UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 30, 2019
or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File Number: 01-14010
Waters Corporation
(Exact name of registrant as specified in its charter)
Delaware | 13-3668640 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
34 Maple Street
Milford, Massachusetts 01757
(Address, including zip code, of principal executive offices)
(508) 478-2000
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of large accelerated filer, accelerated filer, smaller reporting company, and emerging growth company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |||
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
Common Stock, par value $0.01 per share | WAT | New York Stock Exchange, Inc. |
Indicate the number of shares outstanding of the registrants common stock as of April 26, 2019: 69,475,245
WATERS CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
WATERS CORPORATION AND SUBSIDIARIES
(unaudited)
March 30, 2019 | December 31, 2018 | |||||||
ASSETS | (In thousands, except per share data) | |||||||
Current assets: | ||||||||
Cash and cash equivalents |
$ | 684,970 | $ | 796,280 | ||||
Investments |
482,293 | 938,944 | ||||||
Accounts receivable, net |
508,285 | 568,316 | ||||||
Inventories |
333,308 | 291,569 | ||||||
Other current assets |
68,935 | 68,054 | ||||||
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Total current assets |
2,077,791 | 2,663,163 | ||||||
Property, plant and equipment, net | 355,965 | 343,083 | ||||||
Intangible assets, net | 243,415 | 246,902 | ||||||
Goodwill | 356,632 | 355,614 | ||||||
Operating lease assets | 94,680 | | ||||||
Other assets | 121,245 | 118,664 | ||||||
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Total assets |
$ | 3,249,728 | $ | 3,727,426 | ||||
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: | ||||||||
Notes payable and debt |
$ | 100,263 | $ | 178 | ||||
Accounts payable |
72,367 | 68,168 | ||||||
Accrued employee compensation |
31,563 | 64,545 | ||||||
Deferred revenue and customer advances |
222,263 | 164,965 | ||||||
Current operating lease liabilities |
26,926 | | ||||||
Accrued treasury stock repurchases |
25,208 | 23,005 | ||||||
Accrued income taxes |
19,854 | 22,943 | ||||||
Accrued warranty |
11,462 | 12,300 | ||||||
Other current liabilities |
93,373 | 92,827 | ||||||
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Total current liabilities |
603,279 | 448,931 | ||||||
Long-term liabilities: | ||||||||
Long-term debt |
1,048,283 | 1,148,172 | ||||||
Long-term income tax liabilities |
431,224 | 430,866 | ||||||
Long-term operating lease liabilities |
67,788 | | ||||||
Long-term portion of retirement benefits |
56,376 | 55,853 | ||||||
Other long-term liabilities |
75,036 | 76,346 | ||||||
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Total long-term liabilities |
1,678,707 | 1,711,237 | ||||||
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Total liabilities |
2,281,986 | 2,160,168 | ||||||
Commitments and contingencies (Notes 6, 7, 8 and 12) | ||||||||
Stockholders equity: | ||||||||
Preferred stock, par value $0.01 per share, 5,000 shares authorized, none issued at March 30, 2019 and December 31, 2018 |
| | ||||||
Common stock, par value $0.01 per share, 400,000 shares authorized, 160,825 and 160,472 shares issued, 70,136 and 73,115 shares outstanding at March 30, 2019 and December 31, 2018, respectively |
1,608 | 1,605 | ||||||
Additional paid-in capital |
1,872,216 | 1,834,741 | ||||||
Retained earnings |
6,104,191 | 5,995,205 | ||||||
Treasury stock, at cost, 90,689 and 87,357 shares at March 30, 2019 and December 31, 2018, respectively |
(6,901,629 | ) | (6,146,322 | ) | ||||
Accumulated other comprehensive loss |
(108,644 | ) | (117,971 | ) | ||||
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Total stockholders equity |
967,742 | 1,567,258 | ||||||
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Total liabilities and stockholders equity |
$ | 3,249,728 | $ | 3,727,426 | ||||
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The accompanying notes are an integral part of the interim consolidated financial statements.
3
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
(In thousands, except per share data) | ||||||||
Revenues: |
||||||||
Product sales |
$ | 320,503 | $ | 339,117 | ||||
Service sales |
193,359 | 191,553 | ||||||
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Total net sales |
513,862 | 530,670 | ||||||
Costs and operating expenses: |
||||||||
Cost of product sales |
132,390 | 140,466 | ||||||
Cost of service sales |
88,641 | 80,955 | ||||||
Selling and administrative expenses |
134,339 | 130,407 | ||||||
Research and development expenses |
35,060 | 34,480 | ||||||
Purchased intangibles amortization |
2,281 | 1,659 | ||||||
Litigation settlement |
| (1,672 | ) | |||||
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Total costs and operating expenses |
392,711 | 386,295 | ||||||
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Operating income |
121,151 | 144,375 | ||||||
Other (expense) income |
(525 | ) | 346 | |||||
Interest expense |
(11,563 | ) | (13,838 | ) | ||||
Interest income |
8,315 | 9,666 | ||||||
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Income before income taxes |
117,378 | 140,549 | ||||||
Provision for income taxes |
8,392 | 28,598 | ||||||
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Net income |
$ | 108,986 | $ | 111,951 | ||||
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Net income per basic common share |
$ | 1.52 | $ | 1.42 | ||||
Weighted-average number of basic common shares |
71,704 | 78,883 | ||||||
Net income per diluted common share |
$ | 1.51 | $ | 1.40 | ||||
Weighted-average number of diluted common shares and equivalents |
72,415 | 79,715 |
The accompanying notes are an integral part of the interim consolidated financial statements.
