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	57
Consolidated Income Statements for the Years Ended December 31, 2018, 2017 and 2016	58
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016	59
Consolidated Balance Sheets as of December 31, 2018 and 2017	60
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016	61
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016	62
Notes to Consolidated Financial Statements:
Note 1 Summary of Significant Accounting Policies	63
Note 2 Recently Issued Accounting Pronouncements	71
Note 3 Acquisitions and Divestitures	73
Note 4 Revenue	78
Note 5 Restructuring and Asset Impairment Charges	80
Note 6 Other Non-Operating Income, Net	82
Note 7 Income Taxes	82
Note 8 Earnings Per Share	85
Note 9 Inventories	86
Note 10 Property, Plant and Equipment	86
Note 11 Goodwill and Other Intangible Assets	86
Note 12 Derivative Financial Instruments	87
Note 13 Accrued and Other Current Liabilities	90
Note 14 Credit Facilities and Long-Term Debt	90
Note 15 Postretirement Benefit Plans	92
Note 16 Stock-Based Compensation Plans	100
Note 17 Capital Stock	102
Note 18 Accumulated Other Comprehensive Income (Loss)	104
Note 19 Commitment and Contingencies	105
Note 20 Related Party Transactions	107
Note 21 Segment and Geographic Data	108
Note 22 Valuation and Qualifying Accounts	110
Note 23 Quarterly Financial Data	110

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of

Xylem Inc.

Rye Brook, New York

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Xylem Inc. and subsidiaries (the "Company") as of December 31, 2018 and 2017, 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, 2018, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, 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) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Deloitte & Touche LLP

Stamford, Connecticut

February 22, 2019

We have served as the Company's auditor since 2010.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS

(In Millions, except per share data)

Year Ended December 31,	2018				2017				2016
Revenue	$	5,207			$	4,707			$	3,771
Cost of revenue	3,181				2,860				2,309
Gross profit	2,026				1,847				1,462
Selling, general and administrative expenses	1,161				1,089				914
Research and development expenses	189				181				110
Restructuring and asset impairment charges	22				25				30
Operating income	654				552				408
Interest expense	82				82				70
Other non-operating income, net	13				6				2
(Loss)/gain on sale of businesses	—				(10		)		—
Income before taxes	585				466				340
Income tax expense	36				136				80
Net income	549				330				260
Less: Net loss attributable to non-controlling interests	—				(1		)		—
Net income attributable to Xylem	$	549			$	331			$	260
Earnings per share:
Basic	$	3.05			$	1.84			$	1.45
Diluted	$	3.03			$	1.83			$	1.45
Weighted average number of shares:
Basic	179.8				179.6				179.1
Diluted	181.1				180.9				180.0
Dividends declared per share	$	0.8400			$	0.7200			$	0.6196

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Millions)

Year Ended December 31,	2018				2017				2016
Net income	$	549			$	330			$	260
Other comprehensive (loss) income, before tax:
Foreign currency translation adjustment	(85		)		79				(65		)
Net change in derivative hedge agreements:
Unrealized (loss) gain	(8		)		9				—
Amount of loss (gain) reclassified into net income	4				(5		)		(2		)
Net change in postretirement benefit plans:
Net loss	(37		)		(19		)		(20		)
Prior service credit	—				1				1
Amortization of prior service credit cost	(4		)		(3		)		(3		)
Amortization of net actuarial loss into net income	13				13				13
Settlement	1				1				—
Foreign currency translation adjustment	15				(18		)		19
Other comprehensive (loss) income, before tax	(101		)		58				(57		)
Income tax expense (benefit) related to other comprehensive loss	10				(50		)		23
Other comprehensive (loss) income, net of tax	(111		)		108				(80		)
Comprehensive income	$	438			$	438			$	180
Less: comprehensive loss attributable to noncontrolling interests	(2		)		—				—
Comprehensive income attributable to Xylem	$	440			$	438			$	180

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Millions, except per share amounts)

December 31,	2018				2017
ASSETS
Current assets:
Cash and cash equivalents	$	296			$	414
Receivables, less allowances for discounts, returns and doubtful accounts of $35 and $35 in 2018 and 2017, respectively	1,031				956
Inventories	595				524
Prepaid and other current assets	172				177
Total current assets	2,094				2,071
Property, plant and equipment, net	656				643
Goodwill	2,976				2,768
Other intangible assets, net	1,232				1,168
Other non-current assets	264				210
Total assets	$	7,222			$	6,860
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	586			$	549
Accrued and other current liabilities	546				551
Short-term borrowings and current maturities of long-term debt	257				—
Total current liabilities	1,389				1,100
Long-term debt, net	2,051				2,200
Accrued postretirement benefits	400				442
Deferred income tax liabilities	303				252
Other non-current accrued liabilities	297				347
Total liabilities	4,440				4,341
Commitment and Contingencies (Note 19)
Stockholders’ equity:
Common stock — par value $0.01 per share:
Authorized 750.0 shares, issued 192.9 and 192.3 shares in 2018 and 2017, respectively	2				2
Capital in excess of par value	1,950				1,912
Retained earnings	1,639				1,227
Treasury stock – at cost 13.2 shares and 12.4 shares in 2018 and 2017, respectively	(487		)		(428		)
Accumulated other comprehensive loss	(336		)		(210		)
Total stockholders’ equity	2,768				2,503
Non-controlling interest	14				16
Total equity	2,782				2,519
Total liabilities and stockholders’ equity	$	7,222			$	6,860

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (In Millions)

Year Ended December 31,	2018				2017				2016
Operating Activities
Net income	$	549			$	330			$	260
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	117				109				87
Amortization	144				125				64
Deferred income taxes	(47		)		(33		)		14
Share-based compensation	30				21				18
Restructuring and asset impairment charges	22				25				30
Loss/(gain) from sale of businesses	—				10				—
Other, net	9				19				6
Payments for restructuring	(21		)		(28		)		(16		)
Contributions to postretirement benefit plans	(41		)		(33		)		(27		)
Changes in assets and liabilities (net of acquisitions):
Changes in receivables	(103		)		(79		)		(6		)
Changes in inventories	(97		)		27				(15		)
Changes in accounts payable	51				50				61
Changes in accrued liabilities	(6		)		28				13
Changes in accrued taxes	—				104				(13		)
Net changes in other assets and liabilities	(21		)		11				21
Net Cash — Operating activities	586				686				497
Investing Activities
Capital expenditures	(237		)		(170		)		(124		)
Proceeds from the sale of property, plant and equipment	—				1				1
Acquisitions of businesses and assets, net of cash acquired	(433		)		(33		)		(1,782		)
Proceeds from sale of businesses	22				16				—
Cash received from investments	11				10				—
Cash paid for investments	(11		)		(11		)		—
Other, net	5				6				19
Net Cash — Investing activities	(643		)		(181		)		(1,886		)
Financing Activities
Short-term debt issued	335				—				274
Short-term debt repaid, net	(52		)		(282		)		(80		)
Long-term debt issued, net	1				—				1,540
Long-term debt repaid	(120		)		—				(608		)
Repurchase of common stock	(59		)		(25		)		(4		)
Proceeds from exercise of employee stock options	7				16				24
Dividends paid	(152		)		(130		)		(112		)
Other, net	—				—				—
Net Cash — Financing activities	(40		)		(421		)		1,034
Effect of exchange rate changes on cash	(21		)		22				(17		)
Net change in cash and cash equivalents	(118		)		106				(372		)
Cash and cash equivalents at beginning of year	414				308				680
Cash and cash equivalents at end of year	$	296			$	414			$	308
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest	$	78			$	78			$	49
Income taxes (net of refunds received)	$	75			$	57			$	78

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				Capital in Excess of Par Value				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Non-Controlling Interest				Total
Balance at December 31, 2015	$	2			$	1,834			$	885			$	(238	)		$	(399	)		$	—			$	2,084
Net income									260																260
Other comprehensive loss, net													(80		)										(80		)
Dividends declared ($0.6196 per share)									(112		)														(112		)
Stock incentive plan activity					42																				42
Repurchase of common stock																	(4		)						(4		)
Acquisition activity																					$	17			$	17
Balance at December 31, 2016	$	2			$	1,876			$	1,033			$	(318	)		$	(403	)		$	17			$	2,207
Cumulative effect of change in accounting principle									(7		)														(7		)
Net income									331												(1		)		330
Other comprehensive income, net													108												108
Dividends declared ($.72 per share)									(130		)														(130		)
Stock incentive plan activity					36												(5		)						31
Repurchase of common stock																	(20		)						(20		)
Balance at December 31, 2017	$	2			$	1,912			$	1,227			$	(210	)		$	(428	)		$	16			$	2,519
Cumulative effect of change in accounting principle									14				(17		)										(3		)
Net income									549																549
Other comprehensive loss, net													(109		)						(2		)		(111		)
Dividends declared ($.84 per share)									(151		)														(151		)
Stock incentive plan activity					38												(9		)						29
Repurchase of common stock																	(50		)						(50		)
Balance at December 31, 2018	$	2			$	1,950			$	1,639			$	(336	)		$	(487	)		$	14			$	2,782

See accompanying notes to consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

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 three segments, Water Infrastructure, Applied Water and Measurement & Control Solutions. The Water Infrastructure segment focuses on the transportation and treatment of water, offering a range of products including water and wastewater pumps, treatment equipment, and controls and systems. The Applied Water segment serves many of the primary uses of water and focuses on the residential, commercial and industrial markets. The Applied Water segment’s major products include pumps, valves, heat exchangers, controls and dispensing equipment. The Measurement & Control Solutions segment focuses on developing advanced technology solutions that enable intelligent use and conservation of critical water and energy resources as well as analytical instrumentation used in the testing of water. The Measurement & Control Solutions segment's major products include smart metering, networked communications, measurement and control technologies, critical infrastructure technologies, software and services including cloud-based analytics, remote monitoring and data management, leak detection and pressure monitoring solutions and testing 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 (now ITT LLC), Exelis Inc., acquired by Harris Inc. on May 29, 2015, (“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 (now ITT LLC) 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 intercompany transactions between our businesses have been eliminated.

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, valuation of intangible assets, 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

As discussed in Note 2, "Recently Issued Accounting Pronouncements", Xylem adopted the new guidance on recognizing revenue from contracts with customers as of January 1, 2018. In accordance with this new guidance Xylem recognizes revenue in a manner that depicts the transfer of promised goods and services to customers in an amount that reflects the consideration to which it expects to be entitled to for providing those goods and services. For each arrangement with a customer, we identify the contract, the associated performance obligations within the contract, determine the transaction price of that contract, allocate the transaction price to each performance obligation and recognize revenue as each performance obligation is satisfied.

The satisfaction of performance obligations in a contract is based upon when the customer obtains control over the asset. Depending on the nature of the performance obligation, control transfers either at a particular point in time, or over time which determines the recognition pattern of revenue.

For product sales, other than long-term construction-type contracts, we recognize revenue once control has passed at a point in time, which is generally when products are shipped. In instances where contractual terms include a provision for customer acceptance, revenue is recognized when either (i) we have previously demonstrated that the product meets the specified criteria based on either seller or customer specified objective criteria or (ii) upon formal acceptance received from the customer where the product has not been previously demonstrated to meet customer specified objective criteria. We recognize revenue on product sales to channel partners, including resellers, distributors or value-added solution providers at the point in time when control is transferred which is determined based on when the risks and rewards, possession, and title have transferred to the customer, which usually occurs at the point of delivery.

Revenue from performance obligations related to services is recognized over time, as the performance obligations are satisfied. In these instances, the customer consumes the benefit of the service as Xylem performs.

