The following discussion should be read in conjunction with the condensed consolidated financial statements, including the notes, included elsewhere in this report on Form 10-Q (this "Report"). Except as otherwise indicated or unless the context otherwise requires, "Xylem ," "we," "us," "our" and the "Company" refer toXylem Inc. and its subsidiaries. This Report contains information that may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. Generally, the words "anticipate," "estimate," "expect," "project," "intend," "plan," "contemplate," "predict," "forecast," "believe," "target," "will," "could," "would," "should," "potential," "may" and similar expressions identify forward-looking statements. However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. These forward-looking statements include any statements that are not historical in nature, including any statements about the capitalization ofXylem Inc. (the "Company"), the Company's restructuring and realignment plans, 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 will occur in the future - including statements relating to orders, revenues, operating margins and earnings per share growth, and statements expressing general 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 reasonably inferred from, such forward-looking statements. Many of these risks and uncertainties are currently amplified by and may continue to be amplified by, or in the future may be amplified by, the novel coronavirus ("COVID-19") pandemic. Factors that could cause results to differ materially from those anticipated include: overall economic and business conditions; uncertainty of the magnitude, duration, geographic reach and impact on the global economy of the COVID-19 pandemic; the current, and uncertain future, impact of the COVID-19 pandemic on our business, growth, projections, financial condition, operations, cash flows, and liquidity, including the impact of adverse economic conditions caused by the COVID-19 pandemic on our performance or customer markets; actual or potential other epidemics, pandemics or global health crises; geopolitical and other risks associated with our international operations, including military actions, protectionism, economic sanctions or trade barriers including tariffs and embargoes that could affect customer markets and our business, and non-compliance with laws, including foreign corrupt practice laws, data privacy, export and import laws and competition laws; potential for unexpected cancellations or delays of customer orders in our reported backlog; our exposure to fluctuations in foreign currency exchange rates; disruption, competition and pricing pressures in the markets we serve; industrial, governmental and private sector spending; the strength of housing and related markets; weather conditions; ability to retain and attract talent and key members of management; our relationship with and the performance of our supply chain including channel partners; our ability to successfully identify, complete and integrate acquisitions; our ability to borrow or to refinance our existing indebtedness and availability of liquidity sufficient to meet our needs; uncertainty from the expected discontinuance of LIBOR and transition to any other interest rate benchmark; changes in the value of goodwill or intangible assets; the preliminary nature of our cost and savings estimates related to restructuring, realignment and related charges, including the timing of such charges and savings, which are subject to change as the Company makes decisions and refines estimates over time; timing delays in implementing restructuring, realignment and strategic initiatives; our ability to realize all of the cost savings anticipated in connection with restructuring and realignment; management and employee distraction resulting from restructuring actions; our ability to continue making strategic investments for growth; risks relating to product defects, product security, product liability and recalls; claims or investigations by governmental or regulatory bodies; cybersecurity attacks, breaches or other disruptions of information technology systems on which we rely; our sustainability initiatives; the anticipated use of proceeds from our green bond offering, including any failure to allocate the net proceeds to eligible green projects, or to meet or continue to meet the investment requirements of certain environmentally focused investors; litigation and contingent liabilities; and other factors set forth under "Item 1A. Risk Factors" in our 2019 Annual Report, "Item 1A. Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 and in subsequent filings we have made or may make with theSEC . 30 -------------------------------------------------------------------------------- All forward-looking statements made herein are based on information currently available to the Company as of the date of this Report. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Our quarterly financial periods end on the Saturday closest to the last day of the calendar quarter, except for the fourth quarter which ends onDecember 31 . For ease of presentation, the reporting periods included herein are described as ending on the last day of the calendar quarter. OverviewXylem is a leading global water technology company. We design, manufacture and service highly engineered products and solutions ranging across a wide variety of critical applications in utility, industrial, residential and commercial building services settings. Our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery, measurement and use of drinking water to the collection, test, treatment and analysis of wastewater to the return of water to the environment. Our product and service offerings are organized into three reportable segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Measurement & Control Solutions. •Water Infrastructure serves the water infrastructure sector with pump systems that transport water from aquifers, lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumping solutions that move the wastewater and storm water to treatment facilities where our mixers, biological treatment, monitoring and control systems provide the primary functions in the treatment process. We also provide sales and rental of specialty dewatering pumps and related equipment and services. Additionally, our offerings use monitoring and control, smart and connected technologies to allow for remote monitoring of performance and enable products to self-optimize pump operations maximizing energy efficiency and minimizing unplanned downtime and maintenance for our customers. In the Water Infrastructure segment, we provide the majority of our sales directly to customers along with strong applications expertise, while the remaining amount is through distribution partners. •Applied Water serves the water usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning, and for fire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers and controls provide cooling to power plants and manufacturing facilities, circulation for food and beverage processing, as well as boosting systems for agricultural irrigation. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with many of the leading independent distributors in the markets we serve, with the remainder going directly to customers. •Measurement & Control Solutions primarily serves the utility infrastructure solutions and services sector by delivering communications, smart metering, measurement and control technologies and critical infrastructure technologies that allow customers to more effectively use their distribution networks for the delivery, monitoring and control of critical resources such as water, electricity and natural gas. We also provide analytical instrumentation used to measure and analyze water quality, flow and level in clean water, wastewater, surface water and coastal environments. Additionally, we offer software and services including cloud-based analytics, remote monitoring and data management, leak detection, condition assessment, asset management and pressure monitoring solutions. We also offer smart lighting solutions that improve efficiency and public safety efforts across communities. In the Measurement & Control Solutions segment, we generate our sales through a combination of long-standing relationships with leading distributors and dedicated channel partners as well as direct sales depending on the regional availability of distribution channels and the type of product. COVID-19 Pandemic The global spread of the COVID-19 pandemic has curtailed the movement of people, goods and services worldwide, including in many of the regions where we sell our products and services and conduct operations. This section summarizes the most significant impacts related to the COVID-19 pandemic that we have experienced to date, and we have included additional details as applicable throughout other sections of this Report. Many of these impacts did not begin to be felt broadly across our businesses until the latter part of the first quarter of 2020 and continued into the second quarter. In response to the COVID-19 pandemic,Xylem deployed aCOVID-19 Response Team , responsible forXylem 's Pandemic Plan, which is designed to aid in prevention, preparedness, response and recovery at our sites. 