4
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
(In thousands) | ||||||||
Net income |
$ | 108,986 | $ | 111,951 | ||||
Other comprehensive income: |
||||||||
Foreign currency translation |
7,522 | 23,913 | ||||||
Unrealized gains (losses) on investments before income taxes |
2,344 | (2,976 | ) | |||||
Income tax (expense) benefit |
(547 | ) | 93 | |||||
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Unrealized gains (losses) on investments, net of tax |
1,797 | (2,883 | ) | |||||
Retirement liability adjustment before reclassifications |
(61 | ) | (385 | ) | ||||
Amounts reclassified to other (expense) income |
93 | 907 | ||||||
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Retirement liability adjustment before income taxes |
32 | 522 | ||||||
Income tax expense |
(24 | ) | (116 | ) | ||||
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Retirement liability adjustment, net of tax |
8 | 406 | ||||||
Other comprehensive income |
9,327 | 21,436 | ||||||
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Comprehensive income |
$ | 118,313 | $ | 133,387 | ||||
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The accompanying notes are an integral part of the interim consolidated financial statements.
5
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Cash flows from operating activities: | (In thousands) | |||||||
Net income |
$ | 108,986 | $ | 111,951 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Stock-based compensation |
9,941 | 9,892 | ||||||
Deferred income taxes |
1,442 | 1,071 | ||||||
Depreciation |
12,006 | 16,083 | ||||||
Amortization of intangibles |
12,758 | 12,557 | ||||||
Change in operating assets and liabilities: |
||||||||
Decrease in accounts receivable |
59,331 | 40,588 | ||||||
Increase in inventories |
(44,438 | ) | (28,101 | ) | ||||
Increase in other current assets |
(3,547 | ) | (13,049 | ) | ||||
Decrease (increase) in other assets |
4,637 | (4,409 | ) | |||||
Decrease in accounts payable and other current liabilities |
(33,485 | ) | (34,258 | ) | ||||
Increase in deferred revenue and customer advances |
57,539 | 45,096 | ||||||
Effect of the 2017 Tax & Jobs Act |
(3,229 | ) | 12,450 | |||||
(Decrease) increase in other liabilities |
(6,162 | ) | 5,970 | |||||
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Net cash provided by operating activities |
175,779 | 175,841 | ||||||
Cash flows from investing activities: |
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Additions to property, plant, equipment and software capitalization |
(25,666 | ) | (15,992 | ) | ||||
Investment in unaffiliated companies |
| (3,215 | ) | |||||
Purchases of investments |
(26,732 | ) | (170,041 | ) | ||||
Maturities and sales of investments |
486,437 | 1,085,087 | ||||||
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Net cash provided by investing activities |
434,039 | 895,839 | ||||||
Cash flows from financing activities: |
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Proceeds from debt issuances |
166 | 81 | ||||||
Payments on debt |
(80 | ) | (750,000 | ) | ||||
Proceeds from stock plans |
27,631 | 24,287 | ||||||
Purchases of treasury shares |
(753,105 | ) | (282,370 | ) | ||||
Proceeds from derivative contracts |
2,254 | 1,937 | ||||||
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Net cash used in financing activities |
(723,134 | ) | (1,006,065 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
2,006 | 8,588 | ||||||
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(Decrease) increase in cash and cash equivalents |
(111,310 | ) | 74,203 | |||||
Cash and cash equivalents at beginning of period |
796,280 | 642,319 | ||||||
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Cash and cash equivalents at end of period |
$ | 684,970 | $ | 716,522 | ||||
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The accompanying notes are an integral part of the interim consolidated financial statements.
6
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(unaudited, in thousands)
Number of Common Shares |
Common Stock |
Additional Paid-In Capital |
Retained Earnings |
Treasury Stock |
Accumulated Other Comprehensive Income (Loss) |
Total Stockholders Equity |
||||||||||||||||||||||
Balance December 31, 2017 | 159,845 | $ | 1,598 | $ | 1,745,088 | $ | 5,405,380 | $ | (4,808,211 | ) | $ | (110,067 | ) | $ | 2,233,788 | |||||||||||||
Adoption of new accounting pronouncement | | | | (3,969 | ) | | | (3,969 | ) | |||||||||||||||||||
Net income | | | | 111,951 | | | 111,951 | |||||||||||||||||||||
Other comprehensive income | | | | | | 21,436 | 21,436 | |||||||||||||||||||||
Issuance of common stock for employees: | ||||||||||||||||||||||||||||
Employee Stock Purchase Plan |
10 | | 1,565 | | | | 1,565 | |||||||||||||||||||||
Stock options exercised |
222 | 2 | 22,707 | | | | 22,709 | |||||||||||||||||||||
Treasury stock | | | | | (282,370 | ) | | (282,370 | ) | |||||||||||||||||||
Stock-based compensation | 123 | 2 | 9,782 | | | | 9,784 | |||||||||||||||||||||
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Balance March 31, 2018 | 160,200 | $ | 1,602 | $ | 1,779,142 | $ | 5,513,362 | $ | (5,090,581 | ) | $ | (88,631 | ) | $ | 2,114,894 | |||||||||||||
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Number of Common Shares |
Common Stock |
Additional Paid-In Capital |
Retained Earnings |
Treasury Stock |
Accumulated Other Comprehensive Income (Loss) |
Total Stockholders Equity |
||||||||||||||||||||||
Balance December 31, 2018 | 160,472 | $ | 1,605 | $ | 1,834,741 | $ | 5,995,205 | $ | (6,146,322 | ) | $ | (117,971 | ) | $ | 1,567,258 | |||||||||||||
Net income | | | | 108,986 | | | 108,986 | |||||||||||||||||||||
Other comprehensive income | | | | | | 9,327 | 9,327 | |||||||||||||||||||||
Issuance of common stock for employees: | ||||||||||||||||||||||||||||
Employee Stock Purchase Plan |
10 | | 1,670 | | | | 1,670 | |||||||||||||||||||||
Stock options exercised |
239 | 2 | 26,097 | | | | 26,099 | |||||||||||||||||||||
Treasury stock | | | | | (755,307 | ) | | (755,307 | ) | |||||||||||||||||||
Stock-based compensation | 104 | 1 | 9,708 | | | | 9,709 | |||||||||||||||||||||
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Balance March 30, 2019 | 160,825 | $ | 1,608 | $ | 1,872,216 | $ | 6,104,191 | $ | (6,901,629 | ) | $ | (108,644 | ) | $ | 967,742 | |||||||||||||
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The accompanying notes are an integral part of the consolidated financial statements.
