XYLEM INC.
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").
This Report contains information that may constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Generally, the words "anticipate," "estimate," "expect," "project,"
"intend," "plan," "contemplate," "predict," "forecast," "believe," "target,"
"will," "could," "would," "should," "potential," "may" and similar expressions
may, but are not necessary to, identify forward-looking statements. By their
nature, forward-looking statements address uncertain matters and include any
statements that: are not historical, such as statements about the Company's
capitalization, restructuring and realignment plans, and future strategic plans;
describe the Company's business strategy, outlook, objectives, plans, intentions
or goals; or 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 expressing general views about future operating results. 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 statements. The novel
coronavirus ("COVID-19") pandemic is and may continue to amplify many of these
risks and uncertainties.
Factors that could cause results to differ materially from those anticipated
include: overall economic and business conditions; the COVID-19 pandemic's
uncertain magnitude, duration, geographic reach and impact on the global
economy; the current and future impact of the COVID-19 pandemic on our business,
growth, projections, financial condition, operations, cash flows, and liquidity,
including from adverse economic conditions on our performance or customer
markets caused by the COVID-19 pandemic; actual or potential other epidemics,
pandemics or global health crises; geopolitical and other risks associated with
our international operations that could affect customer markets and our
business, such as military actions, protectionism, economic sanctions or trade
barriers, including tariffs and embargoes, and non-compliance with laws or
regulations, including those pertaining to foreign corrupt practices, data
privacy, export and import and competition; potential for unexpected
cancellations or delays of customer orders in our reported backlog; 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 refinance our existing indebtedness;
availability of liquidity sufficient to meet our needs; uncertainty from the
expected discontinuance of LIBOR and transition to another interest rate
benchmark; changes in the value of goodwill or intangible assets; uncertainty
related to restructuring and realignment actions and related charges and
savings, including with respect to the amount and timing of estimated costs and
savings, the timing of or delays in implementing actions, and our ability to
realize all of the anticipated cost savings, all of which are subject to change
as the Company makes decisions and refines plans and estimates over time;
management and employee distraction resulting from restructuring actions; timing
delays in implementing strategic initiatives; our ability to continue strategic
investments for growth; risks relating to products, including defects, security,
liability and recalls; governmental or regulatory claims or investigations;
cybersecurity attacks, breaches or other disruptions of information technology
systems on which we rely, or on our products; our sustainability initiatives;
the use of proceeds from our green bond offering, including failure to
appropriately allocate the net proceeds or meet the investment requirements of
certain environmentally-focused investors; litigation and contingent
liabilities; and other factors set forth under "Item 1A. Risk Factors" in our
2019 Annual Report, "Item 1A. Risk Factors" in the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2020 and in subsequent filings we have
made or may make with the 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.
32
--------------------------------------------------------------------------------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 spread of COVID-19 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 and have continued through the third quarter. As the COVID-19 pandemic began to unfold in the first quarter of 2020,Xylem deployed aCOVID-19 Response Team , responsible forXylem 's Pandemic Plan, which is designed to aid in prevention, preparedness, response and recovery at our sites and across the Company. 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 macroeconomic, market and industry dynamics that are, to varying degrees, related to the COVID-19 pandemic and its consequences. 33 -------------------------------------------------------------------------------- Public health officials have recommended, or governments have mandated, precautions to mitigate the spread of COVID-19, including stay at home or similar measures, such as travel restrictions, for periods of time in many of the areas in which we operate. Operationally, our production facilities located inLatin America ,Europe andAsia Pacific experienced reduced production levels due to such measures to varying degrees during the year, particularly during the first and second quarter. Currently, our overall operating capacity remains just over 90% globally, with all of our production facilities operational. In order to maintain a safe work environment, our production facilities continue to spread out operations over multiple shifts and implement other protective measures such as temperature screening and social distancing, while maintaining operational capabilities. The COVID-19 pandemic is also adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and businesses. While we expect, from time to time, to experience unpredictable interruptions with our external suppliers, we have enhanced our supplier pulsing and redundancy to minimize those impacts. To date, the most significant operational impacts we have experienced are volume reductions ranging across all segments and major geographic regions. 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 have and may continue to 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 third quarter, total backlog increased 21.7% as compared toDecember 31, 2019 and there has not been a notable increase in contract 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, inability to access or travel to customer sites and shipping delays due to stay at home measures. However, because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain and rapidly changing, the pandemic's ongoing and future impacts on our business, financial condition, results of operations, and stock price remain uncertain and difficult to predict, but we expect our results to continue to be adversely impacted beyond the quarter endingSeptember 30, 2020 . In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, management committed to restructuring activities across our businesses and functions globally during the second quarter of 2020. These initiatives are designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. In light of the uncertainty created by the COVID-19 pandemic, we have also proactively taken further cost reduction actions which include a temporary 20% reduction in the base salary of the Company's Chief Executive Officer ("CEO") and all direct reports to the CEO and a temporary 20% reduction in annual cash retainer fees payable to our Board of Directors. These temporary reductions are effective fromJune 1, 2020 throughDecember 31, 2020 . Additionally, we have committed to reduced capital expenditure and discretionary operating spending during the year.Xylem has taken measures to protect the health and safety of our employees and work with our customers to minimize potential disruptions. In the first quarter, we 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 aXylem facility or in the field supporting customers during periods of mandated stay at home or similar measures. These programs will remain in place through the end of 2020 and continue to be evaluated for continuation as necessary going forward.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 andUNICEF , as well as the expansion of the Partner Community Grants program and other philanthropic commitments. Many of our offices globally have transitioned to a substantially remote work from home status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures. As public health officials and governments ease recommendations and regulations regarding stay at home measures, ourCOVID-19 Response Team is applying a set ofXylem "Return to Workplace" health and safety guidelines for remote workers to return to our facilities. These guidelines require government officials to first declare an easing of their restrictions, upon which we do a full review of our site to determine its readiness and follow a phased return to work approach, all in service to help ensure the safety of our people. 34 -------------------------------------------------------------------------------- We will continue to work with our customers, employees, suppliers and communities to address the impacts of COVID-19. We also continue to assess the evolving nature of the pandemic and its possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences. Risk related to the impact of COVID-19 are described in further detail under "Item 1A. Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 . Executive SummaryXylem reported revenue for the third quarter of 2020 of$1,220 million , a decrease of 5.9% compared to$1,296 million reported in the third quarter of 2019. On a constant currency basis, revenue decreased by$85 million , or 6.6%, driven entirely by organic declines across all segments, with the majority of the decline coming from the industrial and utility end markets. Organic revenue decline during the quarter was anticipated as our business continues to be impacted by the COVID-19 pandemic. We generated operating income of$73 million (margin of 6.0%) during the third quarter of 2020, as compared to$11 million (margin of 0.8%) in 2019. Operating income in the third quarter of 2020 benefited from decreases in special charges of$85 million and decreases in restructuring and realignment costs of$15 million as compared to the third quarter of 2019. Excluding the impact of these items, adjusted operating income was$158 million (adjusted margin of 13.0%) during the third quarter of 2020 as compared to$196 million (adjusted margin of 15.1%) in 2019. The decrease in adjusted operating margin was primarily due to cost inflation; unfavorable volume, impacted significantly by COVID-19; unfavorable mix; increased spending on strategic investments and increased inventory management costs. These impacts were partially offset by cost reductions from our productivity, restructuring and other cost saving initiatives. Additional financial highlights for the quarter endedSeptember 30, 2020 include the following: •Orders of$1,246 million , down 7.4% from$1,346 million in the prior year, and down 8.2% on an organic basis, impacted by the COVID-19 pandemic. •Earnings per share of$0.20 , down 44.4% when compared to the prior year ($0.62 , down 24.4% on an adjusted basis). •Net cash flow provided by operating activities of$454 million for the nine months endedSeptember 30, 2020 , up$3 million from the prior year. Free cash flow of$318 million , up$42 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 the non-GAAP measures we consider to be key performance indicators, 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. •"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 35 -------------------------------------------------------------------------------- translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not theU.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 Nine Months Ended September 30, September 30, (In millions, except for per share data) 2020 2019 2020 2019 Net income & Earnings per share$ 37 $ 0.20 $ 65 $ 0.36 $ 106 $ 0.58 $ 283 $ 1.56 Restructuring and realignment, net of tax of$3 and$15 for 2020 and$9 and$17 for 2019 12 0.06 21 0.11 52 0.28 54
0.30
Special charges, net of tax of$6 and$9 for 2020 and$2 and$2 for 2019 65 0.36 164 0.91 76 0.42 168 0.93 Tax-related special items - - (101) (0.56) (5) (0.03) (118) (0.65) Gain from sale of business, net of tax of$0 for 2019 - - - - - - (1)
(0.01)
Adjusted net income & Adjusted earnings per share$ 114 $ 0.62 $ 149 $ 0.82 $ 229 $ 1.25 $ 386 $ 2.13 •"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 both operating and non-operating adjustments for pension costs. •"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. Nine Months Ended September 30, (In millions) 2020 2019
Net cash provided by operating activities
$ 451 Capital expenditures (136) (175) Free cash flow$ 318 $ 276
Net cash used by investing activities $ (326)
Net cash provided (used) by financing activities
$ (99) 36
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•"EBITDA" defined as earnings before interest, taxes, depreciation and
amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to
exclude share-based compensation charges, restructuring and realignment costs,
special charges and gain or loss from sale of businesses.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 2020 2019 2020 2019
Net Income $ 37 $ 65 $ 106 $ 283
Income tax expense (benefit) 13 (77) 21 (45)
Interest expense (income), net 20 14 50 49
Depreciation 30 30 88 88
Amortization 33 35 101 104
EBITDA $ 133 $ 67 $ 366 $ 479
Share-based compensation $ 3 $ 7 19 23
Restructuring and realignment 15 30 67 71
Special charges 71 166 85 170
Gain from sale of business - - - (1)
Adjusted EBITDA $ 222 $ 270 $ 537 $ 742
2020 Outlook
We withdrew 2020 guidance on March 31, 2020 due to uncertainties caused by
COVID-19. We expect revenue to be down 5% to 7% in the fourth quarter, 6% to 8%
organically, driven primarily by the impact of COVID-19.
The following is a summary of our revenue outlook by each of our end markets:
•Utilities revenue decreased by approximately 7% organically through the third
quarter driven by weakness in the United States , the Middle East and Asia
Pacific , partially offset by strength in Europe . During 2020 we expect continued
resilience on the wastewater side as essential operational spending continues
and capital project funding for the year has been secured. However, the clean
water utilities will continue to face workforce challenges from impacts of
COVID-19 on the way in which they need to operate. We are seeing delays in
project deployments, but expect to start to see modest recovery as physical
distancing requirements ease. We continue to gain momentum behind key multi-year
wins setting up healthy longer term growth.
•Industrial revenue decreased by approximately 12% organically through the third
quarter driven by weakness in North America , the emerging markets and western
Europe . As 2020 progresses we expect industrial facilities to begin allowing
access to sales teams and channel partners, but anticipate to continue
experiencing slower orders and activity while non-essential work is deferred.
Exposure to the impacts of soft construction and industrial markets will
continue to have an effect on our dewatering business in North America
potentially leading to demand declines. We anticipate modest recovery in growth
trajectory as countries and regions begin to further re-open and activity
resumes.
•In the commercial markets, organic revenue decline was approximately 9% through
the third quarter driven by weakness in the emerging markets and the United
States , partially offset by strength in western Europe . During 2020 we expect
replacement business in the United States to continue to be impacted by
COVID-19. We anticipate mixed performance in the institutional building sector
depending on the "essential" nature of the end customer and modestly soft new
construction activity in North America .
•In the residential markets, organic revenue decline was approximately 8%
through the third quarter driven by weakness in the United States and western
Europe . This market is primarily driven by replacement revenue serviced through
our distribution network. As such, we anticipate healthy demand in China for
secondary water supply product applications as well as modest share gains in
Europe .
In response to the changes in business and economic conditions arising as a
result of the COVID-19 pandemic, on June 2, 2020 management committed to
structural cost actions across our businesses and functions globally. These
plans are designed to support our long-term financial resilience and simplify
our operations, strengthen our
37
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competitive positioning and better serve our customers. Additionally, we will
continue to strategically execute previously announced restructuring and
realignment actions, primarily to reposition our European and North American
businesses in an effort to optimize our cost structure and improve our
operational efficiency and effectiveness. During 2020, we expect to incur
between $75 million and $85 million in restructuring and realignment costs, with
approximately $25 million of these costs being non-cash charges. We expect to
realize approximately $67 million of net savings in 2020, consisting of $25
million of incremental net savings from restructuring and realignment actions
initiated in 2019, and approximately $42 million of net savings from the
restructuring, realignment and other structural cost actions initiated during
this year.
Results of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
(In millions) 2020 2019 Change 2020 2019 Change
Revenue $ 1,220 $ 1,296 (5.9) % $ 3,503 $ 3,878 (9.7) %
Gross profit 461 509 (9.4) % 1,304 1,509 (13.6) %
Gross margin 37.8 % 39.3 % (150) bp 37.2 % 38.9 % (170) bp
Total operating expenses 388 498 (22.1) % 1,116 1,218 (8.4) %
Expense to revenue ratio 31.8 % 38.4 % (660) bp 31.9 % 31.4 % 50 bp
Restructuring and realignment
costs 15 30 (50.0) % 67 71 (5.6) %
Special charges 70 155 (54.8) % 81 159 (49.1) %
Adjusted operating expenses 303 313 (3.2) % 968 988 (2.0) %
Adjusted operating expenses
to revenue ratio 24.8 % 24.2 % 60 bp 27.6 % 25.5 % 210 bp
Operating income 73 11 563.6 % 188 291 (35.4) %
Operating margin 6.0 % 0.8 % 520 bp 5.4 % 7.5 % (210) bp
Interest and other
non-operating expense, net 23 23 - % 61 54 13.0 %
Gain from sale of business - - - % - 1 NM
Income tax expense (benefit) 13 (77) (116.9) % 21 (45) (146.7) %
Tax rate 26.2 % 623.6 % (59,740) bp 16.6 % (18.9) % 3,550 bp
Net income $ 37 $ 65 (43.1) % $ 106 $ 283 (62.5) %
NM - Not meaningful change
Revenue
Revenue generated during the three and nine months ended September 30, 2020 was
$1,220 million and $3,503 million , reflecting decreases of $76 million , or 5.9%,
and $375 million , or 9.7%, respectively, compared to the same prior year
periods. On a constant currency basis, revenue declined 6.6% and 8.8% for the
three and nine months ended September 30, 2020 . The decreases at constant
currency consisted entirely of declines in organic revenue of $85 million and
$340 million , respectively, reflecting significantly lower demand in the United
States and the Middle East , largely due to COVID-19, partially offset by growth
in China and western Europe in the quarter.
