Item 1A:
Risk Factors
The Company is subject to risks and uncertainties, including, but not limited to, the following:
RISKS RELATED TO THE CORONAVIRUS
(COVID-19)
PANDEMIC
The Company’s business has been and may continue to be negatively affected by outbreaks of disease, such as epidemics or pandemics, including the ongoing
COVID-19
pandemic.
Outbreaks of disease, such as epidemics or pandemics, have and could continue to negatively affect the Company’s business. Both the Company’s domestic and international operations have been and continue to be adversely affected by the ongoing global
COVID-19
pandemic and the resulting volatility and uncertainty it has caused in the U.S. and international markets. Since being declared a pandemic in March 2020 by the World Health,
COVID-19
has continued to spread throughout the U.S. and globally. The
COVID-19
pandemic has caused significant volatility and uncertainty in U.S. and international markets, which has disrupted and is expected to continue to disrupt the Company’s business and could result in a prolonged economic downturn. The Company operates in over 35 countries, including those in the regions most impacted by the
COVID-19
pandemic. Many countries, including the U.S., have implemented measures such as quarantine,
shelter-in-place,
curfew and similar isolation measures, including government orders and other restrictions on the conduct of business operations. Such measures have had and are expected to continue to have adverse impacts on the U.S. and foreign economies of uncertain severity and duration and have had and may continue to have a negative impact on the Company’s operations, including the Company’s sales, supply chain and cash flow. Certain jurisdictions have experienced increased numbers of
COVID-19
infections following the
re-openings
of their economies and easing of restrictions, which, in some cases, has required closings of certain business activity and the imposition of other restrictions in response. It is unclear whether the increases in the number of infections will continue and amplify or whether any
so-called
“second waves” of
COVID-19
infections will be experienced in the United States or elsewhere and, if so, what the impact of that would be on human health and safety, the economy and our business. Although the FDA has approved certain therapies and two vaccines for emergency use and distribution, the initial rollout of vaccine distribution has encountered significant delays and there remains uncertainties about the amount of vaccine available for distribution, the logistics of implementing a national vaccine program and the overall efficacy of the vaccines once widely administered, especially as new strains of
COVID-19
have been discovered, and the level of resistance these new strains have to the existing vaccines remains unknown. Additionally, the widespread pandemic has caused and is expected to continue to cause significant disruption of global financial markets, which may reduce the Company’s ability to access capital.
The
COVID-19
pandemic also has the potential to significantly impact our supply chain if our manufacturing facilities or those of third parties to whom we outsource certain manufacturing processes, the distribution centers where our inventory is managed or the operations of our logistics and other service providers are disrupted, temporarily closed or experience worker shortages. We may also see disruptions or delays in shipments of certain materials or components of our products.
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As a result of the ongoing
COVID-19
pandemic, the Company has transitioned the majority of its workforce to a temporary remote working model, which may result in the Company experiencing lower workforce efficiency and productivity, which in turn may adversely affect the Company’s business, results of operations and financial condition. As company employees work from home and access the Company’s system remotely, the Company may be subject to heightened security risks, including the risks of cyber-attacks. Additionally, if any of the Company’s key management employees are unable to perform their duties for a period of time, including as the result of illness, the Company’s business, results of operations and financial condition could be adversely affected.
The Company cannot reasonably estimate the length or severity of the
COVID-19
pandemic or the related response, or the extent to which the disruption may continue to impact the Company’s business, financial position, results of operations and cash flows. Ultimately, the
COVID-19
pandemic could have a material adverse impact on the Company’s business, financial positions, results of operations and cash flows.
RISKS RELATED TO MACROECONOMIC CONDITIONS
The Company’s international operations may be negatively affected by political events, wars or terrorism and regulatory changes, related to either a specific country or a larger region. These potential political, currency and economic disruptions, as well as foreign currency exchange rate fluctuations, could have a material adverse effect on the Company’s results of operations or financial condition.
Approximately 71% of the Company’s net sales in both 2020 and 2019 were outside of the United States and were primarily denominated in foreign currencies. In addition, the Company has considerable manufacturing operations in Ireland and the U.K., as well as significant subcontractors located in Singapore. As a result, a significant portion of the Company’s sales and operations are subject to certain risks, including adverse developments in the political, regulatory and economic environment, in particular, uncertainty regarding possible changes to foreign and domestic trade policy; the effect of the U.K.’s exit from the European Union as well as the financial difficulties and debt burden experienced by a number of European countries; the instability and potential impact of war or terrorism; the instability and possible dissolution of the Euro as a single currency; sudden movements in a country’s foreign exchange rates due to a change in a country’s sovereign risk profile or foreign exchange regulatory practices; tariffs and other trade barriers; the impact of public health epidemics, such as the coronavirus currently impacting China and elsewhere; difficulties in staffing and managing foreign operations; and associated adverse operational, contractual and tax consequences.
Additionally, the U.S. dollar value of the Company’s net sales, cost of sales, operating expenses, interest, taxes and net income varies with foreign currency exchange rate fluctuations. Significant increases or decreases in the value of the U.S. dollar relative to certain foreign currencies, particularly the Euro, Japanese yen and British pound, could have a material adverse effect or benefit on the Company’s results of operations or financial condition.
Global economic conditions may decrease demand for the Company’s products and harm the Company’s financial results.
The Company is a global business that may be adversely affected by changes in global economic conditions. These changes in global economic conditions, both inside and outside the U.S., may affect the demand for the Company’s products and services. This may result in a decline in sales in the future, increased rate of order cancellations or delays, increased risk of excess or obsolete inventories, longer sales cycles and potential difficulty in collecting sales proceeds. There can be no assurance regarding demand for the Company’s products and services in the future.
Disruption in worldwide financial markets could adversely impact the Company’s access to capital and financial condition.
Financial markets in the U.S., Europe and Asia have experienced times of extreme disruption, including, among other things, sharp increases in the cost of new capital, credit rating downgrades and bailouts, severely
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diminished capital availability and severely reduced liquidity in money markets. Financial and banking institutions have also experienced disruptions, resulting in large asset write-downs, higher costs of capital, rating downgrades and reduced desire to lend money. There can be no assurance that there will not be future deterioration or prolonged disruption in financial markets or financial institutions. Any future deterioration or prolonged disruption in financial markets or financial institutions in which the Company participates may impair the Company’s ability to access its existing cash, utilize its existing syndicated bank credit facility funded by such financial institutions, and impair its ability to access sources of new capital. The cost to the Company of any new capital raised and interest expense would increase if this were to occur.
RISKS RELATED TO OUR BUSINESS
The Company’s financial results are subject to changes in customer demand, which may decrease for a number of reasons, many beyond the Company’s control.
The demand for the Company’s products is dependent upon the size of the markets for its LC,
LC-MS,
thermal analysis, rheometry and calorimetry products; the timing and level of capital spending and expenditures of the Company’s customers; changes in governmental regulations, particularly affecting drug, food and drinking water testing; funding available to academic, governmental and research institutions; general economic conditions and the rate of economic growth in the Company’s major markets; and competitive considerations. The Company typically experiences an increase in sales in its fourth quarter as a result of purchasing habits for capital goods by customers that tend to exhaust their spending budgets by calendar year end. However, there can be no assurance that the Company will effectively forecast customer demand and appropriately allocated research and development expenditures to products with high growth and high margin prospects. Additionally, there can be no assurance that the Company’s results of operations or financial condition will not be adversely impacted by a change in any of the factors listed above or the continuation of uncertain global economic conditions.
Additionally, the analytical instrument market may, from time to time, experience low sales growth. Approximately 59% and 57% of the Company’s net sales in 2020 and 2019, respectively, were to worldwide pharmaceutical and biotechnology companies, which may be periodically subject to unfavorable market conditions and consolidations. Unfavorable industry conditions could have a material adverse effect on the Company’s results of operations or financial condition.
Competitors may introduce more effective or less expensive products than the Company’s, which could result in decreased sales. The competitive landscape may transform as a result of potential changes in ownership, mergers and continued consolidations among the Company’s competitors, which could harm the Company’s business.
The analytical instrument market and, in particular, the portion related to the Company’s HPLC, UPLC,
LC-MS,
thermal analysis, rheometry and calorimetry product lines, is highly competitive and subject to rapid changes in technology. The Company encounters competition from several international instrument suppliers and other companies in both domestic and foreign markets. Some competitors have instrument businesses that are generally more diversified than the Company’s business, but are typically less focused on the Company’s chosen markets. Over the years, some competitors have merged with other competitors for various reasons, including increasing product line offerings, improving market share and reducing costs. There can be no assurance that the Company’s competitors will not introduce more effective and less costly products than those of the Company or that the Company will be able to increase its sales and profitability from new product introductions. There can be no assurance that the Company’s sales and marketing forces will compete successfully against the Company’s competitors in the future.
Strategies for organic growth require developing new technologies and bringing these new technologies to market, which could negatively impact the Company’s financial results.
The Company’s corporate strategy is fundamentally based on winning through organic innovation and deep application expertise. The Company is in the process of developing new products with recently acquired
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technologies. The future development of these new products will require a significant amount of spending over the next few years before significant, robust sales will be realized. Furthermore, these new products will be sold into both the
non-clinical
and clinical markets, and any new products requiring FDA clearance may take longer to bring to market. There can be no assurance given as to the timing of these new product launches and the ultimate realization of sales and profitability in the future.
The Company’s software or hardware may contain coding or manufacturing errors that could impact their function, performance and security, and result in other negative consequences.
Despite testing prior to the release and throughout the lifecycle of a product or service, the detection and correction of any errors in released software or hardware can be time consuming and costly. This could delay the development or release of new products or services, or new versions of products or services, create security vulnerabilities in the Company’s products or services, and adversely affect market acceptance of products or services. If the Company experiences errors or delays in releasing its software or hardware, or new versions thereof, its sales could be affected and revenues could decline. Errors in software or hardware could expose the Company to product liability, performance and warranty claims as well as harm to brand and reputation, which could impact future sales.
Disruption of operations at the Company’s manufacturing facilities could harm the Company’s financial condition.
The Company manufactures LC instruments at facilities in Milford, Massachusetts and through a subcontractor in Singapore; precision chemistry separation columns at its facilities in Taunton, Massachusetts and Wexford, Ireland; MS products at its facilities in Wilmslow, England, Solihull, England and Wexford, Ireland; thermal analysis and rheometry products at its facilities in New Castle, Delaware and other instruments and consumables at various other locations as a result of the Company’s acquisitions. Any prolonged disruption to the operations at any of these facilities, whether due to labor difficulties, destruction of or damage to any facility or other reasons, could have a material adverse effect on the Company’s results of operations or financial condition.
Failure to adequately protect intellectual property could have materially adverse effects on the Company’s results of operations or financial condition.
There can be no assurance that any patents held by the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to the Company. Additionally, there could be successful claims against the Company by third-party patent holders with respect to certain Company products that may infringe the intellectual property rights of such third parties. The Company’s patents, including those licensed from others, expire on various dates. If the Company is unable to protect its intellectual property rights, it could have an adverse and material effect on the Company’s results of operations or financial condition.
The Company’s business would suffer if the Company were unable to acquire adequate sources of supply.
Most of the raw materials, components and supplies purchased by the Company are available from a number of different suppliers; however, a number of items are purchased from limited or single sources of supply and disruption of these sources could have, at a minimum, a temporary adverse effect on shipments and the financial results of the Company. A prolonged inability to obtain certain materials or components could have an adverse effect on the Company’s financial condition or results of operations and could result in damage to its relationships with its customers and, accordingly, adversely affect the Company’s business.