31 -------------------------------------------------------------------------------- Depending on the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences, we anticipate that it will become more difficult to distinguish specific aspects of our operational and financial performance that are most directly related to COVID-19 from those that are more broadly influenced by ongoing macroeconomic, market and industry dynamics that may also be, to varying degrees, related to the COVID-19 pandemic and its consequences. Public health officials have recommended, or governments have mandated, precautions to mitigate the spread of COVID-19, including stay at home or similar measures in many of the areas in which we operate. Operationally, our production facilities located inLatin America ,Europe andAsia Pacific experienced reduced production levels due to such measures. Currently our overall operating capacity remains just over 90% globally, with all of our production facilities operational. Our production facilities continue to spread out operations over multiple shifts and implement other protective measures such as temperature screening and social distancing while maintaining operational capabilities in order to maintain a safe work environment. The COVID-19 pandemic is also adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and businesses. While we expect, from time to time, to experience unpredictable interruptions with our external suppliers, we have enhanced our supplier pulsing and redundancy to minimize those impacts. To date, the most significant impacts were experienced in volume reductions ranging across all segments and major geographic regions. Future demand for our products and services is uncertain as the COVID-19 pandemic has also had an adverse impact on many of the customers we serve. As such, we have and may continue to experience decreased or delayed demand for our products and services, as well as changes in the payment patterns of our customers. At the end of the second quarter, total backlog increased 11.8% as compared toDecember 31, 2019 and there has not been a notable increase in contract cancellations to date. In many cases,Xylem 's products and services are considered "essential services" under various governmental mandates, and as a result we did not experience significant issues in our ability to distribute products or services, aside from customer-driven project delays and shipping delays due to stay at home measures. However, because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain and rapidly changing, the pandemic's ongoing and future impacts on our business, financial condition, results of operations, and stock price remains uncertain and difficult to predict, but we expect our results to continue to be adversely impacted beyond the quarter endingJune 30, 2020 . In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, management committed to restructuring activities across our businesses and functions globally. These initiatives are designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. In light of the uncertainty created by the COVID-19 pandemic, we have also proactively taken further cost reduction actions which include a temporary 20% reduction in the base salary of the Company's Chief Executive Officer ("CEO") and all direct reports to the CEO and a temporary 20% reduction in annual cash retainer fees payable to our Board of Directors. These temporary reductions are effective fromJune 1, 2020 throughDecember 31, 2020 . Additionally, we have committed to reduced capital expenditure and discretionary operating spending during the year.Xylem has taken measures to protect the health and safety of our employees and work with our customers to minimize potential disruptions. In the first quarter, we implemented a support pay program for employees impacted by COVID-19, and an essential services premium pay program for the benefit of employees whose roles are classified as an "essential service" and, as such, are required to work either onsite at aXylem facility or in the field supporting customers during periods of mandated stay at home or similar measures. These programs will remain in place through the third quarter of 2020 and continue to be evaluated for continuation as necessary going forward.Xylem Watermark, our corporate social responsibility program, is also supporting our communities in addressing the challenges posed by this global pandemic through its partnership with Americares andUNICEF , as well as the expansion of the Partner Community Grants program and other philanthropic commitments. Many of our offices globally have transitioned to a fully remote work from home status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures. As public health officials and governments ease recommendations and regulations regarding stay at home measures, ourCOVID-19 Response Team is applying a set ofXylem "Return to Workplace" health and safety guidelines for remote workers to return to our facilities. These guidelines require government officials to first declare an easing of their restrictions, upon which we do a full review of our site to determine its readiness and follow a phased return to work approach, all in service to help ensure the safety of our people. 32 -------------------------------------------------------------------------------- We will continue to work with our customers, employees, suppliers and communities to address the impacts of COVID-19. We continue to assess possible implications to our business, supply chain and customers, and to take necessary actions in an effort to mitigate adverse consequences. Risk related to these items are described in further detail under "Item 1A. Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 . Executive SummaryXylem reported revenue for the second quarter of 2020 of$1,160 million , a decrease of 13.8% compared to$1,345 million reported in the second quarter of 2019. On a constant currency basis, revenue decreased by$160 million , or 11.9%, driven entirely by organic declines across all segments and all end markets. Organic revenue decline during the quarter was anticipated as our business continues to be impacted by the COVID-19 pandemic. We generated operating income of$54 million (margin of 4.7%) during the second quarter of 2020, as compared to$171 million (margin of 12.7%) in 2019. Operating income in the second quarter of 2020 included unfavorable impacts from increased restructuring and realignment costs of$22 million and special charges of$11 million incurred during the period. Excluding the impact of these items, adjusted operating income was$108 million (adjusted margin of 9.3%) during the second quarter of 2020 as compared to$192 million (adjusted margin of 14.3%) in 2019. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased inventory management costs; incremental COVID-19 related costs; increased spending on strategic investments and unfavorable mix. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. Additional financial highlights for the quarter endedJune 30, 2020 include the following: •Orders of$1,232 million , down 11.5% from$1,392 million in the prior year, and down 8.9% on an organic basis, impacted by the COVID-19 pandemic. •Earnings per share of$0.17 , down 77.9% when compared to the prior year ($0.40 , down 49.4% on an adjusted basis). •Net cash flow provided by operating activities of$179 million for the six months endedJune 30, 2020 , down$27 million from the prior year. Free cash flow of$84 million , up$7 million from the prior year. Key Performance Indicators and Non-GAAP Measures Management reviews key performance indicators including revenue, gross margins, segment operating income and margins, orders growth, working capital and backlog, among others. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and to provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases and debt repayment. Excluding revenue,Xylem provides guidance only on a non-GAAP basis due to the inherent difficulty in forecasting certain amounts that would be included in GAAP earnings, such as discrete tax items, without unreasonable effort. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following items to represent the non-GAAP measures we consider to be key performance indicators, as well as the related reconciling items to the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures may not be comparable to similarly titled measures reported by other companies. •"organic revenue" and "organic orders" defined as revenue and orders, respectively, excluding the impact of fluctuations in foreign currency translation and contributions from acquisitions and divestitures. Divestitures include sales of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate. •"constant currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This 33 -------------------------------------------------------------------------------- approach is used for countries whose functional currency is not theU.S. dollar. •"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude restructuring and realignment costs, special charges, gain or loss from sale of businesses and tax-related special items, as applicable. A reconciliation of adjusted net income and adjusted earnings per share is provided below. Three Months Ended Six Months Ended June 30, June 30, (In millions, except for per share data) 2020 2019 2020 2019 Net income & Earnings per share$ 31 $ 0.17 $ 139 $ 0.77 $ 69 $ 0.38 $ 218 $ 1.20 Restructuring and realignment, net of tax of$10 and$12 for 2020 and$4 and$8 for 2019 33 0.18 17 0.09 40 0.22 33
0.18
Special charges, net of tax of$3 and$3 for 2020 and$0 for 2019 10 0.06 - - 11 0.06 4 0.02 Tax-related special items (1) (0.01) (13) (0.07) (5) (0.03) (17) (0.09) Gain from sale of business, net of tax of$0 for 2019 - - - - - - (1)
-
