Edgar Filing: Xylem Inc.

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 1-35229

Xylem Inc.

(Exact name of registrant as specified in its charter)



Indiana		45-2080495
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1 International Drive, Rye Brook, NY 10573

(Address of principal executive offices) (Zip code)

(914) 323-5700

(Registrant's telephone number, including area code)

Indicate 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 during the 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 requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	þ	Accelerated filer	¨

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

As of October 26, 2018, there were 179,716,050 outstanding shares of the registrant’s common stock, par value $0.01 per share.

Xylem Inc.

Table of Contents



ITEM			PAGE
PART I – Financial Information
Item 1	-	Condensed Consolidated Financial Statements:
		Condensed Consolidated Income Statements for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)	3
		Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)	4
		Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 (Unaudited)	5
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017 (Unaudited)	6
		Notes to the Condensed Consolidated Financial Statements (Unaudited)	7
Item 2	-	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3	-	Quantitative and Qualitative Disclosures About Market Risk	56
Item 4	-	Controls and Procedures	56
PART II – Other Information
Item 1	-	Legal Proceedings	57
Item 1A	-	Risk Factors	57
Item 2	-	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 3	-	Defaults Upon Senior Securities	57
Item 4	-	Mine Safety Disclosures	57
Item 5	-	Other Information	57
Item 6	-	Exhibits	57
		Signatures	59

PART I

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

XYLEM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)

(in millions, except per share data)



	Three Months					Nine Months
For the periods ended September 30,	2018		2017			2018		2017
Revenue	$	1,287	$	1,195		$	3,821	$	3,430
Cost of revenue	782		724			2,337		2,090
Gross profit	505		471			1,484		1,340
Selling, general and administrative expenses	279		270			868		812
Research and development expenses	46		45			137		131
Restructuring and asset impairment charges, net	4		4			19		22
Operating income	176		152			460		375
Interest expense	21		21			63		62
Other non-operating income (expense), net	4		1			9		5
Gain (loss) from sale of business	2		(1		)	—		4
Income before taxes	161		131			406		322
Income tax expense	31		27			82		62
Net income	130		104			324		260
Less: Net loss attributable to non-controlling interests	—		(1		)	—		—
Net income attributable to Xylem	$	130	$	105		$	324	$	260
Earnings per share:
Basic	$	0.73	$	0.58		$	1.80	$	1.45
Diluted	$	0.72	$	0.58		$	1.79	$	1.44
Weighted average number of shares:
Basic	179.7		179.6			179.8		179.6
Diluted	181.1		180.9			181.2		180.7
Dividends declared per share	$	0.2100	$	0.1800		$	0.6300	$	0.5400

See accompanying notes to condensed consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(in millions)



	Three Months						Nine Months
For the periods ended September 30,	2018			2017			2018			2017
Net income	$	130		$	104		$	324		$	260
Other comprehensive income, before tax:
Foreign currency translation adjustment	(9		)	7			(61		)	66
Net change in derivative hedge agreements:
Unrealized (losses) gains	—			(1		)	(9		)	4
Amount of gain reclassified into net income	3			—			1			—
Net change in postretirement benefit plans:
Amortization of prior service credit	(2		)	—			(4		)	—
Amortization of net actuarial loss into net income	4			3			11			8
Settlement/Curtailment	—			1			1			1
Other comprehensive (loss) income, before tax	(4		)	10			(61		)	79
Income tax (benefit) expense related to items of other comprehensive income	(3		)	(11		)	7			(40		)
Other comprehensive (loss) income, net of tax	(1		)	21			(68		)	119
Comprehensive income	$	129		$	125		$	256		$	379
Less: comprehensive loss attributable to noncontrolling interests	(2		)	—			(2		)	—
Comprehensive income attributable to Xylem	$	131		$	125		$	258		$	379

See accompanying notes to condensed consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in millions, except per share amounts)



	September 30, 2018			December 31, 2017

ASSETS
Current assets:
Cash and cash equivalents	$	404		$	414
Receivables, less allowances for discounts and doubtful accounts of $34 and $35 in 2018 and 2017, respectively	1,017			956
Inventories	622			524
Prepaid and other current assets	161			177
Total current assets	2,204			2,071
Property, plant and equipment, net	636			643
Goodwill	3,008			2,768
Other intangible assets, net	1,259			1,168
Other non-current assets	219			210
Total assets	$	7,326		$	6,860
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	570		$	549
Accrued and other current liabilities	571			551
Short-term borrowings and current maturities of long-term debt	342			—
Total current liabilities	1,483			1,100
Long-term debt	2,189			2,200
Accrued postretirement benefits	409			442
Deferred income tax liabilities	284			252
Other non-current accrued liabilities	330			347
Total liabilities	4,695			4,341
Commitments and contingencies (Note 19)
Stockholders’ equity:
Common Stock – par value $0.01 per share:
Authorized 750.0 shares, issued 192.9 shares and 192.3 shares in 2018 and 2017, respectively	2			2
Capital in excess of par value	1,942			1,912
Retained earnings	1,452			1,227
Treasury stock – at cost 13.2 shares and 12.4 shares in 2018 and 2017, respectively	(486		)	(428		)
Accumulated other comprehensive loss	(293		)	(210		)
Total stockholders’ equity	2,617			2,503
Non-controlling interests	14			16
Total equity	2,631			2,519
Total liabilities and stockholders’ equity	$	7,326		$	6,860

