Xylem Inc. (XYL) FY 2021 MD&A

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

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

This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

Overview

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

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

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

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

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COVID-19 Pandemic Update

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

This section summarizes the most significant impacts related to the COVID-19 pandemic that we have experienced to date, and we have included additional details as applicable throughout other sections of this Annual Report. Xylem’s COVID-19 Response Team is responsible for Xylem's Pandemic Plan. The Pandemic Plan is designed to aid in prevention, preparedness, response and recovery at our sites and across the Company.

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

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

The COVID-19 pandemic, as well as broader global market supply and demand dynamics, have adversely affected, and are expected to continue to adversely affect, our supply chains. We have experienced, and expect to continue experiencing shortages in the supply of components, including electronics, particularly semiconductors ("chips"), parts and raw materials. We have also experienced, and continue to experience, increased inflation, freight and logistics costs, issues with port congestion, delivery delays and labor. To help mitigate the effects of these challenges and increase the resilience of our supply chain, we continue to enhance and augment our risk management activities, including supplier pulsing and redundancy. Additionally, we have and continue to take measures with respect to buffer stock, the use of alternative suppliers or redesign of certain products to mitigate the impacts of the ongoing supply chain, freight and logistics delays and bolster our access to electronics, parts and raw materials. To some extent, we have been able to pass cost increases through to customers. If these shortages and interruptions continue, or if additional interruptions occur, they could have a negative impact on our results of operations.

These supply chain issues have also impacted our delivery times to customers. To some extent, mitigation strategies have alleviated these issues but our lead times continue to be impacted.

We have seen a recovery in demand for our products. At the end of 2021, total backlog increased 52.6% as compared to December 31, 2020. The severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, and the pandemic’s ongoing and future impacts on our business, financial condition, results of operations, and stock price remain uncertain and difficult to predict.

In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, management committed to restructuring activities across our businesses and functions globally during the second quarter of 2020. These initiatives were designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers. Since the pandemic started, Xylem has taken measures to protect the health and safety of our employees, work with our customers to minimize potential disruptions and positively impact our communities. In the first quarter of 2020, we implemented a support pay program for employees impacted by COVID-19, which is in place through the second quarter of 2022 and will be evaluated for continuation, as necessary.

Xylem Watermark, our corporate social responsibility program, continues to support our communities in addressing the challenges posed by this global pandemic by strengthening access to Water, Sanitation and Hygiene (WASH) facilities in schools and health centers through its partnership with Americares and UNICEF, as well as the Partner Community Grants program and matching donations program for employees and partners, and other philanthropic commitments.

Many of our offices globally remain in a substantially remote work from home status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures. Our COVID-19 Response Team applies a set of health and safety guidelines for employees working in Xylem offices.

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We continue to assess the evolving nature of the pandemic and its possible implications to our business, employees, supply chain, customers and communities, and to take actions in an effort to mitigate adverse consequences.

Risks related to the impacts of COVID-19 as well as our supply chain are described in further detail under "Item 1A. Risk Factors" in the Company's 2021 Annual Report.

Key Performance Indicators and Non-GAAP Measures

Management reviews key performance indicators including revenue, gross margins, segment operating income and operating income margins, free cash flow, 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 non-GAAP measures to be key performance indicators, as well as the related reconciling items to the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures may not be comparable to similarly-titled measures reported by other companies.

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

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

•"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude restructuring and realignment costs, special charges, gain or loss from sale of businesses and tax-related special items, as applicable. A reconciliation of adjusted net income and adjusted earnings per share is provided below.

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

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

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

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gain or loss from sale of businesses, and "adjusted EBITDA margin" defined as adjusted EBITDA 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 both operating and non-operating adjustments for costs related to the UK pension plan buy-out.

▪"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.

Executive Summary

Xylem reported revenue of $5,195 million for 2021, an increase of $319 million, or 6.5%, from $4,876 million reported in 2020. On a constant currency basis, revenue increased by $197 million, or 4.0%, during the year. The increase at constant currency was driven by an increase in organic revenue of $210 million reflecting strong organic growth in the industrial, commercial and residential end markets, partially offset by organic declines in utilities, largely as a result of component shortages in our Measurement & Controls Solutions segment.

