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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, 2016
  
 
 
  
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
2.250% Senior Notes due 2023
 
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, 2016 was approximately $8.0 billion. As of February 17, 2017, there were 179,471,405 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 2017 Annual Meeting of Shareowners, to be held in May 2017, 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, 2016
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
16
 
 
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 (now ITT LLC) and its consolidated subsidiaries (other than Xylem Inc.) as of the applicable periods.
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, which generally are not historical in nature. However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. These forward-looking statements include 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; 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, including the integration of Sensus; 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 in this Report 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 2016 revenue of $3.8 billion and approximately 16,000 employees, is a leading global water technology company. We design, manufacture and service highly engineered solutions ranging across a wide variety of critical applications. For example, our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery and use of drinking water to the collection and treatment of wastewater to the return of water to the environment.
We have differentiated market positions in core application areas including transport, treatment, test, smart metering, building services, industrial processing and irrigation. Setting us apart is a unique set of global assets which include:

Fortress brands with leading market positions, some of which have been operating for more than 100 years

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Far-reaching global distribution networks consisting of direct sales forces and independent channel partners that collectively serve a diverse customer base in more than 150 countries
A substantial installed base that provides for steady recurring revenue
A strong financial position and cash generation profile that enable us to fund strategic organic and inorganic growth initiatives, and consistently return capital to shareholders

Key tenets of our long-term strategy include (1) accelerate profitable growth; (2) increase profitability by driving continuous improvement initiatives; (3) leadership and talent development; and (4) focus on execution and accountability.
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. The Spin-off was completed pursuant to a Distribution Agreement, dated as of October 25, 2011 (the “Distribution Agreement”), among ITT (now ITT LLC), Exelis Inc., acquired by Harris Inc. on May 29, 2015, (“Exelis”) and Xylem.
On October 31, 2016, Xylem Inc. completed the acquisition of all of the direct and indirect subsidiaries of Sensus Worldwide Limited (other than Sensus Industries) (“Sensus”), pursuant to the terms of the Share Purchase Agreement dated as of August 15, 2016, and the first Amendment to the Share Purchase Agreement dated as of October 31, 2016 (together, the “Purchase Agreement”). The aggregate consideration paid for the acquisition was approximately $1.7 billion in cash, subject to certain adjustments as provided in the Purchase Agreement. The consideration was funded with a combination of cash on hand, proceeds from issuances under the Company’s existing commercial paper program, borrowings under a new euro-denominated term loan and the issuance of $500 million aggregate principal amount of 3.250% Senior Notes due 2026 and $400 million aggregate principal amount of 4.375% Senior Notes due 2046.
Our Industry
Our planet faces serious water challenges. Less than 1% of the total water available on earth is fresh water, and these supplies are under threat due to factors such as the draining of aquifers, increased pollution and the effects of climate change. 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, deteriorating pipe systems lose approximately one out of every six gallons of water between the treatment plant and the end customer part of a national (and global) problem of ‘non-revenue water’ that is a major financial challenge of many utilities. These challenges create opportunities for growth in the global water industry, which we estimate to have a total market size of approximately $550 billion.

We compete in areas that are pivotal to improving 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 and 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”). Additionally, through the recent acquisition of Sensus, we now also provide solutions to enhance efficiency, improve safety and conserve resources to customers in the electric and gas sectors. Delivering value in these areas creates significant opportunity for the Company. We estimate our total served market size to be approximately $54 billion.

The Global Water Industry Value Chain
The water industry value chain is comprised of Equipment and Services companies, like Xylem, which address the unique challenges and demands of a diverse customer base. This customer base includes utilities that supply water through an infrastructure network, and engineering, procurement and construction or "EPC" firms, which work with utilities to design and build water and wastewater infrastructure networks, as depicted below. 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. In addition to utilities and EPC customers, Equipment and Service providers also provide distinct technologies to a wide array of entities, including farms, mines, power plants, industrial facilities and residential buildings.

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Water Industry Supply Chain
a10kdiagrama02.jpg


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 accelerate growth, we are focusing on several 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’ productivity, quality and resilience.
Commercial Leadership - We are strengthening our capabilities by simplifying our commercial processes and supporting 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 adjacent markets.
Drive Continuous Improvement. We seek to embed continuous improvement into our culture and simplify our organization to make the Company more agile, more profitable and create room to reinvest 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, 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 with 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.