See accompanying notes to condensed consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in millions)



For the nine months ended September 30,	2018			2017
Operating Activities
Net income	$	324		$	260
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	87			83
Amortization	108			91
Share-based compensation	23			16
Restructuring and asset impairment charges	19			22
Loss (gain) from sale of business	—			(4		)
Other, net	2			18
Payments for restructuring	(18		)	(25		)
Changes in assets and liabilities (net of acquisitions):
Changes in receivables	(76		)	(114		)
Changes in inventories	(115		)	(14		)
Changes in accounts payable	51			3
Other, net	(17		)	43
Net Cash – Operating activities	388			379
Investing Activities
Capital expenditures	(171		)	(119		)
Acquisitions of businesses, net of cash acquired	(433		)	(16		)
Proceeds from sale of assets and business, net of cash disposed	22			11
Cash received from investments	—			10
Cash paid for investments	—			(11		)
Other, net	3			3
Net Cash – Investing activities	(579		)	(122		)
Financing Activities
Short-term debt issued, net	410			—
Short-term debt repaid	(50		)	(184		)
Repurchase of common stock	(58		)	(25		)
Proceeds from exercise of employee stock options	7			8
Dividends paid	(114		)	(97		)
Other, net	—			(1		)
Net Cash – Financing activities	195			(299		)
Effect of exchange rate changes on cash	(14		)	17
Net change in cash and cash equivalents	(10		)	(25		)
Cash and cash equivalents at beginning of year	414			308
Cash and cash equivalents at end of period	$	404		$	283
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	47		$	46
Income taxes (net of refunds received)	$	60		$	58

See accompanying notes to condensed consolidated financial statements.

XYLEM INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Background and Basis of Presentation

Background

Xylem Inc. ("Xylem" or the "Company") is a leading equipment and service provider for water and wastewater applications with a broad portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment. Xylem was incorporated in Indiana on May 4, 2011.

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

Except as otherwise indicated or unless the context otherwise requires, "Xylem," "we," "us," "our" and the "Company" refer to Xylem Inc. and its subsidiaries.

Basis of Presentation

The interim condensed consolidated financial statements reflect our financial position and results of operations in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All intercompany transactions between our businesses have been eliminated.

The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules. We believe that the disclosures made are adequate to make the information presented not misleading. We consistently applied the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2017 ("2017 Annual Report") in preparing these unaudited condensed consolidated financial statements, with the exception of accounting standard updates described in Note 2. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes included in our 2017 Annual Report.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Estimates are revised as additional information becomes available. Estimates and assumptions are used for, but not limited to, postretirement obligations and assets, revenue recognition, income tax contingency accruals and valuation allowances, goodwill and indefinite lived intangible impairment testing and contingent liabilities. Actual results could differ from these estimates.

Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends on December 31. For ease of presentation, the condensed consolidated financial statements included herein are described as ending on the last day of the calendar quarter.

Note 2. Recently Issued Accounting Pronouncements

Pronouncements Not Yet Adopted

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

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


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


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


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

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

This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted with the effect of adoption reflected as of the beginning of the fiscal year of adoption. For cash flow and net investment hedges existing at the date of adoption, a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness is required. Other presentation and disclosure guidance is required only prospectively. We are evaluating the impact of the guidance on our financial condition and results of operations.

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

In February 2016, the FASB issued guidance amending the accounting for leases. Specifically, the amended guidance requires all lessees to record a lease liability at lease inception, with a corresponding right of use asset, except for short-term leases. Lessor accounting is not fundamentally changed. This amended guidance is effective for interim and annual periods beginning after December 15, 2018 using a modified retrospective approach. Early adoption is permitted. We are evaluating the impact of the guidance on our financial condition and results of operations.

Recently Adopted Pronouncements

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

income tax effects of the Tax Act from AOCI to retained earnings. As a result of adopting the guidance, AOCI was reduced by $17 million and retained earnings increased by $17 million. This amount includes the effect of the change in the US federal corporate income tax rate.

