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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 May 1, 2020, there were i179,915,293
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 19, "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 statement 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, 2019 ("2019 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 2019 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 condensed consolidated 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 ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments," amending the accounting for the impairment of financial instruments, including trade receivables. Under previous guidance, credit losses were recognized when the applicable losses had a probable likelihood of occurring and this assessment was
based on past events and current conditions. The amended current 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 adopted this guidance as of January 1, 2020. The adoption of this guidance did not have a material impact on our financial condition and results of operations.
Note 3. iAcquisitions and Divestitures
Acquisitions
During
the three months ended March 31, 2020 and 2019 we spent approximately $i0 million and $i5 million,
net of cash received on acquisition activity, respectively.
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:
(a)Excludes
receivable balances which are disclosed on the balance sheet
/
9
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 March 31, 2020, the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied for contracts
with performance obligations, amount to $i380 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. During the three months ended March 31, 2020, we recognized restructuring charges of $i2 million. 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 within our Water Infrastructure segment.
During the three months ended March 31, 2019, we recognized restructuring charges of $i8 million. 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.
i
The following table presents the components of restructuring expense and asset impairment charges:
Three
Months Ended
March 31,
(in millions)
2020
2019
By component:
Severance
and other charges
$
i2
$
i7
Lease
related charges
i—
i1
Total
restructuring charges
$
i2
$
i8
Asset
impairment
i—
i3
Total
restructuring and asset impairment charges
$
i2
$
i11
By
segment:
Water Infrastructure
$
i2
$
i4
Applied
Water
i—
i—
Measurement
& Control Solutions
i—
i7
/
10
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" and "other non-current accrued liabilities", for the three months ended March 31, 2020 and 2019:
(in millions)
2020
2019
Restructuring
accruals - January 1
$
i27
$
i5
Restructuring
charges
i2
i8
Cash
payments
(i8)
(i4)
Foreign
currency and other
(i1)
i—
Restructuring
accruals - March 31
$
i20
$
i9
By
segment:
Water Infrastructure
$
i1
$
i2
Applied
Water
i1
i—
Measurement
& Control Solutions
i17
i4
Regional
selling locations (a)
i1
i3
(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.
/
11
i
The
following table presents expected restructuring spend for actions commenced as of March 31, 2020:
(in millions)
Water Infrastructure
Applied
Water
Measurement & Control Solutions
Total
Actions Commenced in 2020:
Total expected costs
$
i1
$
i—
$
i—
$
i1
Costs
incurred during Q1 2020
i1
i—
i—
i1
Total
expected costs remaining
$
i—
$
i—
$
i—
$
i—
Actions
Commenced in 2019:
Total expected costs
$
i20
$
i5
$
i27
$
i52
Costs
incurred during 2019
i18
i5
i27
i50
Costs
incurred during Q1 2020
i1
i—
i—
i1
Total
expected costs remaining
$
i1
$
i—
$
i—
$
i1
Actions
Commenced in 2017:
Total expected costs
$
i12
$
i7
$
i4
$
i23
Costs
incurred during 2017
i5
i4
i2
i11
Costs
incurred during 2018
i2
i1
i1
i4
Costs
incurred during 2019
i1
i—
i1
i2
Costs
incurred during Q1 2020
i—
i—
i—
i—
Total
expected costs remaining
$
i4
$
i2
$
i—
$
i6
/
The
Water Infrastructure actions commenced in 2020 consist primarily of severance charges and are substantially complete. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges. The Applied Water and Measurement & Control Solutions actions are complete and the Water Infrastructure actions are expected to continue through the fourth quarter of 2020. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2017 consist primarily of severance charges. The Measurement & Control Solutions actions are complete and the Water Infrastructure and Applied Water actions are expected to continue through 2021.
Asset Impairment
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 9, "Goodwill and Other Intangible Assets," for additional information.
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 March 31, 2020 was $i4 million resulting in an effective tax
rate of i10.0%, compared to a $i15 million charge resulting in an effective tax rate of i16.6%
for the same period in 2019. The effective tax rate for the three month period ended March 31, 2020 differs from the United States federal statutory rate primarily due to the mix of earnings in jurisdictions, partially offset by the Global Intangible Low-Taxed Income ("GILTI") inclusion. Additionally, the effective tax rate for the three month period ended March 31, 2020 is lower than the same period in 2019 due to the relative impact of the benefit from favorable equity compensation deductions on the effective tax rate.
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
12
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 March 31, 2020 was $i128 million, as compared to $i129
million at December 31, 2019, 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 March 31, 2020, we had $i9 million of interest accrued for unrecognized tax benefits.
During 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. 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 is vigorously defending our position through litigation. As of March 31, 2020, we
have not recorded any unrecognized tax benefits related to this uncertain tax position.
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
i180,179
i179,746
Plus
incremental shares from assumed conversions: (b)
Dilutive effect of stock options
i725
i835
Dilutive
effect of restricted stock units and performance share units
i390
i532
Weighted
average common shares outstanding — Diluted
i181,294
i181,113
Basic
earnings per share
$
i0.21
$
i0.44
Diluted
earnings per share
$
i0.21
$
i0.43
(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 15, "Share-Based Compensation Plans", to the condensed consolidated financial statements for further detail on the performance share units.
/
13
Three
Months Ended
March 31,
(in thousands)
2020
2019
Stock options
i1,367
i1,394
Restricted
stock units
i314
i348
Performance
share units
i285
i472
Note
8. iInventories
i
The components of total inventories are summarized as follows:
Amortization
expense related to finite-lived intangible assets was $i35 million and $i35 million for the three month periods ended March 31,
2020 and 2019, respectively.
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
14
million
impairment charge. The charge was calculated using the income approach and is reflected in “Restructuring and asset impairment charges” in our Condensed Consolidated Income Statements.
Note 10. 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 $i376
million and $i0 million as of March 31, 2020 and December 31, 2019, respectively. As of March 31, 2020, 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 $i151 million, $i117 million, $i38
million, $i24 million, $i23 million and $i18
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 2019 we entered into additional cross currency swaps. The total notional amount of derivative instruments designated as net investment hedges was $i702
million and $i714 million as of March 31, 2020 and December 31, 2019, 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 $i554 million as of March 31, 2020 and December 31, 2019, respectively, net of unamortized discount, as a hedge of a net investment in certain foreign subsidiaries.
15
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 loss reclassified from OCI into cost of revenue
i1
i1
Net
Investment Hedges
Cross Currency Swaps
Amount of gain recognized in OCI
$
i45
$
i7
Amount
of income recognized in Interest Expense
i4
i3
Foreign
Currency Denominated Debt
Amount of gain recognized in OCI
$
i10
$
i7
/
As
of March 31, 2020, $i2 million of net losses on cash flow hedges are expected to be reclassified into earnings in the next 12 months.
As of March 31, 2020, no gains or losses on the net investment hedges are expected to be reclassified into earnings over their duration.
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 $i565 million and $i591 million as of March 31, 2020
and December 31, 2019, respectively.
