening market conditions in North America, were largely offset by significant order growth within the AIA platform. SaaS and other experienced modest organic growth during the quarter, driven by order strength in North America. Organic orders for the test application declined during the quarter driven by project timing and soft market conditions in Europe.
For the nine months ended September 30, 2019, orders decreased $41 million, or 3.4%, to $1,180 million (1.5% decrease at constant currency) as compared to the same prior year period. Order intake during the period was negatively impacted by $23
million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline of $5 million, or 0.4%, and $13 million of the net acquisition and divestiture activity during the period. The decrease in organic orders for the nine-month period was driven by the similar factors affecting the third quarter.
46
Backlog
Backlog includes orders on hand as well as contractual customer agreements at the end of the period. Delivery schedules vary from customer to customer based on their requirements. Annual or multi-year contracts
are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. As such, beginning total backlog, plus orders, minus revenues, will not equal ending total backlog due to contract adjustments, foreign currency fluctuations, and other factors. Typically, large projects require longer lead production cycles and deployment schedules and delays can occur from time to time. Total backlog was $1,868 million at September 30, 2019, an increase of $126 million or 7.2%, as compared to September 30,
2018 backlog of $1,742 million, and an increase of $179 million or 10.6%, as compared to December 31, 2018 backlog of $1,689 million. We anticipate that approximately 40% of the backlog at September 30, 2019 will be recognized as revenue in the remainder of 2019.
Gross Margin
Gross margin as a percentage of revenue increased 10 basis points to 39.3% and 38.9%,
respectively, for both the three and nine months ended September 30,2019 as compared to 39.2% and 38.8%, respectively, for comparative 2018 periods. The slight gross margin increase for both the three and nine month periods were primarily driven by cost reductions from global procurement and productivity improvement initiatives and price realization, which were partially offset by cost inflation, unfavorable mix and lower overhead cost absorption.
Operating Expenses
The following table presents operating expenses for the three and nine months ended September
30,2019 and 2018:
Three Months Ended
Nine
Months Ended
September 30,
September 30,
(In millions)
2019
2018
Change
2019
2018
Change
Selling,
general and administrative expenses ("SG&A")
$
273
$
279
(2.2
)
%
$
870
$
868
0.2
%
SG&A
as a % of revenue
21.1
%
21.7
%
(60
)
bp
22.4
%
22.7
%
(30
)
bp
Research
and development expenses ("R&D")
44
46
(4.3
)
%
142
137
3.6
%
R&D
as a % of revenue
3.4
%
3.6
%
(20
)
bp
3.7
%
3.6
%
10
bp
Restructuring
and asset impairment charges
33
4
725.0
%
58
19
205.3
%
Goodwill
impairment charge
148
—
NM
148
—
NM
Operating
expenses
$
498
$
329
51.4
%
$
1,218
$
1,024
18.9
%
Expense
to revenue ratio
38.4
%
25.6
%
1,280
bp
31.4
%
26.8
%
460
bp
Selling,
General and Administrative ("SG&A") Expenses
SG&A expenses decreased by $6 million to $273 million, or 21.1% of revenue, in the third quarter of 2019, as compared to $279 million, or 21.7% of revenue, in the comparable 2018 period; and increased $2 million to $870 million, or 22.4% of revenue, in the nine months endedSeptember 30, 2019,
as compared to $868 million or 22.7% of revenue for the nine months ended in 2018. The improvement in SG&A as a percent of revenue for both periods was primarily driven by cost reductions from global procurement and productivity improvement initiatives, including restructuring savings, which were partially offset by cost inflation and additional investment in strategic growth initiatives.
Research and Development ("R&D") Expenses
R&D expense was $44 million, or 3.4% of revenue, in the third quarter of 2019,
as compared to $46 million or 3.6% of revenue in, the comparable period of 2018; and was $142 million, or 3.7% of revenue, in the nine months endedSeptember 30, 2019, as compared to $137 million or 3.6% of revenue in the comparable period of 2018. Additionally, we capitalized R&D on external sale software of $13 million and $46 million for the three and nine months ended September 30,
2019, as compared to $15 million and $48 million in the prior year periods. Our overall increased spending on R&D over the first nine months of the year is driven by development needs to drive new product growth.
