Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business. Except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to Xylem Inc. and its subsidiaries.

This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Overview

Xylem is a leading global water technology company. We design, manufacture and service highly engineered products and solutions ranging across a wide variety of critical applications in utility, industrial, residential and commercial building services settings. Our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery, measurement and use of drinking water to the collection, test, treatment and analysis of wastewater to the return of water to the environment. Our product and service offerings are organized into three reportable segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Measurement & Control Solutions.

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Water Infrastructure serves the water infrastructure sector with pump systems that transport water from aquifers, lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumping solutions that move the wastewater and storm water to treatment facilities where our mixers, biological treatment, monitoring and control systems provide the primary functions in the treatment process. We also provide sales and rental of specialty dewatering pumps and related equipment and services. Additionally, our offerings use monitoring and control, smart and connected technologies to allow for remote monitoring of performance and enable products to self-optimize pump operations maximizing energy efficiency and minimizing unplanned downtime and maintenance for our customers. In the Water Infrastructure segment, we provide the majority of our sales directly to customers along with strong applications expertise, while the remaining amount is through distribution partners.

•

Applied Water serves the water usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning, and for fire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers and controls provide cooling to power plants and manufacturing facilities, circulation for food and beverage processing, as well as boosting systems for agricultural irrigation. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with many of the leading independent distributors in the markets we serve, with the remainder going directly to customers.

•

Measurement & Control Solutions primarily serves the utility infrastructure solutions and services sector by delivering communications, smart metering, measurement and control technologies and critical infrastructure technologies that allow customers to more effectively use their distribution networks for the delivery, monitoring and control of critical resources such as water, electricity and natural gas. We also provide analytical instrumentation used to measure and analyze water quality, flow and level in clean water, wastewater, surface water and coastal environments. Additionally, we offer software and services including cloud-based analytics, remote monitoring and data management, leak detection, condition assessment, asset management and pressure monitoring solutions. We also offer smart lighting solutions that improve efficiency and public safety efforts across communities. In the Measurement & Control Solutions segment, we generate our sales through a combination of long-standing relationships with leading distributors and dedicated channel partners as well as direct sales depending on the regional availability of distribution channels and the type of product.

Key Performance Indicators and Non-GAAP Measures

Management reviews key performance indicators including revenue, gross margins, segment operating income and margins, orders growth, working capital and backlog, among others. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and to provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases and debt repayment. Excluding revenue, Xylem provides guidance only on a non-GAAP basis due to the inherent difficulty in forecasting certain amounts that would be included in GAAP earnings, such as discrete tax items, without unreasonable effort. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following items to represent non-GAAP measures as well as the related reconciling items to the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

•

"organic revenue" and "organic orders" defined as revenue and orders, respectively, excluding the impact of fluctuations in foreign currency translation and contributions from acquisitions and divestitures. Divestitures include sales of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate.

•	"constant currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not the U.S. dollar.

•	"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude, as applicable, restructuring and realignment costs, special charges, tax-related special items and gains and losses from the sale of a business. A reconciliation of adjusted net income is provided below.

(in millions, except per share data)		2019							2018
Net income & Earnings per share		$	401		$	2.21			$	549		$	3.03
Restructuring and realignment, net of tax of $19 and $12		63			0.35				36			0.20
Special charges, net of tax of $6 and $1		172			0.95				12			0.07
Tax-related special items		(88		)	(0.48		)		(75		)	(0.42		)
(Gain) loss from sale of business, net of tax benefit of $0		(1		)	(0.01		)		—			—
Adjusted net income & Adjusted earnings per share		$	547		$	3.02			$	522		$	2.88

▪	"adjusted operating expenses" and "adjusted gross profit" defined as operating expenses and gross profit, respectively, adjusted to exclude restructuring and realignment costs and special charges.

▪	"adjusted operating income" defined as operating income, adjusted to exclude restructuring and realignment costs and special charges, and "adjusted operating margin" defined as adjusted operating income divided by total revenue.

▪	“realignment costs” defined as costs not included in restructuring costs that are incurred as part of actions taken to reposition our business, including items such as professional fees, severance, relocation, travel, facility set-up and other costs.

▪	"Sensus acquisition related costs" defined as costs incurred by the Company associated with the acquisition of Sensus that are being reported within operating income. These costs include integration costs, acquisition costs, costs related to the recognition of the backlog intangible asset amortization recorded in purchase accounting.

▪	“special charges" defined as costs incurred by the Company, such as acquisition and integration related costs not included in "Sensus acquisition related costs", non-cash impairment charges and other special non-operating items, such as pension adjustments.

▪	"tax-related special items" defined as tax items, such as tax return versus tax provision adjustments, tax exam impacts, tax law change impacts, excess tax benefits/losses and other discrete tax adjustments.

▪

"free cash flow" defined as net cash from operating activities, as reported in the Statement of Cash Flows, less capital expenditures as well as adjustments for other significant items that impact current results which management believes are not related to our ongoing operations and performance. Our definition of "free cash flow" does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow.

(in millions)		2019				2018
Net cash provided by operating activities		$	839			$	586
Capital expenditures		(226		)		(237		)
Free cash flow		$	613			$	349
Cash paid for Sensus acquisition related costs		—				1
Free cash flow, excluding Sensus acquisition related costs		$	613			$	350
Net cash used in investing activities		$	(231	)		$	(643	)
Net cash used by financing activities		$	(177	)		$	(40	)

▪	“EBITDA” defined as earnings before interest, taxes, depreciation and amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to exclude share-based compensation charges, restructuring and realignment costs, gain or loss from sale of businesses and special charges.

(in millions)		2019				2018
Net Income		$	401			$	549
Income tax expense		15				36
Interest expense (Income), net		62				78
Depreciation		117				117
Amortization		140				144
EBITDA		$	735			$	924
Share-based compensation		29				30
Restructuring and realignment		82				47
Special charges		178				12
(Gain) loss from sale of business		(1		)		—
Adjusted EBITDA		$	1,023			$	1,013

Executive Summary

Xylem reported revenue of $5,249 million for 2019, an increase of $42 million, or 0.8%, from $5,207 million reported in 2018. On a constant currency basis, revenue increased by $166 million, or 3.2%, primarily consisting of organic revenue growth of $188 million, or 3.6%, driven by growth in all end markets and across all segments. A net decrease in revenue related to acquisition and divestiture impacts of $22 million partially offset the organic revenue growth during the year.