16
Note 11. 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
i459
i276
Total
long-term debt
$
i2,031
$
i2,040
(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 $i640 million and $i629
million as of March 31, 2020 and December 31, 2019, respectively. The fair value of our Senior Notes due 2023 was $i565 million and $591 million as of March 31, 2020 and December 31, 2019, respectively. The fair value of our Senior Notes due 2026 was $i533
million and $i518 million as of March 31, 2020 and December 31, 2019, respectively. The fair value of our Senior Notes due 2046 was $i400
million and $i431 million as of March 31, 2020 and December 31, 2019, 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
17
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 March 31, 2020, we are in compliance with all covenants for the Senior Notes.
Credit Facilities
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 Facility 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 Facility. As of March 31, 2020, 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 Credit Facility. As of March 31, 2020 and December 31, 2019, 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 future periods.
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 March 31, 2020 and December 31, 2019, $i268 million and $i276
million of the Company's Euro commercial paper program was outstanding, respectively, at a weighted average interest rate of (i0.21)%. We have the ability to continue borrowing under this program going forward in future periods.
18
Other
Borrowings
Effective October 20, 2016, Xylem entered into an uncommitted short term facility with SEB Bank. The line of credit provides for an aggregate principal amount of up to €i110 million (approximately $i120 million).
The full amount of €i100M has been drawn on March 19, 2020 at an interest rate of i0.70% for a duration of three months
with a maturity date on June 19, 2020. As of March 31, 2020 and December 31, 2019, $i120 million and $i0 million
were outstanding under the uncommitted short term facility, respectively.
Effective November 29, 2019, Xylem entered into an uncommitted short term facility with BGL BNP Paribas Bank. The line of credit provides for an aggregate principal amount of up to €i65 million (approximately $i71 million).
The full amount of €i65M has been drawn on March 19, 2020 at an interest rate of i1.25% for a duration of three months
with a maturity date in June 19, 2020. No amounts were outstanding previously under the BGL BNP Paribas Bank short term facility.
Subsequent Events
On April 25, 2020, the Company’s subsidiary, Xylem Europe GmbH (the “borrower”) entered into a 12-month €i100 million (approximately $i109 million)
term loan facility the terms of which are set forth in a term loan agreement, among the borrower, the Company, as parent guarantor and ING Bank. The Company has entered into a parent guarantee in favor of ING Bank also dated April 25, 2020 to secure all present and future obligations of the borrower under the Term Loan Agreement. Borrowings accrue interest at a rate equal to the EURIBOR or a replacement base rate, plus an applicable margin based on Xylem's credit rating. Xylem will also pay quarterly fees whether such commitment is used or unused. To date none of the ING Bank term facility has been drawn down upon.
On April 30, 2020, the
Company entered into a 12-month $i50 million term loan facility the terms of which are set forth in a term loan agreement among the Company and Australia and New Zealand Banking Group Limited. Borrowings accrue interest at a rate equal to an adjusted LIBOR rate plus i1.50%.The full amount of $i50 million has been drawn down upon on April 30, 2020.
Note 13. iPostretirement
Benefit Plans
i
The components of net periodic benefit cost for our defined benefit pension plans are as follows:
Three
Months Ended
March 31,
(in millions)
2020
2019
Domestic defined benefit pension plans:
Service
cost
$
i1
$
i1
Interest
cost
i1
i1
Expected
return on plan assets
(i2)
(i2)
Amortization
of net actuarial loss
i1
—
Net periodic benefit cost
$
i1
$
—
International
defined benefit pension plans:
Service cost
$
i3
$
i3
Interest
cost
i4
i5
Expected
return on plan assets
(i4)
(i9)
Amortization
of net actuarial loss
i3
i2
Net
periodic benefit cost
$
i6
$
i1
Total
net periodic benefit cost
$
i7
$
i1
/
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.
19
The total net periodic benefit cost for other postretirement employee benefit plans was less than $i1 million including net credits recognized into other
comprehensive income of less than $i1 million for the three months ended March 31, 2020 and March 31, 2019, respectively.
We contributed $i12
million and $i5 million to our defined benefit plans during the three months ended March 31, 2020 and 2019, respectively. Additional contributions ranging between approximately $i10
million and $i20 million are expected during the remainder of 2020.
During Q1 2020, the Company purchased a bulk annuity policy with an insurance company for its largest defined benefit plan in the UK, as a plan asset, to facilitate the termination and buy-out of the plan. The bulk annuity fully insures the benefits payable to the participants
of the plan until a full buy-out of the plan can be executed, which is expected to occur in 2021. Included in the Company's Q1 contributions is $i5 million paid to meet the shortfall between the cost of the bulk annuity policy and the plan assets. As a result of the change in assets from a mix of equities and bonds to the bulk annuity, the plan's expected rate of return on assets was reduced to i1.00%
at December 31, 2019. The rate at December 31, 2018 was i7.25%. On January 27, 2020, the plan's assets of $i336 million
were transferred to the insurance company for the purchase of the bulk annuity.
Note 14. iEquity
i
The
following table shows the changes in stockholders' equity for the three months ended March 31, 2020:
Share-based compensation expense was $i8
million and $i9 million during the three months ended March 31, 2020 and 2019, respectively. The unrecognized compensation expense related to our stock options, restricted stock units and performance share units was $i9
million, $i29 million and $i15
million, respectively, at March 31, 2020 and is expected to be recognized over a weighted average period of i2.3, i2.2
and i2.4 years, respectively. The amount of cash received from the exercise of stock options was $i5
million and $i4 million for the three months ended March 31, 2020 and 2019, respectively.
Stock Option Grants
i
The
following is a summary of the changes in outstanding stock options for the three months ended March 31, 2020:
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 three months ended March 31, 2020 was $i5.6 million.
21
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 2020 grants:
Volatility
i22.90
%
Risk-free
interest rate
i1.15
%
Dividend yield
i1.29
%
Expected
term (in years)
i5.8
Weighted-average fair value / share
$
i16.03
Expected
volatility is calculated based on an analysis of historic volatility measures for 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 three months ended March 31, 2020. 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 three months ended March 31, 2020. 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 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 2020 grants:
Volatility
i22.6
%
Risk-free
interest rate
i1.08
%
/
Note
16. iCapital Stock
For the three months ended March 31, 2020 and March 31, 2019the Company repurchased approximately i0.8
million shares of common stock for $i60 million and approximately i0.5 million shares of common stock 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:
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 approximately i0.7 million shares repurchased for $i50 million
under this program for the three months ended March 31, 2020. For the three months ended March 31, 2019, we repurchased approximately i0.3 million shares for $i25
million. There are up to $i288 million in shares that may still be purchased under this plan as of March 31, 2020.
Aside from the aforementioned repurchase program, we repurchased approximately i0.1
million shares and approximately i0.2 million shares for approximately $i10 million and approximately $i14
million for the three months ended March 31, 2020 and 2019, respectively, in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock units.
23
Note 17. iAccumulated
Other Comprehensive Loss
i
The following table provides the components of accumulated other comprehensive loss for the three months ended March 31, 2020:
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.