47
Restructuring and Asset Impairment Charges
Restructuring
During the three and nine months ended September 30,2019, we recognized restructuring charges of $26 million and $48 million, respectively. We incurred these charges primarily as a continuation
of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions in our Applied Water segment. Included in the charges recorded during the three and nine months ended September 30,2019 were $0 million and $2 million, respectively, related to actions commenced in prior years.
During the three and nine months ended September 30,2018, we recognized restructuring
charges of $4 million and $19 million, respectively. We incurred these charges related to actions taken in 2018 primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment. Included in the charges recorded during the three and nine months ended September 30, 2018 were $2 million and $5 million, respectively, related to actions commenced in prior
years.
The following table presents expected restructuring spend for actions commenced as of September 30, 2019:
(in millions)
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Corporate
Total
Actions Commenced in 2019:
Total
expected costs
$
18
$
5
$
27
$
—
$
50
Costs
incurred during Q1 2019
3
—
3
—
6
Costs
incurred during Q2 2019
7
2
5
—
14
Costs
incurred during Q3 2019
6
2
18
—
26
Total
expected costs remaining
$
2
$
1
$
1
$
—
$
4
Actions
Commenced in 2018:
Total expected costs
$
8
$
1
$
7
$
—
$
16
Costs
incurred during 2018
7
1
7
—
15
Costs
incurred during Q1 2019
1
—
—
—
1
Costs
incurred during Q2 2019
—
—
—
—
—
Costs
incurred during Q3 2019
—
—
—
—
—
Total
expected costs remaining
$
—
$
—
$
—
$
—
$
—
Actions
Commenced in 2017:
Total expected costs
$
12
$
7
$
4
$
—
$
23
Costs
incurred during 2017
5
4
2
—
11
Costs
incurred during 2018
2
1
1
—
4
Costs
incurred during Q1 2019
—
—
1
—
1
Costs
incurred during Q2 2019
—
—
—
—
—
Costs
incurred during Q3 2019
—
—
—
—
—
Total
expected costs remaining
$
5
$
2
$
—
$
—
$
7
The
Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges and are expected to continue through the end of 2019. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2018 consist primarily of severance charges and are complete. The Water Infrastructure, Applied Water and Measurement & Control
48
Solutions actions commenced in 2017 consist primarily of severance charges and are expected to continue through the fourth quarter of 2020.
We currently expect to incur between $50 million and $60 million in restructuring costs for the full year. Included in these costs are costs to implement our Global Business Services platform, which
will enable us to simplify, standardize and centralize many of our transactional processes. As a result of all of the actions taken and expected to be taken in 2019, we anticipate approximately $15 million of total net savings to be realized during 2019.
Asset Impairment
During the three and nine months ended September 30, 2019, we determined that certain assets within our Measurement & Control Solutions segment, including customer relationships, internally developed software, proprietary technology, and plant property & equipment, were impaired. Accordingly we recognized impairment charges of $7 million and $10 million during these periods, respectively. Refer to Note 10, "Goodwill and Other Intangible Assets," for additional information.
Goodwill
Impairment Charge
During the third quarter of 2019, the Company recorded a goodwill impairment charge of $148 million related to the Advanced Infrastructure Analytics (“AIA”) goodwill reporting unit. The impairment resulted from a downward revision of forecasted future cash flows. Factors that contributed to the revised forecast in the third quarter include lower than expected results as compared to prior forecasts, largely as a result of slower-than-expected conversion of pipeline opportunities to revenue. Additionally, we have continued to invest in the AIA platform ahead of the adoption curve, which has also impacted the near term profitability of the business. These factors drove a decrease in the fair value, based on a discounted cash flow valuation, of the AIA reporting unit that is below its carrying value as of the third
quarter, requiring an impairment charge. Refer to Note 10, "Goodwill and Other Intangible Assets," for additional information.
Operating Income
Operating income during the third quarter of 2019 was $11 million, reflecting a decrease of 93.8% compared to $176 million in the third quarter of 2018. Operating margin was 0.8% for 2019 versus 13.7% for 2018,
a decrease of 1,290 basis points. Operating margin was negatively impacted by increased special charges of $154 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $19 million as compared to the prior year. Excluding these special charges and restructuring and realignment costs, adjusted operating income was $196 million with an adjusted operating margin of 15.1% in 2019 as compared to adjusted operating income of $188 million with an adjusted operating margin of 14.6% in the third quarter of 2018. The increase in adjusted operating margin was
primarily due to cost reductions from our global procurement and productivity initiatives, including restructuring savings, and improved price realization, which were partially offset by cost inflation, increased cost of quality, unfavorable mix and increased spending on strategic investments.