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The following tables illustrates the impact from organic declines, recent
acquisitions and divestitures, and foreign currency translation in relation to
revenue during the three and nine months ended
Water Infrastructure Applied Water Measurement & Control Solutions Total Xylem
(In millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change
2019 Revenue $ 531 $ 376 $ 389 $ 1,296
Organic Impact (11) (2.1) % (15) (4.0) % (59) (15.2) % (85) (6.6) %
Acquisitions/(Divestitures) - - % - - % - - % - - %
Constant Currency (11) (2.1) % (15) (4.0) % (59) (15.2) % (85) (6.6) %
Foreign currency translation (a) 4 0.8 % 3 0.8 % 2 0.5 % 9 0.7 %
Total change in revenue (7) (1.3) % (12) (3.2) % (57) (14.7) % (76) (5.9) %
2020 Revenue $ 524 $ 364 $ 332 $ 1,220
(a)Foreign currency translation impact for the quarter due to the strengthening
in value of various currencies against the U.S. Dollar, the largest being the
Euro.
Water Infrastructure Applied Water Measurement & Control Solutions Total Xylem
(In millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change
2019 Revenue $ 1,574 $ 1,149 $ 1,155 $ 3,878
Organic Impact (87) (5.5) % (104) (9.1) % (149) (12.9) % (340) (8.8) %Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency (87) (5.5) % (104) (9.1) % (149) (12.9) % (340) (8.8) % Foreign currency translation (a) (24) (1.5) % (6) (0.5) % (5) (0.4) % (35) (0.9) % Total change in revenue (111) (7.1) % (110) (9.6) % (154) (13.3) % (375) (9.7) % 2020 Revenue $ 1,463$ 1,039 $ 1,001 $ 3,503 (a)Foreign currency translation impact for the year due to the weakening in value of various currencies against theU.S. Dollar, the largest being the Norwegian Krone, the South African Rand, the Brazilian Real, the Chinese Yuan and the Australian Dollar. Water Infrastructure Water Infrastructure revenue decreased$7 million , or 1.3%, for the third quarter of 2020 (2.1% decrease at constant currency) as compared to the prior year period. Revenue benefited from$4 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline of$11 million . Organic weakness for the quarter was primarily driven by the industrial end market, particularly inNorth America , due to continued soft market conditions in oil and gas and mining, as well as in the emerging markets and westernEurope . This organic revenue decline for the quarter was partially offset by growth in the utility end market, particularly in westernEurope andChina . From an application perspective, the organic revenue decline during the third quarter was primarily driven by our transport application, where market conditions continued to soften inthe United States for construction, mining and oil and gas, negatively impacting the dewatering applications. The transport application also saw organic growth during the quarter inthe United States , driven by custom pump sales, and in westernEurope . Our treatment application also had modest growth during the quarter, driven by strong backlog execution inChina . For the nine months endedSeptember 30, 2020 , revenue decreased$111 million , or 7.1% (5.5% decrease at constant currency) as compared to prior year. Revenue was negatively impacted by$24 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline of$87 million . Organic weakness for the nine month period was primarily driven by the industrial end market, particularly inNorth America and the emerging markets, heavily impacted by the COVID-19 pandemic during the year. Organic revenue decline during the nine month period was also impacted by weakness, to a lesser extent, in the utility end market, particularly inthe United States , partially offset by organic growth inEurope during the period. The 39 -------------------------------------------------------------------------------- COVID-19 pandemic negatively impacted organic growth during the period throughout the entire segment and both end markets. From an application perspective, the organic revenue decline during the nine months endedSeptember 30, 2020 was driven by our transport application where market conditions continued to soften inUnited States in the dewatering applications, with construction, oil and gas and mining all down during the year. We also saw organic revenue decline within the emerging markets in the transport application, primarily inIndia , withIndia experiencing the lapping of some large projects executed in the prior year, as well as inLatin America . Organic revenue declines within the transport application were partially offset by modest organic growth in the treatment application during the year, primarily driven by projects in the emerging markets. Applied Water Applied Water revenue decreased$12 million , or 3.2%, for the third quarter of 2020 (4.0% decrease at constant currency) as compared to the prior year. Revenue benefited from$3 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of$15 million . Organic weakness for the quarter was primarily driven by the industrial end market with, general industrial weakening driven by COVID-19 impacts and restrictions, particularly in westernEurope andthe United States , and declines in the building services commercial end market, where weakness in the emerging markets and the United Sates were partially offset by strength in westernEurope during the quarter. Organic weakness during the quarter in these end markets was partially offset by modest growth in the building services residential end market. For the nine months endedSeptember 30, 2020 , revenue decreased$110 million , or 9.6% (9.1% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by$6 million of foreign currency translation for the period, with the change at constant currency coming entirely from an organic decline of$104 million . Organic weakness during the nine month period was driven by declines across all end markets and applications, with industrial water and commercial building services declining the most, followed by declines in building services in the residential market as well. Organic revenue declines in the segment were seen across all major geographic regions as well, particularly inthe United States , the emerging markets and westernEurope , where the COVID-19 pandemic restricted activities and caused a slow down and general softening in the markets served. Measurement & Control Solutions Measurement & Control Solutions revenue decreased$57 million , or 14.7%, for the third quarter of 2020 (15.2% at constant currency) as compared to the prior year. Revenue benefited from$2 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of$59 million . Organic weakness for the quarter was driven by declines in the utility end market, primarily inthe United States and theMiddle East and, to a much lesser extent, weakness in the industrial end market in westernEurope . Organic revenue declines in the segment were significantly impacted by project timing and the COVID-19 pandemic during the quarter, particularly inthe United States . From an application perspective, the organic revenue decline for the segment was primarily driven by project timing in the gas business within the energy application where large project deployments inthe United States during the prior year did not repeat and we experienced project delays driven by the COVID-19 pandemic during the year. The water application also experienced organic revenue decline during the quarter, driven by the lapping of strong project deployments in theMiddle East andthe United States during the third quarter of the prior year and negative COVID-19 impacts, which drove market softness inthe United States where travel restrictions and site closures impacted our assessment services business. Organic weakness during the quarter was partially offset by the strong electric sales inthe United States within the energy application. The test and the software as a service ("SaaS") applications both had modest declines in revenue as compared to the prior year in westernEurope and inthe United States , respectively. For the nine months endedSeptember 30, 2020 , revenue decreased$154 million , or 13.3% (12.9% at constant currency) as compared to the prior year. Revenue was negatively impacted by$5 million of foreign currency translation during the nine month period, with the change at constant currency coming entirely from an organic decline of$149 million . Organic weakness for the period was driven by declines in the utility end market, primarily inthe United States and theMiddle East , marginally offset by modest organic growth in westernEurope during the year. To a lesser extent, the test application also experienced organic weakness in the industrial end market across all major geographic regions during the period. Organic revenue declines in the segment were significantly impacted by the COVID-19 pandemic during the period. 