24
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), 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 $i3
million and $i5 million as of March 31, 2020 and December 31, 2019, respectively, for these general legal 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 March 31, 2020 and December 31, 2019, the amount of surety bonds, bank guarantees, stand-by letters of credit and insurance letters of
credit was $i330 million and $i340 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
25
environmental
expenditures are recorded on an undiscounted basis. We have estimated and accrued $i3 million and $i3
million as of March 31, 2020 and December 31, 2019, respectively, for environmental matters.
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)
2020
2019
Warranty accrual – January 1
$
i41
$
i60
Net
charges for product warranties in the period
i22
i5
Settlement
of warranty claims
(i7)
(i13)
Foreign
currency and other
(i1)
i—
Warranty
accrual - March 31
$
i55
$
i52
/
Note
19. iSegment Information
Our business has ithree 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, wastewater and storm water 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.
iAdditionally, 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.
26
The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1 in the 2019 Annual Report). The following tables contain financial information for each reportable segment:
Three
Months Ended
March 31,
(in millions)
2020
2019
Revenue:
Water
Infrastructure
$
i438
$
i482
Applied
Water
i338
i379
Measurement
& Control Solutions
i347
i376
Total
$
i1,123
$
i1,237
Operating
Income:
Water Infrastructure
$
i39
$
i51
Applied
Water
i47
i56
Measurement
& Control Solutions
(i12)
i16
Corporate
and other
(i13)
(i14)
Total
operating income
$
i61
$
i109
Interest
expense
$
i16
i18
Other
non-operating (expense) income, net
(i3)
i2
Gain
from sale of business
i—
i1
Income
before taxes
$
i42
$
i94
Depreciation
and Amortization:
Water Infrastructure
$
i15
$
i15
Applied
Water
i6
i6
Measurement
& Control Solutions
i36
i36
Regional
selling locations (a)
i4
i4
Corporate
and other
i3
i3
Total
$
i64
$
i64
Capital
Expenditures:
Water Infrastructure
$
i10
$
i30
Applied
Water
i9
i6
Measurement
& Control Solutions
i27
i24
Regional
selling locations (b)
i4
i4
Corporate
and other
i1
i5
Total
$
i51
$
i69
(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.
27
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 plans, 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. Many of these risks and uncertainties are currently amplified by and may continue to be amplified by, or in the future
may be amplified by, the novel coronavirus (COVID-19) pandemic.
Factors that could cause results to differ materially from those anticipated include: overall economic and business conditions; uncertainty of the magnitude, duration, geographic reach and impact on the global economy of the COVID-19 pandemic; the current, and uncertain future, impact of the COVID-19 pandemic on our business, growth, projections, financial condition, operations, cash flows, and liquidity, including the impact of adverse economic conditions caused by the COVID-19 pandemic on our performance or customer markets; actual or potential other epidemics, pandemics or global health crises; geopolitical and other risks associated with our international operations, including military actions, protectionism, 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; disruption, competition and pricing pressures in the markets we serve; industrial, governmental and private sector spending; 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 supply chain including 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 security, product liability and recalls; claims or investigations by governmental or regulatory bodies; cybersecurity attacks, breaches or other disruptions of information technology systems on which we rely; our sustainability initiatives; 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, 2019 ("2019 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.
28
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, treatment and analysis 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 and storm water to treatment facilities where our mixers, biological treatment,
monitoring and control systems provide the primary functions in 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 water 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 primarily serves 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 and analyze 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.
COVID-19 Pandemic
The global outbreak of the COVID-19 disease was declared a pandemic by the World Health Organization and a national emergency
by the U.S. Government in March 2020 and has created significant global volatility, uncertainty and economic disruption. The global spread of the COVID-19 pandemic has curtailed the movement of people, goods and services worldwide, including in many of the regions where we sell our products and services and conduct operations.
This section summarizes the most significant impacts related to the COVID-19 pandemic that we have experienced to date, and we have included additional details as applicable throughout other sections of this report. Many of these impacts did not begin to be felt broadly across our businesses until the latter part of the first quarter of 2020. In response to the COVID-19 pandemic, Xylem deployed a COVID-19 Response Team, responsible for Xylem's Pandemic Plan, which is designed to aid in prevention, preparedness, response and recovery at our sites.
Depending
on the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences, we anticipate that it will become more difficult to distinguish specific aspects of our operational and financial performance that are most directly related to COVID-19 from those that are more broadly influenced by ongoing
29
macroeconomic, market and industry dynamics that may also be, to varying degrees, related to the COVID-19 pandemic and its consequences.
Public health officials have recommended, or governments have mandated, precautions to mitigate the spread of COVID-19, including stay at home or similar measures in many of the areas in which we operate. Operationally, our production facilities located in Latin America, Europe
and Asia Pacific have experienced, or continue to experience reduced production levels due to such measures. Those production facilities that experienced temporarily closures have been or will be reopened in the near term.
The COVID-19 pandemic is also adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and businesses. Closures and reduced facility production levels have had short term impacts to our internal supply chain. We expect to continue to experience unpredictable interruptions at our internal and external suppliers.
To date, the most significant impacts were experienced in volume reductions ranging across all segments and concentrated in Asia Pacific, particularly in China and India, and to a lesser extent, the United States and Europe.
Future demand for our products and services
is uncertain as the COVID-19 pandemic has also had an adverse impact on many of the customers we serve. As such, we may experience decreased or delayed demand for our products and services, as well as changes in the payment patterns of our customers. At the end of the first quarter, total backlog increased 4.8% as compared to December 31, 2019 and cancellations were materially consistent with the prior year, with no material cancellations to date. In many cases, Xylem’s products and services are considered "essential services" under various governmental mandates, and as a result we did not experience significant issues in our ability to distribute products or services, aside from customer-driven project delays. However, because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing and difficult to predict, the pandemic’s ongoing and future impacts
on our business, financial condition, results of operations, and stock price remains uncertain and difficult to predict, but we expect our results to continue to be adversely impacted beyond the quarter ending March 31, 2020.
Xylem has taken measures to protect the health and safety of our employees and work with our customers to minimize potential disruptions. We have implemented a support pay program for employees impacted by COVID-19, and an essential services premium pay program for the benefit of employees whose roles are classified as an “essential service” and, as such, are required to work either onsite at a Xylem facility or in the field supporting customers during periods of mandated stay at home or similar measures. Xylem Watermark, our corporate social responsibility program, is also supporting our communities in addressing the challenges
posed by this global pandemic through its partnership with Americares and UNICEF, as well as the expansion of the Partner Community Grants program and other philanthropic commitments.
Many of our offices globally have transitioned to a fully remote work from home status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures.
We will continue to work with our customers, employees, suppliers and communities to address the impacts of COVID-19. We continue to assess possible implications to our business, supply chain and customers, and to take necessary actions in an effort to mitigate adverse consequences.
Risk related to these items are described in further detail under Item 1A, "Risk Factors".
