Xylem
Annual Report 2014

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549FORM 10-K(Mark One)þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2014 or ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 1-35229Xylem Inc.(Exact name of registrant as specified in its charter)Indiana 45-2080495(State or other jurisdiction of incorporation ororganization) (I.R.S. Employer Identification No.) 1 International Drive, Rye Brook, NY 10573(address of principal executive offices and zip code)(914) 323-5700(Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registeredCommon Stock, par value $0.01 per share New York Stock ExchangeSecurities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes þ No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required tobe submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes þ No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):Large Accelerated Filer þ Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller reporting company ¨(Do not check if a smaller reporting company)Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þThe aggregate market value of the common stock of the registrant held by non-affiliates of the registrant as of June 30, 2014 was approximately $7.1 billion.As of January 31, 2015, there were 182,309,721 outstanding shares of the registrant’s common stock, par value $0.01 per share.DOCUMENTS INCORPORATED BY REFERENCEPortions of the registrant’s definitive proxy statement for its 2015 Annual Meeting of Shareowners, to be held in May of 2015, are incorporated by referenceinto Part II and Part III of this Report.Xylem Inc.ANNUAL REPORT ON FORM 10-KFor the fiscal year ended December 31, 2014Table of Contents ITEMPAGEPART I 1Business31A.Risk Factors171B.Unresolved Staff Comments242Properties253Legal Proceedings254Mine Safety Disclosures26*Executive Officers of the Registrant27 Board of Directors28 PART II 5Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities296Selected Financial Data317Management’s Discussion and Analysis of Financial Condition and Results of Operations327A.Quantitative and Qualitative Disclosures About Market Risk528Financial Statements and Supplementary Data539Changes In and Disagreements With Accountants on Accounting and Financial Disclosure1009A.Controls and Procedures1009B.Other Information100 PART III 10Directors, Executive Officers and Corporate Governance10211Executive Compensation10212Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters10213Certain Relationships and Related Transactions, and Director Independence10214Principal Accounting Fees and Services102 PART IV 15Exhibits, Financial Statement Schedules103Signatures104Exhibit Index106 *Included pursuant to Instruction 3 of Item 401(b) of Regulation S-K.2PART IThe following discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, included in thisAnnual Report on Form 10-K (this "Report"). Xylem Inc. was incorporated in Indiana on May 4, 2011. Except as otherwise indicated or unless thecontext otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to Xylem Inc. and its subsidiaries. References in the consolidatedfinancial statements to "ITT" or the "former parent" refer to ITT Corporation and its consolidated subsidiaries (other than Xylem Inc.).Forward-Looking StatementsThis Report contains information that may constitute “forward-looking statements" within the meaning of the Private Securities Litigation Act of1995. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. Generally, the words “anticipate,”“estimate,” “expect,” “project,” “intend,” “plan,” “forecast,” “believe,” “target,” “will,” “could,” “would,” “should” and similar expressions identify forward-looking statements, which generally are not historical in nature. However, the absence of these words or similar expressions does not mean that astatement is not forward-looking. These forward-looking statements include statements about the capitalization of the Company, the Company’srestructuring and realignment, future strategic plans and other statements that describe the Company’s business strategy, outlook, objectives,plans, intentions or goals. All statements that address operating or financial performance, events or developments that we expect or anticipate willoccur in the future - including statements relating to orders, revenue, operating margins and earnings per share growth, and statements expressinggeneral views about future operating results - are forward-looking statements. Forward-looking statements involve known and unknown risks,uncertainties and other important factors that could cause actual results to differ materially from those expressed or implied in, or reasonablyinferred from, such forward-looking statements.Factors that could cause results to differ materially from those anticipated include: economic, political and other risks associated with ourinternational operations, including military actions, economic sanctions or trade embargoes that could affect customer markets, and non-compliance with laws, including foreign corrupt practice laws, export and import laws and competition laws; potential for unexpected cancellationsor delays of customer orders in our reported backlog; our exposure to fluctuations in foreign currency exchange rates; competition and pricingpressures in the markets we serve; the strength of housing and related markets; weather conditions; ability to retain and attract key members ofmanagement; our relationship with and the performance of our channel partners; our ability to borrow or to refinance our existing indebtedness andavailability of liquidity sufficient to meet our needs; changes in the value of goodwill or intangible assets; risks relating to product defects, productliability and recalls; governmental investigations; security breaches or other disruptions of our information technology systems; litigation andcontingent liabilities; and other factors set forth below under “Item 1A. Risk Factors” and those described from time to time in subsequent reportsfiled with the Securities and Exchange Commission (“SEC”).All forward-looking statements made herein are based on information available to the Company as of the date of this Report. The Companyundertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events orotherwise, except as required by law.ITEM 1. BUSINESSBusiness OverviewXylem, with 2014 revenue of $3.9 billion and approximately 12,500 employees, is a world leader in the design, manufacturing, and application ofhighly engineered technologies for the water industry. We are a leading equipment and service provider for water and wastewater applications witha broad portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to theenvironment. We have leading market positions among equipment and service providers in the core application areas of the water equipmentindustry: transport, treatment, test, building services, industrial processing and irrigation. Our Company’s brands, such as Bell & Gossett andFlygt, are well known throughout the industry and have served the water market for many years.We serve a global customer base across diverse end markets while offering localized expertise. We sell our products in more than 150 countriesthrough a balanced distribution network consisting of our direct sales force and independent channel partners. In 2014, 62% of our revenue wasgenerated outside the United States, with 21% of revenue generated in emerging markets.3In 2014, we began implementing an organizational redesign to integrate our commercial teams within geographical regions. The integration of ourcommercial teams creates a cross-Xylem sales and marketing organization, shifting from a dedicated product line organizational structure. Thissales structure is largely in place in the Company’s Europe, Middle East, Africa and Asia regions and to a lesser extent in our other regions. Whilethis organizational redesign did not change the Company’s reportable segments, it had implications on how the Company manages the business,the most significant of which was the shift of certain responsibilities, namely customer and market-related activities, into the regional sellingorganizations.Our IndustryOur planet faces a serious water challenge. Less than 1% of the total water available on earth is fresh water, and this percentage is declining dueto factors such as the draining of aquifers, increased pollution and climate change. In addition, demand for fresh water is rising rapidly due topopulation growth, industrial expansion, and increased agricultural development, with consumption estimated to double every 20 years. By 2025,more than 30% of the world’s population is expected to live in areas without adequate water supply. Even in developed countries with sufficientclean water supply, existing infrastructure for water supply is aging and inadequately funded. In the United States, degrading pipe systems leakone out of every six gallons of water, on average, on its way from a treatment plant to the customer. These challenges are driving opportunities forgrowth in the global water industry, which we estimate to have a total market size of approximately $550 billion.We view these challenges through the lens of water productivity, water quality and resilience. Water productivity refers to the more efficientdelivery and use of clean water. Water quality refers to the efficient and effective management of wastewater. Resilience refers to themanagement of water-related risks and the resilience of water infrastructure. The Company’s customers often face all three of these challenges,ranging from inefficient aging water distribution networks (which require increases in “water productivity”); energy-intensive or unreliable wastewatermanagement systems (which require increases in “water quality”); or exposure to natural disasters such as floods or droughts (which requireincreases in “resilience”). Delivering value in these areas creates significant opportunity for the Company.The water industry supply chain is comprised of Equipment and Services companies, Design and Build service providers, and Utilities. Equipmentand Service providers serve distinct customer types. The Utilities supply water through an infrastructure network. Supply chain companies providesingle, or sometimes combined, functions from equipment manufacturing and services to facility design (engineering, procurement andconstruction, or “EPC” firms) to plant operations (Utilities), as depicted below in Figure 1. The Utilities and EPC customers are looking fortechnology and application expertise from their Equipment and Services providers to address trends such as rising pollution, stricter regulations,and the increased outsourcing of process knowledge. The end users of water consist of a wide array of entities, including farms, mines, powerplants, industrial facilities and residential homes. These customers are predominately served through specialized distributors and originalequipment manufacturers (“OEMs”).4Figure 1: Water Industry Supply ChainOur business focuses on the beginning of the supply chain by providing technology-intensive equipment and services. We sell our equipment andservices via direct and indirect channels that serve the needs of each customer type. On the utility side, we provide the majority of our sales directto customers with strong application expertise, with the remaining amount going through distribution partners. To end users of water, we providethe majority of our sales through long-standing relationships with the world’s leading distributors, with the remainder going direct to customers.The Equipment and Services market addresses the key processes of the water industry, which are best illustrated through the cycle of water, asdepicted in Figure 2, below. We believe this industry has two distinct sectors within the cycle of water: Water Infrastructure and UsageApplications. The key processes of this cycle begin when raw water is extracted by pumps, which provide the necessary pressure and flow, tomove or transport, this water from natural sources, such as oceans, groundwater, lakes and rivers, through pipes to treatment facilities. Treatmentfacilities can provide many forms of treatment, such as filtration, disinfection and desalination, to remove solids, bacteria, and salt, respectively.Throughout each of these stages, analytical instruments test the water to ensure regulatory requirements are met so that it can be utilized by end-use customers. A network of pipes and pumps again transports this clean water to where it is needed, such as to crops for irrigation, to powerplants to provide cooling in industrial water, or to an apartment building as drinking water in residential and commercial buildings. After usage, thewastewater is collected by a separate network of pipes and pumps and transported to a wastewater treatment facility, where processes such asdigestion deactivate and reduce the volume of solids, and disinfection purifies effluent water. Once treated, analytical instruments test the water toensure regulatory requirements are met so that it can be discharged back to the environment, thereby completing the cycle.5Figure 2: Cycle of WaterIn the Water Infrastructure sector, two primary end markets exist: public utility and industrial. The public utility market comprises public, privateand public-private institutions that handle water and wastewater for mostly residential and commercial purposes. The industrial market involves thesupply of water and removal of wastewater for industrial facilities. We view the main macro drivers of this sector to be water quality, the desire forenergy-efficient products, water scarcity, regulatory requirements and infrastructure needs, for both the repair of aging systems in developedcountries as well as new installations in emerging markets.In the Usage Applications sector, end-use customers fall into four main markets: residential, commercial, industrial and agricultural. Homeownersrepresent the end users in the residential market. Owners and managers of properties such as apartment buildings, retail stores, institutionalbuildings, restaurants, schools, hospitals and hotels are examples of end users in the commercial market. The industrial market is wide ranging,involving OEMs, exploration and production firms, and developers and managers of facilities operated by electrical power generators, chemicalmanufacturers, machine shops, clothing manufacturers, beverage dispensing and food processing firms, and car washes. The agricultural marketend users are owners and operators of businesses such as crop and livestock farms, aquaculture, golf courses, and other turf applications. Webelieve population growth, urbanization and regulatory requirements are the primary macro drivers of these markets, as these trends drive the needfor housing, food, community services and retail goods within growing city centers. Water reuse and conservation are driving the need for newtechnologies.Business StrategyOur strategy is to enhance shareholder value by providing distinctive solutions for our customers' most important water productivity, quality andresilience challenges, enabling us to grow revenue, organically and through strategic acquisitions, as we streamline our cost structure. Keyelements of our strategy are summarized below:•Accelerate Profitable Growth. To achieve our goal of accelerating growth, we have identified the following five priorities:•Emerging Market Growth - We seek to accelerate our growth in priority emerging markets through increased focus on productlocalization and channel development.▪Innovation - We seek to enhance the Company’s innovation efforts with increased focus on disruptive technologies that cansignificantly improve customers’ water productivity, quality and resilience.6•Industry vertical marketing - We are strengthening vertical marketing capabilities for key end markets to bring the full breadth ofthe Company’s portfolio to bear on critical customer challenges.•Commercial team effectiveness - We continue to strengthen our regional commercial teams, including through the globaladoption of improved commercial information technology tools, such as customer relationship management software.•Mergers and acquisitions - We continue to evaluate and, where appropriate, will act upon attractive acquisition candidates toaccelerate our growth, including into new markets.•Build a Continuous Improvement Culture. We seek to embed continuous improvement into our culture and simplify our organizationalstructure to make the Company more agile, more profitable, and create room to re-invest in growth. To accomplish this, we will continue tostrengthen our lean six sigma and global strategic sourcing capabilities, and continue to optimize our cost structure by eliminatingunnecessary costs and inefficient overhead.•Build Superior Leadership and Talent Development. We seek to continue to invest in attracting, developing and retaining world-classtalent with an increased focus on leadership and talent development programs. We will continue to align individual performance to theobjectives of the Company and its shareholders.•Build a Culture of Execution and Accountability. We seek to ensure the impact of these strategic focus areas by holding our peopleaccountable and streamlining our performance management and goal deployment systems.Business SegmentsWe have two reportable business segments that are aligned with the cycle of water and the key strategic market applications they provide: WaterInfrastructure (collection, distribution, return) and Applied Water (usage). See Note 21, “Segment and Geographic Data,” in our consolidatedfinancial statements for financial information about segments and geographic areas.The table and descriptions below provide an overview of our business segments. MarketApplications 2014 Revenue(in millions) %Revenue Major Products Primary BrandsWaterInfrastructure Transport $1,779 73% • Water and wastewaterpumps• Filtration, disinfection andbiological treatmentequipment• Test equipment• Controls • Flygt• WEDECO• Godwin• WTW• Sanitaire• YSI• Leopold Treatment 348 14% Test 315 13% $2,442 100% AppliedWater Building Services $781 53% • Pumps• Valves• Heat exchangers• Controls• Dispensingequipment systems • Goulds WaterTechnology• Bell & Gossett• A-C Fire Pump• Standard Xchange• Lowara• Jabsco• Flojet• Flowtronex Industrial Water 592 40% Irrigation 101 7% $1,474 100% 7Water InfrastructureWater Infrastructure involves the process that collects water from a source and distributes it to users, and then returns the wastewater responsiblyto the environment. Within the Water Infrastructure segment, our pump systems transport water from oceans, groundwater, aquifers, lakes, riversand seas. From there, our filtration, ultraviolet ("UV") and ozone systems provide treatment, making the water fit for use. After consumption, ourpump lift stations move the wastewater to treatment facilities where our mixers, biological treatment, monitoring, and control systems provide theprimary functions in the treatment process. Throughout each of these stages, our analytical systems test to ensure quality of water forconsumption as well as for its return to nature. Water Infrastructure serves its customers, public utilities and industrial applications, through threeclosely linked applications: Transport, Treatment and Test of water and wastewater. We estimate our served market size in this sector to beapproximately $20 billion.TransportThe Transport application includes all of the equipment and services involved in the safe and efficient movement of water from sources such asoceans, groundwater, aquifers, lakes, rivers and seas to treatment facilities, and then to users. It also includes the movement of wastewater fromthe point of use to a treatment facility and then back into the environment. Finally, the Transport application also includes dewatering pumps,equipment and services which provide the safe removal or draining of groundwater and surface water from a riverbed, construction site or mineshaft. We offer a wide range of highly engineered products such as water and wastewater submersible pumps, monitoring controls, and applicationsolutions; we do not serve the market for lower-value equipment such as pipes and fittings. We primarily employ configure-to-order capabilities tomaximize manufacturing and logistics efficiencies by producing high volumes of basic product configurations. When we provide a configure-to-order solution, we configure a standard product to our customers’ specifications. To a lesser extent, we provide engineer-to-order products to meetthe customization requirements of our customers. This process requires that we apply our technical expertise and production capabilities toprovide a non-standard solution to the customer. We believe our business is one of the largest players in this served market based onmanagement estimates. With operations on six continents, we also have one of the world’s largest dewatering rental fleets, serviced with our Flygtand Godwin brands. In our Water Infrastructure Segment, Transport accounted for approximately 73% of our segment revenue in 2014, 74% in2013 and 73% in 2012.Flygt — Flygt is a world-leader in the design and manufacture of dry and submersible pumps and related intelligent controls systems. Under theFlygt banner, customers have access to a complete range of products and solutions for moving water, wastewater, and advanced monitoring andcontrol equipment to optimize their use. Founded in Sweden in 1901, Flygt is the originator of the reliable, energy-efficient electrical submersiblepump. Flygt products have applications in various markets, including wastewater lift stations, water and wastewater treatment facilities,pressurized sewage systems, oil and gas, steel, mining and leisure markets. Customers include public utility and industrial water and wastewatersystems operators. In 2012, Xylem successfully launched Flygt Experior which brings together advanced controls, hydraulics and energy-efficientmotor technology to deliver substantial energy savings. During 2014, we won a large contract to provide large custom-made Flygt pumps for theXayaburi run-of-river hydropower dam in Laos. The construction of the dam allows water to be kept within the river’s course and minimally raisesthe water level to allow fish migration between the Upper and Lower Mekong Rivers, while providing electricity to about 1 million people in Laos and3 million people in Thailand.Godwin — With more than 35 years as a leader in pump manufacturing and applications, Godwin has established itself as a well-recognized,market leading brand in the global portable pump market. Godwin manufactures, sells, rents and services its products. Its quick response and 24/7capabilities allow it to provide customized pumping solutions to meet the specific needs of its customers. Founded in Quenington, England,Godwin is currently headquartered in Bridgeport, New Jersey. Godwin's products include fully automatic self-priming Dri-Prime® pumps, a fullrange of Flygt electric submersible pumps, Heidra hydraulic submersible pumps, Wet-Prime gasoline-powered contractor pumps and a broad line ofgenerators and portable light towers, as well as a multitude of pumping accessories and pipe. Godwin products are primarily used in construction,water & wastewater transport, oil & gas markets, hydraulic fracturing, industrial, mining, and municipal, as well as government, temporary fireprotection, environmental, agriculture, and marine. Godwin products are also instrumental in disaster relief efforts. After Superstorm Sandy hit theUnited States in October 2012, Godwin's pumps were instrumental in minimizing or preventing flood damage in various flooded regions throughoutthe Northeast. Godwin's fleet of equipment is rented through 45 U.S. branches and a global network of distributors and Xylem rental and salesfacilities.8TreatmentThe Treatment application includes equipment and services that treat both water for consumption and wastewater to be returned responsibly to theenvironment. Primary served markets include public utilities and industrial operations. While there are several treatment solutions in the markettoday, we focus on three basic treatment types: (i) filtration, (ii) disinfection systems and (iii) biological treatment systems. Filtration uses gravity-based media filters and clarifiers to clean both water and wastewater. Leopold, with more than 90 years of experience, is our leading filtrationbrand. Disinfection systems, both UV and ozone oxidation, treat both public utility drinking water and wastewater, as well as industrial processwater, and are provided through our WEDECO brand. Biological treatment systems are key to the treatment and mixing of solids in wastewaterplants, which are provided through our Sanitaire and Flygt brands. We believe our business is one of the largest players in this served marketbased on management estimates. In our Water Infrastructure Segment, Treatment accounted for approximately 14% of our segment revenue inboth 2014 and 2013, and 15% in 2012.Leopold — Founded in 1924 in Pittsburgh, Pennsylvania, Leopold is a leader in rapid gravity media filtration and clarification solutions for the waterand wastewater industry. In potable drinking water treatment plants, the Clari-DAF system is used to clarify raw water to remove contaminantssuch as turbidity, algae, color, iron/manganese, organics, and taste and odor compounds. Several years ago, we augmented our filtration productswith membrane technology. Our filtration products include the rapid gravity media, membranes and reverse osmosis/ultrafine filtration. Leopoldgravity media filtration is used in potable water treatment plants to remove particulate in the final filtration step. In public utility wastewatertreatment plants, the ClariVAC system is used in final clarifiers to remove the sludge solids. For those areas where nitrogen and phosphorusnutrient removal is required, we provide elimi-NITE systems which convert the filters to become biologically active so that the effluent meets themandated nitrate and phosphorus levels. In desalination systems, Leopold Clari-DAF® systems and Filterworx systems are provided to removecontaminants that will harm reverse osmosis membranes, so that salt can be removed from the seawater to make it potable. Primary customersare public utility water and wastewater systems, as well as desalination plant facilities. During 2014, Leopold launched Oxelia, which is a cutting-edge, ozone-enhanced biologically active filtration system and multi-barrier solution for municipal wastewater treatment. Oxelia combines ozone,filtration and analytical instrumentation to deliver optimal wastewater treatment for water reuse, as well as discharge into sensitive water.WEDECO — WEDECO was founded in 1975 in Herford, Germany to develop chemical-free and environmentally-friendly water treatmenttechnologies, including UV light and ozone systems. There are more than 250,000 installed WEDECO systems for UV disinfection and ozoneoxidation globally in private, public utility and industrial locations. WEDECO introduced ozone technology in 1988 and has been expandinginternationally ever since. UV disinfection systems have a number of applications including water treatment and aquaculture. Ozone disinfectionsystems have applications in drinking water, wastewater, process water, product polishing, bleaching, ozonolysis/synthesis and deodorization.Customers include public utility wastewater and clean water treatment facilities, power plants, pulp and paper mills, food product manufacturersand aquaculture facilities. During 2014, we won a large contract with Bahrain’s Ministry of Works to upgrade a wastewater treatment facilityin Manama, the capital city of Bahrain. The Company will design, install and commission an expansion and upgrade of the existing Wedeco ozonesystems at the Tubli Water Pollution Control Centre which will increase the capacity of the wastewater treatment facility from 200,000 to 240,000cubic meters per day. The enhanced wastewater reuse capacity is necessary for irrigation purposes in the area and will benefit the local agricultureand horticulture sectors in particular. Sanitaire — Launched in 1967, the Sanitaire brand provides complete biological wastewater treatment solutions for public utility and industrialapplications. Sanitaire’s comprehensive offering includes diffused aeration, sequencing batch reactors, drum filters and state-of-the-art controlsthat drive efficient operations. Sanitaire is regarded as a leading brand in diffused aeration, which is a process that introduces air into a liquid,providing an aerobic environment for degradation of organic matter. Fine-pore diffusion of air is highly competitive due to its high oxygen transferefficiency and lower energy costs. Sanitaire wide-band aeration systems are used in applications such as grit chambers and sludge that requirenon-clogging, maintenance-free systems. Principal Sanitaire customers are public utility and industrial wastewater treatment facilities. In 2013,Xylem launched the Sanitaire OSCAR process performance optimization system. When combined with Sanitaire’s advanced aeration system,Xylem was able to deliver 65 percent energy savings to the operators of the Sterno, Sweden wastewater treatment plant.Flygt — Flygt is also a world-leader in the design and manufacturing of submersible, jet and top-entry mixers. Flygt has over 30 years of expertisein the area of wastewater treatment mixing, as well as over 100,000 applications globally. Submersible mixers are often used in sewage treatmentplants to keep solids in suspension in the various process tanks and/or sludge holding tanks. In 2013, Xylem won an order to provide Flygtsubmersible mixers for the9Panama Canal. The project includes four anti-sedimentation mixers at each lock gate of a new Panama Canal channel, as well as local electricalpanels and accessories.TestAnalytical instrumentation is used across most industries to ensure regulatory requirements are met. Growth in this market is primarily driven byincreasing regulation of water and wastewater in North America, Europe and Asia. Our served market is predominately focused on water and theenvironment for quality levels throughout the water infrastructure loop. Analytical systems are applied in three primary ways: in the field, in afacility laboratory, or real time, online monitoring in a treatment facility process. We believe we have a leading position in this served market basedon management estimates. In our Water Infrastructure Segment, Test accounted for approximately 13% of our segment revenue in 2014 and 12%in both 2013 and 2012.WTW — In wastewater treatment facilities, WTW-branded systems monitor parameters such as dissolved oxygen, pH, and turbidity throughout thewater process to ensure regulatory standards are met before water is discharged back into the environment. Founded in 1945, as a major brand inEurope, WTW has strong market penetration in the environmental, water and wastewater segments. WTW holds leading market positions in on-lineinstrumentation and manufactures premium positioned robust and reliable analysis products for the measurement of pH, dissolved oxygen,conductivity, total dissolved solids, turbidity, specific ions and biological oxygen demand. WTW’s product offering includes meters, sensors, data-loggers, photometers and software providing customer solutions for even the most challenging applications. WTW instruments have been placed inmajor monitoring stations around the globe to monitor water quality. One of our largest installations is in the Yangtze river station in China.YSI — Yellow Springs Instrument Company ("YSI"), founded in 1948, develops and manufactures sensors, instruments, software and datacollection platforms for environmental and coastal water quality monitoring and testing. YSI holds a leading market position in surface watermonitoring and sampling which includes equipment that allows users to measure multiple parameters simultaneously, including conductivity,dissolved oxygen, temperature, turbidity, depth or level, chlorophyll, blue green algae and pH, among others, in a variety of applications. YSI'sSonTek Division designs and manufactures acoustic Doppler instruments which provide water velocity measurements for oceans, rivers, lakes,harbors, canals, estuaries and laboratories. YSI also offers Life Sciences products including biochemical analyzers for bioprocess monitoring, foodand beverage processing, and sports physiology. YSI instruments have become integral across Xylem as the technologies have enabledcustomers such as water treatment plants to meet their critical water and wastewater testing requirements while lowering energy costs andimproving process efficiencies. The main market areas are water quality, environmental monitoring, aquaculture, life sciences and ocean research.YSI sensors played a critical role in monitoring water levels and providing other real-time data that helped track Superstorm Sandy which hit theMid-Atlantic and Northeast United States in October of 2012.Applied WaterApplied Water encompasses the uses of water. Since water is used to some degree in almost every aspect of human, economic andenvironmental activity, this segment has a significant number of potential applications and we participate in all major areas of water demand.Irrigation applications constitute the majority of all water usage globally. Examples of what we provide include: boosting systems for farmingirrigation, pumps for dairy operations, and rainwater reuse systems for small scale crop and turf irrigation. Industrial Water applications account forthe next largest amount of global water consumption. Our pumps, heat exchangers, valves and controls provide cooling to power plants andmanufacturing facilities, as well as circulation for food and beverage processing. The remaining portion of global water use resides in human andbuilding consumption, where we deliver water boosting systems for drinking, heating, ventilation and air conditioning ("HVAC") and fire protectionsystems to Residential and Commercial Building Services. We estimate our served market size in this sector to be approximately $15 billion.Residential & Commercial Building ServicesThis business is defined by four main uses of water in building services applications, such as in residential homes and commercial buildings,including offices, hotels, hospitals, schools, restaurants and malls. The first application is in HVAC, where Bell & Gossett and Lowara specialize inpumps and valves that are used in water-driven heating and cooling systems, along with heat exchangers, valves, and monitoring and controlproducts that augment the system. The second is the supply of potable water for consumption, such as for drinking and hygiene. The GouldsWater Technology and Lowara brands provides pumps and boosting systems utilized within buildings, sourcing water from distribution networks orfrom wells. The third application is wastewater removal with sump and sewage pumps, provided by Bell & Gossett, Goulds Water Technology andLowara. The fourth water-related building service10area is fire protection, where our AC Fire brand supplies full pump systems for emergency fire suppression. Bell & Gossett, Goulds WaterTechnology and Lowara have continued to innovate, focusing on providing industry-leading energy-efficient and intelligent pumps for the buildingservices market; many of these products are more efficient than competitive devices. We believe our business is one of the largest players in thisserved market based on management estimates. In our Applied Water Segment, Building Services accounted for approximately 53% of oursegment revenue in 2014, 50% in 2013 and 53% in 2012.Industrial WaterWater is used in most industrial facilities to provide processing steps such as cooling, heating, cleaning and mixing. Our Goulds Water Technologyand Lowara brands supply vertical multistage pumps to bring in source water or to boost pressure for purposes such as circulating water through amanufacturing facility to cool machine tools. Our Standard Xchange brand delivers heat exchangers for combined heat and power applicationswithin power generation plants. We also service niche applications such as flexible impeller pumps for wine processing facilities served by ourJabsco brand, and water-based detergent dispensing and water circulation within car washes served by Flojet and Goulds Water Technology air-operated diaphragm and end suction pumps. Our boosting pumps are also increasingly being used in hydraulic fracturing applications. Across allthese various end applications, we believe our business is the second largest player in this served market based on management estimates. Inour Applied Water Segment, Industrial Water accounted for approximately 40% of our segment revenue in 2014, 43% in 2013 and 40% in 2012.IrrigationThe irrigation business consists of irrigation-related equipment and services associated with bringing water from a source to the plant or livestockneed, including hoses, sprinklers, center pivot and drip irrigation. We focus on the pumps and boosting systems that supply this ancillaryequipment with water. Our Goulds Water Technology brand brings mixed flow pumps, and our Flowtronex group specializes in equipment"packaged solutions" incorporating monitoring and controls to optimize energy efficiency in irrigation delivery. Our Lowara brand also producespumps for agriculture applications and irrigation of gardens and parks. We believe we have a leading position in this served market based onmanagement estimates. In our Applied Water Segment, Irrigation accounted for approximately 7% of our segment revenue in each of 2014, 2013and 2012.As described above, the following brands and products are used across the applications in our Applied Water segment:Goulds Water Technology — With origins dating back more than 150 years, Goulds Water Technology is a leading brand of centrifugal and turbinepumps, controllers, variable frequency drives and accessories for residential and commercial water supply and wastewater applications. GouldsWater Technology is a leader in the water technologies market with its line of residential water well pumps. The Goulds Water Technology productportfolio includes submersible and line shaft turbine, 4” submersible, jet, sump, effluent, sewage and centrifugal pumps for residential, agricultureand irrigation, sewage and drainage, commercial and light industrial use. Goulds Water Technology has various vertical configuration high pressurecentrifugal pumps which are utilized for water boost, filtration and boiler feed applications in industrial environments. Goulds Water Technologysubmersible, deepwell or other pumps can be found in more than a quarter of the existing 15 million household wells and more than 380,000 publicand community wells in the United States. Products for commercial wastewater include sewage, effluent and grinder pumps and packages.Agriculture products include pump and control products for irrigation, stockwater, wash systems, cooling systems and waste management, withturf irrigation products, including submersible and surface pumps for landscape and turf irrigation systems. We serve the building trades marketwith filtration, chilling, pressure boost, wash system, water supply, wastewater and boiler feed applications. We also have a range of standard castiron and bronze end-suction and multistage pumps for various commercial applications. In 2014, the Company won a large project with a miningcustomer at the Kinross Fort Knox gold mine in Fairbanks, Alaska, which will address the customer’s water productivity needs. The projectincludes Goulds Water Technology turbine pump assemblies with motors for the mine’s barren booster pump supply, a process in which previouslymined and processed ore is reprocessed through a leach field to pull more gold from the tailings.Lowara — Founded in 1968 in Vicenza, Italy, Lowara is a leader in stainless steel pump manufacturing technology for water technologyapplications. The Lowara range of products includes submersible, sump, effluent, sewage, centrifugal pumps and booster packages for watersupply and water pumping needs in the residential, agriculture, industrial, public utility, building service and commercial markets worldwide, withparticular strength in Europe. Residential applications include pumps for pressurization, conditioning, fire-fighting systems, lifting stations and11dewatering. Agriculture applications include pumps for irrigation of gardens and parks. Industrial applications include drinking water, industrialwashing equipment and machine tool cooling. The German water services company Erftverband implemented a comprehensive system of Lowarapumps and a Hydrovar speed control smart system to address complex water management needs in Korschenbroich and Kaarst, Germany during2013.Bell & Gossett — Founded in 1916 in Chicago, Illinois, Bell & Gossett ("B&G") is a leader in plumbing and water-based heating and air conditioningmarkets. Products are used in residential applications where single- or multi-family homes are heated with hot water or steam. Key productsinclude circulating pumps, valves, and specialty products used in these systems. B&G also sells wastewater pumps for commercial andresidential applications. In commercial applications, B&G provides a broad range of products, including a wide variety of pumps, heat exchangers,valves and controls for heating and air-conditioning systems, sump pumps for wastewater systems, condensate pumping systems for steamheating systems and a comprehensive line of energy-saving variable speed controls. Training is provided for building system design engineers atB&G’s industry renowned Little Red Schoolhouse in Morton Grove, Illinois which has educated more than 60,000 engineers. Key commercialbuilding types include hospitals, schools, institutional buildings and data centers. B&G products are sold globally by independent manufacturerrepresentatives and distributed locally by HVAC wholesalers. During 2014, the B&G brand Series e-1510 single stage end suction centrifugal pumpwon the Consulting-Specifying Engineer’s Product of the Year award, the premier award for new products in the HVAC, fire/life safety, electricaland plumbing systems engineering markets.A-C Fire Pump — Allis-Chalmers Company ("A-C Fire Pump") was founded in the 1840s in Milwaukee, Wisconsin. It offers turnkey fire pumpsystems for commercial, residential and industrial applications. A-C Fire Pump designs and custom-builds a wide range of fire pump systems,including prefabricated packages and house units that meet every fire protection need. A-C Fire Pump products include In-Line Pumps, VerticalTurbine, Package Systems, Split Case (various series) and 13D Home Defender for residential fire pump service. The 13D Home Defender isdesigned to boost water pressure for automatic residential sprinkler systems. In addition to residential applications, turnkey fire pumping systemsfrom A-C Fire Pump protect an increasing number of petrochemical facilities, commercial buildings and factories around the world. During 2014, wesecured a large project in Bolivia to meet an energy customer’s water resilience needs by providing customized diesel-driven split case A-C FirePumps that will protect gas treatment plants, connecting pipelines and the base camp where workers reside.Flowtronex — Flowtronex, founded in 1974 as Pumping Systems, Inc., began by producing some of the golf industry’s first prefabricated waterpumping systems. The Silent Storm package and Pace Integrated Pump Controller are our two primary products sold into the golf market. Inlandscape, Flowtronex products, primarily the Floboy system, are sold to customers such as cities and nurseries. In golf, Flowtronex products aresold to golf course superintendents through our Toro Distribution partnership. Retrofit sales of golf pumping systems are sold through our FlowNetService Network, a group of factory authorized service technicians that provide set up and start up, and service and repair of Flowtronex pumpstations. During 2014, we launched the Oasis EX, a new pump controller which delivers modern features, such