40 -------------------------------------------------------------------------------- From an application perspective, the organic revenue decline for the segment was driven by the water application, where the COVID-19 pandemic drove market softness inthe United States and we lapped strong project deployments in theMiddle East during the prior year. The energy application also had decline in organic revenue as compared to the prior year, primarily inNorth America as we lapped a few large gas project deployments and have been negatively impacted by the COVID-19 pandemic. The test application also experienced organic revenue decline during the period across all major regions, where we experienced negative impacts from the COVID-19 pandemic, and the lapping of a couple large prior year project executions in theMiddle East . The SaaS application had a modest decline in revenue as compared to the prior year, primarily inthe United States . 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 aXylem business. Orders received during the third quarter of 2020 were$1,246 million , a decrease of$100 million , or 7.4%, over the prior year (8.2% decrease at constant currency). Orders received during the nine months endedSeptember 30, 2020 were$3,739 million , a decrease of$314 million , or 7.7%, over the prior year (6.5% decrease at constant currency). Order intake benefited from$10 million of foreign currency translation during the quarter and was negatively impacted by$49 million of foreign currency translation for the nine months endedSeptember 30, 2020 . The change at constant currency was driven entirely by organic declines of$110 million and$265 million for the three and nine months endedSeptember 30, 2020 , respectively. The following tables illustrates the impact from organic declines, recent acquisitions and divestitures, and foreign currency translation in relation to orders during the three and nine months endedSeptember 30, 2020 : Water Infrastructure Applied Water Measurement & Control Solutions Total Xylem (in millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Orders $ 586$ 376 $ 384$ 1,346 Organic Impact (32) (5.5) % (4) (1.1) % (74) (19.3) % (110) (8.2) %
Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency (32) (5.5) % (4) (1.1) % (74) (19.3) % (110) (8.2) % Foreign currency translation (a) 4 0.7 % 3 0.8 % 3 0.8 % 10 0.7 % Total change in orders (28) (4.8) % (1) (0.3) % (71) (18.5) % (100) (7.4) % 2020 Orders $ 558$ 375 $ 313$ 1,246 (a)Foreign currency translation impact for the quarter due to the strengthening in value of various currencies against theU.S. Dollar, the largest being the Euro. Water Infrastructure Applied Water Measurement & Control Solutions Total Xylem (in millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Orders $ 1,704$ 1,169 $ 1,180 $ 4,053 Organic Impact 4 0.2 % (89) (7.6) % (180) (15.3) % (265) (6.5) %
Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency 4 0.2 % (89) (7.6) % (180) (15.3) % (265) (6.5) % Foreign currency translation (a) (38) (2.2) % (7) (0.6) % (4) (0.3) % (49) (1.2) % Total change in orders (34) (2.0) % (96) (8.2) % (184) (15.6) % (314) (7.7) % 2020 Orders $ 1,670$ 1,073 $ 996$ 3,739
(a)Foreign currency translation impact for the year due to the weakening in
value of various currencies against the
41
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Water Infrastructure
Water Infrastructure segment orders decreased $28 million , or 4.8%, to $558
million (5.5% decrease at constant currency) for the third quarter of 2020 as
compared to the prior year. Order intake during the quarter benefited from $4
million of foreign currency translation, with the change at constant currency
coming from organic order decline in the transport application, which was
partially offset by growth in the treatment application during the quarter.
Organic decline in the transport application was driven by the lapping of a
large project order in India in the prior year, along with market weakness in
construction, oil and gas and mining impacting the dewatering transport
application, primarily in the United States . Organic growth in the treatment
application was primarily driven by strong order intake in Asia Pacific and
North America during the quarter. The COVID-19 pandemic contributed to the
negative dynamics that impacted organic order growth during the quarter.
For the nine months ended September 30, 2020 , orders decreased $34 million , or
2.0%, to $1,670 million (0.2% increase at constant currency) as compared to the
same prior year period. Order intake during the period was negatively impacted
by $38 million of foreign currency translation, with the change at constant
currency coming from organic growth in orders in the treatment application,
which was partially offset by a decline in organic orders in the transport
application. Organic growth in the treatment application was driven by strong
order intake in North America , partially offset by large project orders placed
during the prior year in the emerging markets. The transport application
experienced an organic order decline during the period, primarily driven by
market weakness in construction, oil and gas and mining impacting the dewatering
application in North America , largely offset by the net year over year positive
impact of significant project orders in India . The COVID-19 pandemic also
negatively impacted organic order growth for the segment during the period.
Applied Water
Applied Water segment orders decreased $1 million , or 0.3%, to $375 million
(1.1% decrease at constant currency) for the third quarter of 2020 as compared
to the prior year. Order intake during the quarter benefited from $3 million of
foreign currency translation. The order decrease on a constant currency basis
was primarily driven by organic weakness during the quarter in the commercial
end market in the United States and in the emerging markets, particularly in the
Middle East , which was mostly offset by strong order intake in the residential
end market in the United States .
For the nine months ended September 30, 2020 , orders decreased $96 million , or
8.2%, to $1,073 million (7.6% decrease at constant currency) as compared to the
same prior year period. Order intake during the period was negatively impacted
by $7 million of foreign currency translation. The order decrease on a constant
currency basis was primarily driven by organic weakness across all end markets
in the United States and, to a lesser extent, reduced order intake in the
emerging markets and western Europe during the period.
The organic order growth for the segment during the three and nine month periods
was negatively impacted by the COVID-19 pandemic.
Measurement & Control Solutions
Measurement & Control Solutions segment orders decreased $71 million , or 18.5%,
to $313 million (19.3% decrease at constant currency) for the third quarter of
2020 as compared to the prior year. Order intake during the quarter benefited
from $3 million of foreign currency translation. The order decrease on a
constant currency basis was driven by an organic decline in the water
application which was negatively impacted by the lapping of strong prior year
orders, coupled with negative COVID-19 impacts, including travel restrictions
and site closures. Order intake in the energy applications declined organically
during the quarter, driven by negative COVID-19 impacts, coupled with the
lapping of large prior year gas and electric project deployments. The SaaS
application also experienced an organic order decline during the quarter as
market conditions softened as a result of the COVID-19 pandemic. Organic order
intake in the test application grew modestly during the quarter.
For the nine months ended September 30, 2020 , orders decreased $184 million , or
15.6%, to $996 million (15.3% decrease at constant currency) as compared to the
same prior year period. Order intake during the period was negatively impacted
by $4 million of foreign currency translation. The order decrease on a constant
currency basis was driven by the water application, where we lapped prior year
orders, and, to a lesser extent, the energy application, where prior year gas
project deployments more than offset strong electric order intake during the
period. The SaaS application also contributed to the organic decline during the
period, driven by the lapping of large project deployment orders in North
America during the prior year. The test application, primarily in the U.K.
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and the United States , also experienced a reduction in order intake during the
period. The COVID-19 pandemic significantly impacted the organic order growth
during the period.
