Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page No.
Audited Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm	54
Consolidated Income Statements for the Years Ended December 31, 2014, 2013 and 2012	55
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012	56
Consolidated Balance Sheets as of December 31, 2014 and December 31, 2013	57
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012	58
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012	59
Notes to Consolidated Financial Statements:
Note 1 Summary of Significant Accounting Policies	60
Note 2 Recently Issued Accounting Pronouncements	66
Note 3 Acquisitions and Divestitures	68
Note 4 Restructuring and Asset Impairment Charges	69
Note 5 Separation Costs	70
Note 6 Other Non-Operating Income, Net	71
Note 7 Income Taxes	71
Note 8 Earnings Per Share	75
Note 9 Inventories	76
Note 10 Property, Plant and Equipment	76
Note 11 Goodwill and Other Intangible Assets	76
Note 12 Derivative Financial Instruments	77
Note 13 Accrued and Other Current Liabilities	78
Note 14 Credit Facilities and Long-Term Debt	79
Note 15 Postretirement Benefit Plans	81
Note 16 Stock-Based Compensation	89
Note 17 Capital Stock	92
Note 18 Accumulated Other Comprehensive Income (Loss)	93
Note 19 Commitment and Contingencies	94
Note 20 Related Party Transactions	96
Note 21 Segment and Geographic Data	97
Note 22 Supplemental Information	99
Note 23 Quarterly Financial Data	99

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Xylem Inc.

Rye Brook, New York

We have audited the accompanying consolidated balance sheets of Xylem Inc. and subsidiaries (the "Company") as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Xylem Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2015 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ Deloitte & Touche LLP

Stamford, Connecticut

February 26, 2015

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS

(In Millions, except per share data)

Year Ended December 31,	2014				2013				2012
Revenue	$	3,916			$	3,837			$	3,791
Cost of revenue	2,403				2,338				2,289
Gross profit	1,513				1,499				1,502
Selling, general and administrative expenses	920				986				914
Research and development expenses	104				104				106
Separation costs	—				4				22
Restructuring and asset impairment charges	26				42				17
Operating income	463				363				443
Interest expense	54				55				55
Other non-operating income (expense), net	1				(10		)		—
Gain from sale of business	11				—				—
Income before taxes	421				298				388
Income tax expense	84				70				91
Net income	$	337			$	228			$	297
Earnings per share:
Basic	$	1.84			$	1.23			$	1.60
Diluted	$	1.83			$	1.22			$	1.59
Weighted average number of shares:
Basic	183.1				185.2				185.8
Diluted	184.2				186.0				186.2
Dividends declared per share	$	0.5120			$	0.4656			$	0.4048

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Millions)

Year Ended December 31,	2014				2013				2012
Net income	$	337			$	228			$	297
Other comprehensive income, before tax:
Foreign currency translation adjustment	(206		)		15				48
Net change in cash flow hedges:
Unrealized (losses) gains	(22		)		1				4
Amount of loss (gain) reclassified into net income	6				—				(3		)
Net change in postretirement benefit plans:
Net (loss) gain	(110		)		34				(84		)
Prior service credit (cost)	17				4				(1		)
Amortization of prior service (credit) cost	(1		)		1				1
Amortization of net actuarial loss	11				17				11
Settlement	1				—				2
Foreign exchange	20				2				(8		)
Other comprehensive (loss) income, before tax	(284		)		74				(30		)
Income tax (benefits) expense related to other comprehensive (loss) income	(18		)		22				(23		)
Other comprehensive (loss) income, net of tax	(266		)		52				(7		)
Comprehensive income	$	71			$	280			$	290

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Millions, except per share amounts)

December 31,	2014				2013
ASSETS
Current assets:
Cash and cash equivalents	$	663			$	533
Receivables, less allowances for discounts and doubtful accounts of $34 and $31 in 2014 and 2013, respectively	771				817
Inventories	486				475
Prepaid and other current assets	144				143
Deferred income tax assets	38				41
Total current assets	2,102				2,009
Property, plant and equipment, net	461				488
Goodwill	1,635				1,718
Other intangible assets, net	431				488
Other non-current assets	235				193
Total assets	$	4,864			$	4,896
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	338			$	332
Accrued and other current liabilities	481				479
Short-term borrowings and current maturities of long-term debt	89				42
Total current liabilities	908				853
Long-term debt	1,199				1,199
Accrued postretirement benefits	388				348
Deferred income tax liabilities	158				191
Other non-current accrued liabilities	84				64
Total liabilities	2,737				2,655
Commitment and Contingencies (Note 19)
Stockholders’ equity:
Common Stock — par value $0.01 per share:
Authorized 750.0 shares, issued 188.9 and 187.6 shares in 2014 and 2013, respectively	2				2
Capital in excess of par value	1,796				1,753
Retained earnings	648				405
Treasury stock – at cost 6.6 shares and 3.0 shares in 2014 and 2013, respectively	(220		)		(86		)
Accumulated other comprehensive income	(99		)		167
Total stockholders’ equity	2,127				2,241
Total liabilities and stockholders’ equity	$	4,864			$	4,896

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Millions)

Year Ended December 31,	2014				2013				2012
Operating Activities
Net income	$	337			$	228			$	297
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	95				99				94
Amortization	47				51				48
Deferred income taxes	(29		)		(14		)		1
Share-based compensation	18				27				22
Restructuring and asset impairment charges, net	26				42				17
Gain from sale of business	(11		)		—				—
Other, net	2				15				2
Payments of restructuring	(26		)		(35		)		(9		)
Contributions to postretirement benefit plans	(35		)		(43		)		(46		)
Changes in assets and liabilities (net of acquisitions):
Changes in receivables	(37		)		(47		)		2
Changes in inventories	(49		)		(39		)		5
Changes in accounts payable	17				4				(4		)
Changes in accrued liabilities	3				18				(28		)
Changes in accrued taxes	25				20				(17		)
Net changes in other assets and liabilities	33				(2		)		12
Net Cash — Operating activities	416				324				396
Investing Activities
Capital expenditures	(119		)		(126		)		(112		)
Proceeds from the sale of property, plant and equipment	2				6				5
Acquisitions of businesses and assets, net of cash acquired	—				(81		)		(41		)
Proceeds from sale of business	30				—				—
Other, net	1				2				1
Net Cash — Investing activities	(86		)		(199		)		(147		)
Financing Activities
Net transfer to former parent	—				—				(9		)
Issuance of short-term debt	52				39				13
Principal payments of debt and capital lease obligations	—				(2		)		(14		)
Repurchase of common stock	(134		)		(73		)		(13		)
Proceeds from exercise of employee stock options	26				22				24
Excess tax benefit from share based compensation	2				1				—
Dividends paid	(94		)		(87		)		(75		)
Other, net	1				—				—
Net Cash — Financing activities	(147		)		(100		)		(74		)
Effect of exchange rate changes on cash	(53		)		4				11
Net change in cash and cash equivalents	130				29				186
Cash and cash equivalents at beginning of year	533				504				318
Cash and cash equivalents at end of year	$	663			$	533			$	504
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest	$	51			$	51			$	53
Income taxes (net of refunds received)	$	81			$	65			$	104

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(In Millions, except per share amounts)

	Common Stock				Additional Paid-In Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balance at January 1, 2012	2				1,663				44				122				—				1,831
Net income									297												297
Other comprehensive loss, net													(7		)						(7		)
Dividends declared ($0.4048 per share)									(77		)										(77		)
Stock incentive plan activity					43																43
Repurchase of common stock																	(13		)		(13		)
Balance at December 31, 2012	$	2			$	1,706			$	264			$	115			$	(13	)		$	2,074
Net income									228												228
Other comprehensive income, net													52								52
Dividends declared ($0.4656 per share)									(87		)										(87		)
Stock incentive plan activity					47																47
Repurchase of common stock																	(73		)		(73		)
Balance at December 31, 2013	$	2			$	1,753			$	405			$	167			$	(86	)		$	2,241
Net income									337												337
Other comprehensive income, net													(266		)						(266		)
Dividends declared ($0.5120 per share)									(94		)										(94		)
Stock incentive plan activity					43																43
Repurchase of common stock																	(134		)		(134		)
Balance at December 31, 2014	$	2			$	1,796			$	648			$	(99	)		$	(220	)		$	2,127

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Xylem Inc. (“Xylem” or the “Company”) is a leading equipment and service provider for water and wastewater applications with a broad portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment. Xylem operates in two segments, Water Infrastructure and Applied Water. The Water Infrastructure segment focuses on the transportation, treatment and testing of water, offering a range of products including water and wastewater pumps, treatment and testing equipment, and controls and systems. The Applied Water segment encompasses all the uses of water and focuses on the residential, commercial, industrial and agricultural markets. The Applied Water segment’s major products include pumps, valves, heat exchangers, controls and dispensing equipment.

On October 31, 2011 (the "Distribution Date"), ITT Corporation (“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 the Distribution Agreement, dated as of October 25, 2011 (the “Distribution Agreement”), among ITT, Exelis Inc. (“Exelis”) and Xylem. Xylem Inc. was incorporated in Indiana on May 4, 2011 in connection with the Spin-off.

Hereinafter, 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 notes to the consolidated financial statements to “ITT” or “ former parent” refers to ITT Corporation and its consolidated subsidiaries (other than Xylem Inc.).

Basis of Presentation

The 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 intracompany transactions between our businesses have been eliminated.

In 2014, we began implementing an organizational redesign to integrate its commercial teams within geographical regions. The integration of our commercial teams creates a cross Xylem sales and marketing organization shifting from a dedicated product line organizational structure. This sales structure is largely in place in the Company’s European, Middle East, Africa and Asia regions and to a lesser extent in our other regions. While this organizational redesign did not change the Company’s reportable segments, it had implications on how the Company manages the business, the most significant of which was the shift of certain responsibilities, namely customer and market related activities, into the regional selling organizations. These changes and the related measurement system were effective in the fourth quarter 2014 and as a result, the Company has reported its financial performance based on the new organizational design. Segment orders, revenue and operating income are reallocated between the Company’s two reportable segments, Applied Water and Water Infrastructure. The Company has recast certain historical amounts between the Company’s two 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.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the 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.

Consolidation Principles

We consolidate companies in which we have a controlling financial interest or when Xylem is considered the primary beneficiary of a variable interest entity. We account for investments in companies over which we have the ability to exercise significant influence but do not hold a controlling financial interest under the equity method, and we record our proportionate share of income or losses in the Consolidated Income Statements. Equity method investments are reviewed for impairment when events or circumstances indicate the investment may be other than

temporarily impaired. This requires significant judgment, including an assessment of the investee’s financial condition, the possibility of subsequent rounds of financing, and the investee’s historical and projected results of operations. If the actual results of operations for the investee are significantly different from projections, we may incur future charges for the impairment of these investments.

Foreign Currency Translation

The national currencies of our foreign companies are generally the functional currencies. Balance sheet accounts are translated at the exchange rate in effect at the end of each period; income statement accounts are translated at the average rates of exchange prevailing during the period. Gains and losses on foreign currency translations are reflected in the cumulative translation adjustments component of stockholders’ equity. Net gains or losses from foreign currency transactions are reported currently in selling, general and administrative expenses.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectability is reasonably assured and delivery has occurred or services have been rendered. For product sales, other than long-term construction-type contracts, we recognize revenue at the time title, and risks and rewards of ownership pass, which is generally when products are shipped. Certain contracts with customers require delivery, installation, testing, certification or other acceptance provisions to be satisfied before revenue is recognized. We recognize revenue on product sales to channel partners, including resellers, distributors or value-added solution providers at the time of sale when the channel partners have economic substance apart from Xylem and Xylem has completed its obligations related to the sale. Revenue from the rental of equipment is recognized over the rental period. Service revenue is recognized as services are performed.