as remote monitoring, Web-enabledcontrols and advanced water measurements, to maximize water and energy efficiency in pump stations, while also reducing operating costs andincreasing productivity.Standard Xchange — Since 1917, Standard Xchange has been the leader in the design and manufacture of shell and tube heat exchangers.Standard Xchange is the brand of our complete line of heat transfer products used in industrial and process applications such as heating or coolingliquids or gases, heat recovery in chemical processing, power and co-generation, paper and pulp, OEMs and commercial marine markets.Products include basic shell-and-tube heat exchangers, air coolers, heat transfer coils, compact brazed, welded, gasketed plate units andpackaged steam condensers. Standard Xchange heat exchangers provide cooling for many of the major turbine manufacturers in electrical powergeneration plants around the world.Jabsco — The Jabsco brand is known for its marine, industrial, and hygienic/sanitary pumps and systems that are used in many industries,including marine, industrial, healthcare and food processing. It was founded in 1938 by the inventors of the flexible impeller pump. Jabsco is aleader in the leisure marine market, with a broad range of products including water system, engine cooling pumps, searchlights and marine wastesystems. Jabsco also offers industrial pumps for hygienic applications, fluid transfer in chemical processing, laboratory, paint processing, plating,and construction. Jabsco rotary lobe pumps offer outstanding performance with unique capabilities. Jabsco Hy-line and Ultima rotary lobe pumpssupport food and dairy product production, healthcare, chemical, pharmaceutical and biotech applications, whether the product is thin, viscous orfragile. Jabsco also offers multi-purpose and specialized flexible impeller, diaphragm and sliding vane pumps for chemical and general transferapplications. Jabsco marine products can be found under the decks of millions of pleasure boats around the world.12Flojet — Established in 1975, the Flojet brand encompasses a broad range of small pumps, motors and dispensing pumps for the beverage,industrial, recreational vehicle, marine and food processing markets. Flojet is a leader in the small pump market, offering a versatile range ofproducts serving the beverage market, including both air- and motor-operated diaphragm pumps and centrifugal chilling pumps, as well as boostersystems and accumulator tanks. Flojet’s beverage pumps can be found in applications such as beer dispensing, syrup mixing for carbonateddrinks, re-circulation in vending machines and refrigerators, bottled water dispensers, icemakers and coffee machines. In addition to significantbeverage applications, Flojet’s electric and air-operated diaphragm pumps are utilized in street sweepers, car washes, carpet cleaners, partswashers, agricultural spraying and road rollers. Flojet’s positive displacement diaphragm pumps can be driven by air, electric motor or solenoid.The positive displacement diaphragm design of Flojet pumps makes them ideal for use in conditions that require self-priming and dry runningcapability for short periods of time. Additionally, the compact size of these pumps makes them very useful in tight spaces where one cannotensure a flooded suction. Flojet pumps are designed to be more efficient and are often the choice of customers for applications where low powerconsumption is critical. Xylem services many of the world's leading beverage producers. During 2014, the Company launched Filtration by Flojet,which is a system that uses integrated membrane pre-activated carbon technology to improve water taste and appearance, better protect dispenseequipment and mitigate health concerns in food-service applications.Geographic ProfileThe table below illustrates the annual revenue and percentage of revenue by geographic area for each of the three years ended December 31,2014. Revenue(in millions)2014 2013 2012 $ Amount % of Total $ Amount % of Total $ Amount % of TotalUnited States$1,477 38% $1,434 38% $1,400 37%Europe1,379 35% 1,387 36% 1,338 35%Asia Pacific478 12% 467 12% 469 12%Other582 15% 549 14% 584 16%Total$3,916 $3,837 $3,791 In addition to the traditional markets of the United States and Europe, opportunities in emerging markets within Asia Pacific, Eastern Europe, LatinAmerica and other countries are growing. Revenue derived from emerging markets comprised 21%, 19% and 20% of our revenue in 2014, 2013and 2012, respectively.The table below illustrates the property, plant & equipment and percentage of property, plant & equipment by geographic area for each of the threeyears ended December 31, 2014. Property, Plant & Equipment(in millions)2014 2013 2012 $ Amount % of Total $ Amount % of Total $ Amount % of TotalUnited States$180 39% $186 38% $183 38%Europe206 45% 225 46% 219 45%Asia Pacific53 11% 45 9% 65 13%Other22 5% 32 7% 20 4%Total$461 $488 $487 Distribution, Training and End UseWater Infrastructure provides the majority of its sales through direct channels with remaining sales through indirect channels and servicecapabilities. Both public utility and industrial facility customers increasingly require our teams’ global but locally proficient expertise to use ourequipment in their specific applications. Several trends are increasing the need for this application expertise: (i) the increase in type and amount ofcontaminants in water supply, (ii) increasing environmental regulations, (iii) the need to increase system efficiencies to optimize energy costs, and(iv) the retirement of a largely aging water industry workforce not systematically replaced at utilities.13In the Applied Water segment, many end-use areas are widely different, so specialized distribution partners are often preferred. Our commercialteams have built long-standing relationships around our brands in many of these industries through which we can continue to leverage new productand service applications. Revenue opportunities are balanced between OEMs and after-market customers. Our products in the Applied Watersegment are sold through our global direct sales and strong indirect channels with the majority of revenue going through indirect channels. Wehave long-standing relationships with many of the leading independent distributors in the markets we serve, and we provide incentives todistributors, such as specialized loyalty and training programs.Aftermarket Parts and ServiceDuring their lifecycle, installed products require maintenance, repair services and parts due to the harsh environments in which they operate. Wehave many service centers around the world, which employ service employees to provide aftermarket parts and services to our large installedbase of customers. Service centers offer an array of integrated service solutions for the industry including: preventive monitoring, contractmaintenance, emergency field service, engineered upgrades, inventory management, and overhauls for pumps and other rotating equipment.Depending on the type of product, median lifecycles range from five years to over 50 years, at which time they must be replaced. Many of ourproducts are precisely selected and applied within a larger network of equipment driving a strong preference by customers and installers to replacethem with the same exact brand and model when they reach the end of their lifecycle. This dynamic establishes a large recurring revenue streamfor our business.Supply and SeasonalityWe have a global manufacturing footprint, with production facilities in Europe, North America, Latin America, and Asia. Our inventory managementand distribution practices seek to minimize inventory holding periods by striving to take delivery of the inventory and manufacturing as close aspossible to the sale or distribution of products to our customers. All of our businesses require various parts and raw materials, of which theavailability and prices may fluctuate. Parts and raw materials commonly used in our products include motors, fabricated parts, castings, bearings,seals, nickel, copper, aluminum, and plastics. While we may recover some cost increases through operational improvements, we are still exposedto some pricing risk. We attempt to control costs through fixed-priced contracts with suppliers and various other programs, such as our globalstrategic sourcing initiative.Our business relies on third-party suppliers, contract manufacturing and commodity markets to secure raw materials, parts and components usedin our products. We typically acquire materials and components through a combination of blanket and scheduled purchase orders to support ourmaterials requirements. For most of our products, we have existing alternate sources of supply, or such sources are readily available.We may experience price volatility or supply constraints for materials that are not available from multiple sources. From time to time, we acquirecertain inventory in anticipation of supply constraints or enter into longer-term pricing commitments with vendors to improve the priority, price andavailability of supply. There have been no raw material shortages that have had a significant adverse impact on our business as a whole.Our Water Infrastructure and Applied Water segments experience some modest level of seasonality in its business. This seasonality is dependenton factors such as capital spending of customers as well as weather conditions, including heavy flooding, droughts, and fluctuations intemperatures, which can positively or negatively impact portions of our business.CustomersOur business is not dependent on any single customer or a few customers, the loss of which would have a material adverse effect on our WaterInfrastructure or Applied Water segments or on the Company as a whole. No individual customer accounted for more than 10% of our consolidated2014, 2013 or 2012 revenue.BacklogDelivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cyclesand delays can occur from time to time. Total backlog was $740 million at December 31, 2014 and $707 million at December 31, 2013. Weanticipate that more than 85% of the backlog at December 31, 2014 will be recognized as revenue during 2015.14CompetitionGiven the highly fragmented nature of the water industry, the Water Infrastructure segment competes with a large number of businesses.Competition in the water transport and treatment technologies markets focuses on product performance, reliability and innovation, applicationexpertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery, proximity of service centers, effectiveness of ourdistribution channels and price. In the sale of products and services, we benefit from our large installed base of pumps and complementaryproducts, which require maintenance, repair and replacement parts due to the nature of the products and the conditions under which they operate.Timeliness of delivery, quality and the proximity of service centers are important customer considerations when selecting a provider for after-market products and services as well as equipment rentals. In geographic regions where we are locally positioned to provide a quick response,customers have historically relied on us, rather than our competitors, for after-market products relating to our highly engineered and customizedsolutions. Our key competitors within the Water Infrastructure segment include KSB Inc., Sulzer Ltd., Evoqua Water Technologies (formerlySiemens AG) and Danaher Corporation.Competition in the Applied Water segment focuses on brand equity, application expertise, product delivery and performance, quality, and price. Wecompete by offering a wide variety of innovative and high-quality products, coupled with world-class application expertise. We believe ourdistribution through well-established channels and our reputation for quality significantly enhance our market position. Our ability to deliverinnovative product offerings has allowed us to compete effectively, to cultivate and maintain customer relationships and to serve and expand intomany niche and new markets. Our key competitors within the Applied Water segment include Grundfos, Wilo SE, Pentair Ltd. and Franklin ElectricCo., Inc.Research and DevelopmentResearch and development (“R&D”) is a key element of our engineering culture and is generally focused on the design and development ofproducts and application know-how that anticipate customer needs and emerging trends. Our engineers are involved in new product developmentand improvement of existing products. Our businesses invest substantial resources for R&D. We anticipate we will continue to develop and investin our R&D capabilities to promote a steady flow of innovative, high-quality and reliable products and applications to further strengthen our positionin the markets we serve. We invested $104 million, $104 million, and $106 million for the years ended December 31, 2014, 2013 and 2012,respectively, in R&D.We have engineering and research employees in technology centers around the world. R&D activities are initially conducted in our technologycenters, located in conjunction with some of our major manufacturing facilities to ensure an efficient development process. We have a Center ofExcellence in Stockholm, Sweden, with research, development and engineering employees. We have Centers of Excellence in India and China,where we are accelerating the customization of our application expertise to local needs. In the scale-up process, our R&D activities are conductedat our piloting and testing facilities or at strategic customer sites. These piloting and testing facilities enable us to serve our strategic markets ineach region of the world.Intellectual PropertyWe generally seek patent protection for those inventions and improvements that we believe will improve our competitive position. We believe thatour patents and applications are important for maintaining the competitive differentiation of our products and improving our return on research anddevelopment investments. While we own, control or license a significant number of patents, trade secrets, proprietary information, trademarks,trade names, copyrights, and other intellectual property rights which, in the aggregate, are of material importance to our business, managementbelieves that our business, as a whole, as well as each of our core business segments, is not materially dependent on any one intellectualproperty right or related group of such rights.Patents, patent applications, and license agreements expire or terminate over time by operation of law, in accordance with their terms orotherwise. As the portfolio of our patents, patent applications, and license agreements has evolved over time, we do not expect the expiration ofany specific patent to have a material adverse effect on our financial position or results of operations.15Environmental Matters and RegulationOur manufacturing operations worldwide are subject to many requirements under environmental laws. In the United States, the EnvironmentalProtection Agency and similar state agencies administer laws and regulations concerning air emissions, water discharges, waste disposal,environmental remediation, and other aspects of environmental protection. Such environmental laws and regulations in the United States include,for example, the Federal Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the ComprehensiveEnvironmental Response, Compensation and Liability Act. Environmental requirements significantly affect our operations. We have established aninternal program to address compliance with applicable environmental requirements and, as a result, management believes that we are insubstantial compliance with current environmental regulations.While environmental laws and regulations are subject to change, such changes can be difficult to predict reliably and the timing of potentialchanges is uncertain. Management does not believe, based on current circumstances, that compliance costs pursuant to such regulations willhave a material adverse effect on our financial position or results of operations. However, the effect of future legislative or regulatory changescould be material to our financial condition or results of operations.Accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of theliability can be reasonably estimated, based on current law and existing technologies. It can be difficult to estimate reliably the final costs ofinvestigation and remediation due to various factors. Our accrued liabilities for these environmental matters represent the best estimates related tothe investigation and remediation of environmental media such as water, soil, soil vapor, air and structures, as well as related legal fees basedupon the facts and circumstances as currently known to us. These estimates, and related accruals, are reviewed quarterly and updated forprogress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expendituresare recorded on an undiscounted basis. We do not anticipate these liabilities will have a material adverse effect on our consolidated financialposition or results of operations. We cannot make assurances that other sites, or new details about sites known to us, that could give rise toenvironmental liabilities with such material adverse effects on us will not be identified in the future. At December 31, 2014, we had estimated andaccrued $5 million related to environmental matters.EmployeesAs of December 31, 2014, Xylem had approximately 12,500 employees worldwide. We have more than 3,700 employees in the United States, ofwhom approximately 17% are represented by labor unions, and in certain foreign countries, some of our employees are represented by workcouncils. We believe that our facilities are in favorable labor markets with ready access to adequate numbers of workers and believe our relationswith our employees are good.Company History and Certain RelationshipsOn October 31, 2011 (the "Distribution Date"), ITT completed the Spin-off (the “Spin-off”) of Xylem, formerly ITT’s water equipment and servicesbusinesses ("WaterCo"). The Spin-off was completed pursuant to the Distribution Agreement, dated as of October 25, 2011 (the “DistributionAgreement”), among ITT, Exelis Inc. (“Exelis”) and Xylem.Available InformationWe are required to file annual, quarterly and current reports, proxy statements and other information with the SEC. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports are available free of charge onour website www.xyleminc.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Theinformation on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC.In addition, the public may read or copy any materials filed with the SEC at the SEC’s Public Reference Room located at 100 F Street NE,Washington, D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These reports and other information are also available, free of charge, at www.sec.gov.16ITEM 1A. RISK FACTORSIn evaluating our business, each of the following risks should be carefully considered, along with all of the other information in this Report and inour other filings with the SEC. Should any of these risks and uncertainties develop into actual events, our business, financial condition or resultsof operations could be materially and adversely affected.Risks Related to Operational and External FactorsFailure to compete successfully in our markets could adversely affect our business.We provide products and services into competitive markets. We believe the principal points of competition in our markets are productperformance, reliability and innovation, application expertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery,proximity of service centers, effectiveness of our distribution channels and price. Maintaining and improving our competitive position will requirecontinued investment by us in manufacturing, research and development, engineering, marketing, customer service and support, and ourdistribution networks. We may not be successful in maintaining our competitive position. Our competitors may develop products that are superiorto our products, or may develop more efficient or effective methods of providing products and services or may adapt more quickly than we do tonew technologies or evolving customer requirements. Pricing pressures also could cause us to adjust the prices of certain products to staycompetitive. We may not be able to compete successfully with our existing or new competitors. Failure to continue competing successfully or towin large contracts could adversely affect our business, financial condition or results of operations.Our results of operations and financial condition may be adversely affected by global economic and financial market conditions.We compete around the world in various geographic and product markets. In 2014, 38%, 35% and 21% of our total revenue was from customerslocated in the United States, Europe and emerging markets, respectively. We expect revenue from these markets to be significant for theforeseeable future. Important factors impacting our businesses include the overall strength of these economies and our customers’ confidence inboth local and global macro-economic conditions; industrial and federal, state, local and municipal governmental spending; the strength of theresidential and commercial real estate markets; interest rates; availability of commercial financing for our customers and end-users; andunemployment rates. A slowdown or downturn in these financial or macro-economic conditions could have a significant adverse effect on ourbusiness, financial condition and results of operations.Economic and other risks associated with international sales and operations could adversely affect our business.In 2014, 62% of our total revenue was from customers outside the United States, with 21% of total revenue generated in emerging markets. Weexpect our international operations sales and export sales to continue to be a significant portion of our revenue. We have placed a particularemphasis on increasing our growth and presence in emerging markets. Both our sales from international operations and export sales are subject,in varying degrees, to risks inherent to doing business outside the United States. These risks include the following:•possibility of unfavorable circumstances arising from host country laws or regulations;•currency exchange rate fluctuations and restrictions on currency repatriation;•potential negative consequences from changes to taxation policies;•disruption of operations from labor and political disturbances;•changes in tariff and trade barriers and import and export licensing requirements; and•insurrection or war.Any payment of distributions, loans or advances to us by our foreign subsidiaries could be subject to restrictions on, or taxation of, dividends onrepatriation of earnings under applicable local law, monetary transfer restrictions and foreign currency exchange regulations in the jurisdictions inwhich our subsidiaries operate. In addition to the general risks that we face outside the United States, we now conduct more of our operations inemerging markets than we have in the past, which could involve additional uncertainties for us, including risks that governments may imposelimitations on our ability to repatriate funds; governments may impose withholding or other taxes on17remittances and other payments to us, or the amount of any such taxes may increase; an outbreak or escalation of any insurrection or armedconflict may occur; governments may seek to nationalize our assets; or governments may impose or increase investment barriers or otherrestrictions affecting our business. In addition, emerging markets pose other uncertainties, including the protection of our intellectual property andother assets, pressure on the pricing of our products, higher business conduct risks, less qualified talent and risks of political instability. Wecannot predict the impact such future, largely unforeseeable events might have on our business, financial condition and results of operations.Failure to comply with laws, regulations and policies, including the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation could result in fines, criminal penalties and an adverse effect on our business.We are subject to regulation under a wide variety of U.S. federal and state and non-U.S. laws, regulations and policies, including laws related toanti-corruption, export and import compliance, anti-trust and money laundering, due to our global operations. The U.S. Foreign Corrupt PracticesAct (the "FCPA"), the U.K. Bribery Act of 2010 and similar anti-bribery laws in other jurisdictions generally prohibit companies and theirintermediaries from making improper payments to government officials or other persons for the purpose of obtaining or retaining business. Therehas been an increase in anti-bribery law enforcement activity in recent years, with more frequent and aggressive investigations and enforcementproceedings by both the Department of Justice ("DOJ") and the SEC, increased enforcement activity by non-U.S. regulators, and increases incriminal and civil proceedings brought against companies and individuals. Our policies mandate compliance with these anti-bribery laws. Weoperate in many parts of the world that are recognized as having governmental and commercial corruption and in certain circumstances, strictcompliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal control policies andprocedures will always protect us from improper conduct of our employees or business partners. In the event that we believe or have reason tobelieve that our employees or agents have or may have violated applicable laws, including anti-corruption laws, we may be required to investigateor have outside counsel investigate the relevant facts and circumstances, which can be expensive and require significant time and attention fromsenior management. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, and curtailment of operations incertain jurisdictions, and might adversely affect our business, results of operations or financial condition. In addition, actual or alleged violationscould damage our reputation and ability to do business. Furthermore, detecting, investigating, and resolving actual or alleged violations isexpensive and can consume significant time and attention of our senior management.Our business could be adversely affected by the inability of suppliers to meet delivery requirements.Our business relies on third-party suppliers, contract manufacturing and commodity markets to secure raw materials, parts and components usedin our products. Parts and raw materials commonly used in our products include motors, fabricated parts, castings, bearings, seals, nickel, copper,aluminum, and plastics. We are exposed to the availability of these materials, which may be subject to curtailment or change due to, among otherthings, interruptions in production by suppliers, labor disputes, the impaired financial condition of a particular supplier, suppliers’ allocations toother purchasers, changes in exchange rates and prevailing price levels, ability to meet regulatory requirements, weather emergencies or acts ofwar or terrorism. Any delay in our suppliers’ abilities to provide us with necessary materials could impair our ability to deliver products to ourcustomers and, accordingly, could have a material adverse effect on our business, financial condition or results of operations.Our business could be adversely affected by significant movements in foreign currency exchange rates.We conduct approximately 62% of our business in various locations outside the United States. We are exposed to fluctuations in foreign currencytransaction exchange rates, particularly with respect to the Euro, Swedish Krona, British Pound, Australian Dollar, Canadian Dollar, Polish Zloty,and Hungarian Forint. Any significant change in the value of currencies of the countries in which we do business relative to the value of theU.S. Dollar or Euro could affect our ability to sell products competitively and control our cost structure, which could have a material adverse effecton our business, financial condition and results of operations. Additionally, we are subject to foreign exchange translation risk due to changes inthe value of foreign currencies in relation to our reporting currency, the U.S. dollar. The translation risk is primarily concentrated in the exchangerate between the U.S. dollar and the Euro, British Pound, Chinese Yuan, Swedish Krona and Canadian Dollar. As the U.S. dollar fluctuates againstother currencies in which we transact business, revenue and income can be impacted. Refer to Item 7A "Quantitative and Qualitative Disclosuresabout Market Risk" for additional information on foreign exchange risk.18Weather conditions may adversely affect our financial results.Weather conditions, including heavy flooding, droughts and fluctuations in temperatures, can positively or negatively impact portions of ourbusiness. Within the dewatering space, our pumps provided through our Godwin and Flygt brands are used to remove excess or unwanted water.Heavy flooding due to weather conditions drives increased demand for these applications. On the other hand, drought conditions drive higherdemand for pumps used in agricultural and turf irrigation applications, such as those provided by our Goulds Water Technology, Flowtronex andLowara brands. Fluctuations to warmer and cooler temperatures result in varying levels of demand for products used in residential and commercialapplications where homes and buildings are heated and cooled with HVAC units such as those provided by our B&G brand. Given theunpredictable nature of weather conditions, this may result in volatility for certain portions of our business, as well as the operations of certain ofour customers and suppliers.Our financial results can be difficult to predict.Our business is impacted by an increasing amount of short cycle, and book-and-bill business, which we have limited insight into, particularly forthe business that we transact through our distributors. We are also impacted by large projects, whose timing can change based upon customerrequirements due to a number of factors affecting the project, such as funding, readiness of the project and regulatory approvals. Accordingly, ourfinancial results for any given period can be difficult to predict.Our strategy includes acquisitions, and we may not be able to make acquisitions of suitable candidates or integrate acquisitionssuccessfully.Our historical growth has included acquisitions. As part of our growth strategy, we plan to pursue the acquisition of other companies, assets andproduct lines that either complement or expand our existing business. We cannot make assurances, however, that we will be able to identifysuitable candidates successfully, negotiate appropriate acquisition terms, obtain financing that may be needed to consummate those acquisitions,complete proposed acquisitions, successfully integrate acquired businesses into our existing operations or expand into new markets. In addition,we cannot make assurances that any acquisition, once successfully integrated, will perform as planned, be accretive to earnings, or prove to bebeneficial to our operations or cash flow.Acquisitions involve a number of risks and present financial, managerial and operational challenges, including: diversion of management attentionfrom existing businesses and operations; integration of technology, operations personnel, and financial and other systems; potentially insufficientinternal controls over financial activities or financial reporting at an acquired entity that could impact us on a combined basis; the failure to realizeexpected synergies; the possibility that we have acquired substantial undisclosed liabilities; and the loss of key employees of the acquiredbusinesses.We may incur impairment charges for our goodwill and other indefinite-lived intangible assets which would negatively impact ouroperating results.We have a significant amount of goodwill and purchased intangible assets on our balance sheet as a result of acquisitions we have completed. Asof December 31, 2014, the net carrying value of our goodwill and other indefinite-lived intangible assets totaled approximately $2 billion. Thecarrying value of goodwill represents the fair value of an acquired business in excess of identifiable assets and liabilities as of the acquisition date.The carrying value of indefinite-lived intangible assets represents the fair value of trademarks and trade names as of the acquisition date. We donot amortize goodwill and indefinite-lived intangible assets that we expect to contribute indefinitely to our cash flows, but instead we evaluatethese assets for impairment at least annually, or more frequently if interim indicators suggest that a potential impairment could exist. In testing forimpairment, we will make a qualitative assessment, and if we believe that it is more likely than not that the fair value of a reporting unit is less thanits carrying amount, the quantitative two-step goodwill impairment test is required. Significant negative industry or economic trends, disruptions toour business, inability to effectively integrate acquired businesses, unexpected significant changes or planned changes in use of the assets,divestitures and market capitalization declines may impair our goodwill and other indefinite-lived intangible assets. Any charges relating to suchimpairments could adversely affect our results of operations and financial condition in the periods recognized.19Our ability to successfully execute our organizational redesign as well as other restructuring and realignment actions could impact ourbusiness results.We initiated an organizational redesign during the fourth quarter of 2013, shifting from individually managed businesses to an integrated approachwithin geographical regions. We expect that this will enable us to leverage the breadth of the Company’s product and services portfolio to betterserve our customers and address market opportunities as well as effectively utilize internal support organizations to realize economies of scaleand efficient use of resources. The successful implementation and execution of this redesign as well as our other restructuring and realignmentactions, is critical to achieving our expected cost savings as well as effectively competing in the marketplace. Other factors that may impede asuccessful implementation is retention of key employees, the impact of regulatory matters, and adverse economic market conditions. If theorganizational redesign or restructuring and realignment actions are not executed successfully, the Company’s financial results could be adverselyimpacted.Changes in our effective tax rates may adversely affect our financial results.We sell our products in more than 150 countries and 62% of our revenue was generated outside the United States in 2014. Given the global natureof our business, a number of factors may increase our future effective tax rates, including:•our decision to repatriate non-U.S. earnings for which we have not previously provided for U.S. taxes;•the jurisdictions in which profits are determined to be earned and taxed;•sustainability of historical income tax rates in the jurisdictions in which we conduct business;•the resolution of issues arising from tax audits with various tax authorities; and•changes in the valuation of our deferred tax assets and liabilities, and changes in deferred tax valuation allowances.Any significant increase in our future effective tax rates could reduce net income for future periods.Our business could be adversely affected by inflation and other manufacturing and operating cost increases.Our operating costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, energy and related utilities, freight,and cost of labor. In order to remain competitive, we may not be able to recuperate all or a portion of these higher costs from our customersthrough product price increases. Further, our ability to realize financial benefits from lean six sigma projects may not be able to mitigate fully or inpart these manufacturing and operating cost increases and, as a result, could negatively impact our profitability.Product defects and unanticipated use or inadequate disclosure with respect to our products could adversely affect our business,reputation and financial statements.Manufacturing or design defects in (including in products or components that we source from third parties), unanticipated use of, or inadequatedisclosure of risks relating to the use of products that we make or sell can lead to personal injury, death or property damage. These events couldlead to recalls or safety alerts relating to our products, result in the removal of a product from the market and result in product liability claims beingbrought against us. Although we have liability insurance, we cannot be certain that this insurance coverage will continue to be available to us at areasonable cost or will be adequate to cover any product liability claims. Recalls, removals and product liability claims can result in significantcosts, as well as negative publicity and damage to our reputation that could reduce demand for our products.Our indebtedness may affect our business and may restrict our operational flexibility.As of December 31, 2014, our total outstanding indebtedness was $1,288 million, including our 3.55% Senior Notes of $600 million aggregateprincipal amount due September 2016 and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021. We have anexisting Four Year Competitive Advance and Revolving Credit Facility (the “Credit Facility”), which provides for an aggregate principal amount of upto $600 million. We have a Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with The European Investment Bank ("EIB")in an aggregate principal amount of up to €120 million (approximately $146 million).20Our indebtedness could:•increase our vulnerability to general adverse economic and industry conditions;•limit our ability to obtain additional financing or borrow additional funds;•limit our ability to pay future dividends;•limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;•require that a substantial portion of our cash flow from operations be used for the payment of interest on our indebtedness instead of fundingworking capital, capital expenditures, acquisitions or other general corporate purposes; and•increase the amount of interest expense that we must pay because some of our borrowings are at variable interest rates, which, as interestrates increase, would result in higher interest expense.In addition, there can be no assurance that future borrowings or equity financing will be available to us on favorable terms or at all for the paymentor refinancing of our indebtedness. If we incur additional debt or raise equity through the issuance of preferred stock, the terms of the debt orpreferred stock issued may give the holders rights, preferences and privileges senior to those of holders of our common stock, particularly in theevent of liquidation. The terms of the debt may also impose additional and more stringent restrictions on our operations than we currently have.Our ability to make scheduled principal payments of, to pay interest on, or to refinance our indebtedness and to satisfy our other debt obligationswill depend on our future operating performance, which may be affected by factors beyond our control. If we are unable to service ourindebtedness, our business, financial condition and results of operations would be materially adversely affected.We may be negatively impacted by litigation and regulatory proceedings.We are subject to laws, regulations and potential liability relating to claims, complaints and proceedings, including those related to antitrust,environmental, product, and other matters.We are subject to various laws, ordinances, regulations and other requirements of government authorities in foreign countries and in the UnitedStates, any violation of which could potentially create substantial liability for us and also damage to our reputation. Changes in laws, ordinances,regulations or other government policies, the nature, timing, and effect of which are uncertain, may significantly increase our expenses andliabilities.From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses, including acquisitions anddivestitures. Some of these proceedings seek remedies relating to environmental matters, intellectual property matters, product liability andpersonal injury claims, employment, labor and pension matters, and government and commercial or contract issues, sometimes related toacquisitions or divestitures. We may become subject to significant claims of which we are currently unaware, or the claims of which we are awaremay result in our incurring a significantly greater liability than we anticipate or can estimate. Additionally, we may receive fines or penalties or berequired to change or cease operations at one or more facilities if a regulatory agency determines that we have failed to comply with laws,regulations or orders applicable to our business.Our business could be adversely affected by interruptions in information technology, communications networks and operations orcybersecurity threats.Our business operations rely on information technology and communications networks, and operations that are vulnerable to damage ordisturbance from a variety of sources. Regardless of protection measures, essentially all systems are susceptible to disruption due to failure,vandalism, computer viruses, security breaches, natural disasters, power outages and other events. In addition, cybersecurity threats are evolvingand include, among others, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that couldlead to disruptions in our systems or our third party vendors’ systems and applications, unauthorized release of confidential or otherwise protectedinformation and corruption of data. We also have a concentration of operations on certain sites, e.g. production and shared services centers, wherebusiness interruptions could cause material damage and costs. Transport of goods from suppliers, and to customers, could also be hampered forthe reasons stated above. Although we continue to assess these risks, implement controls, and perform business continuity planning, we cannotbe sure that interruptions with material adverse effects will not occur.21Failure to retain our existing senior management, engineering, sales and other key personnel or the inability to attract and retain newqualified personnel could negatively impact our ability to operate or grow our business.Our success will continue to depend to a significant extent on our ability to retain or attract a significant number of employees in seniormanagement, engineering, sales and other key personnel. The ability to attract or retain employees will depend on our ability to offer competitivecompensation, training and cultural benefits. We will need to continue to develop a roster of qualified talent to support business growth and replacedeparting employees. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledgeand smooth transitions involving key employees could hinder our strategic planning and execution. A failure to retain or attract highly skilledpersonnel could adversely affect our operating results or ability to operate or grow our business.If we do not or cannot adequately protect our intellectual property, if third parties infringe our intellectual property rights, or if thirdparties claim that we are infringing or misappropriating their intellectual property rights, we may suffer competitive injury, expendsignificant resources enforcing our rights or defending against such claims, or be prevented from selling products or services.We own numerous patents, trademarks, copyrights, trade secrets and other intellectual property and licenses to intellectual property owned byothers, which in aggregate are important to our business. The intellectual property rights that we obtain, however, may not provide us with asignificant competitive advantage because they may not be sufficiently broad or may be challenged, invalidated, circumvented, independentlydeveloped, or designed-around, particularly in countries where intellectual property rights laws are not highly developed, protected or enforced. Ourfailure to obtain or maintain intellectual property rights that convey competitive advantage, adequately protect our intellectual property or detect orprevent circumvention or unauthorized use of such property and the cost of enforcing our intellectual property rights could adversely impact ourbusiness, financial condition and results of operations. From time to time, we receive notices from third parties alleging intellectual property infringement or misappropriation. Any dispute or litigationregarding intellectual property could be costly and time-consuming due to the complexity and the uncertainty of intellectual property litigation. Ourintellectual property portfolio may not be useful in asserting a counterclaim, or negotiating a license, in response to a claim of infringement ormisappropriation. In addition, as a result of such claims of infringement or misappropriation, we could lose our rights to critical technology, beunable to license critical technology or sell critical products and services, be required to pay substantial damages or license fees with respect tothe infringed rights or be required to redesign our products at substantial cost, any of which could adversely impact our competitive position andfinancial statements. Even if we successfully defend against claims of infringement or misappropriation, we may incur significant costs anddiversion of management attention and resources, which could adversely affect our business, financial condition and results of operations.We cannot make assurances that we will pay dividends on our common stock or continue to repurchase our common stock under Boardapproved share repurchase plans, and likewise our indebtedness could limit our ability to pay dividends or make share repurchases.The timing, declaration, amount and payment of future dividends to our shareholders fall within the discretion of our Board of Directors and willdepend on many factors, including our financial condition, results of operations and capital requirements, as well as applicable law, regulatoryconstraints, industry practice and other business considerations that our Board of Directors considers relevant. There can be no assurance that wewill pay a dividend in the future or continue to pay dividends.Further, the timing and amount of the repurchase of our common stock under Board approved share repurchase plans has similar dependencies asthe payment of dividends and accordingly, there can be no assurances that we will continue to repurchase our common stock.Additionally, if we cannot generate sufficient cash flow from operations to meet our debt payment obligations, then our ability to pay dividends, ifso determined by the Board of Directors, or make share repurchases will be impaired and we may be required to attempt to restructure or refinanceour debt, raise additional capital or take other actions such as selling assets, reducing or delaying capital expenditures, reducing our dividend ordelaying or curtailing share repurchases. There can be no assurance, however, that any such actions could be effected on satisfactory terms, if atall, or would be permitted by the terms of our debt or our other credit and contractual arrangements.22The level of returns on postretirement benefit plan assets, changes in interest rates and other factors could affect our earnings and cashflows in future periods.Certain members of our current and retired employee population are covered by pension and other employee-related defined benefit plans(collectively, postretirement benefit plans). We may experience significant fluctuations in costs related to our postretirement benefit plans as aresult of macro-economic factors, such as interest rates, that are beyond our control. The cost of our postretirement plans is incurred over longperiods of time and involves factors and uncertainties during those periods which can be volatile and unpredictable, including rates of return onpostretirement benefit plan assets, discount rates used to calculate liabilities and expenses and rates of future compensation increases.Management develops each assumption using relevant plan and Company experience and expectations in conjunction with market-related data.Our liquidity, financial position (including shareholders’ equity) and results of operations could be materially affected by significant changes in keyeconomic indicators, actuarial experience, financial market volatility, future legislation and other governmental regulatory actions.We make contributions to fund our postretirement benefit plans when considered necessary or advantageous to do so. The macro-economicfactors discussed above, including the return on postretirement benefit plan assets and the minimum funding requirements established by localgovernment funding or taxing authorities, or established by other agreement, may influence future funding requirements. A significant decline in thefair value of our plan assets, or other adverse changes to our overall pension and other employee-related benefit plans, could require us to makesignificant funding contributions and affect cash flows in future periods.Unforeseen environmental issues could impact our financial position or results of operations.Our operations are subject to and affected by many federal, state, local and foreign environmental laws and regulations. In addition, we could beaffected by future environmental laws or regulations, including, for example, those imposed in response to climate change concerns. Compliancewith current and future environmental laws and regulations currently requires and is expected to continue to require operating and capitalexpenditures.Environmental laws and regulations may authorize substantial fines and criminal sanctions as well as facility shutdowns to address violations, andmay require the installation of costly pollution control equipment or operational changes to limit emissions or discharges. We also incur, andexpect to continue to incur, costs to comply with current environmental laws and regulations.Developments such as the adoption of new environmental laws and regulations, stricter enforcement of existing laws and regulations, violations byus of such laws and regulations, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, ourinability to recover costs associated with any such developments, or financial insolvency of other responsible parties could in the future have amaterial adverse effect on our financial position and results of operations.The market price of our common stock may fluctuate significantly.We cannot predict the prices at which our common stock may trade. The market price of our common stock may fluctuate widely, depending onmany factors, some of which may be beyond our control, including:•actual or anticipated fluctuations in our operating results due to factors related to our business;•success or failure of our business strategy;•our quarterly or annual earnings, or those of other companies in our industry;•our ability to obtain financing as needed;•announcements by us or our competitors of significant new business awards;•announcements by us or our competitors of significant acquisitions or dispositions;•changes in accounting standards, policies, guidance, interpretations or principles;•changes in earnings estimates by securities analysts or our ability to meet those estimates;•our ability to execute restructuring and realignment actions;•the operating and stock price performance of other comparable companies;23•natural or environmental disasters that investors believe may affect us;•overall market fluctuations;•fluctuations in the budgets of federal, state and local governmental entities around the world;•results from any material litigation or government investigation;•changes in laws and regulations affecting our business; and•general economic conditions and other external factors.Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. Thesebroad market fluctuations could adversely affect the trading price of our common stock.Anti-takeover provisions in our organizational documents and Indiana law could delay or prevent a change in control.Certain provisions of our third amended and restated articles of incorporation and our amended and restated by-laws may delay or prevent amerger or acquisition part or all of our business operations. For example, the third amended and restated articles of incorporation and the amendedand restated by-laws, among other things, require advance notice for shareholder proposals and nominations and do not permit action by writtenconsent of the shareholders, unless unanimous. In addition, the amended and restated articles of incorporation authorize our Board of Directors toissue one or more series of preferred stock. These provisions may also discourage acquisition proposals of our business operations or delay orprevent a change in control, which could harm our stock price. Indiana law also imposes some restrictions on mergers and other businesscombinations between any holder of 10% or more of our outstanding common stock and us.Risks Related to our 2011 Spin-off from ITT CorporationThe Spin-off may expose us to potential liabilities arising out of state and federal fraudulent conveyance laws and legal distributionrequirements.The Spin-off could be challenged under various state and federal fraudulent conveyance laws. An unpaid creditor or an entity vested with the powerof such creditor (such as a trustee or debtor-in-possession in a bankruptcy) could claim that the Spin-off left us, ITT and/or Exelis insolvent or withunreasonably small capital or that we, ITT and/or Exelis intended or believed it would incur debts beyond its ability to pay as they mature and thatITT did not receive fair consideration or reasonably equivalent value in the Spin-off. If a court were to agree with such a plaintiff, then such courtcould void the Spin-off as a fraudulent transfer and could impose a number of different remedies, which could adversely affect our financialcondition and our results of operations.In connection with our Spin-off, ITT and Exelis will indemnify us for certain liabilities and we will indemnify ITT or Exelis for certainliabilities. If we are required to indemnify ITT or Exelis, we may need to divert cash to meet those obligations and our financial resultscould be negatively impacted. In the case of ITT's or Exelis's indemnity, there can be no assurance that those indemnities will besufficient to insure us against the full amount of such liabilities, or as to ITT's or Exelis's ability to satisfy its indemnification obligationsin the future.Pursuant to the Distribution Agreement and certain other agreements with ITT and Exelis, ITT and Exelis agreed to indemnify us from certainliabilities, and we agreed to indemnify ITT and Exelis for certain liabilities. Indemnities that we may be required to provide ITT and Exelis may besignificant and could negatively impact our business, particularly indemnities relating to our actions that could impact the tax-free nature of theSpin-off. Third parties could also seek to hold us responsible for any of the liabilities that ITT or Exelis has agreed to retain. Further, there can beno assurance that the indemnities from ITT and Exelis will be sufficient to protect us against the full amount of such liabilities, or that ITT andExelis will be able to fully satisfy their indemnification obligations. Moreover, even if we ultimately were to succeed in recovering from ITT andExelis any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. Each of these risks couldnegatively affect our business, results of operations and financial condition.ITEM 1B. UNRESOLVED STAFF COMMENTS.None.24ITEM 2. PROPERTIESWe have more than 350 locations in more than 40 countries. These properties total approximately 10.4 million square feet, of which more than 300locations, or approximately 6.0 million square feet, are leased. We consider the offices, plants, warehouses and other properties that we own orlease to be in good condition and generally suitable for the purposes for which they are used. The following table shows the significant locations bysegment:Location State orCountry Principal Business Activity Approx.SquareFeet Owned orExpirationDateof LeaseWater InfrastructureEmmaboda Sweden Administration and Manufacturing 1,194,000 OwnedStockholm Sweden Administration and Research & Development 172,000 2019Shenyang China Manufacturing 125,000 OwnedBridgeport NJ Administration and Manufacturing 136,000 2015Yellow Springs OH Administration and Manufacturing 112,000 OwnedQuenington UK Manufacturing 86,000 2015Applied WaterMorton Grove IL Administration and Manufacturing 530,000 OwnedMontecchio Italy Administration and Manufacturing 379,000 OwnedNanjing China Manufacturing 363,000 OwnedAuburn NY Manufacturing 273,000 OwnedLubbock TX Manufacturing 229,000 OwnedCheektowaga NY Manufacturing 145,000 OwnedCorporate HeadquartersRye Brook NY Administration 67,000 2023ITEM 3. LEGAL PROCEEDINGSFrom time to time, we are involved in legal proceedings that are incidental to the operation of our businesses, including acquisitions anddivestitures, environmental matters, intellectual property matters, anti-trust and anti-corruption matters, product liability and personal injury claims,employment and pension matters, government and commercial contract disputes. Although we cannot predict the outcome of these and otherproceedings, including the cases below, with certainty, we believe that they will not have a material adverse effect on our consolidated financialposition and results of operations.On December 17, 2014, the Korea Fair Trade Commission (“KFTC”) issued a written decision regarding an investigation into bid-rigging allegationsagainst Xylem Water Solutions South Korea Co., Ltd. (“Xylem South Korea”), a subsidiary of Xylem Inc. The KFTC found that certain employeesof Xylem South Korea had participated in activities that violated Korea’s antitrust laws. Xylem South Korea was assessed a fine of approximately$1.6 million and the matter was referred for criminal prosecution. In January 2015, Xylem South Korea paid the fine and filed an appeal of theKFTC’s decision with the Seoul High Court. In connection with the KFTC matter, the Company commenced an internal investigation relating to the allegations against Xylem South Korea. Inlate 2014, the Company broadened this internal investigation to assess related allegations made by certain employees of Xylem South Koreaduring the investigation into the KFTC matter. The broadened investigation includes a review of compliance by Xylem South Korea and itsemployees with the requirements of the Foreign Corrupt Practices Act. The Company engaged independent outside counsel to assist with itsinvestigation and an independent professional services firm to provide forensic accounting assistance. In late January 2015, the Companyvoluntarily contacted the Securities and Exchange Commission and the Department of Justice to advise both agencies of this internalinvestigation. The Company will fully cooperate with any government investigation. Xylem South Korea’s revenue is less than one percent of theCompany’s total revenue. Although the Company currently cannot reasonably estimate the potential liability, if any, related to the25investigation, we currently believe that these matters will not have a material adverse effect on the Company’s business, financial condition orresults of operations.On or about February 17, 2009, following a statement submitted to the Spanish Competition Authority (Comision Nacional de la Competencia,"CNC") by Grupo Industrial Ercole Marelli, S.A. regarding an anti-competitive agreement in which it said it had been participating, the CNCconducted an investigation at ITT Water & Wastewater España S.A. (now named Xylem Water Solutions España S.A.), at the SpanishAssociation of Fluid Pump Manufacturers (the "Association"), and at the offices of other members of the Association. On September 16, 2009, theDirectorate of Investigation of the CNC commenced formal proceedings for alleged restrictive practices, such as several exchanges of informationand a recommendation on general terms and conditions of sale, allegedly prohibited under applicable law. Following the conclusion of the formalproceedings, the CNC Council imposed fines on the Association and nineteen Spanish manufacturers and distributors of fluid pumps, including afine of Euro 2,373,675 applied to ITT Water & Wastewater España S.A. and ITT Corporation. In March 2012, the Company appealed the CNC'sdecision to the Audiencia Nacional (the "High Court"), and vigorously defended the case. In March 2013, the High Court upheld the determinationof the CNC and the fine previously assessed. In June 2013, the Company filed an appeal with the Tribunal Supremo, the Supreme Court ofSpain. Xylem is awaiting the decision of the Supreme Court.ITEM 4. MINE SAFETY DISCLOSURESNone.26EXECUTIVE OFFICERS OF THE REGISTRANTThe following information is provided regarding the executive officers of Xylem:NAME AGE CURRENT TITLE OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARSPatrick K. Decker 50 President and Chief Executive Officer(2014) • President and Chief Executive Officer, Harsco Corp.(diversified, worldwide industrial company) (2012)• President, Flow Control Segment, Tyco InternationalLtd. (industrial products and services company) (2003) Michael T. Speetzen 45 Senior VP and Chief Financial Officer(2011) • VP of Finance, Fluid and Motion Control, ITTCorporation (global manufacturing company) (2009) Tomas Brannemo 43 Senior VP and President, Transport(2014) • VP, Transport (2013)• VP Strategy and Aftermarket and Service (2010)• VP and Director of Business Unit Aftermarket andService (2010)• VP Marketing and Sales, Customer Support, VolvoConstruction Equipment, AB Volvo (multinationalmanufacturing company) (2008) Christopher R. McIntire 51 Senior VP and President, Analytics andTreatment (2013) • Senior VP and President, Analytics (2011)• President and Chief Operating Officer, Nova Analytics(manufacturing and analytical instruments) (2006) Robyn T. Mingle 49 Senior VP and Chief Human ResourcesOfficer (2011) • Senior VP of Human Resources, HovnanianEnterprises, Inc. (real estate company) (2003) Kenneth Napolitano 53 Senior VP and President, Applied WaterSystems (2012) • Senior VP and President, Residential and CommercialWater (2011)• President, Residential and Commercial Water (2009) Colin R. Sabol 47 Senior VP and President, Dewatering(2013) • Senior VP and Chief Strategy and Growth Officer(2011)• VP of Marketing and Business Development, Fluid andMotion Control, ITT Corporation (global manufacturingcompany)(2009) 27NAME AGE CURRENT TITLE OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARSClaudia S. Toussaint 51 Senior VP, General Counsel andCorporate Secretary (2014) • Senior VP, General Counsel and Secretary, BarnesGroup Inc. (international industrial and aerospacemanufacturing) (2012)• General Counsel, Flow Control Segment, TycoInternational Ltd. (industrial products and servicescompany) (2012)• Senior VP, General Counsel and Secretary, BarnesGroup Inc. (international industrial and aerospacemanufacturing) (2010)• Senior VP, General Counsel and Secretary, Embarq(multinational communications company) (2009)Note: Date in parentheses indicates the year in which the position was assumed.BOARD OF DIRECTORSThe following information is provided regarding the Board of Directors of Xylem:NAME TITLEMarkos I. Tambakeras Chairman, Xylem Inc., Former Chairman, President and Chief Executive Officer, Kennametal,Inc. Curtis J. Crawford, Ph.D. President and Chief Executive Officer, XCEO, Inc. Patrick K. Decker President and Chief Executive Officer, Xylem Inc. Robert F. Friel Chairman, President and Chief Executive Officer, PerkinElmer, Inc. Victoria D. Harker Chief Financial Officer, Gannett Co., Inc. Sten E. Jakobsson Former President and Chief Executive Officer, ABB AB Steven R. Loranger Former Chairman, President and Chief Executive Officer, ITT Corporation Edward J. Ludwig Former Chairman, President and Chief Executive Officer, Becton, Dickinson and Company Surya N. Mohapatra, Ph.D. Former Chairman, President and Chief Executive Officer, Quest Diagnostics Incorporated Jerome A. Peribere President and Chief Executive Officer, Sealed Air Corporation James P. Rogers Former Chairman, Chief Executive Officer, Eastman Chemical Company28PART IIITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES2014 and 2013 Market Price and DividendsOur common stock trades publicly on the New York Stock Exchange under the trading symbol “XYL”. The following table shows the high and lowprices per share of our common stock as reported by the New York Stock Exchange and the dividends declared per share for the periodsindicated. High Low DividendFiscal Year ended December 31, 2014 First Quarter$39.79 $32.62 $0.1280Second Quarter40.00 34.50 0.1280Third Quarter39.43 34.77 0.1280Fourth Quarter39.23 31.80 0.1280 Fiscal Year ended December 31, 2013 First Quarter$29.49 $26.39 $0.1164Second Quarter29.19 25.56 0.1164Third Quarter29.79 23.61 0.1164Fourth Quarter34.93 26.99 0.1164The closing price of our common stock on the NYSE on January 30, 2015 was $34.10 per share. As of January 30, 2015, there were 14,700holders of record of our common stock.Dividends are declared and paid on the common stock at the discretion of our Board of Directors and depend on our profitability, financialcondition, capital needs, future prospects, and other factors deemed relevant by our Board. Therefore, there can be no assurance as to what levelof dividends, if any, will be paid in the future. In the first quarter of 2015, we declared a dividend of $0.1408 per share to be paid on March 18, 2015for shareholders of record on February 18, 2015.There have been no unregistered offerings of our common stock during 2014.Fourth Quarter 2014 Share Repurchase ActivityThe following table summarizes our purchases of our common stock for the quarter ended December 31, 2014:(in millions, except per share amounts) Period Total Number of SharesPurchased Average Price Paid per Share(a) Total Number of SharesPurchased as Part of PubliclyAnnounced Plans orPrograms (b) Approximate Dollar Value ofShares That May Yet BePurchased Under the Plans orPrograms (b)10/1/14 - 10/31/14 — — — $108.211/1/14 - 11/30/14 — — — $110.212/1/14 - 12/31/14 — — — $110.0(a)Average price paid per share is calculated on a settlement basis.(b)On August 18, 2012, the Board of Directors authorized the repurchase of up to two million shares of common stock with no expiration date. The program's objective isto offset dilution associated with various Xylem employee stock plans by acquiring shares in the open market from time to time. There were no shares purchasedunder this program during the three months ended December 31, 2014 and there are 1.0 million shares (approximately $40 million based on the closing share price onDecember 31, 2014) that may still be purchased under this plan.On August 20, 2013, the Board of Directors authorized the repurchase of shares up to $250 million with no expiration date. The program's objective is to deploy ourcapital in a manner that benefits our shareholders and maintains our focus on growth. During the three months ended December 31, 2014, there were no sharesrepurchased under this program. There are up to $70 million in shares that may still be purchased under this plan.29PERFORMANCE GRAPHCUMULATIVE TOTAL RETURNThe following graph compares the relative performance of our common stock, the S&P 500 Index and the S&P 500 Industrials Index. This graphcovers the period from October 13, 2011 (the first day our common stock began “when-issued” trading on the NYSE) through December 31, 2014.Our common stock began “regular-way” trading following the Spin-off on November 1, 2011. XYL S&P 500 S&P 1500IndustrialsIndexOctober 13, 2011$100 $100 $100October 31, 2011110 104 106December 31, 2011106 105 108December 31, 2012114 121 124December 31, 2013148 161 175December 31, 2014165 183 192The graph is not, and is not intended to be, indicative of future performance of our common stock.This performance graph shall not be deemed “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934,and should not be deemed incorporated by reference into any of our prior or subsequent filings under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, except as shall be expressly set forth by specific reference in such filing.30ITEM 6. SELECTED FINANCIAL DATAThe following table sets forth selected consolidated financial data for the five years ended December 31, 2014. This selected consolidatedfinancial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements and the notes thereto included in this Report.On and prior to the Distribution Date, our financial position and results of operations consisted of WaterCo, the water equipment and servicesbusinesses of ITT Corporation. The Spin-off was completed pursuant to the Distribution Agreement among ITT, Exelis Inc. and Xylem. Xylem'sfinancial position and results of operations have been derived from ITT’s historical accounting records and are presented on a carve-out basisthrough the Distribution Date, while our financial results for Xylem post Spin-off are prepared on a stand-alone basis. Further, financial informationfor the twelve months ended December 31, 2011 consists of the consolidated results of Xylem on a stand-alone basis for the two months ofNovember and December and the combined results of operations of WaterCo for the first ten months on a carve-out basis. Year EndedDecember 31,(in millions, except per share data)2014 2013 2012 2011 (b) 2010 (c)Results of Operations Data: Revenue$3,916 $3,837 $3,791 $3,803 $3,202Gross profit1,513 1,499 1,502 1,461 1,214Gross margin38.6% 39.1% 39.6% 38.4% 37.9%Operating income463 363 443 395 388Operating margin11.8% 9.5% 11.7% 10.4% 12.1%Net income337 228 297 279 329Per Share Data: Earnings per share: Basic$1.84 $1.23 $1.60 $1.51 $1.78Diluted1.83 1.22 1.59 1.50 1.78Basic shares outstanding (a)183.1 185.2 185.8 185.1 184.6Diluted shares outstanding (a)184.2 186.0 186.2 185.3 184.6Cash dividends per share$0.5120 $0.4656 $0.4048 $0.1012 $—Balance Sheet Data (at period end): Cash and cash equivalents$663 $533 $504 $318 $131Working capital*882 930 859 834 759Total assets4,864 4,896 4,679 4,400 3,742Total debt1,288 1,241 1,205 1,206 4*The Company calculates Working capital as follows: net accounts receivable + inventories - accounts payable - customer advances.(a)On October 31, 2011, the Spin-off from ITT was completed through a tax-free stock dividend to ITT’s shareholders. ITT shareholders received oneshare of Xylem common stock for each share of ITT common stock. As a result on October 31, 2011, we had 184.6 million shares of commonstock outstanding and this share amount is being utilized to calculate earnings per share and diluted earnings per share for all prior periodspresented.(b)In 2011, we acquired YSI Incorporated, which contributed revenue of $35 million in 2011 and $371 million of total assets on date of acquisition.(c)In 2010, we acquired Godwin Pumps of America, Inc. and Nova Analytics Corporation. These businesses in the aggregate contributed revenue of$247 million in 2010 and $1,070 million of total assets on date of acquisition.31ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussionsummarizes the significant factors affecting our results of operations and the financial condition of our business during each of the fiscal years inthe three-year period ended December 31, 2014. Except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our”and “the Company” refer to Xylem Inc. and its subsidiaries. References in the consolidated financial statements to "ITT" or the "former parent"refer to ITT Corporation and its consolidated subsidiaries (other than Xylem Inc.).OverviewXylem is a leading equipment and service provider for water and wastewater applications with a broad portfolio of products and servicesaddressing the full cycle of water, from collection, distribution and use to the return of water to the environment. Our business focuses on providingtechnology-intensive equipment and services. Our product and service offerings are organized into two segments: Water Infrastructure and AppliedWater. Our segments are aligned with each of the sectors in the cycle of water, water infrastructure and usage applications. The WaterInfrastructure segment focuses on the transportation, treatment and testing of water, offering a range of products including water and wastewaterpumps, treatment and testing equipment, and controls and systems. The Applied Water segment serves many of the primary uses of water andfocuses on the residential, commercial, industrial and agricultural markets. The segment’s major products include pumps, valves, heatexchangers, controls and dispensing equipment.•Water Infrastructure serves the water infrastructure sector with pump systems that transport water from oceans, groundwater, aquifers,lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumpingsolutions that move the wastewater to treatment facilities where our mixers, biological treatment, monitoring and control systems provide theprimary functions in the treatment process. We provide analytical instrumentation used to measure water quality, flow, and level inwastewater, surface water, and coastal environments.•Applied Water serves the usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning and forfire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers, valves andcontrols provide cooling to power plants and manufacturing facilities, as well as circulation for food and beverage processing. We alsoprovide boosting systems for farming irrigation, pumps for dairy operations, and rainwater reuse systems for small scale crop and turfirrigation.We sell our equipment and services through direct and indirect channels that serve the needs of each customer type. In the Water Infrastructuresegment, we provide the majority of our sales direct to customers with strong application expertise, while the remaining amount was throughdistribution partners. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with the world’sleading distributors, with the remainder going direct to customers.Key Performance Indicators and Non-GAAP MeasuresManagement reviews key performance indicators including revenue, gross margin, segment operating income and margins, earnings per share,orders growth, working capital, free cash flow and backlog, among others. In addition, we consider certain measures to be useful to managementand investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity andmanagement of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capitalfor deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases anddebt repayment. These metrics, however, are not measures of financial performance under accounting principles generally accepted in the UnitedStates of America (“GAAP”) and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic anddiluted) or net cash from operations as determined in accordance with GAAP. We consider the following non-GAAP measures, which may not becomparable 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 foreign currency fluctuations andcontributions from acquisitions and divestitures. Divestitures include sales of insignificant portions of our business that did not meet thecriteria for classification as a discontinued32operation. The period-over-period change resulting from foreign currency fluctuations assumes no change in exchange rates from the priorperiod.•"constant currency" defined as financial results adjusted for currency translation impacts by translating current period and prior period activityusing 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 excludenon-recurring separation costs from the Spin-off (not excluded after 2012), restructuring and realignment costs, gain on sale of business,special charges and tax-related special items. A reconciliation of adjusted net income is provided below.(in millions, except per share data) 2014 2013 2012Net income $337 $228 $297Separation costs, net of tax (a) — — 16Restructuring and realignment, net of tax 31 46 17Special charges, net of tax — 23 —Tax-related special items 5 14 —Gain on sale of business, net of tax (11) — —Adjusted net income $362 $311 $330Weighted average number of shares - Diluted 184.2 186.0 186.2Adjusted earnings per share $1.97 $1.67 $1.77(a)Costs of $4 million ($2 million, net of tax) during 2013, associated with non-recurring separation activities are not excluded from adjusted netincome.•"operating expenses excluding separation, restructuring and realignment costs and special charges" defined as operating expenses,adjusted to exclude non-recurring separation costs from the Spin-off (not excluded after 2012), restructuring and realignment costs andspecial charges.•"adjusted segment operating income" defined as segment operating income, adjusted to exclude non-recurring separation costs from theSpin-off (not excluded after 2012), restructuring and realignment costs, and "adjusted segment operating margin" defined as adjustedsegment operating income divided by total segment revenue.•“realignment costs” defined as non-recurring costs not included in restructuring costs that are incurred as part of actions taken to repositionour business, including items such as professional fees, relocation, travel and other costs.•“special charges" defined as costs incurred by the Company associated with the settlement of legal proceedings with Xylem Group LLC andcertain costs incurred for the change in chief executive officer made during the third quarter of 2013, as well as costs incurred in the fourthquarter of 2013 for the contractual indemnification of federal tax obligations to ITT and costs associated with a legal judgment arising from ahistorical acquisition matter.•"free cash flow" defined as net cash provided by operating activities less capital expenditures, as well as adjustments for other significantitems that impact current results that management believes are not related to our ongoing operations and performance. Our definition of freecash flow does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of freecash flow.(in millions) 2014 2013 2012Net cash provided by operating activities $416 $324 $396Capital expenditures (119) (126) (112)Separation cash payments (a) — — 28Free cash flow $297 $198 $312(a)Separation cash payments associated with non-recurring separation activities are included in the 2013 free cash flow. Separation cashpayments are excluded from free cash flow in 2012 and include capital expenditures associated with the Spin-off of $4 million.33Executive SummaryXylem reported revenue for 2014 of $3,916 million, an increase of 2.1% from $3,837 million reported in 2013. Significant growth in the industrialand public utility end markets combined with strength in the emerging markets, most notably in China, drove the increase. Continued challengingmarket conditions limited growth in other regions, Europe, for example, was flat organically year-over-year, while Japan and Australia declined.Operating income for 2014 was $463 million, reflecting an increase of $100 million or 27.5% compared to $363 million in 2013, which was primarilydue to savings from lean six sigma activities, global sourcing initiatives and restructuring actions as well as lapping $24 million in non-recurringspecial charges in 2013, which more than offset headwinds from cost inflation and unfavorable sales mix. Additionally, restructuring andrealignment cost actions taken to improve the overall cost base of the business were $43 million in 2014 as compared to $64 million in the prioryear.Additional financial highlights for 2014 include the following:•Net income of $337 million, or $1.83 per diluted share ($362 million or $1.97 per diluted share on an adjusted basis)•Free cash flow of $297 million, and net cash from operating activities of $416 million•Orders of $4,021 million (a 3.9% increase from 2013 on a constant currency basis)•We repurchased $130 million in shares under the $250 million share repurchase program approved by our Board of Directors in 2013 as partof our strategy to enhance shareholder return•Dividends paid to shareholders increased 10.0% in 2014.2015 Business OutlookIn 2015, we are anticipating organic revenue growth of low single digits. The projected organic growth excludes an expected negative foreignexchange translation impact on growth of high single digits, primarily driven by a weaker Euro to U.S. dollar. We expect continued strength in theUnited States industrial markets, but a modest deceleration in emerging market growth and weakness in the oil and gas markets to result in lowsingle digit growth overall for the industrial end market. We expect public utilities to also increase at low single digits where emerging marketinfrastructure investments continue to bolster growth and we see improving market conditions in the United States. In the commercial market, weanticipate growth of low to mid-single digits as the United States appears to continue to slowly recover and emerging markets continue to bestrong, which we expect will be partially offset by soft European markets. We believe the residential markets will be flat to down low single digitsas the United States markets moderate and Europe continues to be negative. Finally, the agriculture markets, which is our smallest end market,we expect will likely be relatively flat compared to 2014 as we are expecting slower growth in the United States from lapping of a strong 2014combined with stabilization in Europe and continued strength in emerging markets.We will continue to execute restructuring and realignment actions to reposition our European and North American business to optimize our coststructure and improve our operational efficiency and effectiveness. During 2014, we incurred $26 million and $17 million in restructuring andrealignment costs, respectively. As a result of the restructuring actions in 2014, we realized $13 million of net savings. In 2015, we expect to incurapproximately $20 million in restructuring and realignment costs. We expect to realize approximately $16 million of incremental net savings in 2015from actions initiated in 2014, and an additional $2 million of net savings from our 2015 actions. Additional strategic actions we are taking includestrategic initiatives to drive above-market growth, advance continuous improvement activities to increase productivity, focus on improving cashperformance and drive a disciplined capital deployment strategy.34Results of Operations(in millions) 2014 2013 2012 2014 v. 2013 2013 v. 2012Revenue $3,916 $3,837 $3,791 2.1 % 1.2 %Gross profit 1,513 1,499 1,502 0.9 % (0.2)%Gross margin 38.6% 39.1% 39.6% (50)bp (50)bpOperating expenses excluding separation,restructuring and realignment costs and specialcharges (a) 1,007 1,048 1,013 (3.9)% 3.5 %Expense to revenue ratio 25.7% 27.3% 26.7% (160)bp 60bpRestructuring and realignment costs 43 64 24 (32.8)% 166.7 %Separation costs (a) — — 22 — % NMSpecial charges — 24 — NM NMTotal operating expenses 1,050 1,136 1,059 (7.6)% 7.3 %Operating income 463 363 443 27.5 % (18.1)%Operating margin 11.8% 9.5% 11.7% 230bp (220)bpInterest and other non-operating expense(income), net 53 65 55 (18.5)% 18.2 %Gain on sale of business 11 — — NM — %Income tax expense 84 70 91 20.0 % (23.1)%Tax rate 19.8% 23.5% 23.4% (370)bp 10bpNet income $337 $228 $297 47.8 % (23.2)%(a)Separation costs of $4 million ($2 million, net of tax) during 2013 are included within the $1,048 million of operating expenses.NM Not Meaningful2014 versus 2013RevenueRevenue generated for 2014 was $3,916 million, an increase of $79 million, or 2.1%, compared to $3,837 million in 2013. On a constant currencybasis, revenue grew 3.3%. The following table illustrates the impact on 2014 revenue from organic growth, recent acquisitions, and fluctuations inforeign currency.