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

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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 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 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, 2019.

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.

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. 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.

COVID-19 Pandemic

The global spread of COVID-19 has curtailed the movement of people, goods and services worldwide, including in many of the regions where we sell our products and services and conduct operations.

This section summarizes the most significant impacts related to the COVID-19 pandemic that we have experienced to date, and we have included additional details as applicable throughout other sections of this Annual Report. Many of these impacts did not begin to be felt broadly across our businesses until the latter part of the first quarter of 2020 and have continued through the remainder of the year. As the COVID-19 pandemic began to unfold in the first quarter of 2020, Xylem deployed a COVID-19 Response Team, responsible for Xylem's Pandemic Plan, which is designed to aid in prevention, preparedness, response and recovery at our sites and across the Company.

Depending on the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences, we anticipate that it will become more difficult to distinguish specific aspects of our operational and financial performance that are most directly related to COVID-19 from those that are more broadly influenced by ongoing macroeconomic, market and industry dynamics that are, to varying degrees, related to the COVID-19 pandemic and its consequences.

Public health officials have recommended, or governments have mandated, precautions to mitigate the spread of COVID-19, including stay at home or similar measures, such as travel restrictions, for periods of time in many of the areas in which we operate. Operationally, a number of our production facilities across the globe experienced reduced production levels due to such measures to varying degrees during the year, however our current overall operating capacity approximates normal levels globally. In order to maintain a safe work environment, our production facilities continue to spread operations over multiple shifts and implement other protective measures such as testing, temperature screening and social distancing, while maintaining operational capabilities.

The COVID-19 pandemic is also adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and businesses. We expect to continue experiencing unpredictable interruptions with our external suppliers into 2021 that could lead to increased logistic costs. We have enhanced our supplier pulsing and redundancy to help mitigate these challenges and do not expect these interruptions to result in a material impact to our business. Additionally, we have in the past and may continue to take measures with respect to buffer stock to minimize freight and logistics delays. If these interruptions are sustained, or additional interruptions occur, they could have a negative impact on our results of operations.

To date, the most significant operational impacts we have experienced are volume reductions ranging across all segments and major geographic regions. Although regions such as Europe and China have started to recover and experienced organic revenue growth during the fourth quarter of 2020, recovery in regions such as the U.S., the Middle East and India continues to lag.

Future demand for our products and services is uncertain as the COVID-19 pandemic has also had an adverse impact on many of the customers we serve. As such, we have, and may continue to, experience decreased or delayed demand for our products and services. At the end of 2020, total backlog increased 17.9% as compared to December 31, 2019. In many cases, Xylem’s products and services are considered "essential services" under various governmental mandates, and as a result we did not experience significant issues in our ability to distribute products or services, aside from customer-driven project delays, inability to access or travel to customer sites and shipping delays due to stay at home measures. However, because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, the pandemic’s ongoing and future impacts on our business, financial condition, results of operations, and stock price remain uncertain and difficult to predict, and we expect that our results may continue to be adversely impacted beyond the year ending December 31, 2020.

In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, management committed to restructuring activities across our businesses and functions globally during the second quarter of 2020. These initiatives are designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. In light of the uncertainty created by the COVID-19 pandemic, we also proactively took further cost reduction actions in 2020, which included a temporary 20% reduction in the base salary of the Company's Chief Executive Officer ("CEO") and all CEO direct reports, and a temporary 20% reduction in annual cash retainer fees payable to our Board of Directors effective from June 1, 2020 through December 31, 2020. Additionally, in 2020 we committed to reduced capital expenditure and discretionary operating spending. We anticipate that our capital expenditure spending will ramp up to more normal levels throughout 2021 as we see improvements in our markets.

Since the pandemic started, Xylem has taken measures to protect the health and safety of our employees, work with our customers to minimize potential disruptions and positively impact our communities. In the first quarter of

2020, we implemented a support pay program for employees impacted by COVID-19, and an essential services premium pay program for the benefit of employees whose roles are classified as an “essential service” and, as such, are required to work either onsite at a Xylem facility or in the field supporting customers during periods of mandated stay at home or similar measures. These programs will remain in place through the first quarter of 2021 and continue to be evaluated for continuation as necessary going forward. Xylem Watermark, our corporate social responsibility program, is also supporting our communities in addressing the challenges posed by this global pandemic through its partnership with Americares and UNICEF, as well as the expansion of the Partner Community Grants program and matching donations program for employees and partners, and other philanthropic commitments. During 2020, Xylem also re-purposed internal manufacturing capabilities and, working with our partners, leveraged our supply chain to donate 300,000 pieces of personal protective equipment ("PPE") to frontline workers.

Many of our offices globally have transitioned to a substantially remote work from home status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures. As public health officials and governments ease recommendations and regulations regarding stay at home measures, our COVID-19 Response Team applies a set of Xylem "Return to Workplace" health and safety guidelines for remote workers to return to our facilities. These guidelines require government officials to first declare an easing of their restrictions, upon which we do a full review of our site to determine its readiness and follow a phased return to work approach, all in service to help ensure the safety of our people.

We will continue to work with our customers, employees, suppliers and communities to address the impacts of COVID-19. We also continue to assess the evolving nature of the pandemic and its possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences.