Operating income for 2019 was $486 million, reflecting a decrease of $168 million, or 25.7%, compared to $654 million in 2018. Operating margin was 9.3% for 2019 versus 12.6% for 2018, a decrease of 330 basis points. Operating margin was negatively impacted by increased special charges of $147 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $34 million during the year. Excluding the impact of these items, adjusted operating income was $727 million, with an adjusted operating margin of 13.9% in 2019 as compared to adjusted operating income of $714 million with an adjusted operating margin of 13.7% in 2018. The slight increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives, including restructuring savings, improved price realization and favorable volume impacts. These impacts were partially offset by cost inflation, unfavorable mix, increased spending on strategic investments and increased cost of quality.

Additional financial highlights for 2019 include the following:

•	Net income attributable to Xylem of $401 million, or $2.21 per diluted share ($547 million or $3.02 per diluted share on an adjusted basis, up 4.8% from 2018)

•	Cash from operating activities of $839 million, and free cash flow, excluding Sensus acquisition related costs, of $613 million up 75% from 2018

•	Orders of $5,339 million, down 1.8% from $5,437 million in 2018 (up 0.9% on an organic basis)

•	Dividends paid to shareholders increased 14% in 2019.

2020 Business Outlook

We anticipate total revenue growth of approximately 1% in 2020, with organic revenue growth anticipated to be in the range of 1% to 3%. The following is a summary of our 2019 organic revenue performance and 2020 organic revenue outlook by end market.

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Utilities increased approximately 6% for 2019 on an organic basis driven by strength in the United States, the emerging markets and western Europe, partially offset by weakness in Canada. For 2020, we expect organic growth in the low-single-digit range driven by healthy water and wastewater spending in the United States, smart meter and infrastructure analytics growth opportunities and steady low-single-digit growth in Europe. We also anticipate a healthy infrastructure investment focus in the emerging markets will continue in China, India and Africa.

•

Industrial increased by approximately 1% for 2019 on an organic basis driven by strength in the United States, Europe and the Middle East and Africa, partially offset by weakness in Latin America and Canada. For 2020, we expect organic revenue to remain relatively flat driven by soft growth within the North America Dewatering business during the first half of the year, as oil and gas markets continue to be soft. We anticipate mixed market conditions outside of the United States with modest strength in Asia Pacific offset by softness in the Middle East due to geopolitical and economic uncertainty. We anticipate that Europe will remain relatively flat during the year.

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In the commercial markets, organic growth was approximately 3% for 2019 driven by strength in the emerging markets and North America, partially offset by weakness in western Europe. For 2020, we expect organic growth in the low-single-digit range as we anticipate that soft overall market conditions will recover during the second half of the year driven by continued strength in the United States and solid market conditions in Europe. The emerging markets will also continue to drive organic growth, led by initiatives in the China and India building markets.

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In residential markets, organic growth was approximately 2% in 2019 driven by strength in the United States and Asia Pacific, partially offset by weakness in western Europe and the Middle East and Africa. For 2020, we expect low-single-digit growth primarily driven by the United States housing market and a strong outlook in Europe. We also anticipate modest growth opportunities for a second water supply in China and other countries within Asia.

We will continue to strategically execute restructuring and realignment actions primarily to reposition our European and North American businesses in an effort to optimize our cost structure and improve our operational efficiency and effectiveness. During 2019, we incurred $53 million and $29 million in restructuring and realignment costs, respectively. We realized approximately $6 million of incremental net savings in 2019 from actions initiated in 2018, and an additional $16 million of net savings from our 2019 actions. As a result of our 2018 and 2019 actions we expect to realize approximately $25 million of incremental net savings in 2020 and beyond. During 2020, we currently expect to incur between $35 million and $45 million in restructuring and realignment costs.

We plan to continue to take actions and focus spending in 2020 on actions that allow us to make progress on our top strategic priorities. The priority of accelerating profitable growth encompasses our initiatives to drive commercial leadership, grow in emerging markets and strengthen innovation and technology through creation of new centers of excellence, a streamlined approach to product development and strategic acquisitions. The priority of driving continuous improvement is an area where we will continue to work to create new opportunities to unlock savings by eliminating waste and increasing efficiencies, which is supported by efforts to expand and further deepen our talent pool. We plan to continue to deploy capital in smart, disciplined ways to develop and acquire solutions to address our customers’ challenges. Finally, we continue to work to improve cash performance and generate capital to return to our shareholders.

Results of Operations

(in millions)		2019				2018				2019 v. 2018
Revenue		$	5,249			$	5,207			0.8	%
Gross profit		2,046				2,026				1.0	%
Gross margin		39.0		%		38.9		%		10	bp
Restructuring and realignment costs		5				5				—	%
Adjusted gross profit		2,051				2,031				1.0	%
Adjusted gross margin		39.1		%		39.0		%		10	bp
Total operating expenses		1,560				1,372				13.7	%
Expense to revenue ratio		29.7		%		26.3		%		340	bp
Restructuring and realignment costs		(77		)		(43		)		79.1	%
Special charges		(159		)		(12		)		NM
Adjusted operating expenses		1,324				1,317				0.5	%
Adjusted operating expenses to revenue ratio		25.2		%		25.3		%		(10	)bp
Operating income		486				654				(25.7	)%
Operating margin		9.3		%		12.6		%		(330	)bp
Interest and other non-operating expense (income), net		71				69				2.9	%
Gain (loss) from sale of business		1				—				NM
Income tax expense		15				36				(58.3	)%
Tax rate		3.7		%		6.1		%		(240	)bp
Net income		$	401			$	549			(27.0	)%

NM Not Meaningful

2019 versus 2018

Revenue

Revenue generated for 2019 was $5,249 million, an increase of $42 million, or 0.8%, compared to $5,207 million in 2018. On a constant currency basis, revenue grew 3.2% during 2019. This increase in revenue at constant currency was primarily driven by an increase in organic revenue of $188 million reflecting strong organic growth in the United States and the emerging markets, with the exception of Latin America, partially offset by declines in Canada and western Europe. A net decrease in revenue related to acquisition and divestiture impacts of $22 million partially offset organic growth during the year.

