10-K 1 xyl1231201510k.htm 10-K 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
þ
  
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
  
 
 
  
For the fiscal year ended December 31, 2015
  
 
 
  
or
  
 
¨
  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
  
 
For the transition period from          to         
Commission file number: 1-35229
Xylem Inc.
(Exact name of registrant as specified in its charter)
Indiana
 
45-2080495
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer Identification No.)
 
 
1 International Drive, Rye Brook, NY 10573
(address of principal executive offices and zip code)
(914) 323-5700
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ  No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.      Yes  ¨  No  þ
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.  Yes  þ  No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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).  Yes  þ  No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer  þ        Accelerated Filer  ¨        Non-Accelerated Filer  ¨        Smaller reporting company  ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  ¨  No  þ
The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant as of June 30, 2015 was approximately $6.7 billion. As of January 29, 2016, there were 178,485,808 outstanding shares of the registrant’s common stock, par value $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for its 2016 Annual Meeting of Shareowners, to be held in May 2016, are incorporated by reference into Part II and Part III of this Report.



Xylem Inc.
ANNUAL REPORT ON FORM 10-K
For the fiscal year ended December 31, 2015
Table of Contents
 
 
 
 
ITEM
PAGE
PART I
 
 
 
 
1
1A.
1B.
2
3
4
*
 
 
 
PART II
 
 
 
 
5
6
7
7A.
8
9
9A.
9B.
 
 
PART III
 
 
 
 
10
11
12
13
14
 
 
PART IV
 
 
 
 
15
 
*
Included pursuant to Instruction 3 of Item 401(b) of Regulation S-K.

2


PART I
The following discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, included in this Annual Report on Form 10-K (this "Report"). Xylem Inc. was incorporated in Indiana on May 4, 2011. Except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to Xylem Inc. and its subsidiaries. References in the consolidated financial statements to "ITT" or the "former parent" refer to ITT Corporation and its consolidated subsidiaries (other than Xylem Inc.).
Forward-Looking Statements
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 such statements about the capitalization of the Company, the Company’s restructuring and realignment, future strategic plans and other statements that describe the Company’s business strategy, outlook, objectives, plans, intentions or goals. All statements that address operating or financial performance, events or developments that we expect or anticipate will occur in the future including statements relating to orders, revenue, operating margins and earnings per share growth, and statements expressing general views about future operating results are forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such forward-looking statements.

Factors that could cause results to differ materially from those anticipated include: overall economic and business conditions, political and other risks associated with our international operations, including military actions, economic sanctions or trade embargoes that could affect customer markets, and non-compliance with laws, including foreign corrupt practice laws, export and import laws and competition laws; potential for unexpected cancellations or delays of customer orders in our reported backlog; our exposure to fluctuations in foreign currency exchange rates;  competition and pricing pressures in the markets we serve; the strength of housing and related markets; weather conditions; ability to retain and attract key members of management; our relationship with and the performance of our channel partners; our ability to successfully identify, complete and integrate acquisitions; our ability to borrow or to refinance our existing indebtedness and availability of liquidity sufficient to meet our needs; changes in the value of goodwill or intangible assets; risks relating to product defects, product liability and recalls; governmental investigations; security breaches or other disruptions of our information technology systems; litigation and contingent liabilities; and other factors set forth below under “Item 1A. Risk Factors” and those described from time to time in subsequent reports filed with the Securities and Exchange Commission (“SEC”).

All forward-looking statements made herein are based on information 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.

ITEM 1.        BUSINESS
Business Overview
Xylem, with 2015 revenue of $3.7 billion and approximately 12,700 employees, is a world leader in the design, manufacturing, and application of highly engineered technologies for the water industry. We are 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. We have leading market positions among equipment and service providers in the core application areas of the water equipment industry: transport, treatment, test, building services, industrial processing and irrigation. Our Company’s brands, such as Bell & Gossett and Flygt, are well known throughout the industry and have served the water market for many years.
We serve a global customer base across diverse end markets while offering localized expertise. We sell our products in approximately 150 countries through a balanced distribution network consisting of our direct sales force and independent channel partners. In 2015, 59% of our revenue was generated outside the United States, with 21% of revenue generated in emerging markets.

3


Our Industry
Our planet faces a serious water challenge. Less than 1% of the total water available on earth is fresh water, and this percentage is declining due to factors such as the draining of aquifers, increased pollution and climate change. In addition, demand for fresh water is rising rapidly due to population growth, industrial expansion, and increased agricultural development, with consumption estimated to double every 20 years. By 2025, more than 30% of the world’s population is expected to live in areas without adequate water supply. Even in developed countries with sufficient clean water supply, existing infrastructure for water supply is aging and inadequately funded. In the United States, degrading pipe systems leak one out of every six gallons of water, on average, on its way from a treatment plant to the customer. These challenges are driving opportunities for growth in the global water industry, which we estimate to have a total market size of approximately $550 billion. We estimate our total served market size to be approximately $37 billion.
We view these challenges through the lens of water productivity, water quality and resilience. Water productivity refers to the more efficient delivery and use of clean water. Water quality refers to the efficient and effective management of wastewater. Resilience refers to the management of water-related risks and the resilience of water infrastructure. The Company’s customers often face all three of these challenges, ranging from inefficient aging water distribution networks (which require increases in “water productivity”); energy-intensive or unreliable wastewater management systems (which require increases in “water quality”); or exposure to natural disasters such as floods or droughts (which require increases in “resilience”). Delivering value in these areas creates significant opportunity for the Company.
The water industry supply chain is comprised of Equipment and Services companies, Design and Build service providers, and Utilities. Equipment and Service providers serve distinct customer types. The Utilities supply water through an infrastructure network. Supply chain companies provide single, or sometimes combined, functions from equipment manufacturing and services to facility design (engineering, procurement and construction, or “EPC” firms) to plant operations (Utilities), as depicted below in Figure 1. The Utilities and EPC customers are looking for technology and application expertise from their Equipment and Services providers to address trends such as rising pollution, stricter regulations, and the increased outsourcing of process knowledge. The end users of water consist of a wide array of entities, including farms, mines, power plants, industrial facilities and residential homes. These customers are predominately served through specialized distributors and original equipment manufacturers (“OEMs”).
Figure 1: Water Industry Supply Chain

Our business focuses on the beginning of the supply chain by providing technology-intensive equipment and services. We sell our equipment and services via direct and indirect channels that serve the needs of each customer type. On the utility side, we provide the majority of our sales direct to customers with strong application expertise, with the remaining amount going through distribution partners. To end users of water, we provide the majority of our sales through long-standing relationships with the world’s leading distributors, with the remainder going direct to customers.

4


The Equipment and Services market addresses the key processes of the water industry, which are best illustrated through the cycle of water, as depicted in Figure 2, below. We believe this industry has two distinct sectors within the cycle of water: Water Infrastructure and Usage Applications. The key processes of this cycle begin when raw water is extracted by pumps, which provide the necessary pressure and flow, to move or transport, this water from natural sources, such as oceans, groundwater, lakes and rivers, through pipes to treatment facilities. Treatment facilities can provide many forms of treatment, such as filtration, disinfection and desalination, to remove solids, bacteria, and salt, respectively. Throughout each of these stages, analytical instruments test the water to ensure regulatory requirements are met so that it can be utilized by end-use customers. A network of pipes and pumps again transports this clean water to where it is needed, such as to crops for irrigation, to power plants to provide cooling in industrial water, or to an apartment building as drinking water in residential and commercial buildings. After usage, the wastewater is collected by a separate network of pipes and pumps and transported to a wastewater treatment facility, where processes such as digestion deactivate and reduce the volume of solids, and disinfection purifies effluent water. Once treated, analytical instruments test the water to ensure regulatory requirements are met so that it can be discharged back to the environment, thereby completing the cycle.
Figure 2: Cycle of Water
In the Water Infrastructure sector, two primary end markets exist: public utility and industrial. The public utility market comprises public, private and public-private institutions that handle water and wastewater for mostly residential and commercial purposes. The industrial market involves the supply of water and removal of wastewater for industrial facilities. We view the main macro drivers of this sector to be water quality, the desire for energy-efficient products, water scarcity, regulatory requirements and infrastructure needs, for both the repair of aging systems in developed countries as well as new installations in emerging markets.
In the Usage Applications sector, end-use customers fall into four main markets: residential, commercial, industrial and agricultural. Homeowners represent the end users in the residential market. Owners and managers of properties such as apartment buildings, retail stores, institutional buildings, restaurants, schools, hospitals and hotels are examples of end users in the commercial market. The industrial market is wide ranging, involving OEMs, exploration and production firms, and developers and managers of facilities operated by electrical power generators, chemical manufacturers, machine shops, clothing manufacturers, beverage dispensing and food processing firms, and car washes. The agricultural market end users are owners and operators of businesses such as crop and livestock farms, aquaculture, golf courses, and other turf applications. We believe population growth, urbanization and regulatory requirements are the primary macro drivers of these markets, as these trends drive the need for housing, food, community services and retail goods within growing city centers. Water reuse and conservation are driving the need for new technologies.

5


Business Strategy
Our strategy is to enhance shareholder value by providing distinctive solutions for our customers' most important water productivity, quality and resilience challenges, enabling us to grow revenue, organically and through strategic acquisitions, as we streamline our cost structure. Key elements of our strategy are summarized below:
Accelerate Profitable Growth. To achieve our goal of accelerating growth, we have identified the following five priorities:
Emerging Markets - We seek to accelerate our growth in priority emerging markets through increased focus on product localization and channel development.
Innovation & Technology - We seek to enhance the Company’s innovation efforts with increased focus on technologies and innovation that can significantly improve customers’ water productivity, quality and resilience.
Commercial Leadership - We are strengthening our capabilities by focusing on simplifying our commercial processes along with the supporting backend information technology systems.
Mergers and acquisitions - We continue to evaluate and, where appropriate, will act upon attractive acquisition candidates to accelerate our growth, including into new markets.
Drive Continuous Improvement. We seek to embed continuous improvement into our culture and simplify our organizational structure to make the Company more agile, more profitable, and create room to re-invest in growth. To accomplish this, we will continue to strengthen our lean six sigma and global procurement capabilities, and continue to optimize our cost structure through business simplification by eliminating structural, process and product complexity.
Leadership and Talent Development. We seek to continue to invest in attracting, developing and retaining world-class talent with an increased focus on leadership and talent development programs. We will continue to align individual performance to the objectives of the Company and its shareholders.
Focus on Execution and Accountability. We seek to ensure the impact of these strategic focus areas by holding our people accountable and streamlining our performance management and goal deployment systems.




















6


Business Segments
We have two reportable business segments that are aligned with the cycle of water and the key strategic market applications they provide: Water Infrastructure (collection, distribution, return) and Applied Water (usage). See Note 20, “Segment and Geographic Data,” in our consolidated financial statements for financial information about segments and geographic areas.
The table and descriptions below provide an overview of our business segments.
 
 
Market
Applications
 
2015 Revenue
(in millions)
 
%
Revenue
 
Major Products
 
Primary Brands
Water
Infrastructure
 
Transport
 
$
1,624

 
73
%
 
 
•   Water and wastewater pumps
•   Filtration, disinfection and biological treatment equipment
•   Test equipment
•   Controls
 
 
•   Flygt
•   Wedeco
•   Godwin
•   WTW
•   Sanitaire
•   YSI
•   Leopold
 
Treatment
 
316

 
14
%
 
 
Test
 
291

 
13
%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
2,231

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Applied
Water
 
Building Services
 
$
774

 
54
%
 
 
•   Pumps
•   Valves
•   Heat exchangers
•   Controls
•   Dispensing
equipment systems
 
 
•   Goulds Water Technology
•   Bell & Gossett
•   A-C Fire Pump
•   Standard
     Xchange
•   Lowara
•   Jabsco
•   Flojet
•   Flowtronex
 
Industrial Water
 
562

 
40
%
 
 
Irrigation
 
86

 
6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
1,422

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Water Infrastructure
Water Infrastructure involves the process that collects water from a source and distributes it to users, and then returns the wastewater responsibly to the environment. Within the Water Infrastructure segment, our pump systems transport water from oceans, groundwater, aquifers, lakes, rivers and seas. From there, our filtration, ultraviolet ("UV") and ozone systems provide treatment, making the water fit for use. After consumption, our pump lift stations move the wastewater to treatment facilities where our mixers, biological treatment, monitoring, and control systems provide the primary functions in the treatment process. Throughout each of these stages, our analytical systems test the quality of water for consumption as well as for its return to nature. Water Infrastructure serves its customers, public utilities and industrial applications, through three closely linked applications: Transport, Treatment and Test of water and wastewater. We estimate our served market size in this sector to be approximately $21 billion.
Transport
The Transport application includes all of the equipment and services involved in the safe and efficient movement of water from sources such as oceans, groundwater, aquifers, lakes, rivers and seas to treatment facilities, and then to users. It also includes the movement of wastewater from the point of use to a treatment facility and then back into the environment. Finally, the Transport application also includes dewatering pumps, equipment and services which provide the safe removal or draining of groundwater and surface water from a riverbed, construction site or mine shaft and bypass pumping for the repair of aging public utility infrastructure, as well as emergency water removal during severe weather events. We offer a wide range of highly engineered products such as water and wastewater submersible pumps, monitoring controls, and application solutions; we do not serve the market for lower-value equipment such as pipes and fittings. We primarily employ configure-to-order capabilities to maximize manufacturing and logistics efficiencies by producing high volumes of basic product configurations. When we provide a configure-to-order solution, we configure a standard product to our customers’ specifications. To a lesser extent, we provide engineer-to-order products to meet the customization requirements of our customers. This process requires that we apply our technical expertise and production capabilities to provide a non-standard solution to the customer. We believe our business is one of the largest players in this served market based on management estimates. With operations on six continents, we also have one of the world’s largest dewatering rental fleets. Our key brands for this application are Flygt and Godwin. Transport accounted for approximately 73% of our Water Infrastructure segment revenue in both 2015 and 2014, and 74% in 2013.