Risks related to the impact of COVID-19 are described in further detail under "Item 1A. Risk Factors".

Key Performance Indicators and Non-GAAP Measures

Management reviews key performance indicators including revenue, gross margins, segment operating income and operating income margins, EBITDA and EBITDA 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 represent the non-GAAP measures we consider to be key performance indicators, 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.

"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 or discontinuance of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate.
"constant currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not the U.S. Dollar.
"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude restructuring and realignment costs, special charges, gain or loss from sale of businesses and tax-related special items, as applicable. A reconciliation of adjusted net income and adjusted earnings per share is provided below.


(in millions, except per share data)	2020				2019
Net income & Earnings per share	$	254	$	1.40	$	401	$	2.21
Restructuring and realignment, net of tax of $17 and $19	60		0.33		63		0.35

Special charges, net of tax of $10 and $6	76		0.42		172		0.95
Tax-related special items	(16)		(0.09)		(88)		(0.48)
(Gain) loss from sale of business, net of tax benefit of $0	—		—		(1)		(0.01)
Adjusted net income & Adjusted earnings per share	$	374	$	2.06	$	547	$	3.02

▪"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.

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


(in millions)	2020			2019
Net Income	$	254		$401
Income tax expense	31			15
Interest expense, net	70			62
Depreciation	117			117
Amortization	134			140
EBITDA	$	606		$735
EBITDA Margin	12.4		%	14.0	%
Share-based compensation	26			29
Restructuring and realignment	77			82

Special charges	86			178
(Gain) loss from sale of business	—			(1)
Adjusted EBITDA	$	795		$1,023
Adjusted EBITDA Margin	16.3		%	19.5	%

▪“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.

▪“special charges" defined as costs incurred by the Company, such as acquisition and integration related costs, non-cash impairment charges and both operating and non-operating adjustments for pension costs.

▪"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. 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)	2020		2019
Net cash provided by operating activities	$	824	$	839
Capital expenditures	(183)		(226)
Free cash flow	$	641	$	613


Net cash used in investing activities	$	(169)	$	(231)
Net cash provided (used) by financing activities	$	473	$	(177)

Executive Summary

Xylem reported revenue of $4,876 million for 2020, a decrease of $373 million, or 7.1%, from $5,249 million reported in 2019. On a constant currency basis, revenue decreased by $366 million, or 7.0%, driven by an organic decline across all end markets and across all segments during the year. Organic revenue decline during the year was anticipated as our business was negatively impacted by the COVID-19 pandemic.

Operating income for 2020 was $367 million, reflecting a decrease of $119 million, or 24.5%, compared to $486 million in 2019. Operating margin was 7.5% for 2020 versus 9.3% for 2019, a decrease of 180 basis points. Operating margin benefited from decreases in special charges of $78 million and decreases in restructuring and realignment costs of $5 million during the year. Excluding the impact of these items, adjusted operating income was $525 million, with an adjusted operating margin of 10.8% in 2020 as compared to adjusted operating income of $727 million with an adjusted operating margin of 13.9% in 2019, a decrease of 310 basis points. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased quality management costs; unfavorable mix and increased spending on strategic investments. These impacts were partially offset by cost reductions from our productivity, restructuring and other cost saving initiatives.

Additional financial highlights for 2020 include the following:

Net income of $254 million, or $1.40 per diluted share ($374 million or $2.06 per diluted share on an adjusted basis, down 31.6% from 2019)
Net cash provided by operating activities of $824 million and free cash flow of $641 million, up 5% from 2019
Orders of $5,033 million, down 5.7% from $5,339 million in 2019 (down 5.3% on an organic basis), impacted by the COVID-19 pandemic; and
Dividends paid to shareholders increased 8% in 2020.

2021 Business Outlook

We anticipate total revenue growth in the range of 6% to 8% in 2021, with organic revenue growth anticipated to be in the range of 3% to 5%. The following is a summary of our 2020 organic revenue performance and 2021 organic revenue outlook by end market.

Utilities revenue decreased by approximately 6% for 2020 on an organic basis driven by weakness in the U.S., the Middle East and Asia Pacific, partially offset by strength in Europe. For 2021, we expect organic growth in the low-to-mid single-digit range with continued resilience on the wastewater side, as utilities remain focused on mission-critical applications and anticipate modest recovery on a global basis through the year. Additionally, we expect that large clean water utility project deployments will be ramping up beginning in the second quarter and increasing throughout the end of the year. We expect to gain momentum behind key multi-year wins setting up healthy longer term growth, however we believe the end market will continue to be impacted by the COVID-19 pandemic through the year.
Industrial revenue decreased by approximately 10% for 2020 on an organic basis driven by weakness across all major geographic regions. For 2021, we expect organic revenue to be relatively flat to up low-single-digits as short-cycle orders and project activity continues to pick up during the year, however activity is still likely to be limited in the near-term by COVID-19 impacts. We expect that continued softness in the segments served by our dewatering business in North America will stabilize and begin to accelerate through the year.
In the commercial markets, organic revenue decline was approximately 6% for 2020 driven by weakness in the U.S. and the emerging markets, partially offset by strength in western Europe. For 2021, we expect organic revenue to be relatively flat to down low-single-digits. We expect replacement business in the U.S. to be modestly soft during the year, as the COVID-19 pandemic continues to impact market conditions. While we anticipate healthy activity in Europe as the region continues to recover, we expect new construction activity in North America to be slow throughout the first half of the year.
In residential markets, organic revenue decline was approximately 2% in 2020 driven by weakness in the U.S. and western Europe, partially offset by strength in Asia Pacific. This market is primarily driven by replacement revenue serviced through our distribution network. For 2021, we expect organic revenue to be up low-to-mid single digits, driven by healthy demand activity from increased residential users in the U.S.

