Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - Xylem Inc.xyl06302017ex322.htm
EX-32.1 - EXHIBIT 32.1 - Xylem Inc.xyl06302017ex321.htm
EX-31.2 - EXHIBIT 31.2 - Xylem Inc.xyl06302017ex312.htm
EX-31.1 - EXHIBIT 31.1 - Xylem Inc.xyl06302017ex311.htm
EX-10.1 - EXHIBIT 10.1 - Xylem Inc.xyl06302017ex101.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
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) (Zip code)
(914) 323-5700
(Registrant's telephone number, including area code)
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 Web site, 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
þ
 
Accelerated filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  þ
As of July 28, 2017, there were 179,568,474 outstanding shares of the registrant’s common stock, par value $0.01 per share.
 



Xylem Inc.
Table of Contents
ITEM
  
  
PAGE
PART I – Financial Information
 
Item 1
-
 
 
 
 
 
 
 
 
 
 
 
Item 2
-
Item 3
-
Item 4
-
PART II – Other Information
 
Item 1
-
Item 1A
-
Item 2
-
Item 3
-
Item 4
-
Item 5
-
Item 6
-
 
 
 

2


PART I

ITEM 1.             CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

XYLEM INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)
(in millions, except per share data)

 
Three Months
 
Six Months
For the period ended June 30,
2017
 
2016
 
2017
 
2016
Revenue
$
1,164

 
$
932

 
$
2,235

 
$
1,779

Cost of revenue
705

 
563

 
1,364

 
1,081

Gross profit
459

 
369

 
871

 
698

Selling, general and administrative expenses
270

 
227

 
542

 
446

Research and development expenses
44

 
27

 
86

 
52

Restructuring and asset impairment charges, net
6

 
6

 
18

 
12

Operating income
139

 
109

 
225

 
188

Interest expense
21

 
20

 
41

 
34

Other non-operating income, net
3

 
1

 
2

 
1

Gain from sale of business

 

 
5

 

Income before taxes
121

 
90

 
191

 
155

Income tax expense
21

 
19

 
35

 
18

Net income
100

 
71

 
156

 
137

Less: Net income attributable to non-controlling interests
1

 

 
1

 

Net income attributable to Xylem
$
99

 
$
71

 
$
155

 
$
137

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.55

 
$
0.39

 
$
0.87

 
$
0.77

Diluted
$
0.55

 
$
0.39

 
$
0.86

 
$
0.76

Weighted average number of shares:
 
 
 
 
 
 
 
Basic
179.6

 
179.1

 
179.6

 
178.8

Diluted
180.6

 
179.9

 
180.6

 
179.6

Dividends declared per share
$
0.1800

 
$
0.1549

 
$
0.3600

 
$
0.3098

See accompanying notes to condensed consolidated financial statements.


3


XYLEM INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(in millions)
 
 
Three Months
 
Six Months
For the period ended June 30,
2017
 
2016
 
2017
 
2016
Net income
$
100

 
$
71

 
$
156

 
$
137

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
30

 
(29
)
 
59

 
(17
)
Net change in derivative hedge agreements:
 
 
 
 
 
 
 
Unrealized gains (loss)
3

 
(4
)
 
5

 

Amount of gain reclassified into net income
(1
)
 
(1
)
 

 
(1
)
Net change in postretirement benefit plans:
 
 
 
 
 
 
 
Amortization of net actuarial loss into net income
2

 
2

 
5

 
5

Other comprehensive income (loss), before tax
34

 
(32
)
 
69

 
(13
)
Income tax (benefit) expense related to items of other comprehensive income
(22
)
 
8

 
(29
)
 
1

Other comprehensive income (loss), net of tax
56

 
(40
)
 
98

 
(14
)
Comprehensive income
$
156

 
$
31

 
$
254

 
$
123

See accompanying notes to condensed consolidated financial statements.

4


XYLEM INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except per share amounts)
 
 
June 30,
2017
 
December 31,
2016
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
288

 
$
308

Receivables, less allowances for discounts and doubtful accounts of $28 and $30 in 2017 and 2016, respectively
944

 
843

Inventories
554

 
522

Prepaid and other current assets
175

 
166

Total current assets
1,961

 
1,839

Property, plant and equipment, net
627

 
616

Goodwill
2,717

 
2,632

Other intangible assets, net
1,184

 
1,201

Other non-current assets
218

 
186

Total assets
$
6,707

 
$
6,474

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
442

 
$
457

Accrued and other current liabilities
515

 
521

Short-term borrowings and current maturities of long-term debt
243

 
260

Total current liabilities
1,200

 
1,238

Long-term debt
2,168

 
2,108

Accrued postretirement benefits
427

 
408

Deferred income tax liabilities
329

 
352

Other non-current accrued liabilities
201

 
161

Total liabilities
4,325

 
4,267

Commitments and contingencies (Note 17)

 

Stockholders’ equity:
 
 
 
Common Stock – par value $0.01 per share:
 
 
 
Authorized 750.0 shares, issued 191.9 shares and 191.4 shares in 2017 and 2016, respectively
2

 
2

Capital in excess of par value
1,894

 
1,876

Retained earnings
1,117

 
1,033

Treasury stock – at cost 12.4 shares and 11.9 shares in 2017 and 2016, respectively
(428
)
 
(403
)
Accumulated other comprehensive loss
(220
)
 
(318
)
Total stockholders’ equity
2,365

 
2,190

Non-controlling interests
17

 
17

Total equity
2,382

 
2,207

Total liabilities and stockholders’ equity
$
6,707

 
$
6,474


See accompanying notes to condensed consolidated financial statements.

5


XYLEM INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in millions)
For the six months ended June 30,
2017
 
2016
Operating Activities
 
 
 
Net income
$
156

 
$
137

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
55

 
41

Amortization
61

 
24

Share-based compensation
11

 
10

Restructuring and asset impairment charges
18

 
12

Gain from sale of business
(5
)
 

Other, net
4

 
8

Payments for restructuring
(17
)
 
(6
)
Changes in assets and liabilities (net of acquisitions):
 
 
 
Changes in receivables
(70
)
 
(19
)
Changes in inventories
(13
)
 
(39
)
Changes in accounts payable
(19
)
 
9

Other, net
(30
)
 
(52
)
Net Cash – Operating activities
151

 
125

Investing Activities
 
 
 
Capital expenditures
(77
)
 
(62
)
Acquisition of business, net of cash acquired
(6
)
 
(70
)
Proceeds from sale of business
11

 

Other, net
3

 
5

Net Cash – Investing activities
(69
)
 
(127
)
Financing Activities
 
 
 
Short-term debt issued
33

 
89

  Short-term debt repaid
(65
)
 
(77
)
Long-term debt issued

 
540

  Long-term debt repaid

 
(608
)
Repurchase of common stock
(25
)
 
(3
)
Proceeds from exercise of employee stock options
7

 
16

Dividends paid
(65
)
 
(56
)
Other, net

 
1

Net Cash – Financing activities
(115
)
 
(98
)
Effect of exchange rate changes on cash
13

 
6

Net change in cash and cash equivalents
(20
)
 
(94
)
Cash and cash equivalents at beginning of year
308

 
680

Cash and cash equivalents at end of period
$
288

 
$
586

Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
46

 
$
34

Income taxes (net of refunds received)
$
47

 
$
49

See accompanying notes to condensed consolidated financial statements.