Operating income for 2021 was $585 million, reflecting an increase of $218 million, or 59.4%, compared to $367 million in 2020. Operating margin was 11.3% for 2021 versus 7.5% for 2020, an increase of 380 basis points. Operating margin benefited from decreases in special charges of $77 million and decreases in restructuring and realignment costs of $55 million during the year. Excluding the impact of these items, adjusted operating income was $611 million, with an adjusted operating margin of 11.8% in 2021 as compared to adjusted operating income of $525 million with an adjusted operating margin of 10.8% in 2020, an increase of 100 basis points. The increase in adjusted operating margin was primarily due to cost reductions from our productivity, restructuring and other cost saving initiatives, favorable volume and price realization. These impacts were partially offset by cost inflation and increased spending on strategic investments.

Additional financial highlights for 2021 include the following:

•Net income of $427 million, or $2.35 per diluted share ($452 million or $2.49 per diluted share on an adjusted basis, up 20.9% from 2020)

•Net cash provided by operating activities of $538 million and free cash flow of $330 million, down 49% from 2020

•Orders of $6,300 million, up 25.2% from $5,033 million in 2020 (up 22.6% on an organic basis)

•Dividends paid to shareholders increased 8% in 2021.

2022 Business Outlook

We anticipate total revenue growth in the range of 1% to 3% in 2022, with organic revenue growth anticipated to be in the range of 3% to 5%. The following is a summary of our 2021 organic revenue performance and 2022 organic revenue outlook by end market.

•Utilities revenue decreased by approximately 3% for 2021 on an organic basis driven by weakness in United States, partially offset by strength in western Europe, with relatively flat growth in the emerging markets. For 2022, we expect organic revenue growth in the low-single-digit range as utilities remain

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focused on mission-critical applications. We expect uneven growth from China and India as multi-year government funding programs are deployed. The timing of large clean water utility project deployments has been impacted by the global shortage of electronic components. We anticipate that these deployments will ramp up when supply constraints ease in the second half of 2022 based on our strong backlog position and orders momentum. Additionally, we expect healthy momentum in the global test and treatment markets with rising demand and focus on pipeline assessment services and increased demand for our smart water solution and digital offerings.

•Industrial revenue increased by approximately 14% for 2021 on an organic basis driven by strength across all major geographic regions. For 2022, we expect organic revenue growth in the mid-single-digit range as activity rebounds globally. We continue to see healthy growth in our dewatering business, especially in the emerging markets from mining demand as well as in the U.S. and Europe reflecting our strong orders and backlog.

•In the commercial markets, organic revenue in 2021 increased by approximately 7% driven across all major geographic regions. For 2022, we expect organic revenue growth in the mid-single-digit range. We expect continued solid replacement business in the U.S. and an acceleration of construction activity. In Europe we expect modest share gains, with demand for eco-friendly products supported by increase in funding for green buildings.

•In residential markets, organic revenue increased by approximately 10% in 2021 driven by strength across all major geographic regions. This market is primarily driven by replacement revenue serviced through our distribution network. For 2022, we expect organic revenue growth in the low-single-digit to mid-single-digit range. We anticipate demand and activity to moderate and remain healthy from increased residential users in the U.S. and western Europe. Additionally, we continue to anticipate strong demand in China for secondary water supply product applications.

We will continue to strategically execute restructuring and realignment actions in an effort to optimize our cost structure, improve our operational efficiency and effectiveness, strengthen our competitive positioning and better serve our customers. During 2021, we incurred $6 million and $16 million in restructuring and realignment costs, respectively. We realized approximately $33 million of incremental net savings in 2021 from actions initiated in 2020, and an additional $2 million of net savings from our 2021 actions. As a result of our 2020 and 2021 actions we expect to realize approximately $8 million of incremental net savings in 2022 and beyond. During 2022, we currently expect to incur between $25 million and $30 million in restructuring and realignment costs.

We plan to continue to take actions and focus spending in 2022 on areas that allow us to make progress on our strategic priorities as well on our top priorities for 2022, which include converting our strong demand momentum into top-line growth by maximizing chip allocation and price realization, continuing our commitment to deliver margin expansion by mitigating supply chain and inflation headwinds and executing on strategic capital deployment opportunities.

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Results of Operations

NM     Not Meaningful

2021 versus 2020

Revenue

Revenue generated for 2021 was $5,195 million, an increase of $319 million, or 6.5%, compared to $4,876 million in 2020. On a constant currency basis, revenue grew 4.0% during 2021. The increase at constant currency was driven by an increase in organic revenue of $210 million reflecting strong organic growth in the industrial, commercial and residential end markets, partially offset by organic declines in utilities, largely as a result of component shortages in our Measurement & Controls Solutions segment.