and Europe. Additionally, we anticipate strong demand in China for secondary water supply product applications.

We will continue to strategically execute restructuring and realignment actions in an effort to optimize our cost structure, improve our operational efficiency and effectiveness, strengthen our competitive positioning and better serve our customers. During 2020, we incurred $54 million and $23 million in restructuring and realignment costs, respectively. We realized approximately $25 million of incremental net savings in 2020 from actions initiated in 2019, and an additional $22 million of net savings from our 2020 actions. As a result of our 2019 and 2020 actions we expect to realize approximately $46 million of incremental net savings in 2021 and beyond. During 2021, we currently expect to incur between $50 million and $60 million in restructuring and realignment costs.

We plan to continue to take actions and focus spending in 2021 on actions that allow us to make progress on our top strategic priorities. These priorities include (1) driving customer success by focusing on enhancing the customer experience, accelerating the digital transformation of water and building a leadership position in services and solutions; (2) growing in the Emerging Markets by investing in localizing our capabilities in these regions; (3) strengthening innovation and technology by creating new customer offerings that help solve water challenges in a more powerful way; (4) enhancing operational excellence by building a culture of continuous improvement; and (5) cultivating leadership talent and development that drives shareholder value creation.

Results of Operations


(in millions)	2020			2019			2020 v. 2019
Revenue	$	4,876		$	5,249		(7.1)	%
Gross profit	1,830			2,046			(10.6)	%
Gross margin	37.5		%	39.0		%	(150)	bp
Restructuring and realignment costs	6			5			20.0	%

Adjusted gross profit	1,836			2,051			(10.5)	%
Adjusted gross margin	37.7		%	39.1		%	(140)	bp
Total operating expenses	1,463			1,560			(6.2)	%
Expense to revenue ratio	30.0		%	29.7		%	30	bp
Restructuring and realignment costs	(71)			(77)			(7.8)	%

Special charges	(81)			(159)			(49.1)	%
Adjusted operating expenses	1,311			1,324			(1.0)	%
Adjusted operating expenses to revenue ratio	26.9		%	25.2		%	170	bp
Operating income	367			486			(24.5)	%
Operating margin	7.5		%	9.3		%	(180)	bp
Interest and other non-operating expense, net	82			71			15.5	%
Gain (loss) from sale of business	—			1			NM
Income tax expense	31			15			106.7	%
Tax rate	10.9		%	3.7		%	720	bp
Net income	$	254		$	401		(36.7)	%

NM Not Meaningful

2020 versus 2019

Revenue

Revenue generated for 2020 was $4,876 million, a decrease of $373 million, or 7.1%, compared to $5,249 million in 2019. On a constant currency basis, revenue declined 7.0% during 2020. The decrease at constant currency was driven by a decline in organic revenue of $364 million reflecting significantly lower volumes in the U.S., primarily, as well as the Middle East, India and Latin America, largely due to COVID-19, partially offset by growth in Europe and China during the year.

The following table illustrates the impact from organic declines, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during 2020:


	Water Infrastructure				Applied Water				Measurement & Control Solutions				Total Xylem
(in millions)	$ Change		% Change		$ Change		% Change		$ Change		% Change		$ Change		% Change
2019 Revenue	$	2,177			$	1,541			$	1,531			$	5,249
Organic Impact	(89)		(4.1)	%	(108)		(7.0)	%	(167)		(10.9)	%	(364)		(6.9)	%
Acquisitions/(Divestitures)	—		—	%	—		—	%	(2)		(0.1)	%	(2)		—	%
Constant Currency	(89)		(4.1)	%	(108)		(7.0)	%	(169)		(11.0)	%	(366)		(7.0)	%
Foreign currency translation (a)	(9)		(0.4)	%	1		0.1	%	1		0.1	%	(7)		(0.1)	%
Total change in revenue	(98)		(4.5)	%	(107)		(6.9)	%	(168)		(11.0)	%	(373)		(7.1)	%
2020 Revenue	$	2,079			$	1,434			$	1,363			$	4,876

(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 Russian Ruble, the Norwegian Krone, the Brazilian Real, the South African Rand and the Chilean Peso. These impacts were partially offset by the strengthening of the Euro during the year.