7


Treatment
The Treatment application includes equipment and services that treat both water for consumption and wastewater to be returned responsibly to the environment or reused. Primary served markets include public utilities and industrial operations. While there are several treatment solutions in the market today, we focus on three basic treatment types: (i) filtration systems, (ii) disinfection systems, (iii) biological treatment systems, including mixers. Our key brands for this application are Leopold, Wedeco, Sanitaire and Flygt. Filtration uses gravity-based media filters and clarifiers to clean both water and wastewater. Leopold, has been a worldwide leader in filtration for over 90 years. Wedeco offers chemical-free and environmentally friendly disinfection systems, both UV and ozone oxidation, to treat public utility drinking water, wastewater and industrial process water. Biological treatment systems are key to the treatment and mixing of solids in wastewater plants, which are provided through our Sanitaire and Flygt brands. We believe our business is one of the largest players in this served market based on management estimates. Treatment accounted for approximately 14% of our Water Infrastructure segment revenue in 2015, 2014 and 2013.
Test
Analytical instrumentation is used across most industries to ensure regulatory requirements are met. Growth in this market is primarily driven by increasing regulation of water and wastewater in North America, Europe and Asia. Our served market is predominately focused on water and the environment for quality levels throughout the water infrastructure loop. Analytical systems are applied in three primary ways: in the field, in a facility laboratory, or real time, online monitoring in a treatment facility process. We believe we have a leading position in this served market based on management estimates. Our key brands for this application are WTW and YSI. Test accounted for approximately 13% of our Water Infrastructure segment revenue in both 2015 and 2014, and 12% in 2013.
Applied Water
Applied Water encompasses the uses of water. Since water is used to some degree in almost every aspect of human, economic and environmental activity, this segment has a significant number of applications and we participate in all major areas of water demand. Residential and Commercial Building Services account for human and building consumption, where we deliver water boosting systems for drinking, heating, ventilation and air conditioning ("HVAC") and fire protection systems. Industrial Water applications account for water consumption activities that use pumps, heat exchangers, valves and controls to provide cooling to power plants and manufacturing facilities, as well as circulation for food and beverage processing. The remaining portion of global water use resides in irrigation applications. Examples of what we provide include: boosting systems for farming irrigation, pumps for dairy operations, and rainwater reuse systems for small scale crop and turf irrigation.We estimate our served market size in this sector to be approximately $16 billion.
Residential & Commercial Building Services
This business is defined by four primary uses of water in building services applications, such as in residential homes and commercial buildings, including offices, hotels, hospitals, schools, restaurants and malls. The first application is in HVAC, where Bell & Gossett and Lowara specialize in pumps and valves that are used in water-driven heating and cooling systems, along with heat exchangers, valves, and monitoring and control products that augment the system. The second is the supply of potable water for consumption, including drinking water and for hygienic purposes . The Goulds Water Technology, Lowara and Bell & Gossett brands provide pumps and boosting systems utilized within buildings, sourcing water from distribution networks or from wells. The third application is wastewater removal with sump and sewage pumps, provided by Bell & Gossett, Goulds Water Technology and Lowara. The fourth water-related building service area is fire protection, where our A-C Fire Pump brand supplies full pump systems for emergency fire suppression. Bell & Gossett, Goulds Water Technology and Lowara have continued to innovate, focusing on providing industry-leading energy-efficient and intelligent pumps for the building services market; many of these products are more efficient than competitive devices. We believe our business is one of the largest players in this served market based on management estimates. Building Services accounted for approximately 54% of our Applied Water segment revenue in 2015, 53% in 2014 and 50% in 2013.
Industrial Water
Water is used in most industrial facilities to provide processing steps such as cooling, heating, cleaning and mixing. Our Goulds Water Technology and Lowara brands supply vertical multistage pumps to bring in source water or to boost pressure for purposes, including water circulation through a manufacturing facility to cool machine tools. Our Standard Xchange brand delivers heat exchangers for combined heat and power applications within power generation plants. We also service niche applications such as wine processing with Jabsco brand flexible impeller pumps, and water-based detergent dispensing and water circulation for car washes served by Flojet air-operated

8


diaphragm and Goulds Water Technology end suction pumps. Our boosting pumps are also increasingly being used in hydraulic fracturing applications. We can support mines throughout exploration, development and operation. Our wide range of durable pumps ensures reliability that minimizes risks, maximizes uptime and delivers superior total cost of ownership. Across all these various end applications, we believe our business is the second largest player in this served market based on management estimates. Industrial Water accounted for approximately 40% of our Applied Water segment revenue in 2015 and 2014, and 43% in 2013.
Irrigation
The irrigation business consists of irrigation-related equipment and services associated with bringing water from a source to a production plant or livestock facility, including hoses, sprinklers, center pivot and drip irrigation systems. We focus on the pumps and boosting systems that supply this ancillary equipment with water. Our Goulds Water Technology brand brings mixed flow pumps, and our Flowtronex group specializes in equipment "packaged solutions" incorporating monitoring and controls to optimize energy efficiency in irrigation delivery. Our Lowara brand also produces pumps for agricultural applications and irrigation for gardens and parks. We believe we have a leading position in this served market based on management estimates. Irrigation accounted for approximately 6% of our Applied Water segment revenue in 2015, and 7% in 2014 and 2013.
Geographic Profile
The table below illustrates the annual revenue and percentage of revenue by geographic area for each of the three years ended December 31.
 
Revenue
(in millions)
2015
 
2014
 
2013
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
United States
$
1,490

 
41
%
 
$
1,477

 
38
%
 
$
1,434

 
38
%
Europe
1,179

 
32
%
 
1,379

 
35
%
 
1,387

 
36
%
Asia Pacific
482

 
13
%
 
478

 
12
%
 
467

 
12
%
Other
502

 
14
%
 
582

 
15
%
 
549

 
14
%
Total
$
3,653

 
 
 
$
3,916

 
 
 
$
3,837

 
 
In addition to the traditional markets of the United States and Europe, opportunities in emerging markets within Asia Pacific, Eastern Europe, Latin America and other countries are growing. Revenue derived from emerging markets comprised 21%, 21% and 19% of our revenue in 2015, 2014 and 2013, respectively.
The table below illustrates the property, plant & equipment and percentage of property, plant & equipment by geographic area for each of the three years ended December 31.
 
Property, Plant & Equipment
(in millions)
2015
 
2014
 
2013
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
United States
$
168

 
38
%
 
$
180

 
39
%
 
$
186

 
38
%
Europe
189

 
43
%
 
206

 
45
%
 
225

 
46
%
Asia Pacific
56

 
13
%
 
53

 
11
%
 
45

 
9
%
Other
26

 
6
%
 
22

 
5
%
 
32

 
7
%
Total
$
439

 
 
 
$
461

 
 
 
$
488

 
 
Distribution, Training and End Use
Water Infrastructure provides the majority of its sales through direct channels with remaining sales through indirect channels and service capabilities. Both public utility and industrial facility customers increasingly require our teams’ global but locally proficient expertise to use our equipment in their specific applications. Several trends are increasing the need for this application expertise: (i) the increase in type and amount of contaminants in water supply, (ii) increasing environmental regulations, (iii) the need to increase system efficiencies to optimize energy costs, (iv) the retirement of a largely aging water industry workforce not systematically replaced at utilities and other end user customers, and (v) the build-out of water infrastructure in the emerging markets.
In the Applied Water segment, many end-use areas are widely different, so specialized distribution partners are often preferred. Our commercial teams have built long-standing relationships around our brands in many of these industries through which we can continue to leverage new product and service applications. Revenue opportunities are balanced between OEMs and after-market customers. Our products in the Applied Water segment are sold

9


through our global direct sales and strong indirect channels with the majority of revenue going through indirect channels. We have long-standing relationships with many of the leading independent distributors in the markets we serve, and we provide incentives to distributors, such as specialized loyalty and training programs.
Aftermarket Parts and Service
During their lifecycle, installed products require maintenance, repair services and parts due to the harsh environments in which they operate. We have many service centers around the world, which employ service employees to provide aftermarket parts and services to our large installed base of customers. Service centers offer an array of integrated service solutions for the industry including: preventive monitoring, contract maintenance, emergency field service, engineered upgrades, inventory management, and overhauls for pumps and other rotating equipment.
Depending on the type of product, median lifecycles range from five years to over 50 years, at which time they must be replaced. Many of our products are precisely selected and applied within a larger network of equipment driving a strong preference by customers and installers to replace them with the same exact brand and model when they reach the end of their lifecycle. This dynamic establishes a large recurring revenue stream for our business.
Supply and Seasonality
We have a global manufacturing footprint, with production facilities in Europe, North America, Latin America, and Asia. Our inventory management and distribution practices seek to minimize inventory holding periods by striving to take delivery of the inventory and manufacturing as close as possible to the sale or distribution of products to our customers. All of our businesses require various parts and raw materials, of which the availability and prices may fluctuate. Parts and raw materials commonly used in our products include motors, fabricated parts, castings, bearings, seals, nickel, copper, aluminum, and plastics. While we may recover some cost increases through operational improvements, we are still exposed to some pricing risk. We attempt to control costs through fixed-priced contracts with suppliers and various other programs, such as our global procurement initiative.
Our business relies on third-party suppliers, contract manufacturing and commodity markets to secure raw materials, parts and components used in our products. We typically acquire materials and components through a combination of blanket and scheduled purchase orders to support our materials requirements. For most of our products, we have existing alternate sources of supply, or such sources are readily available.
We may experience price volatility or supply constraints for materials that are not available from multiple sources. From time to time, we acquire certain inventory in anticipation of supply constraints or enter into longer-term pricing commitments with vendors to improve the priority, price and availability of supply. There have been no raw material shortages that have had a significant adverse impact on our business as a whole.
Our Water Infrastructure and Applied Water segments experience some modest level of seasonality in its business. This seasonality is dependent on factors such as capital spending of customers as well as weather conditions, including heavy flooding, droughts, and fluctuations in temperatures, which can positively or negatively impact portions of our business.
Customers
Our business is not dependent on any single customer or a few customers, the loss of which would have a material adverse effect on our Water Infrastructure or Applied Water segments or on the Company as a whole. No individual customer accounted for more than 10% of our consolidated 2015, 2014 or 2013 revenue.
Backlog
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. Total backlog was $716 million at December 31, 2015 and $740 million at December 31, 2014. We anticipate that more than 81% of the backlog at December 31, 2015 will be recognized as revenue during 2016.
Competition
Given the highly fragmented nature of the water industry, the Water Infrastructure segment competes with a large number of businesses. Competition in the water transport and treatment technologies markets focuses on product performance, reliability and innovation, application expertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery, proximity of service centers, effectiveness of our distribution channels and price. In the sale of products and services, we benefit from our large installed base of pumps and complementary products, which require maintenance, repair and replacement parts due to the nature of the products and the conditions under which they operate. Timeliness of delivery, quality and the proximity of service centers are important

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customer considerations when selecting a provider for after-market products and services as well as equipment rentals. In geographic regions where we are locally positioned to provide a quick response, customers have historically relied on us, rather than our competitors, for after-market products relating to our highly engineered and customized solutions. Our key competitors within the Water Infrastructure segment include KSB Inc., Sulzer Ltd., Evoqua Water Technologies and Danaher Corporation.
Competition in the Applied Water segment focuses on brand equity, application expertise, product delivery and performance, quality, and price. We compete by offering a wide variety of innovative and high-quality products, coupled with world-class application expertise. We believe our distribution through well-established channels and our reputation for quality significantly enhance our market position. Our ability to deliver innovative product offerings has allowed us to compete effectively, to cultivate and maintain customer relationships and to serve and expand into many niche and new markets. Our key competitors within the Applied Water segment include Grundfos, Wilo SE, Pentair Ltd. and Franklin Electric Co., Inc.
Research and Development
Research and development (“R&D”) is a key foundation of our growth strategy and we focus on the design and development of products and application know-how that anticipate customer needs and emerging trends. Our engineers are involved in new product development as well as improvement of existing products to increase customer value. Our businesses invest substantial resources for R&D. We anticipate we will continue to develop and invest in our R&D capabilities to promote a steady flow of innovative, high-quality and reliable products and applications to further strengthen our position in the markets we serve. We invested $95 million, $104 million, and $104 million in R&D in 2015, 2014 and 2013, respectively.
We have R&D and product development capabilities around the world. R&D activities are initially conducted in our technology centers, located in conjunction with some of our major manufacturing facilities to ensure an efficient and robust development process. We have several global technical centers and local development teams around the world where we are supporting global needs and accelerating the customization of our application expertise to local needs. In some cases, our R&D activities are conducted at our piloting and testing facilities and at strategic customer sites. These piloting and testing facilities enable us to serve our strategic markets in each region of the world.
Intellectual Property
We generally seek patent protection for those inventions and improvements that we believe will improve our competitive position. We believe that our patents and applications are important for maintaining the competitive differentiation of our products and improving our return on research and development investments. While we own, control or license a significant number of patents, trade secrets, proprietary information, trademarks, trade names, copyrights, and other intellectual property rights which, in the aggregate, are of material importance to our business, management believes that our business, as a whole, as well as each of our core business segments, is not materially dependent on any one intellectual property right or related group of such rights.
Patents, patent applications, and license agreements expire or terminate over time by operation of law, in accordance with their terms or otherwise. As the portfolio of our patents, patent applications, and license agreements has evolved over time, we do not expect the expiration of any specific patent to have a material adverse effect on our financial position or results of operations.
Environmental Matters and Regulation
Our manufacturing operations worldwide are subject to many requirements under environmental laws. In the United States, the Environmental Protection Agency and similar state agencies administer laws and regulations concerning air emissions, water discharges, waste disposal, environmental remediation, and other aspects of environmental protection. Such environmental laws and regulations in the United States include, for example, the Federal Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act. Environmental requirements significantly affect our operations. We have established an internal program to address compliance with applicable environmental requirements and, as a result, management believes that we are in substantial compliance with current environmental regulations.
While environmental laws and regulations are subject to change, such changes can be difficult to predict reliably and the timing of potential changes is uncertain. Management does not believe, based on current circumstances, that compliance costs pursuant to such regulations will have a material adverse effect on our financial position or results of operations. However, the effect of future legislative or regulatory changes could be material to our financial condition or results of operations.

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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. It can be difficult to estimate reliably the final costs of investigation and remediation due to various factors. Our accrued liabilities for these environmental matters represent the 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 based upon the facts and circumstances as currently known to us. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on an undiscounted basis. We do not anticipate these liabilities will have a material adverse effect on our consolidated financial position or results of operations. We cannot make assurances that other sites, or new details about sites known to us, that could give rise to environmental liabilities with such material adverse effects on us will not be identified in the future. At December 31, 2015, we had estimated and accrued $4 million related to environmental matters.
Employees
As of December 31, 2015, Xylem had approximately 12,700 employees worldwide.  We have more than 3,700 employees in the United States, of whom approximately 17% are represented by labor unions, and in certain foreign countries, some of our employees are represented by work councils.  We believe that our facilities are in favorable labor markets with ready access to adequate numbers of workers and believe our relations with our employees are good.
Company History and Certain Relationships
On October 31, 2011 (the "Distribution Date"), ITT completed the Spin-off (the “Spin-off”) of Xylem, formerly ITT’s water equipment and services businesses ("WaterCo"). The Spin-off was completed pursuant to the Distribution Agreement, dated as of October 25, 2011 (the “Distribution Agreement”), among ITT, Exelis Inc., acquired by Harris Inc. on May 29, 2015, (“Exelis”) and Xylem.
Available Information
We are required to file annual, quarterly and current reports, proxy statements and other information with the SEC.  Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports are available free of charge on our website www.xyleminc.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC.
In addition, the public may read or copy any materials filed with the SEC at the SEC’s Public Reference Room located at 100 F Street NE, Washington, D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These reports and other information are also available, free of charge, at www.sec.gov.