For agreements that contain multiple deliverables, we recognize revenue based on the relative selling price if the deliverable has stand-alone value to the customer and, in arrangements that include a general right of return relative to the delivered element, performance of the undelivered element is considered probable and substantially in the Company’s control. The selling price for a deliverable is based on vendor-specific objective evidence of selling price (“VSOE”), if available, third-party evidence of selling price (“TPE”) if VSOE is not available, or best estimated selling price, if neither VSOE nor TPE is available.

The deliverables in our arrangements with multiple elements include various products and may include related services, such as installation and start-up services. We allocate arrangement consideration based on the relative selling prices of the separate units of accounting determined in accordance with the hierarchy described above. For deliverables that are sold separately, we establish VSOE based on the price when the deliverable is sold separately. We establish TPE, generally for services, based on prices similarly situated customers pay for similar services from third-party vendors. For those deliverables for which we are unable to establish VSOE or TPE, we estimate the selling price considering various factors including market and pricing trends, geography, product customization, and profit objectives. Revenue for multiple element arrangements is recognized when the appropriate revenue recognition criteria for the individual deliverable have been satisfied.

Certain businesses enter into long-term construction-type sales contracts for which revenue is recognized under the percentage-of-completion method based upon percentage of costs incurred to total estimated costs.

Shipping and Handling Costs

Shipping and handling costs are recorded as a component of cost of revenue.

Share-Based Compensation

Share-based awards issued to employees and members of the Board of Directors include non-qualified stock options, restricted stock awards and performance-based awards. Compensation costs resulting from share-based payment transactions are recognized primarily within selling, general and administrative expenses, at fair value over the requisite service period (typically three years) on a straight-line basis. The calculated compensation cost is adjusted based on an estimate of awards ultimately expected to vest. For performance-based awards, the calculated compensation cost is adjusted based on an estimate of awards ultimately expected to vest and our assessment of the probable outcome of the performance condition.The fair value of a non-qualified stock option is determined on the date of grant using a binomial lattice pricing model incorporating multiple and variable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility and changes in dividends. The fair value of restricted stock awards is determined using the closing price of our common

stock on date of grant. The fair value of performance-based share awards at 100% target is determined using the closing price of our common stock on date of grant.

Research and Development

We conduct research and development activities, which consist primarily of the development of new products, product applications, and manufacturing processes. These costs are charged to expense as incurred.

Exit and Disposal Costs

We periodically initiate management-approved restructuring activities to achieve cost savings through reduced operational redundancies and to position ourselves strategically in the market in response to prevailing economic conditions and associated customer demand. Costs associated with restructuring actions can include severance, infrastructure charges to vacate facilities or consolidate operations, contract termination costs and other related charges. For involuntary separation plans, a liability is recognized when it is probable and reasonably estimable. For voluntary separation plans, a liability is recognized when the employee irrevocably accepts the voluntary termination. For one-time termination benefits, such as additional severance pay or benefit payouts, and other exit costs, such as lease termination costs, the liability is measured and recognized initially at fair value in the period in which the liability is incurred, with subsequent changes to the liability recognized as adjustments in the period of change.

Deferred Financing Costs

Deferred financing costs represent costs incurred in conjunction with our debt financing activities and are capitalized in other assets and amortized over the life of the related financing arrangements. If the debt is retired early, the related unamortized deferred financing costs are written off in the period the debt is retired and are recorded in the results of operations under the caption “interest expense.”

Income Taxes

Income taxes are calculated using the asset and liability method. Deferred tax assets and liabilities are determined based on the estimated future tax effects of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities, as measured by the current enacted tax rates.

We maintain valuation allowances when it is more likely than not that all or a portion of a deferred asset will not be realized. The valuation allowance is intended in part to provide for the uncertainty regarding the ultimate utilization of our U.S. capital loss carryforwards, U.S. foreign tax credit carryovers, and foreign net operating loss carryforwards. In determining whether a valuation allowance is warranted, we consider all positive and negative evidence and all sources of taxable income such as prior earnings history, expected future earnings, carryback and carryforward periods and tax strategies to estimate if sufficient future taxable income will be generated to realize the deferred tax asset. The assessment of the adequacy of our valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates, or we adjust these estimates in future periods for current trends or expected changes in our estimating assumptions, we may need to modify the level of valuation allowance that could materially impact our business, financial condition and results of operations.

Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan to reinvest such earnings indefinitely outside the United States. We plan foreign earnings remittance amounts based on projected cash flow needs, as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on these assumptions, we estimate the amount we will distribute to the United States and provide the U.S. federal taxes due on these amounts. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our effective tax rate.

Tax benefits are recognized for an uncertain tax position when, in management’s judgment, it is more likely than not that the position will be sustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, the tax benefit is measured as the largest amount that is judged to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. The liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances and when new information becomes available. Such adjustments are recognized in the period in which they are identified. The effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent

adjustments as considered appropriate by management. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe our liability for unrecognized tax benefits is adequate. We classify interest relating to unrecognized tax benefits as a component of other non-operating (expense) income, net and tax penalties as a component of income tax expense in our Consolidated Income Statements.

Earnings Per Share

We present two calculations of earnings per share (“EPS”). “Basic” EPS equals net income divided by weighted average shares outstanding during the period. “Diluted” EPS equals net income divided by the sum of weighted average common shares outstanding during the period plus potentially dilutive shares. Potentially dilutive common shares that are anti-dilutive are excluded from diluted EPS.

Cash Equivalents

We consider all liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Receivables and Allowance for Doubtful Accounts and Cash Discounts

Receivables primarily comprise uncollected amounts owed to us from transactions with customers and are presented net of allowances for doubtful accounts and cash discounts.

We determine our allowance for doubtful accounts using a combination of factors to reduce our trade receivable balances to their estimated net realizable amount. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, macroeconomic trends and conditions, significant one-time events, historical experience and the financial condition of customers. We record a specific reserve for individual accounts when we become aware of specific customer circumstances, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. The past due or delinquency status of a receivable is based on the contractual payment terms of the receivable. If circumstances related to the specific customer change, we adjust estimates of the recoverability of receivables as appropriate. We determine our allowance for cash discounts primarily based on historical experience with customers.

Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and their dispersion across many different geographical regions. We perform ongoing credit evaluations of the financial condition of our third-party distributors, resellers and other customers and require collateral, such as letters of credit and bank guarantees, in certain circumstances. As of December 31, 2014 and 2013 we do not believe we have any significant concentrations of credit risk.

Inventories

Inventories, which include the costs of material, labor and overhead, are stated at the lower of cost or market using the first in, first out ("FIFO") method. Estimated losses from obsolete and slow-moving inventories are recorded to reduce inventory values to their estimated net realizable value. Our manufacturing operations recognize costs of sales using standard costs with full overhead absorption, which generally approximates actual cost.

Property, Plant and Equipment

These assets are recorded at historical cost and are depreciated using the straight-line method of depreciation over the estimated useful lives as follows:

	Estimated Life
Buildings and improvements	5 to 40 years
Machinery and equipment	2 to 10 years
Furniture and fixtures	3 to 7 years
Equipment held for lease or rental	2 to 10 years

Leasehold improvements are depreciated over the shorter of their estimated useful life or the term of the lease. Costs related to maintenance and repairs that do not prolong the assets' useful lives are expensed as incurred.

Goodwill and Intangible Assets

Goodwill represents purchase consideration paid in a business combination that exceeds the values assigned to the net assets of acquired businesses. Intangible assets include customer relationships, proprietary technology, brands and trademarks, patents and other intangible assets. Intangible assets with a finite life are amortized on a straight-line basis over an estimated economic useful life which ranges from 5 to 20 years and is included in selling, general and administrative expense. Certain of our intangible assets, namely certain brands and trademarks, have an indefinite life and are not amortized.

Long-Lived Asset Impairment

Long-lived assets, including intangible assets with finite lives, are amortized and tested for impairment whenever events or changes in circumstances indicate their carrying value may not be recoverable. We assess the recoverability of long-lived assets based on the undiscounted future cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When an impairment is identified, we reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.

Goodwill and indefinite-lived intangible assets are not amortized, but rather are tested for impairment annually (or more frequently if impairment indicators arise, such as changes to the reporting unit structure, significant adverse changes in the business climate or an adverse action or assessment by a regulator). We conduct our annual impairment testing on the first day of our fourth quarter. For goodwill, the impairment test is a two-step test. In the first step, the estimated fair value of each reporting unit is compared to the carrying value of the net assets assigned to that reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and the second step of the impairment test is not performed. If the carrying value of the reporting unit exceeds its estimated fair value, then the second step of the impairment test is performed in order to measure the impairment loss to be recorded, if any. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. We estimate the fair value of our reporting units and indefinite-lived intangible assets using an income approach. Under the income approach, we estimate fair value based on the present value of estimated future cash flows.

Product Warranties

We accrue for the estimated cost of product warranties at the time revenue is recognized and record it as a component of cost of revenue. Our product warranty liability reflects our best estimate of probable liability under the terms and conditions of our product warranties offered to customers. We estimate the liability based on our standard warranty terms, the historical frequency of claims and the cost to replace or repair our products under warranty. Factors that impact our warranty liability include the number of units sold, the length of warranty term, historical and anticipated rates of warranty claims and cost per claim. We also record a warranty liability for specific matters. We assess the adequacy of our recorded warranty liabilities quarterly and adjust amounts as necessary.

Postretirement Benefit Plans

The determination of defined benefit pension and postretirement plan obligations and their associated costs requires the use of actuarial computations to estimate participant plan benefits to which the employees will be entitled. The significant assumptions primarily relate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, years of service and other factors. We develop each assumption using relevant company experience in conjunction with market-related data for each individual country in which such plans exist. All actuarial assumptions are reviewed annually with third-party consultants and adjusted as necessary. For the recognition of net periodic postretirement cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate of return on the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurement date over the last five years. Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to the extent they exceed 10% of the higher of the market-related value or the projected benefit obligation, over the average remaining service period of active participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy. The fair value of plan assets is determined based on market prices or estimated fair value at the measurement date.

We consider changes to a plan’s benefit formula that eliminate the accrual for future service but continue to allow for future salary increases (i.e. “soft freeze”) a curtailment.

Business Combinations

We allocate the purchase price of acquisitions to the tangible and intangible assets acquired, liabilities assumed, and non-controlling interests in the acquiree based on their estimated fair value at the acquisition date. Changes to the acquisition date provisional fair values prior to the expiration of the measurement period, a period not to exceed 12 months from date of acquisition, are recorded as an adjustment to the associated goodwill. Changes to the acquisition date fair values after expiration of the measurement period are recorded in earnings. The excess of the acquisition price over those estimated fair values is recorded as goodwill. Acquisition-related expenses and restructuring costs, if any, are recognized separately from the business combination and are expensed as incurred.

Derivative Financial Instruments

We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, including forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to hedge certain risks economically, even though hedge accounting does not apply or we elect not to apply hedge accounting.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk is recorded in other comprehensive income ("OCI") and is subsequently reclassified into either revenue or cost of revenue (hedge of sales classified into revenue and hedge of purchases classified into cost of revenue) in the period that the hedged forecasted transaction affects earnings. Any ineffective portion of the change in fair value of the derivative is recognized directly in selling, general and administrative expenses. Our policy is to de-designate cash flow hedges at the time forecasted transactions are recognized as assets or liabilities on a business unit’s balance sheet and report subsequent changes in fair value through selling, general and administrative expenses where the gain or loss due to movements in currency rates on the underlying asset or liability is revalued. If it becomes probable that the originally forecasted transaction will not occur, the gain or loss related to the hedge recorded within accumulated other comprehensive income is immediately recognized into net income.