Adjusted net income & Adjusted earnings per share$ 73 $ 0.40 $ 143 $ 0.79 $ 115 $ 0.63 $ 237 $ 1.31 •"adjusted operating expenses" defined as operating expenses adjusted to exclude restructuring and realignment costs and special charges. •"adjusted operating income" defined as operating income, adjusted to exclude restructuring and realignment costs and special charges, and "adjusted operating margin" defined as adjusted operating income divided by total revenue. •"realignment costs" defined as costs not included in restructuring costs that are incurred as part of actions taken to reposition our business, including items such as professional fees, severance, relocation, travel, facility set-up and other costs. •"special charges" defined as costs incurred by the Company, such as acquisition and integration related costs, non-cash impairment charges and other special non-operating items, such as pension adjustments. •"tax-related special items" defined as tax items, such as tax return versus tax provision adjustments, tax exam impacts, tax law change impacts, excess tax benefits/losses and other discrete tax adjustments. •"free cash flow" defined as net cash from operating activities, as reported in the Statement of Cash Flows, less capital expenditures. Our definition of "free cash flow" does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow. Six Months Ended June 30, (In millions) 2020 2019 Net cash provided by operating activities$ 179 $ 206 Capital expenditures (95) (129) Free cash flow$ 84 $ 77 Net cash used by investing activities$ (88) $ (146) Net cash provided by financing activities$ 774 $ 25 34
-------------------------------------------------------------------------------- •"EBITDA" defined as earnings before interest, taxes, depreciation and amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to exclude share-based compensation charges, restructuring and realignment costs, special charges and gain or loss from sale of businesses. Three Months Ended Six Months Ended June 30, June 30, (in millions) 2020 2019 2020 2019 Net Income$ 31 $ 139 $ 69 $ 218 Income tax expense 4 17 8 32 Interest expense (income), net 16 18 30 35 Depreciation 29 29 58 58 Amortization 33 34 68 69 EBITDA$ 113 $ 237 $ 233 $ 412 Share-based compensation$ 8 $ 7 16 16 Restructuring and realignment 43 21 52 41 Special charges 13 - 14 4 Gain from sale of business - - - (1) Adjusted EBITDA$ 177 $ 265 $ 315 $ 472 2020 Outlook We withdrew 2020 guidance onMarch 31, 2020 due to uncertainties caused by COVID-19. Given the continued uncertainties around the potential impact on the second half of the year, we are not reinstating full-year guidance, but we are providing the revenue outlook for the third quarter. We expect revenue to be down 10% to 14% in the third quarter, 8% to 12% organically, driven primarily by the impact of COVID-19. The following is a summary of our revenue outlook by each of our end markets: •Utilities revenue decreased by approximately 7% organically through the first half of the year driven by weakness inthe United States , theMiddle East andAsia Pacific , partially offset by strength inEurope . During 2020 we expect continued resilience on the wastewater side as essential operational spending continues and capital project funding for the year has been secured. However, the clean water utilities will continue facing workforce challenges from impacts of COVID-19 on the way in which they need to operate. We are seeing delays in project deployments, but expect to start to see modest recovery as physical distancing requirements ease. We continue to gain momentum behind key multi-year wins setting up healthy longer term growth. •Industrial revenue decreased by approximately 13% organically through the first half of the year driven by weakness inNorth America , the emerging markets and westernEurope . As 2020 progresses we expect industrial facilities to continue limiting access to sales teams and channel partners, causing slower orders and activity while non-essential work is deferred. Exposure to the impacts of a soft oil and gas market will continue to have an effect on both our dewatering and applied water businesses potentially leading to demand declines. We anticipate modest recovery in growth trajectory as countries and regions begin to re-open and activity resumes. •In the commercial markets, organic revenue decline was approximately 11% through the first half of the year driven by weakness inthe United States and the emerging markets. During 2020 we expect replacement business inthe United States to continue to be impacted by COVID-19. We anticipate mixed performance in the institutional building sector depending on the "essential" nature of end customer. Backlog remains robust as we work to restock distributors that delayed orders early on in the pandemic. •In the residential markets, organic revenue decline was approximately 14% through the first half of the year driven by weakness in westernEurope ,the United States andAsia Pacific . This market is primarily driven by replacement revenue serviced through our distribution network. As such, we anticipate primarily emergency replacement activity as a result of social distancing requirements. 35 -------------------------------------------------------------------------------- In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, onJune 2, 2020 management committed to structural cost actions across our businesses and functions globally. These plans are designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. Additionally, we will continue to strategically execute previously announced restructuring and realignment actions, primarily to reposition our European and North American businesses in an effort to optimize our cost structure and improve our operational efficiency and effectiveness. During 2020, we expect to incur between$80 million and$100 million in restructuring and realignment costs, with approximately$25 million of these costs being non-cash charges. We expect to realize approximately$67 million of net savings in 2020, consisting of$25 million of incremental net savings from restructuring and realignment actions initiated in 2019, and approximately$42 million of net savings from the restructuring, realignment and other structural cost actions initiated during this year. Results of Operations Three Months Ended Six Months Ended June 30, June 30, (In millions) 2020 2019 Change 2020 2019 Change Revenue$ 1,160 $ 1,345 (13.8) %$ 2,283 $ 2,582 (11.6) % Gross profit 434 526 (17.5) % 843 1,000 (15.7) % Gross margin 37.4 % 39.1 % (170) bp 36.9 % 38.7 % (180) bp Total operating expenses 380 355 7.0 % 728 720 1.1 % Expense to revenue ratio 32.8 % 26.4 % 640 bp 31.9 % 27.9 % 400 bp Restructuring and realignment costs 43 21 104.8 % 52 41 26.8 % Special charges 11 - NM 11 4 175.0 % Adjusted operating expenses 326 334 (2.4) % 665 675 (1.5) % Adjusted operating expenses to revenue ratio 28.1 % 24.8 % 330 bp 29.1 % 26.1 % 300 bp Operating income 54 171 (68.4) % 115 280 (58.9) % Operating margin 4.7 % 12.7 % (800) bp 5.0 % 10.8 % (580) bp Interest and other non-operating expense, net 19 15 26.7 % 38 31 22.6 % Gain from sale of business - - - % - 1 NM Income tax expense 4 17 (76.5) % 8 32 (75.0) % Tax rate 10.9 % 10.5 % 40 bp 10.4 % 12.8 % (240) bp Net income$ 31 $ 139 (77.7) %$ 69 $ 218 (68.3) % NM - Not meaningful change Revenue Revenue generated during the three and six months endedJune 30, 2020 was$1,160 million and$2,283 million , reflecting decreases of$185 million , or 13.8%, and$299 million , or 11.6%, respectively, compared to the same prior year periods. On a constant currency basis, revenue declined 11.9% and 9.9% for the three and six months endedJune 30, 2020 . The decreases at constant currency consisted entirely of declines in organic revenue of$160 million and$255 million , respectively, reflecting significantly lower demand across all major geographic regions and segments largely due to COVID-19 related impacts. 36 --------------------------------------------------------------------------------
The following table illustrates the impact from organic declines, recent
acquisitions and divestitures, and foreign currency translation in relation to
revenue during the three and six months ended
Measurement & Water Infrastructure Applied Water Control Solutions TotalXylem (In millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Revenue $ 561$ 394 $ 390 $ 1,345 Organic Impact (44) (7.8) % (51) (12.9) % (65) (16.7) % (160) (11.9) % Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency (44) (7.8) % (51) (12.9) % (65) (16.7) % (160) (11.9) % Foreign currency translation (a) (16) (2.9) % (6) (1.5) % (3) (0.8) % (25) (1.9) % Total change in revenue (60) (10.7) % (57) (14.5) % (68) (17.4) % (185) (13.8) % 2020 Revenue $ 501$ 337 $ 322 $ 1,160 (a)Foreign currency translation impact for the quarter due to the weakening in value of various currencies against theU.S. Dollar, the largest being the Euro, the Norwegian Krone, the Chinese Yuan, the Australian Dollar, the South African Rand and the British Pound. Measurement & Water Infrastructure Applied Water Control Solutions Total Xylem (In millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Revenue $ 1,043$ 773 $ 766 $ 2,582 Organic Impact (76) (7.3) % (89) (11.5) % (90) (11.7) % (255) (9.9) % Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency (76) (7.3) % (89) (11.5) % (90) (11.7) % (255) (9.9) % Foreign currency translation (a) (28) (2.7) % (9) (1.2) % (7) (0.9) % (44) (1.7) % Total change in revenue (104) (10.0) % (98) (12.7) % (97) (12.7) % (299) (11.6) % 2020 Revenue $ 939$ 675 $ 669 $ 2,283 (a)Foreign currency translation impact for the year due to the weakening in value of various currencies against theU.S. Dollar, the largest being the Euro, the Norwegian Krone, the Australian Dollar, the Chinese Yuan, the South African Rand and the British Pound. Water Infrastructure Water Infrastructure revenue decreased$60 million , or 10.7%, for the second quarter of 2020 (7.8% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by$16 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline of$44 million . Organic weakness for the quarter was primarily driven by the industrial end market, particularly inNorth America , due to continued soft market conditions in oil and gas and mining, as well as in the emerging markets. Organic revenue decline for the quarter was also driven by weakness in the utility end market, particularly inthe United States , due to softness in the construction market as compared to the prior year, as well as inIndia due the market slow down as well as the lapping of a large project delivery in the prior year. Declines in the utility end market were marginally offset by organic growth inEurope during the period primarily driven by spending for operational needs in easternEurope . Market conditions in both end markets for the segment were negatively impacted by the COVID-19 pandemic during the quarter, heavily impacting the organic revenue decline. From an application perspective, the organic revenue decline during the second quarter was primarily driven by our transport application, where market conditions continued to soften inthe United States in the dewatering applications, with construction, mining and oil and gas all down in the quarter, heavily impacted by the COVID-19 pandemic. Organic revenue decline within the transport application was also driven by softness inAsia Pacific andLatin America which were also impacted by the COVID-19 pandemic during the quarter. Organic revenue decline in the transport application was partially offset by modest growth from our treatment application, driven by project deliveries inthe United States during the quarter. 