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ITEM 1A.    RISK FACTORS
In evaluating our business, each of the following risks should be carefully considered, along with all of the other information in this Report and in our other filings with the SEC. Should any of these risks and uncertainties develop into actual events, our business, financial condition or results of operations could be materially and adversely affected.
Risks Related to Operational and External Factors
Failure to compete successfully in our markets could adversely affect our business.
We offer our products and services in competitive markets. We believe the principal points of competition in our markets are product performance, reliability and innovation, application expertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery, proximity of service centers, effectiveness of our distribution channels and price. Maintaining and improving our competitive position will require successful management of these factors, including continued investment by us in manufacturing, research and development, engineering, marketing, customer service and support, and our distribution networks. We may not be successful in maintaining our competitive position. Our competitors may develop products that are superior to our products, or may develop more efficient or effective methods of providing products and services or may adapt more quickly than we do to new technologies or evolving customer requirements. Pricing pressures also could cause us to adjust the prices of certain products to stay competitive, which could adversely affect our financial performance. Failure to continue competing successfully or to win large contracts could adversely affect our business, financial condition or results of operations.
Our results of operations and financial condition may be adversely affected by global economic and financial market conditions.
We compete around the world in various geographic and product markets. In 2015, 41%, 32% and 21% of our total revenue was from customers located in the United States, Europe and emerging markets, respectively. We expect revenue from these markets to be significant for the foreseeable future. Important factors impacting our businesses include the overall strength of these economies and our customers’ confidence in both local and global macro-economic conditions; industrial and federal, state, local and municipal governmental spending; the strength of the residential and commercial real estate markets; interest rates; availability of commercial financing for our customers and end-users; and unemployment rates. A slowdown or prolonged downturn in financial or macro-economic conditions in these areas or in the United States could have a material adverse effect on our business, financial condition and results of operations.
Economic and other risks associated with international sales and operations could adversely affect our business.
In 2015, 59% of our total revenue was from customers outside the United States, with 21% of total revenue generated in emerging markets. We expect our international operations sales and export sales to continue to be a significant portion of our revenue. We have placed a particular emphasis on increasing our growth and presence in emerging markets. Both our sales from international operations and export sales are subject, in varying degrees, to risks inherent to doing business outside the United States. These risks include the following:
possibility of unfavorable circumstances arising from host country laws or regulations;
currency exchange rate fluctuations and restrictions on currency repatriation;
potential negative consequences from changes to taxation policies;
disruption of operations from labor and political disturbances;
changes in tariff and trade barriers and import and export licensing requirements; 
increased costs and risks of developing, staffing and simultaneously managing a number of global operations as a result of distance as well as language and cultural differences; and
insurrection, armed conflict, terrorism or war.
Any payment of distributions, loans or advances to us by our foreign subsidiaries could be subject to restrictions on, or taxation of, dividends on repatriation of earnings under applicable local law, monetary transfer restrictions and foreign currency exchange regulations in the jurisdictions in which our subsidiaries operate. In addition to the general risks that we face outside the United States, we now conduct more of our operations in emerging markets than we have in the past, which could involve additional uncertainties for us, including risks that governments may impose limitations on our ability to repatriate funds; governments may impose withholding or other taxes on

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remittances and other payments to us, or the amount of any such taxes may increase; an outbreak or escalation of any insurrection or armed conflict may occur; governments may seek to nationalize our assets; or governments may impose or increase investment barriers or other restrictions affecting our business. In addition, emerging markets pose other uncertainties, including the difficulty of enforcing agreements, challenges collecting receivables, protection of our intellectual property and other assets, pressure on the pricing of our products, higher business conduct risks, less qualified talent and risks of political instability. We cannot predict the impact such future, largely unforeseeable events might have on our business, financial condition and results of operations.
Failure to comply with laws, regulations and policies, including the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation could result in fines, criminal penalties and an adverse effect on our business.
We are subject to regulation under a wide variety of U.S. federal and state and non-U.S. laws, regulations and policies, including laws related to anti-corruption, export and import compliance, anti-trust and money laundering, due to our global operations. The U.S. Foreign Corrupt Practices Act (the "FCPA"), the U.K. Bribery Act of 2010 and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials or other persons for the purpose of obtaining or retaining business. There has been an increase in anti-bribery law enforcement activity in recent years, with more frequent and aggressive investigations and enforcement proceedings by both the Department of Justice ("DOJ") and the SEC, increased enforcement activity by non-U.S. regulators, and increases in criminal and civil proceedings brought against companies and individuals. Our policies mandate compliance with these anti-bribery laws. We operate in many parts of the world that are recognized as having governmental and commercial corruption and in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal control policies and procedures will always protect us from improper conduct of our employees or business partners. In the event that we believe or have reason to believe that our employees or agents have or may have violated applicable laws, including anti-corruption laws, we may be required to investigate or have outside counsel investigate the relevant facts and circumstances, which can be expensive and require significant time and attention from senior management. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, and curtailment of operations in certain jurisdictions, and might materially and adversely affect our business, results of operations or financial condition. In addition, actual or alleged violations could damage our reputation and ability to do business. Furthermore, detecting, investigating, and resolving actual or alleged violations is expensive and can consume significant time and attention of our senior management.
Our business could be adversely affected by the inability of suppliers to meet delivery requirements.
Our business relies on third-party suppliers, contract manufacturing and commodity markets to secure raw materials, parts and components used in our products. Parts and raw materials commonly used in our products include motors, fabricated parts, castings, bearings, seals, nickel, copper, aluminum, and plastics. We are exposed to the availability of these materials, which may be subject to curtailment or change due to, among other things, interruptions in production by suppliers, labor disputes, the impaired financial condition of a particular supplier, suppliers’ allocations to other purchasers, changes in exchange rates and prevailing price levels, ability to meet regulatory requirements, weather emergencies or acts of war or terrorism. Any delay in our suppliers’ abilities to provide us with necessary materials could impair our ability to deliver products to our customers and, accordingly, could have a material adverse effect on our business, financial condition or results of operations.
Our business could be adversely affected by significant movements in foreign currency exchange rates.
We conduct approximately 59% of our business in various locations outside the United States. We are exposed to fluctuations in foreign currency transaction exchange rates, particularly with respect to the Euro, Swedish Krona, Canadian Dollar, British Pound, Polish Zloty and Australian Dollar. Any significant change in the value of currencies of the countries in which we do business relative to the value of the U.S. Dollar or Euro could affect our ability to sell products competitively and control our cost structure, which could have a material adverse effect on our business, financial condition and results of operations. Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. Dollar and the Euro, British Pound, Chinese Yuan, Swedish Krona, Canadian Dollar and Australian Dollar. As the U.S. Dollar fluctuates against other currencies in which we transact business, revenue and income can be impacted. For instance, our 2015 revenue decreased by 8.0% due to unfavorable foreign currency impacts. Continued strengthening of the U.S. Dollar relative to the Euro and the currencies of the other countries in which we do business, could materially and adversely affect our revenue growth in future periods. Refer to Item 7A "Quantitative and Qualitative Disclosures about Market Risk" for additional information on foreign exchange risk.

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Weather conditions and climate changes may adversely affect, or cause volatility to/in, our financial results.
Weather conditions, including heavy flooding, droughts and fluctuations in temperatures or shifting conditions as a result of climate change, can positively or negatively impact portions of our business. Within the dewatering space, our pumps provided through our Godwin and Flygt brands are used to remove excess or unwanted water. Heavy flooding due to weather conditions drives increased demand for these applications. On the other hand, drought conditions drive higher demand for pumps used in agricultural and turf irrigation applications, such as those provided by our Goulds Water Technology, Flowtronex and Lowara brands. Fluctuations to warmer and cooler temperatures result in varying levels of demand for products used in residential and commercial applications where homes and buildings are heated and cooled with HVAC units such as those provided by our B&G brand. Given the unpredictable nature of weather conditions and climate change, this may result in volatility for certain portions of our business, as well as the operations of certain of our customers and suppliers.
Our financial results can be difficult to predict.
Our business is impacted by an increasing amount of short cycle, and book-and-bill business, which we have limited insight into, particularly for the business that we transact through our distributors. We are also impacted by large projects, whose timing can change based upon customer requirements due to a number of factors affecting the project, such as funding, readiness of the project and regulatory approvals. Accordingly, our financial results for any given period can be difficult to predict.
Our strategy includes acquisitions, and we may not be able to make acquisitions of suitable candidates or integrate acquisitions successfully.
Our historical growth has included acquisitions. As part of our growth strategy, we plan to pursue the acquisition of other companies, assets and product lines that either complement or expand our existing business. We cannot make assurances, however, that we will be able to identify suitable candidates successfully, negotiate appropriate acquisition terms, obtain financing that may be needed to consummate those acquisitions, complete proposed acquisitions, successfully integrate acquired businesses into our existing operations or expand into new markets. In addition, we cannot make assurances that any acquisition, once successfully integrated, will perform as planned, be accretive to earnings, or prove to be beneficial to our operations or cash flow.
Acquisitions involve a number of risks and present financial, managerial and operational challenges, including: diversion of management attention from existing businesses and operations; integration of technology, operations personnel, and financial and other systems; potentially insufficient internal controls over financial activities or financial reporting at an acquired entity that could impact us on a combined basis; the failure to realize expected synergies; the possibility that we become exposed to substantial undisclosed liabilities or new material risks associated with the acquired businesses; and the loss of key employees of the acquired businesses.
We may incur impairment charges for our goodwill and other indefinite-lived intangible assets which would negatively impact our operating results.
We have a significant amount of goodwill and purchased intangible assets on our balance sheet as a result of acquisitions we have completed. As of December 31, 2015, the net carrying value of our goodwill and other indefinite-lived intangible assets totaled approximately $2 billion. The carrying value of goodwill represents the fair value of an acquired business in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of indefinite-lived intangible assets represents the fair value of trademarks and trade names as of the acquisition date. We do not amortize goodwill and indefinite-lived intangible assets that we expect to contribute indefinitely to our cash flows, but instead we evaluate these assets for impairment at least annually, or more frequently if interim indicators suggest that a potential impairment could exist. In testing for impairment, we will make a qualitative assessment, and if we believe that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative two-step goodwill impairment test is required. Significant negative industry or economic trends, disruptions to our business, inability to effectively integrate acquired businesses, unexpected significant changes or planned changes in use of the assets, divestitures and market capitalization declines may impair our goodwill and other indefinite-lived intangible assets. Any charges relating to such impairments could adversely affect our results of operations and financial condition in the periods recognized.
We may not achieve some or all of the expected benefits of our restructuring plans and our restructuring may adversely affect our business.
We have announced restructuring plans in an effort to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. We may not be able to obtain the cost savings and benefits that were initially anticipated in connection with our restructuring. Additionally, as a

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result of our restructuring, we may experience a loss of continuity, loss of accumulated knowledge or inefficiency during transitional periods. Reorganization and restructuring can require a significant amount of management and other employees' time and focus, which may divert attention from operating and growing our business.
The successful implementation and execution of our restructuring and realignment actions is critical to achieving our expected cost savings as well as effectively competing in the marketplace. Factors that may impede a successful implementation is retention of key employees, the impact of regulatory matters, and adverse economic market conditions. If the restructuring and realignment actions are not executed successfully, it could have a material adverse effect on our competitive position, business, financial condition and results of operations.
Changes in our effective tax rates may adversely affect our financial results.
We sell our products in more than 150 countries and 59% of our revenue was generated outside the United States in 2015. Given the global nature of our business, a number of factors may increase our future effective tax rates, including:
our decision to repatriate non-U.S. earnings for which we have not previously provided for U.S. taxes;
the jurisdictions in which profits are determined to be earned and taxed;
sustainability of historical income tax rates in the jurisdictions in which we conduct business;
the resolution of issues arising from tax audits with various tax authorities; and
changes in the valuation of our deferred tax assets and liabilities, and changes in deferred tax valuation allowances.
Any significant increase in our future effective tax rates could reduce net income for future periods.
Our business could be adversely affected by inflation and other manufacturing and operating cost increases.
Our operating costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, energy and related utilities, freight, and cost of labor. In order to remain competitive, we may not be able to recuperate all or a portion of these higher costs from our customers through product price increases. Further, in a declining price environment, our operating margins may contract because we account for inventory using the first-in, first- out method. Actions we take to mitigate volatility in manufacturing and operating costs may not be successful and, as a result, our business, financial condition and results of operation could be materially and adversely affected.
Product defects and unanticipated use or inadequate disclosure with respect to our products could adversely affect our business, reputation and financial statements.
Manufacturing or design defects in (including in products or components that we source from third parties), unanticipated use of, or inadequate disclosure of risks relating to the use of products there can be no assurance that we or our customers or other third parties will not experience operational process failures or other problems that could result in potential product safety, regulatory or environmental risk which can lead to personal injury, death or property damage. These events could lead to recalls or safety alerts relating to our products, result in the removal of a product from the market and result in product liability claims being brought against us. Although we have liability insurance, we cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost or will be adequate to cover any product liability claims. Recalls, removals and product liability claims can result in significant costs, as well as negative publicity and damage to our reputation that could reduce demand for our products.
Our indebtedness may affect our business and may restrict our operational flexibility.
As of December 31, 2015, our total outstanding indebtedness was $1,274 million, including our 3.55% Senior Notes of $600 million aggregate principal amount due September 2016 and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021. We have an existing Five-Year Competitive Advance and Revolving Credit Facility (the “Credit Facility”), which provides for an aggregate principal amount of up to $600 million. We have a Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with The European Investment Bank ("EIB") in an aggregate principal amount of up to €120 million (approximately $132 million).
Our indebtedness could:
increase our vulnerability to general adverse economic and industry conditions;
limit our ability to obtain additional financing or borrow additional funds;

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limit our ability to pay future dividends;
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
require that a substantial portion of our cash flow from operations be used for the payment of interest on our indebtedness instead of funding working capital, capital expenditures, acquisitions or other general corporate purposes; and
increase the amount of interest expense that we must pay because some of our borrowings are at variable interest rates, which, as interest rates increase, would result in higher interest expense.
In addition, there can be no assurance that future borrowings or equity financing will be available to us on favorable terms or at all for the payment or refinancing of our indebtedness. If we incur additional debt or raise equity through the issuance of preferred stock, the terms of the debt or preferred stock issued may give the holders rights, preferences and privileges senior to those of holders of our common stock, particularly in the event of liquidation. The terms of the debt may also impose additional and more stringent restrictions on our operations than we currently have.
Our ability to make scheduled principal payments of, to pay interest on, or to refinance our indebtedness and to satisfy our other debt obligations will depend on our future operating performance, which may be affected by factors beyond our control. If we are unable to service our indebtedness, our business, financial condition and results of operations would be materially adversely affected.
We may be negatively impacted by litigation and regulatory proceedings.
We are subject to laws, regulations and potential liability relating to claims, complaints and proceedings, including those related to antitrust, environmental, product, and other matters.
We are subject to various laws, ordinances, regulations and other requirements of government authorities in foreign countries and in the United States, any violation of which could potentially create substantial liability for us and also damage to our reputation. Changes in laws, ordinances, regulations or other government policies, the nature, timing, and effect of which are uncertain, may significantly increase our expenses and liabilities.
From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses, including acquisitions and divestitures. Some of these proceedings seek remedies relating to environmental matters, intellectual property matters, product liability and personal injury claims, employment, labor and pension matters, and government and commercial or contract issues, sometimes related to acquisitions or divestitures. We may become subject to significant claims of which we are currently unaware, or the claims of which we are aware may result in our incurring a significantly greater liability than we anticipate or can estimate. Additionally, we may receive fines or penalties or be required to change or cease operations at one or more facilities if a regulatory agency determines that we have failed to comply with laws, regulations or orders applicable to our business.
Our business could be adversely affected by interruptions in information technology, communications networks and operations or cybersecurity threats.
Our business operations rely on information technology and communications networks, and operations that are vulnerable to damage or disturbance from a variety of sources. Regardless of protection measures, essentially all systems are susceptible to disruption due to failure, vandalism, computer viruses, security breaches, natural disasters, power outages and other events. In addition, we, and some of our third party vendors, have experienced cybersecurity attacks in the past and may experience them in the future, potentially with more frequency. To date, none have resulted in any material adverse impact to our business or operations. We have adopted measures to mitigate potential risks associated with information technology disruptions and cybersecurity threats, however, given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to production downtimes, operational delays, other detrimental impacts on our operations or ability to provide products and services to our customers, the compromising of confidential or otherwise protected information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems or networks, financial losses from remedial actions, loss of business or potential liability, regulatory enforcement actions, and/or damage to our reputation, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.  We also have a concentration of operations on certain sites, e.g. production and shared services centers, where business interruptions could cause material damage and costs. Transport of goods from suppliers, and to customers, could also be hampered for the reasons stated above.  Although we continue to assess these risks, implement controls, and perform business continuity planning, we cannot be sure that interruptions with material adverse effects will not occur.