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 $2,192 million at September 30, 2020 , an increase of
$324 million or 17.3%, as compared to September 30, 2019 backlog of $1,868
million , and an increase of $391 million or 21.7%, as compared to December 31,
2019 backlog of $1,801 million . We anticipate that approximately 32% of the
backlog at September 30, 2020 will be recognized as revenue in the remainder of
2020. There were no significant order cancellations during the quarter.
Gross Margin
Gross margin as a percentage of revenue decreased 150 and 170 basis points to
37.8% and 37.2% for the three and nine months ended September 30, 2020 , as
compared to 39.3% and 38.9% for comparative 2019 periods. The gross margin
decrease for quarter was primarily driven by cost inflation, unfavorable mix,
unfavorable volume, impacted by COVID-19 and increased inventory management
costs, which were partially offset by cost reductions from our global
procurement and productivity improvement initiatives and price realization. The
gross margin decrease for the nine month period was primarily driven by cost
inflation, increased inventory management costs, unfavorable mix, unfavorable
volume, impacted by COVID-19, and other lesser impacts, which were partially
offset by cost reductions from our global procurement and productivity
improvement initiatives and price realization.
Operating Expenses
The following table presents operating expenses for the three and nine months
ended September 30, 2020 and 2019:
Three Months Ended Nine Months Ended
September 30, September 30,
(In millions) 2020 2019 Change 2020 2019 Change
Selling, general and administrative
expenses ("SG&A") $ 266 $ 273 (2.6) % $ 851 $ 870 (2.2) %
SG&A as a % of revenue 21.8 % 21.1 % 70 bp 24.3 % 22.4 % 190 bp
Research and development expenses
("R&D") 45 44 2.3 % 138 142 (2.8) %
R&D as a % of revenue 3.7 % 3.4 % 30 bp 3.9 % 3.7 % 20 bp
Restructuring and asset impairment
charges 19 33 (42.4) % 69 58 19.0 %
Goodwill impairment charge 58 148 (60.8) % 58 148 (60.8) %
Operating expenses $ 388 $ 498 (22.1) % $ 1,116 $ 1,218 (8.4) %
Expense to revenue ratio 31.8 % 38.4 % (660) bp 31.9 % 31.4 % 50 bp
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses decreased by $7 million to $266 million , or 21.8% of revenue, in
the third quarter of 2020, as compared to $273 million , or 21.1% of revenue, in
the comparable 2019 period; and decreased $19 million to $851 million , or 24.3%
of revenue, in the nine months ended September 30, 2020 , as compared to $870
million , or 22.4% of revenue, for the nine months ended in 2019. The increase in
SG&A as a percent of revenue for both periods was primarily driven by the drop
in revenue, which was significantly driven by impacts of the COVID-19 pandemic,
as well as cost inflation and additional investment in strategic growth
initiatives. Cost reductions from
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global procurement and productivity improvement initiatives, including
restructuring savings, partially offsets these items.
Research and Development ("R&D") Expenses
R&D expense was $45 million , or 3.7% of revenue, in the third quarter of 2020,
as compared to $44 million , or 3.4% of revenue, in the comparable period of
2019; and was $138 million , or 3.9% of revenue, in the nine months ended
September 30, 2020 , as compared to $142 million , or 3.7% of revenue, in the
comparable period of 2019. The increase in R&D as a percent of revenue for both
periods was primarily driven by the drop in revenue, which was significantly
driven by impacts of the COVID-19 pandemic.
Restructuring and Asset Impairment Charges
Restructuring
In response to the changes in business and economic conditions arising as a
result of the COVID-19 pandemic, on June 2, 2020 management committed to
restructuring activities across our businesses and functions globally. The plan
is designed to support our long-term financial resilience and simplify our
operations, strengthen our competitive positioning and better serve our
customers.
As a result of this action, during the three and nine months ended September 30,
2020 , we recognized restructuring charges of $8 million and $48 million ,
respectively. These charges included reduction of headcount across all segments
and asset impairments within our Measurement & Control Solutions segment.
Immaterial restructuring charges incurred during the first quarter are included
in the plan information presented below.
During the three and nine months ended September 30, 2019 , we recognized
restructuring charges of $26 million and $48 million , respectively. We incurred
these charges primarily as a continuation of our efforts to reposition our
European and North American businesses to optimize our cost structure and
improve our operational efficiency and effectiveness. The charges included the
reduction of headcount and consolidation of facilities within our Measurement &
Control Solutions and Water Infrastructure segments, as well as headcount
reductions within our Applied Water segment.
The following is a roll-forward for the nine months ended September 30, 2020 and
2019 of employee position eliminations associated with restructuring activities:
2020 2019
Planned reductions - January 1 196 69
Additional planned reductions 670 621
Actual reductions and reversals (604) (465)
Planned reductions -
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The following table presents expected restructuring spend in 2020 and
thereafter:
Measurement &
(in millions) Water Infrastructure Applied Water Control Solutions Corporate Total
Actions Commenced in 2020:
Total expected costs $ 27 $ 11 $ 35 $ 3 $ 76
Costs incurred during Q1 2020 1 - - - 1
Costs incurred during Q2 2020 5 2 30 - 37
Costs incurred during Q3 2020 7 1 1 - 9
Total expected costs remaining $ 14 $ 8 $ 4 $ 3 $ 29
Actions Commenced in 2019:
Total expected costs $ 19 $ 5 $ 27 $ - $ 51
Costs incurred during 2019 18 5 27 - 50
Costs incurred during Q1 2020 1 - - - 1
Costs incurred during Q2 2020 1 - - - 1
Costs incurred during Q3 2020 (1) - - - (1)
Total expected costs remaining $ - $ - $ - $ - $ -
The Water Infrastructure, Applied Water, and Measurement & Control Solutions
actions commenced in 2020 consist primarily of severance charges across segments
and asset impairment charges in our Measurement & Control Solutions segment.
These actions are expected to continue through 2021. The Water Infrastructure,
Applied Water, and Measurement & Control Solutions actions commenced in 2019
consist primarily of severance charges. The actions commenced in 2019 are
complete.
During the second quarter of 2020 the discontinuance of a product line resulted
$17 million of asset impairments, primarily related to customer relationships,
trademarks and fixed assets within our Measurement & Control Solutions segment.
We currently expect to incur between $55 million and $60 million in
restructuring costs for the full year, with approximately $20 million of these
costs being non-cash charges. These restructuring charges are primarily related
to actions taken in response to the changes in business and economic conditions
arising as a result of the COVID-19 pandemic. We expect to realize approximately
$25 million of incremental net savings in 2020 from restructuring actions
initiated in 2019, and approximately $22 million of net savings in 2020 from the
restructuring actions initiated during this year.
Asset Impairment
During the third quarter of 2020, we determined that certain assets within our
Measurement & Control Solutions segment, including software and proprietary
technology were impaired. Accordingly we recognized an impairment charge of $11
million . Refer to Note 9, "Goodwill and Other Intangible Assets," for additional
information.
During the second quarter of 2020, we determined that internally developed
in-process software within our Measurement & Control Solutions segment was
impaired as a result of actions taken to prioritize strategic investments.
Accordingly we recognized an impairment charge of $10 million . Refer to Note 9,
"Goodwill and Other Intangible Assets," for additional information.