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

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

Note 3. Acquisitions and Divestitures

2018 Acquisitions and Divestitures

Pure Technologies Ltd.

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

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

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



(in millions)	Amount
Cash	$	14
Receivables	23
Inventories	5
Prepaid and other current assets	2
Property, plant and equipment	22
Intangible assets	149
Other long-term assets	1
Accounts payable	(3		)
Accrued and other current liabilities	(11		)
Deferred income tax liabilities	(27		)
Other non-current accrued liabilities	(2		)
Total identifiable net assets	173

Goodwill	261
Total consideration	$	434

The fair values of Pure's assets and liabilities were determined based on preliminary estimates and assumptions which management believes are reasonable. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These adjustments will primarily relate to intangible assets and income tax related items. The final determination of the fair value of certain assets and liabilities will be completed as soon as the necessary information is available but no later than one year from the acquisition date.

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

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



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

The following table summarizes, on an unaudited pro forma basis, the condensed combined results of operations of the Company for the three and nine month periods ended September 30, 2018 and September 30, 2017, respectively, assuming the acquisition of Pure was made on January 1, 2017.



(in millions)	Three Months		Nine Months
For the period ended September 30,	2018	2017	2018	2017
Revenue	N/A	$1,220	$3,826	$3,502
Net income	N/A	$102	$321	$254

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

•Amortization expense of acquired intangibles


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


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

•The related tax impact of the above referenced adjustments

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

During the three and eight months ended September 30, 2018 Pure had operating losses of $2 million and $5 million, respectively.

Other Acquisition Activity

During the three and nine months ended September 30, 2018 we spent approximately $3 million and $13 million, net of cash received on other acquisition activity.

During the third quarter we divested our Precision Die Casting business for approximately $22 million, net of cash assumed. The sale resulted in a immaterial gain for the three and nine months ended September 30, 2018, which is reflected in gain from sale of business in our Condensed Consolidated Income Statement. The business, which was part of our Measurement & Controls Solutions segment, provided aluminum die casting products primarily to customers in the automotive sector. The business reported 2017 annual revenue of approximately $32 million.

2017 Acquisitions and Divestitures

During the three and nine months ended September 30, 2017 we spent approximately $10 million and $16 million, respectively, on various acquisition activity.

On February 17, 2017, we divested our United Kingdom and Poland based membranes business for approximately $10 million. The sale resulted in a gain of $4 million, which is reflected in gain from sale of business in our Condensed Consolidated Income Statement. The business, which was part of our Applied Water segment, provided membrane filtration products primarily to customers in the municipal water and industrial sectors. The business reported 2016 annual revenue of approximately $8 million.

Note 4. Revenue

As discussed in Note 2, "Recently Issued Accounting Pronouncements", Xylem adopted the new guidance on recognizing revenue from contracts with customers as of January 1, 2018.

Xylem recognizes revenue in a manner that depicts the transfer of promised goods and services to customers in an amount that reflects the consideration to which it expects to be entitled to for providing those goods and services. For each arrangement with a customer, we identify the contract, the associated performance obligations within the contract, determine the transaction price of that contract, allocate the transaction price to each performance obligation and recognize revenue as each performance obligation is satisfied.

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

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

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

Certain businesses also enter into long-term construction-type sales contracts where revenue is recognized over time. In these instances, revenue is recognized using a measure of progress that applies an input method based on costs incurred in relation to total estimated costs.

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

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

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

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

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

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

Product Warranties

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

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

Disaggregation of Revenue

The following table illustrates the sources of revenue:



	Three Months Ended		Nine Months Ended
(in millions)	September 30, 2018		September 30, 2018
Revenue from contracts with customers	$	1,222	$	3,642
Other	65		179
Total	$	1,287	$	3,821

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



	Three Months Ended		Nine Months Ended
(in millions)	September 30, 2018		September 30, 2018
Water Infrastructure
Transport	$	380	$	1,114
Treatment	96		274

Applied Water
Commercial Building Services	149		436
Residential Building Services	59		172
Industrial Water	170		524

Measurement and Control Solutions
Water	168		514
Electric	36		110
Gas	54		144
Software and Services/Other	26		96
Test	84		258

Total	$	1,222	$	3,642

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



	Three Months Ended		Nine Months Ended
(in millions)	September 30, 2018		September 30, 2018
Water Infrastructure
United States	$	139	$	387
Europe	174		542
Emerging Markets & Other	163		459

Applied Water
United States	197		583
Europe	93		291
Emerging Markets & Other	88		258

Measurement and Control Solutions
United States	238		674
Europe	59		214
Emerging Markets & Other	71		234