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Failure to retain our existing senior management, engineering, sales and other key personnel or the inability to attract and retain new qualified personnel could negatively impact our ability to operate or grow our business.
Our success will continue to depend to a significant extent on our ability to retain or attract a significant number of employees in senior management, engineering, sales and other key personnel. The ability to attract or retain employees will depend on our ability to offer competitive compensation, training and cultural benefits. We will need to continue to develop a roster of qualified talent to support business growth and replace departing employees. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. A failure to retain or attract highly skilled personnel could adversely affect our operating results or ability to operate or grow our business.
If we do not or cannot adequately protect our intellectual property, if third parties infringe our intellectual property rights, or if third parties claim that we are infringing or misappropriating their intellectual property rights, we may suffer competitive injury, expend significant resources enforcing our rights or defending against such claims, or be prevented from selling products or services.
We own numerous patents, trademarks, copyrights, trade secrets and other intellectual property and licenses to intellectual property owned by others, which in aggregate are important to our business. The intellectual property rights that we obtain, however, may not provide us with a significant competitive advantage because they may not be sufficiently broad or may be challenged, invalidated, circumvented, independently developed, or designed-around, particularly in countries where intellectual property rights laws are not highly developed, protected or enforced. Our failure to obtain or maintain intellectual property rights that convey competitive advantage, adequately protect our intellectual property or detect or prevent circumvention or unauthorized use of such property and the cost of enforcing our intellectual property rights could adversely impact our business, financial condition and results of operations.  
From time to time, we receive notices from third parties alleging intellectual property infringement or misappropriation. Any dispute or litigation regarding intellectual property could be costly and time-consuming due to the complexity and the uncertainty of intellectual property litigation. Our intellectual property portfolio may not be useful in asserting a counterclaim, or negotiating a license, in response to a claim of infringement or misappropriation. In addition, as a result of such claims of infringement or misappropriation, we could lose our rights to critical technology, be unable to license critical technology or sell critical products and services, be required to pay substantial damages or license fees with respect to the infringed rights or be required to redesign our products at substantial cost, any of which could adversely impact our competitive position, financial condition and results of operations. Even if we successfully defend against claims of infringement or misappropriation, we may incur significant costs and diversion of management attention and resources, which could adversely affect our business, financial condition and results of operations.
We cannot make assurances that we will pay dividends on our common stock or continue to repurchase our common stock under Board approved share repurchase plans, and likewise our indebtedness could limit our ability to pay dividends or make share repurchases.
The timing, declaration, amount and payment of future dividends to our shareholders fall within the discretion of our Board of Directors and will depend on many factors, including our financial condition, results of operations and capital requirements, as well as applicable law, regulatory constraints, industry practice and other business considerations that our Board of Directors considers relevant. There can be no assurance that we will pay a dividend in the future or continue to pay dividends.
Further, the timing and amount of the repurchase of our common stock under Board approved share repurchase plans has similar dependencies as the payment of dividends and accordingly, there can be no assurances that we will continue to repurchase our common stock.
Additionally, if we cannot generate sufficient cash flow from operations to meet our debt payment obligations, then our ability to pay dividends, if so determined by the Board of Directors, or make share repurchases will be impaired and we may be required to attempt to restructure or refinance our debt, raise additional capital or take other actions such as selling assets, reducing or delaying capital expenditures, reducing our dividend or delaying or curtailing share repurchases. There can be no assurance, however, that any such actions could be effected on satisfactory terms, if at all, or would be permitted by the terms of our debt or our other credit and contractual arrangements.


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The level of returns on postretirement benefit plan assets, changes in interest rates and other factors could affect our earnings and cash flows in future periods.
Certain members of our current and retired employee population are covered by pension and other employee-related defined benefit plans (collectively, postretirement benefit plans). We may experience significant fluctuations in costs related to our postretirement benefit plans as a result of macro-economic factors, such as interest rates, that are beyond our control. The cost of our postretirement plans is incurred over long periods of time and involves factors and uncertainties during those periods which can be volatile and unpredictable, including rates of return on postretirement benefit plan assets, discount rates used to calculate liabilities and expenses and rates of future compensation increases. Management develops each assumption using relevant plan and Company experience and expectations in conjunction with market-related data. Our liquidity, financial position (including shareholders’ equity) and results of operations could be materially affected by significant changes in key economic indicators, actuarial experience, financial market volatility, future legislation and other governmental regulatory actions.
We make contributions to fund our postretirement benefit plans when considered necessary or advantageous to do so. The macro-economic factors discussed above, including the return on postretirement benefit plan assets and the minimum funding requirements established by local government funding or taxing authorities, or established by other agreement, may influence future funding requirements. A significant decline in the fair value of our plan assets, or other adverse changes to our overall pension and other employee-related benefit plans, could require us to make significant funding contributions and affect cash flows in future periods.
Unforeseen environmental issues could impact our financial position or results of operations.
Our operations are subject to and affected by many federal, state, local and foreign environmental laws and regulations. In addition, we could be affected by future environmental laws or regulations, including, for example, those imposed in response to climate change concerns. Compliance with current and future environmental laws and regulations currently requires and is expected to continue to require operating and capital expenditures.
Environmental laws and regulations may authorize substantial fines and criminal sanctions as well as facility shutdowns to address violations, and may require the installation of costly pollution control equipment or operational changes to limit emissions or discharges. We also incur, and expect to continue to incur, costs to comply with current environmental laws and regulations.
Developments such as the adoption of new environmental laws and regulations, stricter enforcement of existing laws and regulations, violations by us of such laws and regulations, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, our inability to recover costs associated with any such developments, or financial insolvency of other responsible parties could in the future have a material adverse effect on our financial position and results of operations.
The market price of our common stock may fluctuate significantly.
We cannot predict the prices at which our common stock may trade. The market price of our common stock may fluctuate widely, depending on many factors, some of which may be beyond our control, including:
actual or anticipated fluctuations in our operating results due to factors related to our business;
success or failure of our business strategy;
our quarterly or annual earnings, or those of other companies in our industry;
our ability to obtain financing as needed;
announcements by us or our competitors of significant new business awards;
announcements by us or our competitors of significant acquisitions or dispositions;
changes in accounting standards, policies, guidance, interpretations or principles;
changes in earnings estimates by securities analysts or our ability to meet those estimates;
our ability to execute restructuring and realignment actions;
the operating and stock price performance of other comparable companies;
natural or environmental disasters that investors believe may affect us;
overall market fluctuations;
fluctuations in the budgets of federal, state and local governmental entities around the world;

19


results from any material litigation or government investigation;
changes in laws and regulations affecting our business; and
general economic conditions and other external factors.
Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations could adversely affect the trading price of our common stock.
Anti-takeover provisions in our organizational documents and Indiana law could delay or prevent a change in control.
Certain provisions of our third amended and restated articles of incorporation and our amended and restated by-laws may delay or prevent a merger or acquisition of part or all of our business operations. For example, the third amended and restated articles of incorporation and the amended and restated by-laws, among other things, require advance notice for shareholder proposals and nominations and do not permit action by written consent of the shareholders, unless unanimous. In addition, the amended and restated articles of incorporation authorize our Board of Directors to issue one or more series of preferred stock. These provisions may also discourage acquisition proposals of our business operations or delay or prevent a change in control, which could harm our stock price. Indiana law also imposes some restrictions on mergers and other business combinations between any holder of 10% or more of our outstanding common stock and us.
Risks Related to our 2011 Spin-off from ITT Corporation
In connection with our Spin-off, ITT and Exelis, acquired by Harris Inc. on May 29, 2015, will indemnify us for certain liabilities and we will indemnify ITT or Exelis for certain liabilities. If we are required to indemnify ITT or Exelis, we may need to divert cash to meet those obligations and our financial results could be negatively impacted. In the case of ITT's or Exelis's indemnity, there can be no assurance that those indemnities will be sufficient to insure us against the full amount of such liabilities, or as to ITT's or Exelis's ability to satisfy its indemnification obligations in the future.
Pursuant to the Distribution Agreement and certain other agreements with ITT and Exelis, ITT and Exelis agreed to indemnify us from certain liabilities, and we agreed to indemnify ITT and Exelis for certain liabilities. Indemnities that we may be required to provide ITT and Exelis may be significant and could negatively impact our business, particularly indemnities relating to our actions that could impact the tax-free nature of the Spin-off. Third parties could also seek to hold us responsible for any of the liabilities that ITT or Exelis has agreed to retain. Further, there can be no assurance that the indemnities from ITT and Exelis will be sufficient to protect us against the full amount of such liabilities, or that ITT and Exelis will be able to fully satisfy their indemnification obligations. Moreover, even if we ultimately were to succeed in recovering from ITT and Exelis any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. Each of these risks could negatively affect our business, results of operations and financial condition.
ITEM 1B.    UNRESOLVED STAFF COMMENTS.
None.


20


ITEM 2.        PROPERTIES
We have approximately 350 locations in more than 40 countries. These properties total approximately 10.2 million square feet, of which more than 300 locations, or approximately 5.5 million square feet, are leased. We consider the offices, plants, warehouses and other properties that we own or lease to be in good condition and generally suitable for the purposes for which they are used. The following table shows the significant locations by segment:
Location
 
State or
Country
 
Principal Business Activity
 
Approx.
Square
Feet
 
Owned or
Expiration
Date
of Lease
Water Infrastructure
Emmaboda
 
Sweden
 
Administration and Manufacturing
 
1,194,000

 
Owned
Stockholm
 
Sweden
 
Administration and Research & Development
 
172,000

 
2019
Shenyang
 
China
 
Manufacturing
 
125,000

 
Owned
Bridgeport
 
NJ
 
Administration and Manufacturing
 
136,000

 
2020
Yellow Springs
 
OH
 
Administration and Manufacturing
 
112,000

 
Owned
Quenington
 
UK
 
Manufacturing
 
86,000

 
2020
Applied Water
Morton Grove
 
IL
 
Administration and Manufacturing
 
530,000

 
Owned
Montecchio
 
Italy
 
Administration and Manufacturing
 
379,000

 
Owned
Nanjing
 
China
 
Manufacturing
 
363,000

 
Owned
Auburn
 
NY
 
Manufacturing
 
273,000

 
Owned
Lubbock
 
TX
 
Manufacturing
 
229,000

 
Owned
Cheektowaga
 
NY
 
Manufacturing
 
147,000

 
Owned
Corporate Headquarters
Rye Brook
 
NY
 
Administration
 
67,000

 
2023

ITEM 3.        LEGAL PROCEEDINGS
From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings seek remedies relating to environmental matters, intellectual property matters, personal injury claims, employment and pension matters, government contract issues and commercial or contractual disputes, sometimes related to acquisitions or divestitures. See Note 18, "Commitments and Contingencies", of the consolidated financial statements included in Item 8 of Part II of this 10-K for information regarding certain legal proceedings in which we are involved.

ITEM 4.        MINE SAFETY DISCLOSURES
None.

21


EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is provided regarding the executive officers of Xylem as of February 1, 2016:
NAME
 
AGE
 
CURRENT TITLE
 
OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS
Patrick K. Decker
 
51
 
President and Chief Executive Officer (2014)
 
• President and Chief Executive Officer, Harsco Corp. (diversified, worldwide industrial company) (2012)
• President, Flow Control Segment, Tyco International Ltd. (industrial products and services company) (2003)
 
 
 
 
 
 
 
Shashank Patel
 
55
 
Interim Chief Financial Officer (2015)
 
• VP, Finance, Applied Water Systems (2010)
 
 
 
 
 
 
 
Tomas Brannemo
 
46
 
Senior VP and President, Transport (2014)
 
• VP, Transport (2013)
• VP and Director of Business Unit Aftermarket and Service (2010)
 
 
 
 
 
 
 
David Flinton
 
45
 
Senior VP and President, Dewatering (2015)
 
• VP, Engineering and Marketing, Applied Water Systems (2013)
• VP, Global Product Management, Applied Water Systems (2012)
• VP, Strategy and Integrated Management System (former Water Solutions division) (2010)
 
 
 
 
 
 
 
Pak Steven Leung
 
55
 
Senior VP and President, Emerging Markets (2015)

 
VP, Global Sales, Valves and Controls, Pentair Plc (diversified, worldwide industrial manufacturing company) (2013)
VP and General Manager, Global Process, Tyco International Ltd. (industrial products and services company) (2010)
 
 
 
 
 
 
 
Kenneth Napolitano
 
53
 
Senior VP and President, Applied Water Systems (2012)
 
• Senior VP and President, Residential and Commercial Water (2011)

• President, Residential and Commercial Water (2009)
 
 
 
 
 
 
 
Colin R. Sabol
 
48
 
Senior VP and President, Analytics and Treatment (2015)
 
• Senior VP and President, Dewatering (2013)
• Senior VP and Chief Strategy and Growth Officer (2011)
 
 
 
 
 
 
 
Kairus Tarapore
 
54
 
Senior VP and Chief Human Resources Officer (2015)
 
• Senior VP and Chief Administrative Officer, Babcock & Wilcox Company (2013)
• Executive VP, Human Resources, Ceridian Corporation (2006)
 
 
 
 
 
 
 

22


NAME
 
AGE
 
CURRENT TITLE
 
OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS
Claudia S. Toussaint
 
52
 
Senior VP, General Counsel and Corporate Secretary (2014)
 
• Senior VP, General Counsel and Secretary, Barnes Group Inc. (international industrial and aerospace manufacturing) (2012)
• General Counsel, Flow Control Segment, Tyco International Ltd. (industrial products and services company) (2012)
• Senior VP, General Counsel and Secretary, Barnes Group Inc. (international industrial and aerospace manufacturing) (2010)
Note: Date in parentheses indicates the year in which the position was assumed.
 
BOARD OF DIRECTORS
The following information is provided regarding the Board of Directors of Xylem:
NAME
 
TITLE
Markos I. Tambakeras
 
Chairman, Xylem Inc., Former Chairman, President and Chief Executive Officer, Kennametal, Inc.
 
 
 
Curtis J. Crawford, Ph.D.
 
President and Chief Executive Officer, XCEO, Inc.
 
 
 
Patrick K. Decker
 
President and Chief Executive Officer, Xylem Inc.
 
 
 
Robert F. Friel
 
Chairman, President and Chief Executive Officer, PerkinElmer, Inc.
 
 
 
Victoria D. Harker
 
Chief Financial Officer, TEGNA Inc.
 
 
 
Sten E. Jakobsson
 
Former President and Chief Executive Officer, ABB AB
 
 
 
Steven R. Loranger
 
Former Chairman, President and Chief Executive Officer, ITT Corporation
 
 
 
Edward J. Ludwig
 
Former Chairman, President and Chief Executive Officer, Becton, Dickinson and Company
 
 
 
Surya N. Mohapatra, Ph.D.
 
Former Chairman, President and Chief Executive Officer, Quest Diagnostics Incorporated
 
 
 
Jerome A. Peribere
 
President and Chief Executive Officer, Sealed Air Corporation


23


PART II
ITEM 5.        MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
2015 and 2014 Market Price and Dividends
Our common stock trades publicly on the New York Stock Exchange under the trading symbol “XYL”. The following table shows the high and low prices per share of our common stock as reported by the New York Stock Exchange and the dividends declared per share for the periods indicated.
 
High
 
Low
 
Dividend
Fiscal Year ended December 31, 2015
 
 
 
 
 
First Quarter
$
38.59

 
$
33.54

 
$
0.1408

Second Quarter
37.70

 
34.80

 
0.1408

Third Quarter
37.32

 
29.90

 
0.1408

Fourth Quarter
38.00

 
32.16

 
0.1408

 
 
 
 
 
 
Fiscal Year ended December 31, 2014
 
 
 
 
 
First Quarter
$
39.79

 
$
32.62

 
$
0.1280

Second Quarter
40.00

 
34.50

 
0.1280

Third Quarter
39.43

 
34.77

 
0.1280

Fourth Quarter
39.23

 
31.80

 
0.1280

The closing price of our common stock on the NYSE on January 29, 2016 was $35.95 per share. As of January 29, 2016, there were 13,784 holders of record of our common stock.
Dividends are declared and paid on the common stock at the discretion of our Board of Directors and depend on our profitability, financial condition, capital needs, future prospects, and other factors deemed relevant by our Board. Therefore, there can be no assurance as to what level of dividends, if any, will be paid in the future. In the first quarter of 2016, we declared a dividend of $0.1549 per share to be paid on March 16, 2016 for shareholders of record on February 18, 2016.
There have been no unregistered offerings of our common stock during 2015.