Commitments and Contingencies

We record accruals for commitments and loss contingencies for those which are both probable and for which the amount can be reasonably estimated. In addition, legal fees are accrued for cases where a loss is probable and the related fees can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount of loss. We review these accruals quarterly and adjust the accruals to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other current information.

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 estimated liability is reduced to reflect the anticipated participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective shares of the relevant costs. These accruals are reviewed quarterly and are adjusted as assessment and remediation efforts progress or as additional technical or legal information becomes available. Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures. Accruals for environmental liabilities are primarily included in other non-current liabilities at undiscounted amounts and exclude claims for recoveries from insurance companies or other third parties.

Concentrations of Credit Risk

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable from trade customers. We maintain cash and cash equivalents and

derivative contracts with various financial institutions. These financial institutions are located in many different geographical regions, and our policy is designed to limit exposure with any one institution. As part of our cash and risk management processes, we perform periodic evaluations of the relative credit standing of the financial institutions. We have not sustained any material credit losses during the previous three years from instruments held at financial institutions. We may utilize forward contracts to protect against the effects of foreign currency fluctuations. Such contracts involve the risk of non-performance by the counterparty. Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and their dispersion across many different industries and geographic regions. We perform ongoing credit evaluations of the financial condition of our third-party distributors, resellers and other customers and require collateral, such as letters of credit and bank guarantees, in certain circumstances.

Substantially all of the cash and cash equivalents, including foreign cash balances, at December 31, 2014 and 2013 were uninsured. Foreign cash balances at December 31, 2014 and 2013 were $537 million and $423 million, respectively.

Fair Value Measurements

We determine fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We use a hierarchical structure to prioritize the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1), then to quoted market prices for similar assets or liabilities in active markets (Level 2) and gives the lowest priority to unobservable inputs (Level 3).

Note 2. Recently Issued Accounting Pronouncements

Pronouncements Not Yet Adopted

In January 2015, the Financial Accounting Standards Board (“FASB”) issued guidance which eliminates from U.S. GAAP the concept of an extraordinary item. Under existing U.S. GAAP, an event or transaction must be unusual in nature and must occur infrequently to be considered an extraordinary item. Additionally, under current U.S. GAAP extraordinary items are separately presented in a company’s income statement and disclosed in the footnotes to the company’s financial statements. As a result of the new guidance regarding extraordinary items, a company will no longer (1) segregate an extraordinary item from the results of ordinary operations, (2) separately present an extraordinary item on its income statement, and (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. This guidance is effective for annual reporting periods beginning after December 15, 2015 and may be applied prospectively or retrospectively. This guidance is not expected to have an impact on our financial condition or results of operations.

In June 2014, the FASB issued guidance related to the recognition of compensation on employee share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. The standard states that the performance target should not be reflected in estimating the grant date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. This guidance is effective for annual reporting periods beginning after December 15, 2015, with early adoption permitted. The components of the guidance may be applied either (a) prospectively to all awards granted or modified after the effective date, or (b) retrospectively to all awards outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. This guidance is not expected to have an impact on our financial condition or 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 annual reporting periods beginning after December 15, 2016, 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 not permitted. We are currently evaluating the impact of the guidance on our financial condition and results of operations.

In April 2014, the FASB issued guidance related to the reporting of discontinued operations. The guidance states that the disposal of a business or operation is required to be reported as discontinued operations if the disposal represents a strategic shift that will have a major effect on an entity’s operations and financial results. The guidance also expands disclosures about discontinued operations and the disposal of significant businesses that did not qualify for discontinued operations presentation. This standard is effective prospectively for disposals (or businesses that qualify as “held for sale”) that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted. The impact of this guidance on our financial condition and results of operations will depend on the occurrence and the significance of disposal transactions that meet the criteria described above.

In January 2014, the FASB issued guidance related to service concession arrangements. A service concession arrangement is an arrangement between a public-sector entity grantor and an operating entity under which the operating entity operates the grantor's infrastructure (for example, airports, roads and bridges). The guidance states that service concession arrangements should not be accounted for under the guidance of Topic 840, Leases, but rather other guidance as deemed appropriate. This guidance is effective for fiscal years beginning on or after December 15, 2014 with early adoption permitted. Opening retained earnings will be adjusted in the year of adoption to reflect the cumulative historical impact of any arrangements existing at the date of adoption, and the new guidance will then be applied to the financial statements on a prospective basis. The adoption of this guidance is not expected to have a material impact on our financial condition or results of operations.

Recently Adopted Pronouncements

In July 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit. The guidance requires that an unrecognized tax benefit or a portion of an unrecognized tax benefit, be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If an applicable deferred tax asset is not available or a company does not expect to use the applicable deferred tax asset, the unrecognized tax benefit should be presented in an entity's financial statements as a liability and should not be combined with a deferred tax asset. This guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance did not have a material impact on our financial condition or results of operations.

In March 2013, the FASB issued guidance on the release of a cumulative translation adjustment ("CTA") related to an entity's investment in a foreign entity into income. The guidance requires such CTA to be released when there has been a: (1) sale of a subsidiary or group of net assets within a foreign entity and the sale represents the substantially complete liquidation of the investment in the foreign entity, (2) loss of a controlling financial interest in an investment in a foreign entity or (3) step acquisition for a foreign entity. This guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance did not have a material impact on our financial condition or results of operations.

In February 2013, the FASB issued guidance related to the measurement and disclosure of obligations resulting from joint and several liability arrangements. The new guidance requires companies to measure obligations resulting from joint and several liability arrangements as the sum of (1) the amount the company agreed to pay on the basis of its arrangement among co-obligors and (2) any additional amount the company expects to pay on behalf of its co-obligors. Additionally, the new guidance requires the disclosure of a description of the joint and several arrangement and the total outstanding amount of the obligation for all joint parties. This guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance did not have a material impact on our financial condition or results of operations.

Note 3. Acquisitions and Divestitures

2014 Divestiture

On July 2, 2014, we divested our Wolverhampton, U.K.-based pneumatic and hydraulic valves business for approximately $30 million. The sale resulted in a gain of $11 million, reflected in gain from sale of business in our Consolidated Income Statement. The business, which was part of our Applied Water segment, provided a wide range of products, primarily to industrial original equipment manufacturer customers in the oil and gas sector. The business reported 2013 annual revenue of approximately $25 million.

2013 Acquisitions

During 2013, we spent $84 million ($81 million, net of cash acquired) on acquisitions. As the acquisitions were not material, individually or in the aggregate, to results of operations, pro forma results of operations reflecting results prior to the acquisitions and certain other disclosure items have not been presented.

MultiTrode

On March 1, 2013 we acquired MultiTrode Pty Ltd ("MultiTrode"), a water and wastewater technology and services company based in Australia, for approximately $26 million. MultiTrode offers advanced monitoring and control technologies to municipal and private water and waste water authorities as well as industrial clients. The company had approximately 60 employees and generated revenue of approximately $13 million in its fiscal year ended June 30, 2012.

Our consolidated financial statements include MultiTrode's results of operations prospectively from March 1, 2013 within the Water Infrastructure segment.

PIMS

On February 5, 2013 we acquired PIMS Group ("PIMS"), a wastewater services company based in the United Kingdom, for approximately $57 million, including a cash payment of $55 million and the assumption of certain liabilities. PIMS is a supplier of wastewater installation and maintenance services for the private sector, municipal and industrial markets. The company had approximately 220 employees and generated revenue of approximately $38 million for its fiscal year ended April 30, 2012.

Our consolidated financial statements include PIMS' results of operations prospectively from February 5, 2013 within the Water Infrastructure segment.

2012 Acquisitions

Heartland and MJK

During 2012, we spent $41 million, net of cash acquired, on two acquisitions that were not material individually or in the aggregate to our results of operations or financial position. On October 26, 2012, we acquired Heartland Pump Rental & Sales, Inc. ("Heartland"), a dewatering pump sale and rental company, for approximately $29 million. Heartland generated revenue of approximately $33 million for the fiscal year ended December 31, 2011. On July 13, 2012, we acquired MJK Automation (“MJK”) for a purchase price of approximately $12 million. MJK, which reported 2011 revenue of $11 million for the fiscal year ended June 30, 2012, is a leading manufacturer of flow and level sensors, and measurement and control technology for water and wastewater applications. Our financial statements include Heartland and MJK results of operations prospectively from October 26, 2012 and July 13, 2012, respectively, within the Water Infrastructure segment. As the acquisitions were not material to results of operations, pro forma results of operations reflecting results prior to the acquisitions and certain other disclosure items have not been presented.

Note 4. Restructuring and Asset Impairment 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 2014 and 2013, the costs incurred primarily relate to the reduction in structural costs, including the elimination of headcount and consolidation of facilities primarily within our Water Infrastructure and Applied Water segments. During 2012, the costs incurred primarily relate to restructuring related severance payments for reductions in force initiatives primarily within our Water Infrastructure segment. The components of restructuring and asset impairment charges incurred during each of the previous three years ended are presented below.

		Year Ended December 31,
(in millions)		2014				2013				2012
By component:
Severance and other charges		$	26			$	38			$	17
Lease related charges		1				2				—
Reversal of restructuring accruals		(1		)		—				—
Total restructuring charges		26				40				17
Asset impairment		—				2				—
Total restructuring and asset impairment charges		$	26			$	42			$	17
By segment:
Water Infrastructure		$	19			$	33			$	14
Applied Water		6				9				3
Corporate and other		1				—				—

Restructuring

The following table displays a rollforward of the restructuring accruals, presented on our Consolidated Balance Sheet within accrued liabilities, for the years ended December 31, 2014 and 2013.

(in millions)		2014				2013
Restructuring accruals - January 1		$	13			$	9
Restructuring charges		26				40
Cash payments		(26		)		(35		)
Other		(1		)		(1		)
Restructuring accruals - December 31		$	12			$	13
By segment:
Water Infrastructure		$	5			$	6
Applied Water		3				3
Regional selling locations (a)		3				4
Corporate and other		1				—

(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 of employee position eliminations associated with restructuring activities for the years ended December 31, 2014 and 2013.

		2014			2013
Planned reductions - January 1		51			54
Additional planned reductions		320			513
Actual reductions		(238	)		(516	)
Planned reductions - December 31		133			51

Total expected costs associated with actions commenced during 2014 of approximately $22 million for Water Infrastructure include $18 million incurred in 2014 and $4 million remaining to be incurred in 2015. These costs primarily comprise severance charges. We currently expect these actions to continue through the end of 2015. Total expected costs of approximately $10 million for Applied Water include $6 million incurred in 2014 and $4 million remaining to be incurred during 2015. These costs primarily comprise severance charges. We currently expect these actions to continue through the end of 2015. Total expected and incurred costs associated with Corporate and other actions commenced during 2014 were $1 million. These actions were completed during 2014.

Total expected costs associated with actions that commenced during 2013 are approximately $32 million for Water Infrastructure. Approximately $31 million of the expected cost was incurred in 2013 and $1 million was incurred during 2014. Total expected costs associated with actions that commenced during 2013 are approximately $8 million for Applied Water. Approximately $8 million of the expected cost was incurred in 2013. These actions are substantially complete.

Asset Impairment Charges

During the fourth quarter of 2013 we performed our annual impairment test of our indefinite-lived intangibles assets, which resulted in an impairment charge of $2 million related to trade names within our Water Infrastructure segment. Refer to Note 11, “Goodwill and Other Intangible Assets,” for additional information.

Note 5. Separation Costs

We had non-recurring separation costs related to our Spin-off from ITT as presented below.