5


Business Segments, Distribution and Competitive Landscape
We have three reportable business segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Sensus. 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
 
2016 Revenue
(in millions)
 
%
Revenue
 
Major Products
 
Primary Brands
Water
Infrastructure
 
Transport
 
$
1,599

 
71
%
 
 
•   Water and wastewater pumps
•   Filtration, disinfection and biological treatment equipment
•   Test equipment
•   Controls
 
 
•   Flygt
•   Wedeco
•   Godwin
•   WTW
•   Sanitaire
•   YSI
•   Leopold
 
Treatment
 
333

 
15
%
 
 
Test
 
314

 
14
%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
2,246

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Applied
Water
 
Building Services
 
$
764

 
55
%
 
 
•   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
 
540

 
39
%
 
 
 
Irrigation
 
89

 
6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
1,393

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sensus
 
Water
 
$
74

 
56
%
 

•   Smart meters
•   Networked communications software
•  Base stations
•  Regulators
•  Data analytics

 

•   Sensus
•  Smith Blair


 
Electric
 
27

 
20
%
 
 
 
Gas
 
16

 
12
%
 
 
 
 
Software and Services/Other
 
15

 
11
%
 
 
 
 
(a)
 
$
132

 
100
%
 
 
 
 
 
 
 
 
 
 
 
(a)
 
Includes revenue from November 1, 2016 through December 31, 2016
 
 
Water Infrastructure
Our Water Infrastructure segment supports the process that collects water from a source and distributes it to users, and then returns the wastewater responsibly to the environment through three closely linked applications: Transport, Treatment and Test. The Transport application also includes sales and rental of specialty dewatering pumps and related 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.
The customer base consists of two primary end markets: public utility and industrial. The public utility market includes public, private and public-private entities that support water and wastewater networks. The industrial market includes customers who require similar water and wastewater infrastructure networks to support various industrial operations.
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 both the type and amount of contaminants found in the 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 that has not been systematically replaced at utilities and other end-user customers, and (v) the build-out of water infrastructure in the

6


emerging markets. We estimate our served market size in this sector to be approximately $23 billion.
Given the highly fragmented nature of the water industry, the Water Infrastructure segment competes with a large number of businesses. We differentiate ourselves in the market by focusing 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, which requires maintenance, repair and replacement parts due to the critical application and nature of the products and the conditions under which they operate. Timeliness of delivery, quality and the proximity of service centers are important 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.
Applied Water
Applied Water encompasses the uses of water and serves a diverse set of end markets including: residential, commercial, industrial and agricultural. Residential consumers represent the end users in the residential market, while 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 includes OEMs, exploration and production firms, and developers and managers of industrial facilities, such as electrical power generators, chemical manufacturers, machine shops, clothing manufacturers, beverage dispensing and food processing firms, and car washes. Agricultural end users include owners and operators of crop and livestock farms, aquaculture, golf courses, and other turf applications.
In the Applied Water segment end-use areas vary widely so specialized distribution partners are often preferred. Our products in the Applied Water segment are sold 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.
We estimate our served market size in this sector to be approximately $19 billion. Population growth, urbanization and regulatory requirements are macro growth drivers of these markets, driving the need for housing, food, community services and retail goods within growing city centers.

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.
Sensus
Sensus develops advanced technology solutions that enable intelligent use and conservation of critical water and      energy resources. The segment delivers communications, smart metering, measurement and control technologies and services that allow customers to more effectively use their distribution networks for the delivery of critical resources such as water, electricity and natural gas. Additionally, we sell software and services including cloud-based analytics, remote monitoring and data management, as well as smart lighting products and solutions that improve efficiency and public safety efforts across communities.
At the heart of our leading technologies is automation and information. Communications networks automate and optimize meter reading, monitor flow and detect, and enable rapid response to unsafe conditions. In short, they provide insight into operations and enable our customers to manage the entire scope of their operations remotely through their networks.
At the center of our offering is the FlexNet communication network, which provides a common communications platform and infrastructure for essential services. This two-way communication technology remotely connects a wide variety of smart points in a given network with protocols, frequently on licensed spectrum that enable reliable, resilient and secure transmissions. These technologies allow our customers to remotely and continuously monitor infrastructure, prioritize and manage maintenance and use data to optimize all aspects of their networks.

7


The majority of our sales in the U.S. are conducted through strong, long-standing relationships with leading distributors and dedicated channel partners for water, gas and electric markets. Internationally, direct sales are often made in markets without established distribution channels, however, some distribution channels are used in more developed markets. With large utilities and government programs a more direct sales approach, with key account management, is employed.
We estimate our served market size in this sector to be approximately $12 billion. Macro growth drivers include increasing regulation and worldwide movement towards smart grid implementation. Water scarcity and conservation, as well as the need to prevent revenue loss (via inaccurate meter readings, leaks or theft) are among the drivers of smart meter technologies.
Our Sensus-branded meters are well positioned in the smart metering sector, the fastest growing sector of the global meter industry. We set ourselves apart in the industry by focusing on new product development and service offerings that are driving tangible savings of non-revenue water through improved meter accuracy, reduced theft and identification of leaks. Our key competitors within the Sensus segment include Itron, Badger Meter, Landys & Gyr, Neptune (Roper) and Elster (Honeywell).
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)
2016
 