The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during 2019:

	Water Infrastructure						Applied Water						Measurement & Control Solutions						Total Xylem
(in millions)	$ Change			% Change			$ Change			% Change			$ Change			% Change			$ Change			% Change
2018 Revenue	$	2,176					$	1,534					$	1,497					$	5,207
Organic Growth	71			3.3	%		36			2.3	%		81			5.4	%		188			3.6	%
Acquisitions/(Divestitures)	—			—	%		—			—	%		(22		)	(1.5	)%		(22		)	(0.4	)%
Constant Currency	71			3.3	%		36			2.3	%		59			3.9	%		166			3.2	%
Foreign currency translation (a)	(70		)	(3.2	)%		(29		)	(1.9	)%		(25		)	(1.7	)%		(124		)	(2.4	)%
Total change in revenue	1			—	%		7			0.5	%		34			2.3	%		42			0.8	%
2019 Revenue	$	2,177					$	1,541					$	1,531					$	5,249

(a)	Foreign currency translation impact for the year primarily due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the Chinese Yuan, the British Pound, the Swedish Krona and the Australian Dollar.

Water Infrastructure

Water Infrastructure revenue slightly increased $1 million to $2,177 million in 2019 (3.3% increase on a constant currency basis) compared to 2018. Revenue was negatively impacted by $70 million of foreign currency translation, with the change at constant currency coming entirely from organic growth during the year of $71 million. Organic growth for the year was driven by strength in the utility end market, particularly in the United States, where we benefited from healthy order intake and strong market conditions across both applications. The utility end market also saw growth in Asia Pacific and western Europe driven by strong project deployments during the year. The industrial end market has remained relatively flat during the year with organic growth in the emerging markets and the United States, where we benefited from solid order intake and a strong mining market over the first half of the year, which was partially offset by declines in western Europe due to the timing of project deployments in the prior year. Organic growth in both end markets also benefited from price realization during the year.

From an application perspective, organic revenue growth for the year was primarily driven by our transport application. The transport application had strong organic revenue growth driven by project deliveries and price realization in the United States and the emerging markets. Organic growth from the global dewatering application was also up modestly for the year, with strong growth in first half of the year, coming from strength in construction and mining in the United States and Australia, being offset by rental revenue declines in North America in the second half of the year driven by a sharp drop off in oil and gas. Organic revenue from our treatment application also contributed to the segment's growth driven by project deliveries in the United States and Asia Pacific where we benefited from strong order intake coming into the year. This organic growth was partially offset by declines in the Middle East and Latin America, primarily due to the lapping of large treatment project deliveries in these regions in the prior year.

Applied Water

Applied Water revenue increased $7 million, or 0.5%, in 2019 (2.3% increase on a constant currency basis) compared to 2018. Revenue was negatively impacted by $29 million of foreign currency translation, with the change at constant currency coming entirely from organic growth during the year of $36 million. Organic growth for the year was primarily driven by strength in the commercial end market, as well as prudent growth in the industrial and residential end markets.

From an application perspective, organic revenue growth during the year was led by strength in the building services application in the commercial market which was driven by market expansion in the emerging markets, primarily in the Middle East & Africa, and product localization in China, partially offset by softness in western Europe. The industrial water application had modest organic growth during the year, primarily driven by market growth in western Europe, coupled with customers stocking orders due to geopolitical concerns, and strength in the United States, partially offset by some declines in the emerging market regions. Organic growth in building services application in the residential market came primarily from healthy market growth in the United States and strong second water supply business in China, which was partially offset by declines in western Europe and the Middle East. Organic growth within the segment also benefited from price realization during the year.

Measurement & Control Solutions

Measurement & Control Solutions revenue increased $34 million, or 2.3%, in 2019 (3.9% increase on a constant currency basis) compared to 2018. Revenue was negatively impacted by $25 million of foreign currency translation during the year. Revenue growth at constant currency was made up of organic revenue growth of $81 million, or 5.4%, which was partially offset by $22 million of reduced revenue related to the net acquisition and divestiture impacts during the year. Organic revenue growth for the year was driven by strength in the utility end market, primarily in the United States and the Middle East, partially offset by declines in the United Kingdom.

From an application perspective, organic revenue from the water metrology application contributed the majority of the organic growth for the segment, with large project deployments in the United States, the Middle East and western Europe during the year. The energy application also contributed to the organic growth during the year as gas project deployments more than offset the timing of a large electric project deployment in the prior year in the United States . This organic growth was partially offset by a decline in the software as a service ("SaaS") and other application primarily due to the timing of a large software sale in the prior year in the United Kingdom. The test application remained relatively flat as compared to the prior year.

Orders/Backlog

An order represents a legally enforceable, written document that includes the scope of work or services to be performed or equipment to be supplied to a customer, the corresponding price and the expected delivery date for the applicable products or services to be provided. An order often takes the form of a customer purchase order (“P.O.”) or a signed quote from a Xylem business. Orders received during 2019 decreased by $98 million, or 1.8%, to $5,339 million (0.6% increase on a constant currency basis). Order intake during the year was negatively impacted by $129 million of foreign currency translation. The order growth on a constant currency basis primarily consisted of organic order growth of $48 million, or 0.9%, over the prior year. Net acquisition and divestiture activity of $17 million negatively impacted order growth during the year.