6


XYLEM INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Background and Basis of Presentation
Background
Xylem Inc. ("Xylem" or the "Company") is a leading equipment and service provider for water and wastewater applications with a broad portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment. Xylem was incorporated in Indiana on May 4, 2011.
As previously announced, in the second quarter of 2017 we implemented an organizational redesign by moving Xylem’s Analytics business from our Water Infrastructure business to our Sensus business, which was acquired in the fourth quarter of 2016. We believe that the combination of these businesses will enhance our focus on advanced sensing technologies and will lead to operating efficiencies by integrating the supply chain process, and moving to a leaner, shared operations and functional structure.  Accordingly, our reportable segments have changed. Beginning with the second quarter of 2017, the Company now reports the financial position and results of operations of its Analytics and Sensus businesses as one new reportable segment, which is currently called Sensus & Analytics. Our Water Infrastructure reportable segment no longer includes the results of our Analytics business. The Company has recast certain historical amounts between the Company's Water Infrastructure and Sensus & Analytics reportable segments, however this change had no impact on the Company's historical consolidated financial position or results of operations. The recast financial information does not represent a restatement of previously issued financial statements. Our Applied Water reportable segment remains unchanged. Refer to Note 18 "Segment Information" for additional segment information.
Xylem operates in three segments, Water Infrastructure, Applied Water and Sensus & Analytics. The Water Infrastructure segment focuses on the transportation and treatment of water, offering a range of products including water and wastewater pumps, treatment equipment, and controls and systems. The Applied Water segment serves many of the primary uses of water and focuses on the residential, commercial and industrial markets. The Applied Water segment’s major products include pumps, valves, heat exchangers, controls and dispensing equipment. The Sensus & Analytics segment focuses on developing advanced technology solutions that enable intelligent use and conservation of critical water and energy resources as well as analytical instrumentation used in the testing of water. The Sensus & Analytics segment's major products include smart metering, networked communications, measurement and control technologies, software and services including cloud-based analytics, remote monitoring and data management, and testing equipment.
Except as otherwise indicated or unless the context otherwise requires, "Xylem," "we," "us," "our" and the "Company" refer to Xylem Inc. and its subsidiaries.
Basis of Presentation
The interim condensed consolidated financial statements reflect our financial position and results of operations in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All intercompany transactions between our businesses have been eliminated.
The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules. We believe that the disclosures made are adequate to make the information presented not misleading. We consistently applied the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016 ("2016 Annual Report") in preparing these unaudited condensed consolidated financial statements, with the exception of accounting standard updates described in Note 2. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes included in our 2016 Annual Report.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and

7


liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Estimates are revised as additional information becomes available. Estimates and assumptions are used for, but not limited to, postretirement obligations and assets, revenue recognition, income tax contingency accruals and valuation allowances, goodwill and indefinite lived intangible impairment testing and contingent liabilities. Actual results could differ from these estimates.
Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends on December 31. For ease of presentation, the condensed consolidated financial statements included herein are described as ending on the last day of the calendar quarter.
Note 2. Recently Issued Accounting Pronouncements
Pronouncements Not Yet Adopted
In March 2017, the Financial Accounting Standards Board (“FASB”) issued amended guidance on presentation of net periodic benefit costs.  The amendment requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period.  The other components are required to be presented in the income statement separately and outside a subtotal of income from operations, if one is presented.  The amendment also requires entities to disclose the income statement lines that contain the other components if they are not appropriately described.  This guidance is effective retrospectively for periods beginning after December 15, 2017, including interim periods within those annual periods.  Early adoption is permitted.  We are evaluating the impact of the guidance on our financial condition and results of operations.
In June 2016, the FASB issued guidance amending the accounting for the impairment of financial instruments, including trade receivables. Under current guidance, credit losses are recognized when the applicable losses are probable of occurring and this assessment is based on past events and current conditions. The amended guidance eliminates the “probable” threshold and requires an entity to use a broader range of information, including forecast information when estimating expected credit losses. Generally, this should result in a more timely recognition of credit losses. This guidance is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted for interim and annual periods beginning after December 15, 2018. The requirements of the amended guidance should be applied using a modified retrospective approach except for debt securities, which require a prospective transition approach. We are evaluating the impact of the guidance on our financial condition and results of operations.
In February 2016, the FASB issued guidance amending the accounting for leases. Specifically, the amended guidance requires all lessees to record a lease liability at lease inception, with a corresponding right of use asset, except for short-term leases. Lessor accounting is not fundamentally changed. This amended guidance is effective for interim and annual periods beginning after December 15, 2018 using a modified retrospective approach. Early adoption is permitted. We are evaluating the impact of the guidance on our financial condition and results of operations.
In May 2014, the FASB issued guidance on recognizing revenue from contracts with customers. The guidance outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the model is that an entity recognizes revenue to portray the transfer of goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also expands disclosure requirements regarding revenue recognition. This guidance is effective for interim and annual reporting periods beginning after December 15, 2017 and may be applied retrospectively to each prior period presented or with the cumulative effect recognized as of the date of initial application. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2016. We are evaluating the impact of the guidance on our financial condition and results of operations.
Recently Adopted Pronouncements
In May 2017, the FASB issued guidance, which amends the scope of modification accounting guidance for share-based payment arrangements. The guidance outlines the types of changes to the terms or conditions of share-based payment arrangements that would require the use of modification accounting. Specifically, modification accounting would not apply if the fair value, vesting conditions, and classification of the award as equity or liability are the same immediately before and after the modification. This guidance is effective prospectively for interim and annual reporting periods beginning December 15, 2017 and early adoption is permitted. We elected to early

8


adopt this guidance effective the second quarter of 2017. The adoption of this guidance did not impact our financial condition or results from operations.
In January 2017, the FASB issued guidance amending the impairment testing of goodwill. Under current guidance, the testing of goodwill for impairment is performed at least annually using a two-step test. Step one involves comparing the fair value of a “reporting unit” to its carrying amount. If the applicable book value exceeds the reporting unit’s fair value then step two must be performed. Step two involves comparing the fair value of the reporting unit’s goodwill to the applicable carrying amount of the asset and recognizing an impairment charge equal to the amount by which the carrying amount of the goodwill exceeds its implied fair value. The amended guidance eliminates step two of the impairment test and allows an entity to record an impairment charge equal to the amount that the carrying amount of the applicable reporting unit exceeds its fair value, up to the value of the recorded goodwill. This guidance is effective prospectively for interim and annual goodwill impairment tests beginning after December 15, 2019 with early adoption permitted for interim or annual tests after January 1, 2017. We elected to early adopt this guidance effective the first quarter of 2017. The adoption of this guidance did not impact our financial condition or results of operations.
In October 2016, the FASB issued guidance amending the accounting for income taxes. Under current guidance the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to an outside party. The amended guidance eliminates the prohibition against immediate recognition of current and deferred income tax amounts associated with intra-entity transfers of assets other than inventory. This guidance is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. The requirements of the amended guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We elected to early adopt this guidance effective the first quarter of 2017. As a result of adopting the amended guidance, prepaid tax assets were reduced by $14 million, long-term deferred tax assets increased $3 million, and accrued taxes were reduced by $4 million. The net impact of these adjustments on retained earnings was a decrease of $7 million.
In July 2015, the FASB issued guidance regarding simplifying the measurement of inventory. Under prior guidance, inventory is measured at the lower of cost or market, where market is defined as replacement cost, with a ceiling of net realizable value and a floor of net realizable value less a normal profit margin. The amended guidance requires the measurement of inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance is effective prospectively for interim and annual periods beginning after December 15, 2016 and early application is permitted. We adopted this guidance effective the first quarter of 2017. The adoption of this guidance did not impact our financial condition or results of operations.
Note 3. Acquisitions and Divestitures
2017 Acquisitions and Divestitures
On February 17, 2017, we divested our United Kingdom and Poland based membranes business for approximately $11 million. The sale resulted in a gain of $5 million, which is reflected in gain from sale of business in our Condensed Consolidated Income Statement. The business, which was part of our Applied Water segment, provided membrane filtration products primarily to customers in the municipal water and industrial sectors. The business reported 2016 annual revenue of approximately $8 million.
2016 Acquisitions and Divestitures
Sensus Worldwide Limited
On October 31, 2016, the Company acquired all of the outstanding equity interests of Sensus Worldwide Limited (other than Sensus Industries Limited) (“Sensus”) effective October 31, 2016 for $1,766 million ($1,710 million net of cash acquired), including a $6 million payment in 2017 for a working capital adjustment. Sensus develops advanced technology solutions that enable intelligent use and conservation of critical water and energy resources. Sensus' major products include smart metering, networked communications, measurement and control technologies, software and services including cloud-based analytics, remote monitoring and data management.