During the third quarter of 2019, we determined that certain assets within our
Measurement & Control Solutions segment, including customer relationships,
internally developed software, proprietary technology, and plant property &
equipment, were impaired. Accordingly we recognized an impairment charge of $7
million . Refer to Note 9, "Goodwill and Other Intangible Assets," for additional
information.
During the first quarter of 2019, we determined that certain assets within our
Measurement & Control Solutions segment, including customer relationships, were
impaired. Accordingly we recognized an impairment charge of $3 million . Refer to
Note 9, "Goodwill and Other Intangible Assets," for additional information.
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Goodwill Impairment Charge
During the third quarter of 2020, the Company recorded a goodwill impairment
charge of $58 million related to the AIA goodwill reporting unit within our
Measurement & Control Solutions segment. The AIA reporting unit is comprised of
our assessment services business (primarily the Pure acquisition) as well as our
digital solutions business. The impairment resulted from management's updated
forecast of future cash flows for the AIA businesses, which reflects significant
negative volume impacts, primarily on our assessment services business, due to
travel restrictions and site closures as a result of the COVID-19 pandemic. Our
ongoing investment in the AIA businesses also continues to impact near term
profitability. These factors drove a decrease in the fair value, based on a
discounted cash flow valuation, of the AIA reporting unit that is below its
carrying value as of the third quarter, requiring an impairment charge. Refer to
Note 9, "Goodwill and Other Intangible Assets," for additional information.
During the third quarter of 2019, the Company recorded a goodwill impairment
charge of $148 million related to the AIA goodwill reporting unit within our
Measurement & Control Solutions segment. The impairment resulted from a downward
revision of forecasted future cash flows. Factors that contributed to the
revised forecast in the third quarter include lower than expected results as
compared to prior forecasts, largely as a result of slower-than-expected
conversion of pipeline opportunities to revenue. Additionally, we have continued
to invest in the AIA platform ahead of the adoption curve, which has also
impacted the near term profitability of the business. These factors drove a
decrease in the fair value, based on a discounted cash flow valuation, of the
AIA reporting unit that is below its carrying value as of the third quarter,
requiring an impairment charge. Refer to Note 9, "Goodwill and Other Intangible
Assets," for additional information.
Operating Income
Operating income during the third quarter of 2020 was $73 million , reflecting an
increase of 563.6% compared to $11 million in the third quarter of 2019.
Operating margin was 6.0% for the third quarter of 2020 versus 0.8% for the
comparable period in 2019, an increase of 520 basis points. Operating margin
benefited from decreases in special charges of $85 million and decreases in
restructuring and realignment costs of $15 million as compared to the third
quarter of 2019. Excluding the impact of these items, adjusted operating income
was $158 million with an adjusted operating margin of 13.0% in the third quarter
of 2020 as compared to adjusted operating income of $196 million with an
adjusted operating margin of 15.1% in the third quarter of 2019. The decrease in
adjusted operating margin was primarily due to cost inflation; unfavorable
volume, impacted significantly by COVID-19; unfavorable mix; increased spending
on strategic investments and increased inventory management costs. These impacts
were partially offset by cost reductions from our productivity, restructuring
and other cost saving initiatives.
Operating income for the nine months ended September 30, 2020 was $188 million ,
reflecting a decrease of 35.4% compared to $291 million in 2019. Operating
margin was 5.4% for the nine months ended September 30, 2020 versus 7.5% for the
comparable period in 2019, a decrease of 210 basis points. Operating margin
benefited from decreases in special charges of $78 million and decreases in
restructuring and realignment costs of $4 million as compared to the prior year.
Excluding the impact of these items, adjusted operating income was $336 million
with an adjusted operating margin of 9.6% for the nine months ended September
30, 2020 as compared to adjusted operating income of $521 million with an
adjusted operating margin of 13.4% in 2019. The decrease in adjusted operating
margin was primarily due to unfavorable volume, impacted significantly by
COVID-19; cost inflation; increased inventory management costs; unfavorable mix
and increased spending on strategic investments. These impacts were partially
offset by cost reductions from our productivity, restructuring and other cost
saving initiatives.
46
--------------------------------------------------------------------------------The table below provides a reconciliation of the total and each segment's operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin:
Three Months Ended Nine Months Ended
September 30, September 30,
(In millions) 2020 2019 Change 2020 2019 Change
Water Infrastructure
Operating income $ 89 $ 97 (8.2) % $ 201 $ 246 (18.3) %
Operating margin 17.0 % 18.3 % (130) bp 13.7 % 15.6 % (190) bp
Restructuring and realignment costs 8 7 14.3 % 21 25 (16.0) %
Adjusted operating income $ 97 $ 104 (6.7) % $ 222 $ 271 (18.1) %
Adjusted operating margin 18.5 % 19.6 % (110) bp 15.2 % 17.2 % (200) bp
Applied Water
Operating income $ 56 $ 61 (8.2) % $ 144 $ 179 (19.6) %
Operating margin 15.4 % 16.2 % (80) bp 13.9 % 15.6 % (170) bp
Restructuring and realignment costs 2 3 (33.3) % 8 10 (20.0) %
Adjusted operating income $ 58 $ 64 (9.4) % $ 152 $ 189 (19.6) %
Adjusted operating margin 15.9 % 17.0 % (110) bp 14.6 % 16.4 % (180) bp
Measurement & Control Solutions
Operating loss $ (62) $ (136) (54.4) % $ (120) $ (94) 27.7 %
Operating margin (18.7) % (35.0) % 1,630 bp (12.0) % (8.1) % (390) bp
Restructuring and realignment costs 5 20 (75.0) % 38 36 5.6 %
Special charges 69 155 (55.5) % 79 159 (50.3) %
Adjusted operating income (loss) $ 12 $ 39 (69.2) % $ (3) $ 101 (103.0) %
Adjusted operating margin 3.6 % 10.0 % (640) bp (0.3) % 8.7 % (900) bp
Corporate and other
Operating loss $ (10) $ (11) (9.1) % $ (37) $ (40) (7.5) %
Special charges 1 - NM 2 - NM
Adjusted operating loss $ (9) $ (11) (18.2) % $ (35) $ (40) (12.5) %
Total Xylem
Operating income $ 73 $ 11 563.6 % $ 188 $ 291 (35.4) %
Operating margin 6.0 % 0.8 % 520 bp 5.4 % 7.5 % (210) bp
Restructuring and realignment costs 15 30 (50.0) % 67 71 (5.6) %
Special charges 70 155 (54.8) % 81 159 (49.1) %
Adjusted operating income $ 158 $ 196 (19.4) % $ 336 $ 521 (35.5) %
Adjusted operating margin 13.0 % 15.1 % (210) bp 9.6 % 13.4 % (380) bp
NM - Not meaningful percentage change
Water Infrastructure
Operating income for our Water Infrastructure segment decreased $8 million , or
8.2%, for the third quarter of 2020 compared to the prior year, with operating
margin also decreasing from 18.3% to 17.0%. Operating margin was negatively
impacted by a slight increase in restructuring and realignment costs of $1
million in 2020. Excluding these restructuring and realignment costs, adjusted
operating income decreased $7 million , or 6.7%, with adjusted operating margin
decreasing from 19.6% to 18.5%. The decrease in adjusted operating margin for
the quarter was primarily due to cost inflation; unfavorable mix; increased
inventory management costs; unfavorable volume, impacted significantly by
COVID-19, and increased spending on strategic investments. These impacts were
partially offset by cost reductions from our productivity and other cost saving
initiatives.