The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to orders during 2019:

	Water Infrastructure						Applied Water						Measurement & Control Solutions						Total Xylem
(in millions)	$ Change			% Change			$ Change			% Change			$ Change			% Change			$ Change			% Change
2018 Orders	$	2,255					$	1,557					$	1,625					$	5,437
Organic Growth	53			2.4	%		28			1.8	%		(33		)	(2.0	)%		48			0.9	%
Acquisitions/(Divestitures)	—			—	%		—			—	%		(17		)	(1.0	)%		(17		)	(0.3	)%
Constant Currency	53			2.4	%		28			1.8	%		(50		)	(3.1	)%		31			0.6	%
Foreign currency translation (a)	(74		)	(3.3	)%		(29		)	(1.9	)%		(26		)	(1.6	)%		(129		)	(2.4	)%
Total change in orders	(21		)	(0.9	)%		(1		)	(0.1	)%		(76		)	(4.7	)%		(98		)	(1.8	)%
2019 Orders	$	2,234					$	1,556					$	1,549					$	5,339

(a)	Foreign currency translation impact for the year primarily due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the Chinese Yuan, the British Pound, the Swedish Krona and the Australian Dollar.

Water Infrastructure

Water Infrastructure segment orders decreased $21 million, or 0.9%, to $2,234 million (2.4% increase on a constant currency basis). Order intake during the year was negatively impacted by $74 million of foreign currency translation. The order increase on a constant currency basis was driven by organic order growth in the transport application. Transport organic order growth was primarily driven by a large smart city project order secured in India during the second half of the year and strong market conditions, coupled with some price realization, in Europe, China and North America. Organic orders for the treatment application declined during the year, primarily driven by project timing in North America and India due to the timing of large project orders in the prior year, partially offset by strong order intake in the Middle East during the year.

Applied Water

Applied Water segment orders slightly decreased $1 million to $1,556 million (1.8% increase on a constant currency basis). Order intake during the year was negatively impacted by $29 million of foreign currency translation. The order increase on a constant currency basis was driven by strong organic order growth in the United States and China across both applications, which were partially offset by a reduction of orders in the Middle East.

Measurement & Control Solutions

Measurement & Control Solutions segment orders decreased $76 million, or 4.7%, to $1,549 million (3.1% decrease on a constant currency basis). Order intake during the year was negatively impacted by $26 million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline of $33 million, or 2.0%, which followed a difficult comparison to the prior year organic order growth of 18%, and $17 million of the net acquisition and divestiture impacts on the year. The decrease in organic orders during the year was driven by the energy application decline in North America, which had a significant electric deployment order in the prior year that did not repeat. Water application orders grew organically during the year driven by strong order intake within the AIA platform, partially offset by the lapping of large prior year orders for metrology projects, coupled with some softening market conditions, in North America and the Middle East. SaaS and other experienced modest organic growth during the year, driven by order strength in North America, largely offset by the lapping of a

large UK software order in the prior year. Organic orders for the test application declined during the quarter driven by project timing and soft market conditions in Europe.

Backlog

Backlog includes orders on hand as well as contractual customer agreements at the end of the period. Delivery schedules vary from customer to customer based on their requirements. Annual or multi-year contracts are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. As such, beginning total backlog, plus orders, minus revenues, will not equal ending total backlog due to contract adjustments, foreign currency fluctuations, and other factors. Typically, large projects require longer lead production cycles and deployment schedules and delays can occur from time to time. Total backlog was $1,801 million at December 31, 2019 and $1,689 million at December 31, 2018, an increase of 6.6%. We anticipate that approximately 60% of our total backlog at December 31, 2019 will be recognized as revenue during 2020. This is down from prior years due to the changing profile of our backlog which includes a greater portion of large multi-year projects.

Gross Margin

Gross margin as a percentage of consolidated revenue increased 10 basis points to 39.0% in 2019 as compared to 38.9% in 2018. The slight gross margin increase was primarily driven by cost reductions from global procurement and productivity improvement initiatives and price realization, which were partially offset by cost inflation and unfavorable mix.

Operating Expenses

(in millions)	2019				2018				Change
Selling, general and administrative expenses ("SG&A")	$	1,158			$	1,161			(0.3	)%
SG&A as a % of revenue	22.1		%		22.3		%		(20	)bp
Research and development expenses ("R&D")	191				189				1.1	%
R&D as a % of revenue	3.6		%		3.6		%		—
Restructuring and asset impairment charges	63				22				186.4	%
Operating expenses	$	1,412			$	1,372			2.9	%
Expense to revenue ratio	26.9		%		26.3		%		60	bp

Selling, General and Administrative ("SG&A") Expenses

SG&A expenses decreased by $3 million (decrease of 0.3%) to 22.1% of revenue in 2019, as compared to 22.3% of revenue in 2018. The improvement in SG&A as a percent of revenue for the year was primarily driven by cost reductions from global procurement and productivity improvement initiatives, including restructuring savings, which were partially offset by cost inflation and additional investment in strategic growth initiatives.

Research and Development ("R&D") Expenses

R&D expense was $191 million, or 3.6% of revenue, in 2019 as compared to $189 million, or 3.6% of revenue, in 2018. Additionally, we capitalized R&D on external sale software of $59 million in 2019 as compared to $60 million in 2018. Our increased spending on R&D is driven by development needs to drive new product growth.

Restructuring and Asset Impairment Charges

Restructuring

During 2019, we incurred restructuring costs of $20 million, $5 million and $28 million in our Water Infrastructure, Applied Water and Measurement & Control Solutions segments, respectively. We incurred these charges related to actions taken in 2019 primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment.

During 2018, we recognized restructuring costs of $9 million, $2 million and $9 million in our Water Infrastructure, Applied Water and Measurement & Control Solutions, respectively. These charges were incurred primarily in an effort to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment.