Certain businesses also enter into long-term construction-type sales contracts where revenue is recognized over time. In these instances, revenue is recognized using a measure of progress that applies an input method based on costs incurred in relation to total estimated costs. We also recognize revenue for certain of these arrangements using the output method and measure progress based on shipments of product where control has transferred to the customer.

If shipping and handling activities are performed after a customer obtains control of a good, we account for the shipping and handling activities as activities to fulfill a promise to transfer a good. Shipping and handling related costs are accrued as revenue is recognized.

For all contracts with customers, we determine the transaction price in the arrangement and allocate the transaction price to each performance obligation identified in the contract. Judgment is required to determine the appropriate unit of account, and we separate out the performance obligations if they are capable of being distinct and if they are distinct within the context of the contract. We base our allocation of the transaction price to the performance obligations on the relative standalone selling prices for the goods or services contained in a particular performance obligation. The standalone selling prices are determined first by reference to observable prices. In the event observable prices are not available, we estimate the stand-alone selling price by maximizing observable inputs and apply an adjusted market assessment approach, expected cost plus margin approach, or a residual approach in limited situations. Revenue in these instances is recognized on individual performance obligations within the same contract as they are satisfied.

The transaction price is adjusted for our estimate of variable consideration which may include a right of return, discounts, rebates, penalties and retainage. To estimate variable consideration, we apply the expected value or the most likely amount method, based on whichever method most appropriately predicts the amount of consideration we expect to receive. The method applied is typically based on historical experience and known trends. We constrain the amounts of variable consideration that are included in the transaction price, to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur or when uncertainties around the variable consideration are resolved.

We exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with specific revenue-producing transaction and collected from a customer, for example sales, use, value added and some excise taxes.

For all contracts with customers, payment received for our products and services may not necessarily follow the same pattern of revenue recognition to which it relates and are dictated by the terms and conditions of our contracts with customers. Payments received for product sales typically occur following delivery and the satisfaction of the performance obligation based upon the terms outlined in the contracts. Payments received for services typically occur following the services being rendered. For long-term construction-type projects, payments are typically made throughout the contract as progress is made.

In limited situations, contracts with customers include financing components where payment terms exceed one year, however, we believe that the financing effects are not significant to Xylem. In addition, we apply a practical expedient and do not adjust the promised amount of consideration in a contract for the effects of significant financing components when we expect payment terms to be one year or less from the time the goods or services are transferred until ultimate payment.

We offer standard warranties for our products to ensure that our products comply with agreed-upon specifications in our contracts. For standard warranties, these do not give rise to performance obligations and represent assurance-type warranties. In certain instances, product warranty terms are adjusted to account for the specific nature of the contract. In these instances, we assess the warranties to determine whether they represent service-type warranties, and should be accounted for as a separate performance obligation in the contract.

Costs to obtain a contract include incremental costs that the Company has incurred which it expects to recover. Incremental costs only include costs that the Company would not have incurred had the contract not been obtained. Costs that would have been incurred regardless of whether or not the contract was obtained are expensed as incurred, unless they are explicitly chargeable to the customer whether or not the contract is obtained.

Costs to obtain contracts are capitalized when incurred. The costs to obtain contracts are then amortized in a manner that is consistent with the pattern of transfer of the related goods or services provided in the contract. The Company elects to apply the practical expedient to expense costs to obtain contracts when the associated amortization period of those costs would be one year or less.

For annual periods prior to January 1, 2018, 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. Generally, these elements are satisfied within the same reporting period although certain contracts may be completed over 6 months. 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 unit awards and performance share unit 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 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 unit awards is determined using the closing price of our common stock on date of grant. The fair value of Return on Invested Capital ("ROIC") performance share units at 100% target is determined using the closing price of our common stock on date of grant. The fair value of Total Shareholder Return ("TSR") performance share units is calculated on the date of grant using a Monte Carlo simulation model utilizing several key assumptions, including expected Company and peer company share price volatility, correlation coefficients between peers, the risk-free rate of return, the expected dividend yield and other award design features.

Research and Development

We conduct research and development activities, which consist primarily of the development of new products, product applications, and manufacturing processes. To the extent these activities are related to developing software that is sold to our customers, we capitalize the applicable development costs. All other research and development 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 long-term debt 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.

Due to the U.S. Tax Cuts and Jobs Act (the "Tax Act"), we have recorded net foreign withholding taxes and state income taxes on earnings that are expected to be repatriated to the U.S. parent. We have not recorded any deferred taxes on the amounts that the Company currently does not intend to repatriate as the determination of any deferred taxes on this amount is not practicable.

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 Discounts

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

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

Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and their dispersion across many different geographical regions. We perform ongoing credit evaluations of the financial condition of our third-party distributors, resellers and other customers and require collateral, such as letters of credit and bank guarantees, in certain circumstances. As of December 31, 2018 and 2017 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 net realizable value 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, software 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 1 to 25 years and is included in cost of revenue or selling, general and administrative expense. Certain of our intangible assets, namely certain brands and trademarks, as well as FCC licenses, 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 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. If the carrying value of the reporting unit exceeds its estimated fair value, then an impairment charge is recognized for that excess up to the amount of recorded goodwill. We estimate the fair value of our reporting units using an income approach. We estimate the fair value of our intangible assets with indefinite lives using either the income approach or the market approach. Under the income approach, we calculate fair value based on the present value of estimated future cash flows. Under the market approach, we calculate fair value based on recent sales and selling prices of similar assets.

Product Warranties

For assurance-type 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.

For service-type warranties (i.e. non-standard warranties) costs incurred to fulfill the extended or service warranty are recognized/recorded as the costs are incurred.

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 wil

l 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”) to be 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. The excess of the acquisition price over those estimated fair values is recorded as goodwill. 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. 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.

During the fourth quarter of 2018 we adopted new accounting guidance that eliminates the concept of ineffectiveness for cash flow and net investment hedges (refer to Note 2, “Recently Issued Accounting Pronouncements”). Prior to this adoption, the effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk was recorded in other comprehensive income ("OCI") and was 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 was recognized directly in selling, general and administrative expenses. Our policy was 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 became probable that the originally forecasted transaction would not occur, the gain or loss related to the hedge recorded within accumulated other comprehensive income ("AOCI") was immediately recognized into net income.

Prior to the adoption of the new guidance, changes in the fair value of derivatives designated and that qualify as net investment hedges of foreign exchange risk were recorded in OCI. Amounts in AOCI were reclassified into earnings at the time the hedged net investment is sold or substantially liquidated. Effectiveness of derivatives designated as net investment hedges was assessed using the forward method.

Subsequent to adopting the new hedge guidance, changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk are recorded in other comprehensive income ("OCI") and are 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. 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 ("AOCI") is immediately recognized into net income.

Subsequent to adopting the new hedge guidance effectiveness of derivatives designated as net investment hedges is assessed using the spot method. The changes in the fair value of these derivatives due to movements in spot exchange rates are recorded in OCI. Amounts in AOCI are reclassified into earnings at the time the hedged net investment is sold or substantially liquidated. Furthermore, we will recognize interest income based on the interest rate differential embedded in the derivative instrument.

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, 2018 and 2017 were uninsured. Foreign cash balances at December 31, 2018 and 2017 were $274 million and $373 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 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.

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.

NAV Practical Expedient is the measurement of fair value using the net asset value ("NAV") per share (or its equivalent) as an alternative to the fair value hierarchy as discussed above.

Note 2**. Recently Issued Accounting Pronouncements**

Pronouncements Not Yet Adopted

In August 2018, the Financial Accounting Standards Board (“FASB”) issued guidance regarding the accounting for implementation costs of a hosting arrangement that is a service contract. The guidance establishes the requirement to capitalize certain implementation costs incurred in a hosting arrangement that is a service contract, effectively aligning with the requirement to capitalize certain implementation costs incurred to develop or obtain internal-use software. This guidance is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted. The requirements of the amended guidance may be applied using either a retrospective or prospective approach. We are evaluating the impact of the guidance on our financial condition and results of operations.

In June 2016, the FASB issued guidance amending the accounting for the impairment of financial instruments, including trade receivables. Under current guidance, credit losses are recognized when the applicable losses are probable of occurring and this assessment is based on past events and current conditions. The amended guidance eliminates the “probable” threshold and requires an entity to use a broader range of information, including forecast information when estimating expected credit losses. Generally, this should result in a more timely recognition of credit losses. This guidance is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted for interim and annual periods beginning after December 15, 2018. The requirements of the amended guidance should be applied using a modified retrospective approach except for debt securities, which require a prospective transition approach. We are evaluating the impact of the guidance on our financial condition and results of operations.

In February 2016, the FASB issued guidance amending the accounting for leases. Specifically, the amended guidance requires all lessees to record a lease liability at lease inception, with a corresponding right of use asset ("ROU"), except for short-term leases. Lessor accounting is not fundamentally changed. This amended guidance is effective for interim and annual periods beginning after December 15, 2018 using a modified retrospective approach. Early adoption is permitted. We will apply the modified retrospective approach by recording a cumulative effect adjustment as of the date of adoption, whereby prior comparative periods will not be retrospectively presented in the consolidated financial statements. As a result, adoption of the standard will result in the recognition of ROU assets and lease liabilities for operating leases of between $255 million and $285 million, as of January 1, 2019, the date of initial application. The guidance will not have a material impact on our consolidated income statements and statements of cash flow.

Recently Adopted Pronouncements

In August 2017, the FASB issued amended guidance on hedging activities. The amendment better aligns a company’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying for hedging relationships and the presentation of hedge results. Specifically, the guidance:

(1)	Eliminates the concept of recognizing periodic hedge ineffectiveness for cash flow and net investment hedges;

(2)	Eliminates the benchmark interest rate concept of variable - rate instruments in cash flow hedges and allows companies to designate the contractually specified interest rate as the hedged risk;

(3)	Requires a company to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported; and

(4)Provides the ability to perform subsequent hedge effectiveness tests qualitatively.

This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted with the effect of adoption reflected as of the beginning of the fiscal year of adoption. For cash flow and net investment hedges existing at the date of adoption, a cumulative-effect

adjustment related to eliminating the separate measurement of ineffectiveness is required. Other presentation and disclosure guidance is required only prospectively. We adopted this guidance in the fourth quarter of 2018. The adoption resulted in the recognition of $2 million of interest income as a result of our transition from the forward rate method to the spot rate method in accounting for our net investment hedges.

In February 2018, the FASB issued new guidance on the reclassification of certain tax effects in Accumulated Other Comprehensive Income ("AOCI"). The guidance allows a reclassification from AOCI to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (the “Tax Act”). This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted. The guidance may be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. We early adopted this guidance effective the first quarter of 2018, and elected to reclassify the income tax effects of the Tax Act from AOCI to retained earnings. As a result of adopting the guidance, AOCI was reduced by $17 million and retained earnings increased by $17 million. This amount includes the effect of the change in the US federal corporate income tax rate.

In March 2017, the FASB issued amended guidance on the presentation of net periodic benefit costs. The amendment requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components are required to be presented in the income statement separately and outside a subtotal of income from operations, if one is presented. The amendment also requires entities to disclose the income statement lines that contain the other components if they are not appropriately described. This guidance is effective retrospectively for periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. We adopted this guidance effective the first quarter of 2018. The prior period consolidated income statements and segment results have been retrospectively adjusted in accordance with the new guidance. The impact to the presentation between operating income and other non-operating income within Xylem's Consolidated Income Statements was approximately $4 million and $2 million for the years ended December 31, 2017 and 2016, respectively.