37 -------------------------------------------------------------------------------- For the six months endedJune 30, 2020 , revenue decreased$104 million , or 10.0% (7.3% decrease at constant currency) as compared to prior year. Revenue was negatively impacted by$28 million of foreign currency translation, with the change at constant currency coming entirely from an organic decline of$76 million . Organic weakness for the six month period was primarily driven by the industrial end market, particularly inNorth America , due to continued soft market conditions in oil and gas and mining, and in the emerging markets, where organic growth was heavily impacted by the COVID-19 pandemic during the year. Organic revenue decline during the six month period was also driven by weakness in the utility end market, particularly inthe United States , due to softness in construction and the lapping of projects in the prior year, as well as inIndia due to the timing of project deployments in the prior year. Declines in the utility end market in these regions were partially offset by organic growth inEurope during the period. The COVID-19 pandemic negatively impacted organic growth during the period throughout the entire segment and both end markets. From an application perspective, the organic revenue decline during the six months endedJune 30, 2020 was driven by our transport application where market conditions continued to soften inUnited States in the dewatering applications, with construction, oil and gas and mining all down during the first half of the year. We also saw organic revenue decline within the emerging markets in the transport application, primarily driven softness inLatin America andIndia , withIndia experiencing the lapping of some large projects executed in the prior year. Organic revenue declines in the transport application for all regions were impacted by the COVID-19 pandemic during the period. Organic revenue declines within the transport application were partially offset by modest organic growth in the treatment application during the year, primarily driven by projects in the middle east. Applied Water Applied Water revenue decreased$57 million , or 14.5%, for the second quarter of 2020 (12.9% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by$6 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of$51 million . Organic weakness for the quarter was driven by declines across all end markets and in all major geographic regions. Organic revenue declines in the segment were impacted by weakening market conditions during the quarter which have been accelerated by the COVID-19 pandemic, particularly inthe United States , westernEurope and in the emerging markets where restricted activities impacted the markets served. From an application perspective, the organic revenue decline in the second quarter was led by weakness in the industrial water application driven bythe United States , westernEurope and the emerging markets, where we experienced industry softening, which has been amplified by the COVID-19 pandemic with restricted activities. The building services application in the commercial markets also experienced a decline in organic revenue during the quarter which was driven by the impact of the COVID-19 pandemic inthe United States where the timing of shipments was impacted by the economic slowdown and restricted activity. Weakness in the building services application in the residential market also contributed to the organic revenue decline during the quarter, primarily inthe United States and westernEurope . For the six months endedJune 30, 2020 , revenue decreased$98 million , or 12.7% (11.5% decrease at constant currency) as compared to the prior year. Revenue was negatively impacted by$9 million of foreign currency translation for the period, with the change at constant currency coming entirely from an organic decline of$89 million . Organic weakness during the first half of the year was driven by declines across all end markets and in all major geographic regions. Organic revenue declines in the segment were significantly driven by impacts from the COVID-19 pandemic, particularly inthe United States , the emerging markets and westernEurope where lockdown activities caused a slow down in the markets served and the general softening of market conditions. From an application perspective, the organic revenue decline for the six month period was led by weakness in the building services application. The building services application in the commercial markets experienced a decline in organic revenue during the period driven by the impact of the COVID-19 pandemic inthe United States , where construction was impacted by the economic slowdown, as well as in the emerging markets, particularlyChina and theMiddle East . Weakness in the building services application in the residential market also contributed to the organic revenue decline during the first half of the year, primarily inthe United States and westernEurope . The segment also had organic revenue declines in the industrial water application driven by continued industry softening, which has been amplified by the COVID-19 pandemic, inthe United States , westernEurope and the emerging markets. 38 -------------------------------------------------------------------------------- Measurement & Control Solutions Measurement & Control Solutions revenue decreased$68 million , or 17.4%, for the second quarter of 2020 (16.7% at constant currency) as compared to the prior year. Revenue was negatively impacted by$3 million of foreign currency translation for the quarter, with the change at constant currency coming entirely from an organic decline of$65 million . Organic weakness for the quarter was driven by a decline in the utility end market, primarily inNorth America and theMiddle East and, to a lesser extent, weakness in the industrial end market across all major geographic regions. Organic revenue declines in the segment were significantly impacted by the COVID-19 pandemic during the quarter, particularly inthe United States . From an application perspective, the organic revenue decline for the segment was driven by the water application, where the COVID-19 pandemic drove market softness inthe United States , and we lapped strong project deployments in theMiddle East during the second quarter of the prior year. The test application also experienced organic revenue decline during the quarter, primarily driven by the negative impacts of the COVID-19 pandemic experienced inNorth America and westernEurope , as well as the lapping of large ocean and coastal projects in theMiddle East in the prior year. Organic revenue declined in the energy application driven by large gas project deployments inthe United States during the prior year that did not repeat, coupled with softening market conditions, which were negatively impacted by the COVID-19 pandemic. The software as a service ("SaaS") application had a modest decline in revenue as compared to the prior year, primarily inthe United States . For the six months endedJune 30, 2020 , revenue decreased$97 million , or 12.7% (11.7% at constant currency) as compared to the prior year. Revenue was negatively impacted by$7 million of foreign currency translation during the six month period, with the change at constant currency coming entirely from an organic decline of$90 million . Organic weakness for the period was driven by a decline in the utility end market, primarily inthe United States , theMiddle East andAsia Pacific , marginally offset by modest organic growth in westernEurope during the first half of the year. Organic revenue declines in the segment were impacted by the COVID-19 pandemic during the period, particularly inthe United States and the emerging markets. From an application perspective, the organic revenue decline for the segment was driven by the water application, where the COVID-19 pandemic drove market softness inthe United States and we lapped strong project deployments in theMiddle East during the prior year. The test application also experienced organic revenue decline during the period across all major regions, where we experienced negative impacts from the COVID-19 pandemic, and large prior year project executions in theMiddle East . The energy application and, to a lesser extent, the SaaS application also had declines in organic revenue as compared to the prior year, primarily inthe United States as we lapped a few large project deployments and continue to be negatively impacted by the COVID-19 pandemic. Orders / Backlog An order represents a legally enforceable, written document that includes the scope of work or services to be performed or equipment to be supplied to a customer, the corresponding price and the expected delivery date for the applicable products or services to be provided. An order often takes the form of a customer purchase order or a signed quote from aXylem business. Orders received during the second quarter of 2020 were$1,232 million , a decrease of$160 million , or 11.5%, over the prior year (8.9% decrease at constant currency). Orders received during the six months endedJune 30, 2020 were$2,493 million , a decrease of$214 million , or 7.9%, over the prior year (5.7% decrease at constant currency). Order intake was negatively impacted by$36 million and$59 million of foreign currency translation for the three and six months endedJune 30, 2020 , respectively. The change at constant currency was driven entirely by organic declines of$124 million and$155 million for the three and six months endedJune 30, 2020 , respectively. 39 --------------------------------------------------------------------------------