	Year Ended December 31,
(in millions)	2014				2013				2012
Rebranding and marketing costs	$	—			$	—			$	8
Advisory and professional fees	—				—				7
Information and technology costs	—				2				3
Employee retention and hiring costs	—				—				1
Lease termination and other real estate costs	—				2				1
Other	—				—				2
Total separation costs in operating income	—				4				22
Tax-related separation cost	—				—				—
Income tax benefit	—				(2		)		(6		)
Total separation costs, net of tax	$	—			$	2			$	16

Note 6. Other Non-Operating Income (Expense), Net

The components of other non-operating income (expense), net are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Interest income	$	2			$	3			$	4
Income from joint ventures	2				2				4
Other expense – net (a)	(3		)		(15		)		(8		)
Total other non-operating income (expense), net	$	1			$	(10	)		$	—

(a) 2013 includes $10 million of expense incurred under the tax matters agreement with ITT. Refer to Note 7 "Income Taxes" for additional information regard the tax matters agreement.

Note 7. Income Taxes

The source of pre-tax income and the components of income tax expense are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Income components:
Domestic	$	118			$	49			$	106
Foreign	303				249				282
Total pre-tax income	$	421			$	298			$	388
Income tax expense components:
Current:
Domestic – federal	$	44			$	37			$	27
Domestic – state and local	7				1				7
Foreign	62				46				56
Total Current	113				84				90
Deferred:
Domestic – federal	$	(14	)		$	(6	)		$	10
Domestic – state and local	—				—				(2		)
Foreign	(15		)		(8		)		(7		)
Total Deferred	(29		)		(14		)		1
Total income tax provision	$	84			$	70			$	91
Effective income tax rate	19.8		%		23.5		%		23.4		%

Reconciliations between taxes at the U.S. federal income tax rate and taxes at our effective income tax rate on earnings before income taxes are as follows:

	Year Ended December 31,
	2014			2013			2012
Tax provision at U.S. statutory rate	35.0	%		35.0	%		35.0	%
Increase (decrease) in tax rate resulting from:
State income taxes	1.0			0.7			1.2
Settlements of tax examinations	0.4			—			0.2
Valuation allowance	22.9			39.4			8.9
Tax exempt interest	(26.3	)		(43.0	)		(18.2	)
Foreign tax rate differential	(4.2	)		(4.1	)		(3.4	)
Repatriation of foreign earnings, net of foreign tax credits	(1.7	)		5.1			0.4
Tax incentives	(6.2	)		(8.1	)		—
Other – net	(1.1	)		(1.5	)		(0.7	)
Effective income tax rate	19.8	%		23.5	%		23.4	%

We operate under tax incentives, which are effective January 2013 through December 2023 and may be extended if certain additional requirements are satisfied. The tax incentives are conditional upon our meeting certain employment thresholds. The impact of these tax incentives decreased our tax provision by 6.2% and 8.1% in 2014 and 2013, respectively.

Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse.

The following is a summary of the components of the net deferred tax assets and liabilities recognized in the Consolidated Balance Sheets:

	December 31,
(in millions)	2014				2013
Deferred tax assets:
Employee benefits	$	124			$	114
Accrued expenses	25				20
Loss and other tax credit carryforwards	456				374
Inventory	6				6
Other	3				1
	$	614			$	515
Valuation allowance	(427		)		(349		)
Net deferred tax asset	$	187			$	166
Deferred tax liabilities:
Intangibles	$	173			$	180
Investment in foreign subsidiaries	8				15
Property, plant, and equipment	22				19
Other	30				42
Total deferred tax liabilities	$	233			$	256

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to realize existing deferred tax assets. On the basis of this evaluation, as of December 31, 2014, a valuation allowance of $427 million has been established to reduce the deferred income tax asset related to certain U.S. and foreign net operating losses, and U.S. and foreign capital loss carryforwards.

A reconciliation of our valuation allowance on deferred tax assets is as follows:

(in millions)	2014				2013				2012
Valuation allowance — January 1	$	349			$	229			$	195
Change in assessment	(4		)		—				—
Current year operations	82				120				34
Valuation allowance — December 31	$	427			$	349			$	229

The valuation allowance is primarily attributable to foreign deferred tax assets.

Deferred taxes are classified net of unrecognized tax benefits in the Consolidated Balance Sheets as follows:

	December 31,
(in millions)	2014				2013
Current assets	$	38			$	41
Non-current assets	79				64
Current liabilities	(5		)		(4		)
Non-current liabilities	(158		)		(191		)
Total net deferred tax liabilities	$	(46	)		$	(90	)

Tax attributes available to reduce future taxable income begin to expire as follows:

(in millions)	December 31, 2014				First Year of Expiration
U.S. net operating loss	$	8			December 31, 2024
State net operating loss	53				December 31, 2015
U.S. tax credits	38				December 31, 2020
Foreign net operating loss	1,496				December 31, 2015

The foreign tax credit for financial statement purposes differs from the amount for tax return purposes due to unrecognized tax benefits.

As of December 31, 2014, we have provided a deferred tax liability of $8 million on the excess of $65 million of financial reporting over the tax basis of investments in certain foreign subsidiaries that has not been indefinitely reinvested. However, we have not provided for deferred taxes on the excess of financial reporting over the tax basis of investments in certain foreign subsidiaries in the amount of $1.9 billion because we plan to reinvest such amounts indefinitely outside the U.S. The determination of the amount of federal and state income taxes is not practicable because of complexities of the hypothetical calculation.

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 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. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(in millions)	2014				2013				2012
Unrecognized tax benefits — January 1	$	30			$	8			$	5
Additions for:
Current year tax positions	9				23				1
Prior year tax positions	7				—				2
Reductions for:
Settlements	(2		)		(1		)		—
Unrecognized tax benefits — December 31	$	44			$	30			$	8

The amount of unrecognized tax benefits at December 31, 2014, was $44 million which, if ultimately recognized, will reduce our annual effective tax rate. We do not believe that the unrecognized tax benefits will significantly change within the next twelve months.

In many cases, unrecognized tax benefits are related to tax years that remain subject to examination by the relevant taxing authorities. By virtue of previously filed separate company tax returns including tax returns filed by ITT, we are routinely under audit by federal, state, local and foreign taxing authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax jurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior year returns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for tax contingencies and the amounts owed by the company are recorded in the period they become known. Under the Tax Matters Agreement, as discussed below, ITT assumes all consolidated tax liabilities and related interest and penalties for the pre-spin period. The following table summarizes the earliest open tax years by major jurisdiction:

Jurisdiction		Earliest Open Year
Canada		2009
Germany		2005
Italy		2009
Luxembourg		2010
Poland		2007
Sweden		2009
Switzerland		2010
United Kingdom		2011
United States		2009

We classify interest relating to unrecognized tax benefits as a component of other non-operating (expense) income, net and tax penalties as a component of income tax expense in our Consolidated Income Statements. The amount of interest relating to unrecognized tax benefits as of December 31, 2014 was $1 million.

Tax Matters Agreement

In connection with the Spin-off, Xylem, ITT and Exelis entered into a Tax Matters Agreement. Under the agreement, we may be obligated to make payments to ITT and Exelis under certain conditions. These conditions include a payment to ITT in the event audit settlement payments exceed amounts specified in the agreement. We also may be obligated to make payments in the event the Spin-off is determined to be taxable.

The Tax Matters Agreement governs the respective rights, responsibilities and obligations of ITT, Xylem and the other Spincos (members of the ITT group that were spun-off, including Xylem are collectively referred to as “Spincos”) with respect to taxes for periods ending on or before the Spin-off. In general, pursuant to the Tax Matters Agreement, ITT will prepare and file the tax returns that include ITT (or any of its subsidiaries) and Xylem (or any of its subsidiaries) for all taxable periods ending on or prior to, and including, October 31, 2011, with the appropriate tax authorities, and, except as otherwise set forth below, ITT will pay any taxes relating thereto to the relevant tax authority. In connection with any audit adjustments with respect to such returns, we have agreed to indemnify ITT for a portion of such tax liability to the extent it exceeds an agreed-upon threshold.

We will file all tax returns that include solely Xylem and/or its subsidiaries and any separate company tax returns for Xylem and/or its subsidiaries for all taxable periods ending on or prior to, and including, October 31, 2011, and will pay all taxes due with respect to such tax returns (including any taxes attributable to an audit adjustment with respect to such returns). In general, ITT controls all audits and administrative matters and other tax proceedings relating to the consolidated U.S. federal income tax return of the ITT group and any other tax returns for which the ITT group is responsible.

Notwithstanding the receipt of any such IRS ruling, tax opinion or officer’s certificate, generally Xylem and each other Spinco must indemnify ITT and each other Spinco for any taxes and related losses resulting from (i) any act or failure to act by such Spinco described in the covenants above, (ii) any acquisition of equity securities or assets of such Spinco or any member of its group, and (iii) any breach by such Spinco or any member of its group of any

representation or covenant contained in the separation documents or the documents relating to the IRS private letter ruling or tax opinion concerning the Spin-off of such Spinco.

Under U.S. federal income tax law, ITT and the Spincos are severally liable for all of ITT’s U.S. federal income taxes attributable to periods prior to and including the year of the Spin-off, which ended on December 31, 2011.

Thus, if ITT failed to pay the U.S. federal income taxes attributable to it under the Tax Matters Agreement for periods prior to and including the year of the Spin-off, the Spincos would be severally liable for such taxes. In the event a Spinco is required to make a payment in respect of a Spin-off related tax liability of the ITT consolidated U.S. federal income tax return group under these rules for which such Spinco is not responsible under the Tax Matters Agreement and full indemnification cannot be obtained from the Spinco responsible for such payment under the Tax Matters Agreement, ITT will indemnify the Spinco that was required to make the payment from and against the portion of such liability for which full indemnification cannot be obtained from the Spinco responsible for such payment under the Tax Matters Agreement.

The Tax Matters Agreement also contains provisions regarding the apportionment of tax attributes of the ITT consolidated U.S. federal income tax return group, authority to make tax elections, cooperation, and other customary matters.

As of December 31, 2014, the net amount Xylem owed ITT pursuant to the Tax Matters Agreement is $7 million.

Note 8. Earnings Per Share

The following is a reconciliation of the shares used in calculating basic and diluted net earnings per share.

	Year Ended December 31,
	2014				2013				2012
Net Income (in millions)	$	337			$	228			$	297
Shares (in thousands):
Weighted average common shares outstanding	183,030				185,082				185,459
Add: Participating securities (a)	47				134				325
Weighted average common shares outstanding — Basic	183,077				185,216				185,784
Plus incremental shares from assumed conversions: (b)
Dilutive effect of stock options	643				264				213
Dilutive effect of restricted stock	529				558				233
Weighted average common shares outstanding — Diluted	184,249				186,038				186,230
Basic earnings per share	$	1.84			$	1.23			$	1.60
Diluted earnings per share	$	1.83			$	1.22			$	1.59

(a)	Restricted stock awards containing rights to non-forfeitable dividends which 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 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 and performance share awards, reduced by the repurchase of shares with the proceeds from the assumed exercises, unrecognized compensation expense for outstanding awards and the estimated tax benefit of the assumed exercises. Performance share units will be included in the treasury stock calculation of diluted earnings per share upon achievement of underlying performance conditions. See Note 16, "Stock-Based Compensation Plans" for further detail on the performance share units.

	Year Ended December 31,
(in thousands)	2014			2013			2012
Stock options	2,720			4,126			4,285
Restricted shares	525			703			870
Performance shares	119			80			—

Note 9. Inventories

	December 31,
(in millions)	2014				2013
Finished goods	$	194			$	189
Work in process	42				31
Raw materials	250				255
Total inventories	$	486			$	475

Note 10. Property, Plant and Equipment

	December 31,
(in millions)	2014				2013
Land, buildings and improvements	$	252			$	263
Machinery and equipment	655				685
Equipment held for lease or rental	207				192
Furniture and fixtures	87				93
Construction work in progress	41				49
Other	23				22
Total property, plant and equipment, gross	1,265				1,304
Less accumulated depreciation	804				816
Total property, plant and equipment, net	$	461			$	488

Depreciation expense was $95 million, $99 million, and $94 million for 2014, 2013, and 2012, respectively.