7
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1 Basis of Presentation and Summary of Significant Accounting Policies
Waters Corporation (the Company, we, our, or us) is a specialty measurement company that operates with a fundamental underlying purpose to advance the science that enables our customers to enhance human health and well-being. The Company has pioneered analytical workflow solutions involving liquid chromatography, mass spectrometry and thermal analysis innovations serving the life, materials and food sciences for more than 60 years. The Company primarily designs, manufactures, sells and services high performance liquid chromatography (HPLC), ultra performance liquid chromatography (UPLCTM and together with HPLC, referred to as LC) and mass spectrometry (MS) technology systems and support products, including chromatography columns, other consumable products and comprehensive post-warranty service plans. These systems are complementary products that are frequently employed together (LC-MS) and sold as integrated instrument systems using common software platforms. LC is a standard technique and is utilized in a broad range of industries to detect, identify, monitor and measure the chemical, physical and biological composition of materials, and to purify a full range of compounds. MS technology, principally in conjunction with chromatography, is employed in drug discovery and development, including clinical trial testing, the analysis of proteins in disease processes (known as proteomics), nutritional safety analysis and environmental testing. LC-MS instruments combine a liquid phase sample introduction and separation system with mass spectrometric compound identification and quantification. In addition, the Company designs, manufactures, sells and services thermal analysis, rheometry and calorimetry instruments through its TATM product line. These instruments are used in predicting the suitability and stability of fine chemicals, pharmaceuticals, water, polymers, metals and viscous liquids for various industrial, consumer goods and healthcare products, as well as for life science research. The Company is also a developer and supplier of advanced software-based products that interface with the Companys instruments, as well as other manufacturers instruments.
The Companys interim fiscal quarter typically ends on the thirteenth Saturday of each quarter. Since the Companys fiscal year end is December 31, the first and fourth fiscal quarters may have more or less than thirteen complete weeks. The Companys first fiscal quarters for 2019 and 2018 ended on March 30, 2019 and March 31, 2018, respectively.
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with the instructions to the Quarterly Report on Form 10-Q and do not include all of the information and footnote disclosures required for annual financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America. The consolidated financial statements include the accounts of the Company and its subsidiaries, which are wholly owned. All inter-company balances and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with GAAP 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. Actual amounts may differ from these estimates under different assumptions or conditions.
It is managements opinion that the accompanying interim consolidated financial statements reflect all adjustments (which are normal and recurring) that are necessary for a fair statement of the results for the interim periods. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the U.S. Securities and Exchange Commission (SEC) on March 1, 2019.
Translation of Foreign Currencies
The functional currency of each of the Companys foreign operating subsidiaries is the local currency of its country of domicile, except for the Companys subsidiaries in Hong Kong, Singapore and the Cayman Islands, where the underlying transactional cash flows are denominated in currencies other than the respective local currency of domicile. The functional currency of the Hong Kong, Singapore and Cayman Islands subsidiaries is the U.S. dollar, based on the respective entitys cash flows.
For most of the Companys foreign operations, assets and liabilities are translated into U.S. dollars at exchange rates prevailing on the balance sheet date, while revenues and expenses are translated at average exchange rates prevailing during the respective period. Any resulting translation gains or losses are included in accumulated other comprehensive income in the consolidated balance sheets.
8
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Cash, Cash Equivalents and Investments
Cash equivalents represent highly liquid investments, with original maturities of 90 days or less, while investments with longer maturities are classified as investments. 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 March 30, 2019 and December 31, 2018, $411 million out of $1,167 million and $471 million out of $1,735 million, respectively, of the Companys total cash, cash equivalents and investments were held by foreign subsidiaries. In addition, $263 million out of $1,167 million and $251 million out of $1,735 million of cash, cash equivalents and investments were held in currencies other than the U.S. dollar at March 30, 2019 and December 31, 2018, respectively.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company has very limited use of rebates and other cash considerations payable to customers and, as a result, the transaction price determination does not have any material variable consideration. The allowance for doubtful accounts is the best estimate of the amount of probable credit losses in the existing accounts receivable. The allowance is based on a number of factors, including historical experience and the customers credit-worthiness. The allowance for doubtful accounts is reviewed on at least a quarterly basis. Past due balances over 90 days and over a specified amount are reviewed individually for collectibility. Account balances are charged against the allowance when the Company determines it is probable that the receivable will not be recovered. The Company does not have any off-balance sheet credit exposure related to its customers. Historically, the Company has not experienced significant bad debt losses.