The Company’s sales would deteriorate if the Company’s outside contractors fail to provide necessary components or modules.
Certain components or modules of the Company’s LC and MS instruments are manufactured by outside contractors, including the manufacturing of LC instrument systems and related components by contract
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manufacturing firms in Singapore. Disruptions of service by these outside contractors could have an adverse effect on the supply chain and the financial results of the Company. A prolonged inability to obtain these components or modules could have an adverse effect on the Company’s financial condition or results of operations.
The Company’s business could be harmed by actions of distributors and other third parties that sell our products.
The Company sells some products through third parties, including distributors and value-added resellers. This exposes us to various risks, including competitive pressure, concentration of sales volumes, credit risks and compliance risks. We may rely on one or a few key distributors for a product or market and the loss of these distributors could reduce our revenue or net earnings. Distributors may also face financial difficulties, including bankruptcy, which could harm our collection of accounts receivable. Violations of the U.S. Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act or similar anti-bribery laws by distributors or other third-party intermediaries could materially impact our business. Risks related to our use of distributors may reduce sales, increase expenses and weaken our competitive position.
The Company’s financial results are subject to unexpected shifts in
pre-tax
income between tax jurisdictions, changing application of tax law and tax audit examinations.
The Company is subject to rates of income tax that range from 0% up to 34% in various jurisdictions in which it conducts business. In addition, the Company typically generates a substantial portion of its income in the fourth quarter of each fiscal year. Geographical shifts in income from previous quarters’ projections caused by factors including, but not limited to, changes in volume and product mix and fluctuations in foreign currency translation rates, could therefore have potentially significant favorable or unfavorable effects on the Company’s income tax expense, effective tax rate and results of operations.
Governments in the jurisdictions in which the Company operates implement changes to tax laws and regulations from time to time. Any changes in corporate income tax rates or regulations regarding transfer pricing or repatriation of dividends or capital, as well as changes in the interpretation of existing tax laws and regulations, in the jurisdictions in which the Company operates could adversely affect the Company’s cash flow and lead to increases in its overall tax burden, which would negatively affect the Company’s profitability.
The Company has a tax exemption in Singapore on certain types of income through March 2021, based upon the achievement and continued satisfaction of certain operational and financial milestones, which the Company met as of December 31, 2020 and expects to maintain through March 2021. Currently, the Company has determined that it is more likely than not to realize the tax exemption in Singapore and, accordingly, has not recognized any reserves for unrecognized tax benefits on its balance sheet related to this tax exemption. In the event that any of the milestone targets were not met, the Company would not be entitled to the tax exemption on income earned in Singapore dating back to the start date of the agreement (April 1, 2016), and all the tax benefits previously recognized would be reversed, resulting in the recognition of income tax expense equal to the statutory tax of 17% on income earned during that period. In addition, the Company has a new Development and Expansion Incentive in Singapore that provides a concessionary income tax rate of 5% on certain types of income for the period April 1, 2021 through March 31, 2026.
As a global business, the Company is subject to tax audit examinations in various jurisdictions throughout the world. The Company must manage the cost and disruption of responding to governmental audits, investigation and proceedings. In addition, the impact of the settlement of pending or future tax audit examination could have an unfavorable effect on the Company’s income tax expense, effective tax rate and results of operations.
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RISKS RELATED TO HUMAN CAPITAL MANAGEMENT
We may not be able to attract and retain qualified employees.
Our future success depends upon the continued service of our executive officers and other key management and technical personnel, and on our ability to continue to identify, attract, retain and motivate them. Implementing our business strategy requires specialized engineering and other talent, as our revenues are highly dependent on technological and product innovations. The market for employees in our industry is extremely competitive, and competitors for talent, particularly engineering talent, increasingly attempt to hire, and to varying degrees have been successful in hiring, our employees. A number of such competitors for talent are significantly larger than us and are able to offer compensation in excess of what we are able to offer. Further, existing immigration laws make it more difficult for us to recruit and retain highly skilled foreign national graduates of universities in the United States, making the pool of available talent even smaller. If we are unable to attract and retain qualified employees, our business may be harmed.
The loss of key members of management and the risks inherent in succession planning could adversely affect the Company’s results of operations or financial condition.
The operation of the Company requires managerial and operational expertise. None of the Company’s key management employees, with the exception of the President and Chief Executive Officer, have an employment contract with the Company and there can be no assurance that such individuals will remain with the Company. On December 31, 2020, our Senior Vice President and Chief Financial Officer departed from the Company and the Company appointed an interim Chief Financial Officer, effective January 1, 2021. We are currently conducting a search for a new Chief Financial Officer. Competition for experienced talent is intense and our process to search for a successor may be time-consuming and divert the board of directors’ and managements’ attention away from our business. This search and any eventual transition to a permanent Chief Financial Officer may be disruptive to our operations. Any delay or failure in identifying, attracting or retaining a permanent Chief Financial Officer, and successfully managing this leadership transition could have an adverse effect on our results of operations or financial condition. Additionally, if, for any reason, other key personnel do not continue to be active in management, the Company’s results of operations or financial condition could be adversely affected.
RISKS RELATED TO CYBERSECURITY AND DATA PRIVACY
Disruption, cyber-attack or unforeseen problems with the security, maintenance or upgrade of the Company’s information and
web-based
systems could have an adverse effect on the Company’s operations and financial condition.
The Company relies on its technology infrastructure and that of its software and banking partners, among other functions, to interact with suppliers, sell products and services, fulfill contract obligations, ship products, collect and make electronic wire and check based payments and otherwise conduct business. The Company’s technology infrastructure may be vulnerable to damage or interruption from, but not limited to, natural disasters, power loss, telecommunication failures, terrorist attacks, computer viruses, unauthorized access to customer or employee data, unauthorized access to and funds transfers from Company bank accounts and other attempts to harm the Company’s systems. Additionally, we must maintain and periodically upgrade our information and web-based systems, which has caused and will in the future cause temporary interruptions to our technology infrastructure. Any prolonged disruption to the Company’s technology infrastructure, at any of its facilities, could have a material adverse effect on the Company’s results of operations or financial condition.
If the Company’s security measures are compromised or fail to adequately protect its technology infrastructure, research and development efforts or manufacturing operations, the Company’s products and services may be perceived as vulnerable or unreliable, the information protected by the Company’s controls and processes may be subject to unauthorized access, acquisition or modification, the Company’s brand and reputation could be damaged, the services that the Company provides to its customers could be disrupted, and customers may stop using the Company’s products and services, all of which could reduce the Company’s revenue and earnings, increase its expenses and expose the Company to legal claims and regulatory actions.
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The Company is in the business of designing, manufacturing, selling and servicing analytical instruments to life science, pharmaceutical, biochemical, industrial, nutritional safety and environmental, academic and governmental customers working in research and development, quality assurance and other laboratory applications, and the Company is also a developer and supplier of software-based products that support instrument systems. Many of the Company’s customers are in highly regulated industries. While the Company has invested time and resources implementing measures designed to protect the integrity and security of its technology infrastructure, research and development processes, manufacturing operations, products and services, and the internal and external data managed by the Company, there is a risk these measures will be defeated or compromised or that they are otherwise insufficient to protect against existing or emerging threats. The Company also has acquired companies, products, services and technologies over time and may face inherent risk when integrating these acquisitions into the Company. In addition, at times, the Company faces attempts by third parties to defeat its security measures or exploit vulnerabilities in its systems. These risks will increase as the Company continues to grow and expand geographically, and its systems, products and services become increasingly digital and sensor- and
web-based.
The Company could suffer significant damage to its brand and reputation if a security incident resulted in unauthorized access to, acquisition of, or modification to the Company’s technology infrastructure, research and development processes, manufacturing operations, its products and services as well as the internal and external data managed by the Company. Such an incident could disrupt the Company’s operations and customers could lose confidence in the Company’s ability to deliver quality and reliable products or services. This could negatively impact sales and could increase costs related to fixing and addressing these incidents and any vulnerabilities exposed by them, as well as to lawsuits, regulatory investigations, claims or legal liability including contractual liability, costs and expenses owed to customers and business partners.
RISKS RELATED TO COMPLIANCE, REGULATORY OR LEGAL CHANGES
Compliance failures could harm the Company’s business.
The Company is subject to regulation by various federal, state and foreign governments and agencies in areas including, among others, health and safety, import/export, privacy and data protection, FCPA and environmental laws and regulations. A portion of the Company’s operations are subject to regulation by the FDA and similar foreign regulatory agencies. These regulations are complex and govern an array of product activities, including design, development, labeling, manufacturing, promotion, sales and distribution. Any failure by the Company to comply with applicable governmental regulations could result in product recalls, the imposition of fines, restrictions on the Company’s ability to conduct or expand its operations or the cessation of all or a portion of its operations.
Regulators globally are increasingly imposing greater fines and penalties for privacy and data protection violations, and the European Union has enacted a broad data protection regulation with fines based on a percentage of global revenues. Changes in laws or regulations associated with enhanced protection of certain sensitive types of personal information, such as information related to health, could greatly increase the cost of compliance and the cost of providing the Company’s products or services. Any failure, or perceived failure, by the Company to comply with laws and regulations on privacy, data security or consumer protection, or other policies, public perception, standards, self-regulatory requirements or legal obligations, could result in lost or restricted business, proceedings, actions or fines brought against the Company or levied by governmental entities or others, or could otherwise adversely affect the business and harm the Company’s reputation.
Some of the Company’s operations are subject to domestic and international laws and regulations with respect to the manufacturing, handling, use or sale of toxic or hazardous substances. This requires the Company to devote substantial resources to maintain compliance with those applicable laws and regulations. If the Company fails to comply with such requirements in the manufacturing or distribution of its products, it could face civil and/or criminal penalties and potentially be prohibited from distributing or selling such products until they are compliant.
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Some of the Company’s products are also subject to the rules of certain industrial standards bodies, such as the International Standards Organization. The Company must comply with these rules, as well as those of other agencies, such as the United States Occupational Safety and Health Administration. Failure to comply with such rules could result in the loss of certification and/or the imposition of fines and penalties, which could have a material adverse effect on the Company’s operations.
As a publicly-traded company, the Company is subject to the rules of the SEC and the New York Stock Exchange. In addition, the Company must comply with the Sarbanes-Oxley regulations, which require the Company to establish and maintain adequate internal control over financial reporting. The Company’s efforts to comply with such laws and regulations are time consuming and costly. While we continue to enhance our controls, we cannot be certain that we will be able to prevent future significant deficiencies or material weaknesses. Failure to comply with such regulations or having inadequate internal controls could have a material adverse effect on the Company’s financial condition and operations, which could cause investors to lose confidence in our reported financial information and could have a negative effect on the trading price of our stock and our access to capital.
The Company is subject to the rules of the SEC under the Dodd-Frank Wall Street Reform and Consumer Protection Act, requiring disclosure as to whether certain materials (tantalum, tin, gold and tungsten), known as conflict minerals, which may be contained in the Company’s products, are mined from the Democratic Republic of the Congo and adjoining countries. In 2019, the Company was not able to determine with certainty the country of origin of some of the conflict minerals in its manufactured products. However, the Company does not have knowledge that any of its conflict minerals originated from the Democratic Republic of the Congo or adjoining countries. The Company is in the process of evaluating its 2020 supply chain, and the Company plans to file its 2020 Form SD with the SEC in May 2021. The results of this and future evaluations may impose additional costs and may introduce new risks related to the Company’s ability to verify the origin of any conflict minerals contained in its products.