47
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For the nine months ended September 30, 2020 , operating income decreased $45
million , or 18.3%, as compared to the prior year, with operating margin also
decreasing from 15.6% to 13.7%. 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 $49
million , or 18.1%, with adjusted operating margin decreasing from 17.2% to
15.2%. The decrease in adjusted operating margin during the period was primarily
due to cost inflation, unfavorable volume, impacted significantly by COVID-19;
unfavorable mix; increased inventory management costs; increased spending on
strategic investments, negative currency impacts and other lesser impacts. These
impacts were partially offset cost reductions from our productivity and other
cost saving initiatives and price realization.
Applied Water
Operating income for our Applied Water segment decreased $5 million , or 8.2%,
for the third quarter of 2020 compared to the prior year, with operating margin
also decreasing from 16.2% to 15.4%. Operating margin benefited from a slight
decrease in restructuring and realignment costs of $1 million in 2020. Excluding
these restructuring and realignment costs, adjusted operating income decreased
$6 million , or 9.4%, with adjusted operating margin decreasing from 17.0% to
15.9%. The decrease in adjusted operating margin for the quarter was primarily
due to cost inflation; unfavorable volume, impacted significantly by COVID-19;
increased spending on strategic investments and other various lesser impacts.
These impacts were partially offset by cost reductions from our productivity and
other cost saving initiatives and price realization.
For the nine months ended September 30, 2020 , operating income decreased $35
million , or 19.6%, as compared to the prior year, with operating margin also
decreasing from 15.6% to 13.9%. Operating margin benefited from a slight
decrease in restructuring and realignment costs of $2 million in 2020. Excluding
these restructuring and realignment costs, adjusted operating income decreased
$37 million , or 19.6%, with adjusted operating margin decreasing from 16.4% to
14.6%. The decrease in adjusted operating margin during the period was primarily
due to unfavorable volume, impacted significantly by COVID-19; cost inflation
and increased inventory management costs. These impacts were partially offset by
cost reductions from our productivity and other cost saving initiatives.
Measurement & Control Solutions
Operating loss for our Measurement & Control Solutions segment decreased $74
million , or 54.4%, for the third quarter of 2020 compared to the prior year,
resulting in an operating loss of $62 million , with operating margin increasing
from (35.0)% to (18.7)%. Operating margin benefited from decreases in special
charges of $86 million and decreases in restructuring and realignment costs of
$15 million in 2020. Excluding these items, adjusted operating income decreased
$27 million , or 69.2%, with adjusted operating margin decreasing from 10.0% to
3.6%. The decrease in adjusted operating margin for the quarter was primarily
due to unfavorable volume, impacted significantly by COVID-19; unfavorable mix;
cost inflation; increased quality management costs; increased spending on
strategic investments and other various lesser impacts. These impacts were
partially offset by cost reductions from our productivity and other cost saving
initiatives and price realization.
For the nine months ended September 30, 2020 , operating loss increased $26
million , or 27.7%, as compared to the prior year, resulting in an operating loss
of $120 million , with operating margin also decreasing from (8.1)% to (12.0)%.
Operating margin benefited from a decrease in special charges of $80 million ,
which was slightly offset by increased restructuring and realignment costs of $2
million in 2020. Excluding these items, adjusted operating income decreased $104
million , or 100.3%, resulting in an adjusted operating loss of $3 million , with
adjusted operating margin decreasing from 8.7% to (0.3)%. The decrease in
adjusted operating margin during the period was driven by unfavorable volume,
impacted significantly by COVID-19; cost inflation; increased quality management
costs, primarily due to a $15 million warranty charge recorded during the first
quarter for a firmware issue in some of our meters; unfavorable mix and
increased spending on strategic investments. These impacts were partially offset
by cost reductions from our productivity and other cost saving initiatives.
Corporate and other
Operating loss for corporate and other decreased $1 million , or 9.1%, for the
third quarter of 2020 compared to the prior year period. For the nine months
ended September 30, 2020 , operating loss for corporate and other decreased $3
million , or 7.5%, compared to the same prior year period. The decreases in cost
are the result of cost saving actions taken during the year.
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Interest Expense
Interest expense was $22 million and $56 million for the three and nine months
ended September 30, 2020 and $16 million and $52 million for the three and nine
months ended September 30, 2019 . The increase in interest expense for both
periods is primarily driven by the issuance of our Green Bond during the second
quarter of 2020. 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 September 30, 2020 was $13
million resulting in an effective tax rate of 26.2%, compared to a benefit of
$77 million resulting in an effective tax rate of 623.6% (on a pre-tax loss for
the period) for the same period in 2019. The income tax provision for the nine
months ended September 30, 2020 was $21 million resulting in an effective tax
rate of 16.6%, compared to a benefit of $45 million resulting in an effective
tax rate of (18.9)% for the same period in 2019. The effective tax rate for the
three and nine month periods ended September 30, 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 and goodwill impairment charge. Additionally, the effective
tax rate for the three and nine month periods ended September 30, 2020 differs
from the same periods in 2019 due primarily to the impact of the changes in tax
law in Switzerland in 2019 along with the impact of the larger goodwill
impairment charge on income before taxes in 2019.
Other Comprehensive Income (Loss)
Other comprehensive income was $13 million for the three months ended September
30, 2020 compared to a loss of $37 million for the same period in 2019. Foreign
currency translation contributed favorable impacts during the quarter of $10
million , driven primarily by the strengthening of the Euro, the British Pound,
the Chinese Yuan, the Polish Zloty and various other currencies as compared to
the U.S. Dollar in 2020 versus the weakening of these currencies in the same
prior year period. These favorable currency translation impacts were partially
offset by the movement in our Euro net investment hedges during the quarter. In
addition to net favorable foreign currency translation impacts, there was a
favorable impact from the movement of tax on the net investment hedges as
compared to the prior year of $31 million during the quarter. Favorable impacts
from pension activity and gain in derivative hedge agreements during the quarter
also contributed to the increase in in other comprehensive income during the
quarter.
For the nine months ended September 30, 2020 , other comprehensive loss was $22
million compared to a loss of $28 million for the same period in 2019. Foreign
currency translation contributed unfavorable impacts during the period of $44
million , driven primarily by the movement in our Euro net investment hedges and
the weakening of the South African Rand as compared to the U.S. Dollar, which
was greater in 2020 than the weakening in the prior year. These unfavorable
currency translation impacts were partially offset by the strengthening of the
Euro and the Chinese Yuan as compared to the U.S. Dollar in 2020 versus the
weakening of these currencies in the same prior year period. Net unfavorable
currency translation impacts were partially offset by the favorable impact from
the movement of tax on the net investment hedges as compared to the prior year
of $27 million , favorable impacts from gain in derivative hedge agreements of
$16 million and favorable pension activity during the period.
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Liquidity and Capital Resources
The following table summarizes our sources and (uses) of cash:
Nine Months Ended
September 30,
(In millions) 2020 2019 Change
Operating activities $ 454 $ 451 $ 3
Investing activities (326) (185) (141)
Financing activities 550 (99) 649
Foreign exchange (a) - (10) 10
Total $ 678 $ 157 $ 521
(a)The impact is primarily due to the strengthening of the Euro, Chinese Yuan
and various other currencies against the U.S. Dollar. These impacts were
partially offset by the weakness of the Canadian Dollar and the Russian Ruble
against the U.S. Dollar.