Water Infrastructure

Water Infrastructure revenue decreased $98 million, or 4.5%, to $2,079 million in 2020 (4.1% decrease on a constant currency basis) compared to 2019. Revenue was negatively impacted by $9 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline during the year of $89 million. Organic weakness during the year was primarily driven by the industrial end market, particularly in North America and the emerging markets, heavily impacted by the COVID-19 pandemic during the year. Organic revenue decline during the year was also impacted by weakness, to a lesser extent, in the utility end market, particularly in the U.S., partially offset by organic growth in Europe during the year. The COVID-19 pandemic negatively impacted organic growth during the year throughout the entire segment and both end markets.

From an application perspective, the organic revenue decline for the year was driven by our transport application, where market conditions continued to soften in the U.S. in the dewatering applications, with construction, mining, oil and gas all down during the year. We also saw organic revenue decline in Asia Pacific within the transport application, primarily in India, where we lapped some large projects executed in the prior year, as well as in Latin America. These declines were partially offset by organic growth in Europe during the year, where demand for essential service work increased during the fourth quarter. Organic revenue declines within the transport application were partially offset by modest organic growth in the treatment application during the year, primarily driven by projects in the emerging markets.

Applied Water

Applied Water revenue decreased $107 million, or 6.9%, in 2020 (7.0% decrease on a constant currency basis) compared to 2019. Revenue benefited from $1 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline during the year of $108 million. Organic weakness during the year was driven by declines across all end markets and applications, with industrial water and commercial building services declining the most, followed by a modest decline in building services in the residential market as well. Organic revenue declines in the segment were driven by the COVID-19 pandemic, where restricted activities caused a slow down and general softening in markets served, particularly in the U.S., the emerging markets and western Europe.

Measurement & Control Solutions

Measurement & Control Solutions revenue decreased $168 million, or 11.0%, in 2020 (11.0% decrease on a constant currency basis) compared to 2019. Revenue benefited from $1 million of foreign currency translation during the year, with the change at constant currency driven by an organic decline of $167 million, or 10.9%, and to a lesser extent, $2 million of reduced revenue related to divestiture impacts during the year. Organic weakness during the year was driven by declines in the utility end market, primarily in the U.S., the Middle East and India, marginally offset by organic growth in western Europe during the year. Organic declines were also driven, to a lesser extent, by weakness in the industrial end market, primarily in western Europe, North America, and the Middle East. Organic revenue declines in the segment were significantly impacted by project timing and the COVID-19 pandemic during the year.

From an application perspective, the organic revenue decline was primarily driven by the water application, where we lapped large prior year project deployments in the U.S. and Middle East and the COVID-19 pandemic drove project delays, primarily due to site-access restrictions, and overall market softness in the U.S. The energy application also had a decline in organic revenue as compared to the prior year, primarily in the U.S. as we lapped a few large gas project deployments and have been negatively impacted by the COVID-19 pandemic. The test application also experienced organic revenue decline during the year driven by negative impacts from the COVID-19 pandemic across most major geographic regions, and the lapping of a couple large prior year project executions in the Middle East. The software as a service ("SaaS") application had a modest decline in revenue as compared to the prior year, primarily in the U.S.

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 or a signed quote from a Xylem business. Orders received during 2020 decreased by $306 million, or 5.7%, to $5,033 million (5.4% decrease on a constant currency basis). Order intake during the year was negatively impacted by $18 million of foreign currency translation. The order decline on a constant currency basis primarily consisted of organic order declines of $284 million, or 5.3%, over the prior year.

The following table illustrates the impact from organic declines, recent acquisitions and divestitures, and foreign currency translation in relation to orders during 2020:


	Water Infrastructure				Applied Water				Measurement & Control Solutions				Total Xylem
(in millions)	$ Change		% Change		$ Change		% Change		$ Change		% Change		$ Change		% Change
2019 Orders	$	2,234			$	1,556			$	1,549			$	5,339
Organic Impact	(80)		(3.6)	%	(73)		(4.7)	%	(131)		(8.5)	%	(284)		(5.3)	%
Acquisitions/(Divestitures)	—		—	%	—		—	%	(4)		(0.3)	%	(4)		(0.1)	%
Constant Currency	(80)		(3.6)	%	(73)		(4.7)	%	(135)		(8.7)	%	(288)		(5.4)	%
Foreign currency translation (a)	(20)		(0.9)	%	—		—	%	2		0.1	%	(18)		(0.3)	%
Total change in orders	(100)		(4.5)	%	(73)		(4.7)	%	(133)		(8.6)	%	(306)		(5.7)	%
2020 Orders	$	2,134			$	1,483			$	1,416			$	5,033

Water Infrastructure

Water Infrastructure segment orders decreased $100 million, or 4.5%, to $2,134 million (3.6% decrease on a constant currency basis). Order intake during the year was negatively impacted by $20 million of foreign currency translation, with the change at constant currency coming from organic order decline in the transport application, which was partially offset by growth in the treatment application during the year. The transport application experienced an organic order decline during the year, primarily driven by market weakness in construction, mining, and oil and gas impacting the dewatering application in North America, along with the lapping of a large project order in India in the prior year. Organic growth in the treatment application was primarily driven by strong order intake in North America. The COVID-19 pandemic also negatively impacted organic order growth for the segment during the year.