Note 11. Goodwill and Other Intangible Assets

Changes in the carrying value of goodwill by operating segment during the years ended December 31, 2014 and 2013 are as follows:

(in millions)	Water Infrastructure				Applied Water				Total
Balance as of December 31, 2012	$	1,085			$	562			$	1,647
Activity in 2013
Goodwill acquired	48				—				48
Foreign currency and other	16				7				23
Balance as of December 31, 2013	$	1,149			$	569			$	1,718
Activity in 2014
Goodwill divested (a)	—				(6		)		(6		)
Foreign currency and other	(51		)		(26		)		(77		)
Balance as of December 31, 2014	$	1,098			$	537			$	1,635

(a)	On July 2, 2014, we divested our Wolverhampton, U.K.-based pneumatic and hydraulic valves business which had $6 million of goodwill associated with the business. Refer to Note 3 "Acquisitions and Divestitures" for additional information.

During the fourth quarter of 2014, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment.

Other Intangible Assets

Information regarding our other intangible assets is as follows:

(in millions)	December 31, 2014												December 31, 2013
	Carrying Amount				Accumulated Amortization				Net Intangibles				Carrying Amount				Accumulated Amortization				Net Intangibles
Customer and distributor relationships	$	331			$	(122	)		$	209			$	352			$	(104	)		$	248
Proprietary technology	106				(41		)		65				109				(36		)		73
Trademarks	36				(17		)		19				35				(16		)		19
Patents and other	19				(17		)		2				20				(17		)		3
Indefinite-lived intangibles	136				—				136				145				—				145
Other intangibles	$	628			$	(197	)		$	431			$	661			$	(173	)		$	488

We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date of our annual impairment assessment in 2014. In 2013 we recorded a $2 million impairment charge related to three trade names within our Water Infrastructure segment. The charge was calculated using an income approach, which is considered a Level 3 input for fair value measurement, and is reflected in “Restructuring and asset impairment charges.” Future impairment tests could result in a charge to earnings. We will continue to evaluate the indefinite-lived intangible assets on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment.

Customer and distributor relationships, proprietary technology, trademarks, patents and other are amortized over weighted average lives of approximately 13 years, 18 years, 16 years and 8 years, respectively.

Total amortization expense for intangible assets was $36 million, $38 million, and $34 million for 2014, 2013 and 2012, respectively.

Estimated amortization expense for each of the five succeeding years is as follows:

(in millions)
2015	$	34
2016	32
2017	32
2018	31
2019	29

Note 12. 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 and payments. 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.

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.

Beginning in 2012, certain business units within our segments 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 held forward foreign exchange contracts with purchase notional amounts totaling $355 million and $275 million as of December 31, 2014 and 2013, respectively. In 2014, our most significant foreign currency derivatives include contracts to purchase Swedish Krona and sell Euro, sell US Dollar and purchase Euro, and to sell British Pound and purchase Euro. The purchased notional amounts associated with these currency derivatives are $140 million, $85 million and $51 million, respectively. In 2013, our most significant foreign currency derivatives include contracts to purchase Swedish Krona and sell Euro, purchase Polish Zloty and sell Euro, and to sell British Pound and purchase Euro. The purchase notional amounts associated with these currency derivatives were $190 million, $34 million and $37 million, respectively.

The table below presents the effect of our derivative financial instruments on the Consolidated Income Statements and Statements of Comprehensive Income.

		Year Ended December 31,
(in millions)		2014				2013				2012
Derivatives in Cash Flow Hedges
Foreign Exchange Contracts
Amount of (loss) gain recognized in OCI (a)		$	(22	)		$	1			$	4
Amount of loss (gain) reclassified from OCI into revenue (a)		5				(2		)		(2		)
Amount of loss (gain) reclassified from OCI into cost of revenue (a)		1				2				(1		)

(a)	Effective portion

As of December 31, 2014, $14 million of the net unrealized losses on cash flow hedges is expected to be reclassified into earnings in the next 12 months. Any ineffective portion of the change in fair value of a cash flow hedge is recognized immediately in selling, general and administrative expenses in the Consolidated Income Statements and, for the twelve months ended December 31, 2014, 2013, and 2012, was not material.

The fair values of our foreign exchange contracts currently included in our hedging program were as follows:

	December 31,
(in millions)	2014				2013
Derivatives designated as hedging instruments
Assets
Other current assets	$	1			$	1
Liabilities
Other current liabilities	(13		)		—
Total fair value	$	(12	)		$	1

Note 13. Accrued and Other Current Liabilities

	December 31,
(in millions)	2014				2013
Compensation and other employee-benefits	$	186			$	215
Customer-related liabilities	66				63
Accrued warranty costs	31				36
Accrued taxes	77				45
Other accrued liabilities	121				120
Total accrued and other current liabilities	$	481			$	479

Note 14. Credit Facilities and Long-Term Debt

Total debt outstanding is summarized as follows:

	December 31,
(in millions)	2014				2013
Short-term borrowings and current maturities of long-term debt	$	89			$	42
Long-term debt:
3.550% Senior Notes due 2016 (a)	600				600
4.875% Senior Notes due 2021 (a)	600				600
Unamortized discount (b)	(1		)		(1		)
Long-term debt	1,199				1,199
Total debt (c)	$	1,288			$	1,241

(a)

The fair value of our Senior Notes (as defined below) 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 2016 (as defined below) was $621 million and $635 million as of December 31, 2014 and 2013, respectively. The fair value of our Senior Notes due 2021 (as defined below) was $653 million and $629 million as of December 31, 2014 and 2013, respectively.

(b)	The unamortized discount is recognized as a reduction in the carrying value of the Senior Notes in the Consolidated Balance Sheets and is being amortized to interest expense in our Consolidated Income Statements over the expected remaining terms of the Senior Notes.

Deferred Financing Costs

We had deferred financing costs of $5 million and $7 million as of December 31, 2014 and December 31, 2013, respectively, related to our revolving credit facility and Senior Notes. Scheduled amortization for future years, assuming no further prepayments of principal, is $2 million in 2015, $2 million in 2016, less than $1 million in 2017, less than $1 million in 2018, less than $1 million in 2019 and $1 million thereafter.

Senior Notes

On September 20, 2011, we issued 3.550% Senior Notes of $600 million aggregate principal amount due September 2016 (the "Senior Notes due 2016") and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021" and together with the Senior Notes due 2016, the “Senior Notes”).

The Senior Notes include covenants which restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale and leaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/or customary grace and cure periods). We may redeem the Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal to the principal amount of the Senior Notes to be redeemed, plus a make-whole premium. If a change of control triggering event (as defined in the Senior Notes) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plus accrued and unpaid interest to the date of repurchase. As of December 31, 2014, we were in compliance with all covenants.

Interest on the Senior Notes due 2016 is payable on March 20 and September 20 of each year. Interest on the Senior Notes due 2021 is payable on April 1 and October 1 of each year.

Four Year Competitive Advance and Revolving Credit Facility

Effective October 31, 2011, Xylem and its subsidiaries entered into a Four Year Competitive Advance and Revolving Credit Facility (the "Credit Facility") with JPMorgan Chase Bank, 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) a competitive advance borrowing option which will be provided on an uncommitted competitive advance basis through an auction mechanism (the "competitive loans"), (ii) revolving extensions of credit (the "revolving loans") outstanding at any time and (iii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time.

At our election, the interest rate per annum applicable to the competitive advances will be based on either (i) a Eurodollar rate determined by reference to LIBOR, plus an applicable margin offered by the lender making such loans and accepted by us or (ii) a fixed percentage rate per annum specified by the lender making such loans. 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 JPMorgan Chase Bank, 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, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) throughout the term. The Credit Facility also contains limitations on, among other things, incurring debt, granting liens, and entering sale and leaseback transactions. In addition, the Credit Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. As of December 31, 2014, we were in compliance with all covenants.

As of December 31, 2014, the Credit Facility remains undrawn.

Research and Development Facility Agreement

On December 4, 2013, the Company amended and restated its Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with The European Investment Bank (the "EIB") to add an additional borrower under the facility. The facility provides an aggregate principal amount of up to €120 million (approximately $146 million) to finance research projects and infrastructure development in the European Union. The Company's wholly-owned subsidiaries in Luxembourg, Xylem Holdings S.á.r.l. and Xylem International S.á.r.l., are the borrowers under the R&D Facility Agreement. The obligations of the borrowers under the R&D Facility Agreement are guaranteed by the Company under an Amended and Restated Deed of Guarantee, dated as of December 4, 2013, in favor of the EIB. The funds are available to finance research and development projects during the period from 2013 through 2016 at the Company's R&D facilities in Sweden, Germany, Italy, the United Kingdom, Austria, Norway and Hungary.

Under the R&D Facility Agreement, the borrower can draw loans on or before June 14, 2015 with a maturity of no longer than 12 years. The R&D Facility Agreement provides for Fixed Rate loans and Floating Rate loans. The interest rate per annum applicable to Fixed Rate loans will be 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 will be at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S. Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin for both Fixed Rate loans and Floating Rate loans shall be determined by reference to the credit rating of the Company.

In accordance with the terms of the R&D Facility Agreement, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) throughout the term. The R&D Facility Agreement also contains limitations on, among other things, incurring debt, granting liens, and entering into sale and leaseback transactions. In addition, the R&D Facility Agreement contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. As of December 31, 2014, we were in compliance with all covenants.

As of December 31, 2014, $84 million was outstanding under the R&D Facility Agreement. Although the borrowing term for this arrangement is for five years, we have classified it as short-term debt on our Consolidated Balance Sheet since we intend to repay this obligation in less than one year.

Note 15. Postretirement Benefit Plans

Defined contribution plans – Xylem and certain of our subsidiaries maintain various defined contribution savings plans, which allow employees to contribute a portion of their pre-tax and/or after-tax income in accordance with specified guidelines. Several of the plans require us to match a percentage of the employee contributions up to certain limits, generally between 3.0% – 7.0% of employee base pay. Xylem’s U.S. plan also provides for transition credits for eligible U.S. employees for the first five years after the Spin-off to supplement retirement benefits in the absence of a defined benefit plan. Age plus years of eligible service greater than or equal to 60, entitles an employee to transition credits. The liability for transition credits was approximately $2 million and $3 million at December 31, 2014 and 2013, respectively. Matching obligations, the majority of which were funded in cash in connection with the plans, along with transition credits and other company contributions are as follows:

(in millions)	Defined Contribution
2014	$	36
2013	35
2012	30

The Xylem Stock Fund, an investment option under the defined contribution plan in which Company employees participate is considered an Employee Stock Ownership Plan. As a result, participants in the Xylem Stock Fund may receive dividends in cash or may reinvest such dividends into the Xylem Stock Fund. Company employees held approximately 415 thousand and 453 thousand shares of Xylem Inc. common stock in the Xylem Stock Fund at December 31, 2014 and 2013, respectively.

Defined benefit pension plans and other postretirement plans – We historically have maintained qualified and nonqualified defined benefit retirement plans covering certain current and former employees, including hourly and union plans as well as salaried plans, which generally require up to 5 years of service to be vested and for which the benefits are determined based on years of credited service and either specified rates, final pay, or final average pay. The other postretirement benefit plans are all unfunded plans in the U.S. and Canada.

During the first quarter of 2012, an annuity was purchased to wind up five pension plans in Canada. This resulted in a settlement change of $2 million. The Company has no further obligation for these plans.