2015
 
2014
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
United States
$
1,574

 
42
%
 
$
1,490

 
41
%
 
$
1,477

 
38
%
Europe
1,195

 
31
%
 
1,179

 
32
%
 
1,379

 
35
%
Asia Pacific
518

 
14
%
 
482

 
13
%
 
478

 
12
%
Other
484

 
13
%
 
502

 
14
%
 
582

 
15
%
Total
$
3,771

 
 
 
$
3,653

 
 
 
$
3,916

 
 
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% of our revenue in each of the last three years.
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)
2016
 
2015
 
2014
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
 
$ Amount
 
% of Total
United States
$
255

 
41
%
 
$
168

 
38
%
 
$
180

 
39
%
Europe
237

 
39
%
 
189

 
43
%
 
206

 
45
%
Asia Pacific
87

 
14
%
 
56

 
13
%
 
53

 
11
%
Other
37

 
6
%
 
26

 
6
%
 
22

 
5
%
Total
$
616

 
 
 
$
439

 
 
 
$
461

 
 
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, plastics, PCBs and electronic components. While we may recover some cost increases through operational improvements, we are still exposed to some pricing risk, including increased pricing risk due to proposed duty and tariff assessments by the United States on foreign imports. 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

8


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 in the past several years that have had a significant adverse impact on our business as a whole.
Our business segments experience a modest level of seasonality in their 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 Company. No individual customer accounted for more than 10% of our consolidated 2016, 2015 or 2014 revenue.
Backlog
Delivery schedules vary from customer to customer based on their requirements. Typically, large projects require longer lead production cycles and delays can occur from time to time. Total backlog was $1,078 million at December 31, 2016 and $716 million at December 31, 2015. This increase is primarily attributable to the addition of Sensus who had a backlog balance of $385 million at December 31, 2016. We anticipate that more than 70% of the backlog at December 31, 2016 will be recognized as revenue during 2017. Backlog includes contractual customer commitments as well as purchase orders on hand as of the end of the period.
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 into 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 $110 million, $95 million, and $104 million in R&D in 2016, 2015 and 2014, 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 specific regions worldwide.
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

9


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.
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. At December 31, 2016, we had estimated and accrued $4 million related to environmental matters.
Employees
As of December 31, 2016, Xylem had approximately 16,000 employees worldwide.  We have more than 5,200 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.
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.

10


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. Our future growth rate depends upon a number of factors, including our ability to (i) identify emerging technological trends in our target end-markets, (ii) develop and maintain competitive products and defend our market share against an ever-expanding number of competitors including many new and non-traditional competitors, (iii) enhance our products by adding innovative features that differentiate our products from those of our competitors and prevent commoditization of our products, (iv) develop, manufacture and bring compelling new products to market quickly and cost-effectively, and (v) attract, develop and retain individuals with the requisite technical expertise and understanding of customers’ needs to develop new technologies and introduce new products.
We may not be successful in maintaining our competitive position. Our competitors may develop disruptive technologies or 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. The failure of our technologies or products to gain market acceptance due to more attractive offerings by our competitors could significantly reduce our revenues and adversely affect our competitive standing and prospects. 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 2016, 42%, 31% 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 fiscal and trade policies; 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 our markets 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 2016, 58% of our total revenue was from customers outside the United States, with 21% of total revenue generated in emerging markets. We expect our sales from international operations 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:
changes in trade protection measures, including tariff and trade barriers and import and export licensing requirements;
potential negative consequences from changes to taxation policies;
unanticipated changes in other laws and regulations or in how such provisions are interpreted or administered;
potential disruptions in our global supply chain;
possibility of unfavorable circumstances arising from host country laws or regulations;

11


currency exchange rate fluctuations and restrictions on currency repatriation; 
disruption of operations from labor and political disturbances;
regional safety and security considerations;
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, our operations in emerging markets 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 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 events might have on our business, financial condition and results of operations.

Our strategy includes acquisitions, and we may not be able to make acquisitions of suitable candidates or integrate acquisitions successfully.

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 may not 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. Failure to successfully execute our acquisition strategy could adversely affect our business, financial condition or results of operations.

We may not achieve some or all of the expected benefits of our restructuring plans and our restructuring may adversely affect our business.

In recent fiscal years, we have initiated restructuring plans in an effort 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 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 include the retention of key employees, the impact of regulatory matters, and adverse economic market conditions. If our restructuring actions are not executed successfully, it could have a material adverse effect on our competitive position, business, financial condition and results of operations.