Operating income for the nine months endedSeptember 30, 2019 was $291 million, reflecting a decrease of 36.7% compared to $460 million in 2018. Operating margin was 7.5% for 2019 versus 12.0% for 2018, a decrease of 450 basis points. Operating margin for the nine months
was negatively impacted by increased special charges of $151 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $34 million as compared to the prior year. Excluding these special charges and restructuring and realignment costs, adjusted operating income was $521 million with an adjusted operating margin of 13.4% for the nine months endedSeptember 30, 2019 as compared to adjusted operating income of $505 million with an adjusted operating margin of 13.2% in 2018. The slight increase in adjusted operating margin was primarily due to cost reductions
from our global procurement and productivity initiatives, including restructuring savings, improved price realization and favorable volume impacts. These impacts were partially offset by cost inflation, increased spending on strategic investments, unfavorable mix, increased cost of quality and lower overhead cost absorption.
49
The table below provides a reconciliation of the total and each segment's operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin:
Three
Months Ended
Nine Months Ended
September 30,
September 30,
(In millions)
2019
2018
Change
2019
2018
Change
Water
Infrastructure
Operating
income
$
97
$
99
(2.0
)
%
$
246
$
240
2.5
%
Operating
margin
18.3
%
18.3
%
—
bp
15.6
%
15.3
%
30
bp
Restructuring
and realignment costs
7
5
40.0
%
25
15
66.7
%
Adjusted
operating income
$
104
$
104
—
%
$
271
$
255
6.3
%
Adjusted
operating margin
19.6
%
19.2
%
40
bp
17.2
%
16.3
%
90
bp
Applied
Water
Operating
income
$
61
$
59
3.4
%
$
179
$
170
5.3
%
Operating
margin
16.2
%
15.6
%
60
bp
15.6
%
15.0
%
60
bp
Restructuring
and realignment costs
3
2
50.0
%
10
7
42.9
%
Adjusted
operating income
$
64
$
61
4.9
%
$
189
$
177
6.8
%
Adjusted
operating margin
17.0
%
16.1
%
90
bp
16.4
%
15.6
%
80
bp
Measurement
& Control Solutions
Operating
income
$
(136
)
$
31
(538.7
)
%
$
(94
)
$
95
(198.9
)
%
Operating
margin
(35.0
)%
8.4
%
(4,340
)
bp
(8.1
)%
8.5
%
(1,660
)
bp
Restructuring
and realignment costs
20
4
400.0
%
36
15
140.0
%
Special
charges
155
—
NM
159
3
NM
Adjusted
operating income
$
39
$
35
11.4
%
$
101
$
113
(10.6
)
%
Adjusted
operating margin
10.0
%
9.5
%
50
bp
8.7
%
10.1
%
(140
)
bp
Corporate
and other
Operating
loss
$
(11
)
$
(13
)
(15.4
)
%
$
(40
)
$
(45
)
(11.1
)
%
Special
charges
—
1
NM
—
5
NM
Adjusted
operating loss
$
(11
)
$
(12
)
(8.3
)
%
$
(40
)
$
(40
)
—
%
Total
Xylem
Operating
income
$
11
$
176
(93.8
)
%
$
291
$
460
(36.7
)
%
Operating
margin
0.8
%
13.7
%
(1,290
)
bp
7.5
%
12.0
%
(450
)
bp
Restructuring
and realignment costs
30
11
172.7
%
71
37
91.9
%
Special
charges
155
1
NM
159
8
NM
Adjusted
operating income
$
196
$
188
4.3
%
$
521
$
505
3.2
%
Adjusted
operating margin
15.1
%
14.6
%
50
bp
13.4
%
13.2
%
20
bp
NM
- Not meaningful percentage change
50
Water Infrastructure
Operating income for our Water Infrastructure segment decreased $2 million, or 2.0%, for the third quarter of 2019 compared to the prior year, with operating margin remaining flat at 18.3%. Operating margin was negatively impacted by increased restructuring and realignment costs of $2 million in 2019. Excluding these restructuring and realignment costs, adjusted operating income remained flat at $104 million for both periods with adjusted
operating margin increasing from 19.2% to 19.6%. The increase in adjusted operating margin for the quarter was primarily due to cost reductions from our global procurement and productivity initiatives and improved price realization, which were partially offset by cost inflation, and unfavorable impacts from cost of quality, volume and mix.