Effective October 1, 2013, the Xylem Canada Company Pension Plan for Salaried Employees was amended to close the plan to new entrants and a soft freeze, where benefits earned to date are based on frozen service but the future average earnings will continue to be recognized. The impact of the curtailment on the Company’s financial statements was immaterial. However, the participants are now considered inactive and actuarial gains and losses will be amortized over 25 years which represents the expected weighted-average remaining lives of the plan participants.

Effective October 14, 2013, an amendment to one of the Company's U.S. business unit's pension plans for its hourly workers modified the benefit formula. Pension benefits for future service will be based only on years of service. The remeasurement at year end resulted in a $4 million prior service credit, which will be amortized into net periodic pension cost over approximately 11 years.

During the third quarter 2014, we amended one of our international pension plans as well as one of our domestic other postretirement plans. The pension plan amendment froze the accrual of benefits and closed the plan to new entrants. The other postretirement plan amendment modified the accrual of benefits and closed the plan to new entrants. The overall impact of these changes was a $10 million increase to funded status. This included a net loss of $3 million ($1 million net of tax) and a prior service credit of $13 million ($8 million net of tax) recognized in other comprehensive income.

Amounts recognized in the Consolidated Balance Sheets for pension and other employee-related benefit plans (collectively, postretirement plans) reflect the funded status of the postretirement benefit plans. The following table provides a summary of the funded status of our postretirement plans, the presentation of such balances and a summary of amounts recorded within accumulated other comprehensive income.

(in millions)	December 31, 2014												December 31, 2013
	Pension				Other				Total				Pension				Other				Total
Fair value of plan assets	$	584			$	—			$	584			$	524			$	—			$	524
Projected benefit obligation	(872		)		(58		)		(930		)		(777		)		(63		)		(840		)
Funded status	$	(288	)		$	(58	)		$	(346	)		$	(253	)		$	(63	)		$	(316	)
Amounts recognized in the balance sheet
Other non-current assets	$	55			$	—			$	55			$	46			$	—			$	46
Accrued and other current liabilities	(10		)		(3		)		(13		)		(11		)		(3		)		(14		)
Accrued postretirement benefits	(333		)		(55		)		(388		)		(288		)		(60		)		(348		)
Net amount recognized	$	(288	)		$	(58	)		$	(346	)		$	(253	)		$	(63	)		$	(316	)
Accumulated other comprehensive income (loss):
Net actuarial losses	$	(297	)		$	(30	)		$	(327	)		$	(228	)		$	(20	)		$	(248	)
Prior service cost	—				17				17				—				—				—
Total	$	(297	)		$	(13	)		$	(310	)		$	(228	)		$	(20	)		$	(248	)

The unrecognized amounts recorded in accumulated other comprehensive income will be subsequently recognized as expense on a straight-line basis only to the extent they exceed 10% of the higher of the market-related value or the projected benefit obligation, over the average remaining service period of active participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy. Actuarial gains and losses incurred in future periods and not recognized as expense in those periods will be recognized as increases or decreases in other comprehensive income, net of tax.

The net actuarial loss included in accumulated other comprehensive income at the end of 2014 and expected to be recognized in net periodic benefit cost during 2015 is $19 million ($14 million, net of tax). The prior service credit included in accumulated other comprehensive income to be recognized in 2015 is $3 million ($2 million, net of tax).

The benefit obligation, fair value of plan assets, funded status, and amounts recognized in the consolidated financial statements for our defined benefit domestic and international pension plans were:

	Domestic Plans								International Plans
	December 31,								December 31,
(in millions)	2014				2013				2014				2013
Change in benefit obligation:
Benefit obligation at beginning of year	$	74			$	83			$	703			$	707
Service cost	2				3				12				14
Interest cost	3				3				27				28
Benefits paid	(3		)		(3		)		(30		)		(32		)
Actuarial (gain) loss	13				(8		)		144				(9		)
Plan amendments, settlements and curtailments	—				(4		)		(2		)		(2		)
Foreign currency translation/other	(1		)		—				(70		)		(3		)
Benefit obligation at end of year	$	88			$	74			$	784			$	703
Change in plan assets:
Fair value of plan assets at beginning of year	$	58			51				$	466			$	426
Employer contributions	4				4				28				36
Actual return on plan assets	3				6				92				42
Benefits paid	(3		)		(3		)		(30		)		(32		)
Plan amendments, settlements and curtailments	—				—				(2		)		(1		)
Foreign currency translation/other	(2		)		—				(30		)		(5		)
Fair value of plan assets at end of year	$	60			$	58			$	524			$	466
Funded (unfunded) status of the plans	$	(28	)		$	(16	)		$	(260	)		$	(237	)

The following table provides a rollforward of the projected benefit obligation for the other postretirement employee benefit plans:

(in millions)	2014				2013
Change in benefit obligation:
Benefit obligation at beginning of year	$	63			$	65
Service cost	1				1
Interest cost	3				3
Benefits paid	(3		)		(3		)
Actuarial loss (gain)	12				(2		)
Plan amendment	(18		)		—
Other	—				(1		)
Benefit obligation at the end of year	$	58			$	63

The accumulated benefit obligation (“ABO”) for all the defined benefit pension plans was $830 million and $741 million at December 31, 2014 and 2013, respectively. For defined benefit pension plans in which the ABO was in excess of the fair value of the plans’ assets, the projected benefit obligation, ABO and fair value of the plans’ assets were as follows:

	December 31,
(in millions)	2014				2013
Projected benefit obligation	$	453			$	404
Accumulated benefit obligation	419				375
Fair value of plan assets	110				106

The components of net periodic benefit cost for our defined benefit pension plans are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Domestic defined benefit pension plans:
Service cost	$	2			$	3			$	3
Interest cost	3				3				3
Expected return on plan assets	(4		)		(4		)		(4		)
Amortization of prior service cost	—				1				1
Amortization of net actuarial loss	2				2				2
Net periodic benefit cost	$	3			$	5			$	5
International defined benefit pension plans:
Service cost	$	12			$	14			$	11
Interest cost	27				28				29
Expected return on plan assets	(32		)		(31		)		(30		)
Amortization of net actuarial loss	7				13				8
Settlement	1				—				2
Net periodic benefit cost	$	15			$	24			$	20
Total net periodic benefit cost	$	18			$	29			$	25

Other changes in assets and benefit obligations recognized in other comprehensive (loss) income, as they pertain to our defined benefit pension plans are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Domestic defined benefit pension plans:
Net loss (gain)	$	14			$	(11	)		$	8
Prior service cost (credit)	1				(4		)		1
Amortization of prior service cost	—				(1		)		(1		)
Amortization of net actuarial loss	(2		)		(2		)		(2		)
Losses (gains) recognized in other comprehensive (loss) income	$	13			$	(18	)		$	6
International defined benefit pension plans:
Net loss (gain)	$	84			$	(21	)		$	62
Amortization of net actuarial loss	(7		)		(13		)		(8		)
Settlement	(1		)		—				(2		)
Foreign currency translation/other	(20		)		(2		)		8
Losses (gains) recognized in other comprehensive (loss) income	$	56			$	(36	)		$	60
Total losses (gains) recognized in other comprehensive (loss) income	$	69			$	(54	)		$	66
Total losses (gains) recognized in comprehensive income	$	87			$	(25	)		$	91

The components of net periodic benefit cost for other postretirement employee benefit plans are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Service cost	$	1			$	1			$	1
Interest cost	3				3				3
Amortization of prior service credit	(1		)		—				—
Amortization of net actuarial loss	2				2				1
Net periodic benefit cost	$	5			$	6			$	5

Other changes in benefit obligations recognized in other comprehensive (loss) income, as they pertain to other postretirement employee benefit plans are as follows:

	Year Ended December 31,
(in millions)	2014				2013				2012
Net loss (gain)	$	12			$	(2	)		$	14
Prior service credit	(18		)		—				—
Amortization of prior service credit	1				—				—
Amortization of net actuarial loss	(2		)		(2		)		(1		)
(Gains) losses recognized in other comprehensive (loss) income	$	(7	)		$	(4	)		$	13
Total (gains) losses recognized in comprehensive income	$	(2	)		$	2			$	18

Assumptions

The following table provides the weighted-average assumptions used to determine projected benefit obligations and net periodic benefit cost, as they pertain to our pension plans.

	2014						2013						2012
	U.S.			Int’l			U.S.			Int’l			U.S.			Int’l
Benefit Obligation Assumptions
Discount rate	4.01	%		3.14	%		4.79	%		4.23	%		4.13	%		4.04	%
Rate of future compensation increase	NM			3.34	%		NM			3.48	%		4.50	%		3.50	%
Net Periodic Benefit Cost Assumptions
Discount rate	4.79	%		4.23	%		4.13	%		4.04	%		4.87	%		4.76	%
Expected long-term return on plan assets	8.00	%		7.30	%		8.00	%		7.33	%		8.00	%		7.35	%
Rate of future compensation increase	NM			3.48	%		4.50	%		3.50	%		4.50	%		3.58	%

NM	Not meaningful. During 2013, an amendment to one of the Company's U.S. business unit's pension plans modified the benefit formula. Similar to all other U.S. pension plans, pension benefits for future service will be based on years of service and not impacted by future compensation increases.

Management develops each assumption using relevant company experience in conjunction with market-related data for each individual country in which plans exist. Assumptions are reviewed annually and adjusted as necessary.

The expected long-term rate of return on assets reflects the expected returns for each major asset class in which the plans hold investments, the weight of each asset class in the target mix, the correlations among asset classes

and their expected volatilities. The assets of the pension plans are held by a number of independent trustees, managed by several investment institutions and are accounted for separately in the Company’s pension funds.

Our expected return on plan assets is estimated by evaluating both historical returns and estimates of future returns. Specifically, we analyze the plans’ actual historical annual return on assets, net of fees, over the past 15, 20 and 25 years; estimate future returns based on independent estimates of asset class returns; and evaluate historical broad market returns over long-term timeframes based on our asset allocation range. For the U.S. Master Trust which has only existed since 2011, historical returns were estimated using a constructed portfolio that reflects the Company’s strategic asset allocation and the historical compound geometric returns of each asset class for the longest time period available. Based on this approach, the weighted average expected long-term rate of return for all of our plan assets effective January 1, 2015 is estimated at 7.38%.

The table below provides the weighted average actual rate of return generated on all of our plan assets during each of the years presented as compared to the weighted average expected long-term rates of return utilized in calculating the net periodic benefit costs.

	2014			2013			2012
Expected long-term rate of return on plan assets	7.38	%		7.40	%		7.42	%
Actual rate of return on plan assets	18.13	%		10.17	%		10.09	%

The assumed rate of future increases in the per capita cost of health care (the health care trend rate) is 6.88% for 2015, decreasing ratably to 5.00% in 2020. An increase or decrease in the health care trend rates by one percent per year would impact the aggregate annual service and interest components by less than $1 million, and impact the benefit obligation by approximately $4 million.

Investment Policy

The investment strategy for managing worldwide postretirement benefit plan assets is to seek an optimal rate of return relative to an appropriate level of risk for each plan. Investment strategies vary by plan, depending on the specific characteristics of the plan, such as plan size and design, funded status, liability profile and legal requirements. In general, the plans are managed closely to their strategic allocations.

The following table provides the actual asset allocations of plan assets as of December 31, 2014 and 2013, and the related asset target allocation ranges by asset category.