24


Fourth Quarter 2015 Share Repurchase Activity
The following table summarizes our purchases of our common stock for the quarter ended December 31, 2015:
(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)
10/1/15 - 10/31/15
 
 
 
 
$479
11/1/15 - 11/30/15
 
0.7
 
36.80
 
0.7
 
$454
12/1/15 - 12/31/15
 
0.7
 
36.71
 
0.7
 
$429
(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. During the three months ended December 31, 2015, we repurchased 1.4 million shares for $50 million. There are up to $420 million in shares that may still be purchased under this plan as of December 31, 2015.
On August 18, 2012, the Board of Directors authorized the repurchase of up to 2.0 million shares of common stock with no expiration date. The program's objective is to offset dilution associated with various Xylem employee stock plans by acquiring shares in the open market from time to time. There were no shares purchased under this program during the three months ended December 31, 2015 and there are 0.3 million shares (approximately $9 million based on the closing share price on December 31, 2015) that may still be purchased under this plan.

25


PERFORMANCE GRAPH
CUMULATIVE TOTAL RETURN
The following graph compares the relative performance of our common stock, the S&P 500 Index and the S&P 500 Industrials Index. This graph covers the period from October 13, 2011 (the first day our common stock began “when-issued” trading on the NYSE) through December 31, 2015. Our common stock began “regular-way” trading following the Spin-off on November 1, 2011.
 
XYL
 
S&P 500
 
S&P 500
Industrials
Index
October 13, 2011
$
100

 
$
100

 
$
100

October 31, 2011
110

 
104

 
106

December 31, 2011
106

 
105

 
108

December 31, 2012
114

 
121

 
124

December 31, 2013
148

 
161

 
175

December 31, 2014
165

 
183

 
192

December 31, 2015
161

 
186

 
187

The graph is not, and is not intended to be, indicative of future performance of our common stock.
This performance graph shall not be deemed “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, and should not be deemed incorporated by reference into any of our prior or subsequent filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filing.

26


ITEM 6.        SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the five years ended December 31, 2015. This selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included in this Report.
On and prior to the Distribution Date, our financial position and results of operations consisted of WaterCo, the water equipment and services businesses of ITT Corporation. The Spin-off was completed pursuant to the Distribution Agreement among ITT, Exelis Inc., acquired by Harris Inc. on May 29, 2015, and Xylem. Xylem's financial position and results of operations have been derived from ITT’s historical accounting records and are presented on a carve-out basis through the Distribution Date, while our financial results for Xylem post Spin-off are prepared on a stand-alone basis. Further, financial information for the twelve months ended December 31, 2011 consists of the consolidated results of Xylem on a stand-alone basis for the two months of November and December and the combined results of operations of WaterCo for the first ten months on a carve-out basis.
 
Year Ended
December 31,
(in millions, except per share data)
2015
 
2014
 
2013
 
2012
 
2011 (a)
Results of Operations Data:
 
 
 
 
 
 
 
 
 
Revenue
$
3,653

 
$
3,916

 
$
3,837

 
$
3,791

 
$
3,803

Gross profit
1,404

 
1,513

 
1,499

 
1,502

 
1,461

Gross margin
38.4
%
 
38.6
%
 
39.1
%
 
39.6
%
 
38.4
%
Operating income
449

 
463

 
363

 
443

 
395

Operating margin
12.3
%
 
11.8
%
 
9.5
%
 
11.7
%
 
10.4
%
Net income
340

 
337

 
228

 
297

 
279

Per Share Data:
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
 
Basic
$
1.88

 
$
1.84

 
$
1.23

 
$
1.60

 
$
1.51

Diluted
1.87

 
1.83

 
1.22

 
1.59

 
1.50

Basic shares outstanding
180.9

 
183.1

 
185.2

 
185.8

 
185.1

Diluted shares outstanding
181.7

 
184.2

 
186.0

 
186.2

 
185.3

Cash dividends per share
$
0.5632

 
$
0.5120

 
$
0.4656

 
$
0.4048

 
$
0.1012

Balance Sheet Data (at period end):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
680

 
$
663

 
$
533

 
$
504

 
$
318

Working capital*
810

 
882

 
930

 
859

 
834

Total assets (b)(c)
4,657

 
4,833

 
4,857

 
4,639

 
4,350

Total debt (b)
1,274

 
1,284

 
1,235

 
1,197

 
1,197


*
The Company calculates Working capital as follows: net accounts receivable + inventories - accounts payable - customer advances.
(a)
In 2011, we acquired YSI Incorporated, which contributed revenue of $35 million in 2011 and $371 million of total assets on date of acquisition.
(b)
Debt issuance costs of $6 million, $8 million and $9 million in 2013, 2012 and 2011, respectively, were reclassified to long-term debt from other non-current assets within the Consolidated Balance Sheet. See Note 2, “Recently Issued Accounting Pronouncements,” of the consolidated financial statements.
(c)
Deferred tax assets of $33 million, $32 million and $41 million in 2013, 2012 and 2011, respectively, were reclassified to deferred tax liabilities within the Consolidated Balance Sheet. See Note 2, “Recently Issued Accounting Pronouncements,” of the consolidated financial statements.



27


ITEM 7.        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business during each of the fiscal years in the three-year period ended December 31, 2015. Except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to Xylem Inc. and its subsidiaries.
Overview
Xylem 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. Our business focuses on providing technology-intensive equipment and services. Our product and service offerings are organized into two reportable segments: Water Infrastructure and Applied Water. Our segments are aligned with each of the sectors in the cycle of water, water infrastructure and usage applications.
Water Infrastructure serves the water infrastructure sector with pump systems that transport water from aquifers, lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumping solutions that move the wastewater to treatment facilities where our mixers, biological treatment, monitoring and control systems provide the primary functions in the treatment process. We provide analytical instrumentation used to measure water quality, flow and level in wastewater, surface water and coastal environments. In the Water Infrastructure segment, we provide the majority of our sales directly to customers with strong application expertise, while the remaining amount is through distribution partners.
Applied Water serves the usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning and for fire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers, valves and controls provide cooling to power plants and manufacturing facilities, as well as circulation for food and beverage processing. We also provide boosting systems for farming irrigation, pumps for dairy operations and rainwater reuse systems for small scale crop and turf irrigation. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with the world’s leading distributors, with the remainder going directly to customers.
We sell our equipment and services through direct and indirect channels that serve the needs of each customer type. In the Water Infrastructure segment, we provide the majority of our sales direct to customers with strong application expertise, while the remaining amount is through distribution partners. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with the world’s leading distributors, with the remainder going direct to customers.
Key Performance Indicators and Non-GAAP Measures
Management reviews key performance indicators including revenue, gross margin, segment operating income and margins, earnings per share, orders growth, working capital, free cash flow and backlog, among others. In addition, we consider certain measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases and debt repayment. 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 operations as determined in accordance with GAAP. We consider the following non-GAAP measures, which 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, intercompany transactions 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 assumes no change in exchange rates from the prior period.
"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.

28


"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, tax-related special items and gain from sale of businesses. A reconciliation of adjusted net income is provided below.
(in millions, except per share data)
 
2015
 
2014
 
2013
Net income
 
$
340

 
$
337

 
$
228

Restructuring and realignment, net of tax benefit of $5, $12 and $18, respectively
 
15

 
31

 
46

Special charges, net of tax benefit of $0 and $9, respectively
 
5

 

 
23

Tax-related special items
 
(15
)
 
5

 
14

Gain on sale of business, net of $0 tax in both years
 
(9
)
 
(11
)
 

Adjusted net income
 
$
336

 
$
362

 
$
311

Weighted average number of shares - Diluted
 
181.7

 
184.2

 
186.0

Adjusted earnings per share
 
$
1.85

 
$
1.97

 
$
1.67

"operating expenses excluding restructuring and realignment costs and special charges" defined as operating expenses, adjusted to exclude restructuring and realignment costs and special charges.
"adjusted operating income (loss)" defined as operating income (loss), 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 legal and professional fees, associated with the Korea matters, costs incurred for the contractual indemnification of tax obligations to ITT, certain costs incurred during the third quarter of 2013 for the settlement of legal proceedings with Xylem Group LLC, as well as the change in chief executive officer and other special non-operating items.
"tax-related special items" defined as tax items, such as tax return versus tax provision adjustments, tax exam impacts, tax law change impacts and other discrete tax adjustments.
"free cash flow" defined as net cash from operating activities, as reported in the Statement of Cash Flow, less capital expenditures, as well as adjustments for other significant items that impact current results that management believes are not related to our ongoing operations and performance. Our definition of free cash flow does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow.
(in millions)
 
2015
 
2014
 
2013
Net cash provided by operating activities
 
$
464

 
$
416

 
$
324

Capital expenditures
 
(117
)
 
(119
)
 
(126
)
Free cash flow
 
$
347

 
$
297

 
$
198

Executive Summary
Xylem reported revenue of $3,653 million for 2015, a decrease of 6.7% from $3,916 million reported in 2014. Revenue increased 1.3% on a constant currency basis due to strong organic growth in the public utility, commercial and residential markets, partially offset by declines in industrial in the oil and gas market. Operating income for 2015 was $449 million, reflecting a decrease of $14 million or 3.0% compared to $463 million in 2014. Operating income as a percentage of revenue was 12.3% for 2015 versus 11.8% for 2014, an increase of 50 basis points. This increase in operating margin was primarily due to reduced restructuring and realignment costs as well as incremental cost savings from continuous improvement initiatives and restructuring actions. Partially offsetting these actions were cost inflation, unfavorable mix and unfavorable foreign exchange translation impacts.



29


Additional financial highlights for 2015 include the following:
Net income of $340 million, or $1.87 per diluted share ($336 million or $1.85 per diluted share on an adjusted basis)
Free cash flow of $347 million, and net cash from operating activities of $464 million
Orders of $3,711 million (a 0.5% increase from 2014 on an organic basis)
We repurchased a total of $175 million in shares under our share repurchase programs approved by our Board of Directors as part of our strategy to enhance shareholder return
Dividends paid to shareholders increased 10% in 2015.
2016 Business Outlook
We continue to anticipate organic revenue growth in the low-to-mid single digits in 2016. The following is a summary of our outlook by market.
Industrial was down 1% for 2015 as general industrial strength was more than offset by oil and gas declines in Canada and the United States. For 2016, we expect growth to be flat to up in the low-single-digits. This projection assumes low-single-digit growth in light industrial applications, and double-digit declines in oil and gas, and mining applications.
Public utilities increased 4% for 2015 driven by the United States recovery and continued emerging markets investments. We expect growth in mid-single-digits for 2016 as we anticipate continued growth in the United States and continued investments across emerging markets. We also anticipate that market conditions in Europe will remain stable.
Commercial experienced growth of 4% for 2015 driven by a recovering institutional building sector in the United States. We expect continued growth in the mid-single-digit range for 2016. Our expectation is that growth in the U.S. institutional building market will continue through the year, urbanization will continue to drive growth in most emerging markets and that conditions in Europe will modestly improve.
Residential markets grew 4% in 2015 with the strongest growth in the U.S. For 2016 we expect low-to-mid-single digit growth driven by continued strength in the U.S. We also expect continued low-single-digit growth in Europe.
Our agriculture markets, which is our smallest end market, declined 8% in 2015 driven by unfavorable U.S. weather conditions. We expect 2016 to grow low-single-digits as we will likely see a modest recovery from the significant weather events in 2015.
We will continue to strategically execute restructuring and realignment actions primarily to reposition our European and North American business in an effort to optimize our cost structure and improve our operational efficiency and effectiveness. During 2015, we incurred $6 million and $14 million in restructuring and realignment costs, respectively. As a result of the restructuring actions in 2015, we realized $2 million of net savings and expect to realize approximately $1 million of incremental net savings in 2016. During 2016, we expect to incur approximately $25 million in restructuring and realignment costs. We expect to realize approximately $8 million of savings from our 2016 actions.
Additional strategic actions we are taking include strategic initiatives to drive above-market growth, advance continuous improvement activities to increase productivity, focus on improving cash performance and drive a disciplined capital deployment strategy.




30


Results of Operations
(in millions)
 
2015
 
2014
 
2013
 
2015 v. 2014
 
2014 v. 2013
Revenue
 
$
3,653

 
$
3,916

 
$
3,837

 
(6.7
)%
 
2.1
 %
Gross profit
 
1,404

 
1,513

 
1,499

 
(7.2
)%
 
0.9
 %
Gross margin
 
38.4
%
 
38.6
%
 
39.1
%
 
(20
)bp
 
(50
)bp
Operating expenses excluding restructuring and realignment costs and special charges
 
930

 
1,007

 
1,048

 
(7.6
)%
 
(3.9
)%
Expense to revenue ratio
 
25.5
%
 
25.7
%
 
27.3
%
 
(20
)bp
 
(160
)bp
Restructuring and realignment costs
 
20

 
43

 
64

 
(53.5
)%
 
(32.8
)%
Special charges
 
5

 

 
24

 
NM

 
NM

Total operating expenses
 
955

 
1,050

 
1,136

 
(9.0
)%
 
(7.6
)%
Operating income
 
449

 
463

 
363

 
(3.0
)%
 
27.5
 %
Operating margin
 
12.3
%
 
11.8
%
 
9.5
%
 
50
bp
 
230
bp
Interest and other non-operating expense (income), net
 
55

 
53

 
65

 
3.8
 %
 
(18.5
)%
Gain on sale of business
 
9

 
11

 

 
(18.2
)%
 
NM

Income tax expense
 
63

 
84

 
70

 
(25.0
)%
 
20.0
 %
Tax rate
 
15.6
%
 
19.8
%
 
23.5
%
 
(420
)bp
 
(370
)bp
Net income
 
$
340

 
$
337

 
$
228

 
0.9
 %
 
47.8
 %
NM     Not Meaningful
2015 versus 2014
Revenue
Revenue generated for 2015 was $3,653 million, a decrease of $263 million, or 6.7%, compared to $3,916 million in 2014. On a constant currency basis, revenue grew 1.3%. This increase was primarily driven by strong organic growth within emerging markets, particularly in China and India. The United States and western Europe also grew organically, which was partially offset by declines in Canada. In addition, the organic growth was partially offset by the divestiture of the Wolverhampton valves business early in the third quarter of 2014.
The following table illustrates the impact on 2015 revenue from organic growth, recent acquisitions/divestitures, and foreign currency translation in relation to revenue.
(in millions)
$ Change
 
% Change
2014 Revenue
$
3,916

 
 
Organic Growth
60

 
1.5
 %
Acquisitions/(Divestitures)
(10
)
 
(0.3
)%
Constant Currency
50

 
1.3
 %
Foreign currency translation (a)
(313
)
 
(8.0
)%
Total change in revenue
(263
)
 
(6.7
)%
2015 Revenue
$
3,653

 
 
(a)
Foreign currency translation impact primarily due to fluctuations in the value of the Euro, Swedish Krona, Australian Dollar, British Pound, Canadian Dollar and Norwegian Krone against the U.S. Dollar.
The following table summarizes revenue by segment for 2015 and 2014:
(in millions)
2015
 