Executive
Summary
Xylem reported revenue for the first quarter of 2020 of $1,123 million, a decrease of 9.2% compared to $1,237 million reported in the first quarter of 2019. On a constant currency basis, revenue decreased by $95 million, or 7.7%, driven entirely by organic declines across all segments and all end markets. While organic revenue decline in the first quarter was anticipated, the decline was much greater than expected as our business was impacted by the global acceleration of the COVID-19 pandemic across all segments.
We generated operating income of $i61
million (margin of 5.4%) during the first quarter of 2020, as compared to $i109 million (margin of 8.8%) in 2019. Operating income in the first quarter of 2020 benefited from decreases in restructuring and realignment costs of $11 million and special charges of $4 million as compared to the first quarter of 2019. Excluding the impact of these items, adjusted operating income was $70 million (adjusted margin of 6.2%) during the first quarter of 2020 as compared to $133 million (adjusted margin of 10.8%) in 2019. The decrease in adjusted operating margin was primarily due to unfavorable
volume, impacted significantly by COVID-19, cost inflation, increased cost of quality, unfavorable mix and increased spending on strategic
30
investments. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives, including restructuring savings, and price realization.
Additional financial highlights for the quarter ended March 31, 2020 include the following:
•Orders of $1,261 million, down 4.1% from $1,315 million in the prior year, and down 2.4% on an organic basis across all segments, heavily impacted by the COVID-19 pandemic.
•Earnings
per share of $i0.21, down 51.2% when compared to the prior year ($0.23, down 55.8% on an adjusted basis).
•Net cash flow used by operating activities of $i2
million for the three months ended March 31, 2020, down $85 million from the prior year. Negative free cash flow of $53 million, down $67 million from the prior year.
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 to 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 restructuring and realignment costs, special charges, gain or loss from sale of businesses and tax-related special items, as applicable. A reconciliation of adjusted net income and adjusted earnings per share is provided below.
Three
Months Ended
March 31,
(In
millions, except for per share data)
2020
2019
Net income & Earnings per share
$
i38
$
i0.21
$
i79
$
i0.43
Restructuring
and realignment, net of tax of $2 and $4
7
0.04
16
0.09
Special
charges, net of tax of $0 and $0
1
—
4
0.02
Tax-related special items
(4)
(0.02)
(4)
(0.02)
Gain
from sale of business, net of tax of $0
—
—
(1)
—
Adjusted net income & Adjusted earnings per share
$
42
$
0.23
$
94
$
0.52
31
•"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.
•“special charges" defined as costs incurred by the
Company, such as acquisition and integration 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, 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. 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.
Three
Months Ended
March 31,
(In millions)
2020
2019
Net cash (used) provided by operating activities
$
(i2)
$
i83
Capital
expenditures
(i51)
(i69)
Free
cash flow
$
(53)
$
14
Net cash used by investing activities
$
(48)
$
(77)
Net cash provided (used) by financing activities
$
87
$
(29)
•“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
March
31,
(in millions)
2020
2019
Net Income
$
38
$
79
Income
tax expense
4
15
Interest expense (income), net
14
17
Depreciation
29
29
Amortization
35
35
EBITDA
$
120
$
175
Share-based
compensation
$
8
$
9
Restructuring and realignment
9
20
Special
charges
1
4
Gain from sale of business
—
(1)
Adjusted EBITDA
$
138
$
207
32
2020
Outlook
We withdrew 2020 guidance on March 31, 2020 due to uncertainties caused by COVID-19. We are not prepared to reinstate full-year guidance, but are providing total organic revenue outlook for the second quarter to be down 20% to 30% driven by the impact of COVID-19.
The following is a summary of our outlook on each of our end markets:
•Utilities revenue decreased by approximately 5% organically in the first quarter driven by weakness in the United States, Asia Pacific and the Middle East, partially offset by strength in Europe. During 2020 we expect operational spending to continue to be resilient and are seeing some areas of opportunity driven by operational pressures facing utilities. Nevertheless, utilities will be facing workforce challenges from impacts
of COVID-19 on the way in which they need to operate . We also expect delays in capital projects being awarded and a potential push back in execution of current projects, but anticipate capex spending to hold up in the mid-to-longer term given the multi-year capex funding mechanisms utilities use and the governmental commitments to continued investment we're seeing in a number of our markets.
•Industrial revenue decreased by approximately 10% organically in the first quarter driven by weakness in North America, Asia Pacific and western Europe. As 2020 progresses we expect industrial facilities to limit access to sales teams and channel partners, causing slower orders and activity while non-essential work is deferred. Exposure to the down-stream impacts of a soft oil and gas market will have an effect on both our dewatering and applied water businesses potentially leading to significant demand declines.
Additionally, we anticipate softness in the marine and beverage dispensing verticals driven by social distancing and mandatory lockdown constraints.
•In the commercial markets, organic revenue decline was approximately 11% in the first quarter driven by weakness in the emerging markets and the United States. During the short-term we expect construction site shut-downs to lead to project delays while backlog remains robust and underlying quote activity remains healthy. Although we have not seen a slowdown in project pipelines at this point in time, this is an area that we will be monitoring closely given likely recessionary effects.
•In the residential markets, organic revenue decline was approximately 14% in the first quarter driven by weakness in western Europe, the United States and Asia Pacific. This market is primarily driven
by replacement revenue serviced through distribution network. As such, we anticipate only emergency replacement activity as a result of social distancing requirements and expect industry softness to continue while lockdowns are in place.
As result of uncertainties caused by the COVID-19 pandemic and its potential impacts on future demand, we are reevaluating aspects of our spending, including capital expenditures, strategic investments and dividends. We have identified approximately $100 million in net reductions of planned spending on a combination of operational and capital expenditures for the remainder of 2020. We will also continue to strategically execute restructuring and realignment actions to reposition our business in an effort to optimize our cost structure and improve our operational efficiency and effectiveness. We are still assessing the amount of any additional restructuring and realignment actions that may
incurred during the year.
33
Results of Operations
Three
Months Ended
March 31,
(In millions)
2020
2019
Change
Revenue
$
1,123
$
1,237
(9.2)
%
Gross
profit
409
474
(13.7)
%
Gross margin
36.4
%
38.3
%
(190)
bp
Total
operating expenses
348
365
(4.7)
%
Expense to revenue ratio
31.0
%
29.5
%
150
bp
Restructuring
and realignment costs
9
20
(55.0)
%
Special
charges
—
4
NM
Adjusted operating expenses
339
341
(0.6)
%
Adjusted
operating expenses to revenue ratio
30.2
%
27.6
%
260
bp
Operating income
61
109
(44.0)
%
Operating
margin
5.4
%
8.8
%
(340)
bp
Interest and other non-operating expense, net
19
16
18.8
%
Gain
from sale of business
—
1
NM
Income tax expense
4
15
(73.3)
%
Tax
rate
10.0
%
16.6
%
(660)
bp
Net income
$
38
$
79
(51.9)
%
NM
- Not meaningful change
Revenue
Revenue generated during the three months ended March 31, 2020 was $1,123 million, reflecting a decrease of $114 million, or 9.2%, compared to the same prior year period. On a constant currency basis, revenue declined 7.7% for the three months ended March 31, 2020. The decrease at constant currency consisted entirely of a decline in organic revenue of $95 million reflecting significantly lower demand across all major geographic regions and segments largely due to COVID-19 related impacts.