In May 2014, the FASB issued guidance on recognizing revenue from contracts with customers. The guidance outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the model is that an entity recognizes revenue to portray the transfer of goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also expands disclosure requirements regarding revenue recognition. This guidance is effective for interim and annual reporting periods beginning after December 15, 2017 and may be applied retrospectively to each prior period presented or using a modified retrospective approach with the cumulative effect recognized as of the date of initial application. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2016. We adopted this guidance as of January 1, 2018 using the modified retrospective transition method. The adoption of the guidance did not have a material impact on our financial condition and results of operations. See Note 4, "Revenue", for further details.

In May 2017, the FASB issued guidance, which amends the scope of modification accounting guidance for share-based payment arrangements. The guidance outlines the types of changes to the terms or conditions of share-based payment arrangements that would require the use of modification accounting. Specifically, modification accounting would not apply if the fair value, vesting conditions, and classification of the award as equity or liability are the same immediately before and after the modification. This guidance is effective prospectively for interim and annual reporting periods beginning December 15, 2017 and early adoption is permitted. We elected to early adopt this guidance effective the second quarter of 2017. The adoption of this guidance did not impact our financial condition or results from operations.

In January 2017, the FASB issued guidance amending the impairment testing of goodwill. Under current guidance, the testing of goodwill for impairment is performed at least annually using a two-step test. Step one involves comparing the fair value of a “reporting unit” to its carrying amount. If the applicable book value exceeds the reporting unit’s fair value then step two must be performed. Step two involves comparing the fair value of the reporting unit’s goodwill to the applicable carrying amount of the asset and recognizing an impairment charge equal to the amount by which the carrying amount of the goodwill exceeds its implied fair value. The amended guidance eliminates step two of the impairment test and allows an entity to record an impairment charge equal to the amount that the carrying amount of the applicable reporting unit exceeds its fair value, up to the value of the recorded goodwill. This guidance is effective prospectively for interim and annual goodwill impairment tests beginning after December 15, 2019 with early adoption permitted for interim or annual tests after January 1, 2017. We elected to

early adopt this guidance effective the first quarter of 2017. The adoption of this guidance did not impact our financial condition or results of operations.

In October 2016, the FASB issued guidance amending the accounting for income taxes. Under current guidance the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to an outside party. The amended guidance eliminates the prohibition against immediate recognition of current and deferred income tax amounts associated with intra-entity transfers of assets other than inventory. This guidance is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. The requirements of the amended guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We elected to early adopt this guidance effective the first quarter of 2017. As a result of adopting the amended guidance, prepaid tax assets were reduced by $14 million, long-term deferred tax assets increased $3 million, and accrued taxes were reduced by $4 million. The net impact of these adjustments on retained earnings was a decrease of $7 million.

In July 2015, the FASB issued guidance regarding simplifying the measurement of inventory. Under prior guidance, inventory is measured at the lower of cost or market, where market is defined as replacement cost, with a ceiling of net realizable value and a floor of net realizable value less a normal profit margin. The amended guidance requires the measurement of inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance is effective prospectively for interim and annual periods beginning after December 15, 2016 and early application is permitted. We adopted this guidance effective the first quarter of 2017. The adoption of this guidance did not impact our financial condition or results of operations.

Note 3**. Acquisitions and Divestitures**

2018 Acquisitions and Divestitures

Pure Technologies Ltd.

On January 31, 2018, we acquired all the issued and outstanding shares of Pure Technologies Ltd. (“Pure”), a leader in intelligent leak detection and condition assessment solutions for water distribution networks for approximately $420 million, net of cash received. Acquisition costs of $4 million were reflected as a component of selling, general and administrative expenses in our Consolidated Income Statement.

Pure’s results of operations were consolidated with the Company effective February 1, 2018 and are reflected in the Measurement & Control Solutions segment.

The Pure purchase price allocation as of January 31, 2018 is shown in the following table.

(in millions)	Amount
Cash	$	14
Receivables	23
Inventories	4
Prepaid and other current assets	2
Property, plant and equipment	22
Intangible assets	149
Other long-term assets	1
Accounts payable	(3		)
Accrued and other current liabilities	(12		)
Deferred income tax liabilities	(25		)
Other non-current accrued liabilities	(2		)
Total identifiable net assets	173
Goodwill	261
Total consideration	$	434

During the fourth quarter of 2018 we finalized the Pure purchase price allocation. The fair values of Pure's assets and liabilities were determined based on estimates and assumptions which management believes are reasonable.

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

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

Category		Life		Amount (in millions)
Customer Relationships		17 - 18 years		$	84
Technology		3 - 10 years		38
Tradenames		20 years		21
Internally Developed Software		3 years		6
Total				$	149

The following table summarizes, on an unaudited pro forma basis, the condensed combined results of operations of the Company for the years ended December 31, 2018 and 2017, respectively, assuming the acquisition of Pure was made on January 1, 2017.

(in millions)	Year Ended December 31,
	2018	2017
Revenue	$5,212	$4,809
Net income	$546	$323

The foregoing unaudited pro forma results are for informational purposes only and are not necessarily indicative of the actual results of operations that might have occurred had the acquisition occurred on January 1, 2017, nor are they necessarily indicative of future results. The pro forma financial information includes the impact of purchase accounting and other nonrecurring items directly attributable to the acquisition, which include:

•	Amortization expense of acquired intangibles

•	Adjustments to the depreciation of property, plant and equipment reflecting the impact of the calculated fair value of those assets in accordance with purchase accounting

•	Adjustments to interest expense to remove historical Pure interest costs and reflect Xylem's current debt profile

•	The related tax impact of the above referenced adjustments

The pro forma results do not include any cost savings or operational synergies that may be generated or realized due to the acquisition of Pure.

During the eleven month period ended December 31, 2018 Pure had revenue and an operating loss of $96 million and $2 million, respectively.

Other Acquisition Activity

During the twelve months ended December 31, 2018 we spent approximately $13 million, net of cash received on other acquisition activity.

During the third quarter we divested our Precision Die Casting business for approximately $22 million, net of cash assumed. The sale resulted in an immaterial gain, which is reflected in gain from sale of business in our Consolidated Income Statement. The business, which was part of our Measurement & Controls Solutions segment, provided aluminum die casting products primarily to customers in the automotive sector. The business reported 2017 annual revenue of approximately $32 million.

2017 Acquisitions and Divestitures

Acquisition Activity

During 2017 we spent approximately $33 million on acquisition activity, including the acquisition of EmNet LLC (“EmNet”), a developer of software and data analytics solutions for municipalities.

Divestitures

On October 31, 2017, we divested our Flowtronex and Water Equipment Technologies (WET) businesses for $6 million. The sale resulted in a gain of approximately $1 million, which is reflected in gain from sale of business in our Consolidated Income Statement. The business, which was part of our Applied Water segment, provided turf and reverse osmosis packages to customers in the agricultural and industrial sectors. The business reported approximately $9 million of revenue in the first 10 months of 2017.

On February 17, 2017, we divested our United Kingdom and Poland based membranes business for approximately $10 million. The sale resulted in a gain of $5 million, which is reflected in gain from sale of business in our Consolidated Income Statement. The business, which was part of our Applied Water segment, provided membrane filtration products primarily to customers in the municipal water and industrial sectors. The business reported 2016 annual revenue of approximately $8 million.

Assets Held for Sale

During the fourth quarter of 2017 two of our businesses qualified as held for sale treatment. Accordingly an estimated loss of $16 million was recognized.

2016 Acquisitions

Sensus Worldwide Limited

On October 31, 2016, we acquired all of the outstanding equity interests of Sensus Worldwide Limited (other than Sensus Industries Limited) (“Sensus”) effective October 31, 2016 for $1,766 million ($1,710 million net of cash acquired), including a $6 million payment in 2017 for a working capital adjustment. Sensus develops advanced technology solutions that enable intelligent use and conservation of critical water and energy resources. Sensus' major products include smart metering, networked communications, measurement and control technologies, software and services including cloud-based analytics, remote monitoring and data management. The Company acquired Sensus because it believes that, within its market category, its products have superior qualities and usefulness to customers. The Company also acquired Sensus on the strength of its developed technology that we plan to leverage across our existing base of products and customers.

Acquisition costs of $19 million were reflected as a component of selling, general and administrative expenses in our Consolidated Income Statements.

Sensus results of operations were consolidated with the Company effective November 1, 2016 and it is part of the Measurement & Control Solutions segment. Refer to Note 21, "Segment and Geographic Data" for Measurement & Control Solutions segment information.

The Sensus purchase price allocation as of October 31, 2016 is shown in the following table.

(in millions)	Amount
Cash	$	56
Receivables	104
Inventories	79
Prepaid and other current assets	19
Property, plant and equipment	176
Intangible assets	782
Other long-term assets	5
Accounts payable	(69		)
Accrued and other current liabilities	(90		)
Deferred income tax liabilities	(198		)
Accrued post retirement benefits	(84		)
Other non-current accrued liabilities	(60		)
Total identifiable net assets	720
Goodwill	1,063
Non-controlling interest	(17		)
Total consideration	$	1,766

In the third quarter of 2017 we finalized the Sensus purchase price allocation. The fair values of Sensus' assets and liabilities were determined based on estimates and assumptions which management believes are reasonable.

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

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

Category		Life		Amount (in millions)
Customer and Distributor Relationships		2 - 18 years		$	543
Tradenames		10 - 25 years		98
Internally Developed Network Software		7 years		60
FCC Licenses		Indefinite lived		24
Technology		5 - 15 years		39
Other		1 - 16 years		18
Total				$	782

The following table summarizes, on an unaudited proforma basis, the condensed combined results of operations of the Company for the year ended December 31, 2016 assuming the acquisition of Sensus was made on January 1, 2015.

	Year Ended December 31,
(in millions)	2016
Revenue	$	4,528
Net income	$	286

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

•	Adjustments to revenue resulting from the valuation of the acquired deferred revenue balance to fair value as part of purchase accounting

•	Amortization expense of acquired intangibles

•	Amortization of the fair value step-up in inventory

•	Adjustments to the depreciation of property, plant and equipment reflecting the impact of the calculated fair value of those assets in accordance with purchase accounting

•	Amortization of the fair value adjustment for warranty liabilities

•	Adjustments to interest expense to remove historical Sensus interest costs and reflect Xylem's current debt profile

•	The related tax impact of the above referenced adjustments

The pro forma results do not include any cost savings or operational synergies that may be generated or realized due to the acquisition of Sensus.

For the two month period ended December 31, 2016 Sensus had revenue and an operating loss of $132 million and $13 million, respectively.

Visenti Pte. Ltd

On October 18, 2016, we acquired Visenti Pte. Ltd. (“Visenti”), a smart water analytics company focused on leak detection and pressure monitoring solutions to help water utilities manage their water networks for $8 million. Visenti, a privately-owned company headquartered in Singapore, has approximately 25 employees. Our consolidated financial statements include Visenti's results of operations prospectively from October 18, 2016 within the Measurement & Control Solutions segment.

Tideland Signal Corporation

On February 1, 2016, we acquired Tideland Signal Corporation (“Tideland”), a leading producer of analytics solutions in the coastal and ocean management sectors, for $70 million. Tideland, a privately-owned company headquartered in Texas, has approximately 160 employees. Our consolidated financial statements include Tideland's results of operations prospectively from February 1, 2016 within the Measurement & Control Solutions segment.