The following table illustrates the impact from organic declines, recent
acquisitions and divestitures, and foreign currency translation in relation to
orders during the three and six months ended
Measurement & Water Infrastructure Applied Water Control Solutions Total Xylem (in millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Orders $ 586$ 399 $ 407 $ 1,392 Organic Impact 39 6.7 % (67) (16.8) % (96) (23.6) % (124) (8.9) % Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency 39 6.7 % (67) (16.8) % (96) (23.6) % (124) (8.9) % Foreign currency translation (a) (27) (4.6) % (6) (1.5) % (3) (0.7) % (36) (2.6) % Total change in orders 12 2.0 % (73) (18.3) % (99) (24.3) % (160) (11.5) % 2020 Orders $ 598$ 326 $ 308 $ 1,232 (a)Foreign currency translation impact for the quarter due to the weakening in value of various currencies against theU.S. Dollar, the largest being the Euro, the Norwegian Krone, the Chinese Yuan, the Australian Dollar, the South African Rand and the British Pound. Measurement & Water Infrastructure Applied Water Control Solutions TotalXylem (in millions) $ Change % Change $ Change % Change $ Change % Change $ Change % Change 2019 Orders $ 1,118$ 793 $ 796 $ 2,707 Organic Impact 36 3.2 % (85) (10.7) % (106) (13.3) % (155) (5.7) %
Acquisitions/(Divestitures) - - % - - % - - % - - % Constant Currency 36 3.2 % (85) (10.7) % (106) (13.3) % (155) (5.7) % Foreign currency translation (a) (42) (3.8) % (10) (1.3) % (7) (0.9) % (59) (2.2) % Total change in orders (6) (0.5) % (95) (12.0) % (113) (14.2) % (214) (7.9) % 2020 Orders $ 1,112$ 698 $ 683 $ 2,493 (a)Foreign currency translation impact for the year due to the weakening in value of various currencies against theU.S. Dollar, the largest being the Euro, the Norwegian Krone, the Australian Dollar, the Chinese Yuan, the South African Rand and the British Pound. Water Infrastructure Water Infrastructure segment orders increased$12 million , or 2.0%, to$598 million (6.7% increase at constant currency) for the second quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by$27 million of foreign currency translation, with the change at constant currency coming from organic order growth in the transport application, which was partially offset by an organic decline in orders in the treatment application. Organic growth in the transport application was driven by strong order intake inIndia , where we had a significant project order of greater than$100 million during the quarter, partially offset by market weakness in the dewatering transport application, primarily inthe United States . The treatment application saw a reduction in organic orders during the quarter, primarily in the emerging markets andNorth America where we had several large project orders during the prior year, and inEurope where market conditions softened. We believe the COVID-19 pandemic also negatively impacted organic order growth during the quarter. For the six months endedJune 30, 2020 , orders decreased$6 million , or 0.5%, to$1,112 million (3.2% increase at constant currency) as compared to the same prior year period. Order intake during the period was negatively impacted by$42 million of foreign currency translation, with the change at constant currency coming from organic growth in orders in the transport application, which was partially offset by a modest decline in organic orders in the treatment application. Organic growth in the transport application was driven by strong order intake inIndia , where we had a significant project order during the second quarter of greater than$100 million , partially offset by market weakness in the transport applications, primarily driven by the dewatering application inNorth America . The treatment application experienced a modest organic order decline during the first half of the year, primarily driven 40 -------------------------------------------------------------------------------- by large project orders in the emerging markets placed during the prior year, which was partially offset by strong order intake inEurope andLatin America during the period. e believe the COVID-19 pandemic also negatively impacted organic order growth for the segment during the first half of the year. Applied Water Applied Water segment orders decreased$73 million , or 18.3%, to$326 million (16.8% decrease at constant currency) for the second quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by$6 million of foreign currency translation. The order decrease on a constant currency basis was primarily driven by organic weakness across all end markets inthe United States and reduced order intake in westernEurope and the emerging markets during the quarter with continued negative impact on orders from the COVID-19 pandemic. For the six months endedJune 30, 2020 , orders decreased$95 million , or 12.0%, to$698 million (10.7% decrease at constant currency) as compared to the same prior year period. Order intake during the period was negatively impacted by$10 million of foreign currency translation. The order decrease on a constant currency basis was primarily driven by organic weakness across all end markets inthe United States and, to a lesser extent, reduced order intake in the emerging markets and westernEurope during the period. We believe that the COVID-19 pandemic negatively impacted the organic order growth during the period. Measurement & Control Solutions Measurement & Control Solutions segment orders decreased$99 million , or 24.3%, to$308 million (23.6% decrease at constant currency) for the second quarter of 2020 as compared to the prior year. Order intake during the quarter was negatively impacted by$3 million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline in the water application which was negatively impacted by the COVID-19 pandemic and the lapping of strong prior year orders. Order intake in the test application also declined organically during the quarter, driven by negative COVID-19 impacts inNorth America andEurope . The energy application experienced reduced order intake during the quarter as the impact from large prior year gas project deployments, coupled with the negative impact of the COVID-19 pandemic, more than offset electric order growth during the quarter. The SaaS application also saw modest organic order decline in the quarter as several of our large prior year orders did not repeat. For the six months endedJune 30, 2020 , orders decreased$113 million , or 14.2%, to$683 million (13.3% decrease at constant currency) as compared to the same prior year period. Order intake during the period was negatively impacted by$7 million of foreign currency translation. The order decrease on a constant currency basis was driven by an organic decline in the water application and, to a lesser extent, the energy application, specifically driven by prior year gas project deployments, both of which were negatively impacted by the COVID-19 pandemic and the lapping of prior year orders. The SaaS application also contributed to the organic decline driven by the lapping of large project deployment orders inNorth America during the prior year. The test application, primarily inNorth America , also experienced a reduction in order intake during the period. We believe that the COVID-19 pandemic negatively impacted the organic order growth during the period. Backlog Backlog includes orders on hand as well as contractual customer agreements at the end of the period. Delivery schedules vary from customer to customer based on their requirements. Annual or multi-year contracts are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. As such, beginning total backlog, plus orders, minus revenues, will not equal ending total backlog due to contract adjustments, foreign currency fluctuations, and other factors. Typically, large projects require longer lead production cycles and deployment schedules and delays can occur from time to time. Total backlog was$2,013 million atJune 30, 2020 , an increase of$148 million or 7.9%, as compared toJune 30, 2019 backlog of$1,865 million , and an increase of$212 million or 11.8%, as compared toDecember 31, 2019 backlog of$1,801 million . We anticipate that approximately 46% of the backlog atJune 30, 2020 will be recognized as revenue in the remainder of 2020. Cancellations in the quarter were materially consistent with the prior year. Gross Margin Gross margin as a percentage of revenue decreased 170 and 180 basis points to 37.4% and 36.9% for the three and six months endedJune 30, 2020 , as compared to 39.1% and 38.7% for comparative 2019 periods. The gross margin decrease for both periods was primarily driven by cost inflation, increased inventory management costs, unfavorable volume, impacted by COVID-19, unfavorable mix and other lesser impacts, which were partially offset 41 -------------------------------------------------------------------------------- by cost reductions from our global procurement and productivity improvement initiatives and price realization. Operating Expenses The following table presents operating expenses for the three and six months endedJune 30, 2020 and 2019: Three Months Ended Six Months