The following is a summary of the activity of the Companys allowance for doubtful accounts for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Balance at | Balance at | |||||||||||||||
Beginning | End of | |||||||||||||||
of Period | Additions | Deduction | Period | |||||||||||||
Allowance for Doubtful Accounts |
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March 30, 2019 |
$ | 7,663 | $ | 2,159 | $ | (2,324 | ) | $ | 7,498 | |||||||
March 31, 2018 |
$ | 6,109 | $ | 1,056 | $ | (1,033 | ) | $ | 6,132 |
Fair Value Measurements
In accordance with the accounting standards for fair value measurements and disclosures, certain of the Companys assets and liabilities are measured at fair value on a recurring basis as of March 30, 2019 and December 31, 2018. Fair values determined by Level 1 inputs utilize observable data, such as quoted prices in active markets. Fair values determined by Level 2 inputs utilize data points other than quoted prices in active markets that are observable either directly or indirectly. Fair values determined by Level 3 inputs utilize unobservable data points for which there is little or no market data, which require the reporting entity to develop its own assumptions.
9
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
The following table represents the Companys assets and liabilities measured at fair value on a recurring basis at March 30, 2019 (in thousands):
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets | Other | Significant | ||||||||||||||
Total at | for Identical | Observable | Unobservable | |||||||||||||
March 30, | Assets | Inputs | Inputs | |||||||||||||
2019 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets: |
||||||||||||||||
U.S. Treasury securities |
$ | 98,576 | $ | | $ | 98,576 | $ | | ||||||||
Foreign government securities |
3,476 | | 3,476 | | ||||||||||||
Corporate debt securities |
367,621 | | 367,621 | | ||||||||||||
Time deposits |
52,507 | | 52,507 | | ||||||||||||
Waters 401(k) Restoration Plan assets |
33,951 | 33,951 | | | ||||||||||||
Foreign currency exchange contracts |
355 | | 355 | | ||||||||||||
Interest rate cross-currency swap agreements |
7,120 | | 7,120 | | ||||||||||||
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Total |
$ | 563,606 | $ | 33,951 | $ | 529,655 | $ | | ||||||||
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Liabilities: |
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Contingent consideration |
$ | 2,591 | $ | | $ | | $ | 2,591 | ||||||||
Foreign currency exchange contracts |
619 | | 619 | | ||||||||||||
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Total |
$ | 3,210 | $ | | $ | 619 | $ | 2,591 | ||||||||
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The following table represents the Companys assets and liabilities measured at fair value on a recurring basis at December 31, 2018 (in thousands):
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets | Other | Significant | ||||||||||||||
Total at | for Identical | Observable | Unobservable | |||||||||||||
December 31, | Assets | Inputs | Inputs | |||||||||||||
2018 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets: |
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U.S. Treasury securities |
$ | 164,315 | $ | | $ | 164,315 | $ | | ||||||||
Foreign government securities |
3,463 | | 3,463 | | ||||||||||||
Corporate debt securities |
723,059 | | 723,059 | | ||||||||||||
Time deposits |
108,638 | | 108,638 | | ||||||||||||
Waters 401(k) Restoration Plan assets |
33,104 | 33,104 | | | ||||||||||||
Foreign currency exchange contracts |
503 | | 503 | | ||||||||||||
Interest rate cross-currency swap agreements |
1,093 | 1,093 | ||||||||||||||
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Total |
$ | 1,034,175 | $ | 33,104 | $ | 1,001,071 | $ | | ||||||||
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Liabilities: |
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Contingent consideration |
$ | 2,476 | $ | | $ | | $ | 2,476 | ||||||||
Foreign currency exchange contracts |
224 | | 224 | | ||||||||||||
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Total |
$ | 2,700 | $ | | $ | 224 | $ | 2,476 | ||||||||
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10
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Fair Value of 401(k) Restoration Plan Assets
The 401(k) Restoration Plan is a nonqualified defined contribution plan and the assets were held in registered mutual funds and have been classified as Level 1. The fair values of the assets in the plan are determined through market and observable sources from daily quoted prices on nationally recognized securities exchanges.
Fair Value of Cash Equivalents, Investments, Foreign Currency Exchange Contracts and Interest Rate Cross-Currency Swap Agreements
The fair values of the Companys cash equivalents, investments and foreign currency exchange contracts are determined through market and observable sources and have been classified as Level 2. These assets and liabilities have been initially valued at the transaction price and subsequently valued, typically utilizing third-party pricing services. The pricing services use many inputs to determine value, including reportable trades, benchmark yields, credit spreads, broker/dealer quotes, current spot rates and other industry and economic events. The Company validates the prices provided by third-party pricing services by reviewing their pricing methods and obtaining market values from other pricing sources.
Fair Value of Contingent Consideration
The fair value of the Companys liability for contingent consideration relates to earnout payments in connection with the July 2014 acquisition of Medimass Research, Development and Service Kft. and is determined using a probability-weighted discounted cash flow model, which uses significant unobservable inputs, and has been classified as Level 3. Subsequent changes in the fair value of the contingent consideration liability are recorded in the results of operations. The fair value of the contingent consideration liability associated with future earnout payments is based on several factors, including the estimated future results and a discount rate that reflects both the likelihood of achieving the estimated future results and the Companys creditworthiness. A change in any of these unobservable inputs can significantly change the fair value of the contingent consideration. Although there is no contractual limit, the fair value of future contingent consideration payments was estimated to be $3 million and $2 million at March 30, 2019 and December 31, 2018, respectively, based on the Companys best estimate, as the earnout is based on future sales of certain products, some of which are currently in development, through 2034.