Applied Water

Applied Water segment orders decreased $73 million to $1,483 million, or 4.7%, as compared to the prior year and was not significantly impacted by foreign currency translation during the year. The order decrease was primarily driven by organic weakness across all end markets, primarily in the U.S. and, to a lesser extent, in the emerging markets and western Europe. The organic order growth for the segment during the year was negatively impacted by the COVID-19 pandemic.

Measurement & Control Solutions

Measurement & Control Solutions segment orders decreased $133 million, or 8.6%, to $1,416 million (8.7% decrease on a constant currency basis). Order intake during the year benefited from $2 million of foreign currency translation, with the change at constant currency driven by an organic decline of $131 million and, to a lesser extent, a $4 million reduction in orders related to divestiture impacts during the year. Organic weakness during the year was driven by the water application, where we lapped prior year project orders and, to a lesser extent, the energy application, where prior year gas project deployments more than offset strong electric order intake during the year. The SaaS application also contributed to the organic decline during the year, driven by the lapping of large project orders in North America during the prior year. The test application also experienced a reduction in order intake during the year, primarily in the U.K and the U.S. The COVID-19 pandemic significantly impacted the organic order growth during the year.

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 $2,124 million at December 31, 2020 and $1,801 million at December 31, 2019, an increase of 17.9%. We anticipate that approximately 55% of our total backlog at December 31, 2020 will be recognized as revenue during 2021.

Gross Margin

Gross margin as a percentage of consolidated revenue decreased 150 basis points to 37.5% in 2020 as compared to 39.0% in 2019. The gross margin decrease for the year was primarily driven by cost inflation, increased quality management costs, unfavorable mix, unfavorable volume, impacted by COVID-19, and other lesser impacts, which were partially offset by cost reductions from our global procurement and productivity improvement initiatives and price realization.

Operating Expenses


(in millions)	2020			2019			Change
Selling, general and administrative expenses ("SG&A")	$	1,143		$	1,158		(1.3)	%
SG&A as a % of revenue	23.4		%	22.1		%	130	bp
Research and development expenses ("R&D")	187			191			(2.1)	%
R&D as a % of revenue	3.8		%	3.6		%	20	bp
Restructuring and asset impairment charges	75			63			19.0	%
Goodwill impairment charge	58			148			(60.8)	%
Operating expenses	$	1,463		$	1,560		(6.2)	%
Expense to revenue ratio	30.0		%	29.7		%	30	bp

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

SG&A expenses decreased by $15 million (decrease of 1.3%) to 23.4% of revenue in 2020, as compared to 22.1% of revenue in 2019. The increase in SG&A as a percent of revenue for the year was primarily driven by the drop in revenue, which was significantly driven by impacts of the COVID-19 pandemic, as well as cost inflation and additional investment in strategic growth initiatives. Cost reductions from our productivity, restructuring and other cost saving initiatives partially offset these items.

Research and Development ("R&D") Expenses

R&D expense was $187 million, or 3.8% of revenue, in 2020 as compared to $191 million, or 3.6% of revenue, in 2019. The increase in R&D as a percent of revenue for year was primarily driven by the Company's continued focus on strategic investments during the year, while revenue was negatively impacted by the COVID-19 pandemic.

Restructuring and Asset Impairment Charges

Restructuring

In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, on June 2, 2020 management committed to a restructuring plan that includes actions across our businesses and functions globally. The plan is designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers.

As a result of this action, during 2020, we recognized restructuring charges of $20 million, $4 million and $30 million in our Water Infrastructure, Applied Water and Measurement & Control Solutions segments, respectively. These charges included reduction of headcount across all segments and asset impairments within our Measurement & Control Solutions segment. Immaterial restructuring charges incurred during the first quarter are included in the plan information presented below.

During 2019, we recognized restructuring costs of $20 million, $5 million and $28 million in our Water Infrastructure, Applied Water and Measurement & Control Solutions, respectively. These charges were incurred 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.

The following is a roll-forward of employee position eliminations associated with restructuring activities for the years ended December 31, 2020 and 2019:


	2020	2019
Planned reductions - January 1	196	69
Additional planned reductions	811	674
Actual reductions and reversals	(688)	(547)
Planned reductions - December 31	319	196

The following table presents expected restructuring spend in 2020 and thereafter:


(in millions)	Water Infrastructure		Applied Water		Measurement & Control Solutions		Corporate		Total
Actions Commenced in 2020:
Total expected costs	$	26	$	11	$	34	$	2	$	73
Costs incurred during 2020	19		4		30		—		53
Total expected costs remaining	$	7	$	7	$	4	$	2	$	20

Actions Commenced in 2019:
Total expected costs	$	19	$	5	$	27	$	—	$	51
Costs incurred during 2019	18		5		27		—		50
Costs incurred during 2020	1		—		—		—		1
Total expected costs remaining	$	—	$	—	$	—	$	—	$	—

The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2020 consist primarily of severance charges in each of the segments and asset impairment charges in our Measurement & Control Solutions segment. These actions are expected to continue through 2021. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges. The actions commenced in 2019 are complete.

During the second quarter of 2020 the discontinuance of a product line resulted in $17 million of asset impairments, primarily related to customer relationships, trademarks and fixed assets within our Measurement & Control Solutions segment.