Ended June 30, June 30, (In millions) 2020 2019 Change 2020 2019 Change Selling, general and administrative expenses ("SG&A")$ 288 $ 294 (2.0) %$ 585 $ 597 (2.0) % SG&A as a % of revenue 24.8 % 21.9 % 290 bp 25.6 % 23.1 % 250 bp Research and development expenses ("R&D") 44 47 (6.4) % 93 98 (5.1) % R&D as a % of revenue 3.8 % 3.5 % 30 bp 4.1 % 3.8 % 30 bp Restructuring and asset impairment charges 48 14 242.9 % 50 25 100.0 % Operating expenses$ 380 $ 355 7.0 %$ 728 $ 720 1.1 % Expense to revenue ratio 32.8 % 26.4 % 640 bp 31.9 % 27.9 % 400 bp Selling, General and Administrative ("SG&A") Expenses SG&A expenses decreased by$6 million to$288 million , or 24.8% of revenue, in the second quarter of 2020, as compared to$294 million , or 21.9% of revenue, in the comparable 2019 period; and decreased$12 million to$585 million , or 25.6% of revenue, in the six months endedJune 30, 2020 , as compared to$597 million , or 23.1% of revenue, for the six months ended in 2019. The increase in SG&A as a percent of revenue for both periods was primarily driven by the drop in revenue, which was significantly driven by impacts of the COVID-19 pandemic, as well as in cost inflation and additional investment in strategic growth initiatives, which were partially offset by cost reductions from global procurement and productivity improvement initiatives, including restructuring savings. Research and Development ("R&D") Expenses R&D expense was$44 million , or 3.8% of revenue, in the second quarter of 2020, as compared to$47 million , or 3.5% of revenue, in the comparable period of 2019; and was$93 million , or 4.1% of revenue, in the six months endedJune 30, 2020 , as compared to$98 million , or 3.8% of revenue, in the comparable period of 2019. The increase in R&D as a percent of revenue for both periods was primarily driven by the drop in revenue, which was significantly driven by impacts of the COVID-19 pandemic. Restructuring and Asset Impairment Charges Restructuring In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, onJune 2, 2020 management committed to restructuring activities across our businesses and functions globally. The plan is designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. As a result of this action, during the three and six months endedJune 30, 2020 , we recognized restructuring charges of$38 million and$40 million , respectively. These charges included reduction of headcount across segments and asset impairments within our Measurement & Control Solutions segment. Immaterial restructuring charges incurred during the first quarter are included in the plan information presented below. During the three and six months endedJune 30, 2019 , we recognized restructuring charges of$14 million and$22 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. 42 --------------------------------------------------------------------------------
The following is a roll-forward for the six months ended
2020 2019
Planned reductions -
660 121 The following table presents expected restructuring spend for actions commenced as ofJune 30, 2020 : Measurement & (in millions) Water Infrastructure Applied Water Control Solutions Corporate Total Actions Commenced in 2020: Total expected costs $ 28$ 13 $ 34$ 3 $ 78 Costs incurred during Q1 2020 1 - - - 1 Costs incurred during Q2 2020 5 2 30 37 Total expected costs remaining $ 22$ 11 $ 4$ 3 $ 40 Actions Commenced in 2019: Total expected costs $ 20 $ 5 $ 27 $ -$ 52 Costs incurred during 2019 18 5 27 - 50 Costs incurred during Q1 2020 1 - - - 1 Costs incurred during Q2 2020 1 - - - 1 Total expected costs remaining $ - $ - $ - $ - $ - Actions Commenced in 2017: Total expected costs $ 8 $ 5 $ 4 $ -$ 17 Costs incurred during 2017 5 4 2 - 11 Costs incurred during 2018 2 1 1 - 4 Costs incurred during 2019 1 - 1 - 2 Costs incurred during Q1 2020 - - - - - Costs incurred during Q2 2020 - - - - Total expected costs remaining $ - $ - $ - $ - $ - The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2020 consist primarily of severance charges across segments and asset impairment charges in our Measurement & Control Solutions segment. These actions are expected to continue through 2021. The Water Infrastructure, Applied Water, and Measurement & Control Solutions actions commenced in 2019 consist primarily of severance charges. The actions commenced in 2019 are complete. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2017 consist primarily of severance charges and are complete. The discontinuance of a product line resulted$17 million of asset impairments, primarily related to customer relationships, trademarks and fixed assets within our Measurement & Control Solutions segment. We currently expect to incur between$60 million and$80 million in restructuring costs for the full year, with approximately$20 million of these costs being non-cash charges. These restructuring charges are primarily related to actions taken in response to the changes in business and economic conditions arising as a result of the 43 -------------------------------------------------------------------------------- COVID-19 pandemic. We expect to realize approximately$25 million of incremental net savings in 2020 from restructuring actions initiated in 2019, and approximately$22 million of net savings in 2020 from the restructuring actions initiated during this year. Asset Impairment During the second quarter of 2020 we determined that internally developed in-process software within our Measurement & Control Solutions segment was impaired as a result of actions taken to prioritize strategic investments. Accordingly we recognized an impairment charge of$10 million . Refer to Note 9, "Goodwill and Other Intangible Assets," for additional information. During the first quarter of 2019 we determined that certain assets within our Measurement & Control Solutions segment, including customer relationships, were impaired. Accordingly we recognized an impairment charge of$3 million . Refer to Note 9, "Goodwill and Other Intangible Assets," for additional information. Operating Income Operating income during the second quarter of 2020 was$54 million , reflecting a decrease of 68.4% compared to$171 million in the second quarter of 2019. Operating margin was 4.7% for the second quarter of 2020 versus 12.7% for the comparable period in 2019, a decrease of 800 basis points. Operating margin was negatively impacted by increased restructuring and realignment costs of$22 million and special charges of$11 million incurred in during the quarter. Excluding these restructuring and realignment costs and special charges, adjusted operating income was$108 million with an adjusted operating margin of 9.3% in the second quarter of 2020 as compared to adjusted operating income of$192 million with an adjusted operating margin of 14.3% in the second quarter of 2019. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased inventory management costs; incremental COVID-19 related costs; increased spending on strategic investments and unfavorable mix. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. Operating income for the six months endedJune 30, 2020 was$115 million , reflecting a decrease of 58.9% compared to$280 million in 2019. Operating margin was 5.0% for the six months endedJune 30, 2020 versus 10.8% for the comparable period in 2019, a decrease of 580 basis points. Operating margin was negatively impacted by increased restructuring and realignment costs of$11 million and increased special charges of$7 million as compared to the prior year. Excluding these restructuring and realignment costs and special charges, adjusted operating income was$178 million with an adjusted operating margin of 7.8% for the six months endedJune 30, 2020 as compared to adjusted operating income of$325 million with an adjusted operating margin of 12.6% in 2019. The decrease in adjusted operating margin was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased inventory management costs; unfavorable mix; increased spending on strategic investments and other lesser impacts. These impacts were partially offset by our productivity and other cost saving initiatives and price realization. 44 --------------------------------------------------------------------------------
The table below provides a reconciliation of the total and each segment's operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin:
Three Months Ended Six Months Ended June 30, June 30, (In millions) 2020 2019 Change 2020 2019 Change Water Infrastructure Operating income$ 73 $ 98 (25.5) %$ 112 $ 149 (24.8) % Operating margin 14.6 % 17.5 % (290) bp 11.9 % 14.3 % (240) bp Restructuring and realignment costs 8 9 (11.1) % 13 18 (27.8) % Adjusted operating income$ 81 $ 107 (24.3) %$ 125 $ 167 (25.1) % Adjusted operating margin 16.2 % 19.1 % (290) bp 13.3 % 16.0 % (270) bp Applied Water Operating income$ 41 $ 62 (33.9) %$ 88 $ 118 (25.4) % Operating margin 12.2 % 15.7 % (350) bp 13.0 % 15.3 % (230) bp Restructuring and realignment costs 4 4 - % 6 7 (14.3) % Adjusted operating income$ 45 $ 66 (31.8) %$ 94 $ 125 (24.8) % Adjusted operating margin 13.4 % 16.8 % (340) bp 13.9 % 16.2 % (230) bp Measurement & Control Solutions Operating (loss) income$ (46) $ 26 (276.9) %$ (58) $ 42 (238.1) % Operating margin (14.3) % 6.7 % (2,100) bp (8.7) % 5.5 % (1,420) bp Restructuring and realignment costs 31 8 287.5 % 33 16 106.3 % Special charges 10 - NM 10 4 150.0 % Adjusted operating (loss) income$ (5) $ 34 (114.7) %$ (15) $ 62 (124.2) % Adjusted operating margin (1.6) % 8.7 % (1,030) bp (2.2) % 8.1 % (1,030) bp Corporate and other Operating loss$ (14) $ (15) (6.7) %$ (27) $ (29) (6.9) % Special charges 1 - NM 1 - NM Adjusted operating loss$ (13) $ (15) (13.3) %$ (26) $ (29) (10.3) % Total Xylem Operating income$ 54 $ 171 (68.4) %$ 115 $ 280 (58.9) % Operating margin 4.7 % 12.7 % (800) bp 5.0 % 10.8 % (580) bp Restructuring and realignment costs 43 21 104.8 % 52 41 26.8 % Special charges 11 - NM 11 4 175.0 % Adjusted operating income$ 108 $ 192 (43.8) %$ 178 $ 325 (45.2) % Adjusted operating margin 9.3 % 14.3 % (500) bp 7.8 % 12.6 % (480) bp NM - Not meaningful percentage change Water Infrastructure Operating income for our Water Infrastructure segment decreased$25 million , or 25.5%, for the second quarter of 2020 compared to the prior year, with operating margin also decreasing from 17.5% to 14.6%. Operating margin benefited from a slight decrease in restructuring and realignment costs of$1 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased$26 million , or 24.3%, with adjusted operating margin decreasing from 19.1% to 16.2%. The decrease in adjusted operating margin for the quarter was primarily due to cost inflation; unfavorable volume, impacted significantly by COVID-19; increased inventory management costs; unfavorable mix; increased spending on strategic investments and other lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. 