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Our business could be adversely affected by cyber threats or interruptions in information technology, communications networks and operations.
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, insider risk, computer viruses, security breaches, natural disasters, power outages and other events. In addition, we have designed products and services that connect to and are part of the “Internet of Things.” While we attempt to provide adequate security measures to safeguard our products from cyber threats, the potential for an attack remains. A successful attack may result in inappropriate access to our or our customer's information or an inability for our products to function properly.
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, such as 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 and disaster recovery planning, we cannot be sure that interruptions with material adverse effects will not occur.
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, trade regulations, including 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. 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 significant movements in foreign currency exchange rates.
We conduct approximately 58% 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 2016 revenue decreased by

13


2.0% 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.
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.
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 our products could create product safety, regulatory or environmental risks, including 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 and have a material adverse effect on our business, financial condition and results of operations.
Weather conditions and climate changes may adversely affect, or cause volatility in, our financial results.
Weather conditions, including heavy flooding, droughts and fluctuations in temperatures or weather patterns, including as a result of climate change, can positively or negatively impact portions of our business. Within the dewatering space, 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.
Changes in our effective tax rates may adversely affect our financial results.
We sell our products in more than 150 countries and 58% of our revenue was generated outside the United States in 2016. 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.

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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.
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 tariff regimes, 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 indebtedness may affect our business and may restrict our operational flexibility.
As of December 31, 2016, our total outstanding indebtedness was $2,368 million as described under “Liquidity and Capital Resources." Our indebtedness could:
increase our vulnerability to general adverse economic and industry conditions;
limit our ability to obtain additional financing or borrow additional funds;
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 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. These proceedings may seek remedies relating to environmental matters, acquisitions or divestitures, product liability and personal injury claims, employment, labor and pension matters, and government contract issues and commercial or

15


contractual disputes. Our acquisition of Sensus has increased our exposure to intellectual property litigation and we expect that this risk will continue to increase as we execute on our innovation and technology priorities.

It is not possible to predict with certainty the outcome of claims, investigations, and lawsuits, and we could in the future incur judgments, fines or penalties or enter into settlements of lawsuits and claims that could have an adverse effect on our business, results of operations and financial condition in any particular period.  Additionally, we may 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.

The global and diverse nature of our operations means that legal and compliance risks will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, will arise from time to time. In addition, subsequent developments in legal proceedings may affect our assessments and estimates of loss contingencies recorded as a reserve and require us to make payments in excess of our reserves, which could have an adverse effect on our results of operations and financial condition.
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.
A significant number of our products in our Sensus segment are affected by the availability and regulation of radio spectrum and could be affected by interference with the radio spectrum that we use.
A significant number of the products in our Sensus segment use radio spectrum, which is subject to government regulation.   To the extent we introduce new products designed for use in the United States or another country into a new market, such products may require significant modification or redesign in order to meet frequency requirements and other regulatory specifications.  In some countries, limitations on frequency availability or the cost of making necessary modifications may preclude us from selling our products in those countries. The regulations that govern our use of the radio spectrum may change and that the changes may require us to modify our products, either directly or due to interference caused by new consumer products allowed under the regulations.  The inability to modify our products to meet such requirements, the possible delays in completing such modifications, and the cost of such modifications all could have a material adverse effect on our business, financial condition, and results of operations.  
In the United States, our products are primarily designed to use licensed spectrum in the 900MHz range.  If the Federal Communications Commission (“FCC”) did not renew our existing spectrum licenses, our business could be adversely affected.  In addition, there may be insufficient available frequencies in some markets to sustain or develop our planned operations at a commercially feasible price or at all.

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Outside of the United States, certain of our products require the use of radio frequency and are subject to regulations. In some jurisdictions, radio station licenses may be granted for a fixed term and must be periodically renewed. Our advanced and smart metering systems typically transmit to (and receive information from, if applicable) handheld, mobile, or fixed network reading devices in licensed bands made available to us through strategic partnerships and are reliant to some extent on the licensed spectrum continuing to be available through our partners or our customers. We may be unable to find partners or customers that have access to sufficient frequencies in some markets to sustain or develop our planned operations or to find partners or customers that have access to sufficient frequencies in the relevant markets at a commercially feasible price or at all.
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, 2016, the net carrying value of our goodwill and other indefinite-lived intangible assets totaled approximately $3 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.
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.
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

17


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 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.
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;
stock repurchases;
acquisitions and divestitures;
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;
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.