The Company may be harmed by improper conduct of any of our employees, agents or business partners.
We cannot provide assurance that our internal controls and compliance systems will always protect the Company from acts committed by employees, agents or business partners that would violate domestic and international laws, including laws governing payments to government officials, bribery, fraud, kickbacks and false claims, pricing, sales and marketing practices, conflicts of interest, competition, export and import compliance, money laundering and data privacy. In particular, the FCPA, the U.K. Bribery Act and similar anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business, and we operate in many parts of the world that have experienced governmental corruption to some degree. Any such improper actions or allegations of such acts could damage our reputation and subject us to civil or criminal investigations in the U.S. and in other jurisdictions and related shareholder lawsuits, could lead to substantial civil and criminal, monetary and
non-monetary
penalties and could cause us to incur significant legal and investigatory fees. In addition, the government may seek to hold us liable as a successor for violations committed by companies in which we invest or that we acquire. We also rely on our suppliers to adhere to our supplier standards of conduct and material violations of such standards of conduct could occur that could have a material effect on our business, reputation and financial statements.
GENERAL RISK FACTORS
The effects of climate change could harm the Company’s business.
The Company’s manufacturing processes for certain of its products involve the use of chemicals and other substances that are regulated under various international, federal, state and local laws governing the environment. In the event that any future climate change legislation would require that stricter standards be imposed by domestic or international environmental regulatory authorities with respect to the use and/or levels of possible
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emissions from such chemicals and/or other substances, the Company may be required to make certain changes and adaptations to its manufacturing processes. Any such changes could have a material adverse effect on the financial statements of the Company.
Another potential effect of climate change is an increase in the severity of global weather conditions. The Company’s manufacturing facilities are located in the U.S., U.K., Ireland and Germany. In addition, the Company manufactures a growing percentage of its HPLC, UPLC and MS products in both Singapore and Ireland. Severe weather and geological conditions or events, including earthquakes, hurricanes and/or tsunamis, could potentially cause significant damage to the Company’s manufacturing facilities in each of these countries. The effects of such damage and the resulting disruption of manufacturing operations and the impact of lost sales could have a material adverse impact on the financial results of the Company.
Estimates and assumptions made in accounting for the Company’s results from operations are dependent on future results, which involve significant judgments and may be imprecise and may differ materially from actual results.
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities at the dates of the financial statements. These estimates and assumptions must be made due to certain information used in preparation of our financial statements which is dependent on future events, cannot be calculated with a high degree of precision from data available or is not capable of being readily calculated based on generally accepted methodologies. The Company believes that the accounting related to revenue recognition, bad debts, inventory valuation, goodwill and intangible assets, income taxes, warranty and installation provisions, litigation, retirement plan obligations, stock-based compensation, business combinations and asset acquisitions, uncertain tax positions and contingencies involves significant judgments and estimates. Actual results for all estimates could differ materially from the estimates and assumptions used, which could have a material adverse effect on our financial condition and results of operations.
The Company’s financial condition and results of operations could be adversely affected by changes to the Company’s retirement plans or retirement plan assets.
The Company sponsors various retirement plans, both inside and outside the U.S. Any changes in regulations made by governments in countries in which the Company sponsors retirement plans could adversely impact the Company’s cash flows or results of operations. In connection with these retirement plans, the Company is exposed to market risks associated with changes in the various capital markets. For example, changes in long-term interest rates affect the discount rate that is used to measure the Company’s retirement plan obligations and related expense. In addition, changes in the market value of investments held by the retirement plans could materially impact the funded status of the retirement plans, and affect the related pension expense and level and timing of contributions required under applicable laws.
The Company’s financial condition and results of operations could be adversely affected if the Company is unable to maintain a sufficient level of cash flow.
The Company had $1.4 billion in debt and $443 million in cash, cash equivalents and investments as of December 31, 2020. As of December 31, 2020, the Company also had the ability to borrow an additional $1.4 billion from its existing, committed credit facility. All but a small portion of the Company’s debt was in the U.S. There is a substantial cash requirement in the U.S. to fund operations and capital expenditures, service debt interest obligations, finance potential U.S. acquisitions and continue authorized stock repurchase programs. As such, the Company’s financial condition and results of operations could be adversely impacted if the Company is unable to generate and maintain a sufficient level of cash flow to address these requirements through (1) cash from operations, (2) the Company’s ability to access its existing cash and revolving credit facility, (3) the ability to expand the Company’s borrowing capacity and (4) other sources of capital obtained at an acceptable cost.
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Debt covenants, and the Company’s failure to comply with them, could negatively impact the Company’s capital and financial results.
The Company’s debt is subject to restrictive debt covenants that limit the Company’s ability to engage in certain activities that could otherwise benefit the Company. These debt covenants include restrictions on the Company’s ability to enter into certain contracts or agreements, which may limit the Company’s ability to make dividend or other payments, secure other indebtedness, enter into transactions with affiliates and consolidate, merge or transfer all or substantially all of the Company’s assets. The Company is also required to meet specified financial ratios under the terms of the Company’s debt agreements. The Company’s ability to comply with these financial restrictions and all other covenants is dependent on the Company’s future performance, which is subject to, but not limited to, prevailing economic conditions and other factors, including factors that are beyond the Company’s control, such as foreign exchange rates, interest rates, changes in technology and changes in the level of competition.
Item 1B: Unresolved Staff Comments
None.
Item 2:
Properties
Waters Corporation operates 20 United States facilities and 71 international facilities, including field offices. The Company believes its facilities are suitable and adequate for its current production level and for reasonable growth over the next several years. The Company’s primary facilities are summarized in the table below.
Primary Facility Locations
Location Function (1) Owned/Leased
Golden, CO M, R, S, D, A Leased
New Castle, DE M, R, S, D, A Owned
Franklin, MA D Leased
Milford, MA M, R, S, A Owned
Taunton, MA M, R Owned
Cambridge, MA R, S Leased
Eden Prairie, MN M, R, S, D, A Leased
Nixa, MO M, S, D, A Leased
Lindon, UT M, R, S, D, A Leased
Newcastle, England R, S, D, A Leased
Solihull, England M,A Owned
Wilmslow, England M, R, S, D, A Owned
St. Quentin, France S, A Leased
Huellhorst, Germany M, R, S, D, A Owned
Budapest, Hungary R Leased
Wexford, Ireland M, R, D, A Owned
Bangalore, India M, S, D, A Owned
Etten-Leur, Netherlands S, D, A Owned
Brasov, Romania R, A Leased
Singapore R, S, D, A Leased
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The Company operates and maintains 10 field offices in the United States and 59 field offices abroad in addition to sales offices in the primary facilities listed above. The Company’s field office locations are listed below.
Field Office Locations (2)
United States International
Costa Mesa, CA Australia Hungary Norway
Pleasanton, CA Austria India People’s Republic of China
Wood Dale, IL Belgium Ireland Portugal
Carmel, IN Brazil Israel Poland
Columbia, MD Canada Italy Spain
Morrisville, NC Czech Republic Japan Sweden
Parsippany, NJ Denmark Korea Switzerland
Plymouth Meeting, PA Finland Malaysia Taiwan
Bellaire, TX France Mexico United Arab Emirates
Salt Lake City, UT Germany Netherlands United Kingdom
Item 3:
Legal Proceedings
From time to time, the Company and its subsidiaries are involved in various litigation matters arising in the ordinary course of business. The Company believes it has meritorious arguments in its current litigation matters and believes any outcome, either individually or in the aggregate, will not be material to the Company’s financial position or results of operations.
Item 4:
Mine Safety Disclosures
Not applicable.
INFORMATION ABOUT OUR EXECUTIVE OFFICERS
Officers of the Company are elected annually by the Board of Directors and hold office at the discretion of the Board of Directors. The following persons serve as executive officers of the Company:
Dr. Udit Batra, 50, was appointed a Director of the Company as well as President and CEO on September 1, 2020. He most recently served as Chief Executive Officer of the Life Science business of Merck KGaA, Darmstadt, Germany, which operates as MilliporeSigma in the United States and Canada, and as a member of its Executive Board, roles he held from 2014 and 2016, respectively, through July 2020. Prior to that, Dr. Batra served as President and Chief Executive Officer of Merck KGaA, Darmstadt, Germany’s Consumer Health business. Dr. Batra oversaw the company’s Bioethics Advisory Panel and had Board responsibility for the global Information Technology function. Before joining Merck KGaA, Darmstadt, Germany, Dr. Batra held several positions of increasing responsibility at Novartis, including Global Head of Corporate Strategy in Switzerland, Country President for the Pharma Business of Novartis in Australia and New Zealand and the Global Head of Public Health and Market Access in Cambridge, Massachusetts. Dr. Batra also served at the global consultancy McKinsey & Company across the healthcare, consumer and
non-profit
sectors. Dr. Batra started his career at Merck Research Labs in West Point, Pennsylvania as a research engineer.
Keeley Aleman, 44, was appointed Senior Vice President, General Counsel and Secretary in October of 2019. Ms. Aleman joined Waters Corporation in 2006 as the Assistant General Counsel and held various legal roles focusing on business transactions, commercial strategies, international development, compliance, corporate governance and organizational matters. Prior to joining Waters Corporation she held corporate associate positions at Goodwin Procter, LLP, and Testa, Hurwitz & Thibeault, LLP.
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Robert G. Carson, 47, was appointed Senior Vice President, Corporate Development in February 2018. Prior to joining Waters Corporation, he held several positions during his 16 years at Medtronic plc, including Vice President and General Manager, Pacemaker Business from January 2017 to January 2018. In addition, Mr. Carson spent nearly 12 years in Medtronic’s spinal implants and biologics business, serving as Vice President and General Manager from July 2016 to January 2017, Vice President of Global Marketing & Strategy from April 2015 to July 2016 and Vice President & Therapy Segment Leader from October 2012 to April 2015. Mr. Carson began his career with Banc of America Securities.
Dr. Michael C. Harrington, 60, was appointed Senior Vice President, Global Markets in February 2016. Dr. Harrington joined Waters Corporation in 1987 and has held several senior positions with Waters Corporation, including Vice President, Europe and Asia Pacific Operations, Senior Director of US Sales Operations, Director of US Chemistry Sales and General Manager of Phase Separations. Prior to joining Waters Corporation, Dr. Harrington held senior sales positions at Celsis, Inc.
Belinda Hyde, 50, was appointed Senior Vice President, Global Human Resources of Waters Corporation in January 2021. She is responsible for all aspects of the Global Human Resources function including talent management, total rewards, HR business partners, HR operations and technology, employee engagement and diversity and inclusion. Prior to joining Waters, Belinda served as the Chief Human Resources Officer for SPX FLOW, from July 2015 to December 2020, and Schnitzer Steel. She has also held leadership roles in business and cultural transformation, executive development, talent management, compensation, benefits, training, internal communications and business partner support at companies such as Caltex Petroleum, Dell Technologies, Invitrogen and Celanese Corporation. Belinda earned a Bachelor of Arts in psychology from the University of Texas, as well as both a master’s degree and doctorate in industrial and organizational psychology from the University of Houston.
Ian S. King, 64, was appointed Senior Vice President, Global Products in July 2017. Mr. King joined Waters in 1982 and previously served as Senior Vice President, Instrument Technology; Vice President, Separations Technologies; and Vice President and General Manager of Consumable Division, as well as a variety of scientific and management positions in Waters Corporation’s international subsidiaries. Prior to joining Waters Corporation, Mr. King worked at Edinburgh University as a research scientist.