The following table illustrates the impact from organic declines, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during the three months ended March
31, 2020:
Water
Infrastructure
Applied Water
Measurement & Control Solutions
Total Xylem
(In millions)
$ Change
% Change
$ Change
% Change
$
Change
% Change
$ Change
% Change
2019 Revenue
$
482
$
379
$
376
$
1,237
Organic
Impact
(32)
(6.6)
%
(38)
(10.0)
%
(25)
(6.6)
%
(95)
(7.7)
%
Acquisitions/(Divestitures)
—
—
%
—
—
%
—
—
%
—
—
%
Constant
Currency
(32)
(6.6)
%
(38)
(10.0)
%
(25)
(6.6)
%
(95)
(7.7)
%
Foreign
currency translation (a)
(12)
(2.5)
%
(3)
(0.8)
%
(4)
(1.1)
%
(19)
(1.5)
%
Total
change in revenue
(44)
(9.1)
%
(41)
(10.8)
%
(29)
(7.7)
%
(114)
(9.2)
%
2020
Revenue
$
438
$
338
$
347
$
1,123
(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 Australian Dollar, the Norwegian Krone, the Swedish Krona and the Chinese Yuan.
34
Water Infrastructure
Water Infrastructure revenue decreased $44 million, or 9.1%, for the first quarter of 2020 (6.6% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by $12 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline of $32 million. Organic weakness for the quarter was primarily driven by the industrial end market, particularly
in North America, due to continued soft market conditions in oil and gas, and in Asia Pacific, where organic growth was heavily impacted by the COVID-19 pandemic. Organic revenue decline for the quarter was also driven by weakness in the utility end market, particularly in the United States, due to softness in construction and the lapping of projects in the prior year, as well as in India due to the timing of project deployments in the prior year. We estimate that almost half of the organic revenue declines in the segment were impacted by the COVID-19 pandemic, particularly in China and India.
From an application perspective, the organic revenue decline during the first quarter was primarily driven by our transport application where market conditions continued to soften in North America in the dewatering applications, with oil and gas, construction and mining all down in the quarter. Asia Pacific also contributed to the organic
revenue decline within the transport application, primarily driven by the timing of large utility project deployments in India and the negative impact of the COVID-19 pandemic throughout the region. The treatment application contributed a more modest organic revenue decline during the quarter driven by the timing of filtration project deliveries in the United States.
Applied Water
Applied Water revenue decreased $41 million, or 10.8%, for the first quarter of 2020 (10.0% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by $3 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of $38 million. Organic weakness for the quarter was driven by declines across all end markets and in all major geographic regions. We estimate that approximately two thirds of the
organic revenue declines in the segment were driven by impacts from the COVID-19 pandemic, particularly in China and the United States where lockdown activities caused a slow down in the markets served.
From an application perspective, the organic revenue decline in the first quarter was led by weakness in the building services application in the commercial markets which was driven by the impact of the COVID-19 pandemic within the emerging markets, particularly China, and in the United States where the timing of shipments was impacted by the economic slowdown. The industrial water application also experienced a decline in organic revenue during the quarter driven by industry softening, which has been further impacted by the COVID-19 pandemic, in the emerging markets, western Europe and the United States. Weakness in the building services application in the residential market also contributed to the organic revenue decline
during the quarter, primarily in western Europe, the United States and Asia Pacific.
Measurement & Control Solutions
Measurement & Control Solutions revenue decreased $29 million, or 7.7%, for the first quarter of 2020 (6.6% at constant currency) as compared to the prior year. Revenue was negatively impacted by $4 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of $25 million. Organic weakness for the quarter was driven by a decline in the utility end market, primarily in the United States, Asia Pacific and the Middle East, partially offset by organic growth in Europe during the quarter.
From an application perspective, the organic revenue decline for the segment was driven by the water application, where we lapped strong project deployments
in the United States and India during the first quarter of the prior year, and the COVID-19 pandemic which negatively impacted organic growth in the Middle East. Organic revenue declines within the water application were partially offset by organic growth in Europe during the quarter, primarily driven by software sales. The test application also experienced organic revenue decline during the quarter, primarily driven by declines in western Europe, China and North America, largely due to impacts from the COVID-19 pandemic, including component shortages from China. The software as a service ("SaaS") and energy applications had modest declines in revenue as compared to the prior year, primarily in the United States as we lapped a few large project deployments.
35
Orders
/ Backlog
An order represents a legally enforceable, written document that includes the scope of work or services to be performed or equipment to be supplied to a customer, the corresponding price and the expected delivery date for the applicable products or services to be provided. An order often takes the form of a customer purchase order or a signed quote from a Xylem business. Orders received during the first quarter of 2020 were $1,261 million, a decrease of $54 million, or 4.1%, over the prior year (2.4% decrease at constant currency). Order intake was negatively impacted by $23 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of $31 million.
The following table illustrates the impact from organic declines, recent acquisitions and divestitures, and foreign currency translation in relation to orders during
the three months ended March 31, 2020:
Water Infrastructure
Applied
Water
Measurement & Control Solutions
Total Xylem
(in millions)
$ Change
% Change
$ Change
% Change
$ Change
% Change
$ Change
% Change
2019
Orders
$
532
$
394
$
389
$
1,315
Organic Impact
(3)
(0.6)
%
(18)
(4.6)
%
(10)
(2.6)
%
(31)
(2.4)
%
Acquisitions/(Divestitures)
—
—
%
—
—
%
—
—
%
—
—
%
Constant
Currency
(3)
(0.6)
%
(18)
(4.6)
%
(10)
(2.6)
%
(31)
(2.4)
%
Foreign
currency translation (a)
(15)
(2.8)
%
(4)
(1.0)
%
(4)
(1.0)
%
(23)
(1.7)
%
Total
change in orders
(18)
(3.4)
%
(22)
(5.6)
%
(14)
(3.6)
%
(54)
(4.1)
%
2020
Orders
$
514
$
372
$
375
$
1,261
(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 Australian Dollar, the Norwegian Krone, the Swedish Krona and the Chinese Yuan.
Water Infrastructure
Water Infrastructure segment orders decreased $18 million, or 3.4%, to $514 million (0.6% decrease at constant currency) for the first quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by $15 million of foreign currency translation, with the change at constant currency coming from an organic decline in orders in the transport application, which was largely offset by organic order growth in the treatment application. Transport orders were primarily impacted by reduced order intake in North America as compared to the prior year where we had a couple of large project orders, as well as market weakness in the dewatering transport applications in the United States and Europe. The treatment application saw
organic order growth in the quarter, primarily driven by strong order intake in Europe, North America and Latin America during the quarter, which was partially offset by a reduction of orders in India. We believe that substantially all of the organic order decline during the quarter was due to COVID-19 impacts, partially offset by organic order growth in the treatment application.