9


Sensus results of operations were consolidated with the Company effective November 1, 2016 and along with our Analytics business it constitutes a separate reportable segment. Refer to Note 18 "Segment Information" for Sensus segment information.

The preliminary Sensus purchase price allocation as of October 31, 2016 is shown in the following table.
(in millions)
Amount
Cash
$
56

Receivables
104

Inventories
79

Prepaid and other current assets
20

Property, plant and equipment
181

Intangible assets
795

Other long-term assets
6

Accounts payable
(69
)
Accrued and other current liabilities
(91
)
Deferred income tax liabilities
(212
)
Accrued post retirement benefits
(84
)
Other non-current accrued liabilities
(60
)
Total identifiable net assets
725

 
 
Goodwill
1,058

Non-controlling interest
(17
)
   Total consideration
$
1,766


The fair values of Sensus assets and liabilities were determined based on preliminary estimates and assumptions which management believes are reasonable. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These adjustments will primarily relate to property, plant and equipment, intangible assets, certain liabilities, and income tax related items. The final determination of the fair value of certain assets and liabilities will be completed as soon as the necessary information is available but no later than one year from the acquisition date.

Goodwill arising from the acquisition consists largely of synergies and economies of scale expected from combining the operations of Sensus and Xylem. All of the goodwill was assigned to the Sensus & Analytics segment and is not deductible for tax purposes.


10


The preliminary estimate of the fair value of Sensus identifiable intangible assets was determined primarily using the “income approach,” which requires a forecast of all of the expected future cash flows either through the use of the multi-period excess earnings method or the relief-from-royalty method. Some of the more significant assumptions inherent in the development of intangible asset values include: the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows, the assessment of the intangible asset’s life cycle, as well as other factors. The following table summarizes key information underlying identifiable intangible assets related to the Sensus acquisition:
Category
 
Life
 
Amount (in millions)
Customer and Distributor Relationships
 
2 - 18 years
 
$
556

Tradenames
 
10 - 25 years
 
98

Internally Developed Network Software
 
7 years
 
60

FCC Licenses
 
Indefinite lived
 
24

Technology
 
5 - 15 years
 
39

Other
 
1 - 16 years
 
18

Total
 
 
 
$
795


The following table summarizes, on an unaudited pro forma basis, the condensed combined results of operations of the Company for the three and six months ended June 30, 2016 assuming the acquisition of Sensus was made on January 1, 2015.
(in millions)
Three Months Ended June 30, 2016
Six Months Ended June 30, 2016
Revenue
$
1,167

$
2,242

Net income
$
85

$
183


The foregoing unaudited pro forma results are for informational purposes only and are not necessarily indicative of the actual results of operations that might have occurred had the acquisition occurred on January 1, 2015, nor are they necessarily indicative of future results. The pro forma financial information includes the impact of purchase accounting and other nonrecurring items directly attributable to the acquisition, which include:

Amortization expense of acquired intangibles
Adjustments to the depreciation of property, plant and equipment reflecting the impact of the calculated fair value of those assets in accordance with purchase accounting
Amortization of the fair value adjustment for warranty liabilities
Adjustments to interest expense to remove historical Sensus interest costs and reflect Xylem's current debt profile
The related tax impact of the above referenced adjustments

The pro forma results do not include any cost savings or operational synergies that may be generated or realized due to the acquisition of Sensus. The pro forma six-month period reflects the inclusion of a $16 million tax valuation release and a $27 million reduction to warranty expense in the first calendar quarter of 2016.
Tideland Signal Corporation
On February 1, 2016, we acquired Tideland Signal Corporation (“Tideland”), a leading producer of analytics solutions in the coastal and ocean management sectors, for $70 million. Tideland, a privately-owned company headquartered in Texas, had approximately 160 employees. Our condensed consolidated financial statements include Tideland’s results of operations from February 1, 2016 within the Sensus & Analytics segment.

11


Note 4. Restructuring Charges
From time to time, the Company will incur costs related to restructuring actions in order to optimize our cost base and more strategically position ourselves based on the economic environment and customer demand. During the three and six months ended June 30, 2017, we recognized restructuring charges of $6 million and $13 million million, respectively. We incurred these charges primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Applied Water and Water Infrastructure segments, as well as headcount reductions within our Sensus & Analytics segment.
During the three and six months ended June 30, 2016, we recognized restructuring charges of $6 million and $12 million, respectively. We incurred these charges primarily in an effort to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Applied Water and Water Infrastructure segments, as well as Corporate headcount reductions.
The following table presents the components of restructuring expense and asset impairment charges.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in millions)
2017
 
2016
 
2017
 
2016
By component:
 
 
 
 
 
 
 
Severance and other charges
$
6

 
$
6

 
$
14

 
$
12

Reversal of restructuring accruals

 

 
(1
)
 

Total restructuring charges
$
6

 
$
6

 
$
13

 
$
12

Asset impairment

 

 
5

 

Total restructuring and asset impairment charges
$
6

 
$
6

 
$
18

 
$
12

 
 
 
 
 
 
 
 
By segment:
 
 
 
 
 
 
 
Water Infrastructure
$
3

 
$
5

 
$
5

 
$
7

Applied Water
2

 
1

 
10

 
3

Sensus & Analytics
1

 

 
3

 

      Corporate and other

 

 

 
2


12


The following table displays a rollforward of the restructuring accruals, presented on our Condensed Consolidated Balance Sheets within accrued and other current liabilities, for the six months ended June 30, 2017 and 2016.
(in millions)
 
2017
 
2016
Restructuring accruals - January 1
 
$
15

 
$
3

Restructuring charges
 
13

 
12

Cash payments
 
(17
)
 
(6
)
Foreign currency and other
 

 

Restructuring accruals - June 30
 
$
11

 
$
9

 
 
 
 
 
By segment:
 
 
 
 
Water Infrastructure
 
$
1

 
$
5

Applied Water
 
4

 
1

Sensus & Analytics
 
3

 

Regional selling locations (a)
 
3

 
1

Corporate and other
 

 
2

(a)
Regional selling locations consist primarily of selling and marketing organizations that incurred restructuring expense which was allocated to the segments. The liabilities associated with restructuring expense were not allocated to the segments.
The following is a rollforward for the six months ended June 30, 2017 and 2016 of employee position eliminations associated with restructuring activities.
 
 
2017
 
2016
Planned reductions - January 1
 
188

 
82

Additional planned reductions
 
105

 
223

Actual reductions and reversals
 
(185
)
 
(203
)
Planned reductions - June 30
 
108

 
102


The following table presents expected restructuring spend:
(in millions)
 
Water Infrastructure
 
Applied Water
 
Sensus & Analytics
 
Corporate
 
Total
Actions Commenced in 2017:
 
 
 
 
 
 
 
 
 
 
Total expected costs
 
$
14

 
$
6

 
$
1

 
$

 
$
21

Costs incurred during Q1 2017
 

 
1

 
1

 

 
2

Costs incurred during Q2 2017
 
3

 
1

 

 

 
4

Total expected costs remaining
 
$
11


$
4


$


$


$
15

 
 
 
 
 
 
 
 
 
 
 
Actions Commenced in 2016:
 
 
 
 
 
 
 
 
 
 
Total expected costs
 
$
13

 
$
13

 
$
10

 
$
2

 
$
38

Costs incurred during 2016
 
11

 
10

 
6

 
2

 
29

Costs incurred during Q1 2017
 
2

 
2

 
1

 

 
5

Costs incurred during Q2 2017
 

 
1

 
1

 

 
2

Total expected costs remaining
 
$


$


$
2


$


$
2

The Water Infrastructure, Applied Water, and Sensus & Analytics actions commenced in 2017 consist primarily of severance charges and are expected to continue through the end of 2018. The Water Infrastructure, Applied