The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during 2021:

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

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Water Infrastructure

Water Infrastructure revenue increased $168 million, or 8.1%, to $2,247 million in 2021 (5.0% increase on a constant currency basis) compared to 2020. Revenue benefited from $65 million of foreign currency translation, with the change at constant currency coming entirely from organic growth of $103 million. Organic growth during the year was driven by the industrial end market across all of our major geographic regions, with particular strength across the emerging markets, especially in Africa where we had strong dewatering sales, and in Latin America, where prior year COVID-19 impacts caused significant project delays. Industrial also had strong growth in western Europe and Oceania from continued general industrial strength. Organic growth was partially offset by weakness in the utility end market, driven by softness in the dewatering business in the U.S., and weakness in the emerging markets partially offset by strength in western Europe, where operational spending and project execution was strong.

From an application perspective, organic revenue growth was driven by our transport applications. The transport applications had strong dewatering revenue growth across the emerging markets, where we experienced market recovery from COVID-19 impacts and strength in mining, and growth from aftermarket parts and services revenue in western Europe. Transport growth in these regions was partially offset by weakness in the U.S. driven by declines in the dewatering construction market. Organic revenue from our treatment applications also contributed to the segment's growth during the year, driven by market recovery in western Europe, and project orders in the emerging markets, which were partially offset by the timing of project deliveries Latin America.

Applied Water

Applied Water revenue increased $179 million, or 12.5%, in 2021 (10.1% increase on a constant currency basis) compared to 2020. Revenue benefited from $34 million of foreign currency translation, with the change at constant currency coming entirely from organic growth during the year of $145 million. Organic growth for the year included growth across all three of the applications and end markets in the segment. The organic growth was led by strength in industrial, which was primarily driven by market recovery and good backlog execution in the emerging markets, particularly in China and India, as well as strength in specialty flow control applications in both the U.S. and western Europe. Commercial building services had strong organic growth as we executed on healthy backlog coming into the year in the U.S., saw good COVID-19 recovery in western Europe and growth in the emerging markets, driven by project and backlog execution in China. Residential building services also had strong organic growth in the U.S. as we executed on healthy backlog coming into the year, as well as in the emerging markets, where we experienced strong second water supply business in China.

Measurement & Control Solutions

Measurement & Control Solutions revenue decreased $28 million, or 2.1%, in 2021 (3.7% decrease on a constant currency basis) compared to 2020. Revenue benefited from $23 million of foreign currency translation during the year, with the change at constant currency driven by an organic decline of $38 million, or 2.8%, and to a lesser extent, $13 million of reduced revenue related to divestiture impacts during the year. Organic weakness for the year was driven by declines in the utility end market, primarily in North America, partially offset by modest strength in western Europe and the emerging markets. Strength in the industrial end market, across all major geographies, partially offset revenue declines in the segment.

In order to simplify and focus the application discussion, beginning with the first quarter of 2021, have been aggregating the test application into the water application and the software as a service and other application into the water and energy applications, as applicable, as both of these sub-applications provide products and services to the broader, ultimate applications of water and energy. From an application perspective, organic revenue decline during the year was driven by declines in the electric business within the energy application in North America due to electronic component shortages. The water application had modest organic growth in western Europe largely attributable to our test business and growth in the emerging markets. This growth was largely offset by declines in our metrology business in the U.S. due to deployment constraints as a result of chip shortages.

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Orders/Backlog

An order represents a legally enforceable, written document that includes the scope of work or services to be performed or equipment to be supplied to a customer, the corresponding price and the expected delivery date for the applicable products or services to be provided. An order often takes the form of a customer purchase order or a signed quote from a Xylem business. Orders received during 2021 increased by $1,267 million, or 25.2%, to $6,300 million (22.4% increase on a constant currency basis). Order intake during the year benefited from $140 million of foreign currency translation. The increase on a constant currency basis primarily consisted of organic order growth of $1,139 million, or 22.6%, over the prior year.

The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to orders during 2021:

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

Water Infrastructure

Water Infrastructure segment orders increased $337 million, or 15.8%, to $2,471 million (12.2% increase on a constant currency basis). Order intake during the year benefited from $76 million of foreign currency translation. The order increase on a constant currency basis consisted of organic order growth in both the transport and treatment applications. Organic growth in the transport application was driven by healthy market conditions in the U.S. and strong order intake in western Europe, as well as increased demand for dewatering applications in the emerging markets. Organic orders for the treatment application also increased during the year due to strong order intake in the first half of the year, driven by strength in the U.S. and western Europe.