Sources and Uses of Liquidity
Operating Activities
Net cash provided by operating activities was $454 million for the nine months
ended September 30, 2020 as compared to $451 million in the comparable prior
year period. This slight increase was primarily driven by a significant decrease
in cash paid for taxes during the current year as compared to the prior year,
partially from delayed timing of payments related to COVID-19 related
concessions, as well as increases in accrued expenses, mostly due to timing, and
improved working capital, which were largely offset by a decrease in cash from
earnings.
Investing Activities
Cash used in investing activities was $326 million for the nine months ended
September 30, 2020 as compared to $185 million in the comparable prior year
period. This increase in cash used of $141 million was mainly driven by $200
million of cash paid for time deposit investments during 2020, partially offset
by lower spending on capital expenditures compared to the prior year and an $18
million reduction in spending on acquisitions.
Financing Activities
Cash generated by financing activities was $550 million for the nine months
ended September 30, 2020 as compared to cash used of $99 million in the
comparable prior year period. This net increase in cash used by financing
activities during the period was primarily driven by the issuance of our Green
Bond and higher levels of short-term debt during the year, partially offset by
the repayment of short-term debt during 2020 and an increase in share repurchase
activity of $22 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 continue to evaluate
aspects of our spending, including capital expenditures, strategic investments
and dividends. Additionally, we have committed to reducing our annual capital
expenditures. We will continue to evaluate aspects of our spending as the year
progresses. We have elected to utilize certain federal, state and foreign tax
programs related to timing of tax payments and deductions to further manage our
liquidity, and the liabilities associated with these programs are appropriately
classified in the applicable "Accrued and other current liabilities" or "Other
non-current accrued liabilities" accounts in our Condensed Consolidated Balance
Sheets. We will continue to consider available federal, state and foreign tax
programs.
Historically, we have generated operating cash flow sufficient to fund our
primary cash needs. As the uncertainty and severity associated with the global
spread of the COVID-19 pandemic continued to grow during the year, Xylem issued
Senior Notes of $1 billion in aggregate principal on June 26, 2020 . The primary
long-term intention of incurring this debt is to fund green projects across our
business segments, as well as manage liquidity risk and increase flexibility, as
the duration of the economic effects of the pandemic are uncertain. See Note 12,
"Credit Facilities and Debt", of our condensed consolidated financial statements
for a description of our credit facilities and long-term debt. Xylem 's liquidity
position has continued to evolve favorably from an operational perspective
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during the third quarter of 2020, and we will continue to monitor the economic
effects of the COVID-19 pandemic and its impact on 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. Our securities are rated investment grade. A
significant change in credit rating could impact our ability to borrow at
favorable rates. Refer to Note 12, "Credit Facilities and Debt", of our
condensed consolidated financial statements for a description of limitations on
obtaining additional funding.
We monitor our global funding requirements and seek to meet our liquidity needs
on a cost effective basis. As of September 30, 2020 , the COVID-19 pandemic has
not materially impacted our borrowing costs or other costs of capital, however
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. To provide for
continued access to the full capacity of our credit facilities going forward,
Xylem entered into Amendment No. 1 to the 2019 Credit Facility on June 22, 2020
which modified the covenant calculation methodology through the quarter ending
September 30, 2021 and restricts stock repurchases until March 31, 2021 , except
for shares of common stock in an amount not to exceed the number of shares
issued after the date of the Amendment, subject to customary exceptions. See
Note 12, "Credit Facilities and Debt", of our condensed consolidated financial
statements for a description of our credit facilities and long-term debt.
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 and service debt and other obligations. In addition,
our existing committed credit facilities and access to the public debt markets
would provide further liquidity if required. Currently, we have available
liquidity of approximately $2.4 billion , consisting of $1.4 billion of cash,
$800 million of available credit facilities and $200 million in short-term
investments as disclosed in Note 12, "Credit Facilities and Debt", of our
condensed consolidated financial statements. Our debt repayment obligations in
2020 consist of $40 million in outstanding commercial paper. Our next long term
debt maturity is October 2021 .
Risk related to these items are described in our risk factor disclosures
referenced under "Item 1A. Risk Factors" in our 2019 Annual Report and "Item 1A.
Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2020 .
Credit Facilities & Long-Term Contractual Commitments
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 54% and 52% of our revenue from non-United States
operations for the three and nine months ended September 30, 2020 , respectively,
and approximately 51% for both the three and nine month periods ended September
30, 2019 . 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 September 30, 2020 , we have provided a deferred tax liability
of $6 million for net foreign withholding taxes and state income taxes on $503
million of earnings expected to be repatriated to the United States parent as
deemed necessary in the future.
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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.
During the fourth quarter of 2019 we completed our annual goodwill assessment.
Our 2019 impairment analysis indicated that the fair value of the AIA goodwill
reporting unit, within our Measurement & Control Solutions segment, exceeded its
carrying value by less than 20%. The AIA reporting unit is comprised of our
assessment services business (primarily the Pure acquisition) as well as our
digital solutions business. 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.
In the third quarter of 2020, management updated forecasts of future cash flows
for the AIA businesses, which reflect significant negative volume impacts from
the COVID-19 pandemic, primarily on our assessment services business. Our
ongoing investment in the AIA businesses also continues to impact near term
profitability. Based on these factors we determined that there were indicators
that the AIA reporting unit's goodwill may be impaired, and accordingly, we
performed an interim goodwill impairment test as of July 1, 2020 . The results of
the impairment test showed that the fair value of the AIA reporting unit was
lower than the carrying value, resulting in a $58 million goodwill impairment
charge. As of September 30, 2020 the remaining goodwill balance in our AIA
reporting unit after recording the goodwill impairment charge was $112 million .
Also, during the third quarter of 2020, due to the factors discussed above, we
assessed whether the carrying amounts of the AIA reporting unit's long-lived
assets may not be recoverable and therefore impaired. Our assessment resulted in
an impairment charge of $11 million , primarily related to software and
proprietary technology. The charge was calculated using an income approach.
The fair value of our reporting units and intangible assets is judgmental in
nature and involves the use of significant estimates and assumptions,
particularly related to future operating results and cash flows. These estimates
and assumptions include, but are not limited to, revenue growth rates and
operating margins used to calculate projected future cash flows, risk-adjusted
discount rates, and future economic and market conditions. In addition, the
identification of reporting units and the allocation of assets and liabilities
to the reporting units when determining the carrying value of each reporting
unit also require judgment. The uncertainty of the future impact of the COVID-19
pandemic may also contribute to further deterioration of our future cash flows.
If we do not achieve our forecasts it is possible that the goodwill of the AIA
reporting unit could be deemed to be impaired again in a future period.
The risks and potential impacts of COVID-19 on the fair value of our assets are
included in our risk factor disclosures referenced under "Item 1A. Risk Factors"
in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
2020 .
New Accounting Pronouncements
See Note 2, "Recently Issued Accounting Pronouncements", to the condensed
consolidated financial statements for a complete discussion of recent accounting
pronouncements.
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