13


Water, Sensus & Analytics and Corporate actions commenced in 2016 consist primarily of severance charges and are expected to continue through the end of 2018.
Asset Impairment Charges
During the first quarter of 2017 we determined that certain assets within our Applied Water segment, including a tradename, were impaired. Accordingly we recognized an impairment charge of $5 million. Refer to Note 9, "Goodwill and Other Intangible Assets," for additional information.
Note 5. Income Taxes
Our quarterly provision for income taxes is measured using an estimated annual effective tax rate, adjusted for discrete items within periods presented. The comparison of our effective tax rate between periods is significantly impacted by the level and mix of earnings and losses by tax jurisdiction, foreign income tax rate differentials and discrete items.
The income tax provision for the three months ended June 30, 2017 was $21 million resulting in an effective tax rate of 16.8%, compared to $19 million resulting in an effective tax rate of 21.6% for the same period in 2016. The income tax provision for the six months ended June 30, 2017 was $35 million resulting in an effective tax rate of 18.1%, compared to $18 million resulting in an effective tax rate of 11.8% for the same period in 2016. The effective tax rate was lower than the United States federal statutory rate primarily due to the mix of earnings in jurisdictions in both periods. The decrease in the effective tax rate for the three months ended June 30, 2017 as compared to the same period in the prior year was primarily due to the mix of earnings in jurisdictions and repatriation of foreign earnings in 2016 that did not recur. Additionally, the effective tax rate for the period ending June 30, 2016 included the release of an unrecognized tax benefit in 2016 due to the effective settlement of a tax examination, offset in part by the establishment of a valuation allowance.
Unrecognized Tax Benefits
We recognize tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the condensed consolidated financial statements from such positions are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
The amount of unrecognized tax benefits at June 30, 2017 was $68 million, which if ultimately recognized will reduce our effective tax rate. We do not believe that the unrecognized tax benefits will significantly change within the next twelve months.
We classify interest expense relating to unrecognized tax benefits as a component of other non-operating expense, net, and tax penalties as a component of income tax expense in our Condensed Consolidated Income Statements. As of June 30, 2017, we had $3 million of interest accrued for unrecognized tax benefits.

14


Note 6. Earnings Per Share
The following is a reconciliation of the shares used in calculating basic and diluted net earnings per share.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Net income attributable to Xylem (in millions)
$
99

 
$
71

 
$
155

 
$
137

Shares (in thousands):
 
 
 
 
 
 
 
Weighted average common shares outstanding
179,571

 
179,020

 
179,557

 
178,790

Add: Participating securities (a)
28

 
46

 
31

 
38

Weighted average common shares outstanding — Basic
179,599

 
179,066

 
179,588

 
178,828

Plus incremental shares from assumed conversions: (b)
 
 
 
 
 
 
 
Dilutive effect of stock options
640

 
459

 
600

 
396

Dilutive effect of restricted stock units and performance share units
362

 
365

 
438

 
377

Weighted average common shares outstanding — Diluted
180,601

 
179,890

 
180,626

 
179,601

Basic earnings per share
$
0.55

 
$
0.39

 
$
0.87

 
$
0.77

Diluted earnings per share
$
0.55

 
$
0.39

 
$
0.86

 
$
0.76

(a)
Restricted stock unit awards containing rights to non-forfeitable dividends that participate in undistributed earnings with common shareholders are considered participating securities for purposes of computing earnings per share.
(b)
Incremental shares from stock options, restricted stock units and performance share units are computed by the treasury stock method. The weighted average shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented or were otherwise excluded under the treasury stock method. The treasury stock method calculates dilution assuming the exercise of all in-the-money options and vesting of restricted stock units and performance share units, reduced by the repurchase of shares with the proceeds from the assumed exercises and unrecognized compensation expense for outstanding awards. Performance share units will be included in the treasury stock calculation of diluted earnings per share upon achievement of underlying performance or market conditions at the end of the reporting period. See Note 14, "Share-Based Compensation Plans" to the condensed consolidated financial statements for further detail on the performance share units.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Stock options
1,854

 
2,068

 
1,813

 
2,161

Restricted stock units
464

 
582

 
427

 
591

Performance share units
530

 
409

 
467

 
334

Note 7. Inventories
The components of total inventories are summarized as follows: 
(in millions)
June 30,
2017
 
December 31,
2016
Finished goods
$
233

 
$
220

Work in process
52

 
42

Raw materials
269

 
260

Total inventories
$
554

 
$
522



15


Note 8. Property, Plant and Equipment
The components of total property, plant and equipment, net are as follows:
(in millions)
June 30,
2017
 
December 31,
2016
Land, buildings and improvements
$
317

 
$
299

Machinery and equipment
774

 
731

Equipment held for lease or rental
233

 
218

Furniture and fixtures
104

 
95

Construction work in progress
77

 
76

Other
20

 
19

Total property, plant and equipment, gross
1,525

 
1,438

Less accumulated depreciation
898

 
822

Total property, plant and equipment, net
$
627

 
$
616

Depreciation expense of $27 million and $55 million million was recognized in the three and six months ended June 30, 2017, respectively, and $21 million and $41 million for the three and six months ended June 30, 2016.
Note 9. Goodwill and Other Intangible Assets
Goodwill    
Changes in the carrying value of goodwill by reportable segment for the six months ended June 30, 2017 are as follows:
(in millions)
Water
Infrastructure
 
Applied Water
 
Sensus & Analytics
 
Total
Balance as of January 1, 2017
$
1,074

 
$
505

 
$
1,053

 
$
2,632

Activity in 2017
 
 
 
 
 
 
 
Divested/Acquired

 
(2
)
 
(5
)
 
(7
)
Foreign currency and other
34

 
15

 
43

 
92

Balance as of June 30, 2017
$
1,108

 
$
518

 
$
1,091

 
$
2,717

Other Intangible Assets
Information regarding our other intangible assets is as follows:
 
June 30, 2017
 
December 31, 2016
(in millions)
Carrying
Amount
 
Accumulated
Amortization
 
Net
Intangibles
 
Carrying
Amount
 
Accumulated
Amortization
 
Net
Intangibles
Customer and distributor relationships
$
906

 
$
(205
)
 
$
701

 
$
891

 
$
(168
)
 
$
723

Proprietary technology and patents
158

 
(69
)
 
89

 
156

 
(61
)
 
95

Trademarks
142

 
(34
)
 
108

 
139

 
(23
)
 
116

Software
258

 
(136
)
 
122

 
218

 
(118
)
 
100

Other
25

 
(18
)
 
7

 
26

 
(13
)
 
13

Indefinite-lived intangibles
157

 

 
157

 
154

 

 
154

Other Intangibles
$
1,646

 
$
(462
)
 
$
1,184

 
$
1,584

 
$
(383
)
 
$
1,201

Amortization expense related to finite-lived intangible assets was $30 million and $61 million for the three and six months ended June 30, 2017, respectively, and $12 million and $24 million for the three and six months ended June 30, 2016, respectively.