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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, our articles of incorporation and our by-laws, among other things, require advance notice for shareholder proposals and nominations. In addition, our 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.
In connection with our Spin-off, ITT (now ITT LLC) and Exelis, acquired by Harris Inc., will indemnify us for certain liabilities and we will indemnify ITT (now ITT LLC) or Exelis for certain liabilities. If we are required to indemnify ITT (now ITT LLC) 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 (now ITT LLC) and Exelis, ITT (now ITT LLC) and Exelis agreed to indemnify us from certain liabilities, and we agreed to indemnify ITT (now ITT LLC) and Exelis for certain liabilities. Indemnities that we may be required to provide ITT (now ITT LLC) 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 (now ITT LLC) or Exelis has agreed to retain. Further, there can be no assurance that the indemnities from ITT (now ITT LLC) and Exelis will be sufficient to protect us against the full amount of such liabilities, or that ITT (now ITT LLC) and Exelis will be able to fully satisfy their indemnification obligations. Moreover, even if we ultimately were to succeed in recovering from ITT (now ITT LLC) 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.


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ITEM 2.        PROPERTIES
We have approximately 380 locations in more than 48 countries. These properties total approximately 12.7 million square feet, of which more than 300 locations, or approximately 6.6 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 our 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
 
1,197,000

 
Owned
Stockholm
 
Sweden
 
Administration and Research & Development
 
172,000

 
Leased
Shenyang
 
China
 
Manufacturing
 
125,000

 
Owned
Bridgeport
 
NJ
 
Administration and Manufacturing
 
136,000

 
Leased
Yellow Springs
 
OH
 
Administration and Manufacturing
 
112,000

 
Owned
Quenington
 
UK
 
Manufacturing
 
86,000

 
Leased
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
Sensus
Ludwigshafen
 
Germany
 
Manufacturing
 
318,000

 
Owned
Jiangdu City
 
China
 
Manufacturing
 
316,000

 
Owned
Texarkana
 
AR
 
Manufacturing
 
254,000

 
Owned
Uniontown
 
PA
 
Manufacturing
 
240,000

 
Leased
DuBois
 
PA
 
Manufacturing
 
197,000

 
Owned
DuBois
 
PA
 
Manufacturing
 
137,000

 
Leased
Regional Selling Locations
Dubai
 
United Arab Emirates
 
Manufacturing
 
144,000

 
Owned
Nottinghamshire
 
United Kingdom
 
Sales Office
 
139,000

 
Leased
Nanterre
 
France
 
Sales Office
 
139,000

 
Leased
Langenhagen
 
Germany
 
Sales Office
 
134,000

 
Leased
Corporate Headquarters
Rye Brook
 
NY
 
Administration
 
67,000

 
Leased

ITEM 3.        LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings that are incidental to the operation of our businesses. These proceedings may seek remedies relating to environmental matters, intellectual property matters, acquisitions or divestitures, personal injury claims, employment and pension matters, government contract issues and commercial or contractual disputes. 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 we are involved in.

ITEM 4.        MINE SAFETY DISCLOSURES
Not applicable.

20


EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is provided regarding the executive officers of Xylem as of February 1, 2017:
NAME
 
AGE
 
CURRENT TITLE
 
OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS
Patrick K. Decker
 
52
 
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)
 
 
 
 
 
 
 
E. Mark Rajkowski
 
58
 
Senior VP and Chief Financial Office (2016)
 
• Senior VP and Chief Financial Officer, MeadWestvaco Corp. (worldwide packaging company) (2004)
 
 
 
 
 
 
 
D. Randall Bays
 
61
 
Senior VP and President, Sensus (2016)
 
• President, Sensus (worldwide smart meter company) (2013)
• President and Chief Executive Officer, Kinetek Inc. (diversified, worldwide industrial company) (2004)
 
 
 
 
 
 
 
Tomas Brannemo
 
45
 
Senior VP and President, Transport (2014)
 
• VP, Transport (2013)
• VP and Director of Business Unit Aftermarket and Service (2010)
 
 
 
 
 
 
 
David Flinton
 
46
 
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
 
60
 
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
 
54
 
Senior VP and President, Applied Water Systems (2012)
 
• Senior VP and President, Residential and Commercial Water (2011)

 
 
 
 
 
 
 
Colin R. Sabol
 
49
 
Senior VP and President, Analytics and Treatment (2015)
 
• Senior VP and President, Dewatering (2013)
• Senior VP and Chief Strategy and Growth Officer (2011)
 
 
 
 
 
 
 

21


NAME
 
AGE
 
CURRENT TITLE
 
OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS
Kairus Tarapore
 
55
 
Senior VP and Chief Human Resources Officer (2015)
 
• Senior VP and Chief Administrative Officer, Babcock & Wilcox Company (energy and environmental technologies and services) (2013)
• Executive VP, Human Resources, Ceridian Corporation (2006)
 
 
 
 
 
 
 
Claudia S. Toussaint
 
53
 
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 as of February 1, 2017:
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


22


PART II
ITEM 5.        MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
2016 and 2015 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, 2016
 
 
 
 
 
First Quarter
$
41.33

 
$
31.67

 
$
0.1549

Second Quarter
46.67

 
40.54

 
0.1549

Third Quarter
52.71

 
44.44

 
0.1549

Fourth Quarter
54.99

 
45.60

 
0.1549

 
 
 
 
 
 
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

The closing price of our common stock on the NYSE on January 31, 2017 was $49.31 per share. As of January 31, 2017, there were 12,632 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 2017, we declared a dividend of $0.18 per share to be paid on March 15, 2017 for shareholders of record on February 16, 2017.
There were no unregistered offerings of our common stock during 2016.