Applied Water

Applied Water segment orders increased $377 million, or 25.4% to $1,860 million (22.8% increase on a constant currency bases). Order intake during the year benefited from $39 million of foreign currency translation. The order increase on a constant currency basis was driven by organic order growth in the U.S. across all end markets and applications, where we benefited from strong demand, amplified by early ordering to mitigate longer lead times, as well as strength in the specialty flow control applications; in western Europe, where we benefited from strong order intake; and in the emerging markets, driven by China, as markets conditions recovered from the COVID-19 pandemic.

Measurement & Control Solutions

Measurement & Control Solutions segment orders increased $553 million, or 39.1%, to $1,969 million (37.3% increase on a constant currency basis). Order intake during the year benefited from $25 million of foreign currency translation. The order increase on a constant currency basis included organic order growth of $540 million, or 38.1% which was partially offset by a $12 million reduction in orders related to divestiture impacts during the year. Organic order growth was led by the water application, primarily in our metrology business, but also from our test business. Order intake in the energy application also grew organically during the year, where the electric and gas businesses benefited from COVID-19 recovery, coupled with increased order intake due to the known chip shortages.

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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 occur from time to time. Total backlog was $3,240 million at December 31, 2021 and $2,124 million at December 31, 2020, an increase of 52.6%. We anticipate that approximately 60% of our total backlog at December 31, 2021 will be recognized as revenue during 2022.

Gross Margin

Gross margin as a percentage of consolidated revenue increased 50 basis points to 38.0% in 2021 as compared to 37.5% in 2020. The gross margin increase for the year was primarily driven by cost reductions from our productivity, restructuring and other cost saving initiatives, price realization and favorable volume, partially offset by inflation.

Operating Expenses

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

SG&A expenses increased by $36 million (increase of 3.1%) to 22.7% of revenue in 2021, as compared to 23.4% of revenue in 2020. Revenue growth was higher than SG&A increases resulting in a lower SG&A as a percentage of sales. Cost increases were driven by increased investments in strategic growth initiatives and inflation, partially offset by cost reductions from our productivity, restructuring and other cost saving initiatives.

Research and Development ("R&D") Expenses

R&D expense was $204 million, or 3.9% of revenue, in 2021 as compared to $187 million, or 3.8% of revenue, in 2020. The increase in R&D as a percent of revenue for year was primarily driven by the Company's continued focus on strategic investments during the year.

Restructuring and Asset Impairment Charges

Restructuring

In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, on June 2, 2020 management committed to a restructuring plan that includes actions across our businesses and functions globally. The plan was 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 2021, we recognized restructuring charges of $4 million and $2 million in our Water Infrastructure and Applied Water segments, respectively. These charges included reduction of headcount across both segments. Other, less significant, restructuring actions taken in 2021 resulted in $3 million of charges during 2021 and are included in the information presented below.

As a result of this action, during 2020, we recognized restructuring charges of $19 million, $4 million and $30 million in our Water Infrastructure, Applied Water and Measurement & Control Solutions segments, respectively. These charges included reduction of headcount across all segments and asset impairments within our Measurement & Control Solutions segment. Immaterial restructuring charges incurred during the first quarter of 2020 are included in the 2020 plan information presented below.

The following is a roll-forward of employee position eliminations associated with restructuring activities for the years ended December 31, 2021 and 2020:

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The following table presents the total costs expected to be incurred, the amount incurred in the period, and the cumulative costs incurred to date for our 2020 and 2021 restructuring actions:

During the third quarter of 2021, we recorded an adjustment of $3 million to decrease the liability within the Measurement & Control Solutions segment, related to actions commenced in 2019. As a result of this adjustment, the estimated total cost of the actions commenced in 2019 decreased to $24 million for the Measurement & Control Solutions segment. The actions commenced in 2019 are complete.

The Water Infrastructure and Measurement & Control Solutions actions commenced in 2021 consist primarily of severance charges. These actions are expected to continue through the end of 2022.

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 complete.

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

As a result of the actions initiated in 2021, we achieved savings of approximately $1 million in 2021 and estimate annual future net savings beginning in 2022 of approximately $2 million, resulting in $1 million of incremental savings from 2021 actions.