These restructuring charges are primarily related to actions taken in response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic. As a result of the actions initiated in 2020, we achieved savings of approximately $22 million in 2020 and estimate annual future net savings beginning in 2021 of approximately $63 million, resulting in $41 million of incremental savings from 2020 actions

Asset Impairment

During the second and third quarters of 2020, we determined that certain assets within our Measurement & Control Solutions segment, including software, proprietary technology, and internally developed in-process software, were impaired. Accordingly we recognized impairment charges of $21 million during the year. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

During the first and third quarters 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 impairment charges of $10 million during the year. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

Goodwill Impairment Charge

During the third quarter of 2020, the Company recorded a goodwill impairment charge of $58 million related to the AIA goodwill reporting unit within our Measurement & Control Solutions segment. The AIA goodwill reporting unit is

comprised of our assessment services business (primarily the Pure acquisition) as well as our digital solutions business. The impairment resulted from management's updated forecast of future cash flows for the AIA businesses, which reflects significant negative volume impacts, primarily on our assessment services business, due to travel restrictions and site closures as a result of the COVID-19 pandemic. Our ongoing investment in the AIA businesses also continues to impact near-term profitability. These factors drove a decrease in the fair value, based on a discounted cash flow valuation, of the AIA goodwill reporting unit that is below its carrying value as of the third quarter, requiring an impairment charge. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

During the third quarter of 2019, the Company recorded a goodwill impairment charge of $148 million related to the 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 of 2019 included 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 goodwill 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 $367 million (operating margin of 7.5%) during 2020, a decrease of $119 million, or 24.5%, when compared to operating income of $486 million (operating margin of 9.3%) during the prior year. Operating margin benefited from decreases in special charges of $78 million and decreases in restructuring and realignment costs of $5 million as compared to the prior year. Excluding these special charges and restructuring and realignment costs, adjusted operating income was $525 million (adjusted operating margin of 10.8%) for 2020 as compared to adjusted operating income of $727 million (adjusted operating margin of 13.9%) during the prior year. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased quality management costs; unfavorable mix and increased spending on strategic investments. These impacts were partially offset by cost reductions from our productivity, restructuring and other cost saving initiatives.

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)	2020			2019			Change
Water Infrastructure
Operating income	$	318		$	365		(12.9)	%
Operating margin	15.3		%	16.8		%	(150)	bp
Restructuring and realignment costs	28			31			(9.7)	%

Adjusted operating income	$	346		$	396		(12.6)	%
Adjusted operating margin	16.6		%	18.2		%	(160)	bp
Applied Water
Operating income	$	205		$	241		(14.9)	%
Operating margin	14.3		%	15.6		%	(130)	bp
Restructuring and realignment costs	9			13			(30.8)	%

Adjusted operating income	$	214		$	254		(15.7)	%
Adjusted operating margin	14.9		%	16.5		%	(160)	bp
Measurement & Control Solutions
Operating loss	$	(106)		$	(67)		58.2	%
Operating margin	(7.8)		%	(4.4)		%	(340)	bp

Restructuring and realignment costs	40			38			5.3	%
Special charges	79			159			(50.3)	%
Adjusted operating income	$	13		$	130		(90.0)	%
Adjusted operating margin	1.0		%	8.5		%	(750)	bp
Corporate and other
Operating loss	$	(50)		$	(53)		(5.7)	%


Special charges	2			—			NM
Adjusted operating loss	$	(48)		$	(53)		(9.4)	%
Total Xylem
Operating income	$	367		$	486		(24.5)	%
Operating margin	7.5		%	9.3		%	(180)	bp
Restructuring and realignment costs	77			82			(6.1)	%

Special charges	81			159			(49.1)	%
Adjusted operating income	$	525		$	727		(27.8)	%
Adjusted operating margin	10.8		%	13.9		%	(310)	bp

NM Not Meaningful

Water Infrastructure

Operating income for our Water Infrastructure segment decreased $47 million, or 12.9%, during 2020 as compared to the prior year, with operating margin also decreasing from 16.8% to 15.3%. Operating margin benefited from a decrease in restructuring and realignment costs of $3 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased $50 million, or 12.6%, with adjusted operating margin decreasing from 18.2% to 16.6%. The decrease in adjusted operating margin during the year was primarily due to cost inflation; unfavorable volume, impacted significantly by COVID-19; unfavorable mix; increased inventory management costs; increased spending on strategic investments and increased customer related reserves. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization.

Applied Water

Operating income for our Applied Water segment decreased $36 million, or 14.9%, during 2020 as compared to the prior year, with operating margin also decreasing from 15.6% to 14.3%. Operating margin benefited from a decrease in restructuring and realignment costs of $4 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased $40 million, or 15.7%, with adjusted operating margin decreasing from 16.5% to 14.9%. The decrease in adjusted operating margin during the year was primarily due to cost inflation; unfavorable volume, impacted significantly by COVID-19; increased inventory management costs and other lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization.