The following is a rollforward of employee position eliminations associated with restructuring activities for the years ended December 31, 2019 and 2018:

		2019			2018
Planned reductions - January 1		69			47
Additional planned reductions		674			206
Actual reductions and reversals		(547	)		(184	)
Planned reductions - December 31		196			69

The following table presents expected restructuring spend:

(in millions)		Water Infrastructure				Applied Water				Measurement & Control Solutions				Corporate				Total
Actions Commenced in 2019:
Total expected costs		$	19			$	5			$	28			$	—			$	52
Costs incurred during 2019		18				5				27				—				50
Total expected costs remaining		$	1			$	—			$	1			$	—			$	2
Actions Commenced in 2018:
Total expected costs		$	8			$	1			$	7			$	—			$	16
Costs incurred during 2018		7				1				7				—				15
Costs incurred during 2019		1				—				—				—				1
Total expected costs remaining		$	—			$	—			$	—			$	—			$	—
Actions Commenced in 2017:
Total expected costs		$	12			$	7			$	4			$	—			$	23
Costs incurred during 2017		5				4				2				—				11
Costs incurred during 2018		2				1				1				—				4
Costs incurred during 2019		1				—				1				—				2
Total expected costs remaining		$	4			$	2			$	—			$	—			$	6

The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges. The Applied Water actions are complete, the Water Infrastructure actions are expected to continue through Q1 2020, and the Measurement & Control Solutions actions are expected to continue through the fourth quarter of 2020. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2018 consist primarily of severance charges and are complete. The Water Infrastructure, Applied Water, Measurement & Control Solutions and Corporate actions commenced in 2017 consist primarily of severance charges and are expected to continue through 2021. As a result of the actions initiated in 2019, we achieved savings of approximately $15 million in 2019 and estimate annual future net savings beginning in 2020 of approximately $39 million, resulting in $24 million of incremental savings from the 2019 actions.

Asset Impairment

During the first and third quarter of 2019 we determined that certain assets within our Measurement & Control Solutions segment, including customer relationships, internally developed software, proprietary technology, and plant property & equipment, were impaired. Accordingly we recognized an impairment charge of $10 million during the year. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

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

Goodwill Impairment Charge

During the third quarter of 2019, the Company recorded a goodwill impairment charge of $148 million related to the Advanced Infrastructure Analytics (“AIA”) goodwill reporting unit. The impairment resulted from a downward revision of forecasted future cash flows. Factors that contributed to the revised forecast in the third quarter include lower

than expected results as compared to prior forecasts, largely as a result of slower-than-expected conversion of pipeline opportunities to revenue. Additionally, we have continued to invest in the AIA platform ahead of the adoption curve, which has also impacted the near-term profitability of the business. These factors drove a decrease in the fair value, based on a discounted cash flow valuation, of the AIA reporting unit that was below its carrying value as of July 1, 2019, requiring an impairment charge. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

Operating Income

Operating income was $486 million (operating margin of 9.3%) during 2019, a decrease of $168 million, or 25.7%, when compared to operating income of $654 million (operating margin of 12.6%) during the prior year. Operating margin for the year was negatively impacted by increased special charges of $147 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $34 million as compared to the prior year. Excluding these special charges and restructuring and realignment costs, adjusted operating income was $727 million (adjusted operating margin of 13.9%) for 2019 as compared to adjusted operating income of $714 million (adjusted operating margin of 13.7%) during the prior year. The slight increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives, including restructuring savings, improved price realization and favorable volume impacts. These impacts were partially offset by cost inflation, unfavorable mix, increased spending on strategic investments and increased cost of quality.

The table below provides a reconciliation of total and each segment's operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin:

(In millions)	2019				2018				Change
Water Infrastructure
Operating income	$	365			$	359			1.7		%
Operating margin	16.8		%		16.5		%		30		bp
Restructuring and realignment costs	31				20				55.0		%
Special charges	—				2				NM
Adjusted operating income	$	396			$	381			3.9		%
Adjusted operating margin	18.2		%		17.5		%		70		bp
Applied Water
Operating income	$	241			$	236			2.1		%
Operating margin	15.6		%		15.4		%		20		bp
Restructuring and realignment costs	13				10				30.0		%
Adjusted operating income	$	254			$	246			3.3		%
Adjusted operating margin	16.5		%		16.0		%		50		bp
Measurement & Control Solutions
Operating (loss) income	$	(67	)		$	118			(156.8	)	%
Operating margin	(4.4		)%		7.9		%		(1,230	)	bp
Restructuring and realignment costs	38				18				111.1		%
Special charges	159				5				NM
Adjusted operating income	$	130			$	141			(7.8	)	%
Adjusted operating margin	8.5		%		9.4		%		(90	)	bp
Corporate and other
Operating loss	$	(53	)		$	(59	)		(10.2	)	%
Special charges	—				5				NM		%
Adjusted operating loss	$	(53	)		$	(54	)		(1.9	)	%
Total Xylem
Operating income	$	486			$	654			(25.7	)	%
Operating margin	9.3		%		12.6		%		(330	)	bp
Restructuring and realignment costs	82				48				70.8		%
Special charges	159				12				1,225.0		%
Adjusted operating income	$	727			$	714			1.8		%
Adjusted operating margin	13.9		%		13.7		%		20		bp

NM Not Meaningful

Water Infrastructure

Operating income for our Water Infrastructure segment increased $6 million, or 1.7%, during 2019 as compared to the prior year, with operating margin also increasing from 16.5% to 16.8%. Operating margin was negatively impacted year-over-year by increased restructuring and realignment costs of $11 million and positively impacted by special charges of $2 million incurred in 2018 that did not recur in 2019. Excluding these items, adjusted operating income increased $15 million, or 3.9%, with adjusted operating margin increasing from 17.5% to 18.2%. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives, price realization and favorable volume, which were partially offset by cost inflation, unfavorable mix, increased cost of quality and increased spending on strategic investments.

Applied Water

Operating income for our Applied Water segment increased $5 million, or 2.1%, during 2019 as compared to the prior year, with operating margin also increasing from 15.4% to 15.6%. Operating margin was negatively impacted by increased restructuring and realignment costs of $3 million in 2019. Excluding these restructuring and realignment costs, adjusted operating income increased $8 million, or 3.3%, with adjusted operating margin increasing from 16.0% to 16.5%. The increase in adjusted operating margin was primarily due to cost reductions from our global procurement and productivity initiatives and price realization, which were partially offset by cost inflation, including tariffs, increased cost of quality, unfavorable mix, unfavorable volume and increased spending on strategic investments.