Asset Impairment

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

Goodwill Impairment Charge

During the third quarter of 2020, the Company recorded a goodwill impairment charge of $58 million related to the Advanced Infrastructure Analytics (“AIA”) goodwill reporting unit within our Measurement & Control Solutions segment. The AIA goodwill reporting unit is comprised of our assessment services business (primarily the Pure acquisition) as well as our decision intelligence solutions business. The impairment resulted from management's updated forecast of future cash flows for the AIA businesses, which reflected significant negative volume impacts, primarily on our assessment services business, due to travel restrictions and site closures as a result of the COVID-19 pandemic. These factors drove a decrease in the fair value, based on a discounted cash flow valuation,

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of the AIA goodwill reporting unit that was below its carrying value, requiring an impairment charge. Refer to Note 12, "Goodwill and Other Intangible Assets," for additional information.

Operating Income and Adjusted EBITDA

Operating income was $585 million (operating margin of 11.3%) during 2021, an increase of $218 million, or 59.4%, when compared to operating income of $367 million (operating margin of 7.5%) during the prior year. Operating margin benefited from decreases in special charges of $77 million and decreases in restructuring and realignment costs of $55 million as compared to the prior year. Excluding these special charges and restructuring and realignment costs, adjusted operating income was $611 million (adjusted operating margin of 11.8%) for 2021 as compared to adjusted operating income of $525 million (adjusted operating margin of 10.8%) during the prior year. The increase in adjusted operating margin was primarily due to cost reductions from our productivity, restructuring and other cost saving initiatives, favorable volume and price realization. These impacts were partially offset by cost inflation and increased spending on strategic investments.

Adjusted EBITDA was $890 million (Adjusted EBITDA margin of 17.1%) during 2021, an increase of $95 million, or 11.9%, when compared to Adjusted EBITDA of $795 million (Adjusted EBITDA margin of 16.3%) during the prior year. The increase in Adjusted EBITDA margin was primarily due to the same factors impacting operating margin noted above.

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

NM    Not Meaningful

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The table below provides a reconciliation of total and each segment's adjusted EBITDA to Consolidated EBITDA and net income:

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Water Infrastructure

Operating income for our Water Infrastructure segment increased $69 million, or 21.7%, during 2021 as compared to the prior year, with operating margin also increasing from 15.3% to 17.2%. Operating margin benefited from a decrease in restructuring and realignment costs of $16 million in 2021. Excluding these restructuring and realignment costs, adjusted operating income increased $53 million, or 15.3%, with adjusted operating margin increasing from 16.6% to 17.8%. The increase in adjusted operating margin during the year was primarily due to cost reductions from our productivity, restructuring and other cost saving initiatives and favorable volume. These impacts were partially offset by cost inflation and increased spending on strategic investments.

Adjusted EBITDA was $447 million (Adjusted EBITDA margin of 19.9%) during 2021, an increase of $52 million, or 13%, when compared to Adjusted EBITDA of $395 million (Adjusted EBITDA margin of 19.0%) during the prior year. The increase in Adjusted EBITDA margin was primarily due to the same factors impacting the increase in adjusted operating margin; however, Adjusted EBITDA margin did not benefit from the year over year reduction in depreciation and amortization expense.

Applied Water

Operating income for our Applied Water segment increased $35 million, or 17.1%, during 2021 as compared to the prior year, with operating margin also increasing from 14.3% to 14.9%. Operating margin benefited from a decrease in restructuring and realignment costs of $2 million in 2021, partially offset by an increase in special charges of $1 million. Excluding these items, adjusted operating income increased $34 million, or 15.9%, with adjusted operating margin increasing from 14.9% to 15.4%. The increase in adjusted operating margin during the year was primarily due to cost reductions from our productivity, restructuring and other cost saving initiatives, favorable volume, and price realization. These impacts were partially offset by cost inflation and increased logistics cost, increased spending on strategic investments, increased inventory management costs.

Adjusted EBITDA was $271 million (Adjusted EBITDA margin of 16.8%) during 2021, an increase of $31 million, or 13%, when compared to Adjusted EBITDA of $240 million (Adjusted EBITDA margin of 16.7%) during the prior year. The increase in Adjusted EBITDA margin was primarily due to the same factors impacting the increase in adjusted operating margin; however, Adjusted EBITDA margin did not benefit from the year over year reduction in depreciation and amortization expense.

Measurement & Control Solutions

Operating income for our Measurement & Control Solutions segment increased $118 million, or 111.3%, during 2021 as compared to the prior year, resulting in an operating income of $12 million, with operating margin increasing from (7.8)% to 0.9%. Operating margin benefited from a decrease in special charges of $79 million, and a decrease in restructuring and realignment costs of $37 million in 2021. Excluding these items, adjusted operating income increased $2 million, or 15.4%, with adjusted operating margin increasing from 1.0% to 1.1%. The increase in adjusted operating margin during the year was driven by cost reductions from our productivity, restructuring and other cost saving initiatives and improved quality management costs, primarily due to a specific warranty charge recorded during the prior year that did not recur related to a firmware issue that was identified and addressed timely. These impacts were partially offset by cost inflation, unfavorable volume and increased spending on strategic investments.