23


Fourth Quarter 2016 Share Repurchase Activity
The following table summarizes our purchases of our common stock for the quarter ended December 31, 2016:
(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)
10/1/16 - 10/31/16
 
 
 
 
$432
11/1/16 - 11/30/16
 
 
 
 
$433
12/1/16 - 12/31/16
 
 
 
 
$432
(a)
Average price paid per share is calculated on a settlement basis.
(b)
On August 24, 2015, our Board of Directors authorized the repurchase of up to $500 million in shares with no expiration date. The program's objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. There were no shares repurchased under this program during the three months ended December 31, 2016. There are up to $420 million in shares that may still be purchased under this plan as of December 31, 2016.
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, 2016 and there are 0.3 million shares (approximately $12 million based on the closing share price on December 31, 2016) that may still be purchased under this plan.

24


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 December 31, 2011 through December 31, 2016.
cumulativereturn2016a01.jpg
 
XYL
 
S&P 500
 
S&P 500
Industrials
Index
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

December 31, 2016
221

 
208

 
222

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.

25


ITEM 6.        SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the five years ended December 31, 2016. 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.
 
Year Ended
December 31,
(in millions, except per share data)
2016 (a)
 
2015
 
2014
 
2013
 
2012
Results of Operations Data:
 
 
 
 
 
 
 
 
 
Revenue
$
3,771

 
$
3,653

 
$
3,916

 
$
3,837

 
$
3,791

Gross profit
1,461

 
1,404

 
1,513

 
1,499

 
1,502

Gross margin
38.7
%
 
38.4
%
 
38.6
%
 
39.1
%
 
39.6
%
Operating income
406

 
449

 
463

 
363

 
443

Operating margin
10.8
%
 
12.3
%
 
11.8
%
 
9.5
%
 
11.7
%
Net income
260

 
340

 
337

 
228

 
297

Per Share Data:
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
 
Basic
$
1.45

 
$
1.88

 
$
1.84

 
$
1.23

 
$
1.60

Diluted
1.45

 
1.87

 
1.83

 
1.22

 
1.59

Basic shares outstanding
179.1

 
180.9

 
183.1

 
185.2

 
185.8

Diluted shares outstanding
180.0

 
181.7

 
184.2

 
186.0

 
186.2

Cash dividends per share
$
0.6196

 
$
0.5632

 
$
0.5120

 
$
0.4656

 
$
0.4048

Balance Sheet Data (at period end):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
308

 
$
680

 
$
663

 
$
533

 
$
504

Working capital*
878

 
810

 
882

 
930

 
859

Total assets
6,474

 
4,657

 
4,833

 
4,857

 
4,639

Total debt
2,368

 
1,274

 
1,284

 
1,235

 
1,197


*
The Company calculates Working capital as follows: net accounts receivable + inventories - accounts payable - customer advances.
(a)
The amounts for the year ended December 31, 2016 reflect the acquisition of Sensus. Refer to Notes 3 and 20 to Consolidated Financial Statements for further information regarding Sensus.




26


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, 2016. 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 global water technology company. We design, manufacture and service highly engineered solutions ranging across a wide variety of critical applications. Our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery and use of drinking water to the collection and treatment of wastewater to the return of water to the environment. Our product and service offerings are organized into three reportable segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Sensus.
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 many of the leading independent distributors in the markets we serve, with the remainder going directly to customers.
Sensus, which we acquired on October 31, 2016, serves the utility infrastructure solutions and services sector by delivering communications, smart metering, measurement and control technologies and services that allow customers to more effectively use their distribution networks for the delivery of critical resources such as water, electricity and natural gas. Additionally, we sell software and services including cloud-based analytics, remote monitoring and data management, and also sell smart lighting products and solutions that improve efficiency and public safety efforts across communities. In the Sensus segment we generate the majority of our sales in the U.S. through long-standing relationships with leading distributors and dedicated channel partners, while we use a combination of direct sales and distribution channels internationally, depending on the regional availability of distribution channels. The Sensus segment has approximately 3,300 employees across 28 locations on six continents.
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 and backlog, among others. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and to provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases and debt repayment. Excluding revenue, Xylem provides guidance only on a non-GAAP basis due to the inherent difficulty in forecasting certain amounts that would be included in GAAP earnings, such as discrete tax items, without unreasonable effort. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following non-GAAP