	2014			2013			Target Allocation Ranges
Equity securities	28.8	%		31.7	%		20-40%
Fixed income	37.3	%		24.7	%		20-60%
Hedge funds	25.0	%		23.5	%		20-60%
Private equity	3.2	%		4.2	%		0-15%
Insurance contracts and other	5.7	%		15.9	%		0-30%

Fair Value of Plan Assets

In measuring plan assets at fair value, a fair value hierarchy is applied which categorizes and prioritizes the inputs used to estimate fair value into three levels. The fair value hierarchy is based on maximizing the use of observable inputs and minimizing the use of unobservable inputs when measuring fair value. Classification within the fair value hierarchy is based on the lowest level input that is significant to the fair value measurement. The three levels of the fair value hierarchy are defined as follows:

•	Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

•	Level 2 inputs are other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices (in non-active markets or in active markets for

similar assets or liabilities), inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

•	Level 3 inputs are unobservable inputs for the assets or liabilities.

In certain instances, fair value is estimated using quoted market prices obtained from external pricing services. In obtaining such data from the pricing service, we have evaluated the methodologies used to develop the estimate of fair value in order to assess whether such valuations are representative of fair value, including net asset value ("NAV"). Additionally, in certain circumstances, the NAV reported by an asset manager may be adjusted when sufficient evidence indicates NAV is not representative of fair value.

The following is a description of the valuation methodologies and inputs used to measure fair value for major categories of investments.

•

Equity securities — Equities (including common and preferred shares, domestic listed and foreign listed, closed end mutual funds and exchange traded funds) are generally valued at the closing price reported on the major market on which the individual securities are traded at the measurement date. Equity securities held by the Company that are publicly traded in active markets are classified within Level 1 of the fair value hierarchy. Those equities that are held in proprietary funds pooled with other investor accounts are generally classified within Level 2 of the hierarchy.

•

Fixed income — United States government securities are generally valued using quoted prices of securities with similar characteristics. Corporate bonds and notes are generally valued by using pricing models (e.g. discounted cash flows), quoted prices of securities with similar characteristics or broker quotes. Fixed income securities are generally classified in Level 2 of the fair value hierarchy, however, bond funds listed on active markets are classified in Level 1.

•

Hedge funds — Hedge funds are pooled funds that employ a range of investment strategies including equity and fixed income, credit driven, macro and multi oriented strategies. The valuation of limited partnership interests in hedge funds may require significant management judgment. The NAV reported by the asset manager is adjusted when it is determined that NAV is not representative of fair value. In making such an assessment, a variety of factors is reviewed, including, but not limited to, the timeliness of NAV as reported by the asset manager and changes in general economic and market conditions subsequent to the last NAV reported by the asset manager. Depending on how these investments can be redeemed and the extent of any adjustments to NAV, hedge funds are classified within either Level 2 (redeemable within 90 days) or Level 3 (redeemable beyond 90 days) of the fair value hierarchy.

•

Private equity — Private equity includes a diversified range of strategies, including buyout funds, distressed funds, venture and growth equity funds and mezzanine funds. The valuation of limited partnership interests in private equity funds may require significant management judgment. The NAV reported by the asset manager is adjusted when it is determined that NAV is not representative of fair value. In making such an assessment, a variety of factors is reviewed, including, but not limited to, the timeliness of NAV as reported by the asset manager and changes in general economic and market conditions subsequent to the last NAV reported by the asset manager. These funds are generally classified within Level 3 of the fair value hierarchy.

•

Insurance contracts and other — Primarily comprised of insurance contracts and cash. Insurance contracts are valued at book value, which approximates fair value, and is calculated using the prior year balance adjusted for investment returns and cash flows and are generally classified as Level 3. Cash and cash equivalents are held in accounts with brokers or custodians for liquidity and investment collateral and are classified as Level 1.

The following table provides the fair value of plan assets held by our pension benefit plans by asset class.

	December 31,
	2014																2013
(in millions)	Total				Level 1				Level 2				Level 3				Total				Level 1				Level 2				Level 3
Asset Category
Equity securities
Global stock funds/securities	$	123			$	112			$	11			$	—			$	123			$	108			$	11			$	4
Index funds	42				4				38				—				40				3				37				—
Emerging markets funds	3				3				—				—				3				3				—				—
Fixed income
Corporate bonds	79				53				22				4				95				40				48				7
Government bonds	139				87				52				—				35				35				—				—
Hedge funds	146				11				85				50				123				9				95				19
Private equity	19				—				—				19				22				—				—				22
Insurance contracts and other	33				16				—				17				83				62				4				17
Total	$	584			$	286			$	208			$	90			$	524			$	260			$	195			$	69

The following table presents a reconciliation of the beginning and ending balances of fair value measurement within our pension plans using significant unobservable inputs (Level 3).

(in millions)	Equity Securities				Fixed Income				Hedge funds				Private Equity				Other				Total
Balance, December 31, 2012	$	3			$	9			$	20			$	24			$	4			$	60
Purchases, sales, settlements	—				(3		)		10				(4		)		12				15
Unrealized loss	—				1				1				1				1				4
Realized gains	1				—				—				—				—				1
Net transfers	—				—				(12		)		—				—				(12		)
Currency impact	—				—				—				1				—				1
Balance, December 31, 2013	4				7				19				22				17				69
Purchases, sales, settlements	(3		)		(3		)		27				(6		)		—				15
Unrealized gains	—				1				5				4				—				10
Currency impact	(1		)		(1		)		(1		)		(1		)		—				(4		)
Balance, December 31, 2014	$	—			$	4			$	50			$	19			$	17			$	90

Contributions and Estimated Future Benefit Payments

Funding requirements under governmental regulations are a major consideration in making contributions to our postretirement plans. We made contributions of $35 million and $43 million to our pension and postretirement benefit plans during 2014 and 2013, respectively. We currently anticipate making contributions to our pension and postretirement benefit plans in the range of $24 million to $34 million during 2015, of which approximately $7 million is expected to be made in the first quarter.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:

(in millions)	Pension				Other Benefits
2015	$	33			$	3
2016	33				3
2017	35				3
2018	35				3
2019	36				4
Years 2020 - 2024	184				19

Note 16. Stock-Based Compensation Plans

Our stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees’ interests with the interests of our shareholders. In addition, members of our Board of Directors participate in our stock-based compensation program in connection with their service on our board. Share-based awards issued to employees include non-qualified stock options, restricted stock awards and performance-based awards. Under the 2011 Omnibus Incentive Plan, the number of shares initially available for awards was 18 million. As of December 31, 2014, there were approximately 9 million shares of common stock available for future grants.

Total share-based compensation costs recognized for 2014, 2013 and 2012 were $18 million, $27 million, and $22 million, respectively. The unamortized compensation expense at December 31, 2014 related to our stock options, restricted shares and performance-based shares was $5 million, $20 million and $3 million, respectively, and is expected to be recognized over a weighted average period of 1.8, 2.0 and 2.0 years, respectively.

The amount of cash received from the exercise of stock options was $26 million for 2014 with a tax benefit of $8 million realized associated with stock option exercises and vesting of restricted stock. We classify as a financing activity the cash flows attributable to excess tax benefits arising from stock option exercises and restricted stock vestings.

On March 17, 2014, the Company named Patrick K. Decker as the new President and Chief Executive Officer of Xylem Inc. As part of Mr. Decker's employment agreement, he was awarded 165,584 stock options, 40,342 restricted stock and 40,342 performance-based shares. The award was granted subject to the approval of the Xylem Omnibus Incentive Plan, which was obtained at the annual meeting of shareholders in May 2014. The share and associated expense amounts are included beginning as of the May approval date.

Stock Option Grants

Options are awarded with a contractual term of ten years and generally vest over or at the conclusion of a three-year period and are exercisable in seven to ten-year periods, except in certain instances of death, retirement or disability. The exercise price per share is the fair market value of the underlying common stock on the date each option is granted. At December 31, 2014, there were options to purchase an aggregate of 3.0 million shares of common stock. The following is a summary of the changes in outstanding stock options for 2014:

(shares in thousands)	Shares			Weighted Average Exercise Price / Share				Weighted Average Remaining Contractual Term (Years)
Outstanding at January 1, 2014	3,504			$	26.80			6.4
Granted	543			$	38.16			10.0
Exercised	(941	)		$	27.43			4.9
Forfeited	(117	)		$	28.78			6.8
Outstanding at December 31, 2014	2,989			$	28.60			6.5
Options exercisable at December 31, 2014	1,924			$	26.50			5.5
Vested and non-vested expected to vest as of December 31, 2014	2,903			$	28.42			6.4

The amount of non-vested options outstanding was 1.0 million and 1.5 million at a weighted average grant date fair value of $32.45 and $26.90 as of December 31, 2014 and January 1, 2014, respectively. The aggregate intrinsic value of the outstanding, exercisable, and vested and non-vested stock options expected to vest at December 31, 2014 was $28 million, $22 million and $28 million respectively. 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 2014 was $10 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 used for 2014, 2013, and 2012:

	2014				2013				2012
Dividend yield	1.34		%		1.69		%		1.52		%
Volatility	28.49		%		31.10		%		33.40		%
Risk-free interest rate	1.82		%		1.28		%		1.42		%
Expected term (in years)	5.60				6.62				7.00
Weighted-average fair value per share	$	9.71			$	7.58			$	8.10

Expected volatility is calculated based on an 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 expected term provided above represents the weighted average of expected behavior for certain groups of employees who have historically exhibited different behavior. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of option grant.

Restricted Stock Grants

Restricted shares granted to employees become fully vested upon the third anniversary of the date of grant, and certain liability-based restricted shares to international employees settle in cash. Prior to the time a restricted share becomes fully vested, the awardees cannot transfer, pledge, hypothecate or encumber such shares. Prior to the time a restricted share is fully vested, the awardees have certain rights of a stockholder and may include the right to vote and receive dividends. If an employee leaves prior to vesting, whether through resignation or termination for cause, the restricted stock and related accrued dividends are forfeited. If an employee retires or is terminated other

than for cause, a pro rata portion of the restricted stock may vest in accordance with the terms of the grant agreements. Restricted shares granted to Board members become fully vested upon the date of the next annual meeting.

Our restricted stock activity was as follows for 2014:

(shares in thousands)	Shares			Weighted Average Grant Date Fair Value / Share
Outstanding at January 1, 2014	1,275			$	27.67
Granted	488			$	38.00
Vested	(480	)		$	27.71
Forfeited	(112	)		$	29.82
Outstanding at December 31, 2014	1,171			$	31.80

Performance-Based Share Grants

As part of the annual 2013 and 2014 grants under the long-term incentive plan, performance-based shares were granted to all executive officers of the Company. The performance-based shares vest based upon performance by the Company over a three-year period against targets approved by the compensation committee of the Company's Board of Directors prior to the grant date. For the performance periods, the performance-based shares were granted at a target of 100% with actual payout contingent upon the achievement of a pre-set, three-year adjusted Return on Invested Capital and cumulative adjusted net income performance target. The calculated compensation cost is adjusted based on an estimate of awards ultimately expected to vest and our assessment of the probable outcome of the performance condition. The fair value of performance-based share awards at 100% target is determined using the closing price of our common stock on date of grant.

Our performance-based share activity was as follows for 2014:

(shares in thousands)	Shares			Weighted Average Grant Date Fair Value / Share
Outstanding at January 1, 2014	52			$	27.49
Granted	84			$	37.87
Vested	—			$	—
Forfeited	(12	)		$	33.11
Outstanding at December 31, 2014	124			$	33.95

Note 17. Capital Stock

The Company has the authority to issue an aggregate of 750 million shares of common stock having a par value of $0.01 per share. The stockholders of Xylem common stock are entitled to receive dividends as declared by the Xylem Board of Directors. Dividends declared were $0.5120, $0.4656 and $0.4048 during 2014, 2013 and 2012, respectively.