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Adjusted EBITDA was $164 million (Adjusted EBITDA margin of 12.3%) during 2021, an increase of $5 million, or 3%, when compared to Adjusted EBITDA of $159 million (Adjusted EBITDA margin of 11.7%) during the prior year. The increase in Adjusted EBITDA margin was due to the same factors as those impacting the increase in adjusted operating margin; however year over year increases in depreciation and amortization did not negatively impact Adjusted EBITDA margin.

Corporate and other

Operating loss for corporate and other increased $4 million, or 8.0%, compared to the prior year. The increase in cost is primarily driven by increased spending on strategic initiatives.

Interest Expense

Interest expense was $76 million and $77 million for 2021 and 2020, respectively. The decrease in interest expense reflects the settlement of our Senior Notes due 2021 and lower short term borrowings during 2021, partially offset by a full year of interest expense associated with our Green Bond issuance during the second quarter of 2020 (as defined in "Funding and Liquidity Strategy"). See Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt and related interest.

Income Tax Expense

The income tax provision for 2021 was $84 million at an effective tax rate of 16.3% as compared to $31 million at an effective tax rate of 10.9% in 2020. The 2021 effective tax rate differs from that of 2020 primarily due to the tax benefits recorded for releases of uncertain tax positions in 2020. In addition, in 2021 the Company recorded a lower tax benefit for excess stock compensation deductions.

Liquidity and Capital Resources

The following table summarizes our sources and uses of cash:

(a)2021 impact is primarily due to weakening of the Euro, and Chilean Peso against the U.S. Dollar.

Sources and Uses of Liquidity

Operating Activities

During 2021, net cash provided by operating activities was $538 million, compared to $824 million in 2020. The $286 million year-over-year decrease was primarily driven by higher working capital levels, impacted by increased safety stock to mitigate supply chain volatility. Also contributing to the decrease were higher interest payments, and increased cash used for income, payroll and other taxes, partially from the delayed timing of payments in the prior year related to COVID-19 tax relief programs. Increased cash earnings partially offset these items.

Investing Activities

Cash used in investing activities was $183 million in 2021, compared to $169 million in 2020. This increase in cash used of $14 million was mainly driven by higher spending on capital expenditures compared to the prior year, partially offset by proceeds received from the sales of businesses in 2021.

Financing Activities

Cash used in financing activities was $855 million in 2021, compared to cash generated from financing activities of $473 million in 2020. This change was primarily driven by the repayment of Senior Notes in 2021 and proceeds received from the issuance of our Green Bond (as defined in "Funding and Liquidity Strategy") and other short-term financings in 2020 that did not reoccur in 2021. Partially offsetting these items was the repayment of short-term debt in 2020.

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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. We continually evaluate aspects of our spending, including capital expenditures, strategic investments and dividends.

In both 2021 and 2020, we elected to utilize certain federal, state and foreign COVID-19 tax relief programs related to timing of tax payments, deductions and credits to further manage our liquidity.

Historically, we have generated operating cash flow sufficient to fund our primary cash needs. Xylem issued Senior Notes of $1 billion in aggregate principal ("Green Bond") on June 26, 2020 to further manage our liquidity. The primary long-term intention of incurring this debt is to fund green projects across our business segments, as well as manage liquidity risk and increase flexibility, as the duration of the economic effects of the pandemic are uncertain. See Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt. Xylem's liquidity position has continued to evolve favorably during 2021, and we will continue to monitor the economic effects of the COVID-19 pandemic and its impact on the Company's future operating cash flows going forward. If our cash flows from operations are less than we expect, we may need to incur debt or issue equity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. There can be no assurance that such financing will be available to us on acceptable terms or that such financing will be available at all. Our securities are rated investment grade. A significant change in credit rating could impact our ability to borrow at favorable rates. Refer to Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of limitations on obtaining additional funding.