27


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 and contributions from acquisitions and divestitures. Divestitures include sales of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate.
"constant currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not the U.S. Dollar.
"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude restructuring and realignment costs, Sensus acquisition related costs, special charges, gain from sale of business and tax-related special items, as applicable. A reconciliation of adjusted net income is provided below.
(in millions, except per share data)
 
2016
 
2015
 
2014
Net income
 
$
260

 
$
340

 
$
337

Restructuring and realignment, net of tax benefit of $13, $5 and $12, respectively
 
34

 
15

 
31

Sensus acquisition related costs, net of tax benefit of $15
 
38

 

 

Special charges, net of tax benefit of $7 and $0, respectively
 
11

 
5

 

Tax-related special items
 
21

 
(15
)
 
5

Gain from sale of business, net of $0 tax in both years
 

 
(9
)
 
(11
)
Adjusted net income
 
$
364

 
$
336

 
$
362

Weighted average number of shares - Diluted
 
180.0

 
181.7

 
184.2

Earnings per share
 
$
1.45

 
$
1.87

 
$
1.83

Adjusted earnings per share
 
$
2.03

 
$
1.85

 
$
1.97

"operating expenses excluding restructuring and realignment costs, Sensus acquisition related costs and special charges" defined as operating expenses, adjusted to exclude restructuring and realignment costs, Sensus acquisition related costs and special charges.
"adjusted operating income (loss)" defined as operating income (loss), adjusted to exclude restructuring and realignment costs, Sensus acquisition related costs and special charges, and "adjusted operating margin" defined as adjusted operating income divided by total revenue.
“realignment costs” defined as costs not included in restructuring costs that are incurred as part of actions taken to reposition our business, including items such as professional fees, severance, relocation, travel, facility set-up and other costs.
"Sensus acquisition related costs" defined as costs incurred by the Company associated with the acquisition of Sensus that are being reported within operating income. These costs include transaction costs, integration costs, costs related to the recognition of inventory step-up and amortization of the backlog intangible asset recorded in purchase accounting.
“special charges" defined as costs incurred by the Company, such as interest expense related to the early extinguishment of debt during Q2 2016, financing costs related to the bridge loan entered into in Q3 2016 for the Sensus acquisition, initial acquisition costs not related to Sensus, costs incurred for the contractual indemnification of tax obligations to ITT 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, significant reserves for cash repatriation, excess tax benefits/losses and other discrete tax adjustments.
"free cash flow" defined as net cash from operating activities, as reported in the statement of cash flow, less capital expenditures, as well as adjustments for other significant items that impact current results which management believes are not related to our ongoing operations and performance. Our definition of free cash

28


flow does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow.
(in millions)
 
2016
 
2015
 
2014
Net cash provided by operating activities
 
$
497

 
$
464

 
$
416

Capital expenditures
 
(124
)
 
(117
)
 
(119
)
Free cash flow
 
$
373

 
$
347

 
$
297

Cash paid for Sensus related acquisition costs
 
13

 

 

Free cash flow, excluding Sensus acquisition related costs
 
$
386

 
$
347

 
$
297


“EBITDA” defined as earnings before interest, taxes, depreciation, amortization expense, and share-based compensation and “Adjusted EBITDA” reflects the adjustment to EBITDA to exclude restructuring and realignment costs, Sensus acquisition related costs, gain from sale of business and special charges.
(in millions)
 
2016
 
2015
 
2014
Net Income
 
$
260

 
$
340

 
$
337

Income tax expense
 
80

 
63

 
84

Interest expense (Income), net
 
68

 
53

 
52

Depreciation
 
87

 
88

 
95

Amortization
 
64

 
45

 
47

Stock compensation
 
18

 
15

 
18

EBITDA
 
$
577

 
$
604

 
$
633

Restructuring and realignment
 
47

 
20

 
43

Sensus acquisition related costs
 
46

 

 

Special charges
 
5

 
5

 

Gain from sale of business
 

 
(9
)
 