Note 4. Revenue

Disaggregation of Revenue

The following table illustrates the sources of revenue:

	Twelve Months Ended
(in millions)	December 31, 2018
Revenue from contracts with customers	$	4,963
Other	244
Total	$	5,207

The following table reflects revenue from contracts with customers by application:

	Twelve Months Ended
(in millions)	December 31, 2018
Water Infrastructure
Transport	$	1,535
Treatment	397
Applied Water
Commercial Building Services	596
Residential Building Services	232
Industrial Water	706
Measurement and Control Solutions
Water	692
Electric	143
Gas	195
Software and Services/Other	123
Test	344
Total	$	4,963

The following table reflects revenue from contracts with customers by geographical region:

	Twelve Months Ended
(in millions)	December 31, 2018
Water Infrastructure
United States	$	539
Europe	758
Emerging Markets & Other	635
Applied Water
United States	797
Europe	386
Emerging Markets & Other	351
Measurement and Control Solutions
United States	913
Europe	273
Emerging Markets & Other	311
Total	$	4,963

Contract Balances

We receive payments from customers based on a billing schedule as established in our contracts. Contract assets relate to revenue recognized in advance of scheduled billings. Contract liabilities relate to payments received in advance of performance under the contracts. Change in contract assets and liabilities are due to our performance under the contract.

The table below provides contract assets, contract liabilities, and significant changes in contract assets and liabilities.

(in millions)	Contract Assets (a)			Contract Liabilities
Balance at 1/1/2018	$	89		$	107
Additions, net	87			101
Revenue recognized from opening balance	—			(89		)
Billings	(76		)	—
Foreign currency and other	(4		)	(6		)
Balance at 12/31/2018	$	96		$	113

(a)	Excludes receivable balances which are disclosed on the balance sheet

Performance obligations

Delivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cycles and delays can occur from time to time. As of December 31, 2018, the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied for contracts with performance obligations, amount to $258 million. We expect to recognize revenue upon the completion of satisfying the majority of these performance obligations in the following 12 to 36 months. The Company elects to apply the practical expedient to exclude from this disclosure revenue related to performance obligations that are part of a contract whose original expected duration is less than one year.

Note 5. 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 2018, 2017 and 2016, the costs incurred primarily relate to an effort to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. In 2018, the charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment. In 2017 and 2016 the charges included the reduction of headcount and consolidation of facilities within our Applied Water, Water Infrastructure, and Measurement & Control Solutions segments, as well as Corporate headcount reductions. The components of restructuring charges incurred during each of the previous three years ended are presented below.

		Year Ended December 31,
(in millions)		2018				2017				2016
By component:
Severance and other charges		$	19			$	20			$	28
Lease related charges		1				—				2
Other restructuring charges		1				2				1
Reversal of restructuring accruals		(1		)		(2		)		(1		)
Total restructuring charges		20				20				30
Asset impairment charges		2				5				—
Total restructuring and asset impairment charges		$	22			$	25			$	30
By segment:
Water Infrastructure		$	11			$	7			$	12
Applied Water		2				13				10
Measurement & Control Solutions		9				5				6
Corporate and other		—				—				2

Restructuring

The following table displays a rollforward of the restructuring accruals, presented on our Consolidated Balance Sheets within accrued and other current liabilities, for the years ended December 31, 2018 and 2017.

(in millions)		2018				2017
Restructuring accruals - January 1		$	7			$	15
Restructuring charges		20				20
Cash payments		(21		)		(28		)
Foreign currency and other		(1		)		—
Restructuring accruals - December 31		$	5			$	7
By segment:
Water Infrastructure		$	1			$	1
Applied Water		1				1
Measurement & Control Solutions		2				2
Regional selling locations (a)		1				3
Corporate and other		—				—

(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, 2018 and 2017.

		2018			2017
Planned reductions - January 1		47			188
Additional planned reductions		206			151
Actual reductions and reversals		(184	)		(292	)
Planned reductions - December 31		69			47

The following table presents expected restructuring spend:

(in millions)		Water Infrastructure				Applied Water				Measurement & Control Solutions				Corporate				Total
Actions Commenced in 2018:
Total expected costs		$	9			$	1			$	7			$	—			$	17
Costs incurred during 2018		7				1				7				—				15
Total expected costs remaining		$	2			$	—			$	—			$	—			$	2
Actions Commenced in 2017:
Total expected costs		$	18			$	12			$	3			$	—			$	33
Costs incurred during 2017		5				4				2				—				11
Costs incurred during 2018		2				1				1				—				4
Total expected costs remaining		$	11			$	7			$	—			$	—			$	18
Actions Commenced in 2016:
Total expected costs		$	13			$	14			$	10			$	2			$	39
Costs incurred during 2016		11				10				6				2				29
Costs incurred during 2017		2				4				3				—				9
Costs incurred during 2018		—				—				1				—				1
Total expected costs remaining		$	—			$	—			$	—			$	—			$	—

The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2018 consist primarily of severance charges and are expected to continue through the third quarter of 2019. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2017 consist primarily of severance charges and are expected to continue through the second quarter of 2020. The Water Infrastructure, Applied Water, Measurement & Control Solutions and Corporate actions commenced in 2016 consist primarily of severance charges and are complete.

Asset Impairment Charges

During the fourth quarter of 2018 we determined that certain assets within our Water Infrastructure segment, including certain software, were impaired. Accordingly we recognized an impairment charge of $2 million.

During the first quarter of 2017 we determined that certain assets within our Applied Water segment, including a tradename, were impaired. Accordingly we recognized an impairment charge of $5 million. Refer to Note 11, "Goodwill and Other Intangible Assets," for additional information.

Note 6. Other Non-Operating Income, Net

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

	Year Ended December 31,
(in millions)	2018				2017				2016
Interest income	$	4			$	3			$	2
Income from joint ventures	5				3				3
Other income (expense) – net	4				—				(3		)
Total other non-operating income, net	$	13			$	6			$	2

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)	2018				2017				2016
Income components:
Domestic	$	208			$	162			$	80
Foreign	377				304				260
Total pre-tax income	$	585			$	466			$	340
Income tax expense components:
Current:
Domestic – federal	$	9			$	109			$	19
Domestic – state and local	13				9				5
Foreign	61				51				42
Total Current	83				169				66
Deferred:
Domestic – federal	$	17			$	(29	)		$	19
Domestic – state and local	5				10				1
Foreign	(69		)		(14		)		(6		)
Total Deferred	(47		)		(33		)		14
Total income tax provision	$	36			$	136			$	80
Effective income tax rate	6.1		%		29.2		%		23.5		%

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,
	2018			2017			2016
Tax provision at U.S. statutory rate	21.0	%		35.0	%		35.0	%
Increase (decrease) in tax rate resulting from:
State income taxes	2.3			1.6			0.8
Uncertain tax positions	2.6			1.6			(6.4	)
Valuation allowance	(47.1	)		3.3			18.5
Tax exempt interest	(1.4	)		(10.6	)		(14.3	)
Foreign tax rate differential	2.9			(6.7	)		(7.9	)
Impact of foreign earnings, net	(1.7	)		37.0			5.9
Tax incentives	(6.2	)		(6.6	)		(8.9	)
Intercompany sale of assets	35.5			—			—
Other – net	(1.8	)		(2.5	)		0.8
Rate change	—			(22.9	)		—
Effective income tax rate	6.1	%		29.2	%		23.5	%

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 and maintaining certain employment thresholds. The inability to meet the thresholds would have a prospective impact and at this time we continue to believe we will meet the requirements.

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)	2018				2017
Deferred tax assets:
Employee benefits	$	97			$	108
Accrued expenses	30				34
Loss and other tax credit carryforwards	279				419
Inventory	7				8
Other	11				24
	424				593
Valuation allowance	(234		)		(350		)
Net deferred tax asset	$	190			$	243
Deferred tax liabilities:
Intangibles	$	247			$	300
Investment in foreign subsidiaries	8				20
Property, plant, and equipment	69				57
Other	29				49
Total deferred tax liabilities	$	353			$	426

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, 2018, a valuation allowance of $234 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)	2018				2017				2016
Valuation allowance — January 1	$	350			$	311			$	248
Change in assessment (a)	1				(28		)		17
Current year operations	(271		)		48				38
Foreign currency and other (b)	154				19				(32		)
Acquisitions	—				—				40
Valuation allowance — December 31	$	234			$	350			$	311

(a)	Increase in assessment in 2018 is primarily attributable to loss positions in various jurisdictions. Decrease in assessment in 2017 is primarily attributable to Foreign Tax Credits utilization resulting from the Tax Act.

(b)	Included in foreign currency and other in 2018 is an increase in net operating losses due to amended prior year tax returns for which a valuation allowance was recorded.

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

	December 31,
(in millions)	2018				2017
Non-current assets	$	140			$	69
Non-current liabilities	(303		)		(252		)
Total net deferred tax liabilities	$	(163	)		$	(183	)

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

(in millions)	December 31, 2018				First Year of Expiration
U.S. net operating loss	$	12			December 31, 2024
State net operating loss	98				December 31, 2019
State excess interest expense	12				Indefinitely
State tax credits	2				Indefinitely
Foreign net operating loss	1,119				December 31, 2019
Foreign tax credits	3				December 31, 2030

The Company has provided a deferred tax liability of $13 million for net foreign withholding taxes and state income taxes on $1.9 billion of earnings expected to be repatriated to the U.S. parent, as of December 31, 2018. The Company currently does not intend to repatriate approximately $1.1 billion taxed under the Tax Act, and has not recorded any deferred taxes related to such amounts as the determination of the amount is not practicable.

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

(in millions)	2018				2017				2016
Unrecognized tax benefits — January 1	$	130			$	67			$	47
Current year tax positions	—				56				12
Prior year tax positions	7				7				(22		)
Acquisitions	—				—				30
Settlements	(1		)		—				—
Unrecognized tax benefits — December 31	$	136			$	130			$	67

The amount of unrecognized tax benefits at December 31, 2018 which, if ultimately recognized, will reduce our annual effective tax rate is $136 million. We believe that it is reasonably possible that the unrecognized tax benefits will be reduced by approximately $8 million within the next 12 months as a result of the expiration of certain statute of limitations.

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 accrued interest relating to unrecognized tax benefits as of December 31, 2018 and 2017 was $7 million and $4 million.

The following table summarizes our earliest open tax years by major jurisdiction:

Jurisdiction		Earliest Open Year
Italy		2013
Luxembourg		2016
Sweden		2013
Germany		2009
United Kingdom		2011
United States		2016
Switzerland		2013

Tax Act

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code. The SEC staff issued SAB 118, which provided guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740.

Our accounting for the reduction of U.S. federal corporate tax rate is complete. We recorded a provisional tax benefit for corporate tax rate reduction of $107 million as of December 31, 2017. Upon further analysis of our deferred tax assets and liabilities, we recognized a measurement-period adjustment of $1.5 million as an additional decrease of the net deferred tax liabilities and recorded a corresponding deferred tax benefit of $1.5 million during the period ended December 31, 2018. The effect of this measurement period adjustment on the 2018 effective tax rate was about 0.3%. A total decrease of the net deferred tax liabilities of $108 million has been recorded for the corporate rate reduction, with a corresponding deferred tax benefit of $108 million.

Our accounting for the Deemed Repatriation Transition Tax ("Transition Tax") is complete. We made an estimate of the Transition Tax and recorded a provisional Transition Tax liability of $153 million as of December 31, 2017. On the basis of revised E&P computations that were completed and additional guidance, we recognized a measurement-period adjustment of a $9 million decrease to the income tax expense in 2018. The effect of the measurement-period adjustment on the 2018 effective tax rate was approximately 1.6%. A total Transition Tax obligation to date of $144 million has been recorded, with a corresponding adjustment of $144 million to income tax expense.