Jonathan M. Pratt, 51, was appointed Senior Vice President and President, TA Instruments in August 2019. Prior to joining Waters Corporation, Mr. Pratt was President of Beckman Coulter Life Sciences from January 2017 to April 2019. Additionally, he held senior positions at Pall Corporation from 2001 to 2017, where he was Vice President and General Manager from October 2015 to December 2016 following Pall Corporation’s acquisition by Danaher Corporation and, prior to that, President of its Food & Beverage, Laboratory and ForteBio businesses from April 2011 to October 2015. In August 2020, Mr. Pratt was appointed to the Board of SPX FLOW, Inc. (NYSE:FLOW) as an independent director and a member of the Audit, Compensation, and Nominating & Governance Committees.
Michael F. Silveira, 54, was elected by the Board of Directors of the Company to serve as the interim Chief Financial Officer, effective January 1, 2021. Mr. Silveira has been with the Company for 16 years and is a Certified Public Accountant. He joined Waters Corporation in 2004 as Assistant Corporate Controller and was most recently appointed Vice President and Corporate Controller in 2013. Prior to joining the Company, he held several financial management positions with
Astro-Med,
Inc (nka AstroNova), Textron, Inc. and KPMG.
Dan Welch, 59, was appointed Senior Vice President, Global Operations in July 2020 and was Vice President of Global Supply Chain since July 2019 and Senior Director, Supply Chain Management since August 2017. Mr. Welch joined Waters Corporation in May 2012 as General Manager and Senior Director of Manufacturing Operations. Prior to joining Waters Corporation, he held senior operations and engineering positions at semiconductor and solar energy companies.
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PART II
The Company’s common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and is listed on the New York Stock Exchange under the symbol “WAT”. As of February 19, 2021, the Company had 78 common stockholders of record. The Company has not declared or paid any dividends on its common stock in its past three fiscal years and does not intend to pay cash dividends in the foreseeable future. Any future determination to pay cash dividends will be made at the discretion of the Board of Directors and will depend on restrictions and other factors the Board of Directors may deem relevant. The Company has not made any sales of unregistered equity securities in the years ended December 31, 2020, 2019 or 2018.
Securities Authorized for Issuance under Equity Compensation Plans
Equity compensation plan information is incorporated by reference from Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, of this document and should be considered an integral part of this Item 5.
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Stock Price Performance Graph
The following performance graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.
The following graph compares the cumulative total return on $100 invested as of December 31, 2015 (the last day of public trading of the Company’s common stock in fiscal year 2015) through December 31, 2020 (the last day of public trading of the common stock in fiscal year 2020) in the Company’s common stock, the NYSE Market Index, the SIC Code 3826 Index and the S&P 500 Index. The return of the indices is calculated assuming reinvestment of dividends during the period presented. The Company has not paid any dividends since its IPO. The stock price performance shown on the graph below is not necessarily indicative of future price performance.
COMPARISON OF CUMULATIVE TOTAL RETURN SINCE DECEMBER 31, 2015
AMONG WATERS CORPORATION, NYSE MARKET INDEX, SIC CODE 3826 INDEX – LABORATORY ANALYTICAL INSTRUMENTS AND S&P 500 INDEX
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Purchases of Equity Securities by the Issuer
The following table provides information about purchases by the Company during the three months ended December 31, 2020 of equity securities registered by the Company under the Exchange Act (in thousands, except per share data):
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Item 6: Selected Financial Data
The following table sets forth selected historical consolidated financial and operating data for the periods indicated. The statement of operations and balance sheet data is derived from financial statements for the years 2020, 2019, 2018, 2017 and 2016. The Company’s financial statements as of December 31, 2020 and 2019, and for each of the three years in the period ended December 31, 2020 are included in Part II, Item 8, Financial Statements and Supplementary Data, of this Form
10-K.
STATEMENT OF OPERATIONS DATA:
BALANCE SHEET AND OTHER DATA:
The Company adopted new accounting guidance related to stock-based compensation in 2017. The new accounting guidance requires the excess tax benefits or deficiencies related to stock-based compensation to be reflected in the consolidated statements of operations as a component of the provision for income taxes, whereas they were previously recognized in equity. This aspect of the new accounting guidance was required to be adopted on a prospective basis for the statement of operations and retroactive restatement was not permitted. In 2020, 2019 and 2018, the Company recognized an excess tax benefit, which decreased income tax expense by $7 million, $9 million and $9 million, respectively, and added $0.11, $0.14 and $0.11, respectively, to net income per diluted share.
In addition, in December 2018, the Company settled a pension plan obligation by making
lump-sum
cash payments and purchasing annuity contracts for participants to permanently extinguish the pension plan’s obligations. As a result, the Company recorded a $46 million charge, which consisted of a $6 million cash contribution to the plan and a $40 million
non-cash
charge related to the reversal of unrecognized actuarial losses recorded in accumulated other comprehensive income in the stockholders’ equity. The $46 million
pre-tax
charge reduced net income per diluted share by $0.39.
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Business and Financial Overview
The Company has two operating segments: Waters
TM
and TA
TM
. Waters products and services primarily consist of high performance liquid chromatography (“HPLC”), ultra performance liquid chromatography (“UPLC
TM
” and, together with HPLC, referred to as “LC”), mass spectrometry (“MS”) and precision chemistry consumable products and related services. TA products and services primarily consist of thermal analysis, rheometry and calorimetry instrument systems and service sales. The Company’s products are used by pharmaceutical, biochemical, industrial, nutritional safety, environmental, academic and governmental customers. These customers use the Company’s products to detect, identify, monitor and measure the chemical, physical and biological composition of materials and to predict the suitability and stability of fine chemicals, pharmaceuticals, water, polymers, metals and viscous liquids in various industrial, consumer goods and healthcare products.
Both the Company’s domestic and international operations have been and continue to be adversely affected by the ongoing global pandemic of a novel strain of coronavirus
(“COVID-19”)
that has led to volatility and uncertainty in the U.S. and international markets. The Company is actively managing its business to respond to the
COVID-19
impact; however, the Company cannot reasonably estimate the length or severity of the
COVID-19
pandemic or the related response, or the extent to which the disruption may materially impact the Company’s business, consolidated financial position, consolidated results of operations or consolidated cash flows in the future.
In 2020, the
COVID-19
pandemic did not materially impact the Company’s manufacturing facilities or those of the third parties to whom it outsources certain manufacturing processes, the distribution centers where its inventory is managed, or the operations of its logistics and other service providers. The Company also did not see material disruptions or delays in shipments of certain materials or components of its products.
At every stage of the pandemic, the Company has taken decisive and appropriate actions, including a mandatory remote work policy for all employees with the exception of those in manufacturing, distribution, and certain laboratory environments, as well as restrictions on
non-essential
travel and visitors into its facilities. The Company has engaged a medical advisor to guide its policy deployment, and the Company continues to take proactive measures to guard the health of its global employee base, and the safety of all customer interactions. The Company has implemented rigorous protocols to promote a safe work environment in all of its locations around the world and continues to closely monitor and update its multi-phase process that was developed during the year to ensure for the safe return of employees to its physical workplaces as social distancing, governmental requirements and other protocols allow.
The vast majority of the markets the Company serves, most notably the pharmaceutical, biomedical research, food/environmental and clinical markets, have continued to operate at various levels, and the Company is working closely with these customers to facilitate their seamless operation. Over the last several years, the Company has executed on a digital workplace strategy focused on providing modern connectivity and
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collaboration tools to its employees. The Company’s strategic technology investments have enabled it to swiftly meet remote working needs as the
COVID-19
situation has escalated and evolved. From a customer-facing perspective, the Company is leveraging digital demand generation activities, including virtual demos across all regions in which it operates, remote instrument installations, virtual sales seminars, online product training, and a rapid acceleration in
one-on-one
communications over emails, phone and video conferencing.
While the Company initially anticipated that the
COVID-19
pandemic would have the biggest impact on the Company’s financial results in the second quarter of 2020, and future quarters would improve as countries lifted their business restrictions, the new outbreaks of
COVID-19
in the U.S. and elsewhere throughout the world have demonstrated that the
COVID-19
pandemic continues to be fluid with uncertainties and risks remaining across the global economy. The Company took a proactive approach to managing through this unpredictability and implemented a series of cost reduction actions that include salary reductions, furloughs and reductions in
non-essential
spending and other working capital reductions in order to preserve liquidity and enhance financial flexibility. These cost reductions were completed by the end of 2020; however, the Company’s plan will be adjusted accordingly depending on the pace of the recovery and any further lockdowns.
The Company’s operating results are as follows for the years ended December 31, 2020, 2019 and 2018 (dollars in thousands, except per share data):
Year Ended December 31, % change
Revenues:
Costs and operating expenses:
Asset impairments 6,945 — — * * —
Litigation provision (settlement) 1,180 — (426 ) * * * *
Operating income as a % of sales 27.3 % 29.4 % 30.6 %
Net income per diluted common share $ 8.36 $ 8.69 $ 7.65 (4 %) 14 %
** Percentage not meaningful
The Company’s net sales decreased approximately 2% in 2020 as compared to 2019, and decreased 1% in 2019 as compared to 2018. The decline in sales in 2020 can be attributed to the lower customer demand due to interruption in business activities caused by the uncertainties from the
COVID-19 pandemic
across the world. The negative impact of
COVID-19
on our business was more pronounced in the first half of 2020 as the Company’s sales declined 12% as compared to the prior year. In the second half of 2020, our customers began to resume laboratory and manufacturing operations and it resulted in the Company’s second half sales growing 7% as compared to the prior year.
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Foreign currency translation increased sales by less than 1% and decreased sales by 2% in 2020 and 2019, respectively. The Company’s acquisitions of Andrew Alliance (as defined below) and ISS (as defined below) did not have material impacts on sales growth in 2020. Unless otherwise noted, sales growth or decline percentages are presented as compared with the same period in the prior year.
Instrument system sales decreased 8% and 4% in 2020 and 2019, respectively. In 2020, the decrease in instrument system sales was attributable to the weaker demand for our products by our customers due to interruption of business activities and the uncertainty caused by
the COVID-19 pandemic. As
customer demand started to return to normal levels, instrument system sales increased 3% in the second half of 2020 as compared to the prior year period, after having declined 22% in the first half of 2020 compared to the prior year period. In 2019, the decrease in instrument system sales was primarily driven by weaker demand for our products by our customers due to uncertainty caused by macroeconomic conditions and governmental policy changes. Foreign currency translation increased instrument system sales by 1% in 2020 and decreased sales by 1% in 2019. Recurring revenues (combined sales of precision chemistry consumables and services) increased 4% and 3% in 2020 and 2019, respectively, as a result of a larger installed base of customers and higher billing demand for service sales. In 2020, recurring revenues were also impacted by the interruption of business activities and the uncertainty caused by
the COVID-19 pandemic.
As our customers began to resume laboratory and manufacturing operations, recurring revenues increased 10% in the second half of 2020 as compared to the prior year period, after having declined 3% in the first half of 2020 compared to the prior year period. Recurring revenues were positively impacted by foreign currency translation in 2020, which increased sales by 1%; however foreign currency translation negatively impacted sales by 2% in 2019.
Geographically, the sales declines in 2020 were broad-based across the world, except for Europe, and were due to the weaker demand and disruption of business activities caused by
the COVID-19 lockdowns.