For the nine months endedSeptember 30, 2019, operating income increased $6 million, or 2.5%, as compared to the prior year, with operating margin also increasing from 15.3% to 15.6%.
Operating margin was negatively impacted by increased restructuring and realignment costs of $10 million in 2019. Excluding these restructuring and realignment costs, adjusted operating income increased $16 million, or 6.3%, with adjusted operating margin increasing from 16.3% to 17.2%. The increase in adjusted operating margin during the period was primarily due to cost reductions from our global procurement and productivity initiatives, price realization and favorable volume, which were partially offset by cost inflation, lower overhead cost absorption, increased cost of quality, increased spending on strategic investments and unfavorable mix.
Applied Water
Operating income for our Applied Water segment
increased $2 million, or 3.4%, for the third quarter of 2019 compared to the prior year, with operating margin also increasing from 15.6% to 16.2%. Operating margin was negatively impacted by increased restructuring and realignment costs of $1 million in 2019. Excluding these restructuring and realignment costs, adjusted operating income increased $3 million, or 4.9%, with adjusted operating margin increasing from 16.1% to 17.0%. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives
and improved price realization, which were partially offset by cost inflation, lower overhead cost absorption and unfavorable mix.
For the nine months endedSeptember 30, 2019, operating income increased $9 million, or 5.3%, as compared to the prior year, with operating margin also increasing from 15.0% to 15.6%. Operating margin was negatively impacted by increased restructuring and realignment costs of $3 million in 2019. Excluding these restructuring and realignment costs, adjusted operating income increased $12 million,
or 6.8%, with adjusted operating margin increasing from 15.6% to 16.4%. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives and price realization, which were partially offset by cost inflation, lower overhead cost absorption, increased spending on strategic investments and unfavorable mix.
Measurement & Control Solutions
Operating income for our Measurement & Control Solutions segment decreased $167 million, or 538.7%, for the third quarter of 2019 compared to the prior year,
with operating margin also decreasing from 8.4% to (35.0)%. Operating margin was negatively impacted by $155 million of special charges, consisting entirely of non-cash impairment charges, incurred during the quarter and increased restructuring and realignment costs of $16 million in 2019. Excluding these items, adjusted operating income increased $4 million, or 11.4%, with adjusted operating margin increasing from 9.5% to 10.0%. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives, favorable volume impacts and price realization, which were partially offset by moderating cost inflation, increased cost of quality
and increased spending on strategic investments.
For the nine months endedSeptember 30, 2019, operating income decreased $189 million, or 198.9%, as compared to the prior year, with operating margin also decreasing from 8.5% to (8.1)%. Operating margin was negatively impacted by increased special charges of $156 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $21 million during the period. Excluding these items, adjusted operating income decreased $12 million, or 10.6%, with adjusted operating
margin decreasing from 10.1% to 8.7%. The decrease in adjusted operating margin was primarily due to increases in cost inflation, increased spending on strategic investments and unfavorable mix impacts. Purchase accounting impacts from prior year acquisitions also negatively affected operating margin. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives, favorable volume impacts and price realization.
51
Corporate and other
Operating loss for corporate and other decreased $2 million, or 15.4%, for the third
quarter of 2019 compared to the prior year, primarily due to $1 million of special charges incurred during the quarter in 2018 that did not recur. Excluding these costs, adjusted operating loss decreased $1 million, or 8.3%, compared to the prior year. For the nine months endedSeptember 30, 2019, operating loss for corporate and other decreased $5 million, or 11.1%, compared to the same prior year period, primarily due to $5 million of special charges incurred during the period in 2018 that did not recur.
Interest Expense
Interest expense was $16 million
and $52 million for the three and nine months ended September 30, 2019, and $21 million and $63 million for the three and nine months ended September 30, 2018. The decrease in interest expense for the both the three and nine month periods ended September 30, 2019 is primarily driven by additional interest expense that was incurred during 2018 related to debt that was entered into to fund our acquisition of Pure Technologies
Ltd., which has been repaid as of September 30, 2019. See Note 13, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt and related interest.