16


During the first quarter of 2017 we determined that the intended use of a finite lived trade name within our Applied Water segment had changed. Accordingly we recorded a $4 million impairment charge. The charge was calculated using income approach, which is considered a Level 3 input for fair value measurement, and is reflected in “Restructuring and asset impairment charges” in our Condensed Consolidated Income Statements.
Note 10. Derivative Financial Instruments
Risk Management Objective of Using Derivatives
We are exposed to certain risks arising from both our business operations and economic conditions, and principally manage our exposures to these risks through management of our core business activities. Certain of our foreign operations expose us to fluctuations of foreign interest rates and exchange rates that may impact revenue, expenses, cash receipts, cash payments, and the value of our stockholders' equity. We enter into derivative financial instruments to protect the value or fix the amount of certain cash flows in terms of the functional currency of the business unit with that exposure and reduce the volatility in stockholders' equity.
Cash Flow Hedges of Foreign Exchange Risk
We are exposed to fluctuations in various foreign currencies against our functional currencies. We use foreign currency derivatives, including currency forward agreements, to manage our exposure to fluctuations in the various exchange rates. Currency forward agreements involve fixing the foreign currency exchange rate for delivery of a specified amount of foreign currency on a specified date.
Certain business units with exposure to foreign currency exchange risks have designated certain currency forward agreements as cash flow hedges of forecasted intercompany inventory purchases and sales. Our principal currency exposures relate to the Euro, Swedish Krona, British Pound, Canadian Dollar, Polish Zloty Australian Dollar and Hungarian Forint. We had foreign exchange contracts with purchase notional amounts totaling $124 million as of June 30, 2017. As of June 30, 2017, our most significant foreign currency derivatives included contracts to purchase Swedish Krona and sell Euro, sell U.S. Dollar and purchase Euro, sell British Pound and purchase Euro, and to purchase Polish Zloty and sell Euro. The purchased notional amounts associated with these currency derivatives are $51 million, $29 million, $16 million, and $13 million, respectively. As of December 31, 2016 we did not hold any foreign exchange contracts.
Hedges of Net Investments in Foreign Operations
We are exposed to changes in foreign currencies impacting our net investments held in foreign subsidiaries.
Cross Currency Swaps
Beginning in 2015, we entered into cross currency swaps to manage our exposure to fluctuations in the Euro-U.S. Dollar exchange rate. The total notional amount of derivative instruments designated as net investment hedges was $427 million and $391 million as of June 30, 2017 and December 31, 2016, respectively.
Foreign Currency Denominated Debt
On March 11, 2016, we issued 2.250% Senior Notes of €500 million aggregate principal amount due March 2023. We designated the entirety of the outstanding balance, or $566 million, net of unamortized discount, as a hedge of a net investment in certain foreign subsidiaries.

17


The table below presents the effect of our derivative financial instruments on the Condensed Consolidated Income Statements and Statements of Comprehensive Income. 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in millions)
2017
 
2016
 
2017
 
2016
Cash Flow Hedges
 
 
 
 
 
 
 
Foreign Exchange Contracts
 
 
 
 
 
 
 
Amount of gain (loss) recognized in OCI (a)
$
3

 
$
(4
)
 
$
5

 
$

Amount of gain reclassified from OCI into revenue (a)
(1
)
 
(1
)
 
(1
)
 

Amount of (gain) loss reclassified from OCI into cost of revenue (a)

 

 
1

 
(1
)
 
 
 
 
 
 
 
 
Net Investment Hedges
 
 
 
 
 
 
 
Cross Currency Swaps
 
 
 
 
 
 
 
Amount of gain (loss) recognized in OCI (a)
$
(23
)
 
$
11

 
$
(31
)
 
$

Foreign Currency Denominated Debt
 
 
 
 
 
 
 
Amount of gain (loss) recognized in OCI (a)
$
(34
)
 
$
10

 
$
(48
)
 
$
(5
)
(a)
Effective portion
As of June 30, 2017, $4 million of net gains on cash flow hedges are expected to be reclassified into earnings in the next 12 months. The ineffective portion of a cash flow hedge is recognized immediately in selling, general and administrative expenses in the Condensed Consolidated Income Statements and was not material for the three and six months ended June 30, 2017 and 2016.
As of June 30, 2017, no gains or losses on the net investment hedges are expected to be reclassified into earnings over their duration. The net investment hedges did not experience any ineffectiveness for the three and six months ended June 30, 2017.
The fair values of our derivative assets and liabilities are measured on a recurring basis using Level 2 inputs and are determined through the use of models that consider various assumptions including yield curves, time value and other measurements.
The fair values of our foreign exchange contracts currently included in our hedging program designated as hedging instruments were as follows:
(in millions)
June 30,
2017
 
December 31,
2016
Derivatives designated as hedging instruments
 
 
 
Assets
 
 
 
Cash Flow Hedges
 
 
 
  Other current assets
$
3

 
$

Liabilities
 
 
 
Cash Flow Hedges
 
 
 
  Other current liabilities
$
(1
)
 
$

Net Investment Hedges
 
 
 
Other non-current liabilities
$
(40
)
 
$
(6
)
The fair value of our long-term debt, due in 2023, designated as a net investment hedge was $609 million and $555 million as of June 30, 2017 and December 31, 2016, respectively.

18


Note 11. Accrued and Other Current Liabilities
The components of total accrued and other current liabilities are as follows:
(in millions)
June 30,
2017
 
December 31,
2016
Compensation and other employee benefits
$
182

 
$
182

Customer-related liabilities
99

 
80

Accrued taxes
66

 
63

Accrued warranty costs
58

 
64

Other accrued liabilities
110

 
132

Total accrued and other current liabilities
$
515

 
$
521

Note 12. Credit Facilities and Debt
Total debt outstanding is summarized as follows:
(in millions)
June 30,
2017
 
December 31,
2016
4.875% Senior Notes due 2021 (a)
$
600

 
$
600

2.250% Senior Notes due 2023 (a)
571

 
522

3.250% Senior Notes due 2026 (a)
500

 
500

4.375% Senior Notes due 2046 (a)
400

 
400

Commercial paper
99

 
65

Research and development facility agreement
42

 
38

Research and development finance contract
120

 
110

Term loan
103

 
157

Debt issuance costs and unamortized discount (b)
(24
)
 
(24
)
Total debt
2,411

 
2,368

Less: short-term borrowings and current maturities of long-term debt
243

 
260

Total long-term debt
$
2,168

 
$
2,108

(a)
The fair value of our Senior Notes was determined using quoted prices in active markets for identical securities, which are considered Level 1 inputs. The fair value of our Senior Notes due 2021 was $650 million and $651 million as of June 30, 2017 and December 31, 2016, respectively. The fair value of our Senior Notes due 2023 was $609 million and $555 million as of June 30, 2017 and December 31, 2016, respectively. The fair value of our Senior Notes due 2026 was $500 million and $487 million as of June 30, 2017 and December 31, 2016, respectively.The fair value of our Senior Notes due 2046 was $416 million and $397 million as of June 30, 2017 and December 31, 2016, respectively.
(b)
The debt issuance costs and unamortized discount are recognized as a reduction in the carrying value of the Senior Notes in the Condensed Consolidated Balance Sheets and are being amortized to interest expense in our Condensed Consolidated Income Statements over the expected remaining terms of the Senior Notes.
Senior Notes
On September 20, 2011, we issued 3.550% Senior Notes of $600 million aggregate principal amount due September 2016 (the "Senior Notes due 2016") and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021"). On March 11, 2016, we issued 2.250% Senior Notes of €500 million aggregate principal amount due March 2023 (the "Senior Notes due 2023"). On October 11, 2016, we issued 3.250% Senior Notes of $500 million aggregate principal amount due October 2026 (the “Senior Notes due 2026”) and 4.375% Senior Notes of $400 million aggregate principal amount due October 2046 (the “Senior Notes due 2046” and, together with the Senior Notes due 2021, the Senior Notes due 2023 and the Senior Notes due 2026, the “Senior Notes”).
The Senior Notes include covenants that restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale and leaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/or customary grace and cure periods). We may redeem the