Sales in Asia decreased 4% in 2020 and increased 2% in 2019, with foreign currency translation having minimal impact on sales in 2020 and negatively impacting sales by 1% in 2019. In 2020, the sales decline in Asia was primarily driven by the 8% decrease in sales in China due to lower demand caused by the
COVID-19
pandemic. Excluding sales in China, the Company’s 2020 sales were flat with foreign currency translation positively impacting sales by 1%. The decline in the Company’s sales in 2019 was a result of increased sales in the U.S., Canada, Japan and the rest of Asia being offset by a decrease in sales in other geographies on weaker demand for our products due to uncertainty caused by macroeconomic conditions, primarily from Brexit as well as Latin America, and governmental policy changes in China.
Sales in Europe increased 5% in 2020 and decreased 4% in 2019, with foreign currency translation positively impacting sales by 3% in 2020 and negatively impacting sales by 4% in 2019. Sales in the Americas decreased 4% and 1% in 2020 and 2019, respectively, with foreign currency translation having minimal impact on sales in 2020 and negatively impacting sales by 1% in 2019.
Sales to pharmaceutical customers increased 2% and were flat in 2020 and 2019, respectively, with foreign currency translation positively impacting sales by 1% in 2020 and negatively impacting sales by 2% in 2019. Combined sales to industrial customers, which include material characterization, food, environmental and fine chemical markets, declined 2% in both 2020 and 2019, with foreign currency translation positively impacting sales by 1% in 2020. The lower volume of sales to both pharmaceutical and industrial customers in 2020 was primarily due to the disruption in business activities caused
by COVID-19.
Similarly, TA sales declined 8% and 4% in 2020 and 2019, respectively.
Combined sales to academic and governmental customers decreased 16% in 2020 and increased 2% in 2019, with foreign currency translation having minimal impact on sales in 2020 and decreasing sales by 1% in 2019. The decline in sales to academic and governmental customers in 2020 was due to the lower demand for our products and services as the academic and governmental institutions adjusted their spending during the year to mitigate the effects of
the COVID-19 pandemic.
The most significant decline in academic and governmental sales in 2020 occurred in China where sales declined 31% due to government-mandated spending reductions.
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Sales to our academic and governmental customers are highly dependent on when institutions receive funding to purchase our instrument systems and, as such, sales can vary significantly from period to period.
Operating income was $645 million in 2020, a decrease of 9% as compared to 2019. This decrease can be attributed to the decline in sales volumes caused by
the COVID-19 pandemic,
unfavorable manufacturing absorption and unfavorable foreign currency translation. The operating income decline was somewhat mitigated by a series of cost reduction actions that included salary reductions, furloughs and reductions
in non-essential spending
that increased operating income by approximately $103 million in 2020 versus our operating plan. Operating income in 2020 also included $27 million of severance-related costs in connection with a reduction in workforce and lease termination and exit costs.
Operating income decreased 4% in 2019 as compared to 2018. This decrease can be attributed to lower sales volume, the effect of foreign currency translation and $10 million of severance-related costs in connection with a reduction in workforce that occurred in early 2019, offset by lower variable incentive compensation costs.
The Company’s effective tax rates were 14.6%, 12.7% and 13.0% for 2020, 2019 and 2018, respectively. Net income per diluted share was $8.36, $8.69 and $7.65 in 2020, 2019 and 2018, respectively. In 2018, the Company settled a pension plan obligation and incurred a $46 million expense which reduced the net income per diluted share by $0.39.
The Company generated $791 million, $643 million and $604 million of net cash flows from operations in 2020, 2019 and 2018, respectively. The increase in operating cash flow in 2020 was primarily a result of the $103 million reduction in expense from the cost actions implemented and working capital improvements during the year. The increase in operating cash flow in 2019 was primarily a result of payments made in 2018 that did not recur, including $103 million of income tax payments made in the U.S. relating to the Company’s estimated 2017 transition tax liability and 2018 estimated tax payments, a $15 million litigation settlement payment and $11 million of contributions to certain defined benefit pension plans. Included in the 2020 and 2019 net cash flow from operations is $38 million and $29 million, respectively, of income tax payments made in the U.S. in relation to the 2017 transition tax liability. Over the next two years, the Company is required to make annual U.S. federal tax payments of approximately $38 million to tax authorities in connection with the Company’s estimated remaining transition tax liabilities of $365 million under the 2017 Tax Act. The final 60% of the total liability is required to be paid over a three-year period beginning in 2023.
Cash flows used in investing activities included capital expenditures related to property, plant, equipment and software capitalization of $172 million, $164 million and $96 million in 2020, 2019 and 2018, respectively. In January of 2020, the Company acquired all of the outstanding stock of Andrew Alliance, S.A. and its two operating subsidiaries, Andrew Alliance USA, Inc. and Andrew Alliance France, SASU (collectively “Andrew Alliance”), for $80 million, net of cash acquired. The Company had an equity investment in Andrew Alliance that was valued at $4 million and included as part of the total consideration. In December 2020, the Company acquired all of the outstanding stock of Integrated Software Solutions Pty Limited and its two operating subsidiaries, Integrated Software Solutions Limited and Integrated Software Solutions USA, LLC (collectively, “ISS”), for $4 million, net of cash acquired. Neither of these acquisitions had a material effect on the Company’s sales and expenses in 2020.
The cash flows from investing activities in 2020 also included $70 million of capital expenditures related to the expansion of the Company’s precision chemistry consumable operations in the U.S. The Company has incurred $151 million on this facility through the end of 2020 and anticipates spending a total of $215 million to build and equip this
new state-of-the-art
manufacturing facility.
In January 2019, the Company’s Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a
two-year
period. During 2020, 2019 and 2018, the Company repurchased
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0.8 million, 11.1 million and 6.8 million shares of the Company’s outstanding common stock at a cost of $167 million, $2.5 billion and $1.3 billion, respectively, under authorized share repurchase programs. As of December 31, 2020, the Company has a total of $1.5 billion authorized for future repurchases. In December 2020, the Company’s Board of Directors authorized the extension of the share repurchase program through January 21, 2023. While the Company believes that it has the financial flexibility to fund these share repurchases given current cash and investment levels and debt borrowing capacity, as well as to invest in research, technology and business acquisitions to further grow the Company’s sales and profits, the Company has temporarily suspended its share repurchases due to the uncertain business conditions caused by
the COVID-19 pandemic.
Results of Operations
Sales by Geography
Geographic sales information is presented below for the years ended December 31, 2020, 2019 and 2018 (dollars in thousands):
Year Ended December 31, % change
Net Sales:
Asia:
Americas:
In 2020, sales decreased 2% as compared to 2019, as the
COVID-19 pandemic
caused interruptions in business activities and uncertainties that resulted in our customers reducing purchases of our products and services. Foreign currency translation had minimal impact on sales in 2020 and negatively impacted sales by 2% in 2019. The sales declines in 2020 occurred in all geographies and were a result of the weaker demand and disruption of business activities caused by
the COVID-19 lockdowns,
except in Europe where sales increased 5% as compared to the prior year. The most significant decline in sales in 2020 occurred in China, where sales declined 8%, as well as declines of 2% in the U.S. and 13% in the Americas Other region.
In 2019, sales in China were negatively impacted by economic uncertainty caused by certain regulatory changes in our food and pharmaceutical markets. The 4% increase in sales in Japan was driven by instrument systems, primarily to pharmaceutical and academic and governmental customers, as well as foreign currency translation, which increased Japan’s sales by 1% in 2019. Sales growth in Asia Other was due primarily to pharmaceutical and academic and governmental customer classes in 2019. Sales in the U.S. increased by 1% despite large pharmaceutical customers slowing capital spending on our instrument systems. Sales declines in Americas Other and Europe were broad-based across all product and customer classes due to macroeconomic conditions and political instability, except in Europe where sales to academic and governmental customers grew 8%. Sales in Europe were also negatively impacted by the effect of foreign currency translation, which decreased sales 4% in 2019.
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Sales by Trade Class
Net sales by customer class are presented below for the years ended December 31, 2020, 2019 and 2018 (dollars in thousands):
Year Ended December 31, % change
In 2020, sales to pharmaceutical customers increased 2% with foreign currency translation positively impacting sales by 1%. The lower sales volumes to pharmaceutical customers in the first half of 2020 can be attributed to the disruption in business activities caused
by COVID-19, despite
increased demand for our products and services from certain pharmaceutical customers who are
involved with COVID-19 diagnostic testing
and the development of new drugs and therapies. Sales to industrial customers in 2020 declined 2%, which were significantly impacted by the TA sales declines of 8% in 2020. The sales declines to academic and governmental customers were broad-based across all product classes as academic and governmental customers adjusted their spending to mitigate the effects of
the COVID-19 pandemic,
which significantly impacted sales in China.
In 2019, sales to pharmaceutical customers were negatively impacted by the effect of foreign currency translation, which decreased sales to pharmaceutical customers by 2%, as well as a slower release of capital budgets by our customers due to uncertain macroeconomic conditions due to Brexit and regulatory changes in our food and pharmaceutical markets in China. Offsetting those declines was an increase in the need for global access to prescription drugs and the testing of newer and complex biologic drugs. The decline in sales to industrial customers in 2019 was due to weaker demand for our
LC-MS
instruments and also a 4% decline in TA sales. The increase in sales to academic and governmental customers was primarily due to higher instrument system sales.
Waters Products and Services Net Sales
Net sales for Waters products and services were as follows for the years ended December 31, 2020, 2019 and 2018 (dollars in thousands):
Year Ended December 31, % change
Waters products and service sales decreased 1% in 2020 and were flat in 2019. Waters instrument system sales (LC and MS technology-based) decreased 8% in 2020 primarily attributed to the weaker demand for our products and services by our customers due to the disruption and uncertainty caused
by the COVID-19 pandemic.
Precision chemistry consumables sales increased 5% and 3% in 2020 and 2019, respectively, despite the disruption in business activities caused
by COVID-19
in 2020. Waters service sales increased 4% and 3% in 2020 and 2019, respectively, primarily due to increased sales of service plans and higher service demand billings
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to a higher installed base of customers respectively, with sales in 2020 being partially offset by the weaker demand and disruption of business activities caused by
the COVID-19 lockdowns.
The effect of foreign currency translation increased Waters sales by 1% in 2020 and decreased sales by 2% in 2019.
In 2020, Waters sales in Europe and Japan increased 6% and 2%, respectively, with foreign currency translation adding 3% to Waters sales growth in Europe. Waters sales in India increased less than 1%, while all other geographies’ sales declined with the most significant sales decline occurring in China, which was down 9%. In 2019, Waters sales increased 2% in Asia, were flat in the Americas and decreased 3% in Europe, where the effect of foreign currency decreased sales by 4%. Within Asia, Waters sales decreased 1% in China and increased 4% in Japan and 9% in the rest of Asia, excluding India.
TA Product and Services Net Sales
Net sales for TA products and services were as follows for the years ended December 31, 2020 and December 31, 2019 (dollars in thousands):
Year Ended December 31, % change
TA product and service sales declines in 2020 were primarily due to lower customer demand resulting from the
COVID-19 pandemic.
TA’s instrument system sales declined in 2019 primarily due to lower customer demand resulting from macroeconomic conditions, tariff posturing and political instability. TA service sales increased in 2019 due to sales of service plans and billings to a higher installed base of customers. The effect of foreign currency translation had a minimal impact on TA’s sales in both 2020 and 2019.
TA sales declined in all major regions in 2020. In 2019, TA sales decreased 4% in the Americas, 12% in Europe and increased 1% in Asia.