Income Tax Expense
The income tax provision for the three months ended September 30, 2019 was a benefit of $77 million resulting in an effective tax rate of 623.6% (on a pre-tax loss for the period), compared to a $31 million charge resulting in an effective tax rate of 19.0% for the same period in 2018. The
income tax provision for the nine months endedSeptember 30, 2019 was a benefit of $45 million resulting in an effective tax rate of (18.9)%, compared to an $82 million charge resulting in an effective tax rate of 20.1% for the same period in 2018. The effective tax rates for the three and nine month periods ended September 30, 2019 differ from the same periods in 2018 primarily due to the income tax benefit that resulted from changes in tax law in Switzerland and the impact of the goodwill impairment charge on income before taxes in 2019. On an adjusted
basis, the effective tax rates were 19.0% and 19.2% for the three and nine months ended September 30, 2019, respectively, and 18.7% and 19.5% for the three and nine months ended September 30, 2018, respectively. See the “adjusted net income” and “adjusted earnings per share” reconciliation of GAAP to non-GAAP measures in the "Key Performance Indicators and Non-GAAP Measures" section for further detail.
Other Comprehensive Income
Other comprehensive loss was $37 million for the three months ended September 30, 2019 compared to a loss of $1 million for the same period in 2018.
Foreign currency translation contributed unfavorable impacts during the quarter of $11 million, driven primarily by the weakening of the Euro, the Great British Pound, the Canadian Dollar, the Polish Zloty, the Hungarian Forint and the Swedish Krona as compared to the U.S. Dollar in 2019 versus the strengthening of these currencies in the same prior year period. These unfavorable currency translation impacts were partially offset by the movement in our Euro net investment hedges during the quarter. In addition to net unfavorable foreign currency translation impacts, there was an unfavorable impact from the movement of tax on the net investment hedges as compared to the prior year of $16 million during the quarter that contributed to the increased loss.
For the nine months endedSeptember 30,
2019, other comprehensive loss was $28 million compared to a loss of $68 million for the same period in 2018. Foreign currency translation contributed favorable impacts during the period of $52 million, driven by the positive movement in our Euro net investment hedges and the strengthening of the Canadian Dollar as compared to the U.S. Dollar in 2019 versus the weakening of this currency in the same prior year period. Additionally, the weakening of the South African Rand, the Indian Rupee and the Chinese Yuan as compared to the U.S. Dollar was less negative in 2019 than the weakening of these currencies in the same prior year period. These increases were partially offset by further weakening of the Euro as compared to the U.S. Dollar in the current period versus
the comparable prior year period. Net favorable foreign currency translation impacts were partially offset by an unfavorable impact from the movement of tax on the net investment hedges as compared to the prior year of $8 million during the period.
52
Liquidity and Capital Resources
The following table summarizes our sources and (uses) of cash:
Nine
Months Ended
September 30,
(In millions)
2019
2018
Change
Operating activities
$
451
$
388
$
63
Investing
activities
(185
)
(579
)
394
Financing activities
(99
)
195
(294
)
Foreign
exchange (a)
(10
)
(14
)
4
Total
$
157
$
(10
)
$
167
(a)
The
impact is primarily due to the strengthening of the Chinese Yuan, the Indian Rupee, the Canadian Dollar and various other currencies against the U.S. Dollar. These impacts were partially offset by the weakness of the Euro against the U.S. Dollar.
Sources and Uses of Liquidity
Operating Activities
During the nine months ended September 30, 2019, net cash provided by operating activities was $451 million, an increase of $63 million as compared to the same prior year period. This increase was primarily driven by an increase in cash from earnings during the period, improvement in working capital levels due to improved inventory management, and decreased payments for post retirement
obligations, which were partially offset by an increase in cash tax payments.
Investing Activities
Cash used in investing activities was $185 million for the nine months ended September 30, 2019 as compared to $579 million in the comparable prior year period. This decrease in cash used was mainly driven by the $433 million spent on 2018 acquisitions, primarily for the acquisition of Pure Technologies Ltd., versus the $18 million spent for acquisition activity during the current year period. This decrease is partially offset by $22 million of proceeds received for a divested business in 2018.