(in millions)$ Change % Change2013 Revenue$3,837 Organic Growth134 3.5 %Acquisitions/(Divestitures)(6) (0.2)%Constant Currency128 3.3 %Foreign currency translation (a)(49) (1.3)%Total change in revenue79 2.1 %2014 Revenue$3,916 (a)Foreign currency impact primarily due to weakness in the value of the Canadian Dollar, Australian Dollar, Argentine Peso, Swedish Krona andNorwegian Krone against the U.S. Dollar, partially offset by strength in the value of the British Pound against the U.S. Dollar.35The following table summarizes revenue by segment for 2014 and 2013:(in millions)2014 2013 As Reported Change Constant CurrencyChangeWater Infrastructure$2,442 $2,384 2.4% 4.4%Applied Water1,474 1,453 1.4% 1.6%Total$3,916 $3,837 2.1% 3.3%Water InfrastructureWater Infrastructure’s revenue increased $58 million, or 2.4% in 2014 (4.4% on a constant currency basis). The 4.4% constant currency increasereflects growth within the industrial water and public utility end markets and $6 million of incremental revenue from our 2013 acquisitions.Organic revenue increased $99 million or 4.2% during the year, which was substantially due to higher volumes in transport, test and treatmentapplications. Revenue from transport applications grew primarily from increased industrial dewatering applications in the United States from oil andgas market-related rental activities. Transport also grew organically from public utility pump and aftermarket demand. Revenue from testapplications increased due to significant strength in the United States from increased government spending coupled with the continued success ofnew products and cross-selling of our European technologies. Revenue from treatment applications grew from the delivery of several large projectsin the emerging markets, particularly in Latin America, partially offset by lower deliverable project backlog in the United States and Europeanmarkets.Applied WaterApplied Water’s revenue increased $21 million, or 1.4% in 2014 (a 1.6% increase on a constant currency basis). The growth on a constantcurrency basis is driven primarily by organic revenue growth of $35 million, or 2.4% versus the prior year due to strength in the commercial buildingservices, industrial water and agriculture end markets, which more than offset declines in the residential building services. The increase in thecurrent year was partially offset by the absence of revenue from our Wolverhampton valves business following its divestiture in the third quarter of2014 as compared to $12 million of revenue for the comparative period in 2013.Organic revenue increased $35 million or 2.4% for the year due primarily to commercial building recovery in the United States institutional buildingmarket, including distributor restocking and promotional activity. Also contributing to the organic growth was industrial water application strengthacross all regions, particularly from projects in the Middle East and Latin America. Irrigation application revenue also grew, driven by the timing ofproject shipments and increased demand for vertical turbines. A decline in European demand for residential applications partially offset organicgrowth.Orders/BacklogOrders received during 2014 increased by $109 million, or 2.8% to $4,021 million (a 3.9% increase on a constant currency basis). Organic ordergrowth increased $153 million or 3.9% for the year.Water Infrastructure segment orders increased $68 million, or 2.8% to $2,511 million (4.4% growth on a constant currency basis), including $8million from acquisitions. Organic order growth of 4.1% was primarily due to higher industrial demand within transport for wastewater pumps in theUnited States and Europe as well as strength within the dewatering business for rental and equipment sales into oil and gas markets. Orders fortest applications also bolstered the growth for the segment from large orders in the United States. The strength in transport and test offset declinesin treatment from project delays in the United States and Europe.Orders increased in our Applied Water segment $41 million, or 2.8% to $1,510 million (3.0% growth on a constant currency basis). Organic growthof 3.6% was driven by strong performance in the commercial building services and industrial water markets in the United States, as well ascontinued strength in China. The growth was partially offset by weakness in the residential markets of Europe.Delivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cycles,and delays can occur from time to time. Total backlog was $740 million at December 31, 2014 and $707 million at December 31, 2013. Weanticipate that more than 85% of the backlog at December 31, 2014 will be recognized as revenue during 2015.36Gross MarginGross margins as a percentage of consolidated revenue declined to 38.6% in 2014 from 39.1% in 2013. The decrease is primarily attributable tolower margin sales within the Water Infrastructure segment caused by higher mix sold to emerging markets, which have lower margins, inconjunction with foreign exchange headwinds as well as unfavorable product sales mix. These negative impacts were partially mitigated bybenefits from restructuring savings and cost-saving initiatives through lean six sigma and global sourcing across both segments.Operating Expenses(in millions)2014 2013 ChangeSelling, General and Administrative (SG&A)$920 $986 (6.7)%SG&A as a % of revenue23.5% 25.7% (220)bpResearch and Development (R&D)104 104 — %R&D as a % of revenue2.7% 2.7% —Restructuring and asset impairment charges26 42 (38.1)%Separation Costs— 4 NMOperating expenses$1,050 $1,136 (7.6)%Expense to revenue ratio26.8% 29.6% (280)bpNM Not meaningful percentage changeSelling, General and Administrative ExpensesSG&A decreased by $66 million or 6.7% to $920 million, or 23.5% of revenue in 2014, as compared to $986 million or 25.7% of revenue in 2013.The decrease in SG&A expenses as a percentage of revenue is due primarily to savings from restructuring actions combined with lapping theimpacts from non-recurring special charges in 2013 of $24 million, which comprise the legal settlement with Xylem Group LLC, costs incurred forthe change in our chief executive officer, costs incurred for the contractual indemnification of federal tax obligations to ITT and costs associatedwith a legal judgment arising from a historical acquisition matter. The decrease was also driven by $7 million less realignment costs in 2014, whichwere costs incurred by the Company to reposition our European business in an effort to optimize our cost structure and improve our operationalefficiency and effectiveness as well as implement our new organizational structure.Research and Development ExpensesR&D spending was flat at $104 million or 2.7% of revenue in both 2014 and 2013.Restructuring and Asset Impairment ChargesDuring 2014, we incurred restructuring costs of $19 million, $6 million and $1 million in our Water Infrastructure and Applied Water segments, andCorporate and other, respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and NorthAmerica to optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount and consolidationof facilities. During 2013, we recognized restructuring costs of $31 million and $9 million in our Water Infrastructure and Applied Water segments,respectively. These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to addressdeclines in sales volumes and optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease inheadcount and consolidation of facilities.Total expected costs associated with actions that commenced during 2014 are approximately $22 million for Water Infrastructure, approximately$10 million for Applied Water and approximately $1 million for Corporate and other. These costs primarily comprise severance charges. The WaterInfrastructure and Applied Water actions are expected to continue through 2015. The Corporate and other actions are complete. As a result ofthese actions initiated in 2014, we achieved savings of approximately $13 million in 2014 and estimate annual future net savings beginning in 2015of approximately $29 million.37Additionally, in the fourth quarter of 2013, we recorded a $2 million impairment charge related to three trade names in our Water Infrastructuresegment associated with acquired businesses within our Analytics operating unit, reflecting a decline in their value since being acquired. Refer toNote 11, “Goodwill and Other Intangible Assets,” for additional information.Operating IncomeWe generated operating income of $463 million during 2014, a $100 million or 27.5% increase from the prior year operating income of $363 million,primarily reflecting cost-saving initiatives and savings from restructuring actions. These benefits were partially offset by cost inflation combinedwith unfavorable impacts from our geographic and product sales mix described above. Another driving factor in the year-over-year improvementwas the absence of the aforementioned special charges in 2013 within SG&A, which did not recur as well as lower restructuring and realignmentcosts. The following table illustrates operating income results by business segments for 2014 and 2013.(in millions)2014 2013 ChangeWater Infrastructure$321 $263 22.1 %Applied Water193 175 10.3 %Segment operating income514 438 17.4 %Corporate and other(51) (75) (32.0)%Total operating income$463 $363 27.5 %Operating margin Water Infrastructure13.1% 11.0% 210bpApplied Water13.1% 11.6% 150bpTotal Xylem11.8% 9.5% 230bpThe table included below provides a reconciliation from segment operating income to adjusted operating income, and a calculation of thecorresponding adjusted operating margin.(in millions)2014 2013 ChangeWater Infrastructure Operating income$321 $263 22.1 %Restructuring and realignment costs29 48 (39.6)%Special charges— 4 NMAdjusted operating income$350 $315 11.1 %Adjusted operating margin14.3% 13.2% 110bpApplied Water Operating income193 175 10.3 %Restructuring and realignment costs13 16 (18.8)%Adjusted operating income$206 $191 7.9 %Adjusted operating margin14.0% 13.1% 90bpTotal Xylem Operating income$463 $363 27.5 %Restructuring and realignment costs43 64 (32.8)%Special charges— 24 NMAdjusted operating income$506 $451 12.2 %Adjusted operating margin12.9% 11.8% 110bpNM Not meaningful percentage change38Water InfrastructureOperating income for our Water Infrastructure segment increased $58 million or 22.1% (increased $35 million or 11.1% on an adjusted basis)compared with the prior year. The 11.1% increase was primarily driven by higher volume, restructuring savings and cost reduction initiatives, suchas global sourcing and lean six sigma. The increase was partially offset by cost inflation, unfavorable sales mix and price.Applied WaterOperating income for our Applied Water segment increased $18 million or 10.3% (increased $15 million or 7.9% on an adjusted basis) compared tothe prior year. The 7.9% increase was driven by lean six sigma initiatives, global sourcing and restructuring savings combined with modest pricerealization. The increase was partially offset by cost inflation and unfavorable foreign exchange headwinds.Interest ExpenseInterest expense was $54 million and $55 million for 2014 and 2013, respectively, primarily related to interest expense on $1.2 billion aggregateprincipal amount of our senior notes. Refer to Note 14, “Credit Facilities and Long-Term Debt,” for further details.Income Tax ExpenseThe income tax provision for 2014 was $84 million at an effective tax rate of 19.8% compared to $70 million at an effective tax rate of 23.5% in2013. The 2014 effective tax rate is lower than 2013 due primarily to geographic mix of earnings.Other Comprehensive Income/(Loss)Other comprehensive loss before tax of $284 million in 2014 as compared to income of $74 million in 2013 was primarily due to a $221 millionforeign currency translation impact due to a weakening of the Euro, British Pound and Swedish Krona against the U.S. dollar. Further contributingto the year-over-year decline was a $110 million net loss in postretirement benefit plans in 2014 as compared to a net gain of $34 million in 2013due to a decrease in discount rates, partially mitigated by actual gains on plan assets in excess of the assumed long-term rate of return. Theeffective tax rate on other comprehensive income decreased as compared to 2013 due primarily to the shift in comprehensive earnings fromforeign currency translation, which is not taxable, as well as from a change in the jurisdictional mix of net gains and losses from postretirementbenefit plans.392013 versus 2012RevenueRevenue generated for 2013 was $3,837 million, an increase of $46 million, or 1.2%, compared to $3,791 million in 2012. On a constant currencybasis, revenue grew 1.1%. The following table illustrates the impact from organic growth, recent acquisitions, and fluctuations in foreign currency,in relation to revenue during 2013.(in millions)$ Change % Change2012 Revenue$3,791 Organic Growth(39) (1.0)%Acquisitions82 2.2 %Constant Currency43 1.1 %Foreign currency translation (a)3 0.1 %Total change in revenue46 1.2 %2013 Revenue$3,837 (a)Foreign currency impact primarily due to strength in the value of the Euro and Swedish Krona against the U.S. Dollar, partially offset by weakness inthe value of the Australian Dollar, South African Rand, Canadian Dollar and British Pound against the U.S. Dollar.The following table summarizes revenue by segment for 2013 and 2012:(in millions)2013 2012 As Reported Change Constant CurrencyChangeWater Infrastructure$2,384 $2,349 1.5% 1.7%Applied Water1,453 1,442 0.8% 0.3%Total$3,837 $3,791 1.2% 1.1%Water InfrastructureWater Infrastructure’s revenue increased $35 million, or 1.5% in 2013 (1.7% on a constant currency basis). Our 2012 and 2013 acquisitionscontributed $82 million of incremental revenue in 2013.Organic revenue decreased $43 million or 1.8% during the year, which was due substantially to lower volumes across the transport, treatment andtest applications. The significant declines were caused primarily by weakness in the Europe, Middle East and Africa treatment markets anddeclines in transport in the Asia Pacific markets from less mining activity. Organic revenue performance improved year-over-year in the third andfourth quarters of 2013 driven by increases in transport revenue, which reflected modest market recovery in northern and central Europe as well asthe United States. Treatment negatively impacted organic growth for the year as revenue decreased from 2012 due substantially to non-recurringlarge custom projects shipped in the prior year as well as project delays from government funding uncertainties. Additionally, test applications,which had flat organic revenue in 2013, experienced lower revenue for the year from delays in orders and the government sequestration in theUnited States during the first half of 2013, which were offset by revenue growth in the second half of the year, specifically in Europe, as well asincremental revenue from price increases, new products and cross-branding initiatives.Applied WaterApplied Water’s revenue increased $11 million, or 0.8% in 2013 (a 0.3% increase on a constant currency basis). The growth on a constantcurrency basis was driven by organic revenue growth predominately due to irrigation and industrial water applications.Organic revenue increased $4 million or 0.3% for the year due primarily to irrigation application revenue caused by drought conditions in the UnitedStates. Strength in the industrial water application also bolstered revenue, particularly within China from large fire pump projects as well as innorthern Europe from increased industrial multistage pump revenue. These revenue increases were partially offset by weakness in Europe,particularly within the residential and commercial building services markets of southern Europe, combined with sluggish industrial and commercialbuilding service markets in the United States and Latin America.40Orders/BacklogOrders received during 2013 increased by $130 million, or 3.4% to $3,912 million (a 3.4% increase on a constant currency basis). These amountsinclude a benefit of $87 million from acquisitions. Organic order growth was $43 million for the year.The Water Infrastructure segment orders increased $79 million, or 3.3% to $2,443 million (3.6% growth on a constant currency basis), including$87 million from acquisitions. Orders increased slightly on a constant currency basis due primarily to a strong second half of 2013 driven by highertransport volume from Europe public utilities and the dewatering business, combined with healthy growth in emerging markets. Orders increased inour Applied Water segment $51 million, or 3.6% to $1,469 million (3.2% growth on a constant currency basis), driven by strong performance in thecommercial building services and industrial water markets in China as well as orders within the residential building services and agriculturemarkets in the United States during 2013, partially offset by weakness in Southern Europe across all end markets.Delivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cyclesand delays can occur from time to time. Total backlog was $707 million at December 31, 2013 and $647 million at December 31, 2012.Gross MarginGross margins as a percentage of consolidated revenue declined to 39.1% in 2013 from 39.6% in 2012. The decrease is attributable to negativeprice realization, geographic sales mix and additional costs associated with recent acquisitions. These negative impacts were partially mitigatedby benefits from restructuring savings and cost saving initiatives such as lean six sigma and global sourcing.Operating Expenses(in millions)2013 2012 ChangeSelling, General and Administrative (SG&A)$986 $914 7.9 %SG&A as a % of revenue25.7% 24.1% 160bpResearch and Development (R&D)104 106 (1.9)%R&D as a % of revenue2.7% 2.8% (10)bpRestructuring and asset impairment charges42 17 147.1 %Separation Costs4 22 (81.8)%Operating expenses$1,136 $1,059 7.3 %Expense to revenue ratio29.6% 27.9% 170bpSelling, General and Administrative ExpensesSG&A increased by $72 million or 7.9% to $986 million or 25.7% of revenue in 2013, as compared to $914 million or 24.1% of revenue in 2012.The increase in SG&A expenses as a percentage of revenue is primarily due to the combined impacts from the legal settlement with Xylem GroupLLC and costs incurred for the change in our chief executive officer of $20 million. The increase was also driven by realignment costs of $17million during 2013 incurred by the Company to reposition our European business in an effort to optimize our cost structure and improve ouroperational efficiency and effectiveness. Acquisitions, increased pension costs and investments in growth platforms also contributed to theincrease.Research and Development ExpensesR&D spending decreased $2 million or 1.9% to $104 million or 2.7% of revenue for 2013 as compared to $106 million or 2.8% of revenue in 2012.41Restructuring and Asset Impairment ChargesDuring 2013, we incurred restructuring costs of $31 million and $9 million in our Water Infrastructure and Applied Water segments, respectively.These charges were incurred primarily in an effort to realign our organizational structure in Europe and North America to address declines in salesvolumes and optimize our cost structure. The charges relate to the reduction in structural costs, including a decrease in headcount andconsolidation of facilities. During 2012, we recognized restructuring charges of $17 million related to restructuring related severance payments formanufacturing reduction in force initiatives primarily within our Water Infrastructure segment.Total expected costs associated with actions that commenced during 2013 are approximately $32 million for Water Infrastructure andapproximately $8 million for Applied Water. These costs primarily comprise severance charges. These actions are substantially complete. As aresult of actions initiated during 2013, we achieved net savings of approximately $13 million in 2013 and annual future net savings beginning in2014 of approximately $36 million.Additionally, in the fourth quarter of 2013 we recorded a $2 million impairment charge related to three trade names in our Water Infrastructuresegment associated with acquired businesses within our Analytics operating unit, reflecting a decline in their value since being acquired. Refer toNote 11, “Goodwill and Other Intangible Assets,” for additional information.Separation CostsWe had non-recurring separation costs related to our Spin-off from ITT as presented below.(in millions)2013 2012Rebranding and marketing costs$— $8Advisory and professional fees— 7Information and technology costs2 3Employee retention and hiring costs— 1Lease termination and other real estate costs2 1Other— 2Total separation costs in operating income4 22Income tax benefit(2) (6)Total separation costs, net of tax$2 $16Operating IncomeWe generated operating income of $363 million during 2013, an $80 million or 18.1% decrease from the prior year operating income of $443 million,primarily reflecting higher operating expenses as increased SG&A, and restructuring and asset impairment charges more than offset reductionsfrom lower separation costs and savings from restructuring activities. The following table illustrates operating income results by businesssegments for 2013 and 2012.(in millions)2013 2012 ChangeWater Infrastructure$263 $334 (21.3)%Applied Water175 178 (1.7)%Segment operating income438 512 (14.5)%Corporate and other(75) (69) 8.7 %Total operating income$363 $443 (18.1)%Operating margin Water Infrastructure11.0% 14.2% (320)bpApplied Water12.0% 12.3% (30)bpTotal Xylem9.5% 11.7% (220)bp42The table included below provides a reconciliation from segment operating income to adjusted operating income, and a calculation of thecorresponding adjusted operating margin.(in millions)2013 2012 ChangeWater Infrastructure Operating income$263 $334 (21.3)%Separation costs— 4 NMRestructuring and realignment costs48 19 152.6 %Special charges4 — NMAdjusted operating income$315 $357 (11.8)%Adjusted operating margin13.2% 15.2% (200)bpApplied Water Operating income175 178 (1.7)%Separation costs— 2 NMRestructuring and realignment costs16 5 220.0 %Adjusted operating income$191 $185 3.2 %Adjusted operating margin13.1% 12.8% 30bpTotal Xylem Operating income$363 $443 (18.1)%Separation costs*— 22 NMRestructuring and realignment costs64 24 166.7 %Special charges24 — NMAdjusted operating income*$451 $489 (7.8)%Adjusted operating margin*11.8% 12.9% (110)bpNM Not meaningful percentage change*Costs associated with non-recurring separation activities of $4 million ($2 million, net of tax) during 2013 are not excluded from adjusted operatingincome.Water InfrastructureOperating income for our Water Infrastructure segment decreased $71 million or 21.3% (decreased $42 million or 11.8% on an adjusted basis)compared with the prior year. The 11.8% decrease was driven by lower volume, inflation, unfavorable foreign exchange impacts, costs associatedwith the establishment of our European headquarters and investments in growth platforms, specifically acquisitions and new product launches. Thedecrease was partially offset by restructuring savings and cost reduction initiatives, such as global sourcing and lean six sigma.Applied WaterOperating income for our Applied Water segment decreased $3 million or 1.7% (increased $6 million or 3.2% on an adjusted basis) compared tothe prior year. The 3.2% increase was driven by lean initiatives, global sourcing and price realization partially offset by inflation and new productdevelopment.Interest ExpenseInterest expense was $55 million for both 2013 and 2012, reflecting the same full year of interest expense related to the issuance of $1.2 billionaggregate principal amount of our senior notes. Refer to Note 14, “Credit Facilities and Long-Term Debt,” for further details.Income Tax ExpenseThe income tax provision for 2013 was $70 million at an effective tax rate of 23.5% compared to $91 million at an effective tax rate of 23.4% in2012. The 2013 effective tax rate is higher than 2012 due to an increase in foreign repatriations partially offset by mix of earnings.43Other Comprehensive Income/(Loss)Other comprehensive income before tax of $74 million in 2013 compared to a loss of $30 million in 2012, an improvement of $104 million, wasprimarily due to a $34 million net gain in 2013 as compared to a net loss of $84 million in 2012 related to postretirement benefit plans. The net gainin 2013 was due to an increase in discount rates as well as actual gains on plan assets in excess of the assumed long-term rate of return ascompared to the net loss in 2012 which was due to a reduction in discount rates, partially mitigated by actual gains on plan assets in excess of theassumed long-term rate of return. This year-over-year improvement was partially offset by a $33 million reduction in foreign currency translationbenefit primarily due to the Euro, Swedish Krona and British Pound strengthening against the U.S. dollar. The effective tax rate on othercomprehensive income decreased as compared to 2012 due primarily to the shift in comprehensive earnings from foreign currency translation,which is not taxable, as well as from a change in the jurisdictional mix of net gains and losses from postretirement benefit plans.Liquidity and Capital ResourcesThe following table summarizes our sources and uses of cash: Year Ended December 31,(in millions)2014 2013 2012Operating activities$416 $324 $396Investing activities(86) (199) (147)Financing activities(147) (100) (74)Foreign exchange (a)(53) 4 11Total$130 $29 $186(a)2014 impact is primarily due to the weakness of the Euro against the US Dollar.Sources and Uses of LiquidityOperating ActivitiesDuring 2014, net cash provided by operating activities was $416 million, compared to $324 million in 2013. The $92 million year-over-year increasewas driven by an increase in income, as well as a modest improvement in working capital performance. Reductions in payments made forrestructuring and postretirement plan contributions in 2014 were largely offset by an increase in tax payments. Also contributing to the increasewas a refund of value-added tax in the current year that had been paid during 2013.During 2013, net cash provided by operating activities was $324 million, compared to $396 million in 2012. The $72 million year-over-year decreasewas driven by an increase in the use of working capital in both segments, due to increased accounts receivable primarily from longer collectiontimes in Europe, and increased inventories to support a higher backlog as well as to be able to support shorter lead times. Additionally, revenuevolume declines during the first half of 2013 reduced cash inflow from income. Payments made for restructuring and realignment activities in 2013also contributed to the decline, largely offset by lower tax payments.Investing ActivitiesCash used in investing activities was $86 million for 2014, compared to $199 million in 2013. The decrease of $113 million was primarily driven bya decrease in acquisition activity as there were no acquisitions in 2014, whereas we spent $81 million for the acquisitions during 2013. Alsocontributing to the decrease was the receipt of $30 million in 2014 for the sale of a business. Capital expenditures were also lower in 2014, with a$7 million reduction primarily due to a decrease in the spending on post Spin-off information technology investments and the relocation of ourcorporate headquarters.44Cash used in investing activities was $199 million in 2013 compared to $147 million in 2012. The changes in investing activities are driven almostentirely by acquisitions activity and, to a lesser extent, from changes in spending on capital expenditures. Cash used for acquisitions was $81million in 2013 compared to $41 million during 2012. Capital expenditures were $126 million in 2013 and $112 million in 2012. The increase incapital expenditures were primarily due to information technology investments within both the Applied Water segment and Corporate as a result ofsystem requirements subsequent to the Spin-off in addition to capital expenditures required for the relocation of our corporate headquarters asrequired by the Spin-off from ITT.Financing ActivitiesCash used by financing activities was $147 million, $100 million and $74 million during 2014, 2013 and 2012, respectively. The increases in cashused for financing activities was primarily driven by an increase in share repurchase activity and dividend payments. In 2014, share repurchaseactivity increased $61 million and dividend payments increased $7 million compared to 2013. Additionally, there was an increase in short-term debtfor borrowings under the European Investment Bank facility of $50 million in 2014 versus $38 million in 2013. In 2013, increases in sharerepurchase activity and dividend payments were $60 million and $12 million, respectively, compared to 2012. The 2013 share repurchase activitywas impacted by $50 million of repurchases under a new share repurchase program approved on August 20, 2013 by the Board of Directors torepurchase up to $250 million in shares.Funding and Liquidity StrategyOur ability to fund our capital needs depends on our ongoing ability to generate cash from operations, and access to the bank and capital markets.Our global funding requirements are continually monitored with appropriate strategies executed to ensure liquidity needs are met cost effectively.Based on our current global cash positions, cash flows from operations and access to the commercial paper markets, we believe there is sufficientliquidity to meet our funding requirements. In addition, our existing committed credit facilities and access to the public debt markets would providefurther liquidity if required.Historically, we have generated operating cash flow sufficient to fund our primary cash needs centered on operating activities, working capital,capital expenditures, and strategic investments. If our cash flows from operations are less than we expect, we may need to incur debt or issueequity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and theavailability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings orabsence 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 thatwe will continue to have access to the capital markets on terms acceptable to us or that financing will be available at all.We anticipate that our present sources of funds, including funds from operations, will provide us with sufficient liquidity and capital resources tomeet our global liquidity and capital needs over the next twelve months.Senior NotesOn September 20, 2011, we issued 3.550% Senior Notes of $600 million aggregate principal amount due September 2016 (the "Senior Notes due2016") and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021" and together with theSenior Notes due 2016, the "Senior Notes").The Senior Notes include covenants which restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale andleaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/orcustomary grace and cure periods). We may redeem the Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal tothe principal amount of the Senior Notes to be redeemed, plus a make-whole premium. If a change of control triggering event (as defined in theSenior Notes) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plusaccrued and unpaid interest to the date of repurchase. As of December 31, 2014, we were in compliance with all covenants.Interest on the Senior Notes due 2016 is payable on March 20 and September 20 of each year. Interest on the Senior Notes due 2021 is payableon April 1 and October 1 of each year.45Four Year Competitive Advance and Revolving Credit FacilityEffective October 31, 2011, Xylem and its subsidiaries entered into a Four Year Competitive Advance and Revolving Credit Facility (the "CreditFacility") with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders. The Credit Facility provides for an aggregateprincipal amount of up to $600 million of: (i) a competitive advance borrowing option which will be provided on an uncommitted competitiveadvance basis through an auction mechanism (the "competitive loans"), (ii) revolving extensions of credit (the "revolving loans") outstanding at anytime and (iii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time.At our election, the interest rate per annum applicable to the competitive advances will be based on either (i) a Eurodollar rate determined byreference to LIBOR, plus an applicable margin offered by the lender making such loans and accepted by us or (ii) a fixed percentage rate perannum specified by the lender making such loans. At our election, interest rate per annum applicable to the revolving loans will be based on either(i) a Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin or (ii) a fluctuatingrate of interest determined by reference to the greatest of: (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the U.S. Federal Funds effectiverate plus half of 1% or (c) the Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, in each case, plus anapplicable margin.In accordance with the terms, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debt to earnings before interest,taxes, depreciation and amortization) throughout the term. The Credit Facility also contains limitations on, among other things, incurring debt,granting liens, and entering sale and leaseback transactions. In addition, the Credit Facility contains other terms and conditions such ascustomary representations and warranties, additional covenants and customary events of default. As of December 31, 2014, we were incompliance with all covenants.As of December 31, 2014, this credit facility remains undrawn. Our intention is to renew the Credit Facility in 2015.Research and Development Facility AgreementOn December 4, 2013, the Company amended and restated its Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with TheEuropean Investment Bank (the "EIB") to add an additional borrower under the facility. The facility provides an aggregate principal amount of up to€120 million (approximately $146 million) to finance research projects and infrastructure development in the European Union. The Company'swholly-owned subsidiaries in Luxembourg, Xylem Holdings S.á.r.l. and Xylem International S.á.r.l., are the borrowers under the R&D FacilityAgreement. The obligations of the borrowers under the R&D Facility Agreement are guaranteed by the Company under an Amended and RestatedDeed of Guarantee, dated as of December 4, 2013, in favor of the EIB. The funds are available to finance research and development projectsduring the period from 2013 through 2016 at the Company's R&D facilities in Sweden, Germany, Italy, the United Kingdom, Austria, Norway andHungary.Under the R&D Facility Agreement, the borrower can draw loans on or before June 14, 2015 with a maturity of no longer than 12 years. The R&DFacility Agreement provides for Fixed Rate loans and Floating Rate loans. The interest rate per annum applicable to Fixed Rate loans will be at afixed percentage rate per annum specified by the EIB which includes the applicable margin. The interest rate per annum applicable to FloatingRate loans will be at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S.Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin for both Fixed Rate loans andFloating Rate loans shall be determined by reference to the credit rating of the Company.In accordance with the terms of the R&D Facility Agreement, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debtto earnings before interest, taxes, depreciation and amortization) throughout the term. The R&D Facility Agreement also contains limitations on,among other things, incurring debt, granting liens, and entering into sale and leaseback transactions. In addition, the R&D Facility Agreementcontains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. Asof December 31, 2014, we were in compliance with all covenants.As of December 31, 2014, $84 million was outstanding under the R&D Facility Agreement. Although the borrowing term for this arrangement is forfive years, we have classified it as short-term debt on our Consolidated Balance Sheet since we intend to repay this obligation in less than oneyear.46Non-U.S. OperationsFor both 2014 and 2013, we generated 62% of our revenue from non-U.S. operations. As we continue to grow our operations in the emergingmarkets and elsewhere outside of the United States, we expect to continue to generate significant revenue from non-U.S. operations and weexpect our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements consideringavailable funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can beaccessed. We may transfer cash from certain international subsidiaries to the U.S. and other international subsidiaries when it is cost effective todo so. Our intent is to indefinitely reinvest all but $65 million of these funds outside of the United States. However, we continually review ourdomestic and foreign cash profile, expected future cash generation and investment opportunities that support our current designation of thesefunds as being indefinitely reinvested and reassess whether there is a demonstrated need to repatriate funds held internationally to support ourU.S. operations. If, as a result of our review, it is determined that all or a portion of the funds may be needed for our operations in the UnitedStates, we would be required to accrue U.S. taxes related to future tax payments associated with the repatriation of these funds. As ofDecember 31, 2014, our foreign subsidiaries were holding $537 million in cash or marketable securities.As of December 31, 2014, our excess of financial reporting over the tax basis of investments in certain foreign subsidiaries totaled $1.9 billion. Wehave not asserted that $65 million of our excess basis difference will be indefinitely reinvested and have therefore provided for United States oradditional foreign withholding taxes for that portion. Generally, such amounts become subject to U.S. taxation upon the remittance of dividendsand under certain other circumstances.Contractual ObligationsThe following table summarizes our contractual commitments as of December 31, 2014:(in millions)2015 2016 - 2017 2018 - 2019 Thereafter TotalDebt and capital lease obligations (1)$89 $600 $— $600 $1,289Interest payments (2)51 80 59 58 248Operating lease obligations63 81 37 25 206Purchase obligations (3)54 7 — — 61Other long-term obligations reflected on thebalance sheet1 2 2 21 26Total commitments$258 $770 $98 $704 $1,830In addition to the amounts presented in the table above, we have recorded liabilities for uncertain tax positions of $44 million. These amounts have beenexcluded from the contractual obligations table due to an inability to reasonably estimate the timing of such payments in individual years. Further, benefitpayments which reflect expected future service related to the Company's pension and other postretirement employee benefit obligations are presented inNote 15, “Postretirement Benefit Plans” and not included in the above table. Finally, estimated environmental payments 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 andremediation. At December 31, 2014, we had estimated and accrued $5 million related to environmental matters.(1)Refer to Note 14, “Credit Facilities and Long-Term Debt,” in the notes to the consolidated financial statements for discussion of the use and availabilityof debt and revolving credit agreements. Amounts represent principal payments of long-term debt including current maturities and excludeunamortized discounts.(2)Amounts represent estimate of future interest payments on long-term debt outstanding as of December 31, 2014.(3)Represents unconditional purchase agreements that are enforceable and legally binding and that specify all significant terms to purchase goods orservices, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of thetransaction. Purchase agreements that are cancellable without penalty have been excluded.Off-Balance Sheet ArrangementsAs of December 31, 2014, we have issued guarantees for the debt and other obligations of consolidated subsidiaries in the normal course ofbusiness. We have determined that none of these arrangements has a material current effect or is reasonably likely to have a material future effecton our consolidated financial statements, liquidity, capital expenditures or capital resources.47Critical Accounting EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent liabilities. Management bases its estimates onhistorical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form thebasis 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 SignificantAccounting Policies,” in the notes to the consolidated financial statements. Accounting estimates and assumptions discussed in this section arethose that we consider most critical to an understanding of our financial statements because they are inherently uncertain, involve significantjudgments, include areas where different estimates reasonably could have been used, and changes in the estimate that are reasonably possiblecould materially impact the financial statements. Management believes that the accounting estimates employed and the resulting balances arereasonable; however, actual results in these areas could differ from management’s estimates under different assumptions or conditions.Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixedor determinable, and collectability of the sales price is reasonably assured. For product sales, delivery does not occur until the products have beenshipped, risk of loss has been transferred to the customer and the contractual terms have been fulfilled. In instances where contractual termsinclude a provision for customer acceptance, revenue is recognized when either (i) we have previously demonstrated that the product meets thespecified criteria based on either seller- or customer-specified objective criteria or (ii) upon formal acceptance received from the customer wherethe product has not been previously demonstrated to meet customer-specified objective criteria. Revenue on service and repair contracts isrecognized after services have been agreed to by the customer and rendered.We enter into contracts to sell our products and services, and while the majority of our sales agreements contain standard terms and conditions,certain agreements contain multiple elements or non-standard terms and conditions. Where sales agreements contain multiple elements or non-standard terms and conditions, judgment is required to determine the appropriate accounting, including whether the deliverables specified in theseagreements should be treated as separate units of accounting for revenue recognition purposes, and, if so, how the transaction price should beallocated among the elements and when to recognize revenue for each element. When a sale involves multiple deliverables, the total revenue fromthe arrangement is allocated to each unit of accounting based on the relative selling price of the deliverable to all other deliverables in the contract.Revenue for multiple element arrangements is recognized when the appropriate revenue recognition criteria for the individual deliverable have beensatisfied. The allocation of sales price between elements may impact the timing of revenue recognition, but will not change the total revenuerecognized on the arrangement. For delivered elements accounted for as separate units of accounting in a multiple element arrangement, revenueis recognized only when the delivered elements have standalone value, there are no uncertainties regarding customer acceptance and there are nocustomer-negotiated refund or return rights affecting the sales recognized.We record a reduction in revenue at the time of sale for estimated product returns, rebates and other allowances, based on historical experienceand known trends.Warranty Accrual. Accruals for estimated expenses related to warranties are made at the time products are sold or services are rendered and arerecorded as a component of cost of revenue. These accruals are established using historical information on the nature, frequency and averagecost of warranty claims and consider any factors that may cause differences in expected future warranty costs as compared to historical claimexperience. While we engage in extensive product quality programs and processes, we base our estimated warranty obligation on product warrantyterms offered to customers, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as wellas specific product class failures outside of our baseline experience. We also record a warranty liability for specific matters. We assess theadequacy of our recorded warranty liabilities quarterly and adjust amounts as necessary.Income Taxes. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases ofassets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. Based on the evaluation ofavailable evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely thannot we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets48and reflect any changes to our estimate of the amount we are more likely than not to realize in the valuation allowance, with a correspondingadjustment 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 incarryback years and the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected bychanges to tax laws, changes to statutory tax rates and changes to future taxable income estimates.Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan toreinvest such earnings indefinitely outside the United States. We plan foreign earnings remittance amounts based on projected cash flow needs,as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on theseassumptions, we estimate the amount we will distribute to the United States and provide the U.S. federal taxes due on these amounts. Materialchanges in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do businesscould impact our effective tax rate.The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictionsacross our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other taxjurisdictions based on our estimate of whether, and to the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefitfrom 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,based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based onthe largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.We adjust our liability for uncertain tax positions in light of changing facts and circumstances; however, due to the complexity of some of theseuncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If ourestimate of tax liabilities proves to be less than the ultimate assessment, an additional tax expense would result. If a payment of these amountsultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the periodwhen we determine the liabilities are no longer necessary.Goodwill and Intangible Assets. We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events orchanges in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-livedintangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment test as of the first day of the fourthquarter. We perform a two-step impairment test for goodwill. In the first step, we compare the estimated fair value of each reporting unit to itscarrying value. If the estimated fair value of the reporting unit exceeds the carrying value of the net assets assigned to that reporting unit, goodwillis not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds itsfair value, then we must perform the second step of the impairment test in order to measure the impairment loss to be recorded, if any. If thecarrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. In our annualimpairment test for indefinite-lived intangible assets, we compare the fair value of those assets to their carrying value. We recognize animpairment loss when the estimated fair value of the indefinite-lived intangible asset is less than its carrying value. We estimate the fair value ofour reporting units and intangible assets with indefinite lives using an income approach. Under the income approach, we calculate fair value basedon the present value of estimated future cash flows.Determining the fair value of a reporting unit or an indefinite-lived intangible asset is judgmental in nature and involves the use of significantestimates and assumptions, particularly related to future operating results and cash flows. These estimates and assumptions include, but are notlimited to, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, assumed royaltyrates, future economic and market conditions and identification of appropriate market comparable data. In addition, the identification of reportingunits and the allocation of assets and liabilities to the reporting units when determining the carrying value of each reporting unit also requirejudgment. Goodwill is tested for impairment at either the operating segment identified in Note 21, “Segment and Geographic Data,” of theconsolidated financial statements, or one level below. The fair value of our reporting units and indefinite-lived intangible assets is based onestimates and assumptions that are believed to be reasonable. Significant changes to these estimates and assumptions could adversely impactour conclusions. Actual future results may differ from those estimates.49During the fourth quarter of 2014, we performed our annual impairment assessment and determined that the estimated fair values of our goodwillreporting units were substantially in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge toearnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes incircumstances indicate there may be a potential impairment.We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date in 2014. During the fourth quarter of 2013we performed our annual impairment test of our indefinite-lived intangibles assets which resulted in an impairment charge of $2 million related totrade names within our Water Infrastructure segment. Refer to Note 11, “Goodwill and Other Intangible Assets,” for additional information.Postretirement Plans. Company employees around the world participate in numerous defined benefit plans. The determination of projected benefitobligations and the recognition of expenses related to these plans are dependent on various assumptions. These major assumptions primarilyrelate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, health care inflationand years of service (some of which are disclosed in Note 15, “Postretirement Benefit Plans,” in the notes to the consolidated financialstatements) and other factors. Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to theextent they exceed 10% of the higher of the market-related value or projected benefit obligation, over the average remaining service period ofactive plan participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy.Significant AssumptionsManagement develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country inwhich such plans exist. All assumptions are reviewed annually with third-party consultants and adjusted as necessary. The table included belowprovides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2014and 2013. 2014 2013 U.S. Int’l U.S. Int’lBenefit Obligation Assumptions Discount rate4.01% 3.14% 4.79% 4.23%Rate of future compensation increaseNM 3.34% NM 3.48%Net Periodic Benefit Cost Assumptions Discount rate4.79% 4.23% 4.13% 4.04%Expected long-term return on plan assets8.00% 7.30% 8.00% 7.33%Rate of future compensation increaseNM 3.48% 4.50% 3.50%NMNot meaningful. During 2013, an amendment to one of the Company's U.S business unit's pension plans modified the benefit formula. Similar to allother U.S. pension plans, pension benefits for future service was changed to be based on years of service and not be impacted by futurecompensation 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 historicalbroad market returns over long-term timeframes based on the strategic asset allocation, which is detailed in Note 15, “Postretirement BenefitPlans,” in the notes to the consolidated financial statements.Based on the approach described above, the chart below shows weighted average actual returns versus the weighted average expected long-termrates of return for our pension plans that were utilized in the calculation of the net periodic pension cost for each respective year. 2014 2013 2012Expected long-term rate of return on plan assets7.38% 7.40% 7.42%Actual rate of return on plan assets18.13% 10.17% 10.09%For the recognition of net periodic pension cost, the calculation of the expected return on plan assets is generally derived by applying the expectedlong-term rate of return to the market-related value of plan assets. The market-50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 thana calculated value, could materially affect net periodic pension cost. Our weighted average expected long-term rate of return on plan assets for allpension plans, effective January 1, 2015 is 7.38%. We estimate that every 25 basis point change in the expected return on plan assets impactsthe 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. Adecrease in the discount rate increases the present value of benefit obligations and increases pension expense. We base the discount rateassumption on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pensiondiscount 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-pointdiscount rate matching the plan’s characteristics. Our weighted average discount rate for all pension plans effective January 1, 2015, is 3.23%.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. EffectiveJanuary 1, 2015, our expected rate of future compensation is 3.34% for all pension plans. The estimated impact of a 25 basis point change in theexpected 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 6.88% for 2015, decreasing ratably to5.00% in 2020. An increase or decrease in the health care trend rates by one percent per year would impact the aggregate annual service andinterest components by less than $1 million, and impact the benefit obligation by approximately $4 million.We currently anticipate making contributions to our pension and postretirement benefit plans in the range of $24 million to $34 million during 2015,of which $7 million is expected to be made in the first quarter.Funded StatusFunded status is derived by subtracting the respective year-end values of the projected benefit obligations from the fair value of plan assets. Weestimate that every 25 basis point change in the discount rate impacts the funded status by approximately $30 million.Fair Value of Plan AssetsThe plan assets of our pension plans comprise a broad range of investments, including domestic and foreign equity securities, interests in privateequity 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 fundinvestments are generally measured at net asset value. However, in certain instances, the values reported by the asset managers were not currentat the measurement date. Accordingly, we made estimate adjustments to the last reported value where necessary to measure the assets at fairvalue 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, 2014 and 2013 for these assets represented less than one percent of total plan assets in eachrespective year. Asset values for other positions were generally measured using market observable prices. We estimate that a 5% change inasset values will impact funded status by approximately $27 million.New Accounting PronouncementsSee Note 2, “Recently Issued Accounting Pronouncements,” in the notes to the consolidated financial statements for a complete discussion ofrecent accounting pronouncements.51ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to market risk, primarily related to foreign currency exchange and interest rates. These exposures are actively monitored bymanagement. Our exposure to foreign exchange rate risk is due to certain costs, revenue and borrowings being denominated in currencies otherthan one of our subsidiaries functional currency. Similarly, we are exposed to market risk as the result of changes in interest rates which mayaffect the cost of our financing. It is our policy and practice to use derivative financial instruments only to the extent necessary to manageexposures.Foreign Currency Exchange Rate RiskWe conduct approximately 62% of our business in various locations outside the United States.Our economic foreign currency risk primarily relates to receipts from customers, payments to suppliers and intercompany transactionsdenominated in foreign currencies. We may use derivative financial instruments to offset risk related to receipts from customers and payments tosuppliers, when it is believed that the exposure will not be limited by our normal operating and financing activities. In January 2012, we began toenter into currency forward contracts periodically in order to manage the exchange rate fluctuation risk on certain intercompany transactionsassociated with third party sales and purchases. These risks are also mitigated by natural hedges including the presence of manufacturingfacilities outside the United States, global sourcing and other spending which occurs in foreign countries. Our principal foreign currency transactionexposures primarily relate to the Euro, Swedish Krona, British Pound, Canadian Dollar, Polish Zloty, Australian Dollar and Hungarian Forint. Weestimate that a hypothetical 10% movement in foreign currency exchange rates would not have a material economic impact to Xylem’s financialposition and results of operations.Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reportingcurrency, the U.S. dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. dollar and the Euro, British Pound,Chinese Yuan, Swedish Krona and Canadian Dollar. As the U.S. dollar strengthens against other currencies in which we transact business,revenue and income will generally be negatively impacted, and if the U.S. dollar weakens, revenue and income will generally be positivelyimpacted. We estimate that a hypothetical 10% movement of the U.S dollar to the various foreign currency exchange rates we translate from, inthe aggregate, could have approximately a 7% impact on Xylem's consolidated revenue and income as reported in U.S. dollars. We expect tocontinue to generate significant revenue from non-U.S. operations and we expect 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 conductbusiness and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to theU.S. and other international subsidiaries when it is cost effective to do so, though our intent is to indefinitely reinvest most of these funds outsideof the U.S. As such, we do not expect translation risk to have a material economic impact on our financial position and results of operations.Interest Rate RiskAs of December 31, 2014, we do not have a material exposure to interest rate risk as our debt portfolio primarily comprises long-term, fixed-rateinstruments. We do not account for our long-term debt using the fair value option.Commodity Price ExposuresPortions of our business are exposed to volatility in the prices of certain commodities, such as copper, nickel and aluminum, among others. Ourprimary exposure to this volatility resides with the use of these materials in purchased component parts. We generally maintain long-term fixedprice contracts on raw materials and component parts; however, we are prone to exposure as these contracts expire. We estimate that ahypothetical 10% adverse movement in prices for raw metal commodities would not be material to our financial position and results of operations.52ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAINDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageNo.Audited Consolidated Financial Statements: Report of Independent Registered Public Accounting Firm54Consolidated Income Statements for the Years Ended December 31, 2014, 2013 and 201255Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 201256Consolidated Balance Sheets as of December 31, 2014 and December 31, 201357Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 201258Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 201259Notes to Consolidated Financial Statements: Note 1 Summary of Significant Accounting Policies60Note 2 Recently Issued Accounting Pronouncements66Note 3 Acquisitions and Divestitures68Note 4 Restructuring and Asset Impairment Charges69Note 5 Separation Costs70Note 6 Other Non-Operating Income, Net71Note 7 Income Taxes71Note 8 Earnings Per Share75Note 9 Inventories76Note 10 Property, Plant and Equipment76Note 11 Goodwill and Other Intangible Assets76Note 12 Derivative Financial Instruments77Note 13 Accrued and Other Current Liabilities78Note 14 Credit Facilities and Long-Term Debt79Note 15 Postretirement Benefit Plans81Note 16 Stock-Based Compensation89Note 17 Capital Stock92Note 18 Accumulated Other Comprehensive Income (Loss)93Note 19 Commitment and Contingencies94Note 20 Related Party Transactions96Note 21 Segment and Geographic Data97Note 22 Supplemental Information99Note 23 Quarterly Financial Data9953REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Stockholders ofXylem Inc.Rye Brook, New YorkWe have audited the accompanying consolidated balance sheets of Xylem Inc. and subsidiaries (the "Company") as of December 31, 2014 and2013, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three yearsin the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is toexpress an opinion on the financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Xylem Inc. and subsidiariesas of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period endedDecember 31, 2014, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company'sinternal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2015 expressed anunqualified opinion on the Company's internal control over financial reporting./s/ Deloitte & Touche LLPStamford, ConnecticutFebruary 26, 201554XYLEM INC. AND SUBSIDIARIESCONSOLIDATED INCOME STATEMENTS(In Millions, except per share data) Year Ended December 31,2014 2013 2012Revenue$3,916 $3,837 $3,791Cost of revenue2,403 2,338 2,289Gross profit1,513 1,499 1,502Selling, general and administrative expenses920 986 914Research and development expenses104 104 106Separation costs— 4 22Restructuring and asset impairment charges26 42 17Operating income463 363 443Interest expense54 55 55Other non-operating income (expense), net1 (10) —Gain from sale of business11 — —Income before taxes421 298 388Income tax expense84 70 91Net income$337 $228 $297Earnings per share: Basic$1.84 $1.23 $1.60Diluted$1.83 $1.22 $1.59Weighted average number of shares: Basic183.1 185.2 185.8Diluted184.2 186.0 186.2Dividends declared per share$0.5120 $0.4656 $0.4048 See accompanying notes to consolidated financial statements.55XYLEM INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(In Millions)Year Ended December 31,2014 2013 2012Net income$337 $228 $297Other comprehensive income, before tax: Foreign currency translation adjustment(206) 15 48Net change in cash flow hedges: Unrealized (losses) gains(22) 1 4Amount of loss (gain) reclassified into net income6 — (3)Net change in postretirement benefit plans: Net (loss) gain(110) 34 (84)Prior service credit (cost)17 4 (1)Amortization of prior service (credit) cost(1) 1 1Amortization of net actuarial loss11 17 11Settlement1 — 2Foreign exchange20 2 (8)Other comprehensive (loss) income, before tax(284) 74 (30)Income tax (benefits) expense related to other comprehensive (loss) income(18) 22 (23)Other comprehensive (loss) income, net of tax(266) 52 (7)Comprehensive income$71 $280 $290See accompanying notes to consolidated financial statements.56XYLEM INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In Millions, except per share amounts) December 31,2014 2013ASSETS Current assets: Cash and cash equivalents$663 $533Receivables, less allowances for discounts and doubtful accounts of $34 and $31 in 2014 and 2013,respectively771 817Inventories486 475Prepaid and other current assets144 143Deferred income tax assets38 41Total current assets2,102 2,009Property, plant and equipment, net461 488Goodwill1,635 1,718Other intangible assets, net431 488Other non-current assets235 193Total assets$4,864 $4,896LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable$338 $332Accrued and other current liabilities481 479Short-term borrowings and current maturities of long-term debt89 42Total current liabilities908 853Long-term debt1,199 1,199Accrued postretirement benefits388 348Deferred income tax liabilities158 191Other non-current accrued liabilities84 64Total liabilities2,737 2,655Commitment and Contingencies (Note 19) Stockholders’ equity: Common Stock — par value $0.01 per share: Authorized 750.0 shares, issued 188.9 and 187.6 shares in 2014 and 2013, respectively2 2Capital in excess of par value1,796 1,753Retained earnings648 405Treasury stock – at cost 6.6 shares and 3.0 shares in 2014 and 2013, respectively(220) (86)Accumulated other comprehensive income(99) 167Total stockholders’ equity2,127 2,241Total liabilities and stockholders’ equity$4,864 $4,896See accompanying notes to consolidated financial statements.57XYLEM INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In Millions)Year Ended December 31,2014 2013 2012Operating Activities Net income$337 $228 $297Adjustments to reconcile net income to net cash provided by operatingactivities: Depreciation95 99 94Amortization47 51 48Deferred income taxes(29) (14) 1Share-based compensation18 27 22Restructuring and asset impairment charges, net26 42 17Gain from sale of business(11) — —Other, net2 15 2Payments of restructuring(26) (35) (9)Contributions to postretirement benefit plans(35) (43) (46)Changes in assets and liabilities (net of acquisitions): Changes in receivables(37) (47) 2Changes in inventories(49) (39) 5Changes in accounts payable17 4 (4)Changes in accrued liabilities3 18 (28)Changes in accrued taxes25 20 (17)Net changes in other assets and liabilities33 (2) 12Net Cash — Operating activities416 324 396Investing Activities Capital expenditures(119) (126) (112)Proceeds from the sale of property, plant and equipment2 6 5Acquisitions of businesses and assets, net of cash acquired— (81) (41)Proceeds from sale of business30 — —Other, net1 2 1Net Cash — Investing activities(86) (199) (147)Financing Activities Net transfer to former parent— — (9)Issuance of short-term debt52 39 13Principal payments of debt and capital lease obligations— (2) (14)Repurchase of common stock(134) (73) (13)Proceeds from exercise of employee stock options26 22 24Excess tax benefit from share based compensation2 1 —Dividends paid(94) (87) (75)Other, net1 — —Net Cash — Financing activities(147) (100) (74)Effect of exchange rate changes on cash(53) 4 11Net change in cash and cash equivalents130 29 186Cash and cash equivalents at beginning of year533 504 318Cash and cash equivalents at end of year$663 $533 $504Supplemental disclosure of cash flow information: Cash paid during the year for: Interest$51 $51 $53Income taxes (net of refunds received)$81 $65 $104See accompanying notes to consolidated financial statements.58XYLEM INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(In Millions, except per share amounts) CommonStock AdditionalPaid-InCapital RetainedEarnings Accumulated OtherComprehensiveIncome (Loss) Treasury Stock TotalBalance at January 1, 20122 1,663 44 122 — 1,831Net income 297 297Other comprehensive loss, net (7) (7)Dividends declared ($0.4048 pershare) (77) (77)Stock incentive plan activity 43 43Repurchase of common stock (13) (13)Balance at December 31, 2012$2 $1,706 $264 $115 $(13) $2,074Net income 228 228Other comprehensive income, net 52 52Dividends declared ($0.4656 pershare) (87) (87)Stock incentive plan activity 47 47Repurchase of common stock (73) (73)Balance at December 31, 2013$2 $1,753 $405 $167 $(86) $2,241Net income 337 337Other comprehensive income, net (266) (266)Dividends declared ($0.5120 pershare) (94) (94)Stock incentive plan activity 43 43Repurchase of common stock (134) (134)Balance at December 31, 2014$2 $1,796 $648 $(99) $(220) $2,127See accompanying notes to consolidated financial statements.59NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNote 1. Summary of Significant Accounting PoliciesXylem Inc. (“Xylem” or the “Company”) is a leading equipment and service provider for water and wastewater applications with a broad portfolio ofproducts and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment. Xylemoperates in two segments, Water Infrastructure and Applied Water. The Water Infrastructure segment focuses on the transportation, treatment andtesting of water, offering a range of products including water and wastewater pumps, treatment and testing equipment, and controls and systems.The Applied Water segment encompasses all the uses of water and focuses on the residential, commercial, industrial and agricultural markets.The Applied Water segment’s major products include pumps, valves, heat exchangers, controls and dispensing equipment.On October 31, 2011 (the "Distribution Date"), ITT Corporation (“ITT”) completed the Spin-off (the “Spin-off”) of Xylem, formerly ITT’s waterequipment and services businesses. The Spin-off was completed pursuant to the Distribution Agreement, dated as of October 25, 2011 (the“Distribution Agreement”), among ITT, Exelis Inc. (“Exelis”) and Xylem. Xylem Inc. was incorporated in Indiana on May 4, 2011 in connection withthe Spin-off.Hereinafter, except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to XylemInc. and its subsidiaries. References in the notes to the consolidated financial statements to “ITT” or “ former parent” refers to ITT Corporation andits consolidated subsidiaries (other than Xylem Inc.).Basis of PresentationThe consolidated financial statements reflect our financial position and results of operations in conformity with accounting principles generallyaccepted in the United States of America (“GAAP”). All intracompany transactions between our businesses have been eliminated.In 2014, we began implementing an organizational redesign to integrate its commercial teams within geographical regions. The integration of ourcommercial teams creates a cross Xylem sales and marketing organization shifting from a dedicated product line organizational structure. Thissales structure is largely in place in the Company’s European, Middle East, Africa and Asia regions and to a lesser extent in our other regions. While this organizational redesign did not change the Company’s reportable segments, it had implications on how the Company manages thebusiness, the most significant of which was the shift of certain responsibilities, namely customer and market related activities, into the regionalselling organizations. These changes and the related measurement system were effective in the fourth quarter 2014 and as a result, the Companyhas reported its financial performance based on the new organizational design. Segment orders, revenue and operating income are reallocatedbetween the Company’s two reportable segments, Applied Water and Water Infrastructure. The Company has recast certain historical amountsbetween the Company’s two reportable segments, however this change had no impact on the Company’s historical consolidated financial positionor results of operations. The recast financial information does not represent a restatement of previously issued financial statements.Use of EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and thereported amounts of revenue and expenses during the reporting period. Estimates are revised as additional information becomes available.Estimates and assumptions are used for, but not limited to, postretirement obligations and assets, revenue recognition, income tax contingencyaccruals and valuation allowances, goodwill and indefinite lived intangible impairment testing and contingent liabilities. Actual results could differfrom these estimates.Consolidation PrinciplesWe consolidate companies in which we have a controlling financial interest or when Xylem is considered the primary beneficiary of a variableinterest entity. We account for investments in companies over which we have the ability to exercise significant influence but do not hold acontrolling financial interest under the equity method, and we record our proportionate share of income or losses in the Consolidated IncomeStatements. Equity method investments are reviewed for impairment when events or circumstances indicate the investment may be other than60temporarily impaired. This requires significant judgment, including an assessment of the investee’s financial condition, the possibility ofsubsequent rounds of financing, and the investee’s historical and projected results of operations. If the actual results of operations for the investeeare significantly different from projections, we may incur future charges for the impairment of these investments.Foreign Currency TranslationThe national currencies of our foreign companies are generally the functional currencies. Balance sheet accounts are translated at the exchangerate in effect at the end of each period; income statement accounts are translated at the average rates of exchange prevailing during the period.Gains and losses on foreign currency translations are reflected in the cumulative translation adjustments component of stockholders’ equity. Netgains or losses from foreign currency transactions are reported currently in selling, general and administrative expenses.Revenue RecognitionRevenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectability is reasonably assuredand delivery has occurred or services have been rendered. For product sales, other than long-term construction-type contracts, we recognizerevenue at the time title, and risks and rewards of ownership pass, which is generally when products are shipped. Certain contracts with customersrequire delivery, installation, testing, certification or other acceptance provisions to be satisfied before revenue is recognized. We recognizerevenue on product sales to channel partners, including resellers, distributors or value-added solution providers at the time of sale when thechannel partners have economic substance apart from Xylem and Xylem has completed its obligations related to the sale. Revenue from the rentalof equipment is recognized over the rental period. Service revenue is recognized as services are performed. For agreements that contain multiple deliverables, we recognize revenue based on the relative selling price if the deliverable has stand-alone valueto the customer and, in arrangements that include a general right of return relative to the delivered element, performance of the undeliveredelement is considered probable and substantially in the Company’s control. The selling price for a deliverable is based on vendor-specific objectiveevidence of selling price (“VSOE”), if available, third-party evidence of selling price (“TPE”) if VSOE is not available, or best estimated sellingprice, if neither VSOE nor TPE is available.The deliverables in our arrangements with multiple elements include various products and may include related services, such as installation andstart-up services. We allocate arrangement consideration based on the relative selling prices of the separate units of accounting determined inaccordance with the hierarchy described above. For deliverables that are sold separately, we establish VSOE based on the price when thedeliverable is sold separately. We establish TPE, generally for services, based on prices similarly situated customers pay for similar services fromthird-party vendors. For those deliverables for which we are unable to establish VSOE or TPE, we estimate the selling price considering variousfactors including market and pricing trends, geography, product customization, and profit objectives. Revenue for multiple element arrangements isrecognized when the appropriate revenue recognition criteria for the individual deliverable have been satisfied.Certain businesses enter into long-term construction-type sales contracts for which revenue is recognized under the percentage-of-completionmethod based upon percentage of costs incurred to total estimated costs.Shipping and Handling CostsShipping and handling costs are recorded as a component of cost of revenue.Share-Based CompensationShare-based awards issued to employees and members of the Board of Directors include non-qualified stock options, restricted stock awards andperformance-based awards. Compensation costs resulting from share-based payment transactions are recognized primarily within selling, generaland administrative expenses, at fair value over the requisite service period (typically three years) on a straight-line basis. The calculatedcompensation cost is adjusted based on an estimate of awards ultimately expected to vest. For performance-based awards, the calculatedcompensation cost is adjusted based on an estimate of awards ultimately expected to vest and our assessment of the probable outcome of theperformance condition.The fair value of a non-qualified stock option is determined on the date of grant using a binomial lattice pricing modelincorporating multiple and variable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility andchanges in dividends. The fair value of restricted stock awards is determined using the closing price of our common61stock on date of grant. The fair value of performance-based share awards at 100% target is determined using the closing price of our commonstock on date of grant.Research and DevelopmentWe conduct research and development activities, which consist primarily of the development of new products, product applications, andmanufacturing processes. These costs are charged to expense as incurred.Exit and Disposal CostsWe periodically initiate management-approved restructuring activities to achieve cost savings through reduced operational redundancies and toposition ourselves strategically in the market in response to prevailing economic conditions and associated customer demand. Costs associatedwith restructuring actions can include severance, infrastructure charges to vacate facilities or consolidate operations, contract termination costsand other related charges. For involuntary separation plans, a liability is recognized when it is probable and reasonably estimable. For voluntaryseparation plans, a liability is recognized when the employee irrevocably accepts the voluntary termination. For one-time termination benefits, suchas additional severance pay or benefit payouts, and other exit costs, such as lease termination costs, the liability is measured and recognizedinitially at fair value in the period in which the liability is incurred, with subsequent changes to the liability recognized as adjustments in the periodof change.Deferred Financing CostsDeferred financing costs represent costs incurred in conjunction with our debt financing activities and are capitalized in other assets and amortizedover the life of the related financing arrangements. If the debt is retired early, the related unamortized deferred financing costs are written off in theperiod the debt is retired and are recorded in the results of operations under the caption “interest expense.”Income TaxesIncome taxes are calculated using the asset and liability method. Deferred tax assets and liabilities are determined based on the estimated futuretax effects of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities, as measured bythe current enacted tax rates.We maintain valuation allowances when it is more likely than not that all or a portion of a deferred asset will not be realized. The valuationallowance is intended in part to provide for the uncertainty regarding the ultimate utilization of our U.S. capital loss carryforwards, U.S. foreign taxcredit carryovers, and foreign net operating loss carryforwards. In determining whether a valuation allowance is warranted, we consider all positiveand negative evidence and all sources of taxable income such as prior earnings history, expected future earnings, carryback and carryforwardperiods and tax strategies to estimate if sufficient future taxable income will be generated to realize the deferred tax asset. The assessment of theadequacy of our valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which ourdeferred tax assets will be recoverable. In the event that actual results differ from these estimates, or we adjust these estimates in future periodsfor current trends or expected changes in our estimating assumptions, we may need to modify the level of valuation allowance that couldmaterially impact our business, financial condition and results of operations.Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan toreinvest such earnings indefinitely outside the United States. We plan foreign earnings remittance amounts based on projected cash flow needs,as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on theseassumptions, we estimate the amount we will distribute to the United States and provide the U.S. federal taxes due on these amounts. Materialchanges in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do businesscould impact our effective tax rate.Tax benefits are recognized for an uncertain tax position when, in management’s judgment, it is more likely than not that the position will besustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, the tax benefit ismeasured as the largest amount that is judged to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxingauthority. The liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances and when new informationbecomes available. Such adjustments are recognized in the period in which they are identified. The effective tax rate includes the net impact ofchanges in the liability for unrecognized tax benefits and subsequent62adjustments as considered appropriate by management. While it is often difficult to predict the final outcome or the timing of resolution of anyparticular tax matter, we believe our liability for unrecognized tax benefits is adequate. We classify interest relating to unrecognized tax benefits asa component of other non-operating (expense) income, net and tax penalties as a component of income tax expense in our Consolidated IncomeStatements.Earnings Per ShareWe present two calculations of earnings per share (“EPS”). “Basic” EPS equals net income divided by weighted average shares outstanding duringthe period. “Diluted” EPS equals net income divided by the sum of weighted average common shares outstanding during the period plus potentiallydilutive shares. Potentially dilutive common shares that are anti-dilutive are excluded from diluted EPS.Cash EquivalentsWe consider all liquid investments purchased with an original maturity of three months or less to be cash equivalents.Receivables and Allowance for Doubtful Accounts and Cash DiscountsReceivables primarily comprise uncollected amounts owed to us from transactions with customers and are presented net of allowances fordoubtful accounts and cash discounts.We determine our allowance for doubtful accounts using a combination of factors to reduce our trade receivable balances to their estimated netrealizable amount. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are pastdue, macroeconomic trends and conditions, significant one-time events, historical experience and the financial condition of customers. We recorda specific reserve for individual accounts when we become aware of specific customer circumstances, such as in the case of bankruptcy filings ordeterioration in the customer’s operating results or financial position. The past due or delinquency status of a receivable is based on thecontractual payment terms of the receivable. If circumstances related to the specific customer change, we adjust estimates of the recoverability ofreceivables as appropriate. We determine our allowance for cash discounts primarily based on historical experience with customers.Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and theirdispersion across many different geographical regions. We perform ongoing credit evaluations of the financial condition of our third-partydistributors, resellers and other customers and require collateral, such as letters of credit and bank guarantees, in certain circumstances. As ofDecember 31, 2014 and 2013 we do not believe we have any significant concentrations of credit risk.InventoriesInventories, which include the costs of material, labor and overhead, are stated at the lower of cost or market using the first in, first out ("FIFO")method. Estimated losses from obsolete and slow-moving inventories are recorded to reduce inventory values to their estimated net realizablevalue. Our manufacturing operations recognize costs of sales using standard costs with full overhead absorption, which generally approximatesactual cost.Property, Plant and EquipmentThese assets are recorded at historical cost and are depreciated using the straight-line method of depreciation over the estimated useful lives asfollows: Estimated LifeBuildings and improvements5 to 40 yearsMachinery and equipment2 to 10 yearsFurniture and fixtures3 to 7 yearsEquipment held for lease or rental2 to 10 yearsLeasehold improvements are depreciated over the shorter of their estimated useful life or the term of the lease. Costs related to maintenance andrepairs that do not prolong the assets' useful lives are expensed as incurred.63Goodwill and Intangible AssetsGoodwill represents purchase consideration paid in a business combination that exceeds the values assigned to the net assets of acquiredbusinesses. Intangible assets include customer relationships, proprietary technology, brands and trademarks, patents and other intangible assets.Intangible assets with a finite life are amortized on a straight-line basis over an estimated economic useful life which ranges from 5 to 20 yearsand is included in selling, general and administrative expense. Certain of our intangible assets, namely certain brands and trademarks, have anindefinite life and are not amortized.Long-Lived Asset ImpairmentLong-lived assets, including intangible assets with finite lives, are amortized and tested for impairment whenever events or changes incircumstances indicate their carrying value may not be recoverable. We assess the recoverability of long-lived assets based on the undiscountedfuture cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flows expectedto result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset.When an impairment is identified, we reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flow approachor, when available and appropriate, to comparable market values.Goodwill and indefinite-lived intangible assets are not amortized, but rather are tested for impairment annually (or more frequently if impairmentindicators arise, such as changes to the reporting unit structure, significant adverse changes in the business climate or an adverse action orassessment by a regulator). We conduct our annual impairment testing on the first day of our fourth quarter. For goodwill, the impairment test is atwo-step test. In the first step, the estimated fair value of each reporting unit is compared to the carrying value of the net assets assigned to thatreporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and the second step of theimpairment test is not performed. If the carrying value of the reporting unit exceeds its estimated fair value, then the second step of theimpairment test is performed in order to measure the impairment loss to be recorded, if any. If the carrying value of a reporting unit’s goodwillexceeds its implied fair value, then we record an impairment loss equal to the difference. We estimate the fair value of our reporting units andindefinite-lived intangible assets using an income approach. Under the income approach, we estimate fair value based on the present value ofestimated future cash flows.Product WarrantiesWe accrue for the estimated cost of product warranties at the time revenue is recognized and record it as a component of cost of revenue. Ourproduct warranty liability reflects our best estimate of probable liability under the terms and conditions of our product warranties offered tocustomers. We estimate the liability based on our standard warranty terms, the historical frequency of claims and the cost to replace or repair ourproducts under warranty. Factors that impact our warranty liability include the number of units sold, the length of warranty term, historical andanticipated rates of warranty claims and cost per claim. We also record a warranty liability for specific matters. We assess the adequacy of ourrecorded warranty liabilities quarterly and adjust amounts as necessary.Postretirement Benefit PlansThe determination of defined benefit pension and postretirement plan obligations and their associated costs requires the use of actuarialcomputations to estimate participant plan benefits to which the employees will be entitled. The significant assumptions primarily relate to discountrates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, years of service and other factors. Wedevelop each assumption using relevant company experience in conjunction with market-related data for each individual country in which suchplans exist. All actuarial assumptions are reviewed annually with third-party consultants and adjusted as necessary. For the recognition of netperiodic postretirement cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate ofreturn on the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurementdate over the last five years. Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to theextent they exceed 10% of the higher of the market-related value or the projected benefit obligation, over the average remaining service period ofactive participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy. The fair value of planassets is determined based on market prices or estimated fair value at the measurement date.We consider changes to a plan’s benefit formula that eliminate the accrual for future service but continue to allow for future salary increases (i.e.