Applied Water
Applied Water segment orders decreased $22 million, or 5.6%, to $372 million (4.6% decrease at constant currency) for the first quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by $4 million of foreign currency translation. The order decrease on a constant currency basis was primarily driven by organic weakness in the United States, where a decrease in industrial order intake was partially offset by commercial order growth during the
quarter, and in Asia Pacific, which was significantly impacted by the COVID-19 pandemic during the quarter. We believe that substantially all of the organic order decline during the quarter was due to COVID-19 impacts.
Measurement & Control Solutions
Measurement & Control Solutions segment orders decreased $14 million, or 3.6%, to $375 million (2.6% decrease at constant currency) for the first quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by $4 million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline in the SaaS application during the quarter, which was negatively impacted by the lapping of large project deployment orders in North America during the prior year. The water application contributed a more modest decline in organic orders during the quarter
as significant prior year project
36
deployments within the AIA platform were largely offset by water metrology orders in North America. These order declines were partially offset by organic growth in the quarter in the test application, primarily in Europe, and in the energy application in North America. We believe that substantially all of the organic order decline during the quarter for the segment was due to COVID-19 impacts.
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 $1,887 million at March 31, 2020, an increase of $54 million or 2.9%, as compared to March 31, 2019 backlog of $1,833 million, and an increase of $86 million or 4.8%, as compared to December 31, 2019 backlog of $1,801
million. We anticipate that approximately 56% of the backlog at March 31, 2020 will be recognized as revenue in the remainder of 2020. Cancellations in the quarter were materially consistent with the prior year.
Gross Margin
Gross margin as a percentage of revenue decreased 190 basis points to 36.4% for the three months ended March 31, 2020 as compared to 38.3% for the comparative 2019 period. The gross margin decrease for the quarter was primarily driven by unfavorable volume, impacted by COVID-19, cost inflation, increased cost of quality due to a product warranty issue in our Sensus business and unfavorable mix, which were partially offset by cost reductions from global procurement and productivity improvement initiatives.
Operating Expenses
The
following table presents operating expenses for the three months ended March 31, 2020 and 2019:
Three Months Ended
March
31,
(In millions)
2020
2019
Change
Selling, general and administrative
expenses ("SG&A")
$
297
$
303
(2.0)
%
SG&A as a % of revenue
26.4
%
24.5
%
190
bp
Research
and development expenses ("R&D")
49
51
(3.9)
%
R&D as a % of revenue
4.4
%
4.1
%
30
bp
Restructuring
and asset impairment charges
2
11
(81.8)
%
Operating
expenses
$
348
$
365
(4.7)
%
Expense to revenue ratio
31.0
%
29.5
%
150
bp
Selling,
General and Administrative ("SG&A") Expenses
SG&A expenses decreased by $6 million to $297 million, or 26.4% of revenue, in the first quarter of 2020, as compared to $303 million, or 24.5% of revenue, in the comparable 2019 period. The increase in SG&A as a percent of revenue for the quarter was primarily driven by the drop in revenue, which was significantly impacted by the COVID-19 pandemic, as well as in cost inflation and additional investment in strategic growth initiatives, which were partially offset by cost reductions from global procurement and productivity improvement initiatives, including restructuring savings.
Research and Development ("R&D") Expenses
R&D expense was $49 million, or 4.4% of revenue, in the first quarter of 2020, as compared to $51 million, or 4.1% of revenue, in the comparable
period of 2019. The increase in R&D as a percent of revenue for the period was primarily driven by the drop in revenue, which was significantly impacted by the COVID-19 pandemic.
Restructuring and Asset Impairment Charges
Restructuring
During the three months ended March 31, 2020, we recognized restructuring charges of $2 million. We incurred
37
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 Water Infrastructure segment.
During the three months ended March 31, 2019, we recognized restructuring charges of $8 million. 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.
The following is a roll-forward for the three months ended March 31, 2020 and 2019 of employee position eliminations associated
with restructuring activities:
2020
2019
Planned reductions - January 1
196
69
Additional
planned reductions
50
158
Actual reductions and reversals
(60)
(134)
Planned reductions - March 31
186
93
The
following table presents expected restructuring spend for actions commenced as of March 31, 2020:
(in millions)
Water Infrastructure
Applied
Water
Measurement & Control Solutions
Total
Actions Commenced in 2020:
Total expected costs
$
1
$
—
$
—
$
1
Costs
incurred during Q1 2020
1
—
—
1
Total expected costs remaining
$
—
$
—
$
—
$
—
Actions
Commenced in 2019:
Total expected costs
$
20
$
5
$
27
$
52
Costs
incurred during 2019
18
5
27
50
Costs incurred during Q1 2020
1
—
—
1
Total
expected costs remaining
$
1
$
—
$
—
$
1
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 2019
1
—
1
2
Costs
incurred during Q1 2020
—
—
—
—
Total expected costs remaining
$
4
$
2
$
—
$
6
The
Water Infrastructure actions commenced in 2020 consist primarily of severance charges and are substantially complete. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges. The Applied Water and Measurement & Control Solutions actions are complete and the Water Infrastructure actions are expected to continue through the fourth quarter of 2020. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2017 consist primarily of severance charges. The Measurement & Control Solutions actions are complete and the Water Infrastructure and Applied Water actions are expected to continue through 2021.
Due to the impact of the COVID-19 pandemic, we are reevaluating the restructuring actions planned for 2020.
38
Asset
Impairment
During the first quarter of 2019 we determined that certain assets within our Measurement & Control Solutions segment, including customer relationships, were impaired. Accordingly we recognized impairment charges of $3 million. Refer to Note 9, "Goodwill and Other Intangible Assets," for additional information.
Operating Income
Operating income during the first quarter of 2020 was $61 million, reflecting a decrease of 44.0% compared to $109 million in the first quarter of 2019. Operating margin was 5.4% for 2020 versus 8.8% for 2019, a decrease of 340 basis points. Operating margin benefited from a decrease in restructuring and realignment costs of $11 million and special charges of $4 million incurred in 2019 that did not recur during the year. Excluding these restructuring and realignment costs
and special charges, adjusted operating income was $70 million with an adjusted operating margin of 6.2% in the first quarter of 2020 as compared to adjusted operating income of $133 million with an adjusted operating margin of 10.8% in the first quarter of 2019. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19, cost inflation, increased cost of quality, unfavorable mix and increased spending on strategic investments. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives, including restructuring savings, and price realization.