2014
 
As Reported Change
 
Constant Currency Change
Water Infrastructure
$
2,231

 
$
2,442

 
(8.6
)%
 
0.9
%
Applied Water
1,422

 
1,474

 
(3.5
)%
 
1.8
%
Total
$
3,653

 
$
3,916

 
(6.7
)%
 
1.3
%

31


Water Infrastructure
Water Infrastructure’s revenue decreased $211 million, or 8.6% in 2015 (0.9% increase on a constant currency basis) compared to 2014. The constant currency increase was driven by organic growth of $22 million or 0.9% due to continued strength in the public utility end market partially offset by weakness in the industrial market. The industrial market performance decline was due to decreases in dewatering applications in the oil and gas market which more than offset increases in the balance of the industrial market.
From an application perspective, organic revenue grew in transport, treatment and test applications. The organic revenue growth from transport applications was predominately due to public utility strength in the emerging markets, the United States and in western Europe, partially offset by declines in industrial dewatering applications from weakness in the oil and gas market in Canada and the United States. The organic revenue growth from treatment applications was due to ozone and filtration projects in China and Australia which was somewhat offset by the lapping of a large project in Latin America in 2014 and general weakness in Europe. Organic revenue growth from test applications was driven by growth in China and India due to demand for new wastewater and river monitoring products.
Applied Water
Applied Water’s revenue decreased $52 million, or 3.5% in 2015 (a 1.8% increase on a constant currency basis) compared to 2014. The growth on a constant currency basis is driven primarily by organic revenue growth of $38 million or 2.6% due to strength in the commercial, industrial water and residential end markets, partially offset by declines in the agriculture end market. This increase in the current year was partially offset by the absence of $11 million in revenue from the divested Wolverhampton valves business.
From an applications perspective, the increase in organic revenue was predominately due to continued growth in commercial building services from a recovering institutional building sector in the United States and strength in Asia. The industrial water application organic revenue grew from project strength in western Europe and the United States, which was partially offset by the aforementioned Wolverhampton divestiture. Residential building services organic revenue increased primarily in the United States due to improvements in the home construction market and market share gain. Irrigation applications organic revenue decline was largely impacted by severe flooding conditions in the southeast and southwest regions of the United States and the lapping of a strong fourth quarter in 2014.
Orders/Backlog
Orders received during 2015 decreased by $310 million, or 7.7% to $3,711 million (a 0.2% increase on a constant currency basis). Organic order growth increased $19 million or 0.5% for the year.
Water Infrastructure segment orders decreased $215 million, or 8.6% to $2,296 million (1.0% growth on a constant currency basis). Organic order growth of 1.0% was predominantly due to organic order increases for treatment applications due to large projects in the Middle East and Greater Asia. The organic orders for test applications were slightly up. Slightly offsetting these increases was a decline in organic orders for transport applications predominately due to decreases in the dewatering transport application due to weakness in the oil and gas market, which more than offset solid growth in the remainder of the transport applications.
Orders decreased in our Applied Water segment $95 million, or 6.3% to $1,415 million (1.0% decline on a constant currency basis). The order decline on a constant currency basis was due to the organic order volume decrease of 0.3%, due to market softness in the oil and gas and agricultural markets, as well as the absence of orders from our Wolverhampton valves divestiture.
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. Total backlog was $716 million at December 31, 2015 and $740 million at December 31, 2014. This decrease is due to foreign currency translation impacts. We anticipate that approximately 81% of the backlog at December 31, 2015 will be recognized as revenue during 2016.
Gross Margin
Gross margins as a percentage of consolidated revenue declined to 38.4% in 2015 from 38.6% in 2014. The gross margin decline was primarily due to negative currency translation impacts. Excluding the negative currency translation impacts, gross margin was slightly higher as compared to 2014. Benefits realized from cost saving initiatives through global sourcing and lean six sigma, as well as increased volume, more than offset material and labor inflation headwinds and unfavorable sales mix, primarily due to higher volume sold to the emerging markets.

32


Operating Expenses
(in millions)
2015
 
2014
 
Change
Selling, general and administrative expenses ("SG&A")
$
854

 
$
920

 
(7.2
)%
SG&A as a % of revenue
23.4
%
 
23.5
%
 
(10
)bp
Research and development expenses ("R&D")
95

 
104

 
(8.7
)%
R&D as a % of revenue
2.6
%
 
2.7
%
 
(10
)bp
Restructuring charges
6

 
26

 
(76.9
)%
Operating expenses
$
955

 
$
1,050

 
(9.0
)%
Expense to revenue ratio
26.1
%
 
26.8
%
 
(70
)bp
Selling, General and Administrative Expenses
SG&A decreased by $66 million or 7.2% to 23.4% of revenue in 2015, as compared to 23.5% of revenue in 2014. The decrease in SG&A expenses as a percentage of revenue was primarily due to currency translation impacts. Additionally, cost inflation was offset by cost savings from continuous improvement initiatives and restructuring actions as well as reduced realignment costs.
Research and Development Expenses
R&D spending decreased $9 million or 8.7% to 2.6% of revenue in 2015 as compared to 2.7% of revenue in 2014 primarily due to currency translation impacts.
Restructuring Charges
During 2015, we incurred restructuring costs of $5 million and $1 million in our Water Infrastructure and Applied Water segments, respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount and consolidation of facilities. During 2014, we recognized restructuring costs of $19 million, $6 million and $1 million in our Water Infrastructure and Applied Water segments, and Corporate and other, respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount and consolidation of facilities.
Total expected costs associated with actions that commenced during 2015 are approximately $5 million for Water Infrastructure and approximately $1 million for Applied Water. These costs primarily comprise severance charges. The Water Infrastructure actions are expected to continue through the second quarter of 2016. Substantially all of cost associated with the Applied Water actions have been incurred. As a result of these actions initiated in 2015, we achieved savings of approximately $2 million in 2015 and estimate annual future net savings beginning in 2016 of approximately $3 million, resulting in $1 million of incremental savings in 2016 from the 2015 actions.
Operating Income
We generated operating income of $449 million during 2015, a $14 million or 3.0% decrease from the prior year. Operating income as a percentage of revenue was 12.3% for 2015 versus 11.8% for 2014, an increase of 50 basis points. This increase in operating margin was primarily due to reduced restructuring and realignment costs, incremental cost savings from continuous improvement initiatives and slightly higher volume. Partially offsetting these actions were cost inflation, unfavorable mix and unfavorable foreign exchange translation impacts.

33


The following table illustrates operating income results for our business segments:
(in millions)
2015
 
2014
 
Change
Water Infrastructure
$
303

 
$
321

 
(5.6
)%
Applied Water
190

 
193

 
(1.6
)%
Segment operating income
493

 
514

 
(4.1
)%
Corporate and other
(44
)
 
(51
)
 
(13.7
)%
Total operating income
$
449

 
$
463

 
(3.0
)%
Operating margin
 
 
 
 
 
Water Infrastructure
13.6
%
 
13.1
%
 
50
bp
Applied Water
13.4
%
 
13.1
%
 
30
bp
Total Xylem
12.3
%
 
11.8
%
 
50
bp
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:
(in millions)
2015
 
2014
 
Change
Water Infrastructure
 
 
 
 
 
Operating income
$
303

 
$
321

 
(5.6
)%
Restructuring and realignment costs
13

 
29

 
(55.2
)%
Special charges
1

 

 
NM

Adjusted operating income
$
317

 
$
350

 
(9.4
)%
Adjusted operating margin
14.2
%
 
14.3
%
 
(10
)bp
Applied Water
 
 
 
 
 
Operating income
$
190

 
$
193

 
(1.6
)%
Restructuring and realignment costs
7

 
13

 
(46.2
)%
Adjusted operating income
$
197

 
$
206

 
(4.4
)%
Adjusted operating margin
13.9
%
 
14.0
%
 
(10
)bp
Corporate and other
 
 
 
 
 
Operating loss
$
(44
)
 
$
(51
)
 
(13.7
)%
Restructuring and realignment costs

 
1

 
(100.0
)%
Adjusted operating loss
$
(44
)
 
$
(50
)
 
(12.0
)%
Total Xylem
 
 
 
 
 
Operating income
$
449

 
$
463

 
(3.0
)%
Restructuring and realignment costs
20

 
43

 
(53.5
)%
Special charges
1

 

 
NM

Adjusted operating income
$
470

 
$
506

 
(7.1
)%
Adjusted operating margin
12.9
%
 
12.9
%
 

NM    Not Meaningful
Water Infrastructure
Operating income for our Water Infrastructure segment decreased $18 million or 5.6% (decreased $33 million or 9.4% on an adjusted basis) compared to the prior year. On an adjusted basis the operating margin decreased from 14.3% to 14.2%. The reduction in operating margin was due to cost inflation and unfavorable mix resulting from the declines in our dewatering business driven by oil and gas weakness, and lower emerging market margins. This reduction was not quite offset by cost savings from procurement initiatives, lean six sigma initiatives and restructuring actions.
Applied Water
Operating income for our Applied Water segment decreased $3 million or 1.6% (decreased $9 million or 4.4% on an adjusted basis) compared to the prior year. On an adjusted basis the operating margin decreased from 14.0% to 13.9%. The reduction in operating margin was due to cost inflation, unfavorable mix and foreign exchange impacts, partially offset by cost reductions from procurement and lean six sigma initiatives and higher volume.

34


Corporate and other
Operating loss for corporate and other decreased $7 million or 13.7% (decreased $6 million or 12.0% on an adjusted basis) compared to the prior year. The reduction in adjusted operating loss was primarily due to reduced information technology and franchise tax costs.
Interest Expense
Interest expense was $55 million and $54 million for 2015 and 2014, respectively, primarily related to interest expense on $1.2 billion aggregate principal amount of our senior notes. Refer to Note 13, “Credit Facilities and Long-Term Debt,” for further details.
Income Tax Expense
The income tax provision for 2015 was $63 million at an effective tax rate of 15.6% compared to $84 million at an effective tax rate of 19.8% in 2014. The 2015 effective tax rate is lower than 2014 due primarily to geographic mix of earnings as well as a reduction in the amount of unrecognized tax benefits recorded.
Other Comprehensive (Loss) Income
Other comprehensive loss before tax of $130 million in 2015 as compared to $284 million loss in 2014 was primarily due to a $23 million net gain in postretirement benefit plans foreign currency in 2015 as compared to a net loss of $110 million for 2014. Further contributing to this decreased loss was a lower translation loss of $26 million primarily due to less weakening of the Euro against the U.S. Dollar largely offset by the additional weakening of the Swedish Krona against the U.S. Dollar. Additionally, there was a release of $8 million of currency translation gains out of Other comprehensive (loss) income recognized as part of the sale of a business.
2014 versus 2013
Revenue
Revenue generated for 2014 was $3,916 million, an increase of $79 million, or 2.1%, compared to $3,837 million in 2013. On a constant currency basis, revenue grew 3.3%. The following table illustrates the impact on 2014 revenue from organic growth, recent acquisitions, and fluctuations in foreign currency.
(in millions)
$ Change
 
% Change
2013 Revenue
$
3,837

 
 
Organic Growth
134

 
3.5
 %
Acquisitions/(Divestitures)
(6
)
 
(0.2
)%
Constant Currency
128

 
3.3
 %
Foreign currency translation (a)
(49
)
 
(1.3
)%
Total change in revenue
79

 
2.1
 %
2014 Revenue
$
3,916

 
 
(a)
Foreign currency impact primarily due to weakness in the value of the Canadian Dollar, Australian Dollar, Argentine Peso, Swedish Krona and Norwegian Krone against the U.S. Dollar, partially offset by strength in the value of the British Pound against the U.S. Dollar.
The following table summarizes revenue by segment for 2014 and 2013:
(in millions)
2014
 
2013
 
As Reported Change
 
Constant Currency Change
Water Infrastructure
$
2,442

 
$
2,384

 
2.4
%
 
4.4
%
Applied Water
1,474

 
1,453

 
1.4
%
 
1.6
%
Total
$
3,916

 
$
3,837

 
2.1
%
 
3.3
%
Water Infrastructure
Water Infrastructure’s revenue increased $58 million, or 2.4% in 2014 (4.4% on a constant currency basis). The 4.4% constant currency increase reflects growth within the industrial water and public utility end markets and $6 million of incremental revenue from our 2013 acquisitions.
Organic revenue increased $99 million or 4.2% during the year, which was substantially due to higher volumes in transport, test and treatment applications. Revenue from transport applications grew primarily from increased industrial dewatering applications in the United States from oil and gas market-related rental activities. Transport

35


also grew organically from public utility pump and aftermarket demand. Revenue from test applications increased due to significant strength in the United States from increased government spending coupled with the continued success of new products and cross-selling of our European technologies. Revenue from treatment applications grew from the delivery of several large projects in the emerging markets, particularly in Latin America, partially offset by lower deliverable project backlog in the United States and European markets.
Applied Water
Applied Water’s revenue increased $21 million, or 1.4% in 2014 (a 1.6% increase on a constant currency basis). The growth on a constant currency basis is driven primarily by organic revenue growth of $35 million, or 2.4% versus the prior year due to strength in the commercial building services, industrial water and agriculture end markets, which more than offset declines in the residential building services. The increase in the current year was partially offset by the absence of revenue from our Wolverhampton valves business following its divestiture in the third quarter of 2014 as compared to $12 million of revenue for the comparative period in 2013.
Organic revenue increased $35 million or 2.4% for the year due primarily to commercial building recovery in the United States institutional building market, including distributor restocking and promotional activity. Also contributing to the organic growth was industrial water application strength across all regions, particularly from projects in the Middle East and Latin America. Irrigation application revenue also grew, driven by the timing of project shipments and increased demand for vertical turbines. A decline in European demand for residential applications partially offset organic growth.
Orders/Backlog
Orders received during 2014 increased by $109 million, or 2.8% to $4,021 million (a 3.9% increase on a constant currency basis). Organic order growth increased $153 million or 3.9% for the year.
Water Infrastructure segment orders increased $68 million, or 2.8% to $2,511 million (4.4% growth on a constant currency basis), including $8 million from acquisitions. Organic order growth of 4.1% was primarily due to higher industrial demand within transport for wastewater pumps in the United States and Europe as well as strength within the dewatering business for rental and equipment sales into oil and gas markets. Orders for test applications also bolstered the growth for the segment from large orders in the United States. The strength in transport and test offset declines in treatment from project delays in the United States and Europe.
Orders increased in our Applied Water segment $41 million, or 2.8% to $1,510 million (3.0% growth on a constant currency basis). Organic growth of 3.6% was driven by strong performance in the commercial building services and industrial water markets in the United States, as well as continued strength in China. The growth was partially offset by weakness in the residential markets of Europe.
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. Total backlog was $740 million at December 31, 2014 and $707 million at December 31, 2013. We anticipate that more than 85% of the backlog at December 31, 2014 will be recognized as revenue during 2015.
Gross Margin
Gross margins as a percentage of consolidated revenue declined to 38.6% in 2014 from 39.1% in 2013. The decrease is primarily attributable to lower margin sales within the Water Infrastructure segment caused by higher mix sold to emerging markets, which have lower margins, in conjunction with foreign exchange headwinds as well as unfavorable product sales mix. These negative impacts were partially mitigated by benefits from restructuring savings and cost-saving initiatives through lean six sigma and global sourcing across both segments.