Measurement & Control Solutions

Operating loss for our Measurement & Control Solutions segment increased $39 million, or 58.2%, during 2020 as compared to the prior year, resulting in an operating loss of $106 million, with operating margin decreasing from (4.4)% to (7.8)%. Operating margin benefited from a decrease in special charges of $80 million, which was slightly offset by increased restructuring and realignment costs of $2 million in 2020. Excluding these items, adjusted operating income decreased $117 million, or 90.0%, with adjusted operating margin decreasing from 8.5% to 1.0%. The decrease in adjusted operating margin during the year was driven by unfavorable volume, impacted significantly by COVID-19 related site-access restrictions and customer project delays; cost inflation; unfavorable mix, increased quality management costs, primarily due to warranty charges recorded during the the year; increased spending on strategic investments and other lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization.

Corporate and other

Operating loss for corporate and other decreased $3 million, or 5.7%, compared to the prior year. The decrease in costs are the result of cost saving actions taken during the year.

Interest Expense

Interest expense was $77 million and $67 million for 2020 and 2019, respectively. The increase in interest expense for both periods is primarily driven by the issuance of our Green Bond (as defined in "Funding and Liquidity Strategy") during the second quarter of 2020. 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 2020 was $31 million at an effective tax rate of 10.9% as compared to $15 million at an effective tax rate of 3.7% in 2019. The 2020 effective tax rate differs from that of 2019 primarily due to the impact of the changes in tax law in Switzerland in 2019 along with the impact of the larger goodwill impairment charge on income before taxes in 2019 as well as a reduction in the amount of unrecognized tax benefits recorded in 2020.

Liquidity and Capital Resources

The following table summarizes our sources and uses of cash:


	Year Ended December 31,
(in millions)	2020		2019		Change
Operating activities	$	824	$	839	$	(15)
Investing activities	(169)		(231)		62
Financing activities	473		(177)		650
Foreign exchange (a)	23		(3)		26
Total	$	1,151	$	428	$	723

(a)2020 impact is primarily due to the strengthening of the Euro, the Chinese Yuan and various other currencies against the U.S. Dollar.

Sources and Uses of Liquidity

Operating Activities

During 2020, net cash provided by operating activities was $824 million, compared to $839 million in 2019. The $15 million year-over-year decrease was primarily driven by a decrease in cash from earnings, partially offset by deferred payments, lower income tax payments, and improved working capital management.

Investing Activities

Cash used in investing activities was $169 million in 2020, compared to $231 million in 2019. This decrease in cash used of $62 million was mainly driven by lower spending on capital expenditures compared to the prior year and a reduction in cash paid for acquisitions.

Financing Activities

Cash generated by financing activities was $473 million in 2020, compared to cash used of $177 million in 2019. The net increase in cash generated by financing activities during the year was primarily driven by the issuance of our Green Bond (as defined in "Funding and Liquidity Strategy") and higher levels of short-term debt during the year, partially offset by the repayment of short-term debt during 2020 and an increase in share repurchase activity of $21 million.

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. As a result of uncertainties caused by the COVID-19 pandemic, we continually evaluated aspects of our spending, including capital expenditures, strategic investments and dividends throughout 2020. Additionally, we committed to reducing our annual capital expenditures during the year. We will continue to evaluate aspects of our spending in 2021 and anticipate our capital expenditures will gradually begin to increase to normal levels during the year as the markets we operate in recover. In 2020, we elected to utilize certain federal, state and foreign tax programs related to timing of tax payments and deductions to further manage our liquidity, and the liabilities associated with these programs are appropriately classified in the applicable "Accrued and other current liabilities" or "Other non-current accrued liabilities" accounts in our Consolidated Balance Sheets.

Historically, we have generated operating cash flow sufficient to fund our primary cash needs. As the uncertainty and severity associated with the global spread of the COVID-19 pandemic continued to grow throughout 2020, Xylem issued Senior Notes of $1 billion in aggregate principal ("Green Bond") on June 26, 2020. The primary long-term intention of incurring this debt is to fund green projects across our business segments, as well as manage liquidity risk and increase flexibility, as the duration of the economic effects of the pandemic are uncertain. See Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt. Xylem's liquidity position has continued to evolve favorably during 2020, and we will continue to monitor the economic effects of the COVID-19 pandemic and its impact on the Company's future operating cash flows going forward. 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. Our securities are rated investment grade. A

significant change in credit rating could impact our ability to borrow at favorable rates. Refer to Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of limitations on obtaining additional funding.

We monitor our global funding requirements and seek to meet our liquidity needs on a cost-effective basis. As of December 31, 2020, the COVID-19 pandemic has not materially impacted our borrowing costs or other costs of capital, however the future impact of the COVID-19 pandemic is uncertain and may increase our borrowing costs and other costs of capital and otherwise adversely affect our business, results of operations, financial condition and liquidity.

We have considered the impacts of the COVID-19 pandemic on our liquidity and capital resources and do not currently expect it to impact our ability to meet future liquidity needs or continue to comply with debt covenants. To provide for continued access to the full capacity of our credit facilities going forward, Xylem entered into Amendment No. 1 to the 2019 Credit Facility (as defined in Note 15, "Credit Facilities and Debt") on June 22, 2020 which modified the covenant calculation methodology through the quarter ending September 30, 2021 and restricts stock repurchases until March 31, 2021, except for shares of common stock in an amount not to exceed the number of shares issued after the date of the Amendment, subject to customary exceptions. See Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt.