39
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
March
31,
(In millions)
2020
2019
Change
Water Infrastructure
Operating
income
$
39
$
51
(23.5)
%
Operating margin
8.9
%
10.6
%
(170)
bp
Restructuring
and realignment costs
5
9
(44.4)
%
Adjusted
operating income
$
44
$
60
(26.7)
%
Adjusted operating margin
10.0
%
12.4
%
(240)
bp
Applied
Water
Operating income
$
47
$
56
(16.1)
%
Operating
margin
13.9
%
14.8
%
(90)
bp
Restructuring and realignment costs
2
3
(33.3)
%
Adjusted
operating income
$
49
$
59
(16.9)
%
Adjusted operating margin
14.5
%
15.6
%
(110)
bp
Measurement
& Control Solutions
Operating (loss) income
$
(12)
$
16
(175.0)
%
Operating
margin
(3.5)
%
4.3
%
(780)
bp
Restructuring
and realignment costs
2
8
(75.0)
%
Special charges
—
4
NM
Adjusted
operating (loss) income
$
(10)
$
28
(135.7)
%
Adjusted operating margin
(2.9)
%
7.4
%
(1,030)
bp
Corporate
and other
Operating loss
$
(13)
$
(14)
(7.1)
%
Adjusted
operating loss
$
(13)
$
(14)
(7.1)
%
Total Xylem
Operating
income
$
61
$
109
(44.0)
%
Operating margin
5.4
%
8.8
%
(340)
bp
Restructuring
and realignment costs
9
20
(55.0)
%
Special
charges
—
4
NM
Adjusted operating income
$
70
$
133
(47.4)
%
Adjusted
operating margin
6.2
%
10.8
%
(460)
bp
NM - Not meaningful percentage change
Water Infrastructure
Operating income for our Water Infrastructure segment decreased $12 million, or 23.5%, for the first quarter of 2020 compared
to the prior year, with operating margin also decreasing from 10.6% to 8.9%. Operating margin benefited from a decrease in restructuring and realignment costs of $4 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased $16 million, or 26.7%, with adjusted operating margin decreasing from 12.4% to 10.0%. The decrease in adjusted operating margin for the quarter was primarily due to cost inflation, unfavorable volume, impacted significantly by COVID-19, unfavorable mix, negative currency impacts and increased spending on strategic investments. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives and price realization.
Applied Water
Operating income for our Applied Water segment decreased $9 million, or 16.1%, for the first quarter of 2020 compared to the prior year, with operating
margin also decreasing from 14.8% to 13.9%. Operating margin
40
benefited from a decrease in restructuring and realignment costs of $1 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased $10 million, or 16.9%, with adjusted operating margin decreasing from 15.6% to 14.5%. The decrease in adjusted operating margin was primarily due to cost inflation, unfavorable volume, impacted significantly by COVID-19, and increased cost of quality. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives and price realization.
Measurement & Control Solutions
Operating income for our Measurement
& Control Solutions segment decreased $28 million, or 175.0%, for the first quarter of 2020 compared to the prior year, resulting in an operating loss of $12 million, with operating margin also decreasing from 4.3% to (3.5)%. Operating margin benefited from a decrease in restructuring and realignment costs of $6 million during the year and $4 million of special charges incurred during 2019 that did not recur in 2020. Excluding these items, adjusted operating income decreased $38 million, or 135.7%, for the quarter, resulting in an adjusted operating loss of $10 million, with adjusted operating margin decreasing from 7.4% to (2.9)%. The decrease in adjusted operating margin was primarily due to increased cost of quality, primarily due to a $15 million warranty charge recorded during the quarter for a firmware issue in some of our meters, unfavorable volume, impacted significantly by COVID-19, cost inflation, unfavorable mix and increased spending on strategic investments. These
impacts were partially offset by cost reductions from our global procurement and productivity initiatives and price realization.
Corporate and other
Operating loss for corporate and other decreased $1 million, or 7.1%, for the first quarter of 2020 compared to the prior year.
Interest Expense
Interest expense was $16 million for the three months ended March 31, 2020 and $18 million for the three months ended March 31, 2019. The decrease in interest expense for the three month period ended March 31, 2020 is primarily driven by the impact of cross currency swaps during the quarter and, to a lesser extent, the favorable interest rates associated with
our Euro Commercial Paper Program borrowings as compared to borrowings from U.S. Dollar Commercial Paper Program during 2019. See Note 10, "Derivative Financial Instruments", of our condensed consolidated financial statements for a description of our cross currency swaps. See Note 12, "Credit Facilities and Debt", of our condensed 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 March 31, 2020 was $4 million resulting in an effective tax rate of 10.0%, compared to a $15 million charge resulting in an effective tax rate of 16.6% for the same period in 2019. The effective tax rate for the three month period ended March 31, 2020
differs from the United States federal statutory rate primarily due to the mix of earnings in jurisdictions, partially offset by the Global Intangible Low-Taxed Income ("GILTI") inclusion. Additionally, the effective tax rate for the three month period ended March 31, 2020 is lower than the same period in 2019 due to the relative impact of the benefit from favorable equity compensation deductions on the effective tax rate.
Other Comprehensive (Loss) Income
Other comprehensive loss was $87 million for the three months ended March 31, 2020 compared to income of $20 million for the same period in 2019. Foreign currency translation contributed unfavorable year-over-year impacts for the quarter of $107 million, driven primarily by the weakening of the Great British Pound, the Canadian
Dollar, the Australian Dollar and the Chinese Yuan as compared to the U.S. Dollar in 2020 versus the strengthening of these currencies in the same prior year period. Additionally, the weakening of the Euro and the South African Rand as compared to the U.S. Dollar was greater in 2020 than the weakening of these currencies in the prior year. 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 $10 million during the quarter that contributed to the loss. Partially offsetting these unfavorable drivers was the decreased loss in derivative hedge agreements during the year.
41
Liquidity
and Capital Resources
The following table summarizes our sources and (uses) of cash:
Three Months Ended
March 31,
(In
millions)
2020
2019
Change
Operating activities
$
(2)
$
83
$
(85)
Investing activities
(48)
(77)
29
Financing
activities
87
(29)
116
Foreign exchange (a)
(22)
2
(24)
Total
$
15
$
(21)
$
36
(a)The
impact is primarily due to the weakness of the Euro, the Canadian Dollar, the Chinese Yuan, the Russian Ruble and various other currencies against the U.S. Dollar.
Sources and Uses of Liquidity
Operating Activities
Net cash used by operating activities was $2 million for the three months ended March 31, 2020 as compared to net cash provided of $83 million in the comparable prior year period. This net decrease was primarily driven by the change in working capital levels as compared to the prior year, largely resulting from the sequential use of working capital following the low levels we saw at the end of 2019, and a decrease in cash from earnings.
Investing Activities
Cash used in investing activities
was $48 million for the three months ended March 31, 2020 as compared to $77 million in the comparable prior year period. This decrease in cash used of $29 million was mainly driven by lower spending on capital expenditures compared to the prior year, which included the purchase of a building and new software tools, and a $5 million reduction in spending on acquisitions.
Financing Activities
Cash generated by financing activities was $87 million for the three months ended March 31, 2020 as compared to cash used of $29 million in the comparable prior year period. This net increase in cash from financing activities during the period was primarily due to higher levels of short-term debt during the first quarter of 2020, partially offset by an increase in share repurchase activity of $21
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. As a result of uncertainties caused by the COVID-19 pandemic, we are reevaluating aspects of our spending, including capital expenditures, strategic investments and dividends. We are also considering available federal, state and foreign tax programs related to timing of tax payments and deductions to further manage our liquidity. Historically, we have generated operating cash flow sufficient to fund our primary cash needs. The potentially prolonged economic effects of the COVID-19 pandemic may impact the Company’s future operating cash flows. 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. The future impact of the COVID-19 pandemic is uncertain and may increase our borrowing costs and other costs of capital and otherwise adversely affect our business, results of operations, financial condition and liquidity.