“soft freeze”) a curtailment.64Business CombinationsWe allocate the purchase price of acquisitions to the tangible and intangible assets acquired, liabilities assumed, and non-controlling interests inthe acquiree based on their estimated fair value at the acquisition date. Changes to the acquisition date provisional fair values prior to theexpiration of the measurement period, a period not to exceed 12 months from date of acquisition, are recorded as an adjustment to the associatedgoodwill. Changes to the acquisition date fair values after expiration of the measurement period are recorded in earnings. The excess of theacquisition price over those estimated fair values is recorded as goodwill. Acquisition-related expenses and restructuring costs, if any, arerecognized separately from the business combination and are expensed as incurred.Derivative Financial InstrumentsWe record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on whether wehave elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied thecriteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of anasset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as ahedge of the exposure to variability in expected future cash flows, including forecasted transactions, are considered cash flow hedges. Derivativesmay also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generallyprovides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value ofthe hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecastedtransactions in a cash flow hedge. We may enter into derivative contracts that are intended to hedge certain risks economically, even thoughhedge accounting does not apply or we elect not to apply hedge accounting.The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk isrecorded in other comprehensive income ("OCI") and is subsequently reclassified into either revenue or cost of revenue (hedge of sales classifiedinto revenue and hedge of purchases classified into cost of revenue) in the period that the hedged forecasted transaction affects earnings. Anyineffective portion of the change in fair value of the derivative is recognized directly in selling, general and administrative expenses. Our policy isto de-designate cash flow hedges at the time forecasted transactions are recognized as assets or liabilities on a business unit’s balance sheet andreport subsequent changes in fair value through selling, general and administrative expenses where the gain or loss due to movements in currencyrates on the underlying asset or liability is revalued. If it becomes probable that the originally forecasted transaction will not occur, the gain or lossrelated to the hedge recorded within accumulated other comprehensive income is immediately recognized into net income.Commitments and ContingenciesWe record accruals for commitments and loss contingencies for those which are both probable and for which the amount can be reasonablyestimated. In addition, legal fees are accrued for cases where a loss is probable and the related fees can be reasonably estimated. Significantjudgment is required to determine both probability and the estimated amount of loss. We review these accruals quarterly and adjust the accruals toreflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other current information.Accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of theliability can be reasonably estimated, based on current law and existing technologies. Our estimated liability is reduced to reflect the anticipatedparticipation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financiallycapable of paying their respective shares of the relevant costs. These accruals are reviewed quarterly and are adjusted as assessment andremediation efforts progress or as additional technical or legal information becomes available. Actual costs to be incurred at identified sites infuture periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures. Accruals for environmentalliabilities are primarily included in other non-current liabilities at undiscounted amounts and exclude claims for recoveries from insurancecompanies or other third parties.Concentrations of Credit RiskFinancial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, andaccounts receivable from trade customers. We maintain cash and cash equivalents and65derivative contracts with various financial institutions. These financial institutions are located in many different geographical regions, and our policyis designed to limit exposure with any one institution. As part of our cash and risk management processes, we perform periodic evaluations of therelative credit standing of the financial institutions. We have not sustained any material credit losses during the previous three years frominstruments held at financial institutions. We may utilize forward contracts to protect against the effects of foreign currency fluctuations. Suchcontracts involve the risk of non-performance by the counterparty. Credit risk with respect to accounts receivable is generally diversified due to thelarge number of entities comprising our customer base and their dispersion across many different industries and geographic regions. We performongoing credit evaluations of the financial condition of our third-party distributors, resellers and other customers and require collateral, such asletters of credit and bank guarantees, in certain circumstances.Substantially all of the cash and cash equivalents, including foreign cash balances, at December 31, 2014 and 2013 were uninsured. Foreign cashbalances at December 31, 2014 and 2013 were $537 million and $423 million, respectively. Fair Value MeasurementsWe determine fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. We use a hierarchical structure to prioritize the inputs to valuation techniques used to measure fair valueinto three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level1), then to quoted market prices for similar assets or liabilities in active markets (Level 2) and gives the lowest priority to unobservable inputs(Level 3).Note 2. Recently Issued Accounting PronouncementsPronouncements Not Yet AdoptedIn January 2015, the Financial Accounting Standards Board (“FASB”) issued guidance which eliminates from U.S. GAAP the concept of anextraordinary item. Under existing U.S. GAAP, an event or transaction must be unusual in nature and must occur infrequently to be considered anextraordinary item. Additionally, under current U.S. GAAP extraordinary items are separately presented in a company’s income statement anddisclosed in the footnotes to the company’s financial statements. As a result of the new guidance regarding extraordinary items, a company will nolonger (1) segregate an extraordinary item from the results of ordinary operations, (2) separately present an extraordinary item on its incomestatement, and (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. This guidance is effective for annualreporting periods beginning after December 15, 2015 and may be applied prospectively or retrospectively. This guidance is not expected to havean impact on our financial condition or results of operations.In June 2014, the FASB issued guidance related to the recognition of compensation on employee share-based payments in which the terms of theaward provide that a performance target that affects vesting could be achieved after the requisite service period. The standard states that theperformance target should not be reflected in estimating the grant date fair value of the award. Compensation cost should be recognized in theperiod in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to theperiods for which the service has already been rendered. If the performance target becomes probable of being achieved before the end of therequisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite serviceperiod. This guidance is effective for annual reporting periods beginning after December 15, 2015, with early adoption permitted. The componentsof the guidance may be applied either (a) prospectively to all awards granted or modified after the effective date, or (b) retrospectively to all awardsoutstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter.This guidance is not expected to have an impact on our financial condition or results of operations.In May 2014, the FASB issued guidance on recognizing revenue from contracts with customers. The guidance outlines a single comprehensivemodel to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance,including industry-specific guidance. The core principle of the model is that an entity recognizes revenue to portray the transfer of goods andservices to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods orservices. The standard also expands disclosure requirements regarding revenue recognition. This guidance is66effective for annual reporting periods beginning after December 15, 2016, and may be applied retrospectively to each prior period presented or withthe cumulative effect recognized as of the date of initial application. Early adoption is not permitted. We are currently evaluating the impact of theguidance on our financial condition and results of operations.In April 2014, the FASB issued guidance related to the reporting of discontinued operations. The guidance states that the disposal of a business oroperation is required to be reported as discontinued operations if the disposal represents a strategic shift that will have a major effect on an entity’soperations and financial results. The guidance also expands disclosures about discontinued operations and the disposal of significant businessesthat did not qualify for discontinued operations presentation. This standard is effective prospectively for disposals (or businesses that qualify as“held for sale”) that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption ispermitted. The impact of this guidance on our financial condition and results of operations will depend on the occurrence and the significance ofdisposal transactions that meet the criteria described above.In January 2014, the FASB issued guidance related to service concession arrangements. A service concession arrangement is an arrangementbetween a public-sector entity grantor and an operating entity under which the operating entity operates the grantor's infrastructure (for example,airports, roads and bridges). The guidance states that service concession arrangements should not be accounted for under the guidance of Topic840, Leases, but rather other guidance as deemed appropriate. This guidance is effective for fiscal years beginning on or after December 15, 2014with early adoption permitted. Opening retained earnings will be adjusted in the year of adoption to reflect the cumulative historical impact of anyarrangements existing at the date of adoption, and the new guidance will then be applied to the financial statements on a prospective basis. Theadoption of this guidance is not expected to have a material impact on our financial condition or results of operations.Recently Adopted PronouncementsIn July 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit. The guidance requires that anunrecognized tax benefit or a portion of an unrecognized tax benefit, be presented as a reduction to a deferred tax asset for a net operating losscarryforward, a similar tax loss, or a tax credit carryforward. If an applicable deferred tax asset is not available or a company does not expect touse the applicable deferred tax asset, the unrecognized tax benefit should be presented in an entity's financial statements as a liability and shouldnot be combined with a deferred tax asset. This guidance is effective for fiscal years beginning after December 15, 2013. The adoption of thisguidance did not have a material impact on our financial condition or results of operations.In March 2013, the FASB issued guidance on the release of a cumulative translation adjustment ("CTA") related to an entity's investment in aforeign entity into income. The guidance requires such CTA to be released when there has been a: (1) sale of a subsidiary or group of net assetswithin a foreign entity and the sale represents the substantially complete liquidation of the investment in the foreign entity, (2) loss of a controllingfinancial interest in an investment in a foreign entity or (3) step acquisition for a foreign entity. This guidance is effective for fiscal years beginningafter December 15, 2013. The adoption of this guidance did not have a material impact on our financial condition or results of operations.In February 2013, the FASB issued guidance related to the measurement and disclosure of obligations resulting from joint and several liabilityarrangements. The new guidance requires companies to measure obligations resulting from joint and several liability arrangements as the sum of(1) the amount the company agreed to pay on the basis of its arrangement among co-obligors and (2) any additional amount the company expectsto pay on behalf of its co-obligors. Additionally, the new guidance requires the disclosure of a description of the joint and several arrangement andthe total outstanding amount of the obligation for all joint parties. This guidance is effective for fiscal years beginning after December 15, 2013.The adoption of this guidance did not have a material impact on our financial condition or results of operations.67Note 3. Acquisitions and Divestitures2014 DivestitureOn July 2, 2014, we divested our Wolverhampton, U.K.-based pneumatic and hydraulic valves business for approximately $30 million. The saleresulted in a gain of $11 million, reflected in gain from sale of business in our Consolidated Income Statement. The business, which was part ofour Applied Water segment, provided a wide range of products, primarily to industrial original equipment manufacturer customers in the oil and gassector. The business reported 2013 annual revenue of approximately $25 million.2013 AcquisitionsDuring 2013, we spent $84 million ($81 million, net of cash acquired) on acquisitions. As the acquisitions were not material, individually or in theaggregate, to results of operations, pro forma results of operations reflecting results prior to the acquisitions and certain other disclosure itemshave not been presented. MultiTrodeOn March 1, 2013 we acquired MultiTrode Pty Ltd ("MultiTrode"), a water and wastewater technology and services company based in Australia, forapproximately $26 million. MultiTrode offers advanced monitoring and control technologies to municipal and private water and waste waterauthorities as well as industrial clients. The company had approximately 60 employees and generated revenue of approximately $13 million in itsfiscal year ended June 30, 2012.Our consolidated financial statements include MultiTrode's results of operations prospectively from March 1, 2013 within the Water Infrastructuresegment.PIMSOn February 5, 2013 we acquired PIMS Group ("PIMS"), a wastewater services company based in the United Kingdom, for approximately $57million, including a cash payment of $55 million and the assumption of certain liabilities. PIMS is a supplier of wastewater installation andmaintenance services for the private sector, municipal and industrial markets. The company had approximately 220 employees and generatedrevenue of approximately $38 million for its fiscal year ended April 30, 2012.Our consolidated financial statements include PIMS' results of operations prospectively from February 5, 2013 within the Water Infrastructuresegment.2012 AcquisitionsHeartland and MJKDuring 2012, we spent $41 million, net of cash acquired, on two acquisitions that were not material individually or in the aggregate to our results ofoperations or financial position. On October 26, 2012, we acquired Heartland Pump Rental & Sales, Inc. ("Heartland"), a dewatering pump sale andrental company, for approximately $29 million. Heartland generated revenue of approximately $33 million for the fiscal year ended December 31,2011. On July 13, 2012, we acquired MJK Automation (“MJK”) for a purchase price of approximately $12 million. MJK, which reported 2011revenue of $11 million for the fiscal year ended June 30, 2012, is a leading manufacturer of flow and level sensors, and measurement and controltechnology for water and wastewater applications. Our financial statements include Heartland and MJK results of operations prospectively fromOctober 26, 2012 and July 13, 2012, respectively, within the Water Infrastructure segment. As the acquisitions were not material to results ofoperations, pro forma results of operations reflecting results prior to the acquisitions and certain other disclosure items have not been presented.68Note 4. Restructuring and Asset Impairment ChargesFrom time to time, the Company will incur costs related to restructuring actions in order to optimize our cost base and more strategically positionourselves based on the economic environment and customer demand. During 2014 and 2013, the costs incurred primarily relate to the reduction instructural costs, including the elimination of headcount and consolidation of facilities primarily within our Water Infrastructure and Applied Watersegments. During 2012, the costs incurred primarily relate to restructuring related severance payments for reductions in force initiatives primarilywithin our Water Infrastructure segment. The components of restructuring and asset impairment charges incurred during each of the previous threeyears ended are presented below. Year Ended December 31,(in millions) 2014 2013 2012By component: Severance and other charges $26 $38 $17Lease related charges 1 2 —Reversal of restructuring accruals (1) — —Total restructuring charges 26 40 17Asset impairment — 2 —Total restructuring and asset impairment charges $26 $42 $17 By segment: Water Infrastructure $19 $33 $14Applied Water 6 9 3Corporate and other 1 — —RestructuringThe following table displays a rollforward of the restructuring accruals, presented on our Consolidated Balance Sheet within accrued liabilities, forthe years ended December 31, 2014 and 2013.(in millions) 2014 2013Restructuring accruals - January 1 $13 $9Restructuring charges 26 40Cash payments (26) (35)Other (1) (1)Restructuring accruals - December 31 $12 $13 By segment: Water Infrastructure $5 $6Applied Water 3 3Regional selling locations (a) 3 4Corporate and other 1 —(a)Regional selling locations consist primarily of selling and marketing organizations that incurred restructuring expense which was allocated to thesegments. The liabilities associated with restructuring expense were not allocated to the segments.69The following is a rollforward of employee position eliminations associated with restructuring activities for the years ended December 31, 2014 and2013. 2014 2013Planned reductions - January 1 51 54Additional planned reductions 320 513Actual reductions (238) (516)Planned reductions - December 31 133 51Total expected costs associated with actions commenced during 2014 of approximately $22 million for Water Infrastructure include $18 millionincurred in 2014 and $4 million remaining to be incurred in 2015. These costs primarily comprise severance charges. We currently expect theseactions to continue through the end of 2015. Total expected costs of approximately $10 million for Applied Water include $6 million incurred in2014 and $4 million remaining to be incurred during 2015. These costs primarily comprise severance charges. We currently expect these actionsto continue through the end of 2015. Total expected and incurred costs associated with Corporate and other actions commenced during 2014 were$1 million. These actions were completed during 2014.Total expected costs associated with actions that commenced during 2013 are approximately $32 million for Water Infrastructure. Approximately$31 million of the expected cost was incurred in 2013 and $1 million was incurred during 2014. Total expected costs associated with actions thatcommenced during 2013 are approximately $8 million for Applied Water. Approximately $8 million of the expected cost was incurred in 2013.These actions are substantially complete.Asset Impairment ChargesDuring the fourth quarter of 2013 we performed our annual impairment test of our indefinite-lived intangibles assets, which resulted in animpairment charge of $2 million related to trade names within our Water Infrastructure segment. Refer to Note 11, “Goodwill and Other IntangibleAssets,” for additional information.Note 5. Separation CostsWe had non-recurring separation costs related to our Spin-off from ITT as presented below. Year Ended December 31,(in millions)2014 2013 2012Rebranding and marketing costs$— $— $8Advisory and professional fees— — 7Information and technology costs— 2 3Employee retention and hiring costs— — 1Lease termination and other real estate costs— 2 1Other— — 2Total separation costs in operating income— 4 22Tax-related separation cost— — —Income tax benefit— (2) (6)Total separation costs, net of tax$— $2 $1670Note 6. Other Non-Operating Income (Expense), NetThe components of other non-operating income (expense), net are as follows: Year Ended December 31,(in millions)2014 2013 2012Interest income$2 $3 $4Income from joint ventures2 2 4Other expense – net (a)(3) (15) (8)Total other non-operating income (expense), net$1 $(10) $—(a) 2013 includes $10 million of expense incurred under the tax matters agreement with ITT. Refer to Note 7 "Income Taxes" for additional informationregard the tax matters agreement.Note 7. Income TaxesThe source of pre-tax income and the components of income tax expense are as follows: Year Ended December 31,(in millions)2014 2013 2012Income components: Domestic$118 $49 $106Foreign303 249 282Total pre-tax income$421 $298 $388Income tax expense components: Current: Domestic – federal$44 $37 $27Domestic – state and local7 1 7Foreign62 46 56Total Current113 84 90Deferred: Domestic – federal$(14) $(6) $10Domestic – state and local— — (2)Foreign(15) (8) (7)Total Deferred(29) (14) 1Total income tax provision$84 $70 $91Effective income tax rate19.8% 23.5% 23.4%71Reconciliations between taxes at the U.S. federal income tax rate and taxes at our effective income tax rate on earnings before income taxes areas follows: Year Ended December 31, 2014 2013 2012Tax provision at U.S. statutory rate35.0 % 35.0 % 35.0 %Increase (decrease) in tax rate resulting from: State income taxes1.0 0.7 1.2Settlements of tax examinations0.4 — 0.2Valuation allowance22.9 39.4 8.9Tax exempt interest(26.3) (43.0) (18.2)Foreign tax rate differential(4.2) (4.1) (3.4)Repatriation of foreign earnings, net of foreign tax credits(1.7) 5.1 0.4Tax incentives(6.2) (8.1) —Other – net(1.1) (1.5) (0.7)Effective income tax rate19.8 % 23.5 % 23.4 %We operate under tax incentives, which are effective January 2013 through December 2023 and may be extended if certain additional requirementsare satisfied. The tax incentives are conditional upon our meeting certain employment thresholds. The impact of these tax incentives decreasedour tax provision by 6.2% and 8.1% in 2014 and 2013, respectively.Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets andliabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. The following is a summary of the components of the net deferred tax assets and liabilities recognized in the Consolidated Balance Sheets: December 31,(in millions)2014 2013Deferred tax assets: Employee benefits$124 $114Accrued expenses25 20Loss and other tax credit carryforwards456 374Inventory6 6Other3 1 $614 $515Valuation allowance(427) (349)Net deferred tax asset$187 $166Deferred tax liabilities: Intangibles$173 $180Investment in foreign subsidiaries8 15Property, plant, and equipment22 19Other30 42Total deferred tax liabilities$233 $256Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to realizeexisting deferred tax assets. On the basis of this evaluation, as of December 31, 2014, a valuation allowance of $427 million has been establishedto reduce the deferred income tax asset related to certain U.S. and foreign net operating losses, and U.S. and foreign capital loss carryforwards.72A reconciliation of our valuation allowance on deferred tax assets is as follows:(in millions)2014 2013 2012Valuation allowance — January 1$349 $229 $195Change in assessment(4) — —Current year operations82 120 34Valuation allowance — December 31$427 $349 $229The valuation allowance is primarily attributable to foreign deferred tax assets.Deferred taxes are classified net of unrecognized tax benefits in the Consolidated Balance Sheets as follows: December 31,(in millions)2014 2013Current assets$38 $41Non-current assets79 64Current liabilities(5) (4)Non-current liabilities(158) (191)Total net deferred tax liabilities$(46) $(90)Tax attributes available to reduce future taxable income begin to expire as follows:(in millions)December 31, 2014 First Year of ExpirationU.S. net operating loss$8 December 31, 2024State net operating loss53 December 31, 2015U.S. tax credits38 December 31, 2020Foreign net operating loss1,496 December 31, 2015The foreign tax credit for financial statement purposes differs from the amount for tax return purposes due to unrecognized tax benefits.As of December 31, 2014, we have provided a deferred tax liability of $8 million on the excess of $65 million of financial reporting over the taxbasis of investments in certain foreign subsidiaries that has not been indefinitely reinvested. However, we have not provided for deferred taxes onthe excess of financial reporting over the tax basis of investments in certain foreign subsidiaries in the amount of $1.9 billion because we plan toreinvest such amounts indefinitely outside the U.S. The determination of the amount of federal and state income taxes is not practicable becauseof complexities of the hypothetical calculation.Unrecognized Tax BenefitsWe recognize tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by thetaxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from suchpositions are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Areconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:(in millions)2014 2013 2012Unrecognized tax benefits — January 1$30 $8 $5Additions for: Current year tax positions9 23 1Prior year tax positions7 — 2Reductions for: Settlements(2) (1) —Unrecognized tax benefits — December 31$44 $30 $873The amount of unrecognized tax benefits at December 31, 2014, was $44 million which, if ultimately recognized, will reduce our annual effectivetax rate. We do not believe that the unrecognized tax benefits will significantly change within the next twelve months.In many cases, unrecognized tax benefits are related to tax years that remain subject to examination by the relevant taxing authorities. By virtueof previously filed separate company tax returns including tax returns filed by ITT, we are routinely under audit by federal, state, local and foreigntaxing authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various taxjurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior yearreturns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for taxcontingencies and the amounts owed by the company are recorded in the period they become known. Under the Tax Matters Agreement, asdiscussed below, ITT assumes all consolidated tax liabilities and related interest and penalties for the pre-spin period. The following tablesummarizes the earliest open tax years by major jurisdiction:Jurisdiction EarliestOpen YearCanada 2009Germany 2005Italy 2009Luxembourg 2010Poland 2007Sweden 2009Switzerland 2010United Kingdom 2011United States 2009We classify interest relating to unrecognized tax benefits as a component of other non-operating (expense) income, net and tax penalties as acomponent of income tax expense in our Consolidated Income Statements. The amount of interest relating to unrecognized tax benefits as ofDecember 31, 2014 was $1 million.Tax Matters AgreementIn connection with the Spin-off, Xylem, ITT and Exelis entered into a Tax Matters Agreement. Under the agreement, we may be obligated to makepayments to ITT and Exelis under certain conditions. These conditions include a payment to ITT in the event audit settlement payments exceedamounts specified in the agreement. We also may be obligated to make payments in the event the Spin-off is determined to be taxable.The Tax Matters Agreement governs the respective rights, responsibilities and obligations of ITT, Xylem and the other Spincos (members of theITT group that were spun-off, including Xylem are collectively referred to as “Spincos”) with respect to taxes for periods ending on or before theSpin-off. In general, pursuant to the Tax Matters Agreement, ITT will prepare and file the tax returns that include ITT (or any of its subsidiaries)and Xylem (or any of its subsidiaries) for all taxable periods ending on or prior to, and including, October 31, 2011, with the appropriate taxauthorities, and, except as otherwise set forth below, ITT will pay any taxes relating thereto to the relevant tax authority. In connection with anyaudit adjustments with respect to such returns, we have agreed to indemnify ITT for a portion of such tax liability to the extent it exceeds anagreed-upon threshold.We will file all tax returns that include solely Xylem and/or its subsidiaries and any separate company tax returns for Xylem and/or its subsidiariesfor all taxable periods ending on or prior to, and including, October 31, 2011, and will pay all taxes due with respect to such tax returns (includingany taxes attributable to an audit adjustment with respect to such returns). In general, ITT controls all audits and administrative matters and othertax proceedings relating to the consolidated U.S. federal income tax return of the ITT group and any other tax returns for which the ITT group isresponsible.Notwithstanding the receipt of any such IRS ruling, tax opinion or officer’s certificate, generally Xylem and each other Spinco must indemnify ITTand each other Spinco for any taxes and related losses resulting from (i) any act or failure to act by such Spinco described in the covenantsabove, (ii) any acquisition of equity securities or assets of such Spinco or any member of its group, and (iii) any breach by such Spinco or anymember of its group of any74representation or covenant contained in the separation documents or the documents relating to the IRS private letter ruling or tax opinionconcerning the Spin-off of such Spinco.Under U.S. federal income tax law, ITT and the Spincos are severally liable for all of ITT’s U.S. federal income taxes attributable to periods prior toand including the year of the Spin-off, which ended on December 31, 2011.Thus, if ITT failed to pay the U.S. federal income taxes attributable to it under the Tax Matters Agreement for periods prior to and including theyear of the Spin-off, the Spincos would be severally liable for such taxes. In the event a Spinco is required to make a payment in respect of aSpin-off related tax liability of the ITT consolidated U.S. federal income tax return group under these rules for which such Spinco is not responsibleunder the Tax Matters Agreement and full indemnification cannot be obtained from the Spinco responsible for such payment under the Tax MattersAgreement, ITT will indemnify the Spinco that was required to make the payment from and against the portion of such liability for which fullindemnification cannot be obtained from the Spinco responsible for such payment under the Tax Matters Agreement.The Tax Matters Agreement also contains provisions regarding the apportionment of tax attributes of the ITT consolidated U.S. federal income taxreturn group, authority to make tax elections, cooperation, and other customary matters.As of December 31, 2014, the net amount Xylem owed ITT pursuant to the Tax Matters Agreement is $7 million.Note 8. Earnings Per ShareThe following is a reconciliation of the shares used in calculating basic and diluted net earnings per share. Year Ended December 31, 2014 2013 2012Net Income (in millions)$337 $228 $297Shares (in thousands): Weighted average common shares outstanding183,030 185,082 185,459Add: Participating securities (a)47 134 325Weighted average common shares outstanding — Basic183,077 185,216 185,784Plus incremental shares from assumed conversions: (b) Dilutive effect of stock options643 264 213Dilutive effect of restricted stock529 558 233Weighted average common shares outstanding — Diluted184,249 186,038 186,230Basic earnings per share$1.84 $1.23 $1.60Diluted earnings per share$1.83 $1.22 $1.59(a)Restricted stock awards containing rights to non-forfeitable dividends which participate in undistributed earnings with common shareholders areconsidered participating securities for purposes of computing earnings per share.(b)Incremental shares from stock options, restricted stock and performance share units are computed by the treasury stock method. The weighted averageshares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periodspresented or were otherwise excluded under the treasury stock method. The treasury stock method calculates dilution assuming the exercise of all in-the-money options and vesting of restricted stock and performance share awards, reduced by the repurchase of shares with the proceeds from theassumed exercises, unrecognized compensation expense for outstanding awards and the estimated tax benefit of the assumed exercises.Performance share units will be included in the treasury stock calculation of diluted earnings per share upon achievement of underlying performanceconditions. See Note 16, "Stock-Based Compensation Plans" for further detail on the performance share units. Year Ended December 31,(in thousands)2014 2013 2012Stock options2,720 4,126 4,285Restricted shares525 703 870Performance shares119 80 —75Note 9. Inventories December 31,(in millions)2014 2013Finished goods$194 $189Work in process42 31Raw materials250 255Total inventories$486 $475Note 10. Property, Plant and Equipment December 31,(in millions)2014 2013Land, buildings and improvements$252 $263Machinery and equipment655 685Equipment held for lease or rental207 192Furniture and fixtures87 93Construction work in progress41 49Other23 22Total property, plant and equipment, gross1,265 1,304Less accumulated depreciation804 816Total property, plant and equipment, net$461 $488Depreciation expense was $95 million, $99 million, and $94 million for 2014, 2013, and 2012, respectively. Note 11. Goodwill and Other Intangible AssetsChanges in the carrying value of goodwill by operating segment during the years ended December 31, 2014 and 2013 are as follows: (in millions)WaterInfrastructure Applied Water TotalBalance as of December 31, 2012$1,085 $562 $1,647Activity in 2013 Goodwill acquired48 — 48Foreign currency and other16 7 23Balance as of December 31, 2013$1,149 $569 $1,718Activity in 2014 Goodwill divested (a)— (6) (6)Foreign currency and other(51) (26) (77)Balance as of December 31, 2014$1,098 $537 $1,635(a)On July 2, 2014, we divested our Wolverhampton, U.K.-based pneumatic and hydraulic valves business which had $6 million of goodwill associatedwith the business. Refer to Note 3 "Acquisitions and Divestitures" for additional information.During the fourth quarter of 2014, we performed our annual impairment assessment and determined that the estimated fair values of our goodwillreporting units were in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge to earnings. Wewill continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstancesindicate there may be a potential impairment.76Other Intangible AssetsInformation regarding our other intangible assets is as follows:(in millions)December 31, 2014 December 31, 2013 CarryingAmount AccumulatedAmortization NetIntangibles CarryingAmount AccumulatedAmortization NetIntangiblesCustomer and distributorrelationships$331 $(122) $209 $352 $(104) $248Proprietary technology106 (41) 65 109 (36) 73Trademarks36 (17) 19 35 (16) 19Patents and other19 (17) 2 20 (17) 3Indefinite-lived intangibles136 — 136 145 — 145Other intangibles$628 $(197) $431 $661 $(173) $488We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date of our annual impairment assessment in2014. In 2013 we recorded a $2 million impairment charge related to three trade names within our Water Infrastructure segment. The charge wascalculated using an income approach, which is considered a Level 3 input for fair value measurement, and is reflected in “Restructuring and assetimpairment charges.” Future impairment tests could result in a charge to earnings. We will continue to evaluate the indefinite-lived intangibleassets on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be apotential impairment.Customer and distributor relationships, proprietary technology, trademarks, patents and other are amortized over weighted average lives ofapproximately 13 years, 18 years, 16 years and 8 years, respectively.Total amortization expense for intangible assets was $36 million, $38 million, and $34 million for 2014, 2013 and 2012, respectively.Estimated amortization expense for each of the five succeeding years is as follows:(in millions) 2015$34201632201732201831201929Note 12. Derivative Financial InstrumentsRisk Management Objective of Using DerivativesWe are exposed to certain risks arising from both our business operations and economic conditions and principally manage our exposures to theserisks through management of our core business activities. Certain of our foreign operations expose us to fluctuations of foreign interest rates andexchange rates that may impact revenue, expenses, cash receipts and payments. We enter into derivative financial instruments to protect thevalue or fix the amount of certain cash flows in terms of the functional currency of the business unit with that exposure.Cash Flow Hedges of Foreign Exchange RiskWe are exposed to fluctuations in various foreign currencies against our functional currencies. We use foreign currency derivatives, includingcurrency forward agreements, to manage our exposure to fluctuations in the various exchange rates. Currency forward agreements involve fixingthe foreign currency exchange rate for delivery of a specified amount of foreign currency on a specified date.77Beginning in 2012, certain business units within our segments with exposure to foreign currency exchange risks have designated certain currencyforward agreements as cash flow hedges of forecasted intercompany inventory purchases and sales. Our principal currency exposures relate tothe Euro, Swedish Krona, British Pound, Canadian Dollar, Polish Zloty, Australian Dollar and Hungarian Forint . We held forward foreign exchangecontracts with purchase notional amounts totaling $355 million and $275 million as of December 31, 2014 and 2013, respectively. In 2014, ourmost significant foreign currency derivatives include contracts to purchase Swedish Krona and sell Euro, sell US Dollar and purchase Euro, and tosell British Pound and purchase Euro. The purchased notional amounts associated with these currency derivatives are $140 million, $85 millionand $51 million, respectively. In 2013, our most significant foreign currency derivatives include contracts to purchase Swedish Krona and sellEuro, purchase Polish Zloty and sell Euro, and to sell British Pound and purchase Euro. The purchase notional amounts associated with thesecurrency derivatives were $190 million, $34 million and $37 million, respectively.The table below presents the effect of our derivative financial instruments on the Consolidated Income Statements and Statements ofComprehensive Income. Year Ended December 31,(in millions) 2014 2013 2012Derivatives in Cash Flow Hedges Foreign Exchange Contracts Amount of (loss) gain recognized in OCI (a) $(22) $1 $4Amount of loss (gain) reclassified from OCI into revenue (a) 5 (2) (2)Amount of loss (gain) reclassified from OCI into cost of revenue (a) 1 2 (1)(a)Effective portionAs of December 31, 2014, $14 million of the net unrealized losses on cash flow hedges is expected to be reclassified into earnings in the next 12months. Any ineffective portion of the change in fair value of a cash flow hedge is recognized immediately in selling, general and administrativeexpenses in the Consolidated Income Statements and, for the twelve months ended December 31, 2014, 2013, and 2012, was not material.The fair values of our foreign exchange contracts currently included in our hedging program were as follows: December 31,(in millions)2014 2013Derivatives designated as hedging instruments Assets Other current assets$1 $1Liabilities Other current liabilities(13) —Total fair value$(12) $1Note 13. Accrued and Other Current Liabilities December 31,(in millions)2014 2013Compensation and other employee-benefits$186 $215Customer-related liabilities66 63Accrued warranty costs31 36Accrued taxes77 45Other accrued liabilities121 120Total accrued and other current liabilities$481 $47978Note 14. Credit Facilities and Long-Term DebtTotal debt outstanding is summarized as follows: December 31,(in millions)2014 2013Short-term borrowings and current maturities of long-term debt$89 $42Long-term debt: 3.550% Senior Notes due 2016 (a)600 6004.875% Senior Notes due 2021 (a)600 600Unamortized discount (b)(1) (1)Long-term debt1,199 1,199Total debt (c)$1,288 $1,241(a)The fair value of our Senior Notes (as defined below) was determined using quoted prices in active markets for identical securities, which areconsidered Level 1 inputs. The fair value of our Senior Notes due 2016 (as defined below) was $621 million and $635 million as of December 31, 2014and 2013, respectively. The fair value of our Senior Notes due 2021 (as defined below) was $653 million and $629 million as of December 31, 2014and 2013, respectively.(b)The unamortized discount is recognized as a reduction in the carrying value of the Senior Notes in the Consolidated Balance Sheets and is beingamortized to interest expense in our Consolidated Income Statements over the expected remaining terms of the Senior Notes.Deferred Financing CostsWe had deferred financing costs of $5 million and $7 million as of December 31, 2014 and December 31, 2013, respectively, related to ourrevolving credit facility and Senior Notes. Scheduled amortization for future years, assuming no further prepayments of principal, is $2 million in2015, $2 million in 2016, less than $1 million in 2017, less than $1 million in 2018, less than $1 million in 2019 and $1 million thereafter.Senior NotesOn September 20, 2011, we issued 3.550% Senior Notes of $600 million aggregate principal amount due September 2016 (the "Senior Notes due2016") and 4.875% Senior Notes of $600 million aggregate principal amount due October 2021 (the "Senior Notes due 2021" and together with theSenior Notes due 2016, the “Senior Notes”).The Senior Notes include covenants which restrict our ability, subject to exceptions, to incur debt secured by liens and engage in sale andleaseback transactions, as well as provide for customary events of default (subject, in certain cases, to receipt of notice of default and/orcustomary grace and cure periods). We may redeem the Senior Notes, as applicable, in whole or in part, at any time at a redemption price equal tothe principal amount of the Senior Notes to be redeemed, plus a make-whole premium. If a change of control triggering event (as defined in theSenior Notes) occurs, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of their principal amount plusaccrued and unpaid interest to the date of repurchase. As of December 31, 2014, we were in compliance with all covenants.Interest on the Senior Notes due 2016 is payable on March 20 and September 20 of each year. Interest on the Senior Notes due 2021 is payableon April 1 and October 1 of each year.Four Year Competitive Advance and Revolving Credit FacilityEffective October 31, 2011, Xylem and its subsidiaries entered into a Four Year Competitive Advance and Revolving Credit Facility (the "CreditFacility") with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders. The Credit Facility provides for an aggregateprincipal amount of up to $600 million of: (i) a competitive advance borrowing option which will be provided on an uncommitted competitiveadvance basis through an auction mechanism (the "competitive loans"), (ii) revolving extensions of credit (the "revolving loans") outstanding at anytime and (iii) the issuance of letters of credit in a face amount not in excess of $100 million outstanding at any time.79At our election, the interest rate per annum applicable to the competitive advances will be based on either (i) a Eurodollar rate determined byreference to LIBOR, plus an applicable margin offered by the lender making such loans and accepted by us or (ii) a fixed percentage rate perannum specified by the lender making such loans. At our election, the interest rate per annum applicable to the revolving loans will be based oneither (i) a Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin or (ii) afluctuating rate of interest determined by reference to the greatest of: (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the U.S. FederalFunds effective rate plus half of 1% or (c) the Eurodollar rate determined by reference to LIBOR, adjusted for statutory reserve requirements, ineach case, plus an applicable margin.In accordance with the terms, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debt to earnings before interest,taxes, depreciation and amortization) throughout the term. The Credit Facility also contains limitations on, among other things, incurring debt,granting liens, and entering sale and leaseback transactions. In addition, the Credit Facility contains other terms and conditions such ascustomary representations and warranties, additional covenants and customary events of default. As of December 31, 2014, we were incompliance with all covenants.As of December 31, 2014, the Credit Facility remains undrawn.Research and Development Facility AgreementOn December 4, 2013, the Company amended and restated its Risk Sharing Finance Facility Agreement (the "R&D Facility Agreement") with TheEuropean Investment Bank (the "EIB") to add an additional borrower under the facility. The facility provides an aggregate principal amount of up to€120 million (approximately $146 million) to finance research projects and infrastructure development in the European Union. The Company'swholly-owned subsidiaries in Luxembourg, Xylem Holdings S.á.r.l. and Xylem International S.