Fair Value of Other Financial Instruments
The Companys accounts receivable, accounts payable and variable interest rate debt are recorded at cost, which approximates fair value due to their short-term nature. The carrying value of the Companys fixed interest rate debt was $510 million at both March 30, 2019 and December 31, 2018, respectively. The fair value of the Companys fixed interest rate debt was estimated using discounted cash flow models, based on estimated current rates offered for similar debt under current market conditions for the Company. The fair value of the Companys fixed interest rate debt was estimated to be $508 million and $502 million at March 30, 2019 and December 31, 2018, respectively, using Level 2 inputs.
Derivative Transactions
The Company is a global company that operates in over 35 countries and, as a result, the Companys 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 Companys subsidiaries purchase or sell products or services in a currency other than its own currency.
The Companys principal strategies in managing exposures to changes in foreign currency exchange rates are to (1) naturally hedge the foreign-currency-denominated liabilities on the Companys 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.
11
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
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 Companys net worldwide intercompany receivables and payables, which are eliminated in consolidation. The Company periodically aggregates its 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 Companys 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
In 2018, the Company entered into three-year interest rate cross-currency swap derivative agreements with an aggregate notional value of $300 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 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 Companys foreign currency exchange contracts and interest rate cross-currency swap agreements included in the consolidated balance sheets are classified as follows (in thousands):
March 30, 2019 | December 31, 2018 | |||||||||||||||
Notional Value | Fair Value | Notional Value | Fair Value | |||||||||||||
Foreign currency exchange contracts: |
||||||||||||||||
Other current assets |
$ | 34,219 | $ | 355 | $ | 112,212 | $ | 503 | ||||||||
Other current liabilities |
$ | 98,745 | $ | 619 | $ | 40,175 | $ | 224 | ||||||||
Interest rate cross-currency swap agreements: |
||||||||||||||||
Other assets |
$ | 300,000 | $ | 7,120 | $ | 300,000 | $ | 1,093 | ||||||||
Accumulated other comprehensive income |
$ | (7,120 | ) | $ | (1,093 | ) |
The following is a summary of the activity included in the statements of comprehensive income related to the foreign currency exchange contracts (in thousands):
Financial | ||||||||||
Statement | Three Months Ended | |||||||||
Classification | March 30, 2019 | March 31, 2018 | ||||||||
Foreign currency exchange contracts: |
||||||||||
Realized (losses) gains on closed contracts |
Cost of sales | $ | (543 | ) | $ | 1,937 | ||||
Unrealized gains (losses) on open contracts |
Cost of sales | 526 | (985 | ) | ||||||
|
|
|
|
|||||||
Cumulative net pre-tax (losses) gains |
Cost of sales | $ | (17 | ) | $ | 952 | ||||
|
|
|
|
|||||||
Interest rate cross-currency swap agreements: |
||||||||||
Interest earned |
Interest income | $ | 2,227 | $ | | |||||
Unrealized gains on contracts |
Stockholders equity | $ | 7,120 | $ | |
In April 2019, the Company entered into three-year interest rate cross-currency swap derivative agreements with a notional value of $110 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments.
12
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Stockholders Equity
In January 2019, the Companys Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a two-year period. This new program replaced the remaining amounts available from the pre-existing program. During the three months ended March 30, 2019 and March 31, 2018, the Company repurchased 3.3 million and 1.3 million shares of the Companys outstanding common stock at a cost of $747 million and $275 million, respectively, under the January 2019 authorization and other previously announced programs. As of March 30, 2019, the Company had repurchased an aggregate of 2.5 million shares at a cost of $598 million under the January 2019 repurchase program and had a total of $3.4 billion authorized for future repurchases. In addition, the Company repurchased $8 million of common stock related to the vesting of restricted stock units during both the three months ended March 30, 2019 and March 31, 2018, respectively. The Company believes that it has the financial flexibility to fund these share repurchases given current cash levels and debt borrowing capacity, as well as to invest in research, technology and business acquisitions.
As of March 30, 2019, the Company accrued $25 million as a result of treasury stock purchases that were settled in the second quarter of 2019.
Product Warranty Costs
The Company accrues estimated product warranty costs at the time of sale, which are included in cost of sales in the consolidated statements of operations. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Companys warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. The amount of the accrued warranty liability is based on historical information, such as past experience, product failure rates, number of units repaired and estimated costs of material and labor. The liability is reviewed for reasonableness at least quarterly.
The following is a summary of the activity of the Companys accrued warranty liability for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Balance at | Balance at | |||||||||||||||
Beginning | Accruals for | Settlements | End of | |||||||||||||
of Period | Warranties | Made | Period | |||||||||||||
Accrued warranty liability: |
||||||||||||||||
March 30, 2019 |
$ | 12,300 | $ | 1,500 | $ | (2,338 | ) | $ | 11,462 | |||||||
March 31, 2018 |
$ | 13,026 | $ | 1,767 | $ | (2,167 | ) | $ | 12,626 |
Restructuring and Other Charges
In January 2019, the Company made organizational changes to better align our resources with our growth and innovation strategies, resulting in a worldwide workforce reduction, impacting 1% of the Companys employees. The Company recorded $8 million of severance and related costs during 2019.
2 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 Companys 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 Companys obligation to
13
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
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 Companys 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 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.
The Company has sales from standalone software, which is 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 Companys 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 Companys 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 the customers 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 Companys 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 Companys deferred revenue liabilities on the consolidated balance sheets consists 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.