We
have considered the impacts of the COVID-19 pandemic on our liquidity and capital resources and do not currently expect it to impact our ability to meet future liquidity needs or continue to comply with debt covenants. Based on our current global cash positions, cash flows from operations and access to the capital markets, we believe there is sufficient liquidity to meet our funding requirements. In addition, our existing committed credit
42
facilities and access to the public debt markets would provide further liquidity if required. Currently, we have available liquidity of approximately $1.7 billion, consisting of cash and available credit facilities, including term loan facilities as disclosed in Note 12, "Credit Facilities and Debt", of our condensed consolidated financial
statements. Our debt repayment obligations in 2020 consist of $268 million in outstanding commercial paper and $191 million of other borrowings. Our next long term debt maturity is October 2021.
Risk related to these items are described below and under Item 1A, "Risk Factors".
See Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements for a description of our credit facilities and long-term debt.
Non-United States Operations
We generated approximately 50% and 51% of our revenue from non-United States operations for the three months ended March 31, 2020 and 2019,
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 expect that 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 need to repatriate funds held internationally to support our United States operations. As of March 31, 2020, we have provided a deferred tax liability of $8 million for net foreign withholding taxes and state income taxes on $505 million of earnings expected to be repatriated to the United States parent as deemed necessary in the future.
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, particularly at this time and moving forward given the uncertainty around the magnitude and duration of the COVID-19 pandemic. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2019 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 2019 Annual Report.
The carrying value of our Advanced Infrastructure Analytics (“AIA”) goodwill reporting unit is $169 million as of March 31, 2020. During the fourth quarter of 2019 we completed our annual goodwill assessment. Our 2019 impairment analysis indicated that the fair value of the AIA reporting unit exceeded its carrying value by less than 20%. We used the income approach to determine the fair value of our goodwill reporting units. Under the income approach, the fair value of the reporting units 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 reporting unit.
Given the uncertainty of the future impact of the COVID-19 pandemic, further deterioration of our future cash flows may lead to a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment.
See Item 1A, "Risk Factors" for a discussion of the potential impacts of COVID-19 on the fair value of our assets.
43
New Accounting Pronouncements
See Note 2, "Recently Issued Accounting Pronouncements", to the condensed consolidated
financial statements for a complete discussion of recent accounting pronouncements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no other material change in the information concerning market risk as stated in our 2019 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.
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.
44
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 18, "Commitments and Contingencies", to the condensed consolidated financial statements for further information and any updates.
ITEM 1A. RISK FACTORS
Information regarding our risk factors appears in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December
31, 2019 filed with the SEC on February 28, 2020 ("Annual Report"). These risk factors describe some of the assumptions, risks, uncertainties and other factors that could materially and adversely affect our business, financial condition or operating results. In addition, the following risk factor represents a material change in our risk factors from those disclosed in Item 1A. of our Annual Report.
Our business, results of operations and stock price have been adversely impacted by the coronavirus disease 2019 (COVID-19), and we are unable to predict the full extent to which COVID-19 may adversely impact our business, operations, financial condition, results of operations, and stock price in the future.
The coronavirus disease 2019 (COVID-19) pandemic has created significant global volatility, uncertainty and economic disruption.
The global spread of the COVID-19 pandemic has curtailed the movement of people, goods and services worldwide, including in many of the regions where we sell our products and services and conduct operations. Public health officials have recommended, or governments have mandated, precautions to mitigate the spread of COVID-19, including stay at home or similar measures in many of the areas in which we operate. This has resulted in temporary production impacts at several of our facilities over the past several months, and also curtailed the business and operations of some of our customers and suppliers.
The COVID-19 pandemic is adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and businesses, and we have experienced, and expect to continue to experience, unpredictable interruptions at our suppliers and reductions in demand for certain of our products and services as the COVID-19
pandemic has also had an adverse impact on many of the customers we serve. Because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing and difficult to predict, the pandemic’s impact on our business, operations, financial condition and results, and stock price remains uncertain and difficult to predict, but we expect our results to be adversely impacted beyond the quarter ending March 31, 2020.
The extent to which the COVID-19 pandemic impacts our business, operations, financial condition and results, and stock price will depend on numerous evolving factors that remain uncertain, many of which are not within our control or which we may not effectively respond to, including: the duration and scope of the pandemic; governmental, business and individuals’ mandates, actions and protocols that have been and continue
to be taken in response to the pandemic; shortage of labor due to stay at home mandates, quarantines or prolonged illness of our employees or that of our customers or suppliers; the impact of the pandemic on economic activity and actions taken in response; the effect on our customers’ demand for our products and services, including slowed decision-making, delay or cancellation of orders or planned projects, or termination of existing agreements; the ability of our suppliers to supply us with products, parts and raw materials, including the ability of our suppliers to meet logistics or delivery requirements; our ability to sell and provide our products and services, including as a result of travel restrictions and people working from home; the ability of our customers to pay for our products and services; any closures of our and our customers’ facilities or suspension of operations; commodity cost volatilities; and the pace of recovery when the COVID-19 pandemic subsides,
as well as response to potential recurrence.
Additionally, concerns over the economic impact of COVID-19 have caused extreme volatility in financial and other capital markets which has, and may continue to, adversely impact our stock price. The financial and capital market volatility may also increase our cost of capital or may limit the availability of additional capital or make it more difficult to secure, possibly only on terms less favorable to us. A sustained downturn may impact our liquidity position, including our ability to continue to pay dividends. A sustained downturn in the financial markets and asset
45
values may also result in the carrying value of our goodwill or other intangible assets exceeding their fair value,
which may require us to recognize an impairment to those assets. The effects of the COVID-19 pandemic, including remote working arrangements for employees, may also impact our financial reporting systems and internal control over financial reporting.
Further, the COVID-19 pandemic, and the volatile regional and global economic conditions stemming from the pandemic, could also precipitate or aggravate the other risk factors that we identify in our 2019 Annual Report on Form 10-K, which could materially adversely affect our business, financial condition, results of operations and/or stock price. Additionally, the COVID-19 pandemic may also affect our operating and financial results in a manner that is not presently known to us or that we currently do not consider to present significant risks to our operations.
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 March 31, 2020:
(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)
1/1/20 - 1/31/20
—
—
—
$338
2/1/20
- 2/29/20
—
—
—
$338
3/1/20 - 3/31/20
0.7
77.06
0.7
$288
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. For the three months ended March 31, 2020, we repurchased 0.7 million shares for $50 million. There are up to $288 million in shares that may still be purchased under this plan as of March 31, 2020.
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.
Term Loan Agreement, dated as of April
25, 2020 among Xylem Europe GmbH, as borrower, Xylem Inc., as parent guarantor and ING Bank, as lender (including Form of Parent Guarantee)
The
following materials from Xylem Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020, 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 March
31, 2020 formatted in Inline XBRL and contained in Exhibit 101.0.
47
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.