Measurement & Control Solutions

Operating income for our Measurement & Control Solutions segment decreased $185 million, or 156.8%, during 2019 as compared to the prior year, with operating margin also decreasing from 7.9% to (4.4)%. Operating margin was negatively impacted by increased special charges of $154 million, consisting entirely of non-cash impairment charges, and increased restructuring and realignment costs of $20 million during the year. Excluding these items, adjusted operating income decreased $11 million, or 7.8%, with adjusted operating margin decreasing from 9.4% to 8.5%. The decrease in adjusted operating margin was primarily due to cost inflation, increased spending on strategic investments and unfavorable mix impacts. Purchase accounting impacts from acquisitions also negatively affected operating margin. These impacts were partially offset by cost reductions from our global procurement and productivity initiatives, favorable volume impacts and price realization.

Corporate and other

Operating loss for corporate and other decreased $6 million, or 10.2%, compared to the prior year, primarily due to $5 million of special charges incurred during 2018 that did not recur. Excluding these costs, adjusted operating expense decreased $1 million, or 1.9%, compared to the prior year.

Interest Expense

Interest expense was $67 million and $82 million for 2019 and 2018, respectively. The decrease in interest expense for the year is primarily driven by the impact of cross currency swaps during the year and, to a lesser extent, additional interest expense that was incurred during 2018 related to debt to fund our acquisition of Pure Technologies Ltd., which was repaid during 2019. See Note 13, "Derivative Financial Instruments" of our consolidated financial statements for a description of our cross currency swaps. See Note 15, "Credit Facilities and Debt" of our consolidated financial statements for a description of our credit facilities and long-term debt and related interest.

Income Tax Expense

The income tax provision for 2019 was $15 million at an effective tax rate of 3.7% as compared to $36 million at an effective tax rate of 6.1% in 2018. The 2019 effective tax rate differs from that of 2018 primarily due to the income tax benefit that resulted from changes in tax law in Switzerland partially offset by the tax impact of the goodwill impairment charge on income before taxes in 2019.

Other Comprehensive (Loss) Income

Other comprehensive loss was $38 million in 2019 as compared to a loss of $111 million in 2018. Foreign currency translation contributed favorable impacts during the year of $113 million driven the strengthening of the British Pound, the Canadian Dollar and the South African Rand as compared to the U.S. Dollar in 2019 versus the weakening of these currencies in the prior year. Additionally, the weakening of the Euro, Chinese Yuan and the Australian Dollar as compared to the U.S. Dollar was less negative in 2019 than the weakening of these currencies in the prior year. These favorable currency translation impacts were partially offset by the movement in our Euro net investment hedges during the quarter. The tax impact on the foreign currency translation related to the Euro net investment hedges also contributed to the net favorable foreign currency translation movement during the year. Partially offsetting these favorable drivers was the increased loss in postretirement benefit plans during the year, primarily actuarial losses.

Liquidity and Capital Resources

The following table summarizes our sources and uses of cash:

	Year Ended December 31,
(in millions)	2019				2018				Change
Operating activities	$	839			$	586			$	253
Investing activities	(231		)		(643		)		412
Financing activities	(177		)		(40		)		(137		)
Foreign exchange (a)	(3		)		(21		)		18
Total	$	428			$	(118	)		$	546

(a)	2019 impact is primarily due to the strengthening of the Chinese Yuan, the Canadian Dollar, the Indian Rupee, the South African Rand, the Russian Ruble and various other currencies against the U.S. Dollar.

Sources and Uses of Liquidity

Operating Activities

During 2019, net cash provided by operating activities was $839 million, compared to $586 million in 2018. The $253 million year-over-year increase was primarily driven by improvement in working capital levels due to the improved management of inventory and collection of receivables, increase in cash from earnings and decreased payments for post-retirement obligations during the period, which were partially offset by an increase in cash tax payments.

Investing Activities

Cash used in investing activities was $231 million in 2019, compared to $643 million in 2018. This decrease in cash used of $412 million was mainly driven by the $433 million spent on 2018 acquisitions, primarily the acquisition of Pure Technologies Ltd., versus the $18 million spent for acquisition activity during the current year and modestly lower spending on capital expenditures compared to the prior year. This decrease is partially offset by $22 million of proceeds received for a divested business in 2018.

Financing Activities

Cash used by financing activities was $177 million in 2019, compared to $40 million in 2018. The increase in cash used during the year was primarily due to higher levels of short-term debt related to acquisition financing in 2018 and an increase in dividends paid of $22 million during the period as compared to the prior year. These drivers are partially offset by the higher net repayment of $120 million of long-term debt in the prior year and a decrease in share repurchase activity of $19 million as compared to the prior year.

Funding and Liquidity Strategy

Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations and access to bank financing and the capital markets. Historically, we have generated operating cash flow sufficient to fund our primary cash needs centered on operating activities, working capital, capital expenditures, strategic investments and dividends. If our cash flows from operations are less than we expect, we may need to incur debt or issue equity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital

markets, and (iii) the current state of the economy. There can be no assurance that such financing will be available to us on acceptable terms or that such financing will be available at all.

We monitor our global funding requirements and seek to meet our liquidity needs on a cost effective basis. Based on our current global cash positions, cash flows from operations and access to the commercial paper markets, we believe there is sufficient liquidity to meet our funding requirements. In addition, our existing committed credit facilities and access to the public debt markets would provide further liquidity if required.

We anticipate that our present sources of funds, including funds from operations and additional borrowings, will provide us with sufficient liquidity and capital resources to meet our liquidity and capital needs in both the United States and outside of the United States over the next twelve months.

Credit Facilities & Long-Term Contractual Commitments

See Note 15, "Credit Facilities and Debt" of our consolidated financial statements for a description of our credit facilities and long-term debt.