We monitor our global funding requirements and seek to meet our liquidity needs on a cost-effective basis. As of December 31, 2021, 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 them to impact our ability to meet future liquidity needs or continue to comply with debt covenants. To provide for continued access to the full capacity of our credit facilities going forward, Xylem entered into Amendment No. 1 to the 2019 Credit Facility (as defined in Note 15, "Credit Facilities and Debt") on June 22, 2020 which modified the covenant calculation methodology through the quarter ending September 30, 2021 and restricted stock repurchases until March 31, 2021, except for shares of common stock in an amount not to exceed the number of shares issued after the date of the Amendment, subject to customary exceptions. See Note 15, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt.

Based on our current global cash positions, cash flows from operations and access to the capital markets, we believe there is sufficient liquidity to meet our funding requirements and service debt and other obligations in both the U.S. and outside of the U.S. over the next 12 months. In addition, we believe our existing committed credit facilities and access to the public debt markets would provide further liquidity if required. Currently, we have available liquidity of approximately $2.1 billion, consisting of $1.3 billion of cash and $800 million of available credit facilities as disclosed in Note 15, "Credit Facilities and Debt", of our consolidated financial statements. Our debt repayment obligations in 2021 consisted of $600 million in Senior Notes which we paid out of cash. Our next long-term debt maturity is March 2023.

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

Contractual Obligations

Material contractual obligations arising in the normal course of business primarily consist of debt obligations and related interest payments, lease obligations and unconditional purchase obligations. Refer Note 15, “Credit Facilities and Debt” and Note 11, “Leases” of the consolidated financial statements for related to these matters.

The Company has future unconditional purchase commitments which are legally binding and that specify all significant terms including price and/or quantity. Total future commitments within the next twelve months for these obligations is $326 million, excluding contracts that can be canceled without penalty.

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Credit Facilities & Long-Term Contractual Commitments

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

Non-U.S. Operations

For 2021 and 2020, we generated 56% and 53% of our revenue from non-U.S. operations, respectively. As we continue to grow our operations in the emerging markets and elsewhere outside of the U.S., we expect to continue to generate significant revenue from non-U.S. operations and expect that a substantial portion of our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to the U.S. and other international subsidiaries when we believe it is cost-effective to do so. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need to repatriate funds held internationally to support our U.S. operations. As of December 31, 2021, we have provided a deferred tax liability of $4 million for net foreign withholding taxes and state income taxes on $591 million of earnings expected to be repatriated to the U.S. parent as deemed necessary in the future.

Off-Balance Sheet Arrangements

We are a party to certain off-balance sheet arrangements including certain guarantees. For discussion of these arrangements, see Note 20, “Commitments and Contingencies” of the consolidated financial statements.

Critical Accounting Estimates

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

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

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

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

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

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

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Certain businesses also enter into long-term construction-type sales contracts where revenue is recognized over time. In these instances, revenue is recognized using a measure of progress that applies an input method based on costs incurred in relation to total estimated costs. We also recognize revenue for certain of these arrangements using the output method and measure progress based on shipments of product where control has transferred to the customer.

For all contracts with customers, we determine the transaction price in the arrangement and allocate the transaction price to each performance obligation identified in the contract. Judgment is required to determine the appropriate unit of account, and we separate out the performance obligations if they are capable of being distinct and are distinct within the context of the contract. The transaction price is adjusted for our estimate of variable consideration, which may include a right of return, discounts, rebates, penalties and retainage. To estimate variable consideration, we apply the expected value or the most likely amount method, based on whichever method most appropriately predicts the amount of consideration we expect to be entitled to. The method applied is typically based on historical experience and known trends. We constrain the amounts of variable consideration that are included in the transaction price, to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur or when uncertainties around the variable consideration are resolved.

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

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

We have recorded net foreign withholding taxes and state income taxes on earnings that are expected to be repatriated to the U.S. parent. We have not recorded any deferred taxes on the amounts that the Company currently does not intend to repatriate. The determination of deferred taxes on this amount is not practicable.

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

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

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

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expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.

Goodwill and Intangible Assets. We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-lived intangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment test as of the first day of the fourth quarter. For goodwill, the estimated fair value of each reporting unit is compared to the carrying value of the net assets assigned to that reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired. If the carrying value of the reporting unit exceeds its estimated fair value, then an impairment charge is recognized for that excess up to the amount of recorded goodwill. We estimate the fair value of our reporting units using an income approach. We estimate the fair value of our intangible assets with indefinite lives using either the income approach or the market approach. Under the income approach, we calculate fair value based on the present value of estimated future cash flows. Under the market approach, we calculate fair value based on recent sales and selling prices of similar assets.