36


Operating Expenses
(in millions)
2014
 
2013
 
Change
Selling, General and Administrative (SG&A)
$
920

 
$
986

 
(6.7
)%
SG&A as a % of revenue
23.5
%
 
25.7
%
 
(220
)bp
Research and Development (R&D)
104

 
104

 
 %
R&D as a % of revenue
2.7
%
 
2.7
%
 
bp
Restructuring and asset impairment charges
26

 
42

 
(38.1
)%
Separation Costs

 
4

 
NM

Operating expenses
$
1,050

 
$
1,136

 
(7.6
)%
Expense to revenue ratio
26.8
%
 
29.6
%
 
(280
)bp
NM    Not meaningful percentage change
Selling, General and Administrative Expenses
SG&A decreased by $66 million or 6.7% to $920 million, or 23.5% of revenue in 2014, as compared to $986 million or 25.7% of revenue in 2013. The decrease in SG&A expenses as a percentage of revenue is due primarily to savings from restructuring actions combined with lapping the impacts from non-recurring special charges in 2013 of $24 million, which comprise the legal settlement with Xylem Group LLC, costs incurred for the change in our chief executive officer, costs incurred for the contractual indemnification of federal tax obligations to ITT and costs associated with a legal judgment arising from a historical acquisition matter. The decrease was also driven by $7 million less realignment costs in 2014, which were costs incurred by the Company to reposition our European business in an effort to optimize our cost structure and improve our operational efficiency and effectiveness as well as implement our new organizational structure.
Research and Development Expenses
R&D spending was flat at $104 million or 2.7% of revenue in both 2014 and 2013.
Restructuring and Asset Impairment Charges
During 2014, we incurred restructuring costs of $19 million, $6 million and $1 million in our Water Infrastructure and Applied Water segments, and Corporate and other, respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount and consolidation of facilities. During 2013, we recognized restructuring costs of $31 million and $9 million in our Water Infrastructure and Applied Water segments, respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to address declines in sales volumes and optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount and consolidation of facilities.
Total expected costs associated with actions that commenced during 2014 are approximately $19 million for Water Infrastructure, approximately $6 million for Applied Water and approximately $1 million for Corporate and other. These costs primarily comprise severance charges and the actions are substantially complete. As a result of these actions initiated in 2014, we achieved savings of approximately $13 million in 2014 and annual future net savings beginning in 2015 of approximately $26 million.
Total costs associated with actions that commenced during 2013 are approximately $32 million for Water Infrastructure and approximately $8 million for Applied Water. These costs primarily comprise severance charges. These actions are substantially complete. As a result of actions initiated during 2013, we achieved net savings of approximately $13 million in 2013 and annual future net savings beginning in 2014 of approximately $36 million.
Additionally, in the fourth quarter of 2013, we recorded a $2 million impairment charge related to three trade names in our Water Infrastructure segment associated with acquired businesses within our Analytics operating unit, reflecting a decline in their value since being acquired. Refer to Note 4, “Restructuring and Asset Impairment Charges,” for additional information.

37


Operating Income
We generated operating income of $463 million during 2014, a $100 million or 27.5% increase from the prior year operating income of $363 million, primarily reflecting cost-saving initiatives and savings from restructuring actions. These benefits were partially offset by cost inflation combined with unfavorable impacts from our geographic and product sales mix described above. Another driving factor in the year-over-year improvement was the absence of the aforementioned special charges in 2013 within SG&A, which did not recur as well as lower restructuring and realignment costs. The following table illustrates operating income results by business segments for 2014 and 2013.
(in millions)
2014
 
2013
 
Change
Water Infrastructure
$
321

 
$
263

 
22.1
 %
Applied Water
193

 
175

 
10.3
 %
Segment operating income
514

 
438

 
17.4
 %
Corporate and other
(51
)
 
(75
)
 
(32.0
)%
Total operating income
$
463

 
$
363

 
27.5
 %
Operating margin
 
 
 
 
 
Water Infrastructure
13.1
%
 
11.0
%
 
210
bp
Applied Water
13.1
%
 
11.6
%
 
150
bp
Total Xylem
11.8
%
 
9.5
%
 
230
bp
The table included below provides a reconciliation from segment operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin.
(in millions)
2014
 
2013
 
Change
Water Infrastructure
 
 
 
 
 
Operating income
$
321

 
$
263

 
22.1
 %
Restructuring and realignment costs
29

 
48

 
(39.6
)%
Special charges

 
4

 
NM

Adjusted operating income
$
350

 
$
315

 
11.1
 %
Adjusted operating margin
14.3
%
 
13.2
%
 
110
bp
Applied Water
 
 
 
 
 
Operating income
$
193

 
$
175

 
10.3
 %
Restructuring and realignment costs
13

 
16

 
(18.8
)%
Adjusted operating income
$
206

 
$
191

 
7.9
 %
Adjusted operating margin
14.0
%
 
13.1
%
 
90
bp
Corporate and other
 
 
 
 
 
Operating loss
$
(51
)
 
$
(75
)
 
(32.0
)%
Restructuring and realignment costs
1

 

 
NM

Special charges

 
20

 
100.0
 %
Adjusted operating loss
$
(50
)
 
$
(55
)
 
(9.1
)%
Total Xylem
 
 
 
 
 
Operating income
$
463

 
$
363

 
27.5
 %
Restructuring and realignment costs
43

 
64

 
(32.8
)%
Special charges

 
24

 
NM

Adjusted operating income
$
506

 
$
451

 
12.2
 %
Adjusted operating margin
12.9
%
 
11.8
%
 
110
bp
NM    Not meaningful percentage change




38


Water Infrastructure
Operating income for our Water Infrastructure segment increased $58 million or 22.1% (increased $35 million or 11.1% on an adjusted basis) compared with the prior year. The 11.1% increase was primarily driven by higher volume, restructuring savings and cost reduction initiatives, such as global sourcing and lean six sigma. The increase was partially offset by cost inflation, unfavorable sales mix and price.
Applied Water
Operating income for our Applied Water segment increased $18 million or 10.3% (increased $15 million or 7.9% on an adjusted basis) compared to the prior year. The 7.9% increase was driven by lean six sigma initiatives, global sourcing and restructuring savings combined with modest price realization. The increase was partially offset by cost inflation and unfavorable foreign exchange headwinds.
Corporate and other
Operating loss for corporate and other decreased $24 million or 32.0% (decreased $5 million or 9.1% on an adjusted basis) compared to the prior year. The reduction in adjusted operating loss was primarily due to reduced stock based compensation expense and costs associated with the corporate headquarter move in 2013 that did not recur in 2014.
Interest Expense
Interest expense was $54 million and $55 million for 2014 and 2013, respectively, primarily related to interest expense on $1.2 billion aggregate principal amount of our senior notes. Refer to Note 13, “Credit Facilities and Long-Term Debt,” for further details.
Income Tax Expense
The income tax provision for 2014 was $84 million at an effective tax rate of 19.8% compared to $70 million at an effective tax rate of 23.5% in 2013. The 2014 effective tax rate is lower than 2013 due primarily to geographic mix of earnings.
Other Comprehensive (Loss) Income
Other comprehensive loss before tax of $284 million in 2014 as compared to income of $74 million in 2013 was primarily due to a $221 million foreign currency translation impact due to a weakening of the Euro, British Pound and Swedish Krona against the U.S. Dollar. Further contributing to the year-over-year decline was a $110 million net loss in postretirement benefit plans in 2014 as compared to a net gain of $34 million in 2013 due to a decrease in discount rates, partially mitigated by actual gains on plan assets in excess of the assumed long-term rate of return. The effective tax rate on other comprehensive income decreased as compared to 2013 due primarily to the shift in comprehensive earnings from foreign currency translation, which is not taxable, as well as from a change in the jurisdictional mix of net gains and losses from postretirement benefit plans.
Liquidity and Capital Resources
The following table summarizes our sources and uses of cash:
 
Year Ended December 31,
(in millions)
2015
 
2014
 
2013
Operating activities
$
464

 
$
416

 
$
324

Investing activities
(132
)
 
(86
)
 
(199
)
Financing activities
(262
)
 
(147
)
 
(100
)
Foreign exchange (a)
(53
)
 
(53
)
 
4

Total
$
17

 
$
130

 
$
29

(a)
2015 and 2014 impact is primarily due to the weakness of the Euro against the U.S. Dollar.
Sources and Uses of Liquidity
Operating Activities
During 2015, net cash provided by operating activities was $464 million, compared to $416 million in 2014. The $48 million year-over-year increase was primarily driven by a decrease in the use of working capital from reduced inventory levels in 2015 and improved collections of receivables. Lower payments for restructuring and

39


postretirement benefit plans were more than offset by increased payments for foreign value-added taxes as compared to the prior year.
During 2014, net cash provided by operating activities was $416 million, compared to $324 million in 2013. The $92 million year-over-year increase was driven by an increase in income, as well as a modest improvement in working capital performance. Reductions in payments made for restructuring and postretirement plan contributions in 2014 were largely offset by an increase in tax payments. Also contributing to the increase was a refund of value-added tax in the current year that had been paid during 2013.
Investing Activities
Cash used in investing activities was $132 million for 2015, compared to $86 million in 2014. The increase of $46 million was primarily due to $18 million spent on an acquisition in 2015 as compared to nothing in 2014 as well as cash received in 2014 of $30 million for the sale of our Wolverhampton business.
Cash used in investing activities was $86 million in 2014 compared to $199 million in 2013. The decrease of $113 million was primarily driven by a decrease in acquisition activity as there were no acquisitions in 2014, whereas we spent $81 million for acquisitions during 2013. Also contributing to the decrease was the receipt of $30 million in 2014 for the sale of a business. Capital expenditures were also lower in 2014, with a $7 million reduction primarily due to a decrease in the spending on post Spin-off information technology investments and the relocation of our corporate headquarters.
Financing Activities
Cash used by financing activities was $262 million, $147 million and $100 million during 2015, 2014 and 2013, respectively. In 2015, the $115 million increase is primarily driven by an increase in share repurchase activity of $45 million and an increase of $8 million, or a 10% per share increase, in dividends paid to shareholders as well as a decrease in cash received from short-term debt borrowings under the European Investment Bank facility of $50 million. In 2014, the $47 million increase reflected cash used for share repurchase activity increasing $61 million and dividend payments increasing $7 million compared to 2013. These uses were partially offset by an increase in cash received from short-term debt borrowings under the European Investment Bank facility of $50 million in 2014 versus $38 million in 2013.
Funding and Liquidity Strategy
Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations, and access to bank financing and the capital markets. Historically, we have generated operating cash flow sufficient to fund our primary cash needs centered on operating activities, working capital, capital expenditures, and strategic investments. 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 global funding requirements are continually monitored with appropriate strategies executed to ensure liquidity needs are met cost effectively. Based on our current global cash positions, cash flows from operations and access to the commercial paper markets, we believe there is sufficient liquidity to meet our funding requirements.  In addition, our existing committed credit facilities and access to the public debt markets would provide further liquidity if required.
We anticipate that our present sources of funds, including funds from operations and additional borrowings, will provide us with sufficient liquidity and capital resources to meet our liquidity and capital needs in both the United States and outside of the United States over the next twelve months.
Senior Notes
On September 20, 2011, we issued 3.550% Senior Notes of $600 million aggregate principal amount due September 2016 (the "Senior Notes due 2016") and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021" and together with the Senior Notes due 2016, the "Senior Notes").
The Senior Notes include covenants which 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

40


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. If a change of control triggering event (as defined in the Senior Notes) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plus accrued and unpaid interest to the date of repurchase. As of December 31, 2015, we were in compliance with all covenants.
Interest on the Senior Notes due 2016 is payable on March 20 and September 20 of each year. Interest on the Senior Notes due 2021 is payable on April 1 and October 1 of each year.
As of December 31, 2015, we have classified $600 million of our Senior Notes due 2016 as long-term based on our current ability and intent to refinance the outstanding borrowings on a long-term basis.
Credit Facility
Effective March 27, 2015, Xylem entered into a Five-Year Revolving Credit Facility with Citibank, N.A., as administrative agent, and a syndicate of lenders. The Credit Facility provides for an aggregate principal amount of up to $600 million of: (i) revolving extensions of credit outstanding at any time and (ii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time. The Credit Facility provides for increases of up to $200 million for a possible maximum total of $800 million in aggregate principal amount at our request and with the consent of the institutions providing such increased commitments.
At our election, the interest rate per annum applicable to the revolving loans will be based on either (i) a Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin or (ii) a fluctuating rate of interest determined by reference to the greatest of: (a) the prime rate of Citibank, N.A., (b) the U.S. Federal funds effective rate plus 0.5% or (c) the Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, in each case, plus an applicable margin.
In accordance with the terms, we may not exceed a maximum leverage ratio of 3.50 to 1.00 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) throughout the term. The Credit Facility also contains limitations on, among other things, incurring secured debt, granting liens, entering into sale and leaseback transactions, mergers, consolidations, liquidations, dissolutions and sales of assets. In addition, the Credit Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. As of December 31, 2015, we were in compliance with all covenants.
As of December 31, 2015, the Credit Facility was undrawn.
Research and Development Facility Agreement
On December 3, 2015, the Company amended and restated its Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with The European Investment Bank (the "EIB") to amend the maturity date. The facility provides an aggregate principal amount of up to €120 million (approximately $132 million) to finance research projects and infrastructure development in the European Union. The Company's wholly owned subsidiaries in Luxembourg, Xylem Holdings S.á r.l. and Xylem International S.á r.l., are the borrowers under the R&D Facility Agreement.  The obligations of the borrowers under the R&D Facility Agreement are guaranteed by the Company under an Amended and Restated Deed of Guarantee, dated as of December 4, 2013, in favor of the EIB. The funds are available during the period from 2013 through 2016 at the Company's facilities in Sweden, Germany, Italy, the United Kingdom, Austria, Norway and Hungary.
Under the R&D Facility Agreement, the borrower can draw loans on or before March 31, 2016 with a maturity of no longer than 12 years. The R&D Facility Agreement provides for Fixed Rate loans and Floating Rate loans. The interest rate per annum applicable to Fixed Rate loans is at a fixed percentage rate per annum specified by the EIB which includes the applicable margin. The interest rate per annum applicable to Floating Rate loans is at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S. Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin for both Fixed Rate loans and Floating Rate loans is determined by reference to the credit rating of the Company.
In accordance with the terms of the R&D Facility Agreement, we may not exceed a maximum leverage ratio of 3.50 to 1.00 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) throughout the term. The R&D Facility Agreement also contains limitations on, among other things, incurring debt, granting liens, and entering into sale and leaseback transactions. In addition, the R&D Facility Agreement contains other terms and conditions, such as customary representations and warranties, additional covenants and customary events of default. As of December 31, 2015, we were in compliance with all covenants.