19


Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal to the principal amount of the Senior Notes to be redeemed, plus a make-whole premium. We may also redeem the Senior Notes in certain other circumstances, as set forth in the applicable Senior Notes indenture.
If a change of control triggering event (as defined in the applicable Senior Notes indenture) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plus accrued and unpaid interest to the date of repurchase.
Interest on the Senior Notes due 2021 is payable on April 1 and October 1 of each year. Interest on the Senior Notes due 2023 is payable on March 11 of each year. Interest on the Senior Notes due 2026 and the Senior Notes due 2046 is payable on May 1 and November 1 of each year beginning on May 1, 2017. As of June 30, 2017, we were in compliance with all covenants for the Senior Notes.
We used the net proceeds of the Senior Notes due 2026 and the Senior Notes due 2046, together with cash on hand, proceeds from issuances under our existing commercial paper program and borrowings under the Term Facility (as described below), to fund the acquisition of Sensus (refer to Note 3 for further information on the Sensus acquisition).
Credit Facilities
Five-Year Revolving Credit Facility
Effective March 27, 2015, Xylem entered into a Five-Year Revolving Credit Facility (the "Credit Facility") with Citibank, N.A., as administrative agent, and a syndicate of lenders. The Credit Facility provides for an aggregate principal amount of up to $600 million of: (i) revolving extensions of credit (the "revolving loans") outstanding at any time and (ii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time. The Credit Facility provides for increases of up to $200 million for a possible maximum total of $800 million in aggregate principal amount at our request and with the consent of the institutions providing such increased commitments.
At our election, the interest rate per annum applicable to the revolving loans will be based on either (i) a Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin or (ii) a fluctuating rate of interest determined by reference to the greatest of: (a) the prime rate of Citibank, N.A., (b) the U.S. Federal funds effective rate plus half of 1% or (c) the Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, in each case, plus an applicable margin.
In accordance with the terms of an amendment to the Credit Facility dated August 30, 2016, we may not exceed a maximum leverage ratio of 4.00 to 1.00 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) for a period of four full fiscal quarters following the Sensus acquisition and a maximum leverage ratio of 3.50 to 1.00 through the rest of the term. The Credit Facility also contains limitations on, among other things, incurring secured debt, granting liens, entering into sale and leaseback transactions, mergers, consolidations, liquidations, dissolutions and sales of assets. In addition, the Credit Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. As of June 30, 2017 the Credit Facility was undrawn and we are in compliance with all covenants.
European Investment Bank - R&D Finance Contract
On October 28, 2016, the Company entered into a Finance Contract (the “Finance Contract”) with the European Investment Bank (the “EIB”). The Company's wholly owned subsidiaries in Luxembourg, Xylem Holdings S.á r.l. and Xylem International S.á r.l., are the borrowers under the Finance Contract and Xylem Inc. is the Guarantor.  The Finance Contract provides for up to €105 million (approximately $120 million) to finance research, development and innovation projects in the field of sustainable water and wastewater solutions during the period from 2017 through 2019 in Sweden, Germany, Italy, UK, Hungary and Austria. The Company has unconditionally guaranteed the performance of the borrowers under the Finance Contract. Under the Finance Contract, the borrowers are able to draw loans on or before April 28, 2018, with a maturity of no longer than 11 years.
Both the Finance Contract and the R&D Facility Agreement (described below) are subject to the same leverage ratio as the Credit Facility. Both agreements also contain limitations on, among other things, incurring debt, granting liens, and entering into sale and leaseback transactions, as well as other terms and conditions, such as customary representations and warranties, additional covenants and customary events of default.

20


Both the Finance Contract and the R&D Facility Agreement provide for fixed rate loans and floating rate loans. Under the Finance Contract, the interest rate per annum applicable to fixed rate loans is at a fixed percentage rate per annum specified by the EIB which includes the applicable margin. The interest rate per annum applicable to floating rate loans is at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S. Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin is 59 basis points (0.59%). As of June 30, 2017 and December 31, 2016, $120 million and $110 million were outstanding under the Finance Contract, respectively.
European Investment Bank - R&D Facility Agreement
On December 3, 2015, the Company amended and restated its Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with the EIB to amend the maturity date. The Facility provides an aggregate principal amount of up to €120 million (approximately $137 million) to finance research projects and infrastructure development in the European Union. The Company's wholly owned subsidiaries in Luxembourg, Xylem Holdings S.á r.l. and Xylem International S.á r.l., are the borrowers under the R&D Facility Agreement. The obligations of the borrowers under the R&D Facility Agreement are guaranteed by the Company under an Amended and Restated Deed of Guarantee, dated as of December 4, 2013, in favor of the EIB.
Under the R&D Facility Agreement, the borrower was able to draw loans on or before March 31, 2016 with a maturity of no longer than 12 years. As of June 30, 2017 and December 31, 2016 $42 million and $38 million were outstanding, respectively, under the R&D Facility Agreement. Although the borrowing term for this arrangement is up to five years, we have classified it as short-term debt on our Consolidated Balance Sheets since we intend to repay this obligation in less than a year.
Term Loan Facility
On October 24, 2016, the Company’s subsidiary, Xylem Europe GmbH (the “borrower”) entered into a 12-month €150 million (approximately $171 million) term loan facility (the “Term Facility”) the terms of which are set forth in a term loan agreement, among the borrower, the Company, as parent guarantor and ING Bank.  The Company has entered into a parent guarantee in favor of ING Bank also dated October 24, 2016 to secure all present and future obligations of the borrower under the Term Loan Agreement.  The Term Facility was used to partially fund the acquisition of Sensus. The Term Facility will mature on October 26, 2017. The Term Facility bears interest at EURIBOR plus 0.35%. The agreement contains certain representations and warranties, certain affirmative covenants, certain negative covenants, a financial covenant, certain conditions and events of default that are customarily required for similar financings. As of June 30, 2017 and December 31, 2016, $103 million and $157 million were outstanding under the Term Loan Facility, respectively.
Commercial Paper
Our commercial paper program generally serves as a means of short-term funding and has a combined outstanding limit of $600 million inclusive of the Five-Year Revolving Credit Facility. As of June 30, 2017 and December 31, 2016 $99 million and $65 million of the Company’s $600 million commercial paper program was outstanding at a weighted average interest rate of 1.44% and 1.12%, respectively. We will periodically borrow under this program and may borrow under it in future periods.

21


Note 13. Postretirement Benefit Plans
The components of net periodic benefit cost for our defined benefit pension plans are as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in millions)
2017
 
2016
 
2017
 
2016
Domestic defined benefit pension plans:
 
 
 
 
 
 
 
Service cost
$
1

 
$
1

 
$
2

 
$
1

Interest cost
1

 
1

 
2

 
2

Expected return on plan assets
(1
)
 
(1
)
 
(3
)
 
(2
)
Amortization of net actuarial loss

 

 
1

 
1

Net periodic benefit cost
$
1

 
$
1

 
$
2

 
$
2

International defined benefit pension plans:
 
 
 
 
 
 
 
Service cost
$
3

 
$
2

 
$
6

 
$
5

Interest cost
5

 
6

 
10

 
12

Expected return on plan assets
(8
)
 
(8
)
 
(16
)
 
(17
)
Amortization of net actuarial loss
2

 
2

 
4

 
4

Net periodic benefit cost
$
2

 
$
2

 
$
4

 
$
4

Total net periodic benefit cost
$
3

 
$
3

 
$
6

 
$
6

The total net periodic benefit cost for other postretirement employee benefit plans was less than $1 million and $1 million including amounts recognized in other comprehensive income ("OCI") of less than $1 million, for both the three and six months ended June 30, 2017. The total net periodic benefit cost for other postretirement employee benefit plans was $1 million and $2 million, including amounts recognized in OCI of less than $1 million, for both the three and six months ended June 30, 2016.
We contributed $13 million and $14 million to our defined benefit plans during the six months ended June 30, 2017 and 2016, respectively. Additional contributions ranging between approximately $9 million and $15 million are expected during the remainder of 2017.
Note 14. Share-Based Compensation Plans
Share-based compensation expense was $5 million and $11 million during the three and six months ended June 30, 2017, respectively, and $5 million and $10 million during the three and six months ended June 30, 2016, respectively. The unrecognized compensation expense related to our stock options, restricted stock units and performance share units was $8 million, $25 million and $15 million, respectively, at June 30, 2017 and is expected to be recognized over a weighted average period of 2.1, 2.1 and 2.2 years, respectively. The amount of cash received from the exercise of stock options was $7 million and $16 million for the six months ended June 30, 2017 and 2016, respectively.

22


Stock Option Grants
The following is a summary of the changes in outstanding stock options for the six months ended June 30, 2017. 
 