Financing Activities
Cash
used by financing activities was $99 million for the nine months ended September 30, 2019 as compared to cash generated of $195 million in the comparable prior year period. The net decrease in cash generated by financing activities during the period was primarily due to higher levels of short-term debt related to acquisition financing during the first quarter of 2018 and an increase in dividends paid of $17 million during the period as compared to the prior year. These drivers were partially offset by a decrease in share repurchase activity of $19 million.
Funding and Liquidity Strategy
Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations, and access
to bank financing and the capital markets. Historically, we have generated operating cash flow sufficient to fund our primary cash needs centered on operating activities, working capital, capital expenditures, strategic investments and dividend payments. If our cash flows from operations are less than we expect, we may need to incur debt or issue equity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. There can be no assurance that such financing will be available to us on acceptable terms or that such financing will be available at all.
We monitor our global funding requirements
and seek to meet our liquidity needs on a cost effective basis. Based on our current global cash positions, cash flows from operations and access to the commercial paper markets, we believe there is sufficient liquidity to meet our funding requirements. In addition, our newly expanded committed credit facilities and access to the public debt markets would provide further liquidity if required.
53
We anticipate that our present sources of funds, including funds from operations and additional borrowings, will provide us with sufficient liquidity and capital resources to meet our liquidity and capital needs both inside and outside of the United States over the next twelve months.
See
Note 13, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt.
Non-United States Operations
We generated approximately 51% of our revenue from non-United States operations for the three and nine months ended September 30,2019 and 52% and 54% for the three and nine months ended September 30, 2018, respectively. As we continue to grow our operations in the emerging markets and elsewhere outside of the United States, we expect to continue to generate significant revenue from non-United States operations and we expect a substantial portion of our cash will be predominately held by our foreign subsidiaries.
We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to the United States and other international subsidiaries when we believe it is cost effective to do so. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities, and reassess whether there is a demonstrated need to repatriate funds held internationally to support our United States operations. As of September 30, 2019,
we have provided a deferred tax liability of $9 million for foreign withholding taxes and state income taxes on $505 million expected to be repatriated to the United States parent as deemed necessary. Repatriation is not expected to have a material impact on liquidity. As of September 30, 2019, our foreign subsidiaries were holding $298 million in cash or marketable securities.
Critical Accounting Estimates
Our discussion and analysis of our results of operations and capital resources are based on our condensed consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these condensed consolidated financial
statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. We believe the most complex and sensitive judgments, because of their significance to the condensed consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2018 Annual Report describes the critical accounting estimates used in preparation of the condensed consolidated financial statements. Actual results in these areas could differ from management’s estimates. Other than as discussed below, there have been no significant changes in the information concerning our critical accounting estimates as stated in our 2018
Annual Report.
During the fourth quarter of 2018, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were in excess of their carrying values. Our Advanced Infrastructure Analytics (“AIA”) business within our Measurement & Control Solutions segment was the only goodwill reporting unit whose fair value was not substantially in excess of its carrying value. At the time, our assessment indicated that the fair value of the AIA business exceeded its carrying amount by less than 10%.
In the third quarter of 2019, the Company revised its forecasted future cash flows for the AIA business. Factors that contributed to the revised forecast in the third quarter include lower than expected results as compared to prior forecasts,
largely as a result of slower-than-expected conversion of pipeline opportunities to revenue. Additionally, we have continued to invest in the AIA platform ahead of the adoption curve, which has also impacted the near term profitability of the business. Based on these factors we determined that there were indicators that the AIA reporting unit’s goodwill may be impaired, and accordingly, we performed an interim goodwill impairment test as of July 1, 2019. The results of the impairment test showed that the fair value of the AIA reporting unit was lower than the carrying value, resulting in a $148 million goodwill impairment charge. As of September 30, 2019 the remaining goodwill balance in our AIA reporting unit after recording the goodwill impairment charge was $170 million.
Also, during the third quarter of 2019, due to the
factors discussed above, we assessed whether the carrying amounts of the AIA reporting unit’s long-lived assets may not be recoverable and therefore impaired. Our
54
assessment resulted in an impairment charge of $7 million, primarily related to customer relationships, proprietary technology, software and property, plant and equipment. The charge was calculated using an income approach.