The FASB has indicated that a company can make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). During the third quarter of 2018, we adopted the period cost method to treat the tax effects of future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred.

Note 8. Earnings Per Share

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

	Year Ended December 31,
	2018				2017				2016
Net income attributable to Xylem (in millions)	$	549			$	331			$	260
Shares (in thousands):
Weighted average common shares outstanding	179,750				179,602				179,069
Add: Participating securities (a)	27				27				37
Weighted average common shares outstanding — Basic	179,777				179,629				179,106
Plus incremental shares from assumed conversions: (b)
Dilutive effect of stock options	876				712				499
Dilutive effect of restricted stock units and performance share units	479				516				433
Weighted average common shares outstanding — Diluted	181,132				180,857				180,038
Basic earnings per share	$	3.05			$	1.84			$	1.45
Diluted earnings per share	$	3.03			$	1.83			$	1.45

(a)	Restricted stock awards containing rights to non-forfeitable dividends that participate in undistributed earnings with common shareholders are considered participating securities for purposes of computing earnings per share.

(b)Incremental shares from stock options, restricted stock units and performance share units are computed by the treasury stock method. The weighted average shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented or were otherwise excluded under the treasury stock method. The treasury stock method calculates dilution assuming the exercise of all in-the-money options and vesting of restricted stock units and performance share units, reduced by the repurchase of shares with the proceeds from the assumed exercises and unrecognized compensation expense for outstanding awards. Performance share units are included in the treasury stock calculation of diluted earnings per share based upon achievement of underlying performance and market conditions at the end of the reporting period, as applicable. See Note 16, "Stock-Based Compensation Plans" for further detail on the performance share units.

	Year Ended December 31,
(in thousands)	2018			2017			2016
Stock options	1,300			1,626			1,892
Restricted stock units	333			379			514
Performance share units	465			504			373

Note 9. Inventories

The components of total inventories are summarized as follows:

	December 31,
(in millions)	2018				2017
Finished goods	$	248			$	223
Work in process	45				42
Raw materials	302				259
Total inventories	$	595			$	524

Note 10. Property, Plant and Equipment

The components of total property, plant and equipment, net are as follows:

	December 31,
(in millions)	2018				2017
Land, buildings and improvements	$	326			$	329
Machinery and equipment	819				799
Equipment held for lease or rental	249				241
Furniture and fixtures	109				101
Construction work in progress	107				85
Other	22				21
Total property, plant and equipment, gross	1,632				1,576
Less accumulated depreciation	976				933
Total property, plant and equipment, net	$	656			$	643

Depreciation expense was $117 million, $109 million, and $87 million for 2018, 2017, and 2016, respectively.

Note 11**. Goodwill and Other Intangible Assets**

Changes in the carrying value of goodwill by reportable segment during the years ended December 31, 2018 and 2017 are as follows:

(in millions)	Water Infrastructure				Applied Water				Measurement & Control Solutions				Total
Balance as of December 31, 2016	$	640			$	505			$	1,487			$	2,632
Activity in 2017
Divested/acquired	—				(3		)		10				7
Foreign currency and other	27				24				78				129
Balance as of December 31, 2017	$	667			$	526			$	1,575			$	2,768
Activity in 2018
Acquired	—				—				279				279
Foreign currency and other	(14		)		(10		)		(47		)		(71		)
Balance as of December 31, 2018	$	653			$	516			$	1,807			$	2,976

During the fourth quarter of 2018, 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, 2018												December 31, 2017
	Carrying Amount				Accumulated Amortization				Net Intangibles				Carrying Amount				Accumulated Amortization				Net Intangibles
Customer and distributor relationships	$	951			$	(286	)		$	665			$	906			$	(241	)		$	665
Proprietary technology and patents	198				(93		)		105				163				(75		)		88
Trademarks	148				(41		)		107				138				(37		)		101
Software	355				(164		)		191				277				(130		)		147
Other	24				(19		)		5				26				(20		)		6
Indefinite-lived intangibles	159				—				159				161				—				161
Other intangibles	$	1,835			$	(603	)		$	1,232			$	1,671			$	(503	)		$	1,168

We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date of our impairment assessment in 2018 or 2017. 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 and patents, trademarks, software and other are amortized over weighted average lives of approximately 14 years, 14 years, 13 years, 5 years and 5 years, respectively.

Total amortization expense for intangible assets was $144 million, $125 million, and $64 million for 2018, 2017 and 2016, respectively.

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

(in millions)
2019	$	135
2020	127
2021	112
2022	102
2023	97

During the first quarter of 2017 we determined that the intended use of a finite lived trade name within our Applied Water segment had changed. Accordingly we recorded a $4 million impairment charge. The charge was calculated using the income approach, which is considered a Level 3 input for fair value measurement purposes, and is reflected in "Restructuring and asset impairment charges" in our Consolidated Income Statements.

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 interest rates and exchange rates that may impact revenue, expenses, cash receipts, cash payments, and the value of our stockholders' equity. We enter into derivative financial instruments to protect the value or fix the amount of certain cash flows in terms of the functional currency of the business unit with that exposure and reduce the volatility in stockholders' equity.

Cash Flow Hedges of Foreign Exchange Risk

We are exposed to fluctuations in various foreign currencies against our functional currencies. We use foreign currency derivatives, including currency forward agreements, to manage our exposure to fluctuations in the various exchange rates. Currency forward agreements involve fixing the foreign currency exchange rate for delivery of a specified amount of foreign currency on a specified date.

Certain business units with exposure to foreign currency exchange risks have designated certain currency forward agreements as cash flow hedges of forecasted intercompany inventory purchases and sales. Our principal currency exposures relate to the Euro, Swedish Krona, British Pound, Canadian Dollar, Polish Zloty, and Australian Dollar. We had foreign exchange contracts with purchase notional amounts totaling $506 million and $455 million as of December 31, 2018 and 2017, respectively. As of December 31, 2018, our most significant foreign currency derivatives included contracts to sell U.S. Dollar and purchase Euro, purchase Swedish Krona and sell Euro, sell British Pound and purchase Euro, purchase Polish Zloty and sell Euro, purchase U.S. Dollar and sell Canadian Dollar and to sell Canadian Dollar and purchase Euro. The purchase notional amounts associated with these currency derivatives were $191 million, $168 million, $52 million, $37 million, $29 million and $22 million, respectively. As of December 31, 2017, the purchase notional amounts associated with these currency derivatives were $147 million, $149 million, $66 million, $34 million, $28 million and $25 million, respectively.

Hedges of Net Investments in Foreign Operations

We are exposed to changes in foreign currencies impacting our net investments held in foreign subsidiaries.

Cross Currency Swaps

We enter into cross currency swaps to manage our exposure to fluctuations in the Euro-U.S. Dollar exchange rate. The total notional amount of derivative instruments designated as net investment hedges was $426 million and $446 million as of December 31, 2018 and 2017, respectively.

Foreign Currency Denominated Debt

On March 11, 2016, we issued 2.250% Senior Notes of €500 million aggregate principal amount due March 2023. We designated the entirety of the outstanding balance, or $566 million and $592 million as of December 31, 2018 and 2017, respectively, net of unamortized discount, as a hedge of a net investment in certain foreign subsidiaries.

Forward Contracts

On September 23, 2016, we entered into forward contacts with a total notional amount of €300 million to manage our exposure to fluctuations in the Euro-U.S. Dollar exchange rate. The contracts were designated as net investment hedges and were settled in 2016.

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

		Year Ended December 31,
(in millions)		2018				2017				2016
Derivatives in Cash Flow Hedges
Foreign Exchange Contracts
Amount of (loss) gain recognized in OCI (a)		$	(8	)		$	9			$	—
Amount of (gain) reclassified from OCI into revenue (a)		—				(6		)		(2		)
Amount of loss reclassified from OCI into cost of revenue (a)		4				1				—
Derivatives in Net Investment Hedges
Cross Currency Swaps
Amount of (loss) gain recognized in OCI (a)		$	22			$	(53	)		$	19
Amount income recognized in Interest Expense		2				—				—
Foreign Currency Denominated Debt
Amount of (loss) gain recognized in OCI (a)		$	27			$	(74	)		$	28
Forward Contracts
Amount of gain recognized in OCI (a)		$	—			$	—			$	9

(a)	Effective portion

As of December 31, 2018, $1 million of the net losses on cash flow hedges is expected to be reclassified into earnings in the next 12 months.

As of December 31, 2018, no gains or losses on the net investment hedges are expected to be reclassified into earnings over the next 12 months.

The ineffective portion of the change in fair value of a cash flow hedge was not material for 2018, 2017, and 2016.

The net investment hedges did not experience any ineffectiveness in 2018, 2017 and 2016.

The fair values of our derivative assets and liabilities are measured on a recurring basis using Level 2 inputs and are determined through the use of models that consider various assumptions including yield curves, time value and other measurements.

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

	December 31,
(in millions)	2018				2017
Derivatives designated as hedging instruments
Assets
Cash Flow Hedges
Other current assets	$	3			$	3
Liabilities
Cash Flow Hedges
Other current liabilities	(1		)		(1		)
Net Investment Hedges
Other non-current liabilities	(46		)		(64		)

The fair value of our long-term debt, due in 2023, designated as a net investment hedge was $599 million and $638 million as of December 31, 2018 and 2017, respectively.

Note 13. Accrued and Other Current Liabilities

	December 31,
(in millions)	2018				2017
Compensation and other employee-benefits	$	194			$	203
Customer-related liabilities	129				119
Accrued warranty costs	44				55
Accrued taxes	85				75
Other accrued liabilities	94				99
Total accrued and other current liabilities	$	546			$	551

Note 14**. Credit Facilities and Long-Term Debt**

Total debt outstanding is summarized as follows:

	December 31,
(in millions)	2018				2017
4.875% Senior Notes due 2021 (a)	$	600			$	600
2.250% Senior Notes due 2023 (a)	570				597
3.250% Senior Notes due 2026 (a)	500				500
4.375% Senior Notes due 2046 (a)	400				400
Research and development finance contract	—				125
Term loan	257				—
Debt issuance costs and unamortized discount (b)	(19		)		(22		)
Total debt	2,308				2,200
Less: short-term borrowings and current maturities of long-term debt	257				—
Total long-term debt	$	2,051			$	2,200

(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 2021 (as defined below) was $620 million and $648 million as of December 31, 2018 and 2017, respectively. The fair value of our Senior Notes due 2023 (as defined below) was $599 million and $638 million as of December 31, 2018 and 2017, respectively. The fair value of our Senior Notes due 2026 (as defined below) was $476 million and $498 million as of December 31, 2018 and 2017, respectively. The fair value of our Senior Notes due 2046 (as defined below) was $397 million and $431 million as of December 31, 2018 and 2017, respectively.

(b)	The debt issuance costs and 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.

Senior Notes

On September 20, 2011, we issued 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021"). On March 11, 2016, we issued 2.250% Senior Notes of €500 million aggregate principal amount due March 2023 (the "Senior Notes due 2023"). On October 11, 2016, we issued 3.250% Senior Notes of $500 million aggregate principal amount due October 2026 (the “Senior Notes due 2026”) and 4.375% Senior Notes of $400 million aggregate principal amount due October 2046 (the “Senior Notes due 2046” and, together with the Senior Notes due 2021, the Senior Notes due 2023 and the Senior Notes due 2026, the “Senior Notes”).