Share units            (in thousands)
 
Weighted
Average
Exercise
Price / Share
 
Weighted  Average
Remaining
Contractual
Term (Years)
 
Aggregate Intrinsic Value (in millions)
Outstanding at January 1, 2017
2,126

 
$
33.71

 
6.9
 
 
Granted
498

 
48.33

 
 
 
 
Exercised
(217
)
 
31.70

 
 
 
 
Forfeited and expired
(47
)
 
42.00

 
 
 
 
Outstanding at June 30, 2017
2,360

 
$
36.81

 
7.2
 
$
44

Options exercisable at June 30, 2017
1,423

 
$
32.89

 
6.0
 
$
32

Vested and expected to vest as of June 30, 2017
2,239

 
$
36.32

 
7.1
 
$
43

The total intrinsic value of options exercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during the six months ended June 30, 2017 was $4.5 million.
Stock Option Fair Value
The fair value of each option grant was estimated on the date of grant using the binomial lattice pricing model which incorporates multiple and variable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility and changes in dividends. The following are weighted-average assumptions for 2017 grants.
Volatility
25.40

%
Risk-free interest rate
2.07

%
Dividend yield
1.49

%
Expected term (in years)
5.1

 
Weighted-average fair value / share
$
10.65

 
Expected volatility is calculated based on a weighted analysis of historic and implied volatility measures for a set of peer companies and Xylem. We use historical data to estimate option exercise and employee termination behavior within the valuation model. Employee groups and option characteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options are expected to remain outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of option grant.
Restricted Stock Unit Grants
The following is a summary of restricted stock unit activity for the six months ended June 30, 2017. The fair value of the restricted stock units is equal to the closing share price on the date of the grant. 
 
Share units (in thousands)
 
Weighted
Average
Grant Date
Fair Value /Share
Outstanding at January 1, 2017
899

 
$
37.67

Granted
332

 
49.26

Vested
(353
)
 
38.27

Forfeited
(42
)
 
40.74

Outstanding at June 30, 2017
836

 
$
36.05


23


ROIC Performance Share Unit Grants
The following is a summary of Return on Invested Capital ("ROIC") performance share unit grants for the six months ended June 30, 2017. The fair value of the ROIC performance share units is equal to the closing share price on the date of the grant. 
 
Share units (in thousands)
 
Weighted
Average
Grant Date
Fair Value /Share
Outstanding at January 1, 2017
250

 
$
37.11

Granted
110

 
48.33

Vested

 

Forfeited
(67
)
 
38.40

Outstanding at June 30, 2017
293

 
$
41.01

TSR Performance Share Units Grants
The following is a summary of our Total Shareholder Return ("TSR") performance share unit grants for the six months ended June 30, 2017.
 
Share units (in thousands)
 
Weighted
Average
Grant Date
Fair Value /Share
Outstanding at January 1, 2017
108

 
$
46.15

Granted
110

 
45.43

Vested

 

Forfeited
(9
)
 
44.14

Outstanding at June 30, 2017
209

 
$
47.20

The fair value of TSR performance share units was calculated on the date of grant using a Monte Carlo simulation model utilizing several key assumptions, including expected Company and peer company share price volatility, correlation coefficients between peers, the risk-free rate of return, the expected dividend yield and other award design features. The following are weighted-average assumptions for 2017 grants.
Volatility
30.5
%
Risk-free interest rate
1.51
%
Dividend yield
1.49
%

Note 15. Capital Stock
On August 24, 2015, our Board of Directors authorized the repurchase of up to $500 million in shares with no expiration date. The program's objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. For the three and six months ended June 30, 2017 we repurchased 0.1 million shares for $7 million. There were no shares repurchased under this program during the three and six months ended June 30, 2016. There are up to $413 million in shares that may still be purchased under this plan as of June 30, 2017.
On August 18, 2012, our 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. For the three and six months ended June 30, 2017 we repurchased 0.25 million shares for $13 million. There were no shares repurchased under this program during the three and six months ended June 30, 2016. As of June 30, 2017, we have exhausted the authorized amount to repurchase shares under this plan.

24


Aside from the aforementioned repurchase programs, we repurchased less than 0.1 million shares and 0.1 million shares for less than $1 million and $5 million for the three and six months ended June 30, 2017, respectively, in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock units. Likewise, we repurchased less than 0.1 million shares and 0.1 million shares for less than $1 million and $3 million for the three and six months ended June 30, 2016, respectively.
Note 16. Accumulated Other Comprehensive Income (Loss)
The following table provides the components of accumulated other comprehensive income (loss) for the three months ended June 30, 2017:
(in millions)
Foreign Currency Translation
 
Postretirement Benefit Plans
 
Derivative Instruments
 
Total
Balance at April 1, 2017
$
(103
)
 
$
(175
)
 
$
2

 
$
(276
)
Foreign currency translation adjustment
30

 

 

 
30

Tax on foreign currency translation adjustment
22

 

 

 
22

Amortization of net actuarial loss on postretirement benefit plans into:
 
 
 
 
 
 
 
Selling, general and administrative expenses

 
1

 

 
1

Other non-operating income

 
1

 

 
1

Income tax impact on amortization of postretirement benefit plan items

 

 

 

Unrealized gain on derivative hedge agreements

 

 
3

 
3

Reclassification of unrealized gain on derivative hedge agreements into revenue

 

 
(1
)
 
(1
)
Balance at June 30, 2017
$
(51
)
 
$
(173
)
 
$
4

 
$
(220
)
The following table provides the components of accumulated other comprehensive income (loss) for the six months ended June 30, 2017:
(in millions)
Foreign Currency Translation
 
Postretirement Benefit Plans
 
Derivative Instruments
 
Total
Balance at January 1, 2017
$
(140
)
 
$
(177
)
 
$
(1
)
 
$
(318
)
Foreign currency translation adjustment
59

 

 

 
59

Tax on foreign currency translation adjustment
30

 

 

 
30

Amortization of net actuarial loss on postretirement benefit plans into:
 
 
 
 
 
 
 
Cost of revenue

 
1

 

 
1

Selling, general and administrative expenses

 
3

 

 
3

Other non-operating income

 
1

 

 
1

Income tax impact on amortization of postretirement benefit plan items

 
(1
)
 

 
(1
)
Unrealized gain on derivative hedge agreements

 

 
5

 
5

Reclassification of unrealized loss on derivative hedge agreements into cost of revenue

 

 
1

 
1

Reclassification of unrealized gain on derivative hedge agreements into revenue

 

 
(1
)
 
(1
)
Balance at June 30, 2017
$
(51
)
 
$
(173
)
 
$
4

 
$
(220
)