á.r.l., are the borrowers under the R&D FacilityAgreement. The obligations of the borrowers under the R&D Facility Agreement are guaranteed by the Company under an Amended and RestatedDeed of Guarantee, dated as of December 4, 2013, in favor of the EIB. The funds are available to finance research and development projectsduring the period from 2013 through 2016 at the Company's R&D facilities in Sweden, Germany, Italy, the United Kingdom, Austria, Norway andHungary.Under the R&D Facility Agreement, the borrower can draw loans on or before June 14, 2015 with a maturity of no longer than 12 years. The R&DFacility Agreement provides for Fixed Rate loans and Floating Rate loans. The interest rate per annum applicable to Fixed Rate loans will be at afixed percentage rate per annum specified by the EIB which includes the applicable margin. The interest rate per annum applicable to FloatingRate loans will be at the rate determined by reference to EURIBOR for loans drawn in Euros and LIBOR for loans drawn in Pounds Sterling or U.S.Dollars, plus an applicable spread specified by the EIB which includes the applicable margin. The applicable margin for both Fixed Rate loans andFloating Rate loans shall be determined by reference to the credit rating of the Company.In accordance with the terms of the R&D Facility Agreement, we may not exceed a maximum leverage ratio of 3.50 (based on a ratio of total debtto earnings before interest, taxes, depreciation and amortization) throughout the term. The R&D Facility Agreement also contains limitations on,among other things, incurring debt, granting liens, and entering into sale and leaseback transactions. In addition, the R&D Facility Agreementcontains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. Asof December 31, 2014, we were in compliance with all covenants.As of December 31, 2014, $84 million was outstanding under the R&D Facility Agreement. Although the borrowing term for this arrangement is forfive years, we have classified it as short-term debt on our Consolidated Balance Sheet since we intend to repay this obligation in less than oneyear.80Note 15. Postretirement Benefit PlansDefined contribution plans – Xylem and certain of our subsidiaries maintain various defined contribution savings plans, which allow employeesto contribute a portion of their pre-tax and/or after-tax income in accordance with specified guidelines. Several of the plans require us to match apercentage of the employee contributions up to certain limits, generally between 3.0% – 7.0% of employee base pay. Xylem’s U.S. plan alsoprovides for transition credits for eligible U.S. employees for the first five years after the Spin-off to supplement retirement benefits in the absenceof a defined benefit plan. Age plus years of eligible service greater than or equal to 60, entitles an employee to transition credits. The liability fortransition credits was approximately $2 million and $3 million at December 31, 2014 and 2013, respectively. Matching obligations, the majority ofwhich were funded in cash in connection with the plans, along with transition credits and other company contributions are as follows:(in millions)Defined Contribution2014$36201335201230The Xylem Stock Fund, an investment option under the defined contribution plan in which Company employees participate is considered anEmployee Stock Ownership Plan. As a result, participants in the Xylem Stock Fund may receive dividends in cash or may reinvest such dividendsinto the Xylem Stock Fund. Company employees held approximately 415 thousand and 453 thousand shares of Xylem Inc. common stock in theXylem Stock Fund at December 31, 2014 and 2013, respectively.Defined benefit pension plans and other postretirement plans – We historically have maintained qualified and nonqualified defined benefitretirement plans covering certain current and former employees, including hourly and union plans as well as salaried plans, which generally requireup to 5 years of service to be vested and for which the benefits are determined based on years of credited service and either specified rates, finalpay, or final average pay. The other postretirement benefit plans are all unfunded plans in the U.S. and Canada.During the first quarter of 2012, an annuity was purchased to wind up five pension plans in Canada. This resulted in a settlement change of $2million. The Company has no further obligation for these plans.Effective October 1, 2013, the Xylem Canada Company Pension Plan for Salaried Employees was amended to close the plan to new entrants anda soft freeze, where benefits earned to date are based on frozen service but the future average earnings will continue to be recognized. Theimpact of the curtailment on the Company’s financial statements was immaterial. However, the participants are now considered inactive andactuarial gains and losses will be amortized over 25 years which represents the expected weighted-average remaining lives of the planparticipants. Effective October 14, 2013, an amendment to one of the Company's U.S. business unit's pension plans for its hourly workers modified the benefitformula. Pension benefits for future service will be based only on years of service. The remeasurement at year end resulted in a $4 million priorservice credit, which will be amortized into net periodic pension cost over approximately 11 years.During the third quarter 2014, we amended one of our international pension plans as well as one of our domestic other postretirement plans. Thepension plan amendment froze the accrual of benefits and closed the plan to new entrants. The other postretirement plan amendment modified theaccrual of benefits and closed the plan to new entrants. The overall impact of these changes was a $10 million increase to funded status. Thisincluded a net loss of $3 million ($1 million net of tax) and a prior service credit of $13 million ($8 million net of tax) recognized in othercomprehensive income.81Amounts recognized in the Consolidated Balance Sheets for pension and other employee-related benefit plans (collectively, postretirement plans)reflect the funded status of the postretirement benefit plans. The following table provides a summary of the funded status of our postretirementplans, the presentation of such balances and a summary of amounts recorded within accumulated other comprehensive income.(in millions)December 31, 2014 December 31, 2013 Pension Other Total Pension Other TotalFair value of plan assets$584 $— $584 $524 $— $524Projected benefit obligation(872) (58) (930) (777) (63) (840)Funded status$(288) $(58) $(346) $(253) $(63) $(316)Amounts recognized in the balancesheet Other non-current assets$55 $— $55 $46 $— $46Accrued and other current liabilities(10) (3) (13) (11) (3) (14)Accrued postretirement benefits(333) (55) (388) (288) (60) (348)Net amount recognized$(288) $(58) $(346) $(253) $(63) $(316)Accumulated other comprehensiveincome (loss): Net actuarial losses$(297) $(30) $(327) $(228) $(20) $(248)Prior service cost— 17 17 — — —Total$(297) $(13) $(310) $(228) $(20) $(248)The unrecognized amounts recorded in accumulated other comprehensive income will be subsequently recognized as expense on a straight-linebasis only to the extent they exceed 10% of the higher of the market-related value or the projected benefit obligation, over the average remainingservice period of active participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy.Actuarial gains and losses incurred in future periods and not recognized as expense in those periods will be recognized as increases or decreasesin other comprehensive income, net of tax.The net actuarial loss included in accumulated other comprehensive income at the end of 2014 and expected to be recognized in net periodicbenefit cost during 2015 is $19 million ($14 million, net of tax). The prior service credit included in accumulated other comprehensive income to berecognized in 2015 is $3 million ($2 million, net of tax).82The benefit obligation, fair value of plan assets, funded status, and amounts recognized in the consolidated financial statements for our definedbenefit domestic and international pension plans were: Domestic Plans International Plans December 31, December 31,(in millions)2014 2013 2014 2013Change in benefit obligation: Benefit obligation at beginning of year$74 $83 $703 $707Service cost2 3 12 14Interest cost3 3 27 28Benefits paid(3) (3) (30) (32)Actuarial (gain) loss13 (8) 144 (9)Plan amendments, settlements and curtailments— (4) (2) (2)Foreign currency translation/other(1) — (70) (3)Benefit obligation at end of year$88 $74 $784 $703Change in plan assets: Fair value of plan assets at beginning of year$58 51 $466 $426Employer contributions4 4 28 36Actual return on plan assets3 6 92 42Benefits paid(3) (3) (30) (32)Plan amendments, settlements and curtailments— — (2) (1)Foreign currency translation/other(2) — (30) (5)Fair value of plan assets at end of year$60 $58 $524 $466Funded (unfunded) status of the plans$(28) $(16) $(260) $(237)The following table provides a rollforward of the projected benefit obligation for the other postretirement employee benefit plans:(in millions)2014 2013Change in benefit obligation: Benefit obligation at beginning of year$63 $65Service cost1 1Interest cost3 3Benefits paid(3) (3)Actuarial loss (gain)12 (2)Plan amendment(18) —Other— (1)Benefit obligation at the end of year$58 $63The accumulated benefit obligation (“ABO”) for all the defined benefit pension plans was $830 million and $741 million at December 31, 2014 and2013, respectively. For defined benefit pension plans in which the ABO was in excess of the fair value of the plans’ assets, the projected benefitobligation, ABO and fair value of the plans’ assets were as follows: December 31,(in millions)2014 2013Projected benefit obligation$453 $404Accumulated benefit obligation419 375Fair value of plan assets110 10683The components of net periodic benefit cost for our defined benefit pension plans are as follows: Year Ended December 31,(in millions)2014 2013 2012Domestic defined benefit pension plans: Service cost$2 $3 $3Interest cost3 3 3Expected return on plan assets(4) (4) (4)Amortization of prior service cost— 1 1Amortization of net actuarial loss2 2 2Net periodic benefit cost$3 $5 $5International defined benefit pension plans: Service cost$12 $14 $11Interest cost27 28 29Expected return on plan assets(32) (31) (30)Amortization of net actuarial loss7 13 8Settlement1 — 2Net periodic benefit cost$15 $24 $20Total net periodic benefit cost$18 $29 $25Other changes in assets and benefit obligations recognized in other comprehensive (loss) income, as they pertain to our defined benefit pensionplans are as follows: Year Ended December 31,(in millions)2014 2013 2012Domestic defined benefit pension plans: Net loss (gain)$14 $(11) $8Prior service cost (credit)1 (4) 1Amortization of prior service cost— (1) (1)Amortization of net actuarial loss(2) (2) (2)Losses (gains) recognized in other comprehensive (loss) income$13 $(18) $6International defined benefit pension plans: Net loss (gain)$84 $(21) $62Amortization of net actuarial loss(7) (13) (8)Settlement(1) — (2)Foreign currency translation/other(20) (2) 8Losses (gains) recognized in other comprehensive (loss) income$56 $(36) $60Total losses (gains) recognized in other comprehensive (loss) income$69 $(54) $66Total losses (gains) recognized in comprehensive income$87 $(25) $9184The components of net periodic benefit cost for other postretirement employee benefit plans are as follows: Year Ended December 31,(in millions)2014 2013 2012Service cost$1 $1 $1Interest cost3 3 3Amortization of prior service credit(1) — —Amortization of net actuarial loss2 2 1Net periodic benefit cost$5 $6 $5Other changes in benefit obligations recognized in other comprehensive (loss) income, as they pertain to other postretirement employee benefitplans are as follows: Year Ended December 31,(in millions)2014 2013 2012Net loss (gain)$12 $(2) $14Prior service credit(18) — —Amortization of prior service credit1 — —Amortization of net actuarial loss(2) (2) (1)(Gains) losses recognized in other comprehensive (loss) income$(7) $(4) $13Total (gains) losses recognized in comprehensive income$(2) $2 $18AssumptionsThe following table provides the weighted-average assumptions used to determine projected benefit obligations and net periodic benefit cost, asthey pertain to our pension plans. 2014 2013 2012 U.S. Int’l U.S. Int’l U.S. Int’lBenefit Obligation Assumptions Discount rate4.01% 3.14% 4.79% 4.23% 4.13% 4.04%Rate of future compensation increaseNM 3.34% NM 3.48% 4.50% 3.50%Net Periodic Benefit Cost Assumptions Discount rate4.79% 4.23% 4.13% 4.04% 4.87% 4.76%Expected long-term return on plan assets8.00% 7.30% 8.00% 7.33% 8.00% 7.35%Rate of future compensation increaseNM 3.48% 4.50% 3.50% 4.50% 3.58%NMNot meaningful. During 2013, an amendment to one of the Company's U.S. business unit's pension plans modified the benefit formula. Similar to allother U.S. pension plans, pension benefits for future service will be based on years of service and not impacted by future compensation increases.Management develops each assumption using relevant company experience in conjunction with market-related data for each individual country inwhich plans exist. Assumptions are reviewed annually and adjusted as necessary.The expected long-term rate of return on assets reflects the expected returns for each major asset class in which the plans hold investments, theweight of each asset class in the target mix, the correlations among asset classes85and their expected volatilities. The assets of the pension plans are held by a number of independent trustees, managed by several investmentinstitutions and are accounted for separately in the Company’s pension funds.Our expected return on plan assets is estimated by evaluating both historical returns and estimates of future returns. Specifically, we analyze theplans’ actual historical annual return on assets, net of fees, over the past 15, 20 and 25 years; estimate future returns based on independentestimates of asset class returns; and evaluate historical broad market returns over long-term timeframes based on our asset allocation range. Forthe U.S. Master Trust which has only existed since 2011, historical returns were estimated using a constructed portfolio that reflects theCompany’s strategic asset allocation and the historical compound geometric returns of each asset class for the longest time period available.Based on this approach, the weighted average expected long-term rate of return for all of our plan assets effective January 1, 2015 is estimated at7.38%.The table below provides the weighted average actual rate of return generated on all of our plan assets during each of the years presented ascompared to the weighted average expected long-term rates of return utilized in calculating the net periodic benefit costs. 2014 2013 2012Expected long-term rate of return on plan assets7.38% 7.40% 7.42%Actual rate of return on plan assets18.13% 10.17% 10.09%The assumed rate of future increases in the per capita cost of health care (the health care trend rate) is 6.88% for 2015, decreasing ratably to5.00% in 2020. An increase or decrease in the health care trend rates by one percent per year would impact the aggregate annual service andinterest components by less than $1 million, and impact the benefit obligation by approximately $4 million.Investment PolicyThe investment strategy for managing worldwide postretirement benefit plan assets is to seek an optimal rate of return relative to an appropriatelevel of risk for each plan. Investment strategies vary by plan, depending on the specific characteristics of the plan, such as plan size and design,funded status, liability profile and legal requirements. In general, the plans are managed closely to their strategic allocations.The following table provides the actual asset allocations of plan assets as of December 31, 2014 and 2013, and the related asset target allocationranges by asset category. 2014 2013 TargetAllocationRangesEquity securities28.8% 31.7% 20-40%Fixed income37.3% 24.7% 20-60%Hedge funds25.0% 23.5% 20-60%Private equity3.2% 4.2% 0-15%Insurance contracts and other5.7% 15.9% 0-30%Fair Value of Plan AssetsIn measuring plan assets at fair value, a fair value hierarchy is applied which categorizes and prioritizes the inputs used to estimate fair value intothree levels. The fair value hierarchy is based on maximizing the use of observable inputs and minimizing the use of unobservable inputs whenmeasuring fair value. Classification within the fair value hierarchy is based on the lowest level input that is significant to the fair valuemeasurement. The three levels of the fair value hierarchy are defined as follows:•Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.•Level 2 inputs are other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly.Level 2 inputs include quoted prices (in non-active markets or in active markets for86similar assets or liabilities), inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated byobservable market data by correlation or other means.•Level 3 inputs are unobservable inputs for the assets or liabilities.In certain instances, fair value is estimated using quoted market prices obtained from external pricing services. In obtaining such data from thepricing service, we have evaluated the methodologies used to develop the estimate of fair value in order to assess whether such valuations arerepresentative of fair value, including net asset value ("NAV"). Additionally, in certain circumstances, the NAV reported by an asset manager maybe adjusted when sufficient evidence indicates NAV is not representative of fair value.The following is a description of the valuation methodologies and inputs used to measure fair value for major categories of investments.•Equity securities — Equities (including common and preferred shares, domestic listed and foreign listed, closed end mutual funds andexchange traded funds) are generally valued at the closing price reported on the major market on which the individual securities are traded atthe measurement date. Equity securities held by the Company that are publicly traded in active markets are classified within Level 1 of thefair value hierarchy. Those equities that are held in proprietary funds pooled with other investor accounts are generally classified within Level 2of the hierarchy.•Fixed income — United States government securities are generally valued using quoted prices of securities with similar characteristics.Corporate bonds and notes are generally valued by using pricing models (e.g. discounted cash flows), quoted prices of securities with similarcharacteristics or broker quotes. Fixed income securities are generally classified in Level 2 of the fair value hierarchy, however, bond fundslisted on active markets are classified in Level 1.•Hedge funds — Hedge funds are pooled funds that employ a range of investment strategies including equity and fixed income, credit driven,macro and multi oriented strategies. The valuation of limited partnership interests in hedge funds may require significant managementjudgment. The NAV reported by the asset manager is adjusted when it is determined that NAV is not representative of fair value. In makingsuch an assessment, a variety of factors is reviewed, including, but not limited to, the timeliness of NAV as reported by the asset managerand changes in general economic and market conditions subsequent to the last NAV reported by the asset manager. Depending on how theseinvestments can be redeemed and the extent of any adjustments to NAV, hedge funds are classified within either Level 2 (redeemable within90 days) or Level 3 (redeemable beyond 90 days) of the fair value hierarchy.•Private equity — Private equity includes a diversified range of strategies, including buyout funds, distressed funds, venture and growth equityfunds and mezzanine funds. The valuation of limited partnership interests in private equity funds may require significant managementjudgment. The NAV reported by the asset manager is adjusted when it is determined that NAV is not representative of fair value. In makingsuch an assessment, a variety of factors is reviewed, including, but not limited to, the timeliness of NAV as reported by the asset managerand changes in general economic and market conditions subsequent to the last NAV reported by the asset manager. These funds aregenerally classified within Level 3 of the fair value hierarchy.•Insurance contracts and other — Primarily comprised of insurance contracts and cash. Insurance contracts are valued at book value, whichapproximates fair value, and is calculated using the prior year balance adjusted for investment returns and cash flows and are generallyclassified as Level 3. Cash and cash equivalents are held in accounts with brokers or custodians for liquidity and investment collateral and areclassified as Level 1.87The following table provides the fair value of plan assets held by our pension benefit plans by asset class. December 31, 2014 2013(in millions)Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3Asset Category Equity securities Global stockfunds/securities$123 $112 $11 $— $123 $108 $11 $4Index funds42 4 38 — 40 3 37 —Emerging markets funds3 3 — — 3 3 — —Fixed income Corporate bonds79 53 22 4 95 40 48 7Government bonds139 87 52 — 35 35 — —Hedge funds146 11 85 50 123 9 95 19Private equity19 — — 19 22 — — 22Insurance contracts andother33 16 — 17 83 62 4 17Total$584 $286 $208 $90 $524 $260 $195 $69The following table presents a reconciliation of the beginning and ending balances of fair value measurement within our pension plans usingsignificant unobservable inputs (Level 3).(in millions)EquitySecurities Fixed Income Hedge funds Private Equity Other TotalBalance, December 31, 2012$3 $9 $20 $24 $4 $60Purchases, sales, settlements— (3) 10 (4) 12 15Unrealized loss— 1 1 1 1 4Realized gains1 — — — — 1Net transfers— — (12) — — (12)Currency impact— — — 1 — 1Balance, December 31, 20134 7 19 22 17 69Purchases, sales, settlements(3) (3) 27 (6) — 15Unrealized gains— 1 5 4 — 10Currency impact(1) (1) (1) (1) — (4)Balance, December 31, 2014$— $4 $50 $19 $17 $90Contributions and Estimated Future Benefit PaymentsFunding requirements under governmental regulations are a major consideration in making contributions to our postretirement plans. We madecontributions of $35 million and $43 million to our pension and postretirement benefit plans during 2014 and 2013, respectively. We currentlyanticipate making contributions to our pension and postretirement benefit plans in the range of $24 million to $34 million during 2015, of whichapproximately $7 million is expected to be made in the first quarter.88The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:(in millions)Pension Other Benefits2015$33 $3201633 3201735 3201835 3201936 4Years 2020 - 2024184 19Note 16. Stock-Based Compensation PlansOur stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees’interests with the interests of our shareholders. In addition, members of our Board of Directors participate in our stock-based compensationprogram in connection with their service on our board. Share-based awards issued to employees include non-qualified stock options, restrictedstock awards and performance-based awards. Under the 2011 Omnibus Incentive Plan, the number of shares initially available for awards was 18million. As of December 31, 2014, there were approximately 9 million shares of common stock available for future grants.Total share-based compensation costs recognized for 2014, 2013 and 2012 were $18 million, $27 million, and $22 million, respectively. Theunamortized compensation expense at December 31, 2014 related to our stock options, restricted shares and performance-based shares was $5million, $20 million and $3 million, respectively, and is expected to be recognized over a weighted average period of 1.8, 2.0 and 2.0 years,respectively.The amount of cash received from the exercise of stock options was $26 million for 2014 with a tax benefit of $8 million realized associated withstock option exercises and vesting of restricted stock. We classify as a financing activity the cash flows attributable to excess tax benefits arisingfrom stock option exercises and restricted stock vestings.On March 17, 2014, the Company named Patrick K. Decker as the new President and Chief Executive Officer of Xylem Inc. As part of Mr.Decker's employment agreement, he was awarded 165,584 stock options, 40,342 restricted stock and 40,342 performance-based shares. Theaward was granted subject to the approval of the Xylem Omnibus Incentive Plan, which was obtained at the annual meeting of shareholders inMay 2014. The share and associated expense amounts are included beginning as of the May approval date.89Stock Option GrantsOptions are awarded with a contractual term of ten years and generally vest over or at the conclusion of a three-year period and are exercisable inseven to ten-year periods, except in certain instances of death, retirement or disability. The exercise price per share is the fair market value of theunderlying common stock on the date each option is granted. At December 31, 2014, there were options to purchase an aggregate of 3.0 millionshares of common stock. The following is a summary of the changes in outstanding stock options for 2014:(shares in thousands)Shares WeightedAverageExercisePrice / Share Weighted AverageRemainingContractualTerm (Years)Outstanding at January 1, 20143,504 $26.80 6.4Granted543 $38.16 10.0Exercised(941) $27.43 4.9Forfeited(117) $28.78 6.8Outstanding at December 31, 20142,989 $28.60 6.5Options exercisable at December 31, 20141,924 $26.50 5.5Vested and non-vested expected to vest as of December 31, 20142,903 $28.42 6.4The amount of non-vested options outstanding was 1.0 million and 1.5 million at a weighted average grant date fair value of $32.45 and $26.90 asof December 31, 2014 and January 1, 2014, respectively. The aggregate intrinsic value of the outstanding, exercisable, and vested and non-vestedstock options expected to vest at December 31, 2014 was $28 million, $22 million and $28 million respectively. The total intrinsic value of optionsexercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during 2014 was $10million.Stock Option Fair ValueThe fair value of each option grant was estimated on the date of grant using the binomial lattice pricing model which incorporates multiple andvariable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility and changes in dividends. Thefollowing are weighted-average assumptions used for 2014, 2013, and 2012: 2014 2013 2012Dividend yield1.34% 1.69% 1.52%Volatility28.49% 31.10% 33.40%Risk-free interest rate1.82% 1.28% 1.42%Expected term (in years)5.60 6.62 7.00Weighted-average fair value per share$9.71 $7.58 $8.10Expected volatility is calculated based on an analysis of historic and implied volatility measures for a set of peer companies and Xylem. We usehistorical data to estimate option exercise and employee termination behavior within the valuation model. Employee groups and optioncharacteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options areexpected to remain outstanding. The expected term provided above represents the weighted average of expected behavior for certain groups ofemployees who have historically exhibited different behavior. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time ofoption grant.Restricted Stock GrantsRestricted shares granted to employees become fully vested upon the third anniversary of the date of grant, and certain liability-based restrictedshares to international employees settle in cash. Prior to the time a restricted share becomes fully vested, the awardees cannot transfer, pledge,hypothecate or encumber such shares. Prior to the time a restricted share is fully vested, the awardees have certain rights of a stockholder andmay include the right to vote and receive dividends. If an employee leaves prior to vesting, whether through resignation or termination for cause,the restricted stock and related accrued dividends are forfeited. If an employee retires or is terminated other90than for cause, a pro rata portion of the restricted stock may vest in accordance with the terms of the grant agreements. Restricted shares grantedto Board members become fully vested upon the date of the next annual meeting.Our restricted stock activity was as follows for 2014: (shares in thousands)Shares Weighted AverageGrant Date FairValue / ShareOutstanding at January 1, 20141,275 $27.67Granted488 $38.00Vested(480) $27.71Forfeited(112) $29.82Outstanding at December 31, 20141,171 $31.80Performance-Based Share GrantsAs part of the annual 2013 and 2014 grants under the long-term incentive plan, performance-based shares were granted to all executive officers ofthe Company. The performance-based shares vest based upon performance by the Company over a three-year period against targets approved bythe compensation committee of the Company's Board of Directors prior to the grant date. For the performance periods, the performance-basedshares were granted at a target of 100% with actual payout contingent upon the achievement of a pre-set, three-year adjusted Return on InvestedCapital and cumulative adjusted net income performance target. The calculated compensation cost is adjusted based on an estimate of awardsultimately expected to vest and our assessment of the probable outcome of the performance condition. The fair value of performance-based shareawards at 100% target is determined using the closing price of our common stock on date of grant.Our performance-based share activity was as follows for 2014:(shares in thousands)Shares Weighted AverageGrant Date FairValue / ShareOutstanding at January 1, 201452 $27.49Granted84 $37.87Vested— $—Forfeited(12) $33.11Outstanding at December 31, 2014124 $33.9591Note 17. Capital StockThe Company has the authority to issue an aggregate of 750 million shares of common stock having a par value of $0.01 per share. Thestockholders of Xylem common stock are entitled to receive dividends as declared by the Xylem Board of Directors. Dividends declared were$0.5120, $0.4656 and $0.4048 during 2014, 2013 and 2012, respectively.The changes in common stock outstanding for the three years ended December 31 are as follows:(in thousands of shares)2014 2013 2012Beginning Balance, January 1184,557 185,658 184,641Stock incentive plan activity1,226 1,203 1,367Repurchase of common stock(3,483) (2,304) (350)Ending Balance, December 31182,300 184,557 185,658 On August 20, 2013, the Board of Directors authorized the repurchase up to $250 million in shares with no expiration date. The program'sobjective is to deploy our capital in a manner that benefits our shareholders and maintains our focus on growth. During 2014, we repurchased 3.4million shares for $130 million under this program. There are up to $70 million in shares that may still be purchased under this plan. During 2013,we repurchased 1.7 million shares for $50 million under this program.On August 18, 2012, the Board of Directors authorized the repurchase of up to 2.0 million shares of common stock with no expiration date. Theprogram's objective is to offset dilution associated with various Xylem employee stock plans by acquiring shares in the open market from time totime. There were no shares repurchased under this plan during 2014. There are up to 1.0 million shares that may still be purchased under thisplan. We repurchased 0.6 million shares for $17 million under this program during 2013.Aside from the aforementioned repurchase programs, we repurchased 0.2 million and 0.2 million shares for $4 million and $6 million during 2014and 2013, respectively in relation to settlement of employee tax withholding obligations due as a result of the vesting of restricted stock. Theserepurchases are included in the stock incentive plan activity in the above table.92Note 18. Accumulated Other Comprehensive Income (Loss)The following table provides the components of accumulated other comprehensive income for 2014, 2013 and 2012:(in millions)Foreign CurrencyTranslation Postretirement BenefitPlans Derivative Instruments TotalBalance at January 1, 2012$288 $(166) $— $122Foreign currency translation adjustment48 48Changes in postretirement benefit plans (93) (93)Income tax expense on changes in postretirement benefitplans 27 27Amortization of prior service cost and net actuarial loss onpostretirement benefit plans into: Cost of revenue 5 5Selling, general and administrative expenses 5 5Other non-operating (expense) income, net 4 4Income tax expense on amortization of postretirementbenefit plan items (4) (4)Unrealized gain on foreign exchange agreements 4 4Income tax expense on unrealized gain on foreignexchange agreements (1) (1)Reclassification of unrealized gain on foreign exchangeagreements into revenue (2) (2)Reclassification of unrealized gain on foreign exchangeagreements into cost of revenue (1) (1)Tax on reclassification of unrealized gain on foreignexchange agreements 1 1Balance at December 31, 2012$336 $(222) $1 $115Foreign currency translation adjustment15 15Changes in postretirement benefit plans 40 40Income tax expense on changes in postretirement benefitplans (17) (17)Amortization of prior service cost and net actuarial loss onpostretirement benefit plans into: Cost of revenue 7 7Selling, general and administrative expenses 7 7Research and development expenses 1 1Other non-operating (expense) income, net 3 3Income tax expense on amortization of postretirementbenefit plan items (5) (5)Unrealized gain on foreign exchange agreements 1 1Reclassification of unrealized gain on foreign exchangeagreements into revenue (2) (2)Reclassification of unrealized loss on foreign exchangeagreements into cost of revenue 2 2Balance at December 31, 2013$351 $(186) $2 $16793(in millions)Foreign CurrencyTranslation Postretirement BenefitPlans Derivative Instruments TotalBalance at January 1, 2014$351 $(186) $2$167Foreign currency translation adjustment(206) (206)Changes in postretirement benefit plans (92) (92)Income tax expense on changes in postretirement benefitplans 20 20Foreign currency translation adjustment for postretirementbenefit plans 20 20Amortization of prior service cost and net actuarial loss onpostretirement benefit plans into: Cost of revenue 4 4Selling, general and administrative expenses 5 5Other non-operating (expense) income, net 1 1Income tax expense on amortization of postretirementbenefit plan items (3) (3)Unrealized loss on foreign exchange agreements (22) (22)Income tax benefit on unrealized loss on foreign exchangeagreements 1 1Reclassification of unrealized loss on foreign exchangeagreements into revenue 5 5Reclassification of unrealized loss on foreign exchangeagreements into cost of revenue 1 1Balance at December 31, 2014$145 $(231) $(13) $(99)Note 19. Commitments and ContingenciesGeneralFrom time to time, we are involved in legal proceedings that are incidental to the operation of our businesses, including acquisitions anddivestitures, intellectual property matters, product liability and personal injury claims, employment and pension matters, government andcommercial contract disputes.On December 17, 2014, the Korea Fair Trade Commission (“KFTC”) issued a written decision regarding an investigation into bid-rigging allegationsagainst Xylem Water Solutions South Korea Co., Ltd. (“Xylem South Korea”), a subsidiary of Xylem Inc. The KFTC found that certain employeesof Xylem South Korea had participated in activities that violated Korea’s antitrust laws. Xylem South Korea was assessed a fine of approximately$1.6 million and the matter was referred for criminal prosecution. In January 2015, Xylem South Korea paid the fine and filed an appeal of theKFTC’s decision with the Seoul High Court. In connection with the KFTC matter, the Company commenced an internal investigation relating to the allegations against Xylem South Korea. Inlate 2014, the Company broadened this internal investigation to assess related allegations made by certain employees of Xylem South Koreaduring the investigation into the KFTC matter. The broadened investigation includes a review of compliance by Xylem South Korea and itsemployees with the requirements of the Foreign Corrupt Practices Act. The Company engaged independent outside counsel to assist with itsinvestigation and an independent professional services firm to provide forensic accounting assistance. In late January 2015, the Companyvoluntarily contacted the Securities and Exchange Commission and the Department of Justice to advise both agencies of this internalinvestigation. The Company will fully cooperate with any government investigation. Xylem South Korea’s revenue is less than one percent of theCompany’s total revenue. Although the Company currently cannot reasonably estimate the potential liability, if any, related to the investigation, wecurrently believe that these matters will not have a material adverse effect on the Company’s business, financial condition or results of operations.94On October 1, 2014, the court approved a settlement agreement with respect to a purchase price dispute with the minority shareholders arisingfrom one of our historical acquisitions. All outstanding claims have been settled and the court proceedings have been terminated. Theoutstanding balance of the settlement has been reflected in the 2014 Consolidated Balance Sheet.From time to time claims may be asserted against Xylem alleging injury caused by any our products resulting from asbestos exposure. We believethere are numerous legal defenses available for such claims and would defend ourselves vigorously. Pursuant to the Distribution Agreementamong ITT, Exelis and Xylem, ITT has an obligation to indemnify, defend and hold Xylem harmless for asbestos product liability matters, includingsettlements, judgments, and legal defense costs associated with all pending and future claims that may arise from past sales of ITT’s legacyproducts. We believe ITT remains a substantial entity with sufficient financial resources to honor its obligations to us.Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment ofthe merits of the particular claims, we do not expect that any asserted or unasserted legal claims or proceedings, individually or in aggregate, willhave a material adverse effect on our results of operations, or financial condition. We have estimated and accrued $9 million and $17 million as ofDecember 31, 2014 and 2013, respectively for these general legal matters.IndemnificationsAs part of our Spin-off from our former parent, ITT, Exelis Inc. and Xylem will indemnify, defend and hold harmless each of the other parties withrespect to such parties’ assumed or retained liabilities under the Distribution Agreement and breaches of the Distribution Agreement or related spinagreements. The former parent’s indemnification obligations include asserted and unasserted asbestos and silica liability claims that relate to thepresence or alleged presence of asbestos or silica in products manufactured, repaired or sold prior to October 31, 2011, the Distribution Date,subject to limited exceptions with respect to certain employee claims, or in the structure or material of any building or facility, subject toexceptions with respect to employee claims relating to Xylem buildings or facilities. The indemnification associated with pending and futureasbestos claims does not expire. Xylem has not recorded a liability for material matters for which we expect to be indemnified by the former parentor Exelis Inc. through the Distribution Agreement and we are not aware of any claims or other circumstances that would give rise to materialpayments from us under such indemnifications. EnvironmentalIn the ordinary course of business, we are subject to federal, state, local, and foreign environmental laws and regulations. We are responsible, orare alleged to be responsible, for ongoing environmental investigation and remediation of sites in various countries. These sites are in variousstages of investigation and/or remediation and in many of these proceedings our liability is considered de minimis. We have received notificationfrom the U.S. Environmental Protection Agency, and from similar state and foreign environmental agencies, that a number of sites formerly orcurrently owned and/or operated by Xylem or for which we are responsible under the Distribution Agreement, and other properties or water suppliesthat may be or have been impacted from those operations, contain disposed or recycled materials or wastes and require environmentalinvestigation and/or remediation. These sites include instances where we have been identified as a potentially responsible party under federal andstate environmental laws and regulations.Accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of theliability can be reasonably estimated, based on current law and existing technologies. Our accrued liabilities for these environmental mattersrepresent the best estimates related to the investigation and remediation of environmental media such as water, soil, soil vapor, air and structures,as well as related legal fees. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation andremediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on anundiscounted basis. We have estimated and accrued $5 million and $8 million as of December 31, 2014 and 2013, respectively, for environmentalmatters.It is difficult to estimate the final costs of investigation and remediation due to various factors, including incomplete information regarding particularsites and other potentially responsible parties, uncertainty regarding the extent of investigation or remediation and our share, if any, of liability forsuch conditions, the selection of alternative remedial95approaches, and changes in environmental standards and regulatory requirements. We believe the total amount accrued is reasonable based onexisting facts and circumstances.Operating LeasesWe lease certain offices, manufacturing buildings, machinery, computers and other equipment. Such leases expire at various dates through 2047and may include renewal and payment escalation clauses. We often pay maintenance, insurance and tax expense related to leased assets. Totalrent expense for the three years ended December 31, 2014 was as follows:(in millions)Total2014$73201377201273At December 31, 2014, we are obligated to make minimum rental payments under operating leases which are as follows:(in millions)2015 2016 2017 2018 2019 ThereafterMinimum rental payments$63 $48 $33 $24 $13 $25WarrantiesWe warrant numerous products, the terms of which vary widely. In general, we warrant products against defect and specific non-performance.Warranty expense was $27 million, $34 million, and $32 million for 2014, 2013 and 2012, respectively. The table below provides changes in theproduct warranty accrual over each period.(in millions)2014 2013Warranty accrual – January 1$37 $40Net changes for product warranties in the period27 34Settlement of warranty claims(31) (37)Foreign currency and other(2) —Warranty accrual – December 31$31 $37Note 20. Related Party TransactionsSales and purchases to unconsolidated affiliates for 2014, 2013 and 2012 are as follows:(in millions) 2014 2013 2012Sales to unconsolidated affiliates $16 $15 $12Purchases from unconsolidated affiliates 18 20 2096Note 21. Segment and Geographic DataOur business has two reportable segments: Water Infrastructure and Applied Water. The Water Infrastructure segment, focuses on thetransportation, treatment and testing of water, offering a range of products including water and wastewater pumps, treatment and testingequipment, and controls and systems. The Applied Water segment, encompasses the uses of water and focuses on the residential, commercial,industrial and agricultural markets offering a wide range of products, including pumps, valves and heat exchangers. Our Regional selling locationsconsist primarily of selling and marketing organizations and related support that offer products and services across both of our reportablesegments. Corporate and other consists of corporate office expenses including compensation, benefits, occupancy, depreciation, and otheradministrative costs, as well as charges related to certain matters, such as environmental matters that are managed at a corporate level and arenot included in the business segments in evaluating performance or allocating resources. The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1). Thefollowing tables contain financial information for each reportable segment: Year Ended December 31,(in millions)2014 2013 2012Revenue: Water Infrastructure$2,442 $2,384 $2,349Applied Water1,474 1,453 1,442Total$3,916 $3,837 $3,791Operating income: Water Infrastructure$321 $263 $334Applied Water193 175 178Corporate and other(51) (75) (69)Total operating income463 363 443Interest expense54 55 55Other non-operating income (expense)1 (10) —Gain from sale of business11 — —Income before taxes$421 $298 $388Depreciation and amortization: Water Infrastructure$100 $104 $95Applied Water25 26 28Regional selling locations (a)12 13 12Corporate and other5 7 7Total$142 $150 $142Capital expenditures: Water Infrastructure$73 $67 $66Applied Water28 31 25Regional selling locations (b)10 12 15Corporate and other8 16 6Total$119 $126 $112(a)Depreciation and amortization expense incurred by the Regional selling locations was included in an overall allocation of Regional selling locationcosts to the segments; however, a certain portion of that expense was not specifically identified to a segment. That is the expense captured in thisRegional selling location line.