Cost of Sales
Cost of sales were flat in 2020 as compared to 2019, due to lower sales volume, change in sales mix, unfavorable manufacturing absorption and the effect of foreign currency translation increasing cost of sales by 1% in 2020, primarily from the favorable foreign currency translation effect the British Pound had on the Company’s U.K. manufacturing operations.
Cost of sales is affected by many factors, including, but not limited to, foreign currency translation, product mix, product costs of instrument systems and amortization of software platforms. At current foreign currency exchange rates, the Company expects foreign currency translation to slightly increase sales and gross profit during 2021.
Selling and Administrative Expenses
Selling and administrative expenses increased 4% in 2020 and were flat in 2019. The increase in selling and administrative expenses in 2020 can be attributed to the salary merit and incentive compensation increases along with the severance-related costs in connection with a reduction in workforce and lease-termination and exit costs. Severance and lease termination and exit costs were $27 million and $10 million in 2020 and 2019, respectively. Offsetting these increases in selling and administrative expenses were $70 million of savings in 2020, which
includes COVID-19 and
restructuring cost saving actions that reduced planned salaries
and non-essential spending.
The effect of foreign currency translation had minimal impact on selling and administrative expenses in 2020 and decreased selling and administrative expenses by 1% in 2019.
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As a percentage of net sales, selling and administrative expenses were 23.4%, 22.2% and 22.2% for 2020, 2019 and 2018, respectively.
Research and Development Expenses
Research and development expenses decreased 2% in 2020 and were flat in 2019. Research and development expenses in 2020 include $15 million of cost action savings from salary reductions, furloughs and reductions
in non-essential spending.
Research and development expenses in both 2020 and 2019 were impacted by additional headcount, merit compensation and costs associated with new products and the development of new technology initiatives. Foreign currency translation had minimal impact on research and development costs in 2020 and decreased research and development costs by 2% in 2019.
Asset Impairments
During 2020, due to a shift in strategic priorities, the Company recorded a
non-cash
charge of $10 million for the impairment of certain intangible assets associated with the acquisition of Medimass Research Development and Service Kft (“Medimass”). In conjunction with the intangible asset impairment, the Company also reduced its liability for contingent consideration of $3 million during 2020 as the carrying value of this liability is based on the future sales of the Medimass intangible assets that were impaired. See Note 2, Basis of Presentation and Summary of Significant Accounting Policies, under the heading “Asset Impairments” in the Notes to Consolidated Financial Statements for a description of the impairment charge.
Interest Expense, Net
The increase in net interest expense in 2020 can be attributed to lower cash and investment balances in 2020 compared to 2019.
Provision for Income Taxes
The Company’s effective tax rates were 14.6%, 12.7% and 13.0% in 2020, 2019 and 2018, respectively.
The Company’s effective income tax rate differs from the U.S. federal statutory rate each year due to differences in the proportionate amounts of
pre-tax
income recognized in jurisdictions with different effective tax rates and the items discussed below.
The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the U.K. and Singapore, where the statutory tax rates were 21%, 12.5%, 19% and 17%, respectively, as of December 31, 2020. The Company has received a tax exemption on income arising from qualifying activities in Singapore through March 2021, based upon the achievement of certain contractual milestones, which the Company met as of December 31, 2020 and expects to maintain through March 2021. The effect of applying the 0% concessionary income tax rate rather than the statutory tax rate to income arising from qualifying activities in Singapore increased the Company’s net income during the years ended December 31, 2020, 2019 and 2018 by $21 million, $24 million and $28 million, respectively, and increased the Company’s net income per diluted share by $0.33, $0.35 and $0.36, respectively. In addition, the Company has a new Development and Expansion Incentive in Singapore that provides a concessionary income tax rate of 5% on certain types of income for the period of April 1, 2021 through March 31, 2026.
During 2020, the Company’s effective tax rate differed from the 21% U.S. statutory tax rate primarily due to the jurisdictional mix of earnings, a $13 million provision related to the Global Intangible
Low-Taxed
Income (“GILTI”) tax and a tax benefit of $7 million on stock-based compensation.
The 2019 effective tax rate differed from the U.S. federal statutory tax rate primarily due to the jurisdictional mix of earnings, an $11 million provision related to the GILTI tax and a tax benefit of $9 million on stock-based compensation.
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The 2018 effective tax rate differed from the U.S. federal statutory tax rate primarily due to the jurisdictional mix of earnings, a $14 million provision related to the GILTI tax, an $8 million provision for a change in foreign currency exchange rates related to the transition tax, a $9 million benefit related to stock-based compensation and a $6 million net benefit related to the finalization of the impact of the Tax Cuts and Jobs Act (the “2017 Act”).
At the end of 2018, and as a result of the enactment of the 2017 Act, we reevaluated our historic assertion and no longer considered undistributed earnings from foreign subsidiaries to be indefinitely reinvested. The Company recorded a tax provision of $3 million, $3 million and $4 million for 2020, 2019 and 2018, respectively, for future withholding taxes and U.S. state taxes on the repatriation of 2020, 2019 and 2018 undistributed earnings.
The Company’s effective tax rate is influenced by many significant factors, including, but not limited to, the wide range of income tax rates in jurisdictions in which the Company operates; sales volumes and profit levels in each tax jurisdiction; changes in tax laws, tax rates and policies; the outcome of various ongoing tax audit examinations; and the impact of foreign currency transactions and translation. As a result of variability in these factors, the Company’s effective tax rates in the future may not be similar to the effective tax rates for the current or prior years, or for previously forecasted periods.
Liquidity and Capital Resources
Condensed Consolidated Statements of Cash Flows (in thousands):
Year Ended December 31,
Asset impairments 6,945 — —
Change in accounts payable and other current liabilities 140,598 9,784 (81,663 )
Cash Flow Provided By Operating Activities
Net cash provided by operating activities was $791 million, $643 million and $604 million in 2020, 2019 and 2018, respectively. The changes within net cash provided by operating activities include the following significant changes in the sources and uses of net cash provided by operating activities, aside from the changes in net income:
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Cash (Used in) Provided By Investing Activities
Net cash used in investing activities totaled $264 million in 2020. Net cash provided by investing activities totaled $769 million and $1,683 million in 2019 and 2018, respectively. Additions to fixed assets and capitalized software were $172 million, $164 million and $96 million in 2020, 2019 and 2018, respectively. In February 2018, the Company’s Board of Directors approved expanding its chemistry synthesis operations in the U.S. The Company anticipates spending an estimated $215 million to build and equip this new
state-of-the-art
manufacturing facility, which will be paid for with existing cash, investments and debt capacity. Through December 31, 2020, the Company has incurred $151 million of costs for this facility.
During 2020, 2019 and 2018, the Company purchased $26 million, $37 million and $1.0 billion of investments, respectively. During 2020, 2019 and 2018, $21 million, $978 million and $2.8 billion of investments matured, respectively. The majority of the proceeds received in 2019 and 2018 were repatriated into the U.S. at lower income tax rates as a result of the 2017 Tax Act and used to reduce the Company’s debt and to repurchase shares.
Asset and business acquisitions, net of cash acquired, were $81 million and $31 million during 2020 and 2018, respectively. There were no business acquisitions in 2019. During 2020, 2019 and 2018, the Company made $6 million, $9 million and $8 million of investments in unaffiliated companies, respectively.
In January 2020, the company entered into a definitive agreement to acquire Andrew Alliance, an innovator in specialty laboratory automation technology, including software and robotics for approximately $80 million in cash. The Company had an equity investment in Andrew Alliance that was valued at $4 million and included as part of the total consideration. This acquisition did not have a material effect on the Company’s sales and expenses in 2020.
In December 2020, the company entered into a definitive agreement to acquire ISS, a provider of clinical laboratory software systems, for $4 million in cash. This acquisition did not have a material effect on the Company’s sales and expenses in 2020.
Cash Used in Financing Activities
In November 2017, the Company entered into a credit agreement (the “2017 Credit Agreement”), which provides for a $1.5 billion revolving facility and a $300 million term loan. The revolving facility and term loan both mature on November 30, 2022 and require no scheduled prepayments before that date.
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The interest rates applicable to the 2017 Credit Agreement are, at the Company’s option, equal to either the alternate base rate (which is a rate per annum equal to the greatest of (a) the prime rate in effect on such day, (b) the Federal Reserve Bank of New York Rate on such day plus 1/2 of 1% per annum and (c) the adjusted LIBO rate on such day (or if such day is not a business day, the immediately preceding business day) for a deposit in U.S. dollars with a maturity of one month plus 1% per annum) or the applicable 1, 2, 3 or 6 month adjusted LIBO rate or EURIBO rate for Euro-denominated loans, in each case, plus an interest rate margin based upon the Company’s leverage ratio, which can range between 0 and 12.5 basis points for alternate base rate loans and between 80 and 112.5 basis points for LIBO rate or EURIBO rate loans. The facility fee on the 2017 Credit Agreement ranges between 7.5 and 25 basis points per annum, based on the leverage ratio, of the amount of the revolving facility commitments and the outstanding term loan. The 2017 Credit Agreement requires that the Company comply with an interest coverage ratio test of not less than 3.50:1 as of the end of any fiscal quarter for any period of four consecutive fiscal quarters and a leverage ratio test of not more than 3.50:1 as of the end of any fiscal quarter. In addition, the 2017 Credit Agreement includes negative covenants, affirmative covenants, representations and warranties and events of default that are customary for investment grade credit facilities.
Interest on the Company’s fixed rate senior unsecured notes is payable semi-annually each year. Interest on the floating rate senior unsecured notes is payable quarterly. The Company may prepay all or some of the senior unsecured notes at any time in an amount not less than 10% of the aggregate principal amount outstanding, plus the applicable make-whole amount or prepayment premium for Series H and J senior unsecured notes. In the event of a change in control of the Company (as defined in the note purchase agreement), the Company may be required to prepay the senior unsecured notes at a price equal to 100% of the principal amount thereof, plus accrued and unpaid interest. These senior unsecured notes require that the Company comply with an interest coverage ratio test of not less than 3.50:1 for any period of four consecutive fiscal quarters and a leverage ratio test of not more than 3.50:1 as of the end of any fiscal quarter. In addition, these senior unsecured notes include customary negative covenants, affirmative covenants, representations and warranties and events of default.
The Company’s net debt borrowings decreased by $325 million in 2020, increased by $535 million in 2019 and decreased by $850 million in 2018. As of December 31, 2020, the Company had a total of $1.4 billion in outstanding debt, which consisted of $960 million in outstanding senior unsecured notes $300 million borrowed under a term loan and $100 million borrowed under a revolving credit facility, with both the term loan and revolving credit facilities under the 2017 Credit Agreement. As of December 31, 2020, the Company had a total amount available to borrow under the 2017 Credit Agreement of $1.4 billion after outstanding letters of credit. As of December 31, 2020, the Company was in compliance with all debt covenants.
As of December 31, 2020, the Company has entered into three-year interest rate cross-currency swap derivative agreements with a notional value of $560 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. As a result of entering into these agreements, the Company lowered its net interest expense by $15 million, $12 million and $3 million during 2020, 2019 and 2018, respectively. The Company anticipates that these swap agreements will lower net interest expense by approximately $11 million annually in 2021 and $1 million in 2022 as the three-year term of the agreements expire.