The Senior Notes include covenants that restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale and leaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/or customary grace and cure periods). We may redeem the Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal to the principal amount of the Senior Notes to be redeemed, plus a make-whole premium. We may also redeem the Senior Notes in certain other circumstances, as set forth in the applicable Senior Notes indenture.

If a change of control triggering event (as defined in the applicable Senior Notes indenture) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plus accrued and unpaid interest to the date of repurchase.

Interest on the Senior Notes due 2021 is payable on April 1 and October 1 of each year. Interest on the Senior Notes due 2023 is payable on March 11 of each year. Interest on the Senior Notes due 2026 and the Senior Notes due 2046 is payable on May 1 and November 1 of each year beginning on May 1, 2017. As of December 31, 2018, we were in compliance with all covenants for the Senior Notes.

We used the net proceeds of the Senior Notes due 2026 and the Senior Notes due 2046, together with cash on hand, proceeds from issuances under our existing commercial paper program and borrowings under the Term Facility (as described below), to fund the acquisition of Sensus (refer to Note 3 for further information on the Sensus acquisition).

Credit Facilities

Five-Year Revolving Credit Facility

Effective March 27, 2015, Xylem entered into a Five-Year Revolving Credit Facility (the "Credit Facility") with Citibank, N.A., as administrative agent, and a syndicate of lenders. The Credit Facility provides for an aggregate principal amount of up to $600 million of: (i) revolving extensions of credit (the "revolving loans") outstanding at any time and (ii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time. The Credit Facility provides for increases of up to $200 million for a possible maximum total of $800 million in aggregate principal amount at our request and with the consent of the institutions providing such increased commitments.

At our election, the interest rate per annum applicable to the revolving loans will be based on either (i) a Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin or (ii) a fluctuating rate of interest determined by reference to the greatest of: (a) the prime rate of Citibank, N.A., (b) the U.S. Federal funds effective rate plus half of 1% or (c) the Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, in each case, plus an applicable margin.

In accordance with the terms of an amendment to the Credit Facility dated August 30, 2016, we may not exceed a maximum leverage ratio of 4.00 to 1.00 (based on a ratio of total debt to earnings before interest, taxes, depreciation and amortization) for a period of 12-months following the Sensus acquisition and a maximum leverage ratio of 3.50 to 1.00 through the rest of the term. The Credit Facility also contains limitations on, among other things, incurring secured debt, granting liens, entering into sale and leaseback transactions, mergers, consolidations, liquidations, dissolutions and sales of assets. In addition, the Credit Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. As of December 31, 2018 the Credit Facility was undrawn and we are in compliance with all covenants.

European Investment Bank - R&D Finance Contract

On October 28, 2016, the Company entered into a Finance Contract (the “Finance Contract”) with the European Investment Bank (the “EIB”). The Company's wholly owned subsidiaries in Luxembourg, Xylem Holdings S.á r.l. and Xylem International S.á r.l., are the borrowers under the Finance Contract and Xylem Inc. is the Guarantor. The Finance Contract provides for up to €105 million (approximately $120 million) to finance research, development and innovation projects in the field of sustainable water and wastewater solutions during the period from 2017 through 2019 in Sweden, Germany, Italy, the United Kingdom, Hungary and Austria. The Company has unconditionally guaranteed the performance of the borrowers under the Finance Contract. Under the Finance Contract, the borrowers are able to draw loans on or before April 28, 2018, with a maturity of no longer than 11 years.

The Finance Contract is subject to the same leverage ratio as the Credit Facility. Both agreements also contain limitations on, among other things, incurring debt, granting liens, and entering into sale and leaseback transactions, as well as other terms and conditions, such as customary representations and warranties, additional covenants and customary events of default.

The Finance Contract provides for fixed rate loans and floating rate loans. Under the Finance Contract, the interest rate per annum applicable to fixed rate loans is at a fixed percentage rate per annum specified by the EIB which includes the applicable margin. The interest rate per annum applicable to floating rate loans is at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S. Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin is 59 basis points (0.59%). As of December 31, 2017, there was $125 million outstanding under the Finance Contract. On November 28, 2018, the Finance Contract was repaid and settled for $120 million.

Term Loan Facility

On January 26, 2018, the Company’s subsidiary, Xylem Europe GmbH (the “borrower”) entered into a 12-month €225 million (approximately $257 million) term loan facility (the “Term Facility”) the terms of which are set forth in a term loan agreement, among the borrower, the Company, as parent guarantor and ING Bank. The Company has entered into a parent guarantee in favor of ING Bank also dated January 26, 2018 to secure all present and future obligations of the borrower under the Term Loan Agreement. The Term Facility was used to partially fund the acquisition of Pure Technologies Ltd.. On January 25, 2019, the Company extended the Term Facility for another month and intends to further extend the Term Facility at the next maturity.

Commercial Paper

Our commercial paper program generally serves as a means of short-term funding and has a combined outstanding limit of $600 million inclusive of the Five-Year Revolving Credit Facility. As of December 31, 2018 and December 31, 2017, none of the Company's $600 million commercial paper program was outstanding. We will periodically borrow under this program and may borrow under it in future periods.

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 eligible pay. Matching obligations, the majority of which were funded in cash in connection with the plans, and other company contributions are as follows:

(in millions)	Defined Contribution
2018	$	39
2017	38
2016	35

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 328 thousand and 344 thousand shares of Xylem Inc. common stock in the Xylem Stock Fund at December 31, 2018 and 2017, 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 2018 and 2017, we made several amendments to plans that had no material impact to the Company's financial statements.

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, 2018												December 31, 2017
	Pension				Other				Total				Pension				Other				Total
Fair value of plan assets	$	567			$	—			$	567			$	628			$	—			$	628
Projected benefit obligation	(862		)		(52		)		(914		)		(950		)		(55		)		(1,005		)
Funded status	$	(295	)		$	(52	)		$	(347	)		$	(322	)		$	(55	)		$	(377	)
Amounts recognized in the balance sheet
Other non-current assets	$	68			$	—			$	68			$	81			$	—			$	81
Accrued and other current liabilities	(12		)		(3		)		(15		)		(13		)		(3		)		(16		)
Accrued postretirement benefits	(351		)		(49		)		(400		)		(390		)		(52		)		(442		)
Net amount recognized	$	(295	)		$	(52	)		$	(347	)		$	(322	)		$	(55	)		$	(377	)
Accumulated other comprehensive income (loss):
Net actuarial losses	$	(260	)		$	(24	)		$	(284	)		$	(251	)		$	(24	)		$	(275	)
Prior service credit	(4		)		12				8				(1		)		12				11
Total	$	(264	)		$	(12	)		$	(276	)		$	(252	)		$	(12	)		$	(264	)

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 2018 and expected to be recognized in net periodic benefit cost during 2019 is $12 million ($9 million, net of tax). The prior service credit included in accumulated other comprehensive income to be recognized in 2019 is $4 million ($3 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)	2018				2017				2018				2017
Change in benefit obligation:
Benefit obligation at beginning of year	$	107			$	100			$	843			$	754
Service cost	3				3				9				12
Interest cost	4				4				19				21
Benefits paid	(5		)		(5		)		(36		)		(30		)
Actuarial loss (gain)	(10		)		5				(20		)		10
Plan amendments, settlements and curtailments	—				1				3				(2		)
Foreign currency translation/other	—				(1		)		(55		)		78
Benefit obligation at end of year	$	99			$	107			$	763			$	843
Change in plan assets:
Fair value of plan assets at beginning of year	$	84			69				$	544			$	493
Employer contributions	22				10				16				20
Actual return on plan assets	(4		)		10				(20		)		21
Benefits paid	(5		)		(5		)		(36		)		(30		)
Plan amendments, settlements and curtailments	—				—				—				(3		)
Foreign currency translation/other	—				—				(34		)		43
Fair value of plan assets at end of year	$	97			$	84			$	470			$	544
Unfunded status of the plans	$	(2	)		$	(23	)		$	(293	)		$	(299	)

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

(in millions)	2018				2017
Change in benefit obligation:
Benefit obligation at beginning of year	$	55			$	64
Service cost	—				1
Interest cost	2				2
Benefits paid	(3		)		(3		)
Actuarial gain/(loss)	1				(5		)
Plan Amendment and other	(3		)		(4		)
Benefit obligation at the end of year	$	52			$	55

The accumulated benefit obligation (“ABO”) for all the defined benefit pension plans was $829 million and $916 million at December 31, 2018 and 2017, 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)	2018				2017
Projected benefit obligation	$	500			$	528
Accumulated benefit obligation	470				499
Fair value of plan assets	137				126

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

	Year Ended December 31,
(in millions)	2018				2017				2016
Domestic defined benefit pension plans:
Service cost	$	3			$	3			$	3
Interest cost	4				4				4
Expected return on plan assets	(7		)		(6		)		(5		)
Amortization of net actuarial loss	2				2				2
Net periodic benefit cost	$	2			$	3			$	4
International defined benefit pension plans:
Service cost	$	9			$	12			$	10
Interest cost	19				21				21
Expected return on plan assets	(35		)		(34		)		(30		)
Amortization of net actuarial loss	9				9				8
Settlement	1				1				—
Net periodic benefit cost	$	3			$	9			$	9
Total net periodic benefit cost	$	5			$	12			$	13

The components of net periodic benefit cost other than the service cost component are included in the line item "other non-operating income (expense), net" in the Consolidated Income Statements.

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

	Year Ended December 31,
(in millions)	2018				2017				2016
Domestic defined benefit pension plans:
Net (gain) loss	$	1			$	1			$	(1	)
Prior service cost	—				1				—
Amortization of net actuarial loss	(2		)		(2		)		(2		)
(Gains) losses recognized in other comprehensive loss	$	(1	)		$	—			$	(3	)
International defined benefit pension plans:
Net (gain) loss	$	35			$	23			$	18
Prior service credit	3				1				(1		)
Amortization of net actuarial loss	(9		)		(9		)		(8		)
Settlement	(1		)		(1		)		—
Foreign Exchange	(15		)		19				(20		)
(Gains) losses recognized in other comprehensive loss	$	13			$	33			$	(11	)
Total (gains) losses recognized in other comprehensive loss	$	12			$	33			$	(14	)
Total (gains) losses recognized in comprehensive income	$	17			$	45			$	(1	)

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

	Year Ended December 31,
(in millions)	2018				2017				2016
Service cost	$	—			$	1			$	1
Interest cost	2				2				3
Amortization of prior service credit	(4		)		(3		)		(3		)
Amortization of net actuarial loss	2				2				3
Net periodic benefit cost	$	—			$	2			$	4

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

	Year Ended December 31,
(in millions)	2018				2017				2016
Net loss (gain)	$	1			$	(5	)		$	3
Prior service credit	(3		)		(3		)		—
Amortization of prior service credit	4				3				3
Amortization of net actuarial loss	(2		)		(2		)		(3		)
Foreign Exchange/Other	—				(1		)		1
Losses (gains) recognized in other comprehensive loss	$	—			$	(8	)		$	4
Total losses (gains) recognized in comprehensive income	$	—			$	(6	)		$	8

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.

	2018						2017						2016
	U.S.			Int’l			U.S.			Int’l			U.S.			Int’l
Benefit Obligation Assumptions
Discount rate	4.50	%		2.60	%		3.75	%		2.43	%		4.25	%		2.63	%
Rate of future compensation increase	NM			2.92	%		NM			2.93	%		NM			2.76	%
Net Periodic Benefit Cost Assumptions
Discount rate	3.75	%		2.43	%		4.25	%		2.63	%		4.27	%		3.44	%
Expected long-term return on plan assets	8.00	%		7.23	%		8.00	%		7.20	%		8.00	%		7.25	%
Rate of future compensation increase	NM			2.93	%		NM			2.76	%		NM			3.29	%

NM	Not meaningful. The pension benefits for future service for all the U.S. pension plans are based on years of service and not impacted by future compensation increases.