The following is a summary of the activity of the Companys deferred revenue and customer advances for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
March 30, 2019 | March 31, 2018 | |||||||
Balance at the beginning of the period |
$ | 204,257 | $ | 192,590 | ||||
Recognition of revenue included in balance at beginning of the period |
(77,742 | ) | (93,286 | ) | ||||
Revenue deferred during the period, net of revenue recognized |
134,506 | 147,939 | ||||||
|
|
|
|
|||||
Balance at the end of the period |
$ | 261,021 | $ | 247,243 | ||||
|
|
|
|
The Company classified $39 million of deferred revenue and customer advances in other long-term liabilities at both March 30, 2019 and December 31, 2018.
14
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
The amount of deferred revenue and customer advances equals the transaction price allocated to unfulfilled performance obligations for the period presented. Such amounts are expected to be recognized in the future as follows (in thousands):
March 30, 2019 | ||||
Deferred revenue and customer advances expected to be recognized in: |
||||
One year or less |
$ | 222,263 | ||
13-24 months |
22,180 | |||
25 months and beyond |
16,578 | |||
|
|
|||
Total |
$ | 261,021 | ||
|
|
3 Marketable Securities
The Companys marketable securities within cash equivalents and investments included in the consolidated balance sheets are detailed as follows (in thousands):
March 30, 2019 | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gain | Loss | Value | |||||||||||||
U.S. Treasury securities |
$ | 98,723 | $ | 12 | $ | (159 | ) | $ | 98,576 | |||||||
Foreign government securities |
3,489 | 1 | (14 | ) | 3,476 | |||||||||||
Corporate debt securities |
368,163 | 121 | (663 | ) | 367,621 | |||||||||||
Time deposits |
52,507 | | | 52,507 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 522,882 | $ | 134 | $ | (836 | ) | $ | 522,180 | |||||||
|
|
|
|
|
|
|
|
|||||||||
Amounts included in: |
||||||||||||||||
Cash equivalents |
$ | 39,886 | $ | 1 | $ | | $ | 39,887 | ||||||||
Investments |
482,996 | 133 | (836 | ) | 482,293 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 522,882 | $ | 134 | $ | (836 | ) | $ | 522,180 | |||||||
|
|
|
|
|
|
|
|
|||||||||
December 31, 2018 | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gain | Loss | Value | |||||||||||||
U.S. Treasury securities |
$ | 164,619 | $ | 16 | $ | (320 | ) | $ | 164,315 | |||||||
Foreign government securities |
3,486 | 1 | (24 | ) | 3,463 | |||||||||||
Corporate debt securities |
725,778 | 41 | (2,760 | ) | 723,059 | |||||||||||
Time deposits |
108,638 | | | 108,638 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 1,002,521 | $ | 58 | $ | (3,104 | ) | $ | 999,475 | |||||||
|
|
|
|
|
|
|
|
|||||||||
Amounts included in: |
||||||||||||||||
Cash equivalents |
$ | 60,532 | $ | | $ | (1 | ) | $ | 60,531 | |||||||
Investments |
941,989 | 58 | (3,103 | ) | 938,944 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 1,002,521 | $ | 58 | $ | (3,104 | ) | $ | 999,475 | |||||||
|
|
|
|
|
|
|
|
15
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
The estimated fair value of marketable debt securities by maturity date is as follows (in thousands):
March 30, 2019 | December 31, 2018 | |||||||
Due in one year or less |
$ | 437,648 | $ | 797,649 | ||||
Due after one year through three years |
84,532 | 201,826 | ||||||
|
|
|
|
|||||
Total |
$ | 522,180 | $ | 999,475 | ||||
|
|
|
|
4 Inventories
Inventories are classified as follows (in thousands):
March 30, 2019 | December 31, 2018 | |||||||
Raw materials |
$ | 119,101 | $ | 111,641 | ||||
Work in progress |
18,314 | 15,552 | ||||||
Finished goods |
195,893 | 164,376 | ||||||
|
|
|
|
|||||
Total inventories |
$ | 333,308 | $ | 291,569 | ||||
|
|
|
|
5 Goodwill and Other Intangibles
The carrying amount of goodwill was $357 million and $356 million at March 30, 2019 and December 31, 2018, respectively. During the three months ended March 30, 2019, the effect of foreign currency translation increased goodwill by $1 million.
The Companys intangible assets included in the consolidated balance sheets are detailed as follows (dollars in thousands):
March 30, 2019 | December 31, 2018 | |||||||||||||||||||||||
Weighted- | Weighted- | |||||||||||||||||||||||
Gross | Average | Gross | Average | |||||||||||||||||||||
Carrying | Accumulated | Amortization | Carrying | Accumulated | Amortization | |||||||||||||||||||
Amount | Amortization | Period | Amount | Amortization | Period | |||||||||||||||||||
Capitalized software |
$ | 456,388 | $ | 311,229 | 5 years | $ | 454,307 | $ | 307,634 | 5 years | ||||||||||||||
Purchased intangibles |
201,126 | 145,970 | 11 years | 201,566 | 144,184 | 11 years | ||||||||||||||||||
Trademarks and IPR&D |
13,817 | | | 13,677 | | | ||||||||||||||||||
Licenses |
5,710 | 5,119 | 6 years | 5,568 | 4,875 | 6 years | ||||||||||||||||||
Patents and other intangibles |
79,940 | 51,248 | 8 years | 77,753 | 49,276 | 8 years | ||||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||
Total |
$ | 756,981 | $ | 513,566 | 7 years | $ | 752,871 | $ | 505,969 | 7 years | ||||||||||||||
|
|
|
|
|
|
|
|
The gross carrying value of intangible assets and accumulated amortization for intangible assets decreased by $7 million and $5 million, respectively, in the three months ended March 30, 2019 due to the effects of foreign currency translation. Amortization expense for intangible assets was $13 million for both the three months ended March 30, 2019 and March 31, 2018. Amortization expense for intangible assets is estimated to be $52 million per year for each of the next five years.