Non-U.S. Operations

For 2019 and 2018, we generated 51% and 53% of our revenue from non-U.S. operations, respectively. As we continue to grow our operations in the emerging markets and elsewhere outside of the United States, we expect to continue to generate significant revenue from non-U.S. operations and expect that a substantial portion of our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to the U.S. and other international subsidiaries when we believe it is cost effective to do so. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need to repatriate funds held internationally to support our U.S. operations. As of December 31, 2019, we have provided a deferred tax liability of $9 million for net foreign withholding taxes and state income taxes on $505 million of earnings expected to be repatriated to the U.S. parent in the future.

Contractual Obligations

The following table summarizes our contractual commitments as of December 31, 2019:

(in millions)	2020				2021 - 2022				2023 - 2024				Thereafter				Total
Debt obligations (1)	$	276			$	600			$	557			$	900			$	2,333
Interest payments (1) (2)	76				122				80				418				696
Lease obligations (3)	65				87				50				62				264
Purchase obligations (4)	95				7				—				—				102
Other long-term obligations reflected on the balance sheet	1				23				23				8				55
Total commitments	$	513			$	839			$	710			$	1,388			$	3,450

In addition to the amounts presented in the table above, we have recorded liabilities for net investment hedges of $24 million and employee severance indemnities of $16 million. These amounts have been excluded from the contractual obligations table due to an inability to reasonably estimate the timing or amounts of such payments in individual years. Further, benefit payments which reflect expected future service related to the Company's pension and other postretirement employee benefit obligations are presented in Note 16, “Postretirement Benefit Plans” of the consolidated financial statements and deferred income tax liabilities and uncertain tax positions are presented in Note 7, "Income Taxes" of the consolidated financial statements, and as such, these obligations are not included in the above table. Finally, estimated environmental payments and workers' compensation and general liability reserves are excluded from the table above. We estimate, based on historical experience, that we will spend approximately $2 million to $3 million per year on environmental investigation and remediation and approximately $5 million to $6 million per year on workers' compensation and general liability. At December 31, 2019, we had estimated and accrued $3 million and $20 million related to environmental matters, and workers' compensation and general liability, respectively.

(1)	Refer to Note 15, “Credit Facilities and Debt,” of the consolidated financial statements for discussion of the use and availability of debt and revolving credit agreements. Amounts represent principal payments of short-term and long-term debt including current maturities and exclude unamortized discounts.

(2)	Amounts represent estimates of future interest payments on short-term and long-term debt outstanding as of December 31, 2019.

(3)	Refer to Note 11, "Leases" of the consolidated financial statements for further lease discussion.

(4)	Represents unconditional purchase agreements that are enforceable and legally binding and that specify all significant terms to purchase goods or services, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase agreements that are able to cancel without penalty have been excluded.

Off-Balance Sheet Arrangements

As of December 31, 2019, we have issued guarantees for the debt and other obligations of consolidated subsidiaries in the normal course of business. We have determined that none of these arrangements has a material current effect or is reasonably likely to have a material future effect on our consolidated financial statements, financial condition, changes in financial condition, revenues or expenses, liquidity, capital expenditures or capital resources.

We obtain certain stand-by letters of credit, bank guarantees and surety bonds from third-party financial institutions in the ordinary course of business when required under contracts or to satisfy insurance related requirements. As of December 31, 2019, the amount of surety bonds, bank guarantees, stand-by letters of credit, and insurance letters of credit was $340 million.

Critical Accounting Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Significant accounting policies used in the preparation of the Consolidated Financial Statements are discussed in Note 1, “Summary of Significant Accounting Policies,” of the consolidated financial statements. Accounting estimates and assumptions discussed in this section are those that we consider most critical to an understanding of our financial statements because they are inherently uncertain, involve significant judgments, include areas where different estimates reasonably could have been used, and changes in the estimate that are reasonably possible could materially impact the financial statements. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management’s estimates under different assumptions or conditions.

Revenue Recognition. 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 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.

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. 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 be entitled to. 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.

The adoption of the new revenue guidance did not provide materially different results from historical revenue guidance.

Income Taxes. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely than not we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes to our estimate of the amount we are more likely than not to realize in the valuation allowance, with a corresponding adjustment to earnings or other comprehensive income, as appropriate.

In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years and the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected by changes to tax laws, changes to statutory tax rates and changes to future taxable income estimates.

Due to 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.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and to the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities or upon completion of the litigation process, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.

We adjust our liability for uncertain tax positions in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional tax expense would result. If a payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

Business Combinations. We record acquisitions using the purchase method of accounting. All of the assets acquired, liabilities assumed, contractual contingencies and contingent consideration is recorded at fair value as of the acquisition date. The excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired is recorded as goodwill. The application of the purchase method of accounting for business combinations requires management to make significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed, in order to properly allocate purchase price consideration between assets that are depreciated and amortized from goodwill. These assumptions and estimates include a market participant’s use of the asset and the appropriate discount rates for a market participant. Our estimates are based on historical experience, information obtained from the management of the acquired companies and, when appropriate, includes assistance from independent third-party appraisal firms. Significant assumptions and estimates include, but are not limited to, the cash flows that an asset is expected to generate in the future, the cost to build/recreate certain technology, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and

unpredictable. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.

Goodwill and Intangible Assets. We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-lived intangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment test as of the first day of the fourth quarter. 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.

Determining the fair value of a reporting unit or an indefinite-lived intangible asset is judgmental in nature and involves the use of significant estimates and assumptions, particularly related to future operating results and cash flows. These estimates and assumptions include, but are not limited to, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, assumed royalty rates, future economic and market conditions and identification of appropriate market comparable data. In addition, the identification of reporting units and the allocation of assets and liabilities to the reporting units when determining the carrying value of each reporting unit also require judgment. Goodwill is tested for impairment at either the operating segment identified in Note 22, “Segment and Geographic Data,” of the consolidated financial statements, or one level below. The fair value of our reporting units and indefinite-lived intangible assets is based on estimates and assumptions that are believed to be reasonable. Significant changes to these estimates and assumptions could adversely impact our conclusions. Actual future results may differ from those estimates.