The changes in common stock outstanding for the three years ended December 31 are as follows:

(in thousands of shares)	2014			2013			2012
Beginning Balance, January 1	184,557			185,658			184,641
Stock incentive plan activity	1,226			1,203			1,367
Repurchase of common stock	(3,483	)		(2,304	)		(350	)
Ending Balance, December 31	182,300			184,557			185,658

On August 20, 2013, the Board of Directors authorized the repurchase up to $250 million in shares with no expiration date. The program's objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. During 2014, we repurchased 3.4 million shares for $130 million under this program. There are up to $70 million in shares that may still be purchased under this plan. During 2013, we repurchased 1.7 million shares for $50 million under this program.

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 repurchased under this plan during 2014. There are up to 1.0 million shares that may still be purchased under this plan. We repurchased 0.6 million shares for $17 million under this program during 2013.

Aside from the aforementioned repurchase programs, we repurchased 0.2 million and 0.2 million shares for $4 million and $6 million during 2014 and 2013, respectively in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock. These repurchases are included in the stock incentive plan activity in the above table.

Note 18. Accumulated Other Comprehensive Income (Loss)

The following table provides the components of accumulated other comprehensive income for 2014, 2013 and 2012:

(in millions)	Foreign Currency Translation				Postretirement Benefit Plans				Derivative Instruments				Total
Balance at January 1, 2012	$	288			$	(166	)		$	—			$	122
Foreign currency translation adjustment	48												48
Changes in postretirement benefit plans					(93		)						(93		)
Income tax expense on changes in postretirement benefit plans					27								27
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into:
Cost of revenue					5								5
Selling, general and administrative expenses					5								5
Other non-operating (expense) income, net					4								4
Income tax expense on amortization of postretirement benefit plan items					(4		)						(4		)
Unrealized gain on foreign exchange agreements									4				4
Income tax expense on unrealized gain on foreign exchange agreements									(1		)		(1		)
Reclassification of unrealized gain on foreign exchange agreements into revenue									(2		)		(2		)
Reclassification of unrealized gain on foreign exchange agreements into cost of revenue									(1		)		(1		)
Tax on reclassification of unrealized gain on foreign exchange agreements									1				1
Balance at December 31, 2012	$	336			$	(222	)		$	1			$	115
Foreign currency translation adjustment	15												15
Changes in postretirement benefit plans					40								40
Income tax expense on changes in postretirement benefit plans					(17		)						(17		)
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into:
Cost of revenue					7								7
Selling, general and administrative expenses					7								7
Research and development expenses					1								1
Other non-operating (expense) income, net					3								3
Income tax expense on amortization of postretirement benefit plan items					(5		)						(5		)
Unrealized gain on foreign exchange agreements									1				1
Reclassification of unrealized gain on foreign exchange agreements into revenue									(2		)		(2		)
Reclassification of unrealized loss on foreign exchange agreements into cost of revenue									2				2
Balance at December 31, 2013	$	351			$	(186	)		$	2			$	167

(in millions)	Foreign Currency Translation				Postretirement Benefit Plans				Derivative Instruments				Total
Balance at January 1, 2014	$	351			$	(186	)		$	2			$	167
Foreign currency translation adjustment	(206		)										(206		)
Changes in postretirement benefit plans					(92		)						(92		)
Income tax expense on changes in postretirement benefit plans					20								20
Foreign currency translation adjustment for postretirement benefit plans					20								20
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into:
Cost of revenue					4								4
Selling, general and administrative expenses					5								5
Other non-operating (expense) income, net					1								1
Income tax expense on amortization of postretirement benefit plan items					(3		)						(3		)
Unrealized loss on foreign exchange agreements									(22		)		(22		)
Income tax benefit on unrealized loss on foreign exchange agreements									1				1
Reclassification of unrealized loss on foreign exchange agreements into revenue									5				5
Reclassification of unrealized loss on foreign exchange agreements into cost of revenue									1				1
Balance at December 31, 2014	$	145			$	(231	)		$	(13	)		$	(99	)

Note 19. Commitments and Contingencies

General

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.

On December 17, 2014, the Korea Fair Trade Commission (“KFTC”) issued a written decision regarding an investigation into bid-rigging allegations against Xylem Water Solutions South Korea Co., Ltd. (“Xylem South Korea”), a subsidiary of Xylem Inc. The KFTC found that certain employees of Xylem South Korea had participated in activities that violated Korea’s antitrust laws. Xylem South Korea was assessed a fine of approximately $1.6 million and the matter was referred for criminal prosecution. In January 2015, Xylem South Korea paid the fine and filed an appeal of the KFTC’s decision with the Seoul High Court.

In connection with the KFTC matter, the Company commenced an internal investigation relating to the allegations against Xylem South Korea. In late 2014, the Company broadened this internal investigation to assess related allegations made by certain employees of Xylem South Korea during the investigation into the KFTC matter. The broadened investigation includes a review of compliance by Xylem South Korea and its employees with the requirements of the Foreign Corrupt Practices Act. The Company engaged independent outside counsel to assist with its investigation and an independent professional services firm to provide forensic accounting assistance. In late January 2015, the Company voluntarily contacted the Securities and Exchange Commission and the Department of Justice to advise both agencies of this internal investigation. The Company will fully cooperate with any government investigation. Xylem South Korea’s revenue is less than one percent of the Company’s total revenue. Although the Company currently cannot reasonably estimate the potential liability, if any, related to the investigation, we currently believe that these matters will not have a material adverse effect on the Company’s business, financial condition or results of operations.

On October 1, 2014, the court approved a settlement agreement with respect to a purchase price dispute with the minority shareholders arising from one of our historical acquisitions. All outstanding claims have been settled and the court proceedings have been terminated. The outstanding balance of the settlement has been reflected in the 2014 Consolidated Balance Sheet.

From time to time claims may be asserted against Xylem alleging injury caused by any 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, Exelis and Xylem, ITT 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 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 $9 million and $17 million as of December 31, 2014 and 2013, respectively for these general legal matters.

Indemnifications

As part of our Spin-off from our former parent, ITT, 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.

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 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 $5 million and $8 million as of December 31, 2014 and 2013, 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.

Operating Leases

We lease certain offices, manufacturing buildings, machinery, computers and other equipment. Such leases expire at various dates through 2047 and may include renewal and payment escalation clauses. We often pay maintenance, insurance and tax expense related to leased assets. Total rent expense for the three years ended December 31, 2014 was as follows:

(in millions)	Total
2014	$	73
2013	77
2012	73

At December 31, 2014, we are obligated to make minimum rental payments under operating leases which are as follows:

(in millions)	2015				2016				2017				2018				2019				Thereafter
Minimum rental payments	$	63			$	48			$	33			$	24			$	13			$	25

Warranties

We warrant numerous products, the terms of which vary widely. In general, we warrant products against defect and specific non-performance. Warranty expense was $27 million, $34 million, and $32 million for 2014, 2013 and 2012, respectively. The table below provides changes in the product warranty accrual over each period.

(in millions)	2014				2013
Warranty accrual – January 1	$	37			$	40
Net changes for product warranties in the period	27				34
Settlement of warranty claims	(31		)		(37		)
Foreign currency and other	(2		)		—
Warranty accrual – December 31	$	31			$	37

Note 20. Related Party Transactions

Sales and purchases to unconsolidated affiliates for 2014, 2013 and 2012 are as follows:

(in millions)		2014				2013				2012
Sales to unconsolidated affiliates		$	16			$	15			$	12
Purchases from unconsolidated affiliates		18				20				20

Note 21. Segment and Geographic Data

Our business has two reportable segments: Water Infrastructure and Applied Water. The Water Infrastructure segment, focuses on the transportation, treatment and testing of water, offering a range of products including water and wastewater pumps, treatment and testing equipment, and controls and systems. The Applied Water segment, encompasses the uses of water and focuses on the residential, commercial, industrial and agricultural markets offering a wide range of products, including pumps, valves and heat exchangers. Our Regional selling locations consist primarily of selling and marketing organizations and related support that offer products and services across both of 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.

The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1). The following tables contain financial information for each reportable segment:

	Year Ended December 31,
(in millions)	2014				2013				2012
Revenue:
Water Infrastructure	$	2,442			$	2,384			$	2,349
Applied Water	1,474				1,453				1,442
Total	$	3,916			$	3,837			$	3,791
Operating income:
Water Infrastructure	$	321			$	263			$	334
Applied Water	193				175				178
Corporate and other	(51		)		(75		)		(69		)
Total operating income	463				363				443
Interest expense	54				55				55
Other non-operating income (expense)	1				(10		)		—
Gain from sale of business	11				—				—
Income before taxes	$	421			$	298			$	388
Depreciation and amortization:
Water Infrastructure	$	100			$	104			$	95
Applied Water	25				26				28
Regional selling locations (a)	12				13				12
Corporate and other	5				7				7
Total	$	142			$	150			$	142
Capital expenditures:
Water Infrastructure	$	73			$	67			$	66
Applied Water	28				31				25
Regional selling locations (b)	10				12				15
Corporate and other	8				16				6
Total	$	119			$	126			$	112

(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 is the expense captured in this Regional selling location line.

(b)	Represents capital expenditures incurred by the Regional selling locations not allocated to the segments.

The following table illustrates revenue by product category, net of intercompany revenue.

	Year Ended December 31,
(in millions)	2014				2013				2012
Pumps, accessories, parts and service	$	3,094			$	3,076			$	3,054
Other (a)	822				761				737
Total	$	3,916			$	3,837			$	3,791

(a)	Other includes treatment equipment, analytical instrumentation, heat exchangers, valves and controls.

The following table contains the total assets for each reportable segment as of December 31, 2014, 2013 and 2012.

	Total Assets
(in millions)	2014				2013				2012
Water Infrastructure	$	2,128			$	2,224			$	2,169
Applied Water	1,114				1,122				1,131
Regional selling locations (a)	961				983				797
Corporate and other (b)	661				567				582
Total	$	4,864			$	4,896			$	4,679

(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 deferred tax assets and certain property, plant and equipment.

Geographical Information

Revenue is attributed to countries based upon the location of the customer. Property, Plant & Equipment is attributed to countries based upon the location of the assets.

	Revenue
	Year Ended December 31,
(in millions)	2014				2013				2012
United States	$	1,477			$	1,434			$	1,400
Europe	1,379				1,387				1,338
Asia Pacific	478				467				469
Other	582				549				584
Total	$	3,916			$	3,837			$	3,791

	Property, Plant & Equipment
	December 31,
(in millions)	2014				2013				2012
United States	$	180			$	186			$	183
Europe	206				225				219
Asia Pacific	53				45				65
Other	22				32				20
Total	$	461			$	488			$	487

Note 22. Valuation and Qualifying Accounts

The table below provides changes in the allowance for doubtful accounts over each period.

(in millions)	2014				2013				2012
Balance at beginning of year	$	22			$	25			$	29
Additions charged to expense	9				8				4
Deductions/other	(7		)		(11		)		(8		)
Balance at end of year	$	24			$	22			$	25

Note 23. Quarterly Financial Data (Unaudited)

		2014 Quarter Ended
(In millions, except per share amounts)		Dec. 31				Sept. 30				June 30				Mar. 31
Revenue		$	1,042			$	963			$	1,005			$	906
Gross profit		407				376				388				342
Operating income		141				130				116				76
Net income		$	96			$	106			$	86			$	49
Earnings per share:
Basic		$	0.53			$	0.58			$	0.47			$	0.27
Diluted		$	0.52			$	0.58			$	0.47			$	0.27

		2013 Quarter Ended
(In millions, except per share amounts)		Dec. 31				Sept. 30				June 30				Mar. 31
Revenue		$	1,033			$	965			$	960			$	879
Gross profit		410				384				371				334
Operating income		129				98				70				66
Net income		$	68			$	73			$	46			$	41
Earnings per share:
Basic		$	0.37			$	0.39			$	0.25			$	0.22
Diluted		$	0.37			$	0.39			$	0.25			$	0.22