16
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
6 Debt
In November 2017, the Company entered into a new credit agreement (the 2017 Credit Agreement) that 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.
The interest rates applicable to the 2017 Credit Agreement are, at the Companys 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 Companys 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.
As of both March 30, 2019 and December 31, 2018, the Company had a total of $560 million of outstanding senior unsecured notes. Interest on the 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.
In February 2019, certain defined terms related to the subsidiary guarantors were amended in the 2017 Credit Agreement and senior unsecured note agreements. In addition, the Company amended the senior unsecured note agreements to allow the Company to elect an increase in the permitted leverage ratio from 3.50:1 to 4.0:1, for a period of three consecutive quarters, for a material acquisition of $400 million or more. During the period of time where the leverage ratio exceeds 3.50:1, the interest payable on the senior unsecured notes shall increase by 0.50%. The debt covenants in the senior unsecured note agreements were also modified to address the change in accounting guidance for leases.
In 2018, the Company entered into three-year interest rate cross-currency swap derivative agreements with an aggregate notional value of $300 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. In April 2019, the Company entered into three-year interest rate cross-currency swap derivative agreements with a notional value of $110 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. See Note 1, Basis of Presentation and Summary of Significant Accounting Policies.
17
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
The Company had the following outstanding debt at March 30, 2019 and December 31, 2018 (in thousands):
March 30, 2019 | December 31, 2018 | |||||||
Foreign subsidiary lines of credit |
$ | 263 | $ | 178 | ||||
Senior unsecured notes - Series B - 5.00%, due February 2020 |
100,000 | | ||||||
|
|
|
|
|||||
Total notes payable and debt, current |
100,263 | 178 | ||||||
Senior unsecured notes - Series B - 5.00%, due February 2020 |
| 100,000 | ||||||
Senior unsecured notes - Series E - 3.97%, due March 2021 |
50,000 | 50,000 | ||||||
Senior unsecured notes - Series F - 3.40%, due June 2021 |
100,000 | 100,000 | ||||||
Senior unsecured notes - Series G - 3.92%, due June 2024 |
50,000 | 50,000 | ||||||
Senior unsecured notes - Series H - floating rate*, due June 2024 |
50,000 | 50,000 | ||||||
Senior unsecured notes - Series I - 3.13%, due May 2023 |
50,000 | 50,000 | ||||||
Senior unsecured notes - Series K - 3.44%, due May 2026 |
160,000 | 160,000 | ||||||
Credit agreement |
590,000 | 590,000 | ||||||
Unamortized debt issuance costs |
(1,717 | ) | (1,828 | ) | ||||
|
|
|
|
|||||
Total long-term debt |
1,048,283 | 1,148,172 | ||||||
|
|
|
|
|||||
Total debt |
$ | 1,148,546 | $ | 1,148,350 | ||||
|
|
|
|
|||||
* Series H senior unsecured notes bear interest at a 3-month LIBOR for that floating rate interest period plus 1.25%. |
|
As of both March 30, 2019 and December 31, 2018, the Company had a total amount available to borrow under the 2017 Credit Agreement of $1,208 million after outstanding letters of credit. The weighted-average interest rates applicable to the senior unsecured notes and credit agreement borrowings collectively were 3.80% and 3.83% at March 30, 2019 and December 31, 2018, respectively. As of March 30, 2019, the Company was in compliance with all debt covenants.
The Company and its foreign subsidiaries also had available short-term lines of credit totaling $90 million at both March 30, 2019 and December 31, 2018, for the purpose of short-term borrowing and issuance of commercial guarantees. The weighted-average interest rates applicable to these short-term borrowings were 4.44% and 1.88% for March 30, 2019 and December 31, 2018, respectively.
7 Income Taxes
The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the U.K. and Singapore, where the statutory tax rates are 21%, 12.5%, 19% and 17%, respectively, as of March 30, 2019. The Company has a contractual tax rate of 0% on qualifying activities in Singapore through March 2021, based upon the achievement of certain contractual milestones, which the Company expects to continue to meet. The effect of applying the contractual tax rate rather than the statutory tax rate to income from qualifying activities in Singapore increased the Companys net income for the three months ended March 30, 2019 and March 31, 2018 by $4 million and $6 million, respectively, and increased the Companys net income per diluted share by $0.06 and $0.07, respectively.
The Companys effective tax rate for the three months ended March 30, 2019 and March 31, 2018 was 7.1% and 20.3%, respectively. The income tax provision includes a $7 million and $6 million income tax benefit related to stock-based compensation for the three months ended March 30, 2019 and March 31, 2018, respectively. The effective tax rate for the three months ended March 30, 2019 includes a $3 million income tax benefit related to the finalization of certain regulations relating to the Tax Cuts and Jobs Act (the 2017 Tax Act). This income tax benefit decreased the effective tax rate by 2.9 percentage points for the three months ended March 30, 2019. The effective tax rate for the three months ended March 31, 2018 includes $12 million of additional income tax expense related to the change in foreign currency exchange rates on the earnings taxed in December 2017 under the toll charge of the 2017 Tax Act. This additional income tax expense increased the effective tax rate by 8.9 percentage points for the three months ended March 31, 2018. The remaining differences between the effective tax rates can primarily be attributed to differences in the proportionate amounts of pre-tax income recognized in jurisdictions with different effective tax rates.
18
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
The Company accounts for its uncertain tax 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 continues to classify interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes.