(b)Represents capital expenditures incurred by the Regional selling locations not allocated to the segments.97The following table illustrates revenue by product category, net of intercompany revenue. Year Ended December 31,(in millions)2014 2013 2012Pumps, accessories, parts and service$3,094 $3,076 $3,054Other (a)822 761 737Total$3,916 $3,837$3,791(a)Other includes treatment equipment, analytical instrumentation, heat exchangers, valves and controls.The following table contains the total assets for each reportable segment as of December 31, 2014, 2013 and 2012. Total Assets(in millions)2014 2013 2012Water Infrastructure$2,128 $2,224 $2,169Applied Water1,114 1,122 1,131Regional selling locations (a)961 983 797Corporate and other (b)661 567 582Total$4,864 $4,896 $4,679(a)The Regional selling locations have assets that consist primarily of cash, accounts receivable and inventory which are not allocated to the segments.(b)Corporate and other consists of items pertaining to our corporate headquarters function, which principally consist of deferred tax assets and certainproperty, plant and equipment.Geographical InformationRevenue is attributed to countries based upon the location of the customer. Property, Plant & Equipment is attributed to countries based upon thelocation of the assets. Revenue Year Ended December 31,(in millions)2014 2013 2012United States$1,477 $1,434 $1,400Europe1,379 1,387 1,338Asia Pacific478 467 469Other582 549 584Total$3,916 $3,837 $3,791 Property, Plant & Equipment December 31,(in millions)2014 2013 2012United States$180 $186 $183Europe206 225 219Asia Pacific53 45 65Other22 32 20Total$461 $488 $48798Note 22. Valuation and Qualifying Accounts The table below provides changes in the allowance for doubtful accounts over each period.(in millions)2014 2013 2012Balance at beginning of year$22 $25 $29Additions charged to expense9 8 4Deductions/other(7) (11) (8)Balance at end of year$24 $22 $25Note 23. Quarterly Financial Data (Unaudited) 2014 Quarter Ended(In millions, except per share amounts) Dec. 31 Sept. 30 June 30 Mar. 31 Revenue $1,042 $963 $1,005 $906Gross profit 407 376 388 342Operating income 141 130 116 76Net income $96 $106 $86 $49Earnings per share:Basic $0.53 $0.58 $0.47 $0.27Diluted $0.52 $0.58 $0.47 $0.27 2013 Quarter Ended(In millions, except per share amounts) Dec. 31 Sept. 30 June 30 Mar. 31 Revenue $1,033 $965 $960 $879Gross profit 410 384 371 334Operating income 129 98 70 66Net income $68 $73 $46 $41Earnings per share:Basic $0.37 $0.39 $0.25 $0.22Diluted $0.37 $0.39 $0.25 $0.2299ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone.ITEM 9A. CONTROLS AND PROCEDURESEvaluation of Disclosure Controls and ProceduresOur management, with the participation of our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO"), evaluated the effectivenessof the design and operation of our disclosure controls and procedures as of the end of the year ended December 31, 2014 pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (“the Exchange Act”). Based upon that evaluation, our CEO and our CFO concluded that ourdisclosure controls and procedures as of the year ended December 31, 2014 were effective, in all material respects, and designed to providereasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (1) recorded,processed, summarized and reported, within the time periods specified in the SEC's rules and forms and (2) accumulated and communicated toour management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures.Management's Annual Report on Internal Control Over Financial ReportingAs required by the SEC's rules and regulations for the implementation of Section 404 of the Sarbanes-Oxley Act, the Company's management isresponsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act. The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.The Company's management, including the CEO and CFO, conducted an assessment of the effectiveness of our internal control over financialreporting as of December 31, 2014 based on the framework established in Internal Control - Integrated Framework issued by the Committee ofSponsoring Organization of the Treadway Commission (2013). This assessment included an evaluation of the design of our internal control overfinancial reporting and testing of the operational effectiveness of those controls. Based on our assessment, the Company's management hasconcluded that our internal control over financial reporting was effective as of December 31, 2014.The effectiveness of the Company's internal control over financial reporting as of December 31, 2014 has been audited by Deloitte & Touche LLP,an independent registered public accounting firm, as stated in their report which appears following Item 9B of this Annual Report on Form 10-K.Changes in Internal Control Over Financial ReportingThere were no changes in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2014 thathave materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.ITEM 9B. OTHER INFORMATIONNone100REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Stockholders ofXylem Inc.Rye Brook, New YorkWe have audited the internal control over financial reporting of Xylem Inc. and subsidiaries (the "Company") as of December 31, 2014, based oncriteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the TreadwayCommission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessmentof the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control OverFinancial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk thata material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, andperforming such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for ouropinion.A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive andprincipal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and otherpersonnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policiesand procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on thefinancial statements.Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper managementoverride of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of anyevaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may becomeinadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, basedon the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the TreadwayCommission.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidatedfinancial statements as of and for the year ended December 31, 2014 of the Company and our report dated February 26, 2015 expressed anunqualified opinion on those financial statements./s/ Deloitte & Touche LLPStamford, ConnecticutFebruary 26, 2015101PART IIIITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEThe information required by this Item is incorporated herein by reference to the information in our Definitive Proxy Statement to be filed with theSEC in connection with our 2015 Annual Meeting of Shareholders (the “2015 Proxy Statement”) set forth under the captions “Proposal 1 - Electionof Directors,” "Director Selection and Composition," "Committees of the Board of Directors -- Audit Committee" and “Section 16(a) BeneficialOwnership Reporting Compliance.”The information called for by Item 10 with respect to executive officers is set forth in Part I of this Report under the caption “Executive Officers ofthe Registrant” and is incorporated by reference in this section.We have adopted corporate governance principles and charters for each of our standing committees. The principles address director qualificationstandards, responsibilities, access to management and independent advisors, compensation, orientation and continuing education, managementsuccession principles and board and committee self-evaluation. The corporate governance principles and standing committee charters areavailable on the Company’s website at www.investors.xyleminc.com. A copy of the corporate governance principles and standing committeecharters is also available to any shareholder who requests a copy from the Company’s Corporate Secretary.We have also adopted a written code of conduct which is applicable to all our directors, officers and employees, including the Company’s ChiefExecutive Officer and Chief Financial Officer and other executive officers identified pursuant to this Item 10. In accordance with the SEC’s rulesand regulations, a copy of the code has been posted to our website and a copy of the code of conduct is also available to any shareholder whorequests it. We intend to disclose any changes in our code of conduct by posting a revised version on our website at www.xyleminc.com.ITEM 11. EXECUTIVE COMPENSATIONThe information required by this Item is incorporated herein by reference to the information in our 2015 Proxy Statement set forth under captions“Executive Compensation," "2014 Non-Management Director Compensation" and “Report of the Leadership Development & CompensationCommittee.”ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSThe information required by this Item is incorporated herein by reference to the information in our 2015 Proxy Statement set forth under thecaptions “Stock Ownership of Directors, Executive Officers and Certain Beneficial Owners” and "Equity Compensation Plan Information."ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCEThe information required by this Item is incorporated herein by reference to the information in our 2015 Proxy Statement set forth under the caption“Information About our Board of Directors.” ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESThe information required by this Item is incorporated herein by reference to the information in our 2015 Proxy Statement set forth under the caption“Independent Registered Public Accounting Firm Fees.”102PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES(a)(1)The Index to Consolidated Financial Statements of the Registrant under Item 8 of this Report is incorporated herein by reference asthe list of Financial Statements required as part of this Report. (2)Financial Statement Schedules — All financial statement schedules have been omitted because they are not applicable or therequired information is shown in the financial statements or notes thereto. (3)Exhibits — The exhibit list in the Exhibit Index is incorporated by reference as the list of exhibits required as part of this Report.103SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to besigned on its behalf by the undersigned, thereunto duly authorized. XYLEM INC. (Registrant) /s/ John P. Connolly John P. Connolly Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer)February 26, 2015104Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated:February 26, 2015 /s/ Patrick K. Decker Patrick K. Decker President and Chief Executive Officer (Principal Executive Officer) February 26, 2015 /s/ Michael T. Speetzen Michael T. Speetzen Senior Vice President and Chief Financial Officer (Principal Financial Officer) February 26, 2015 /s/ Markos I. Tambakeras Markos I. Tambakeras, Chairman February 26, 2015 /s/ Curtis J. Crawford Curtis J. Crawford, Director February 26, 2015 /s/ Robert F. Friel Robert F. Friel, Director February 26, 2015 /s/ Victoria D. Harker Victoria D. Harker, Director February 26, 2015 /s/ Sten E. Jakobsson Sten E. Jakobsson, Director February 26, 2015 /s/ Steven R. Loranger Steven R. Loranger, Director February 26, 2015 /s/ Edward J. Ludwig Edward J. Ludwig, Director February 26, 2015 /s/ Surya N. Mohapatra Surya N. Mohapatra, Director February 26, 2015 /s/ Jerome A. Peribere Jerome A. Peribere, Director February 26, 2015 /s/ James P. Rogers James P. Rogers, Director105EXHIBIT INDEXExhibitNumberDescriptionLocation (2.1)Distribution Agreement, dated as of October 25, 2011, among ITTCorporation, Exelis Inc. and Xylem Inc.Incorporated by reference to Exhibit 10.1 of ITTCorporation’s Form 10-Q Quarterly Report filed onOctober 28, 2011 (CIK No. 216228, File No. 1-5672). (3.1)Third Amended and Restated Articles of Incorporation of Xylem Inc.Incorporated by reference to Exhibit 3.1 of XylemInc.’s Form 10-Q filed on July 29, 2014 (CIK No.131190969, File No. 1-35229). (3.2)Amended and Restated By-laws of Xylem Inc.Incorporated by reference to Exhibit 3.2 of XylemInc.’s Form 10-Q filed on July 29, 2014 (CIK No.131190969, File No. 1-35229). (4.1)Indenture, dated as of September 20, 2011, between Xylem Inc., ITTCorporation, as initial guarantor, and Union Bank, N.A., as trusteeIncorporated by reference to Exhibit 4.2 of ITTCorporation’s Form 8-K Current Report filed onSeptember 21, 2011 (CIK No. 216228, File No. 1-5672). (4.2)Form of Xylem Inc. 3.550% Senior Notes due 2016Incorporated by reference to Exhibit 4.5 of XylemInc.'s Form S-4 Registration Statement filed on May24, 2012 (CIK No. 1524472, File No. 333-181643). (4.3)Form of Xylem Inc. 4.875% Senior Notes due 2021Incorporated by reference to Exhibit 4.6 of XylemInc.'s Form S-4 Registration Statement filed on May24, 2012 (CIK No. 1524472, File No. 333-181643). (10.1)Form of Xylem 2011 Omnibus Incentive Plan Non-Qualified Stock OptionAward Agreement - 2015Filed herewith. (10.2)Benefits and Compensation Matters Agreement, dated as of October 25,2011, among ITT Corporation, Exelis Inc. and Xylem Inc.Incorporated by reference to Exhibit 10.2 of ITTCorporation’s Form 10-Q Quarterly Report filed onOctober 28, 2011 (CIK No. 216228, File No. 1-5672). (10.3)Tax Matters Agreement, dated as of October 25, 2011, among ITTCorporation, Exelis Inc. and Xylem Inc.Incorporated by reference to Exhibit 10.3 of ITTCorporation’s Form 10-Q Quarterly Report filed onOctober 28, 2011 (CIK No. 216228, File No. 1-5672). (10.4)Master Transition Services Agreement, dated as of October 25, 2011,among ITT Corporation, Exelis Inc. and Xylem Inc.Incorporated by reference to Exhibit 10.4 of ITTCorporation’s Form 10-Q Quarterly Report filed onOctober 28, 2011 (CIK No. 216228, File No. 1-5672). (10.5)Four-Year Competitive Advance and Revolving Credit Facility Agreement,dated as of October 25, 2011, among Xylem Inc., the Lenders NamedTherein, J.P. Morgan Chase Bank, N.A., as Administrative Agent andCitibank, N.A., as Syndication Agent.Incorporated by reference to Exhibit 10.5 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.6)Xylem 2011 Omnibus Incentive PlanIncorporated by reference to Exhibit 4.3 of XylemInc.’s Registration Statement on Form S-8 filed onOctober 28, 2011 (CIKNo. 1524472, File No. 333-177607). (10.7)Xylem 1997 Long-Term Incentive PlanIncorporated by reference to Exhibit 10.7 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). 106ExhibitNumberDescriptionLocation(10.8)Xylem 1997 Annual Incentive PlanIncorporated by reference to Exhibit 10.8 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.9)Xylem Annual Incentive Plan for Executive OfficersIncorporated by reference to Exhibit 10.9 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.10)Xylem Retirement Savings PlanIncorporated by reference to Exhibit 10.1 of XylemInc.’s Form 10-Q filed on July 30, 2013 (CIK No.1524472, File No. 1-35229). (10.11)Xylem Supplemental Retirement Savings PlanIncorporated by reference to Exhibit 10.11 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.12)Xylem Deferred Compensation PlanIncorporated by reference to Exhibit 4.5 of XylemInc.’s Registration Statement onForm S-8 filed on October 28, 2011 (CIKNo. 1524472, File No. 333-177607). (10.13)Xylem Deferred Compensation Plan forNon-Employee DirectorsIncorporated by reference to Exhibit 10.13 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.14)Xylem Enhanced Severance Pay PlanIncorporated by reference to Exhibit 10.29 of XylemInc.’s Form 10-Q Quarterly Report filed on May 3, 2012(CIK No. 1524472, File No. 1-35229). (10.15)Xylem Special Senior Executive Severance Pay PlanIncorporated by reference to Exhibit 10.1 of XylemInc.’s Form 10-Q Quarterly Report filed on October 28,2014 (CIK No. 1524472, File No. 1-35229). (10.16)Xylem Senior Executive Severance Pay PlanIncorporated by reference to Exhibit 10.16 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.17)Form of Xylem 2011 Omnibus Incentive Plan 2011 Non-Qualified StockOption Award Agreement — Founders GrantIncorporated by reference to Exhibit 10.17 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). (10.18)Form of Xylem 2011 Omnibus Incentive Plan Non-Qualified Stock OptionAward Agreement — General GrantIncorporated by reference to Exhibit 10.18 of XylemInc.’s Form 10-Q Quarterly Report filed onNovember 21, 2011 (CIK No. 1524472, File No. 1-35229). (10.19)Form of Xylem 2011 Omnibus Incentive Plan-Performance Share UnitAgreementIncorporated by reference to Exhibit 10.3 of XylemInc.'s Form 10-Q Quarterly Report filed on April 30,2013 (CIK No. 1524472, File No. 1-35229). (10.20)Form of Director’s Indemnification AgreementIncorporated by reference to Exhibit 10.24 of XylemInc.’s Form 10-Q Quarterly Report filed on November21, 2011 (CIK No. 1524472, File No. 1-35229). 107ExhibitNumberDescriptionLocation(10.21)Form of Xylem 2011 Omnibus Incentive Plan 2012 Restricted Stock UnitAgreementIncorporated by reference to Exhibit 10.2 of XylemInc.'s Form 10-Q Quarterly Report filed on April 30,2013 (CIK No. 1524472, File No. 1-35229). (10.22)Form of Xylem 2011 Omnibus Incentive Plan 2012 Non-Qualified StockOption Award AgreementIncorporated by reference to Exhibit 10.1 of XylemInc.'s Form 10-Q Quarterly Report filed on April 30,2013 (CIK No. 1524472, File No. 1-35229). (10.23)Letter Agreement between Xylem Inc. and Patrick K. DeckerIncorporated by reference to Exhibit 10.1 of XylemInc.'s Form 10-Q Quarterly Report filed on April 29,2014 (CIK No. 1524472, File No. 1-35229). (10.24)Restricted Stock Unit Grant Agreement between Xylem Inc. and Patrick K.DeckerIncorporated by reference to Exhibit 10.1 of XylemInc.'s Form 8-K Current Report filed on March 20, 2014(CIK No. 1524472, File No. 1-35229). (10.25)Research and Development Facility Agreement - Xylem Water TechnologiesRisk-Sharing Financing Facility First Amended and Restated FinanceContract, dated December 4, 2013, among the European Investment Bank,Xylem Holdings S.a.r.l. and Xylem International S.a.r.l., as borrowers, andXylem Inc., as guarantor.Incorporated by reference to Exhibit 10.30 of XylemInc.’s Form 10-K Annual Report filed on February 27,2014 (CIK No. 1524472, File No. 1-35229). (10.26)Agreement dated June 28, 2014, Amending the Research and DevelopmentFacility Agreement - Xylem Water Technologies Risk-Sharing FinancingFacility First Amended and Restated Finance Contract, dated December 4,2013, among the European Investment Bank, Xylem Holdings S.á r.l. andXylem International S.á r.l., as borrowers, and Xylem Inc., as guarantor.Incorporated by reference to Exhibit 10.1 of XylemInc.’s Form 10-Q Quarterly Report filed on July 29,2014 (CIK No. 1524472, File No. 1-35229) (11.0)Statement re computation of per share earningsInformation required to be presented in Exhibit 11 isprovided under "Earnings Per Share" in Note 8 to theconsolidated financial statements in Part II, Item 8.“Financial Statements and Supplementary Data” of thisAnnual Report on Form 10-K in accordance with theprovisions of Financial Accounting Standards BoardAccounting Standards Codification 260, Earnings PerShare. (12.0)Statements re computation of ratiosFiled herewith. (21.0)Subsidiaries of the RegistrantFiled herewith. (23.1)Consent of Independent Registered Public Accounting FirmFiled herewith. (31.1)Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities ExchangeAct of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002Filed herewith. (31.2)Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities ExchangeAct of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002Filed herewith. 108ExhibitNumberDescriptionLocation(32.1)Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002This Exhibit is intended to be furnished in accordancewith Regulation S-K Item 601(b) (32) (ii) and shall notbe deemed to be filed for purposes of Section 18 of theSecurities Exchange Act of 1934 or incorporated byreference into any filing under the Securities Act of1933 or the Securities Exchange Act of 1934, exceptas shall be expressly set forth by specific reference. (32.2)Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002This Exhibit is intended to be furnished in accordancewith Regulation S-K Item 601(b) (32) (ii) and shall notbe deemed to be filed for purposes of Section 18 of theSecurities Exchange Act of 1934 or incorporated byreference into any filing under the Securities Act of1933 or the Securities Exchange Act of 1934, exceptas shall be expressly set forth by specific reference. (101)The following materials from Xylem Inc.’s Annual Report on Form 10-K forthe year ended December 31, 2014, formatted in XBRL (Extensible BusinessReporting Language): (i) Consolidated Income Statements, (ii) ConsolidatedStatements of Comprehensive Income, (iii) Consolidated Balance Sheets,(iv) Consolidated Statements of Cash Flows and (v) Notes to ConsolidatedFinancial StatementsSubmitted electronically with this report.109EXHIBIT 10.1XYLEM2011 OMNIBUS INCENTIVE PLAN[YEAR] NON-QUALIFIED STOCK OPTION AWARD AGREEMENTTHIS AGREEMENT (the “Agreement”), effective as of [Month] [day], [year], by and between Xylem Inc. (the “Company”) and [name] (the“Optionee”), WITNESSETH:WHEREAS, the Optionee is now employed by the Company or an Affiliate (as defined in the Company’s 2011 Omnibus Incentive Plan (the “Plan”))as an employee, and in recognition of the Optionee’s valued services, the Company, through the Leadership Development and CompensationCommittee of its Board of Directors (the “Committee”), desires to provide an opportunity for the Optionee to acquire or enlarge stock ownership inthe Company, pursuant to the provisions of the Plan.NOW, THEREFORE, in consideration of the terms and conditions set forth in this Agreement and the provisions of the Plan, a copy of which isattached hereto and incorporated herein as part of this Agreement, and any administrative rules and regulations related to the Plan as may beadopted by the Committee, the parties hereto hereby agree as follows:1.Grant of Options. In accordance with, and subject to, the terms and conditions of the Plan and this Agreement, the Company herebyconfirms the grant on [Month][day], [year], (the “Grant Date”) to the Optionee of the option to purchase from the Company all or any part ofan aggregate of [#,###] shares (the “Options”), at the purchase price of $[##.##] per share (the “Exercise Price”). All Options shall beNonqualified Stock Options.2.Terms and Conditions. It is understood and agreed that the Options are subject to the following terms and conditions:(a)Expiration Date. The Options shall expire on [Month] [day], [year + 10], or, if the Optionee’s employment terminates before thatdate, on the date specified in subsection 2(e) below.(b)Exercise of Options. The Options may not be exercised until it has become vested.(c)Vesting. Subject to subsections 2(a), 2(d), and 2(e), the Options shall vest in three installments as follows:(i)1/3 of the Options shall vest on [Month] [day], [year + 1],(ii)1/3 of the Options shall vest on [Month] [day], [year + 2], and(iii)1/3 of the Options shall vest on [Month] [day], [year + 3].For the avoidance of doubt, active employment of an Optionee by the Company or an Affiliate, for the purposes of vesting in theOptions granted hereunder, shall include employment with the Company for so long as the Grantee continues working at such entity.Active employment does not include any potential severance period.Subject to subsections 2(a) and 2(d), to the extent not earlier vested pursuant to paragraphs (i), (ii), and (iii) of this subsection, theOptions shall vest in full upon an Acceleration Event (as defined in the Plan).(d)Effect of Acceleration Event. Subject to subsections 2(a) and 2(e), any unvested Options shall vest in full upon Acceleration Event.(e)Effect of Termination of Employment. Options may only vest while the Grantee is actively employed by the Company or anAffiliate. If the Optionee’s employment terminates before [Month] [day], [year + 10], the following would apply to any outstandingOptions:(i)Termination due to Death or Disability (as defined below). Any unvested Options shall immediately become 100% vested uponthe Optionee’s termination of employment. Any vested Options shall expire on the earlier of [Month] [day], [year + 10], or thedate three years after the Optionee’s termination of active employment.(i)Termination due to Retirement (as defined below). A prorated portion (as defined below), of any unvested Options shallimmediately vest upon the Optionee’s termination of employment. Any vested Options shall expire on the earlier of [Month][day], [year + 10], or the date three years after the Optionee’s termination of employment.(ii)Termination other than Death, Disability and Retirement. Any unvested Options shall automatically expire on the date of theOptionee’s termination of employment. Any vested portion of the Options shall expire on the earlier of [Month] [day], [year +10], or the date three months after the Optionee’s termination of employment.(iii)Notwithstanding the foregoing, if an Optionee’s employment is terminated on or within two years after an Acceleration Event (A)by the Company (or an Affiliate, as the case may be) for other than Cause (as determined by the Committee), and not becauseof the Optionee’s death, Disability, or Retirement, or (B) by the Optionee because the Optionee in good faith believed that as aresult of such Acceleration Event he or she was unable effectively to discharge his or her present duties or the duties of theposition the Optionee occupied just prior to the occurrence of such Acceleration Event, any unvested Options shall immediatelybecome 100% vested upon the Optionee’s termination of employment and vested Options shall expire on the earlier of [Month][day], [year + 10], or the date seven months after the Optionee’s termination of employment.Disability. For purposes of this Agreement, the term “Disability” shall mean the complete and permanent inability of the Optionee toperform all duties under the terms of his or her employment, as determined by the Committee upon the basis of such evidence,including independent medical reports and data, as the Committee deems appropriate or necessary.Retirement. For purposes of this Agreement, the term “Retirement” shall mean the termination of the Optionee's employment, if, atthe time of such termination, the Optionee is at least age 55 and has completed 10 years of service with the Company or the Optioneeis age 65 or older.Prorated Vesting Upon Retirement. The prorated portion of the Options that vests upon the Optionee’s termination of employmentdue to the Optionee's Retirement shall be determined by multiplying the total number of unvested Options at the time of theOptionee’s termination of employment by a fraction, of which the numerator is the number of full months the Optionee has beencontinually employed since the Grant Date and the denominator is 36. For this purpose, full months of employment shall be based onmonthly anniversaries of the Grant Date, not calendar months.(f)Payment of Exercise Price. Permissible methods for payment of the Exercise Price upon exercise of the Options are described inSection 6.6 of the Plan, or, if the Plan is amended, successor provisions. In addition to the methods of exercise permitted by Section6.6 of the Plan, the Optionee may exercise all or part of the Options by way of (i) broker-assisted cashless exercise in a mannerconsistent with the Federal Reserve Board's Regulation T, unless the Committee determines that such exercise method is prohibitedby law, or (ii) net-settlement, whereby the Optionee directs the Company to withhold shares that otherwise would be issued uponexercise of the Options having an aggregate Fair Market Value on the date of the exerciseequal to the Exercise Price, or the portion thereof being exercised by way of net-settlement (rounding up to the nearest whole share).(g)Tax Withholding. The Company shall have the power and the right to deduct or withhold, or require the Optionee to remit to theCompany, all applicable federal, state, and local taxes, domestic or foreign, required by law or regulation to be withheld with respect tothe exercise of the Options. The Optionee may elect to satisfy the withholding requirement, in whole or in part, by having theCompany withhold shares that otherwise would be issued upon exercise of the Options, with the number of shares withheld having aFair Market Value on the date the tax is to be determined equal to the minimum statutory total tax that could be imposed on thetransaction (rounding up to the nearest whole share). Any such election shall be subject to any restrictions or limitations that theCommittee, in its sole discretion, deems appropriate.(h)Automatic Exercise in Certain Circumstances. Subject to subsection 2(i) of this Agreement, to the extent any portion of the Optionsheld by active participants are otherwise exercisable but remain unexercised at the close of business on [Month] [day], [year + 10],and if on such date the Fair Market Value of the shares subject to such exercisable but unexercised portion of these Options exceedsthe aggregate consideration that would have been required to be paid to purchase such shares had such portion of the Options beenexercised, the Optionee will automatically be paid, in cancellation of such portion of the Options, an amount of Company shareshaving a Fair Market Value equal to such excess (rounding up to the nearest whole share), if any; provided, however, that such anexercise shall not occur to the extent the Optionee (and, if applicable, the Optionee’s authorized legal representative) may waive inwriting the applicability of this subsection 2(h).The Optionee hereby acknowledges that tax and other legal requirements must be met prior to any settlement of Options under thissubsection and herby consents to any tax or other consequences that may arise in connection with this subparagraph(i)Compliance with Laws and Regulations. Notwithstanding anything to the contrary herein, the Company shall not be obligated toissue any shares pursuant to this Agreement, at any time, if the offering of the shares covered by this Agreement, or the exercise ofthe Options by the Optionee, violates or is not in compliance with any laws, rules or regulations of the United States or any state orcountry. The Optionee understands that, to the extent applicable, the laws of the country in which the Optionee is working at the timeof grant, vesting, and/or exercise of the Options (including any rules or regulations governing securities, foreign exchange, tax, laboror other matters) may restrict or prevent exercise of the Options or may subject the Optionee to additional procedural or regulatoryrequirements for which the Optionee is solely responsible and that the Optionee will have to independently fulfill. The Companyreserves the right to impose other requirements on the Optionee’s participation in the Plan, awards thereunder, and any sharesacquired under the Plan, to the extent the Company determines it is necessary or advisable to comply with applicable law or facilitatethe administration of the Plan.(j)Optionee Bound by Plan and Rules. The Optionee hereby acknowledges receipt of a copy of the Plan and this Agreement andagrees to be bound by the terms and provisions thereof as amended from time to time. The Optionee agrees to be bound by any rulesand regulations for administering the Plan as may be adopted by the Committee during the life of the Options. Terms used herein andnot otherwise defined shall be as defined in the Plan.(k)Governing Law. This Agreement is issued, and the Options evidenced hereby are granted, in White Plains, New York and shall begoverned and construed in accordance with the laws of the State of New York, excluding any conflicts or choice of law rule or principlethat might otherwise refer construction or interpretation of this Agreement to the substantive law of another jurisdiction.By signing a copy of this Agreement, the Optionee acknowledges that s/he has received a copy of the Plan and that s/he has read andunderstands the Plan and this Agreement and agrees to the terms and conditions thereof. The Optionee further acknowledges that the Optionsawarded pursuant to this Agreement must be exercised prior to its expiration as set forth herein, that it is the Optionee's responsibility to exercisethe Options within such time period, and that the Company has no further responsibility to notify the Optionee of the expiration of the exerciseperiod of the Options.IN WITNESS WHEREOF, the Company has caused this instrument to be executed by its Chief Executive Officer and President, or a VicePresident, as of [Month] [day], [year].Agreed to: XYLEM INC. _____________________________ Optionee (Online acceptance constitutes agreement)Dated: _________________ Dated: [Month] [day], [year]EnclosuresEXHIBIT 12Ratio of Earnings to Fixed Charges Years Ended December 31,(In Millions Except Ratios)2014 2013 2012 2011(a) 2010(a)Fixed Charges: Interest Expense, Including Amortization of Deferred Finance Fees$54 $55 $55 $17 $— Interest Portion of Rental Expense (b)24 25 24 21 18 Total Fixed Charges78 80 79 38 18 Earnings Before Income Taxes, Discontinued Operations and Fixed Charges: Pre-tax income (before income or loss from equity investees)421 298 388 379 387 Fixed Charges78 80 79 38 18 Total Earnings Available For Fixed Charges$499 $378 $467 $417 $405 Ratio of Earnings to Fixed Charges:6.4 4.7 5.9 10.9 22.7(a)For all comparative periods presented above, these periods are prior to the Spin-off from ITT and the issuance of $1.2 billion aggregate principalamount of senior notes which were issued in September 2011. Interest on the Senior Notes accrues from September 20, 2011.(b)Calculated as 33% of rent expense, which is a reasonable approximation of the interest factor.EXHIBIT 21SUBSIDIARIES OF THE REGISTRANT*NameJurisdiction of OrganizationName Under Which DoingBusinessAanderaa Data Instruments ASNorway Anadolu Flygt Pompa Pazarlama Ve Ticaret ASTurkey ASE ASNorway Bellingham & Stanley Ltd.England & Wales Bombas Flygt de Venezuela S.A.Venezuela CMS Research CorporationAlabama Design Analysis Associates, Inc.Utah Evolutionary Concepts, Inc.California Faradyne Motors (Suzhou) Co. Ltd.China Flow Control LLCDelaware Flowtronex PSI, LLCNevada Fluid Handling, LLCDelaware Flygt ASNorway Godwin Holdings Ltd.England & Wales Goulds Water Technology Philippines, IncPhilippines Grindex ABSweden Grindex Pumps LLCDelaware Heartland Pump Rental and Sales, Inc.Illinois Jabsco Marine Italia s.r.l.Italy Jabsco S. de R.L. De C.V.Mexico Lowara s.r.l.ItalyLowaraLowara Vogel Polska SP ZOOPoland MJK Automation ApSDenmark MultiTrode Inc.Florida Multitrode Pty LtdAustralia Multitrode UK LimitedEngland & Wales NHK Jabsco Co, Ltd.Japan Nova Analytics Europe LLCDelaware O.I. CorporationOklahomaOI AnalyticalPCI Membrane Systems, Inc.Delaware Pension Trustee Management LtdEngland & Wales Portacel Inc.Pennsylvania Secomam S.A.S.France Sensortechnik Meinsberg GmbHGermany SI Analytics GmbHGermany Texas Turbine LLCDelawareXylem Texas Turbine LLCWater Asset Management, Inc.Delaware Water Company LtdEngland & Wales Water Process LimitedUnited Kingdom Wissenschaftich Technische Werkstaetten GmbHGermany *Pursuant to Item 601(b)(21)(ii) of Regulation S-K, the names of other subsidiaries of Xylem Inc. are omitted because, considered in the aggregate, they would not constitute asignificant subsidiary as of the end of the year covered by this report.NameJurisdiction of OrganizationName Under Which DoingBusinessXylem (China) Company LimitedChina Xylem (Hong Kong) LimitedHong Kong Xylem (Nanjing) Co., LtdChina Xylem (Wuxi) Flow Control Equipment Co., Ltd.China Xylem Analytics Australia Pty Ltd.Australia Xylem Analytics Germany GmbHGermany Xylem Analytics LLCDelaware Xylem Analytics UK LTDEngland Xylem ATI,LLCDelaware Xylem Australia Holdings PTY LTDNew South Wales Xylem Brasil Soluções para Água LtdaBrazil Xylem Canada CompanyNova Scotia Xylem Delaware, Inc.Delaware Xylem Denmark Holdings ApSDenmark Xylem Dewatering Canada LtdFederally Chartered Xylem Dewatering Solutions UK LtdEngland & Wales Xylem Dewatering Solutions, Inc.New JerseyGodwin Pumps of AmericaXylem Europe GmbHSwitzerland Xylem Financing S.a.r.lLuxembourg Xylem Flow Control LimitedEngland & Wales Xylem Germany GmbHFrankfurt am Main Xylem Global S.a.r.lLuxembourg Xylem Holdings S.a.r.l.Luxembourg Xylem Industriebeteiligungen GmbHGermany Xylem Industries S.a.r.l.Luxembourg Xylem International S.a.r.l.Luxembourg Xylem IP Holdings LLCDelaware Xylem IP Management S.a.r.lLuxembourg Xylem Luxembourg S.a r.l.Luxembourg Xylem Management GmbHGermany Xylem Manufacturing Austria GmbHAustria Xylem PCI Membranes Polska S.P. Z.O.O.Poland Xylem Russia LLCRussia Xylem Service Hungary KftHungary Xylem Service Italia Srl Luxemburg BranchItaly Xylem Services Austria GmbHAustria Xylem Services GmbHGermany Xylem Services Italia SrlItaly Xylem Technologies GmbHFrankfurt am Main Xylem Water Holdings LimitedUnited Kingdom Xylem Water LimitedEngland & Wales Xylem Water Services LimitedUnited Kingdom Xylem Water Solutions (Hong Kong) LimitedHong Kong Xylem Water Solutions Argentina S.A.Argentina *Pursuant to Item 601(b)(21)(ii) of Regulation S-K, the names of other subsidiaries of Xylem Inc. are omitted because, considered in the aggregate, they would not constitute asignificant subsidiary as of the end of the year covered by this report.NameJurisdiction of OrganizationName Under Which DoingBusinessXylem Water Solutions Australia LimitedNew South Wales Xylem Water Solutions Austria GmbHAustria Xylem Water Solutions BelgiumBelgium Xylem Water Solutions Chile S.A.Chile Xylem Water Solutions Colombia LtdaColombia Xylem Water Solutions Denmark ApSDenmark Xylem Water Solutions Deutschland GmbHGermanyFlygtXylem Water Solutions España, S.A.Spain Xylem Water Solutions Florida LLCDelaware Xylem Water Solutions France SASFrance Xylem Water Solutions Global Services ABSweden Xylem Water Solutions Herford GmbHGermany Xylem Water Solutions Holdings France SASFrance Xylem Water Solutions India Private LimitedIndia Xylem Water Solutions Ireland Ltd.Ireland Xylem Water Solutions Italia S.R.LItalyFlygtXylem Water Solutions Korea Co., Ltd.Korea Xylem Water Solutions Lietuva, UABLithuania Xylem Water Solutions Magyarorszag KRTHungary Xylem Water Solutions Malyasia SDN. BHD.Malaysia Xylem Water Solutions Manufacturing ABSweden Xylem Water Solutions Metz SASFrance Xylem Water Solutions Mexico S.de R.L. de C.V.Mexico Xylem Water Solutions Middle East Region FZCODubai Xylem Water Solutions Muscat LLCOman Xylem Water Solutions Nederland BVNetherlandsFlygtXylem Water Solutions New Zealand LimitedNew Zealand Xylem Water Solutions Norge ASNorway Xylem Water Solutions Panama s.r.l.Panama Xylem Water Solutions Peru S.A.Peru Xylem Water Solutions Polska Sp.z.o.o.Poland Xylem Water Solutions Portugal Unipessoal Lda.Portugal Xylem Water Solutions Rugby LimitedUnited Kingdom Xylem Water Solutions Schweiz GmbHSwitzerland Xylem Water Solutions Singapore PTE Ltd.Singapore Xylem Water Solutions South Africa (Pty) Ltd.South Africa Xylem Water Solutions South Africa Holdings LLCDelaware Xylem Water Solutions Suomi OyFinland Xylem Water Solutions Sweden ABSweden Xylem Water Solutions U.S.A., Inc.Delaware Xylem Water Solutions UK Holdings LimitedUnited Kingdom Xylem Water Solutions UK LimitedUnited Kingdom Xylem Water Solutions Zelienople LLCDelaware Xylem Water Solutions(Shenyang) CO., LtdChina *Pursuant to Item 601(b)(21)(ii) of Regulation S-K, the names of other subsidiaries of Xylem Inc. are omitted because, considered in the aggregate, they would not constitute asignificant subsidiary as of the end of the year covered by this report.NameJurisdiction of OrganizationName Under Which DoingBusinessXylem Water Systems (California), Inc.California Xylem Water Systems Australia PTY ltd.New South Wales Xylem Water Systems Hungary KFTHungary Xylem Water Systems International, Inc.Delaware Xylem Water Systems Japan CorporationJapan Xylem Water Systems Mexico S. DE R.L. DE C.V.Mexico Xylem Water Systems Philippines Holding, Inc.Delaware Xylem Water Systems Texas Holdings LLCDelaware Xylem Water Systems U.S.A., LLCDelaware Yellow Springs Instrument LTDJapan YSI (Beijing) Co., Ltd.China YSI (China) LimitedHong Kong YSI (Hong Kong) Ltd.Hong Kong YSI (UK) LimitedEngland YSI Environmental South Asia Private Ltd.India YSI IncorporatedOhio YSI Instrumentos E Servicos Ambientais Ltda.Brazil YSI International, Inc.Ohio YSI Nanotech LimitedJapan YSI Trading (Shanghai) Company, Ltd.China *Pursuant to Item 601(b)(21)(ii) of Regulation S-K, the names of other subsidiaries of Xylem Inc. are omitted because, considered in the aggregate, they would not constitute asignificant subsidiary as of the end of the year covered by this report.EXHIBIT 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in Registration Statement No. 333-177607 on Form S-8 of our reports dated February 26, 2015,relating to the consolidated financial statements of Xylem Inc. and subsidiaries (the "Company"), and the effectiveness of the Company's internalcontrol over financial reporting, appearing in this Annual Report on Form 10-K of the Company for the year ended December 31, 2014./s/ Deloitte & Touche LLPStamford, ConnecticutFebruary 26, 2015EXHIBIT 31.1CERTIFICATION PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Patrick K. Decker, certify that:1.I have reviewed this Annual Report on Form 10-K of Xylem Inc. for the period ended December 31, 2014;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periodcovered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting.Date: February 26, 2015 /s/ Patrick K. Decker Patrick K. DeckerPresident and Chief Executive OfficerEXHIBIT 31.2CERTIFICATION PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Michael T. Speetzen, certify that:1.I have reviewed this Annual Report on Form 10-K of Xylem Inc. for the period ended December 31, 2014;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periodcovered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting.Date: February 26, 2015 /s/ Michael T. Speetzen Michael T. SpeetzenSenior Vice President andChief Financial OfficerEXHIBIT 32.1CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report on Form 10-K of Xylem Inc. (the “Company”) for the period ended December 31, 2014 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), I, Patrick K. Decker, President and Chief Executive Officer of theCompany, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany./s/ Patrick K. Decker Patrick K. Decker President and Chief Executive Officer February 26, 2015 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company andfurnished to the Securities and Exchange Commission or its staff upon request.EXHIBIT 32.2CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report on Form 10-K of Xylem Inc. (the “Company”) for the period ended December 31, 2014 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), I, Michael T. Speetzen, Senior Vice President and Chief Financial Officerof the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany./s/ Michael T. Speetzen Michael T. Speetzen Senior Vice President and Chief Financial Officer February 26, 2015 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company andfurnished to the Securities and Exchange Commission or its staff upon request.

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