In January 2019, the Company’s Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a
two-year
period. During 2020, 2019 and 2018, the Company repurchased 0.8 million, 11.1 million and 6.8 million shares of the Company’s outstanding common stock at a cost of $167 million, $2.5 billion and $1.3 billion, respectively, under the January 2019 authorization and other previously announced programs. In December 2020, the Company’s Board of Directors authorized the extension of the share repurchase program through January 21, 2023. In addition, the Company repurchased $9 million, $8 million and $10 million of common stock related to the vesting of restricted stock units during the years ended December 31, 2020, 2019 and 2018, respectively.
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The Company received $66 million, $54 million and $52 million of proceeds from the exercise of stock options and the purchase of shares pursuant to the Company’s employee stock purchase plan in 2020, 2019 and 2018, respectively.
The Company had cash, cash equivalents and investments of $443 million as of December 31, 2020. The majority of the Company’s cash and cash equivalents are generated from foreign operations, with $364 million held by foreign subsidiaries at December 31, 2020, of which $254 million was held in currencies other than U.S. dollars. While the Company believes it has sufficient levels of cash flow and access to its existing cash and cash equivalents, as well as the ability to raise funds from external sources and the borrowing capacity from existing, committed credit facilities, to fund operations and capital expenditures, service debt interest, finance potential acquisitions and continue the authorized stock repurchase program in the U.S., we have temporarily suspended our share repurchases due to the uncertain business conditions caused by the
COVID-19
pandemic.
Management believes, as of the date of this report, that the Company’s financial position, along with expected future cash flows from earnings based on historical trends and the ability to raise funds from external sources and the borrowing capacity from existing, committed credit facilities, will be sufficient to service debt and fund working capital and capital spending requirements, authorized share repurchase amounts and potential acquisitions for at least the next twelve months.
Contractual Obligations and Commercial Commitments
The following is a summary of the Company’s known contractual obligations as of December 31, 2020 (in thousands):
Payments Due by Year (1)
Notes payable and debt $ 150,000 $ 150,000 $ — $ — $ — $ — $ — $ —
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The following is a summary of the Company’s known commercial commitments as of December 31, 2020 (in thousands):
Amount of Commitments Expiration Per Period
Letters of credit $ 1,961 $ 1,961 $ — $ — $ — $ — $ — $ —
From time to time, the Company and its subsidiaries are involved in various litigation matters arising in the ordinary course of business. The Company believes it has meritorious arguments in its current litigation matters and believes any outcome, either individually or in the aggregate, will not be material to the Company’s financial position or results of operations.
The Company has long-term liabilities for deferred employee compensation, including pension and supplemental executive retirement plans. The payments related to the supplemental retirement plan are not included above since they are dependent upon when the employee retires or leaves the Company and whether the employee elects
lump-sum
or annuity payments. During fiscal year 2021, the Company expects to contribute approximately $3 million to $6 million to the Company’s defined benefit plans.
The Company has contingent consideration for an earnout pertaining to its December 2020 acquisition of the net assets of ISS. The earnout payments are not included above since they are dependent upon many factors that cannot be predicted with any certainty. The estimated fair value of the contingent consideration as of December 31, 2020 is $1 million.
The Company licenses certain technology and software from third parties. Future minimum license fees payable under existing license agreements as of December 31, 2020 are immaterial. The Company enters into licensing arrangements with third parties that require future milestone or royalty payments contingent upon future events. Upon the achievement of certain milestones in existing agreements, the Company could make additional future payments of up to $7 million, as well as royalties on future net sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table above.
The Company has not paid any dividends and has no plans, at this time, to pay any dividends in the future.
Off-Balance
Sheet Arrangements
The Company has not created, and is not party to, any special-purpose or
off-balance
sheet entities for the purpose of raising capital, incurring debt or operating parts of its business that are not consolidated (to the extent of the Company’s ownership interest therein) into the consolidated financial statements. The Company has not entered into any transactions with unconsolidated entities whereby it has subordinated retained interests, derivative instruments or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company.
The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company’s business partners or customers, in connection with patent, copyright or other intellectual property infringement claims by any third party with
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respect to its current products, as well as claims relating to property damage or personal injury resulting from the performance of services by the Company or its subcontractors. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, the Company’s costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and management accordingly believes the estimated fair value of these agreements is immaterial.
Critical Accounting Policies and Estimates
Summary
The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results of operations that require management to make estimates about matters that are highly uncertain and that would have a material impact on the Company’s results of operations given changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that reasonably could have been used in the current period. On an ongoing basis, the Company evaluates its policies and estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed 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. Actual amounts may differ from these estimates under different assumptions or conditions. There are other items within the Company’s consolidated financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could potentially have a material impact on the Company’s consolidated financial statements.
Revenue Recognition
The Company recognizes revenue upon transfer of control of promised products and services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company generally enters into contracts that include a combination of products and services. Revenue is allocated to distinct performance obligations and is recognized net of allowances for returns and discounts.
The Company recognizes revenue on product sales at the time control of the product transfers to the customer. In substantially all of the Company’s arrangements, title of the product transfers at shipping point and, as a result, the Company determined control transfers at the point of shipment. In more limited cases, there are destination-based shipping terms and, thus, control is deemed to transfer when the products arrive at the customer site. All incremental costs of obtaining a contract are expensed as and when incurred if the expected amortization period of the asset that would have been recognized is one year or less. Shipping and handling costs are included as a component of cost of sales. In situations where the control of the goods transfers prior to the completion of the Company’s obligation to ship the products to its customers, the Company has elected the practical expedient to account for the shipping services as a fulfillment cost. Accordingly, such costs are recognized when control of the related goods is transferred to the customer. In more rare situations, the Company has revenue associated with products that contain specific customer acceptance criteria and the related revenue is not recognized before the customer acceptance criteria are satisfied. The Company elected to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with specific revenue-producing transactions and collected by the Company from a customer.
Generally, the Company’s contracts for products include a performance obligation related to installation. The Company has determined that the installation represents a distinct performance obligation and revenue is recognized separately upon the completion of installation. The Company determines the amount of the transaction price to allocate to the installation service based on the standalone selling price of the product and the service, which requires judgment. The Company determines the relative standalone selling price of installation based upon a number of factors, including hourly service billing rates and estimated installation hours. In developing these estimates, the Company considers past history, competition, billing rates of current services and other factors.
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The Company has sales from standalone software, which are included in instrument systems revenue. These arrangements typically include software licenses and maintenance contracts, both of which the Company has determined are distinct performance obligations. The Company determines the amount of the transaction price to allocate to the license and maintenance contract based on the relative standalone selling price of each performance obligation. Software license revenue is recognized at the point in time when control has been transferred to the customer. The revenue allocated to the software maintenance contract is recognized on a straight-line basis over the maintenance period, which is the contractual term of the contract, as a time-based measure of progress best reflects the Company’s performance in satisfying this obligation. Unspecified rights to software upgrades are typically sold as part of the maintenance contract on a
when-and-if-available
basis.
Payment terms and conditions vary among the Company’s revenue streams, although terms generally include a requirement of payment within 30 to 60 days of product shipment. Prior to providing payment terms to customers, an evaluation of their credit risk is performed. Returns and customer credits are infrequent and insignificant and are recorded as a reduction to sales. Rights of return are not included in sales arrangements and, therefore, there is minimal variable consideration included in the transaction price of our products.
Service revenue includes (i) service and software maintenance contracts and (ii) service calls (time and materials). Instrument service contracts and software maintenance contracts are typically annual contracts, which are billed at the beginning of the contract or maintenance period. The amount of the service and software maintenance contract is recognized on a straight-line basis to revenue over the maintenance service period, which is the contractual term of the contract, as a time-based measure of progress best reflects the Company’s performance in satisfying this obligation. There are no deferred costs associated with the service contract, as the cost of the service is recorded when the service is performed. Service calls are recognized to revenue at the time a service is performed.
The Company’s deferred revenue liabilities at December 31, 2020 of $240 million on the consolidated balance sheets consist of the obligation on instrument service contracts and customer payments received in advance, prior to transfer of control of the instrument. The Company records deferred revenue primarily related to its service contracts, where consideration is billable at the beginning of the service period.
Allowance for credit losses on Accounts Receivable
The Company adopted new accounting guidance regarding the accounting for credit losses as of January 1, 2020 using a modified retrospective transition approach that was applied to our trade receivable balances. The allowance for credit losses policies described below were effective as of January 1, 2020.
The Company maintains allowances for expected credit losses based on applying a historical loss rate to trade receivable aging balances to estimate a general reserve balance on current receivables along with an additional adjustment for any specific receivables with known or anticipated issues affecting the likelihood of recovery. The historical loss rate is calculated by comparing the prior year actual sales and accounts receivable balances to estimate the period of collection of trade receivables by aging category. This collection information by aging category is then compared to write offs over the same prior year period to estimate the amount of allowance that is attributable to each category of our accounts receivable aging. Past due balances with a probability of default based on historical data as well as relevant available forward-looking information are included in the specific adjustment. If the financial condition of the Company’s customers were to deteriorate beyond what is estimated in the current expected credit loss model, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company does not request collateral from its customers, but collectibility is enhanced through the use of credit card payments and letters of credit. The Company assesses collectibility based on a number of factors, including, but not limited to, past transaction history with the customer, the credit-worthiness of the customer, industry trends and the macro-economic environment. Historically, the Company has not experienced significant credit losses. Sales returns and allowances are estimates of future product returns related to current period revenue. Material differences may
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result in the amount and timing of revenue for any period if management made different judgments or utilized different estimates for sales returns and allowances for doubtful accounts. The Company’s accounts receivable balance at December 31, 2020 was $573 million, net of allowances for expected credit losses of $14 million.
Loss Provision on Inventory
The Company values all of its inventories at the lower of cost or net realizable value on a
first-in,
first-out
basis (“FIFO”). The Company estimates revisions to its inventory valuations based on technical obsolescence, historical demand, projections of future demand, including that in the Company’s current backlog of orders, and industry and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional write-downs may be required. The Company’s inventory balance at December 31, 2020 was recorded at its net realizable value of $304 million, which is net of write-downs of $29 million.
Long-Lived Assets, Intangible Assets and Goodwill
The Company assesses the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger impairment include, but are not limited to, the following:
When the Company determines that the carrying value of an individual intangible asset, long-lived asset or goodwill may not be recoverable based upon the existence of one or more of the above indicators, an estimate of undiscounted future cash flows produced by that intangible asset, long-lived asset or goodwill, including its eventual residual value, is compared to the carrying value to determine whether impairment exists. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the asset is written-down to its estimated fair value. Net intangible assets, long-lived assets and goodwill amounted to $259 million, $494 million and $444 million, respectively, as of December 31, 2020.
The Company performs annual impairment reviews of its goodwill on December 31 of each year. For goodwill impairment review purposes, the Company has two reporting units: Waters and TA. The Company currently does not expect to record an impairment charge in the foreseeable future as the estimated fair values of the reporting units significantly exceeds the carrying value of the reporting units; however, there can be no assurance that, at the time future reviews are completed, a material impairment charge will not be recorded. The factors that could cause a material goodwill impairment charge in the future include, but are not limited to, the following:
• significant adverse change in legal factors or business climate;
• adverse action or assessment by a regulator; and
• unanticipated competition.
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Income Taxes
As part of the process of preparing the consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves the Company estimating its income taxes, taking into account the amount, timing and character of taxable income, tax deductions and credits and assessing changes in tax laws, regulations, agreements and treaties. Differing treatment of items for tax and accounting purposes, such as depreciation, amortization and inventory reserves, result in deferred tax assets and liabilities, which are included within the consolidated balance sheets. In the event that actual results differ from these estimates, or the Company adjusts these estimates in future periods, such changes could materially impact the Company’s financial position and results of operations.