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 to be used in determining net periodic benefit costs for 2019 is estimated at 7.09%.

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.

	2018			2017			2016
Expected long-term rate of return on plan assets	7.34	%		7.30	%		7.32	%
Actual rate of return (loss) on plan assets	(3.85	)%		5.70	%		12.20	%

The assumed rate of future increases in the per capita cost of health care (the health care trend rate) is 8.24% for 2019, decreasing ratably to 4.48% in 2027. An increase or decrease in the health care trend rates by one percent per year would impact the aggregate annual service and interest components by less than $1 million, and impact the benefit obligation by approximately $3 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.

On April 3, 2017 the liquid assets in two United Kingdom Plans transitioned into a new fund structure. The restructuring involved transferring a portion of the assets into pooled diversified growth funds, while some investments were sold off and some were kept in place. At December 31, 2018, the pooled funds make up 54% of the assets of the two United Kingdom Plans. Liability hedging and illiquid assets remain outside of this arrangement.

The following table provides the actual asset allocations of plan assets as of December 31, 2018 and 2017, and the related asset target allocation ranges by asset category.

	2018			2017			Target Allocation Ranges
Equity securities	29.7	%		35.6	%		10-50%
Fixed income	24.5	%		23.4	%		10-40%
Hedge funds	11.8	%		17.0	%		0-40%
Private equity	1.1	%		1.6	%		0-30%
Cash, insurance contracts and other	32.9	%		22.4	%		0-60%

Fair Value of Plan Assets

In measuring plan assets at fair value, the fair value hierarchy is applied which categorizes and prioritizes the inputs used to estimate fair value into three levels. See Note 1 "Summary of Significant Accounting Policies" for further detail on fair value hierarchy.

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 measured at fair value using the NAV per share practical expedient are not classified in the fair value 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 listed on active markets are classified in Level 1. Fixed income held in proprietary funds pooled with other investor accounts measured at fair value using the NAV per share practical expedient are not classified in the fair value hierarchy. Hedging Instruments are collateralized daily with either cash or government bonds, have daily liquidity and pricing based on observable inputs from over-the-counter markets, and are classified as Level 2.

•

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. Generally, hedge funds are valued using the NAV reported by the asset manager, and are 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. All of the hedge funds held have lockups and/or gates. Hedge funds have unfunded commitments of $0 million and $5 million at December 31, 2018 and 2017, respectively.

•

Private equity — Private equity includes a diversified range of strategies, including buyout funds, distressed funds, venture and growth equity funds and mezzanine funds with long-term commitments, and redemptions beginning no earlier than 2018. The valuation of limited partnership interests in private equity funds may require significant management judgment. Generally, private equity is valued using the NAV reported by the asset manager, and 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. Private equity is not liquid and has unfunded commitments of $3 million and $4 million at December 31, 2018 and 2017, respectively.

•

Cash, insurance contracts and other — Primarily comprised of insurance contracts and cash. Insurance contracts are valued at contract 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. Insurance contracts are held by certain foreign pension plans. 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.

	2018																2017
(in millions)	Level 1			Level 2			Level 3			NAV Practical Expedient			Total				Level 1			Level 2			Level 3			NAV Practical Expedient			Total
Equity securities
Global stock funds/securities	$	88		$	—		$	—		$	29		$	117			$	101		$	—		$	—		$	29		$	130
Index funds	—			—			—			1			1				—			—			—			3			3
Diversified Growth and Income Funds	—			—			—			51			51				—			—			—			92			92
Fixed income
Corporate bonds	34			—			—			25			59				24			—			—			8			32
Government bonds	31			—			—			20			51				48			—			—			5			53
Hedging Instruments	5			22			—			—			27				5			36			—			—			41
Diversified Growth and Income Funds	—			—			—			2			2				—			—			—			20			20
Hedge funds	—			—			—			67			67				—			—			—			107			107
Private equity	—			—			—			6			6				—			—			—			10			10
Cash, insurance contracts and other	104			—			12			70			186				90			—			17			33			140
Total plan assets subject to leveling	$	262		$	22		$	12		$	271		$	567			$	268		$	36		$	17		$	307		$	628

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)		Insurance Contracts and Other
Balance, December 31, 2016		$	24
Purchases, sales, settlements		(8		)
Currency impact		1
Balance, December 31, 2017		$	17
Purchases, sales, settlements		(5		)
Currency impact		—
Balance, December 31, 2018		$	12

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 $41 million and $33 million to our pension and postretirement defined benefit plans during 2018 and 2017, respectively. Discretionary contributions were made to the U.S. Plan in the third quarter of 2017 for $6 million and the third quarter of 2018 for $19 million to increase the funding ratio and reduce regulatory fees. We currently anticipate making contributions to our pension and postretirement defined benefit plans in the range of $15 million to $25 million during 2019, of which approximately $5 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
2019	$	35			$	3
2020	36				4
2021	36				4
2022	37				4
2023	39				4
Years 2023 - 2027	205				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 unit awards and performance share unit awards. Under the 2011 Omnibus Incentive Plan, the number of shares initially available for awards was 18 million. As of December 31, 2018, there were approximately 6 million shares of common stock available for future grants.

Total share-based compensation costs recognized for 2018, 2017 and 2016 were $30 million, $21 million, and $18 million, respectively. The unamortized compensation expense at December 31, 2018 related to our stock options, restricted share units and performance share units was $6 million, $20 million and $16 million, respectively, and is expected to be recognized over a weighted average period of 1.8, 1.9 and 1.7 years, respectively.

The amount of cash received from the exercise of stock options was $7 million for 2018 with a tax benefit of $11 million realized associated with stock option exercises and vesting of restricted stock units. We classify as an operating activity the cash flows attributable to excess tax benefits arising from stock option exercises and restricted stock unit vestings.

Stock Option Grants

Options are awarded with a contractual term of ten years and generally vest over a three-year period and are exercisable within the contractual term, 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, 2018, there were options to purchase an aggregate of 2.1 million shares of common stock. The following is a summary of the changes in outstanding stock options for 2018:

	Share units (in thousands)			Weighted Average Exercise Price / Share				Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value (in millions)
Outstanding at January 1, 2018	2,076			$	37.44			7.0
Granted	316			$	75.11
Exercised	(214	)		$	34.08
Forfeited and expired	(53	)		$	49.36
Outstanding at December 31, 2018	2,125			$	43.08			6.5		$	53
Options exercisable at December 31, 2018	1,403			$	35.46			5.5		$	44
Vested and non-vested expected to vest as of December 31, 2018	2,065			$	42.37			6.4		$	53

The amount of non-vested options outstanding was 0.7 million, 0.9 million and 1.0 million at a weighted average fair value of $58.00, $42.84 and $37.10 as of December 31, 2018, 2017 and 2016, 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 2018, 2017 and 2016 was $9 million, $14 million and $12 million, respectively.

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 2018, 2017, and 2016:

	2018				2017				2016
Dividend yield	1.12		%		1.49		%		1.63		%
Volatility	23.41		%		25.39		%		28.87		%
Risk-free interest rate	2.76		%		2.07		%		1.41		%
Expected term (in years)	5.1				5.10				5.60
Weighted-average fair value per option	$	17.80			$	10.66			$	9.05

Expected volatility is calculated based on a weighted analysis of historic and implied volatility measures for a set of peer companies and Xylem. We use historical data to estimate option exercise and employee termination behavior within the valuation model. Employee groups and option characteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options are expected to remain outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of option grant.

Restricted Stock Unit Grants

Restricted shares granted to employees in 2018 vest over a three-year period. Restricted shares granted to employees prior to 2017 generally become fully vested upon the third anniversary of the date of grant. 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 do not have certain rights of a stockholder, such as the right to vote and receive dividends; however, dividends accrue during the vesting period and are paid upon vesting. If an employee leaves prior to vesting, whether through resignation or termination for cause, the restricted stock unit and related accrued dividends are forfeited. If an employee retires, a pro rata portion of the restricted stock unit may vest in accordance with the terms of the grant agreements. Restricted stock units granted to Board members become fully vested upon the day prior to the next annual meeting. The fair value of the restricted share unit awards is determined using the closing price of our common stock on date of grant.

Our restricted stock units activity was as follows for 2018:

	Share Units (in thousands)			Weighted Average Grant Date Fair Value / Share
Outstanding at January 1, 2018	779			$	35.39
Granted	274			74.81
Vested	(458	)		40.39
Forfeited	(58	)		53.09
Outstanding at December 31, 2018	537			59.41

Performance Share Units

Performance share units granted under the long-term incentive plan 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 share units 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 for ROIC performance share units and a relative TSR performance for TSR performance share units. The calculated compensation cost for ROIC performance share units is adjusted based on an estimate of awards ultimately expected to vest and our assessment of the probable outcome of the performance condition.

ROIC Performance Share Unit Grants

The fair value of the ROIC performance share unit awards is determined using the closing price of our common stock on date of grant.

Our ROIC performance share unit activity was as follows for 2018:

	Share units (in thousands)			Weighted Average Grant Date Fair Value / Share
Outstanding at January 1, 2018	298			$	41.48
Granted	77			75.12
Forfeited	(101	)		38.39
Outstanding at December 31, 2018	274			52.11

TSR Performance Share Unit Grants

The following is a summary of our TSR performance share unit grants for 2018.

	Share units (in thousands)			Weighted Average Grant Date Fair Value /Share
Outstanding at January 1, 2018	213			$	47.04
Granted	77			98.86
Forfeited	(16	)		51.39
Outstanding at December 31, 2018	274			61.04

The fair value of TSR performance share units were calculated on the date of grant using a Monte Carlo simulation model utilizing several key assumptions, including expected Company and peer company share price volatility, correlation coefficients between peers, the risk-free rate of return, the expected dividend yield and other award design features. The following are weighted-average key assumptions for 2018 grants.

Volatility	26.80	%
Risk-free interest rate	2.44	%

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 $0.8400, $0.7200 and $0.6196 during 2018, 2017 and 2016, respectively.

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

(share units in thousands)	2018			2017			2016
Beginning Balance, January 1	179,862			179,367			178,377
Stock incentive plan net activity	672			985			1,085
Repurchase of common stock	(810	)		(490	)		(95	)
Ending Balance, December 31	179,724			179,862			179,367

For the years ended December 31, 2018 and December 31, 2017 the Company repurchased 0.8 million shares for $59 million of common stock and repurchased 0.5 million shares for $25 million of common stock, respectively. Repurchases include both share repurchase programs approved by the Board of Directors and repurchases in relation to settlement of employee income tax withholding obligations due as a result of the vesting of restricted stock units. The detail of repurchases by each program are as follows:

On August 24, 2015, our Board of Directors authorized the repurchase of up to $500 million in shares with no expiration date. The program's objective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. For the year ended December 31, 2018 we repurchased 0.7 million shares for $50 million. For the year ended December 31, 2017 we repurchased 0.1 million shares for $7 million. There are up to $363 million in shares that may still be purchased under this plan as of December 31, 2018.

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. For the year ended December 31, 2017 we repurchased 0.3 million shares for $13 million. As of June 2017, we have exhausted the authorized amount to repurchase shares under this plan.