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As of December 31, 2015 and 2014, $76 million and $84 million was outstanding, respectively, under the R&D Facility Agreement. Although the borrowing term for this arrangement is up to five years, we have classified it as short-term debt on our Consolidated Balance Sheet since we intend to repay this obligation in less than a year.
Non-U.S. Operations
For 2015 and 2014, we generated 59% and 62% of our revenue from non-U.S. operations, 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-U.S. operations and we expect 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 U.S. 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, which support our current designation of a portion of these funds as being indefinitely reinvested and reassess whether there is a demonstrated need to repatriate funds held internationally to support our U.S. operations. If, as a result of our review, it is determined that all or a portion of the funds may be needed for our operations in the United States, we may be required to accrue additional U.S. taxes. As of December 31, 2015, our foreign subsidiaries were holding $656 million in cash or marketable securities.
As of December 31, 2015, our excess of financial reporting over the tax basis of investments in certain foreign subsidiaries totaled $1.9 billion. We have not asserted that $41 million of our excess basis difference will be indefinitely reinvested and have therefore provided for U.S or additional foreign withholding taxes for that portion. Generally, such amounts become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances.
Contractual Obligations
The following table summarizes our contractual commitments as of December 31, 2015:
(in millions)
2016
 
2017 - 2018
 
2019 - 2020
 
Thereafter
 
Total
Debt and capital lease obligations (1)
$
678

 
$

 
$

 
$
600

 
$
1,278

Interest payments (1) (2)
51

 
59

 
59

 
29

 
198

Operating lease obligations
55

 
76

 
40

 
19

 
190

Purchase obligations (3)
82

 
3

 

 

 
85

Other long-term obligations reflected on the balance sheet
3

 
6

 
5

 
8

 
22

Total commitments
$
869

 
$
144

 
$
104

 
$
656

 
$
1,773

In addition to the amounts presented in the table above, we have recorded liabilities for uncertain tax positions of $47 million, net investment hedges of $18 million and employee severance indemnity of $13 million. These amounts have been excluded from the contractual obligations table due to an inability to reasonably estimate the timing or amounts of such payments in individual years. Further, benefit payments which reflect expected future service related to the Company's pension and other postretirement employee benefit obligations are presented in Note 14, “Postretirement Benefit Plans” of the consolidated financial statements and not included in the above table. Finally, estimated environmental payments and workers' compensation and general liability reserves are excluded from the table above. We estimate, based on historical experience, that we will spend approximately $1 million to $2 million per year on environmental investigation and remediation and approximately $4 million to $5 million per year on workers' compensation and general liability. At December 31, 2015, we had estimated and accrued $4 million and $24 million related to environmental matters, and workers' compensation and general liability, respectively.
(1)
Refer to Note 13, “Credit Facilities and Long-Term Debt,” of the consolidated financial statements for discussion of the use and availability of debt and revolving credit agreements. Amounts represent principal payments of long-term debt including current maturities and exclude unamortized discounts. As of December 31, 2015, we have classified $600 million of our Senior Notes due 2016 as long-term based on our current ability and intent to refinance the outstanding borrowings on a long-term basis, however, we cannot reasonably estimate the future debt terms and interest payments.
(2)
Amounts represent estimates of future interest payments on long-term debt outstanding as of December 31, 2015.
(3)
Represents unconditional purchase agreements that are enforceable and legally binding and that specify all significant terms to purchase goods or services, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase agreements that are able to cancel without penalty have been excluded.


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Off-Balance Sheet Arrangements
As of December 31, 2015, we have issued guarantees for the debt and other obligations of consolidated subsidiaries in the normal course of business. We have determined that none of these arrangements has a material current effect or is reasonably likely to have a material future effect on our consolidated financial statements, financial condition, changes in financial condition, revenues or expenses, liquidity, capital expenditures or capital resources.
We obtain certain stand-by letters of credit, bank guarantees and surety bonds from third-party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance related requirements. As of December 31, 2015, the amount of stand-by letters of credit, bank guarantees and surety bonds was $161 million.
Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Significant accounting policies used in the preparation of the Consolidated Financial Statements are discussed in Note 1, “Summary of Significant Accounting Policies,” of the consolidated financial statements. Accounting estimates and assumptions discussed in this section are those that we consider most critical to an understanding of our financial statements because they are inherently uncertain, involve significant judgments, include areas where different estimates reasonably could have been used, and changes in the estimate that are reasonably possible could materially impact the financial statements. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management’s estimates under different assumptions or conditions.
Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectability of the sales price is reasonably assured. For product sales, delivery does not occur until the products have been shipped, risk of loss has been transferred to the customer and the contractual terms have been fulfilled. In instances where contractual terms include a provision for customer acceptance, revenue is recognized when either (i) we have previously demonstrated that the product meets the specified criteria based on either seller- or customer-specified objective criteria or (ii) upon formal acceptance received from the customer where the product has not been previously demonstrated to meet customer-specified objective criteria. Revenue on service and repair contracts is recognized after services have been agreed to by the customer and rendered.
We enter into contracts to sell our products and services, and while the majority of our sales agreements contain standard terms and conditions, certain agreements contain multiple elements or non-standard terms and conditions. Where sales agreements contain multiple elements or non-standard terms and conditions, judgment is required to determine the appropriate accounting, including whether the deliverables specified in these agreements should be treated as separate units of accounting for revenue recognition purposes, and, if so, how the transaction price should be allocated among the elements and when to recognize revenue for each element. When a sale involves multiple deliverables, the total revenue from the arrangement is allocated to each unit of accounting based on the relative selling price of the deliverable to all other deliverables in the contract. Revenue for multiple element arrangements is recognized when the appropriate revenue recognition criteria for the individual deliverable have been satisfied. The allocation of sales price between elements may impact the timing of revenue recognition, but will not change the total revenue recognized on the arrangement. For delivered elements accounted for as separate units of accounting in a multiple element arrangement, revenue is recognized only when the delivered elements have standalone value, there are no uncertainties regarding customer acceptance and there are no customer-negotiated refund or return rights affecting the sales recognized.
Certain businesses enter into long-term construction-type sales contracts for which revenue is recognized under the percentage-of-completion method based upon percentage of costs incurred to total estimated costs.
We record a reduction in revenue at the time of sale for estimated product returns, rebates and other allowances, based on historical experience and known trends.
Income Taxes. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which

43


we expect the differences will reverse. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely than not we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes to our estimate of the amount we are more likely than not to realize in the valuation allowance, with a corresponding adjustment to earnings or other comprehensive income, as appropriate.
In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years and the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected by changes to tax laws, changes to statutory tax rates and changes to future taxable income estimates.
Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan to reinvest such earnings indefinitely outside the United States. We plan foreign earnings remittance amounts based on projected cash flow needs, as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on these assumptions, we estimate the amount we will distribute to the United States and provide the U.S. federal taxes due on these amounts. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our effective tax rate.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and to the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
We adjust our liability for uncertain tax positions in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional tax expense would result. If a payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.
Goodwill and Intangible Assets. We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-lived intangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment test as of the first day of the fourth quarter. We perform a two-step impairment test for goodwill. In the first step, we compare the estimated fair value of each reporting unit to its carrying value. If the estimated fair value of the reporting unit exceeds the carrying value of the net assets assigned to that reporting unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds its fair value, then we must perform the second step of the impairment test in order to measure the impairment loss to be recorded, if any. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. In our annual impairment test for indefinite-lived intangible assets, we compare the fair value of those assets to their carrying value. We recognize an impairment loss when the estimated fair value of the indefinite-lived intangible asset is less than its carrying value. We estimate the fair value of our reporting units and intangible assets with indefinite lives using an income approach. Under the income approach, we calculate fair value based on the present value of estimated future cash flows.
Determining the fair value of a reporting unit or an indefinite-lived intangible asset 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, assumed royalty rates, future economic and market conditions and identification of appropriate market comparable data. 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. Goodwill is tested for impairment at either the operating segment identified in Note 20, “Segment and Geographic Data,” of the consolidated financial statements, or one level below. The fair value of our reporting units and indefinite-lived intangible assets is based on estimates and assumptions that are believed to be reasonable. Significant changes to these estimates and assumptions could adversely impact our conclusions. Actual future results may differ from those estimates.

44


During the fourth quarter of 2015, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were substantially in excess of each of their carrying values. However, future goodwill impairment tests could result in 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. We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date in 2015.
Contingent Liabilities. As discussed in Note 18, "Commitments and Contingencies" of the consolidated financial statements, the Company is, from time to time, subject to a variety of litigation, environmental liabilities, product liabilities, and similar contingent liabilities incidental to its business (or the business operations of previously owned entities). The Company recognizes a liability for any contingency that is known or probable of occurrence and reasonably estimable. These assessments require judgments concerning matters such as litigation developments and outcomes, the anticipated outcome of negotiations, the number of future claims and the cost of both pending and future claims. In addition, because most contingencies are resolved over long periods of time, liabilities may change in the future due to various factors, including those discussed in Note 18 of the consolidated financial statements. If the liabilities established by the Company with respect to these contingencies are inadequate, the Company would be required to incur an expense equal to the amount of the loss incurred in excess of the recorded liability, which would adversely affect the Company’s financial statements.
Receivables and Allowance for Doubtful Accounts and Discounts. Receivables primarily comprise uncollected amounts owed to us from transactions with customers and are presented net of allowances for doubtful accounts and early payment discounts.
We determine our allowance for doubtful accounts using a combination of factors to reduce our trade receivable balances to their estimated net realizable amount. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, macroeconomic trends and conditions, significant one-time events, historical experience and the financial condition of customers. In addition, we record a specific reserve for individual accounts when we become aware of specific customer circumstances, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. The past due or delinquency status of a receivable is based on the contractual payment terms of the receivable. If circumstances related to the specific customer change, we adjust estimates of the recoverability of receivables as appropriate. We determine our allowance for early payment discounts primarily based on historical experience with customers.
Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and their dispersion across many different geographical regions. We perform ongoing credit evaluations of the financial condition of our third-party distributors, resellers and other customers and require collateral, such as letters of credit and bank guarantees, in certain circumstances. As of December 31, 2015 and 2014 we do not believe we have any significant concentrations of credit risk.
Postretirement Plans. Company employees around the world participate in numerous defined benefit plans. The determination of projected benefit obligations and the recognition of expenses related to these plans are dependent on various assumptions. These major assumptions primarily relate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, health care inflation and years of service (some of which are disclosed in Note 14, “Postretirement Benefit Plans,” of the consolidated financial statements) and other factors. Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to the extent they exceed 10% of the higher of the market-related value or projected benefit obligation, over the average remaining service period of active plan participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy.










45


Significant Assumptions
Management develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country in which such plans exist. All assumptions are reviewed annually with third-party consultants and adjusted as necessary. The table included below provides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2015 and 2014.
 
2015
 
2014
 
U.S.
 
Int’l
 
U.S.
 
Int’l
Benefit Obligation Assumptions
 
 
 
 
 
 
 
Discount rate
4.27
%
 
3.44
%
 
4.01
%
 
3.14
%
Rate of future compensation increase
NM

 
3.29
%
 
NM

 
3.34
%
Net Periodic Benefit Cost Assumptions
 
 
 
 
 
 
 
Discount rate
4.01
%
 
3.14
%
 
4.79
%
 
4.23
%
Expected long-term return on plan assets
8.00
%
 
7.31
%
 
8.00
%
 
7.30
%
Rate of future compensation increase
NM

 
3.34
%
 
NM

 
3.48
%
NM
Not meaningful. The pension benefits for future service for all the U.S. pension plans are based on years of service and not impacted by future compensation increases.
We determine the expected long-term rate of return on plan assets by evaluating both historical returns and estimates of future returns. Specifically, the Company analyzes the estimated future returns based on independent estimates of asset class returns and evaluates historical broad market returns over long-term timeframes based on the strategic asset allocation, which is detailed in Note 14, “Postretirement Benefit Plans,” of the consolidated financial statements.
Based on the approach described above, the chart below shows weighted average actual returns versus the weighted average expected long-term rates of return for our pension plans that were utilized in the calculation of the net periodic pension cost for each respective year.
 
2015
 
2014
 
2013
Expected long-term rate of return on plan assets
7.38
%
 
7.38
%
 
7.40
%
Actual rate of return on plan assets
3.51
%
 
18.13
%
 
10.17
%
For the recognition of net periodic pension cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate of return to the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurement date over the last five years. The use of fair value, rather than a calculated value, could materially affect net periodic pension cost. The weighted average expected long-term rate of return for all of our plan assets to be used in determining net periodic benefit costs for 2016 is estimated at 7.32%. We estimate that every 25 basis point change in the expected return on plan assets impacts the expense by $1 million.
The discount rate reflects our expectation of the present value of expected future cash payments for benefits at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and increases pension expense. We base the discount rate assumption on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pension discount rate was determined by considering an interest rate yield curve comprising AAA/AA bonds, with maturities between zero and 30 years, developed by the plan’s actuaries. Annual benefit payments are then discounted to present value using this yield curve to develop a single-point discount rate matching the plan’s characteristics. Our weighted average discount rate for all pension plans effective January 1, 2016, is 3.53%. We estimate that every 25 basis point change in the discount rate impacts the expense by $1 million.
The rate of future compensation increase assumption reflects our long-term actual experience and future and near-term outlook. Effective January 1, 2016, our expected rate of future compensation is 3.29% for all pension plans. The estimated impact of a 25 basis point change in the expected rate of future compensation is less than $1 million.
The assumed rate of future increases in the per capita cost of health care (the health care trend rate) is 7.00% for 2016, decreasing ratably to 4.50% in 2027. An increase or decrease in the health care trend rates by one percent per year would impact the aggregate annual service and interest components by less than $1 million, and impact the benefit obligation by approximately $4 million.


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We currently anticipate making contributions to our pension and postretirement benefit plans in the range of $26 million to $36 million during 2016, of which $8 million is expected to be made in the first quarter.
Funded Status
Funded status is derived by subtracting the respective year-end values of the projected benefit obligations from the fair value of plan assets. We estimate that every 25 basis point change in the discount rate impacts the funded status by approximately $26 million.
Fair Value of Plan Assets
The plan assets of our pension plans comprise a broad range of investments, including domestic and foreign equity securities, interests in private equity and hedge funds, fixed income investments, insurance contracts, and cash and cash equivalents.
A portion of our pension benefit plan assets portfolio comprises investments in private equity and hedge funds. The private equity and hedge fund investments are generally measured at net asset value. However, in certain instances, the values reported by the asset managers were not current at the measurement date. Accordingly, we made estimate adjustments to the last reported value where necessary to measure the assets at fair value at the measurement date. These adjustments consider information received from the asset managers, as well as general market information. The adjustment recorded at December 31, 2015 and 2014 for these assets represented less than one percent of total plan assets in each respective year. Asset values for other positions were generally measured using market observable prices. We estimate that a 5% change in asset values will impact funded status by approximately $25 million.
New Accounting Pronouncements
See Note 2, “Recently Issued Accounting Pronouncements,” of the consolidated financial statements for a complete discussion of recent accounting pronouncements.


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ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, primarily related to foreign currency exchange rates and interest rates. These exposures are actively monitored by management. Our exposure to foreign exchange rate risk is due to certain costs, revenue and borrowings being denominated in currencies other than one of our subsidiaries functional currency. Similarly, we are exposed to market risk as the result of changes in interest rates which may affect the cost of our financing. It is our policy and practice to use derivative financial instruments only to the extent necessary to manage exposures.
Foreign Currency Exchange Rate Risk
We conduct approximately 59% of our business in various locations outside the United States.
Our economic foreign currency risk primarily relates to receipts from customers, payments to suppliers and intercompany transactions denominated in foreign currencies. We may use derivative financial instruments to offset risk related to receipts from customers and payments to suppliers, when it is believed that the exposure will not be limited by our normal operating and financing activities. We enter into currency forward contracts periodically in order to manage the exchange rate fluctuation risk on certain intercompany transactions associated with third party sales and purchases. These risks are also mitigated by natural hedges including the presence of manufacturing facilities outside the United States, global sourcing and other spending which occurs in foreign countries. Our principal foreign currency transaction exposures primarily relate to the Euro, Swedish Krona, Canadian Dollar, British Pound, Polish Zloty and Australian Dollar. We estimate that a hypothetical 10% movement in foreign currency exchange rates would not have a material economic impact to Xylem’s financial position and results of operations.
Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. Dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. Dollar and the Euro, British Pound, Chinese Yuan, Swedish Krona, Canadian Dollar and Australian Dollar. As the U.S. Dollar strengthens against other currencies in which we transact business, revenue and income will generally be negatively impacted, and if the U.S. Dollar weakens, revenue and income will generally be positively impacted. We estimate that a hypothetical 10% movement of the U.S. Dollar to the various foreign currency exchange rates we translate from, in the aggregate, could have approximately a 7% impact on Xylem's consolidated revenue and income as reported in U.S. Dollars. We expect to continue to generate significant revenue from non-U.S. operations and we expect 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 U.S. and other international subsi