In the third quarter of 2019, the Company revised its forecasted future cash flows for the AIA business. Factors that contributed to the revised forecast in the third quarter include lower than expected results as compared to prior forecasts, largely as a result of slower-than-expected conversion of pipeline opportunities to revenue. Additionally, we have continued to invest in the AIA platform ahead of the adoption curve, which has also impacted the near term profitability of the business. Based on these factors we determined that there were indicators that the AIA reporting unit’s goodwill may be impaired, and accordingly, we performed an interim goodwill impairment test as of July 1, 2019. The results of the impairment test showed that the fair value of the AIA reporting unit was lower than the carrying value, resulting in a $148 million goodwill impairment charge. As of December 31, 2019 the remaining goodwill balance in our AIA reporting unit after recording the goodwill impairment charge was $171 million.

Also, during the third quarter of 2019, due to the factors discussed above, we assessed whether the carrying amounts of the AIA reporting unit’s long-lived assets may not be recoverable and therefore impaired. Our assessment resulted in an impairment charge of $7 million, related to customer relationships, proprietary technology, software and property, plant and equipment. The charge was calculated using an income approach.

If we do not achieve our forecasts, given that the fair value and the carrying value of the AIA reporting unit were the same at July 1, 2019, it is possible that the goodwill of the AIA reporting unit could be deemed to be impaired in a future period.

During the fourth quarter of 2019, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were substantially in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances require us to do so. We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date in 2019. However, future indefinite-lived intangible impairment tests could result in a charge to earnings. We will continue to evaluate indefinite-lived intangibles 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.

Postretirement Plans. Company employees around the world participate in numerous defined benefit plans. The determination of projected benefit obligations and the recognition of expenses related to these plans are dependent on various assumptions. These major assumptions primarily relate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, health care inflation and years of service (some of which are disclosed in Note 16, “Postretirement Benefit Plans,” of the consolidated financial statements) and other factors. Actual results that differ from our assumptions are accumulated and amortized on a straight-line

basis only to the extent they exceed 10% of the higher of the market-related value or projected benefit obligation, over the average remaining service period of active plan participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy.

Significant Assumptions

Management develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country in which such plans exist. All assumptions are reviewed annually with third-party consultants and adjusted as necessary. The table included below provides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2019 and 2018.

	2019						2018
	U.S.			Int’l			U.S.			Int’l
Benefit Obligation Assumptions
Discount rate	3.25	%		1.80	%		4.50	%		2.60	%
Rate of future compensation increase	NM			2.94	%		NM			2.92	%
Net Periodic Benefit Cost Assumptions
Discount rate	4.50	%		2.60	%		3.75	%		2.43	%
Expected long-term return on plan assets	7.75	%		6.96	%		8.00	%		7.23	%
Rate of future compensation increase	NM			2.92	%		NM			2.93	%

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

We determine the expected long-term rate of return on plan assets by evaluating both historical returns and estimates of future returns. Specifically, the Company analyzes the estimated future returns based on independent estimates of asset class returns and evaluates historical broad market returns over long-term timeframes based on the strategic asset allocation, which is detailed in Note 16, “Postretirement Benefit Plans,” of the consolidated financial statements.

Based on the approach described above, the chart below shows weighted average actual returns versus the weighted average expected long-term rates of return for our pension plans that were utilized in the calculation of the net periodic pension cost for each respective year.

	2019			2018
Expected long-term rate of return on plan assets	7.09	%		7.34	%
Actual rate of return on plan assets	12.59	%		(3.85	)%

For the recognition of net periodic pension cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate of return to the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurement date over the last five years. The use of fair value, rather than a calculated value, could materially affect net periodic pension cost. The weighted average expected long-term rate of return for all of our plan assets to be used in determining net periodic benefit costs for 2020 is estimated at 3.46%. We estimate that every 25 basis point change in the expected return on plan assets impacts the expense by $1 million.

The discount rate reflects our expectation of the present value of expected future cash payments for benefits at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and increases pension expense. We base the discount rate assumption on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pension discount rate was determined by considering an interest rate yield curve comprising AAA/AA bonds, with maturities between zero and 30 years, developed by the plan’s actuaries. Annual benefit payments are then discounted to present value using this yield curve to develop a single-point discount rate matching the plan’s characteristics. Our weighted average discount rate for all pension plans effective January 1, 2020, is 1.97%. We estimate that every 25 basis point change in the discount rate impacts the expense by $1 million.

The rate of future compensation increase assumption reflects our long-term actual experience and future and near-term outlook. Effective January 1, 2020, our expected rate of future compensation is 3.04% for all pension plans. The estimated impact of a 25 basis point change in the expected rate of future compensation is less than $1 million.

The assumed rate of future increases in the per capita cost of health care (the health care trend rate) is 6.53% for 2020, decreasing ratably to 4.50% in 2028. 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.

We currently anticipate making contributions to our pension and postretirement benefit plans in the range of $15 million to $25 million during 2020, of which $5 million is expected to be made in the first quarter.

Funded Status

Funded status is derived by subtracting the respective year-end values of the projected benefit obligations from the fair value of plan assets. We estimate that every 25 basis point change in the discount rate impacts the funded status by approximately $33 million.

Fair Value of Plan Assets

The plan assets of our pension plans comprise a broad range of investments, including domestic and foreign equity securities, interests in private equity and hedge funds, fixed income investments, insurance contracts, and cash and cash equivalents.

A portion of our pension benefit plan assets portfolio comprises investments in private equity and hedge funds. The private equity and hedge fund investments are generally measured at net asset value. However, in certain instances, the values reported by the asset managers were not current at the measurement date. Accordingly, we made estimate adjustments to the last reported value where necessary to measure the assets at fair value at the measurement date. These adjustments consider information received from the asset managers, as well as general market information. The adjustment recorded at December 31, 2019 and 2018 for these assets represented less than one percent of total plan assets in each respective year. Asset values for other positions were generally measured using market observable prices. We estimate that a 5% change in asset values will impact funded status by approximately $28 million.

New Accounting Pronouncements

See Note 2, “Recently Issued Accounting Pronouncements,” of the consolidated financial statements for a complete discussion of recent accounting pronouncements.