Aside from the aforementioned repurchase programs, we repurchased 0.1 million and 0.1 million shares for $9 million and $5 million during 2018 and 2017, respectively, in relation to settlement of employee income tax withholding obligations due as a result of the vesting of restricted stock units. These repurchases are included in the stock incentive plan net activity in the above table.

Note 18. Accumulated Other Comprehensive Loss

The following table provides the components of accumulated other comprehensive loss for 2018, 2017 and 2016:

(in millions)	Foreign Currency Translation				Postretirement Benefit Plans				Derivative Instruments				Total
Balance at January 1, 2016	$	(43	)		$	(185	)		$	(10	)		$	(238	)
Foreign currency translation adjustment	(65		)										(65		)
Foreign currency gain reclassified into gain on sale of business	(21		)										(21		)
Changes in postretirement benefit plans					(19		)						(19		)
Income tax expense on changes in postretirement benefit plans					3								3
Foreign currency translation adjustment for postretirement benefit plans					19								19
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into other non-operating income (expense), net					10								10
Income tax impact on amortization of postretirement benefit plan items					(5		)						(5		)
Reclassification of unrealized loss on derivative hedge agreements into revenue									(2		)		(2		)
Reclassification of unrealized loss on derivative hedge agreements into cost of revenue	(11		)						11				—
Balance at December 31, 2016	$	(140	)		$	(177	)		$	(1	)		$	(318	)
Foreign currency translation adjustment	79												79
Income tax impact on foreign currency translation adjustment	46												46
Changes in postretirement benefit plans					(18		)						(18		)
Income tax expense on changes in postretirement benefit plans					7								7
Foreign currency translation adjustment for postretirement benefit plans					(18		)						(18		)
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into other non-operating income (expense), net					11								11
Income tax impact on amortization of postretirement benefit plan items					(3		)						(3		)
Unrealized loss on derivative hedge agreements									9				9
Reclassification of unrealized (gain) loss on foreign exchange agreements into revenue									(6		)		(6		)
Reclassification of unrealized (gain) loss on foreign exchange agreements into cost of revenue	—								1				1
Balance at December 31, 2017	$	(15	)		$	(198	)		$	3			$	(210	)

(in millions)	Foreign Currency Translation				Postretirement Benefit Plans				Derivative Instruments				Total
Cumulative effect of change in accounting principle	(11		)		(6		)						(17		)
Foreign currency translation adjustment	(83		)										(83		)
Income tax impact on foreign currency translation adjustment	(12		)										(12		)
Changes in postretirement benefit plans					(36		)						(36		)
Foreign currency translation adjustment for postretirement benefit plans					15								15
Income tax expense on changes in postretirement benefit plans					5								5
Amortization of prior service cost and net actuarial loss on postretirement benefit plans into other non-operating income (expense), net					9								9
Income tax impact on amortization of postretirement benefit plan items					(3		)						(3		)
Unrealized loss on derivative hedge agreements									(8		)		(8		)
Reclassification of unrealized (gain) loss on foreign exchange agreements into cost of revenue									4				4
Balance at December 31, 2018	$	(121	)		$	(214	)		$	(1	)		$	(336	)

Note 19**. Commitments and Contingencies**

Legal Proceedings

From time to time we are involved in legal and regulatory proceedings that are incidental to the operation of our businesses (or the business operations of previously owned entities). These proceedings may seek remedies relating to environmental matters, tax, intellectual property matters, acquisitions or divestitures, product liability and personal injury claims, privacy, employment, labor and pension matters, government contract issues and commercial or contractual disputes.

From time to time claims may be asserted against Xylem alleging injury caused by any of our products resulting from asbestos exposure. We believe there are numerous legal defenses available for such claims and would defend ourselves vigorously. Pursuant to the Distribution Agreement among ITT Corporation (now ITT LLC), Exelis and Xylem, ITT Corporation (now ITT LLC) has an obligation to indemnify, defend and hold Xylem harmless for asbestos product liability matters, including settlements, judgments, and legal defense costs associated with all pending and future claims that may arise from past sales of ITT’s legacy products.

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 the aggregate, will have a material adverse effect on our results of operations, or financial condition.

We have estimated and accrued $7 million and $10 million as of December 31, 2018 and 2017, respectively for these general legal matters.

Indemnifications

As part of our 2011 spin-off from our former parent, ITT Corporation (now ITT LLC), Exelis Inc. and Xylem will indemnify, defend and hold harmless each of the other parties with respect to such parties’ assumed or retained liabilities under the Distribution Agreement and breaches of the Distribution Agreement or related spin agreements. The former parent’s indemnification obligations include asserted and unasserted asbestos and silica liability claims that relate to the presence or alleged presence of asbestos or silica in products manufactured, repaired or sold prior to October 31, 2011, the Distribution Date, subject to limited exceptions with respect to certain employee claims, or in the structure or material of any building or facility, subject to exceptions with respect to employee claims relating to Xylem buildings or facilities. The indemnification associated with pending and future asbestos claims does not expire. Xylem has not recorded a liability for material matters for which we expect to be indemnified by the former

parent or Exelis Inc. through the Distribution Agreement and we are not aware of any claims or other circumstances that would give rise to material payments from us under such indemnifications. On May 29, 2015, Harris Inc. acquired Exelis. As the parent of Exelis, Harris Inc. is responsible for Exelis’s indemnification obligations under the Distribution Agreement.

Guarantees

We obtain certain stand-by letters of credit, bank guarantees and surety bonds from third-party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance related requirements. As of December 31, 2018, the amount of stand-by letters of credit, bank guarantees and surety bonds was $275 million.

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 $4 million and $4 million as of December 31, 2018 and 2017, 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. We often pay maintenance, insurance and tax expense related to leased assets. Total rent expense for the three years ended December 31, 2018 was as follows:

(in millions)	Total
2018	$	81
2017	70
2016	63

At December 31, 2018, we are obligated to make minimum rental payments under operating leases which are as follows:

(in millions)	2019				2020				2021				2022				2023				Thereafter
Minimum rental payments	$	76			$	61			$	43			$	33			$	22			$	64

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 $20 million, $28 million, and $32 million for 2018, 2017 and 2016, respectively. The table below provides changes in the combined current and non-current product warranty accruals over each period.

(in millions)	2018				2017
Warranty accrual – January 1	$	82			$	99
Net charges for product warranties in the period	20				28
Settlement of warranty claims	(42		)		(48		)
Foreign currency and other	—				3
Warranty accrual – December 31	$	60			$	82

Note 20**. Related Party Transactions**

Sales to and purchases from unconsolidated entities for 2018, 2017 and 2016 are as follows:

(in millions)		2018				2017				2016
Sales to unconsolidated affiliates		$	10			$	12			$	11
Purchases from unconsolidated affiliates		22				17				22

Note 21**. Segment and Geographic Data**

Our business has three reportable segments: Water Infrastructure, Applied Water and Measurement & Control Solutions. When determining the reportable segments, the Company aggregated operating segments based on their similar economic and operating characteristics. The Water Infrastructure segment focuses on the transportation and treatment of water, offering a range of products including water and wastewater pumps, treatment equipment, and controls and systems. The Applied Water segment serves many of the primary uses of water and focuses on the residential, commercial and industrial markets. The Applied Water segment's major products include pumps, valves, heat exchangers, controls and dispensing equipment. The Measurement & Control Solutions segment focuses on developing advanced technology solutions that enable intelligent use and conservation of critical water and energy resources as well as analytical instrumentation used in the testing of water. The Measurement & Control Solutions segment's major products include smart metering, networked communications, measurement and control technologies, critical infrastructure technologies, software and services including cloud-based analytics, remote monitoring and data management, leak detection and pressure monitoring solutions and testing equipment.

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)	2018				2017				2016
Revenue:
Water Infrastructure	$	2,176			$	2,004			$	1,932
Applied Water	1,534				1,421				1,393
Measurement & Control Solutions	1,497				1,282				446
Total	$	5,207			$	4,707			$	3,771
Operating income:
Water Infrastructure	$	359			$	312			$	295
Applied Water	236				194				188
Measurement & Control Solutions	118				110				—
Corporate and other	(59		)		(64		)		(75		)
Total operating income	654				552				408
Interest expense	82				82				70
Other non-operating income (expense)	13				6				2
(Loss)/gain from sale of businesses	—				(10		)		—
Income before taxes	$	585			$	466			$	340
Depreciation and amortization:
Water Infrastructure	$	66			$	64			$	66
Applied Water	22				23				24
Measurement & Control Solutions	144				122				41
Regional selling locations (a)	20				17				11
Corporate and other	9				8				9
Total	$	261			$	234			$	151
Capital expenditures:
Water Infrastructure	$	84			$	58			$	62
Applied Water	28				20				21
Measurement & Control Solutions	101				69				13
Regional selling locations (b)	16				18				24
Corporate and other	8				5				4
Total	$	237			$	170			$	124

(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)	2018				2017				2016
Pumps, accessories, parts and service	$	3,322			$	2,998			$	2,888
Other (a)	1,885				1,709				883
Total	$	5,207			$	4,707			$	3,771

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

The following table contains the total assets for each reportable segment as of December 31, 2018, 2017 and 2016.

	Total Assets
(in millions)	2018				2017				2016
Water Infrastructure	$	1,233			$	1,232			$	1,179
Applied Water	1,051				1,002				990
Measurement & Control Solutions	3,576				3,198				3,102
Regional selling locations (a)	1,181				1,119				965
Corporate and other (b)	181				309				238
Total	$	7,222			$	6,860			$	6,474

(a)	The Regional selling locations have assets that consist primarily of cash, accounts receivable and inventory which are not allocated to the segments.

(b)	Corporate and other consists of items pertaining to our corporate headquarters function, which principally consist of cash, deferred tax assets, pension assets and certain 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)	2018				2017				2016
United States	$	2,424			$	2,161			$	1,574
Europe	1,449				1,335				1,195
Asia Pacific	660				611				518
Other	674				600				484
Total	$	5,207			$	4,707			$	3,771

	Property, Plant & Equipment
	December 31,
(in millions)	2018				2017				2016
United States	$	281			$	258			$	255
Europe	250				259				237
Asia Pacific	66				85				87
Other	59				41				37
Total	$	656			$	643			$	616

Note 22. Valuation and Qualifying Accounts

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

(in millions)	2018				2017				2016
Balance at beginning of year	$	25			$	21			$	22
Additions charged to expense	5				5				4
Deductions/other	(5		)		(1		)		(5		)
Balance at end of year	$	25			$	25			$	21

Note 23. Quarterly Financial Data (Unaudited)

Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except

for the fourth quarter which ends on December 31.

		2018 Quarter Ended
(in millions, except per share amounts)		Dec. 31				Sept. 30				June 30				Mar. 31
Revenue		$	1,386			$	1,287			$	1,317			$	1,217
Gross profit		542				505				519				460
Operating income		194				176				171				113
Net income attributable to Xylem		$	225			$	130			$	115			$	79
Earnings per share:
Basic		$	1.25			$	0.73			$	0.64			$	0.44
Diluted		$	1.24			$	0.72			$	0.64			$	0.43

		2017 Quarter Ended
(in millions, except per share amounts)		Dec. 31				Sept. 30				June 30				Mar. 31
Revenue		$	1,277			$	1,195			$	1,164			$	1,071
Gross profit		507				471				457				412
Operating income		177				152				137				86
Net income attributable to Xylem		$	71			$	105			$	99			$	56
Earnings per share:
Basic		$	0.40			$	0.58			$	0.55			$	0.31
Diluted		$	0.40			$	0.58			$	0.55			$	0.31