25


Note 17. Commitments and Contingencies
Legal Proceedings
From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses, including acquisitions and divestitures, intellectual property matters, product liability and personal injury claims, employment and pension matters, government and commercial contract disputes.
From time to time claims may be asserted against Xylem alleging injury caused by any of our products resulting from asbestos exposure. We believe there are numerous legal defenses available for such claims and would defend ourselves vigorously. Pursuant to the Distribution Agreement among ITT Corporation (now ITT LLC), Exelis and Xylem, ITT Corporation (now ITT LLC) has an obligation to indemnify, defend and hold Xylem harmless for asbestos product liability matters, including settlements, judgments, and legal defense costs associated with all pending and future claims that may arise from past sales of ITT’s legacy products. We believe ITT Corporation (now ITT LLC) remains a substantial entity with sufficient financial resources to honor its obligations to us.
Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claims, we do not expect that any asserted or unasserted legal claims or proceedings, individually or in aggregate, will have a material adverse effect on our results of operations, or financial condition. We have estimated and accrued $11 million and $11 million as of June 30, 2017 and December 31, 2016, respectively, for these general litigation matters.
Indemnifications
As part of our 2011 spin-off from our former parent, ITT Corporation (now ITT LLC), Exelis Inc. and Xylem will indemnify, defend and hold harmless each of the other parties with respect to such parties’ assumed or retained liabilities under the Distribution Agreement and breaches of the Distribution Agreement or related spin agreements. The former parent’s indemnification obligations include asserted and unasserted asbestos and silica liability claims that relate to the presence or alleged presence of asbestos or silica in products manufactured, repaired or sold prior to October 31, 2011, the Distribution Date, subject to limited exceptions with respect to certain employee claims, or in the structure or material of any building or facility, subject to exceptions with respect to employee claims relating to Xylem buildings or facilities. The indemnification associated with pending and future asbestos claims does not expire. Xylem has not recorded a liability for material matters for which we expect to be indemnified by the former parent or Exelis Inc. through the Distribution Agreement and we are not aware of any claims or other circumstances that would give rise to material payments from us under such indemnifications. On May 29, 2015, Harris Inc. acquired Exelis.  As the parent of Exelis, Harris Inc. is responsible for Exelis’s indemnification obligations under the Distribution Agreement.
Guarantees
We obtain certain stand-by letters of credit, bank guarantees and surety bonds from third-party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance related requirements. As of June 30, 2017 and December 31, 2016, the amount of stand-by letters of credit, bank guarantees and surety bonds was $248 million and $218 million, respectively.
Environmental
In the ordinary course of business, we are subject to federal, state, local, and foreign environmental laws and regulations. We are responsible, or are alleged to be responsible, for ongoing environmental investigation and remediation of sites in various countries. These sites are in various stages of investigation and/or remediation and in many of these proceedings our liability is considered de minimis. We have received notification from the U.S. Environmental Protection Agency, and from similar state and foreign environmental agencies, that a number of sites formerly or currently owned and/or operated by Xylem or for which we are responsible under the Distribution Agreement, and other properties or water supplies that may be or have been impacted from those operations, contain disposed or recycled materials or wastes and require environmental investigation and/or remediation. These sites include instances where we have been identified as a potentially responsible party under federal and state environmental laws and regulations.
Accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. Our accrued liabilities for these environmental matters represent the best estimates related to the

26


investigation and remediation of environmental media such as water, soil, soil vapor, air and structures, as well as related legal fees. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on an undiscounted basis. We have estimated and accrued $4 million and $4 million as of June 30, 2017 and December 31, 2016, respectively, for environmental matters.
It is difficult to estimate the final costs of investigation and remediation due to various factors, including incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the extent of investigation or remediation and our share, if any, of liability for such conditions, the selection of alternative remedial approaches, and changes in environmental standards and regulatory requirements. We believe the total amount accrued is reasonable based on existing facts and circumstances.
Warranties
We warrant numerous products, the terms of which vary widely. In general, we warrant products against defect and specific non-performance. The table below provides the changes in our product warranty accrual.
(in millions)
2017
 
2016
Warranty accrual – January 1
$
99

 
$
33

Net charges for product warranties in the period
17

 
13

Settlement of warranty claims
(24
)
 
(15
)
Foreign currency and other
2

 
1

Warranty accrual - June 30
$
94

 
$
32

Note 18. Segment Information
Our business has three reportable segments: Water Infrastructure, Applied Water and Sensus & Analytics. When determining the reportable segments, the Company aggregated operating segments based on their similar economic and operating characteristics. The Water Infrastructure segment focuses on the transportation and treatment of water, offering a range of products including water and wastewater pumps, treatment equipment, and controls and systems. The Applied Water segment serves many of the primary uses of water and focuses on the residential, commercial and industrial markets. The Applied Water segment’s major products include pumps, valves, heat exchangers, controls and dispensing equipment. The Sensus & Analytics segment focuses on developing advanced technology solutions that enable intelligent use and conservation of critical water and energy resources as well as analytical instrumentation used in the testing of water. The Sensus & Analytics segment's major products include smart metering, networked communications, measurement and control technologies, software and services including cloud-based analytics, remote monitoring and data management, and testing equipment.
Additionally, we have Regional selling locations, which consist primarily of selling and marketing organizations and related support services, that offer products and services across our reportable segments. Corporate and other consists of corporate office expenses including compensation, benefits, occupancy, depreciation, and other administrative costs, as well as charges related to certain matters, such as environmental matters that are managed at a corporate level and are not included in the business segments in evaluating performance or allocating resources.



27


The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1 in the 2016 Annual Report). The following tables contain financial information for each reportable segment:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in millions)
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
Water Infrastructure
$
482

 
$
484

 
$
901

 
$
924

Applied Water
361

 
366

 
694

 
699

Sensus & Analytics
321

 
82

 
640

 
156

Total
$
1,164

 
$
932

 
$
2,235

 
$
1,779

Operating Income:
 
 
 
 
 
 
 
Water Infrastructure
$
74

 
$
66

 
$
114

 
$
117

Applied Water
49

 
51

 
85

 
90

Sensus & Analytics
29

 
4

 
54

 
7

Corporate and other
(13
)
 
(12
)
 
(28
)
 
(26
)
Total operating income
$
139

 
$
109

 
$
225

 
$
188

Interest expense
$
21

 
$
20

 
$
41

 
$
34

Other non-operating income
3

 
1

 
2

 
1

Gain from sale of business

 

 
5

 

Income before taxes
$
121

 
$
90

 
$
191

 
$
155

Depreciation and Amortization:
 
 
 
 
 
 
 
Water Infrastructure
$
15

 
$
16

 
$
31

 
$
33

Applied Water
6

 
6

 
12

 
12

Sensus & Analytics
30

 
5

 
61

 
10

Regional selling locations (a)
4

 
4

 
8

 
6

Corporate and other
2

 
2

 
4

 
4

Total
$
57

 
$
33

 
$
116

 
$
65

Capital Expenditures:
 
 
 
 
 
 
 
Water Infrastructure
$
13

 
$
13

 
$
27

 
$
32

Applied Water
3

 
3

 
10

 
11

Sensus & Analytics
15

 
2

 
32

 
2

Regional selling locations (b)
3

 
5

 
8

 
15

Corporate and other

 
1

 

 
2

Total
$
34

 
$
24

 
$
77

 
$
62

(a)
Depreciation and amortization expense incurred by the Regional selling locations was included in an overall allocation of Regional selling location costs to the segments; however, a certain portion of that expense was not specifically identified to a segment. That expense is captured in this Regional selling location line.
(b)
Represents capital expenditures incurred by the Regional selling locations not allocated to the segments.

28


The following table contains the total assets for each reportable segment: 
(in millions)
June 30,
2017
 
December 31,
2016
Water Infrastructure
$
1,218

 
$
1,179

Applied Water
1,010

 
990

Sensus & Analytics
3,200

 
3,102

Regional selling locations (a)
1,057

 
965

Corporate and other (b)
222

 
238

Total
$
6,707

 
$
6,474

(a)
The Regional selling locations have assets that consist primarily of cash, accounts receivable and inventory which are not allocated to the segments.
(b)
Corporate and other consists of items pertaining to our corporate headquarters function, which principally consist of cash, deferred tax assets, pension assets and certain property, plant and equipment.

29


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed consolidated financial statements, including the notes, included elsewhere in this report on Form 10-Q (this "Report"). Except as otherwise indicated or unless the context otherwise requires, "Xylem," "we," "us," "our" and the "Company" refer to Xylem Inc. and its subsidiaries. References in the condensed consolidated financial statements to "ITT" or the "former parent" refer to ITT Corporation (now ITT LLC) and its consolidated subsidiaries as of the applicable periods.
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; weather conditions; ability to retain and attract key members of management; our relationship with and the performance of our channel partners; our ability to successfully identify, complete and integrate acquisitions, 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 under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016 ("2016 Annual Report") and with subsequent filings we make with the Securities and Exchange Commission ("SEC").
All forward-looking statements made herein are based on information available to the Company as of the date of this Report.  The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends on December 31. For ease of presentation, the reporting periods included herein are described as ending on the last day of the calendar quarter.
Overview
Xylem is a leading global water technology company. We design, manufacture and service highly engineered solutions ranging across a wide variety of critical applications. O