45 -------------------------------------------------------------------------------- For the six months endedJune 30, 2020 , operating income decreased$37 million , or 24.8%, as compared to the prior year, with operating margin also decreasing from 14.3% to 11.9%. Operating margin benefited from a decrease in restructuring and realignment costs of$5 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased$42 million , or 25.1%, with adjusted operating margin decreasing from 16.0% to 13.3%. The decrease in adjusted operating margin during the period was primarily due by cost inflation, unfavorable volume, impacted significantly by COVID-19; unfavorable mix; increased inventory management costs; increased spending on strategic investments, negative currency impacts and other lesser impacts. These impacts were partially offset cost reductions from our productivity and other cost saving initiatives and price realization. Applied Water Operating income for our Applied Water segment decreased$21 million , or 33.9%, for the second quarter of 2020 compared to the prior year, with operating margin also decreasing from 15.7% to 12.2%. Operating margin was impacted by$4 million in restructuring and realignment costs in both years. Excluding these restructuring and realignment costs, adjusted operating income decreased$21 million , or 31.8%, with adjusted operating margin decreasing from 16.8% to 13.4%. The decrease in adjusted operating margin for the quarter was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased inventory management costs; unfavorable mix and other various lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. For the six months endedJune 30, 2020 , operating income decreased$30 million , or 25.4%, as compared to the prior year, with operating margin also decreasing from 15.3% to 13.0%. Operating margin benefited from a slight decrease in restructuring and realignment costs of$1 million in 2020. Excluding these restructuring and realignment costs, adjusted operating income decreased$31 million , or 24.8%, with adjusted operating margin decreasing from 16.2% to 13.9%. The decrease in adjusted operating margin during the period was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased inventory management costs and other lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. Measurement & Control Solutions Operating income for our Measurement & Control Solutions segment decreased$72 million , or 276.9%, for the second quarter of 2020 compared to the prior year, resulting in an operating loss of$46 million , with operating margin also decreasing from 6.7% to (14.3)%. Operating margin was negatively impacted by increased restructuring and realignment costs of$23 million and$10 million of special charges incurred in 2020. Excluding these items, adjusted operating income decreased$39 million , or 114.7%, resulting in an adjusted operating loss of$5 million , with adjusted operating margin decreasing from 8.7% to (1.6)%. The decrease in adjusted operating margin for the quarter was primarily due to unfavorable volume, impacted significantly by COVID-19; cost inflation; increased quality management costs; increased spending on strategic investments and incremental COVID-19 related costs. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. For the six months endedJune 30, 2020 , operating income decreased$100 million , or 238.1%, as compared to the prior year, resulting in an operating loss of$58 million , with operating margin also decreasing from 5.5% to (8.7)%. Operating margin was negatively impacted by increased restructuring and realignment costs of$17 million and increased special charges of$6 million in 2020. Excluding these items, adjusted operating income decreased$77 million , or 124.2%, resulting in an adjusted operating loss of$15 million , with adjusted operating margin decreasing from 8.1% to (2.2)%. The decrease in adjusted operating margin during the period was driven by unfavorable volume, impacted significantly by COVID-19; increased quality management costs, primarily due to a$15 million warranty charge recorded during the first quarter for a firmware issue in some of our meters; cost inflation; increased spending on strategic investments, unfavorable mix and other lesser impacts. These impacts were partially offset by cost reductions from our productivity and other cost saving initiatives and price realization. Corporate and other Operating loss for corporate and other decreased$1 million , or 6.7%, for the second quarter of 2020 compared to the prior year period. For the six months endedJune 30, 2020 , operating loss for corporate and other decreased$2 million , or 6.9%, compared to the same prior year period. The decreases in cost are the result of cost saving actions taken during the year. 46 -------------------------------------------------------------------------------- Interest Expense Interest expense was$18 million and$34 million for the three and six months endedJune 30, 2020 and$18 million and$36 million for the three and six months endedJune 30, 2019 . The decrease in interest expense for the six month period endedJune 30, 2020 is primarily driven by the impact of cross currency swaps. See Note 10, "Derivative Financial Instruments", of our condensed consolidated financial statements for a description of our cross currency swaps. Income Tax Expense The income tax provision for the three months endedJune 30, 2020 was$4 million resulting in an effective tax rate of 10.9%, compared to a$17 million expense resulting in an effective tax rate of 10.5% for the same period in 2019. The income tax provision for the six months endedJune 30, 2020 was$8 million resulting in an effective tax rate of 10.4%, compared to a$32 million expense resulting in an effective tax rate of 12.8% for the same period in 2019. The effective tax rate for the three and six month periods endedJune 30, 2020 differs fromthe United States federal statutory rate primarily due to the mix of earnings in jurisdictions, partially offset by the Global Intangible Low-Taxed Income ("GILTI") inclusion. Additionally, the effective tax rate for the three and six month periods endedJune 30, 2020 differs from the same periods in 2019 due to the relative impact of the benefit from favorable equity compensation deductions on the effective tax rate as well as release of unrecognized tax benefits in 2020, offset by changes in tax law inSwitzerland in 2019. Other Comprehensive Income (Loss) Other comprehensive income was$52 million for the three months endedJune 30, 2020 compared to a loss of$11 million for the same period in 2019. Foreign currency translation contributed favorable impacts during the quarter of$53 million , driven primarily by the strengthening of the British Pound, the Australian Dollar and the Chinese Yuan as compared to theU.S. Dollar in 2020 versus the weakening of these currencies in the same prior year period. Additionally, the strengthening of the Euro as compared to theU.S. Dollar was greater in 2020 than the strengthening in the prior year. These favorable currency translation impacts were partially offset by the movement in our Euro net investment hedges during the quarter. In addition to net favorable foreign currency translation impacts, there were also favorable impacts from gain in derivative hedge agreements of$6 million and the movement of tax on the net investment hedges as compared to the prior year of$5 million that contributed to the increase in in other comprehensive income during the quarter. For the six months endedJune 30, 2020 , other comprehensive loss was$35 million compared to income of$9 million for the same period in 2019. Foreign currency translation contributed unfavorable impacts during the period of$54 million , driven primarily by the weakening of the British Pound, the South African Rand, the Canadian Dollar, the Euro, the Mexican Peso, the Indian Rupee and the Chilean Peso as compared to theU.S. Dollar in 2020 versus the strengthening of these currencies in the same prior year period. These unfavorable currency translation impacts were partially offset by the movement in our Euro net investment hedges during the period. In addition to net unfavorable foreign currency translation impacts, there was an unfavorable impact from the movement of tax on the net investment hedges as compared to the prior year of$5 million during the period that contributed to the loss. Partially offsetting these unfavorable drivers was a gain in derivative hedge agreements during the year as compared to a loss in the same prior year period. -------------------------------------------------------------------------------- Liquidity and Capital Resources The following table summarizes our sources and (uses) of cash: Six Months Ended June 30, (In millions) 2020 2019 Change Operating activities$ 179 $ 206 $ (27) Investing activities (88) (146) 58 Financing activities 774 25 749 Foreign exchange (a) (12) 2 (14) Total$ 853 $ 87 $ 766 (a)The impact is primarily due to the weakness of