Based on our current global cash positions, cash flows from operations and access to the capital markets, we believe there is sufficient liquidity to meet our funding requirements and service debt and other obligations in both the U.S. and outside of the U.S. over the next 12 months. In addition, we believe our existing committed credit facilities and access to the public debt markets would provide further liquidity if required. Currently, we have available liquidity of approximately $2.7 billion, consisting of $1.9 billion of cash and $800 million of available credit facilities as disclosed in Note 15, "Credit Facilities and Debt", of our consolidated financial statements. Our debt repayment obligations in 2021 consist of $600 million in Senior Notes which we expect to pay out of cash. Our next long-term debt maturity is March 2023.

Risk related to these items are described in our risk factor disclosures referenced under “Item 1A. Risk Factors".

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 2020 and 2019, we generated 53% and 51% 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 U.S., 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, 2020, we have provided a deferred tax liability of $7 million for net foreign withholding taxes and state income taxes on $500 million of earnings expected to be repatriated to the U.S. parent as deemed necessary in the future.

Contractual Obligations

The following table summarizes our contractual commitments as of December 31, 2020:


(in millions)	2021		2021 - 2022		2023 - 2024		Thereafter		Total
Debt obligations (1)	$	600	$	612	$	—	$	1,900	$	3,112
Interest payments (1) (2)	98		137		110		459		804
Lease obligations (3)	69		97		57		79		302
Purchase obligations (4)	106		—		—		—		106
Other long-term obligations reflected on the balance sheet	2		32		20		13		67
Total commitments	$	875	$	878	$	187	$	2,451	$	4,391

In addition to the amounts presented in the table above, we have recorded liabilities for net investment hedges of $117 million and employee severance indemnities of $17 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 post-retirement employee benefit obligations are presented in Note 16, “Post-retirement 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 $1 million to $2 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, 2020, 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, 2020.

(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, 2020, 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, 2020, the amount of surety bonds, bank guarantees, insurance letters of credit and stand-by letters of credit was $378 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 estimates 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 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 for providing those goods and services. For each arrangement with a customer, we identify the contract and 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 primarily 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 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.

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 U.S. Tax Cuts and Jobs Act ("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 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 2020, management updated forecasts of future cash flows for the AIA businesses, which reflect significant negative volume impacts from the COVID-19 pandemic, primarily on our assessment services business. Our ongoing investment in the AIA businesses also continues to impact near term profitability. 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, 2020. 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 $58 million

goodwill impairment charge. As of December 31, 2020 the remaining goodwill balance in our AIA reporting unit after recording the goodwill impairment charge was $113 million.

Also, during the third quarter of 2020, 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 $11 million, primarily related to software and proprietary technology. The charge was calculated using an income approach.

The uncertainty of the future impact of the COVID-19 pandemic may also contribute to further deterioration of our future cash flows. If we do not achieve our forecasts it is possible that the goodwill of the AIA reporting unit could be deemed to be impaired again in a future period. The risks and potential impacts of COVID-19 on the fair value of our assets are included in our risk factor disclosures referenced under “Item 1A. Risk Factors".

During the fourth quarter of 2020, 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 2020. 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.

Post-retirement Benefit 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, years of service and other factors (some of which are disclosed in Note 16, “Post-retirement Benefit Plans,” of the consolidated financial statements). 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 are 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 2020 and 2019.


	2020				2019
	U.S.		Int’l		U.S.		Int’l
Benefit Obligation Assumptions
Discount rate	2.50	%	1.06	%	3.25	%	1.80	%
Rate of future compensation increase	NM		2.79	%	NM		2.94	%
Net Periodic Benefit Cost Assumptions
Discount rate	3.25	%	1.80	%	4.50	%	2.60	%
Expected long-term return on plan assets	6.50	%	2.82	%	7.75	%	6.96	%
Rate of future compensation increase	NM		2.94	%	NM		2.92	%

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, “Post-retirement 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.


	2020		2019
Expected long-term rate of return on plan assets	3.46	%	7.09	%
Actual rate of return on plan assets	14.06	%	12.59	%

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 2021 is estimated at 3.24%. 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, 2021, is 1.21%. We estimate that every 25 basis point change in the discount rate impacts the expense by $2 million.

The rate of future compensation increase assumption reflects our long-term actual experience and future and near-term outlook. Effective January 1, 2021, our expected rate of future compensation is 2.91% 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 Company has initiated the process for a full buy-out of its largest defined benefit plan in the UK. Upon completion of the buy-out, expected in 2021, we expect a material settlement charge primarily consisting of unrecognized actuarial losses.

We currently anticipate making contributions to our pension and post-retirement benefit plans in the range of $19 million to $27 million during 2021. We also anticipate an estimated payment of approximately $15-$17 million for the buy-out of the UK pension plan. Approximately $6 million of contributions are 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 $42 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 hedge funds, fixed income investments, insurance contracts, and cash and cash equivalents.

A portion of our pension benefit plan assets portfolio comprises investments in hedge funds which 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, 2020 and 2019 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 $32 million.

New Accounting Pronouncements

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

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