The accounting standards for income taxes require that a company continually evaluate the necessity of establishing or changing a valuation allowance for deferred tax assets depending on whether it is more likely than not that the actual benefit of those assets will be realized in future periods.
Uncertain Tax Positions
The Company accounts for its uncertain tax return positions in accordance with the accounting standards for income taxes, which require financial statement reporting of the expected future tax consequences of uncertain tax positions on the presumption that all concerned tax authorities possess full knowledge of those tax positions, as well as all of the pertinent facts and circumstances, but prohibit any discounting of unrecognized tax benefits associated with those positions for the time value of money. The Company classified interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes. At December 31, 2020, the Company had unrecognized tax benefits, excluding interest and penalties, of $29 million.
The Company has a tax exemption in Singapore on certain types of income through March 2021, based upon the achievement and continued satisfaction of certain operational and financial milestones, which the Company met as of December 31, 2020 and expects to maintain through March 2021. These milestones include the following types of objectives: reaching and maintaining annual revenue and business spending targets; meeting capital expenditures targets; attaining and sustaining employment targets; and establishing a local research and development and service center. Currently, the Company has determined that it is more likely than not to realize the tax exemption in Singapore and, accordingly, has not recognized any reserves for unrecognized tax benefits on its balance sheet related to this exemption. In the event that any of the milestone targets were not met, the Company would not be entitled to the tax exemption on income earned in Singapore dating back to the start date of the agreement (April 1, 2016), and all the tax benefits previously recognized would be reversed, resulting in the recognition of income tax expense equal to the statutory tax of 17% on income earned during that period.
In addition, the Company has a new Development and Expansion Incentive in Singapore that provides a concessionary income tax rate of 5% on certain types of income for the period April 1, 2021 through March 31, 2026. This new incentive has similar requirements for business spending targets, attaining and sustaining employment targets and performance of certain research and manufacturing activities.
Warranty
Product warranties are recorded at the time revenue is recognized for certain product shipments. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s previous estimates, revisions to the estimated warranty liability would be required. At December 31, 2020, the Company’s warranty liability was $11 million.
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Litigation
As described in Part I, Item 3, Legal Proceedings, of this
Form 10-K,
the Company is a party to various pending litigation matters. With respect to each pending claim, management determines whether it can reasonably estimate whether a loss is probable and, if so, the probable range of that loss. If and when management has determined, with respect to a particular claim, both that a loss is probable and that it can reasonably estimate the range of that loss, the Company records a charge equal to either its best estimate of that loss or the lowest amount in that probable range of loss. The Company will disclose additional exposures when the range of loss is subject to considerable uncertainty.
Pension and Other Retirement Benefits
In 2018, the Company settled its defined benefit pension plan in the U.S. As a result of this settlement, the Company’s defined benefit pension obligations were significantly reduced in 2018 and 2019. The Company still maintains a number of smaller defined benefit pension plans and other retirement benefits throughout the world. Assumptions used in determining projected benefit obligations and the fair values of plan assets for the Company’s remaining less significant pension plans and other retirement benefits are evaluated periodically by management. Changes in assumptions are based on relevant Company data. Critical assumptions, such as the discount rate used to measure the benefit obligations and the expected long-term rate of return on plan assets, are evaluated and updated annually. The Company has assumed that the weighted-average expected long-term rate of return on plan assets will be 6.25% for its U.S. benefit plans and 2.99% for its
non-U.S.
benefit plans.
At the end of each year, the Company determines the discount rate that reflects the current rate at which the pension liabilities could be effectively settled. The Company utilized Milliman’s Bond Matching model to determine the discount rate for its U.S. benefit plans. The Company determined the discount rate for its
non-U.S.
benefit plans based on the analysis of the Mercer Pension Discount Curve for high quality investments as of December 31, 2020 that best matched the timing of the plan’s future cash flows for the period to maturity of the pension benefits. Once the interest rates were determined, the plan’s cash flow was discounted at the spot interest rate back to the measurement date. At December 31, 2020, the Company determined the weighted-average discount rate to be 2.25% for the U.S. benefit plans and 1.12% for the
non-U.S.
benefits plans.
A
one-quarter
percentage point increase in the assumed long-term rate of return would decrease the Company’s net periodic benefit cost by less than $1 million. A
one-quarter
percentage point increase in the discount rate would decrease the Company’s net periodic benefit cost by less than $1 million.
Stock-based Compensation
The accounting standards for stock-based compensation require that all share-based payments to employees be recognized in the statements of operations based on their fair values. The Company has used the Black-Scholes option pricing model and Monte Carlo simulation model to determine the fair value of its stock option awards and performance stock unit awards, respectively. Under the fair-value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating stock price volatility and employee stock option exercise behaviors. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest, the amount of the expense has been reduced for estimated forfeitures. These accounting standards require forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If factors change and the Company employs different assumptions in the application of these accounting standards, the compensation expense that the Company records in future periods may differ significantly from what the Company has recorded in the current period. The Company recognizes the expense using the straight-line attribution method.
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As of December 31, 2020, unrecognized compensation costs and related weighted-average lives over which the costs will be amortized were as follows (in millions):
UnrecognizedCompensationCosts Weighted-AverageLife in Years
Stock options $ 22 3.3
Restricted stock units 42 3.3
Performance stock units 9 1.9
Restricted stock — —
Business Combinations and Asset Acquisitions
The Company accounts for business acquisitions under the accounting standards for business combinations. The results of each acquisition are included in the Company’s consolidated results as of the acquisition date and the purchase price of an acquisition is allocated to tangible and intangible assets and assumed liabilities based on their estimated fair values. Any excess of the fair value consideration transferred over the estimated fair values of the net assets acquired is recognized as goodwill. Acquired
in-process
research and development (“IPR&D”) included in a business combination is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred and acquired IPR&D is tested for impairment annually until completion of the acquired programs. Upon commercialization, this indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life, subject to periodic impairment reviews. If the research and development project is abandoned, the indefinite-lived asset is charged to expense. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred.
The Company also acquires intellectual property through licensing arrangements. These arrangements often require upfront payments and may include additional milestone or royalty payments, contingent upon certain future events. IPR&D acquired in an asset acquisition (as opposed to a business combination) is expensed immediately unless there is an alternative future use. Subsequent payments made for the achievement of milestones are evaluated to determine whether they have an alternative future use or should be expensed. Payments made to third parties subsequent to commercialization are capitalized and amortized over the remaining useful life of the related asset, and are classified as intangible assets.
Recent Accounting Standard Changes and Developments
Information regarding recent accounting standard changes and developments is incorporated by reference from Part II, Item 8, Financial Statements and Supplementary Data, of this document and should be considered an integral part of this Item 7. See Note 2 in the Notes to the Consolidated Financial Statements for recently adopted and issued accounting standards.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
Derivative Transactions
The Company is a global company that operates in over 35 countries and, as a result, the Company’s net sales, cost of sales, operating expenses and balance sheet amounts are significantly impacted by fluctuations in foreign currency exchange rates. The Company is exposed to currency price risk on foreign currency exchange rate fluctuations when it translates its
non-U.S.
dollar foreign subsidiaries’ financial statements into U.S. dollars, and when any of the Company’s subsidiaries purchase or sell products or services in a currency other than its own currency.
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The Company’s principal strategies in managing exposures to changes in foreign currency exchange rates are to (1) naturally hedge the foreign-currency-denominated liabilities on the Company’s balance sheet against corresponding assets of the same currency, such that any changes in liabilities due to fluctuations in foreign currency exchange rates are typically offset by corresponding changes in assets and (2) mitigate foreign exchange risk exposure of international operations by hedging the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. The Company presents the derivative transactions in financing activities in the statement of cash flows.
Foreign Currency Exchange Contracts
The Company does not specifically enter into any derivatives that hedge foreign-currency-denominated operating assets, liabilities or commitments on its balance sheet, other than a portion of certain third-party accounts receivable and accounts payable, and the Company’s net worldwide intercompany receivables and payables, which are eliminated in consolidation. The Company periodically aggregates these net worldwide balances by currency and then enters into foreign currency exchange contracts that mature within 90 days to hedge a portion of the remaining balance to minimize some of the Company’s currency price risk exposure. The foreign currency exchange contracts are not designated for hedge accounting treatment. Principal hedged currencies include the Euro, Japanese yen, British pound, Mexican peso and Brazilian real.
Interest Rate Cross-Currency Swap Agreements
As of December 31, 2020, the Company has entered into three-year interest rate cross-currency swap derivative agreements with a notional value of $560 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. Under hedge accounting, the change in fair value of the derivative that relates to changes in the foreign currency spot rate are recorded in the currency
translation adjustment in other comprehensive income and remain in accumulated comprehensive income in stockholders’ equity (deficit) until the sale or substantial liquidation of the foreign operation. The difference between the interest rate received and paid under the interest rate cross-currency swap derivative agreement is recorded in interest income in the statement of operations.
The Company’s foreign currency exchange contracts and interest rate cross-currency swap agreements included in the consolidated balance sheets are classified as follows (in thousands):
NotionalValue FairValue NotionalValue FairValue
Foreign currency exchange contracts:
Interest rate cross-currency swap agreements:
Accumulated other comprehensive loss (income) $ 44,996 $ (4,485 )
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The following is a summary of the activity included in the statements of comprehensive income related to the foreign currency exchange contracts (in thousands):
FinancialStatementClassification
Year Ended December 31,
Foreign currency exchange contracts:
Unrealized gains (losses) on open contracts Cost of sales 1,663 (1,292 ) (105 )
Interest rate cross-currency swap agreements:
Assuming a hypothetical adverse change of 10% in
year-end
exchange rates (a strengthening of the U.S. dollar), the fair market value of the foreign currency exchange contracts outstanding as of December 31, 2020 would decrease
pre-tax
earnings by approximately $9 million. Assuming a hypothetical adverse change of 10% in
year-end
exchange rates (a strengthening of the U.S. dollar), the fair market value of the interest rate cross-currency swap agreements outstanding as of December 31, 2020 would increase by approximately $56 million and would be recorded to foreign currency translation in other comprehensive income within stockholders’ equity (deficit). The related impact on interest income would not have a material effect on
pre-tax
earnings.
The Company’s cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. The Company’s cash equivalents represent highly liquid investments, with original maturities of 90 days or less, primarily in bank deposits, U.S. treasury bill money market funds and commercial paper. As of December 31, 2020, the carrying value of the Company’s cash and cash equivalents approximated fair value.
The Company is exposed to the risk of interest rate fluctuations from the investments of cash generated from operations. Investments with maturities greater than 90 days are classified as investments, and are held primarily in U.S. dollar-denominated treasury bills and commercial paper, bank deposits and corporate debt securities. As of December 31, 2020, the Company estimates that a hypothetical adverse change of 100 basis points across all maturities would not have a material effect on the fair market value of its portfolio.
The Company is also exposed to the risk of exchange rate fluctuations. The Company maintains cash balances in various operating accounts in excess of federally insured limits, and in foreign subsidiary accounts in currencies other than the U.S. dollar. As of December 31, 2020 and 2019, $364 million out of $443 million and $249 million out of $337 million, respectively, of the Company’s total cash, cash equivalents and investments were held by foreign subsidiaries. In addition, $254 million out of $443 million and $176 million out of $337 million of cash, cash equivalents and investments were held in currencies other than the U.S. dollar at December 31, 2020 and 2019, respectively. As of December 31, 2020, the Company had no holdings in auction rate securities or commercial paper issued by structured investment vehicles.