The fair value of our reporting units and intangible assets is judgmental in nature and involves the use of significant estimates and assumptions, particularly related to future operating results and cash flows. These estimates and assumptions include, but are not limited to, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted
discount rates, as well as, future economic and market conditions. In addition, the identification of reporting units and the allocation of assets and liabilities to the reporting units when determining the carrying value of each reporting unit also require judgment. If we do not achieve our forecasts, given that the fair value and the carrying value of the AIA reporting unit were the same at July 1, 2019, it is possible that the goodwill of the AIA reporting unit could be deemed to be impaired again in a future period.
New Accounting Pronouncements
See Note 2, "Recently Issued Accounting Pronouncements," to the condensed consolidated financial statements for a complete discussion of recent accounting pronouncements. We are currently evaluating the impact of certain recently issued
guidance on our financial condition and results of operations in future periods.
55
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Effective July 1, 2018, Argentina was determined to be a highly inflationary economy, and as such we evaluated the impact of revaluing our monetary assets and liabilities under the applicable guidance and do not expect it to have a material impact.
There has been no other material change in the information concerning market risk as stated in our 2018
Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the Chief Executive Officer and Chief Financial Officer of the Company, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that,
as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.
In 2017, the Company undertook steps to advance a multi-year effort to transform many of our support functions and related technologies, including Finance, Human Resources and Procurement. In connection with these restructuring and transformation plans, we continue to centralize certain accounting functions within shared service centers operated by an outsourced provider. This initiative is not in response to any identified deficiency or weakness in the Company’s internal control over financial reporting. In response to
this initiative, the Company has and will continue to align and streamline the design and operation of its financial control environment.
Other than as described in the preceding paragraph, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the 1934 Act) during the fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
56
PART
II
ITEM 1. LEGAL PROCEEDINGS
From time to time we are involved in legal and regulatory proceedings that are incidental to the operation of our businesses (or the business operations of previously owned entities). These proceedings may seek remedies relating to environmental matters, tax, intellectual property matters, acquisitions or divestitures, product liability and personal injury claims, privacy, employment, labor and pension matters, government contract issues and commercial or contractual disputes. See Note 19"Commitments and Contingencies", to the condensed
consolidated financial statements for further information and any updates.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously disclosed in our 2018 Annual Report on Form 10-K under Item 1A. Risk Factors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table presents information with respect to purchases of the
Company's common stock by the Company during the three months ended September 30, 2019:
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
PERIOD
TOTAL NUMBER OF SHARES PURCHASED
AVERAGE
PRICE PAID PER SHARE (a)
TOTAL NUMBER OF SHARES PURCHASED AS PART OF PUBLICLY ANNOUNCED PLANS OR PROGRAMS (b)
APPROXIMATE DOLLAR VALUE OF SHARES THAT MAY YET BE PURCHASED UNDER THE PLANS OR PROGRAMS (b)
7/1/19 - 7/31/19
—
—
—
$338
8/1/19
- 8/31/19
—
—
—
$338
9/1/19 - 9/30/19
—
—
—
$338
This
table does not include shares tendered to satisfy the exercise price in connection with cashless exercises of employee stock options or shares tendered to satisfy tax withholding obligations in connection with employee equity awards.
(a)
Average price paid per share is calculated on a settlement basis.
(b)
On August 24, 2015, our Board of Directors authorized the repurchase of up to $500 million in shares with no expiration date. The program's
objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. There were no shares repurchased under this program during the three months ended September 30, 2019. There are up to $338 million in shares that may still be purchased under this plan as of September 30, 2019.
Certification
pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference into any filing under the Securities Act
of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference.
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated
by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference.
101.0
The following materials from Xylem Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019, formatted in Inline Extensible Business Reporting Language (Inline XBRL): (i) Condensed Consolidated Income Statements, (ii) Condensed Consolidated Statements of Comprehensive Income, (iii) Condensed Consolidated Balance Sheets, (iv) Condensed Consolidated Statements of Cash Flows and (v) Notes to
Condensed Consolidated Financial Statements
The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document.
104.0
The cover page from Xylem Inc.'s Quarterly Report on Form 10-Q for the period ended September 30, 2019 formatted in Inline XBRL and contained in Exhibit 101.0.
58
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.