the Canadian Dollar, the Russian Ruble, the Chilean Peso, the Indian Rupee, the Mexican Peso and various other currencies against theU.S. Dollar. Sources and Uses of Liquidity Operating Activities Net cash provided by operating activities was$179 million for the six months endedJune 30, 2020 as compared to$206 million in the comparable prior year period. This decrease was primarily driven by a decrease in cash from earnings, partially offset by a significant decrease cash paid for taxes during the first half of the current year as compared to the prior year, partially from delayed timing of payments. Investing Activities Cash used in investing activities was$88 million for the six months endedJune 30, 2020 as compared to$146 million in the comparable prior year period. This decrease in cash used of$58 million was mainly driven by lower spending on capital expenditures compared to the prior year and a$18 million reduction in spending on acquisitions. Financing Activities Cash generated by financing activities was$774 million for the six months endedJune 30, 2020 as compared to cash generated of$25 million in the comparable prior year period. This increase in cash generated by financing activities during the period was primarily driven by the issuance of our Green Bond and higher levels of short-term debt during the year, partially offset by the repayment of short-term debt during 2020 and an increase in share repurchase activity of$21 million . Funding and Liquidity Strategy Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations and access to bank financing and the capital markets. As a result of uncertainties caused by the COVID-19 pandemic, we continue to evaluate aspects of our spending, including capital expenditures, strategic investments and dividends. Additionally, we have committed to reducing our annual capital expenditures. We will continue to evaluate aspects of our spending as the year progresses. We have elected to utilize certain federal, state and foreign tax programs related to timing of tax payments and deductions to further manage our liquidity, and the liabilities associated with these programs are appropriately classified in the applicable accrued and other current liabilities or other non-current accrued liabilities accounts in our Condensed Consolidated Balance Sheets. We will continue to consider available federal, state and foreign tax programs. Historically, we have generated operating cash flow sufficient to fund our primary cash needs. As the uncertainty and severity associated with the global spread of the COVID-19 pandemic continued to grow during the year,Xylem issued Senior Notes of$1 billion in aggregate principal onJune 26, 2020 . The primary long-term intention of incurring this debt is to fund green projects across our business segments, as well as manage liquidity risk and increase flexibility, as the duration of the economic effects of the pandemic are uncertain. See Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements for a description of our credit facilities and long-term debt.Xylem 's liquidity position has evolved favorably from an operational perspective during the second quarter of 2020, and we will continue to monitor the economic effects of the COVID-19 pandemic and its impact on the Company's future operating cash flows. If our cash flows from operations are less than we expect, we may need to incur debt or issue equity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and 48 -------------------------------------------------------------------------------- conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. There can be no assurance that such financing will be available to us on acceptable terms or that such financing will be available at all. Our securities are rated investment grade. A significant change in credit rating could impact our ability to borrow at favorable rates. Refer to Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements for a description of limitations on obtaining additional funding. We monitor our global funding requirements and seek to meet our liquidity needs on a cost effective basis. As ofJune 30, 2020 , the COVID-19 pandemic has not materially impacted our borrowing costs or other costs of capital, however the future impact of the COVID-19 pandemic is uncertain and may increase our borrowing costs and other costs of capital and otherwise adversely affect our business, results of operations, financial condition and liquidity. We have considered the impacts of the COVID-19 pandemic on our liquidity and capital resources and do not currently expect it to impact our ability to meet future liquidity needs or continue to comply with debt covenants. To ensure that we will continue to have the full capacity of our credit facilities available going forward,Xylem entered into Amendment No. 1 to the 2019 Credit Facility onJune 22, 2020 which modified the covenant calculation methodology through the quarter endingSeptember 30, 2021 and restricts stock repurchases untilMarch 31, 2021 , except for shares of common stock in an amount not to exceed the number of shares issued after the date of the Amendment, subject to customary exceptions. See Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements for a description of our credit facilities and long-term debt. Based on our current global cash positions, cash flows from operations and access to the capital markets, we believe there is sufficient liquidity to meet our funding requirements and service debt and other obligations. In addition, our existing committed credit facilities and access to the public debt markets would provide further liquidity if required. Currently, we have available liquidity of approximately$2.4 billion , consisting of$1.6 billion of cash and$800 million of available credit facilities as disclosed in Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements. Our debt repayment obligations in 2020 consist of$50 million in outstanding commercial paper and$162 million of other borrowings. Our next long term debt maturity isOctober 2021 . Risk related to these items are described in our risk factor disclosures referenced under "Item 1A. Risk Factors" in our 2019 Annual Report and "Item 1A. Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 . Credit Facilities & Long-Term Contractual Commitments See Note 12, "Credit Facilities and Debt", of our condensed consolidated financial statements for a description of our credit facilities and long-term debt. Non-United States Operations We generated approximately 51% and 50% of our revenue from non-United States operations for the three and six months endedJune 30, 2020 , respectively, and approximately 50% for both the three and six month periods endedJune 30, 2019 . As we continue to grow our operations in the emerging markets and elsewhere outside ofthe United States , we expect to continue to generate significant revenue from non-United States operations and expect that a substantial portion of our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries tothe United States and other international subsidiaries when we believe it is cost effective to do so. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need to repatriate funds held internationally to support ourUnited States operations. As ofJune 30, 2020 , we have provided a deferred tax liability of$8 million for net foreign withholding taxes and state income taxes on$505 million of earnings expected to be repatriated tothe United States parent as deemed necessary in the future. 49
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Critical Accounting Estimates Our discussion and analysis of our results of operations and capital resources are based on our condensed consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. We believe the most complex and sensitive judgments, because of their significance to the condensed consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain, particularly at this time and moving forward given the uncertainty around the magnitude and duration of the COVID-19 pandemic. Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2019 Annual Report describes the critical accounting estimates used in preparation of the condensed consolidated financial statements. Actual results in these areas could differ from management's estimates. Other than as discussed below, there have been no significant changes in the information concerning our critical accounting estimates as stated in our 2019 Annual Report. The carrying value of our Advanced Infrastructure Analytics ("AIA") goodwill reporting unit is$170 million as ofJune 30, 2020 . During the fourth quarter of 2019 we completed our annual goodwill assessment. Our 2019 impairment analysis indicated that the fair value of the AIA reporting unit exceeded its carrying value by less than 20%. We used the income approach to determine the fair value of our goodwill reporting units. Under the income approach, the fair value of the reporting units was based on the present value of the estimated cash flows that the reporting unit is expected to generate over its remaining life. Cash flow projections were based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate was based on the weighted average cost of capital appropriate for the reporting unit. Given the uncertainty of the future impact of the COVID-19 pandemic, further deterioration of our future cash flows may lead to a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment. The risks and potential impacts of COVID-19 on the fair value of our assets are included in our risk factor disclosures referenced under "Item 1A. Risk Factors" in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 New Accounting Pronouncements See Note 2, "Recently Issued Accounting Pronouncements", to the condensed consolidated financial statements for a complete discussion of recent accounting pronouncements.
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