(11
)
Adjusted EBITDA
 
$
675

 
$
620

 
$
665

Executive Summary
Xylem reported revenue of $3,771 million for 2016, an increase of $118 million or 3.2% from $3,653 million reported in 2015. Revenue increased 5.3% on a constant currency basis due to increased revenue of $163 million from acquisitions and organic revenue growth of $29 million driven primarily by a robust public utility end market and a relatively stable commercial business.
Operating income for 2016 was $406 million, reflecting a decrease of $43 million or 9.6% compared to $449 million in 2015. Operating margin was 10.8% for 2016 versus 12.3% for 2015, a decrease of 150 basis points. This decrease in operating income was primarily due to Sensus acquisition related costs of $53 million, increases in restructuring and realignment costs of $27 million and increases in special charges of $4 million. Excluding these costs, adjusted operating income was $511 million, with an adjusted operating margin of 13.6%, reflecting an increase of $41 million or 8.7% and 70 basis points, respectively, as compared with 2015 adjusted operating income of $470 million (adjusted operating margin of 12.9%). This increase in adjusted operating income was driven by strong progress in our productivity initiatives and cost reductions, which more than offset cost inflation, spending on strategic investments and unfavorable mix.
Additional financial highlights for 2016 include the following:
Net income of $260 million, or $1.45 per diluted share ($364 million or $2.03 per diluted share on an adjusted basis)
Cash from operating activities of $497 million, and free cash flow, excluding Sensus acquisition related costs, of $386 million
Orders of $3,824 million, up 3.0% from $3,711 million in 2015 (up 0.3% on an organic basis)
Dividends paid to shareholders increased 10% in 2016.

29


2017 Business Outlook
We anticipate total revenue growth in the range of 20% to 22% in 2017 with organic revenue growth in the low-single-digits and Sensus contributing the additional revenue growth. The following is a summary of our outlook by end market.
Industrial was down 4% for 2016, including agriculture which will be included within industrial going forward, as general industrial strength was more than offset by oil and gas declines in Canada and the United States. For 2017, we expect growth to be flat to up in the low-single-digits. We believe the soft market conditions in general industrial that occurred in the U.S. during 2016 will carry into at least the first half of 2017, with modest growth returning over the second half. We continue to expect that the oil and gas markets will be down year-over-year, despite some pockets of higher activity. We expect Emerging Market performance to continue to be mixed with some strength in China and Latin America, offset by continued weakness in the Middle East.
Public utilities increased 8% for 2016 driven by the United States recovery and continued emerging markets investments. We expect growth to be moderate but still increase low to mid-single-digits. In the U.S., which represents approximately one-quarter of our public utility base, we anticipate solid repair and replacement, or opex, activity coupled with some acceleration of project activity later in the year. In Emerging Markets, we expect large project activities to drive growth particularly in China and India. We also anticipate continued growth in Europe, particularly in the United Kingdom with the third year of positive impacts from the AMP 6 cycle. Additionally, we anticipate Sensus public utility revenue to continue to grow at mid-to-high single digits over their historical performance driven by expected growth in the United States within smart metering applications.
Commercial experienced growth of 2% for 2016 driven by strength in the European market which was partially offset by weakness in the United States. We expect continued growth in the low-single-digit range for 2017. Market data suggests a low-growth environment in the U.S. where we have a leading market position and more than half of our total Commercial exposure. Beyond the U.S., the global outlook is mixed. We believe Europe will be closer to flat with lower construction activity and funding uncertainty in certain countries. Also, our business in Europe will face a tough prior year comparison to this year's 10% growth. China appears to be stabilizing and we expect the market to grow over a weak 2016 performance.
Residential markets were down 3% in 2016 with weakness across most regions. For 2017 we expect low- single-digit growth. In the U.S. we expect relatively flat year over year volumes given the competitive landscape and replacement nature of the sector we serve. The European market looks to be modestly stronger as residential building permitting, which is an indicator of sales, increased during the fourth quarter.
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 2016, we incurred $30 million and $17 million in restructuring and realignment costs, respectively. As a result of these actions in 2016, we realized $10 million of net savings and expect to realize approximately $24 million of incremental net savings in 2017. During 2017, we currently expect to incur approximately $30 million in Sensus integration, restructuring and realignment costs.
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. Additionally, with the acquisition of Sensus, we anticipate increased spending on research and development as a percentage of revenue as Sensus brings a higher profile of R&D given the investment required to support growth and new product launches.



30


Results of Operations
(in millions)
 
2016
 
2015
 
2014
 
2016 v. 2015
 
2015 v. 2014
Revenue
 
$
3,771

 
$
3,653

 
$
3,916

 
3.2
 %
 
(6.7
)%
Gross profit
 
1,461

 
1,404

 
1,513

 
4.1
 %
 
(7.2
)%
Gross margin
 
38.7
%
 
38.4
%
 
38.6
%
 
30
bp
 
(20
)bp
Operating expenses excluding restructuring and realignment costs, Sensus acquisition related costs and special charges
 
950

 
930

 
1,007

 
2.2
 %
 
(7.6
)%
Expense to revenue ratio
 
25.2
%
 
25.5
%
 
25.7
%
 
(30
)bp
 
(20
)bp
Restructuring and realignment costs
 
47

 
20

 
43

 
135.0
 %
 
(53.5
)%
Sensus acquisition related charges
 
53

 

 

 
 
 
 
Special charges
 
5

 
5

 

 
NM

 
NM

Total operating expenses