Total	$	1,222	$	3,642

Contract Balances

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

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



(in millions)	Contract Assets (a)			Contract Liabilities
Balance at 1/1/2018	$	89		$	107
Additions, net	68			92
Revenue recognized from opening balance	—			(83		)
Billings	(62		)	—
Other	(4		)	(6		)
Balance at 9/30/2018	$	91		$	110


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

Performance obligations

Delivery schedules vary from customer to customer based upon their requirements. Typically, large projects require longer lead production cycles and delays can occur from time to time. As of September 30, 2018, the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied for contracts with performance obligations, amount to $209 million. We expect to recognize revenue upon the completion of satisfying these performance obligations in the following 12 to 60 months. The Company elects to apply the practical expedient to exclude from this disclosure revenue related to performance obligations that are part of a contract whose original expected duration is less than one year.

Contract Costs

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

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

Note 5. Restructuring Charges

From time to time, the Company will incur costs related to restructuring actions in order to optimize our cost base and more strategically position ourselves based on the economic environment and customer demand. During the three and nine months ended September 30, 2018, we recognized restructuring charges of $4 million and $19 million, respectively. We incurred these charges primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Measurement & Control Solutions and Water Infrastructure segments, as well as headcount reductions within our Applied Water segment.

During the three and nine months ended September 30, 2017, we recognized restructuring charges of $4 million and $17 million. We incurred these charges primarily as a continuation of our efforts to reposition our European and North American businesses to optimize our cost structure and improve our operational efficiency and effectiveness. The charges included the reduction of headcount and consolidation of facilities within our Applied Water and Water Infrastructure segments, as well as headcount reductions within our Measurement and Control Solutions segment.

The following table presents the components of restructuring expense and asset impairment charges.



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in millions)	2018		2017		2018		2017
By component:
Severance and other charges	$	4	$	3	$	18	$	17
Lease related charges	—		—		1		—
Other restructuring charges	—		1		—		1
Reversal of restructuring accruals	—		—		—		(1		)
Total restructuring charges	$	4	$	4	$	19	$	17
Asset impairment	—		—		—		5
Total restructuring and asset impairment charges	$	4	$	4	$	19	$	22

By segment:
Water Infrastructure	$	2	$	1	$	8	$	6
Applied Water	1		2		2		12
Measurement & Control Solutions	1		1		9		4
Corporate and other	—		—		—		—

The following table displays a rollforward of the restructuring accruals, presented on our Condensed Consolidated Balance Sheets within accrued and other current liabilities, for the nine months ended September 30, 2018 and 2017.



(in millions)	2018			2017
Restructuring accruals - January 1	$	7		$	15
Restructuring charges	19			17
Cash payments	(18		)	(25		)
Foreign currency and other	(1		)	—
Restructuring accruals - September 30	$	7		$	7

By segment:
Water Infrastructure	$	1		$	—
Applied Water	1			1
Measurement & Control Solutions	3			3
Regional selling locations (a)	2			3
Corporate and other	—			—


(a)	Regional selling locations consist primarily of selling and marketing organizations that incurred restructuring expense which was allocated to the segments. The liabilities associated with restructuring expense were not allocated to the segments.

The following is a rollforward for the nine months ended September 30, 2018 and 2017 of employee position eliminations associated with restructuring activities.



	2018		2017
Planned reductions - January 1	47		188
Additional planned reductions	176		140
Actual reductions and reversals	(135	)	(223	)
Planned reductions - September 30	88		105

The following table presents expected restructuring spend:



(in millions)	Water Infrastructure		Applied Water		Measurement & Control Solutions		Corporate		Total
Actions Commenced in 2018:
Total expected costs	$	7	$	1	$	8	$	—	$	16
Costs incurred during Q1 2018	2		1		5		—		8
Costs incurred during Q2 2018	2		—		2		—		4
Costs incurred during Q3 2018	2		—		—		—		2
Total expected costs remaining	$	1	$	—	$	1	$	—	$	2

Actions Commenced in 2017:
Total expected costs	$	18	$	12	$	3	$	—	$	33
Costs incurred during 2017	5		4		2		—		11
Costs incurred during Q1 2018	1		—		—		—		1
Costs incurred during Q2 2018	1		—		—		—		1
Costs incurred during Q3 2018	—		1		1		—		2
Total expected costs remaining	$	11	$	7	$	—	$	—	$	18

Actions Commenced in 2016:
Total expected costs	$	13	$	14	$	11	$	2	$	40
Costs incurred during 2016	11		10		6		2		29
Costs incurred during 2017	2		4		3		—		9
Costs incurred during Q1 2018	—		—		1		—		1
Costs incurred during Q2 2018	—		—		—		—		—
Costs incurred during Q3 2018	—		—