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

In the third quarter of 2020, management updated forecasts of future cash flows for the AIA businesses, which reflected significant negative volume impacts from the COVID-19 pandemic, primarily on our assessment services business. Our ongoing investment in the AIA businesses also continues to impact near term profitability. Based on these factors we determined that there were indicators that the AIA reporting unit’s goodwill may be impaired, and accordingly, we performed an interim goodwill impairment test as of July 1, 2020. The results of the impairment test showed that the fair value of the AIA reporting unit was lower than the carrying value, resulting in a $58 million goodwill impairment charge. As of December 31, 2020, the remaining goodwill balance in our AIA reporting unit after recording the goodwill impairment charge was $113 million.

Also, during the third quarter of 2020, due to the factors discussed above, we assessed whether the carrying amounts of the AIA reporting unit’s long-lived assets may not be recoverable and therefore impaired. Our assessment resulted in an impairment charge of $11 million, primarily related to software and proprietary technology. The charge was calculated using an income approach.

The risks and potential impacts of COVID-19 on the fair value of our assets are included in our risk factor disclosures referenced under “Item 1A. Risk Factors".

During the fourth quarter of 2021, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were substantially in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances require us to do so. We determined that no impairment of the indefinite-lived intangibles existed as of the measurement date in 2021. However, future indefinite-lived intangible impairment tests could result in a charge to earnings. We will continue to evaluate indefinite-lived intangibles on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment.

Post-retirement Benefit Plans. Company employees around the world participate in numerous defined benefit plans. The determination of projected benefit obligations and the recognition of expenses related to these plans are dependent on various assumptions. These major assumptions primarily relate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, years of service and other factors (some of which are disclosed in Note 16, “Post-retirement Benefit Plans,” of the consolidated financial statements). Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to the extent they exceed 10% of the higher of the market-related value or projected benefit obligation, over the average remaining service period of active plan participants, or for plans with all or substantially all inactive participants, over

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the average remaining life expectancy.

Significant Assumptions

Management develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country in which such plans exist. All assumptions are reviewed annually with third-party consultants and are adjusted as necessary. The table below provides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2021 and 2020.

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

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

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

For the recognition of net periodic pension cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate of return to the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurement date over the last five years. The use of fair value, rather than a calculated value, could materially affect net periodic pension cost. The weighted average expected long-term rate of return for all of our plan assets to be used in determining net periodic benefit costs for 2022 is estimated at 3.22%. We estimate that every 25 basis point change in the expected return on plan assets impacts the expense by $1 million.

The discount rate reflects our expectation of the present value of expected future cash payments for benefits at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and increases pension expense. We base the discount rate assumption on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pension discount rate was determined by considering an interest rate yield curve comprising AAA/AA bonds, with maturities between zero and 30 years, developed by the plan’s actuaries. Annual benefit payments are then discounted to present value using this yield curve to develop a single-point discount rate matching the plan’s characteristics. Our weighted average discount rate for all pension plans effective January 1, 2022, is 1.71%. We estimate that every 25 basis point change in the discount rate impacts the expense by $1 million.

The rate of future compensation increase assumption reflects our long-term actual experience and future and near-term outlook. Effective January 1, 2022, our expected rate of future compensation is 2.96% for all pension plans. The estimated impact of a 25 basis point change in the expected rate of future compensation is less than $1 million.

The Company has initiated the process for a full buy-out of its largest defined benefit plan in the UK. Upon completion of the buy-out, expected in 2022, we anticipate a settlement charge of approximately $170 million, primarily consisting of unrecognized actuarial losses.

We currently anticipate making contributions to our pension and post-retirement benefit plans in the range of $19 million to $27 million during 2022. Approximately $6 million of contributions are expected to be made in the first quarter.

Funded Status

Funded status is derived by subtracting the respective year-end values of the projected benefit obligations from the fair value of plan assets. We estimate that every 25 basis point change in the discount rate impacts the funded status by approximately $34 million.

Fair Value of Plan Assets

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

A portion of our pension benefit plan assets portfolio comprises investments in hedge funds which are generally measured at net asset value. However, in certain instances, the values reported by the asset managers were not current at the measurement date. Accordingly, we made estimate adjustments to the last reported value where necessary to measure the assets at fair value at the measurement date. These adjustments consider information received from the asset managers, as well as general market information. The adjustment recorded at December 31, 2021 and 2020 for these assets represented less than 1% of total plan assets in each respective year. Asset values for other positions were generally measured using market observable prices. We estimate that a 5% change in asset values will impact funded status by approximately $31 million.

New Accounting Pronouncements

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

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