The following is a summary of the activity of the Companys uncertain tax positions for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
March 30, 2019 | March 31, 2018 | |||||||
Balance at the beginning of the period |
$ | 26,108 | $ | 5,843 | ||||
Net reductions for lapse of statutes taken during the period |
(43 | ) | (83 | ) | ||||
Net additions for tax positions taken during the current period |
325 | 177 | ||||||
|
|
|
|
|||||
Balance at the end of the period |
$ | 26,390 | $ | 5,937 | ||||
|
|
|
|
With limited exceptions, the Company is no longer subject to tax audit examinations in significant jurisdictions for the years ended on or before December 31, 2013. However, carryforward tax attributes that were generated in years beginning on or before January 1, 2014 may still be adjusted upon examination by tax authorities if the attributes are utilized. The Company continuously monitors the lapsing of statutes of limitations on potential tax assessments for related changes in the measurement of unrecognized tax benefits, related net interest and penalties, and deferred tax assets and liabilities. As of March 30, 2019, the Company expects to record additional reductions in the measurement of its unrecognized tax benefits and related net interest and penalties of less than $1 million within the next twelve months due to potential tax audit settlements and the lapsing of statutes of limitations on potential tax assessments. The Company does not expect to record any other material reductions in the measurement of its unrecognized tax benefits within the next twelve months.
8 Leases
The Company adopted new accounting guidance regarding the accounting for leases as of January 1, 2019 using a modified retrospective transition approach that was applied to leases existing as of, or entered into after, January 1, 2019. The Company elected the package of transition provisions available for expired or existing contracts, which allowed the Company to carryforward historical assessments of (1) whether contracts are or contain leases, (2) lease classification and (3) initial direct costs. Upon adoption, the Company recorded a right-of-use lease asset and lease liabilities in the amount $100 million as of January 1, 2019. The adoption of this standard did not have a material impact on the Companys results of operations, cash flows and retained earnings.
Prior to the adoption of the new lease accounting standard, undiscounted future minimum rents payable as of December 31, 2018 under non-cancelable leases with initial terms exceeding one year were as follows (in thousands):
2019 |
$ | 28,417 | ||
2020 |
23,424 | |||
2021 |
16,032 | |||
2022 |
11,816 | |||
2023 and thereafter |
23,269 | |||
|
|
|||
Total future minimum lease payments |
$ | 102,958 | ||
|
|
The Companys operating leases consist of property leases for sales, demonstration, laboratory, warehouse and office spaces, automotive leases for sales and service personnel and equipment leases, primarily used in our manufacturing and distribution operations. The lease policies described below were effective as of January 1, 2019. For leases with terms greater than 12 months, the Company recorded the related right-of-use asset and lease liability obligation at the present value of lease payments over the term of the leases. Some of the Companys leases include rental escalation clauses, renewal options and/or termination options that are factored into our determination of lease payments. A
19
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
certain number of these leases contain rent escalation clauses, either fixed or adjusted periodically for inflation of market rates, that are factored into the Companys determination of lease payments. The Company also has variable lease payments that do not depend on a rate or index, primarily for items such as common area maintenance and real estate taxes, which are recorded as variable costs when incurred.
In addition, the Companys lease agreements that contain lease and non-lease components are generally accounted for as a single lease component. The Company has elected not to apply the recognition requirements of the new accounting guidance to leases with terms less than 12 months. For these leases, the Company recognizes lease payments in net income on a straight-line basis over the term of the lease. As of March 30, 2019 and March 31, 2018, the Company does not have leases that are classified as finance leases.
When available, the Company uses the rate implicit in the lease to discount lease payments to determine the present value of the lease liabilities; however, most of the leases do not provide a readily determinable implicit rate and, as required by the accounting guidance, the Company estimated its incremental secured borrowing rate to discount the lease payments based on information available at lease commencement (or, for the leases in existence on the adoption date, the January 1, 2019 information). The Companys incremental borrowing rate reflects the estimated rate of interest that the Company would pay to borrow on a collateralized basis over a similar term to the lease payments in a similar economic environment.
As of March 30, 2019, the Company has lease agreements that expire at various dates through 2033, with a weighted-average remaining lease term of 4.8 years. Rental expense was $9 million for the three months ended March 30, 2019 under the new lease accounting standard and $7 million for the three months ended March 31, 2018 under the previous lease accounting standard. The weighted-average discount rate used to determine the present value of lease liabilities was 3.95%. Cash paid for amounts included in the measurement of lease liabilities in operating activities in the statement of cash flows was $9 million during the three months ended March 30, 2019.
The Companys right-of-use lease assets and lease liabilities included in the consolidated balance sheets are classified as follows (in thousands):
Financial Statement Classification |
March 30, 2019 | |||||
Assets: |
||||||
Property operating lease assets |
Operating lease assets | $ | 64,439 | |||
Automobile operating lease assets |
Operating lease assets | 27,573 | ||||
Equipment operating lease assets |
Operating lease assets | 2,668 | ||||
|
|
|||||
Total lease assets |
$ | 94,680 | ||||
|
|
|||||
Liabilities: |
||||||
Current operating lease liabilities |
Current operating lease liabilities | $ | 26,926 | |||
Long-term operating lease liabilities |
Long-term operating lease liabilities | 67,788 | ||||
|
|
|||||
Total lease liabilities |
$ | 94,714 | ||||
|
|
20
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Undiscounted future minimum rents payable as of March 30, 2019 under non-cancelable leases with initial terms exceeding one year reconcile to lease liabilities included in the consolidated balance sheet as follows (in thousands):
2019 (remaining 9 months) |
$ | 22,145 | ||
2020 |
25,541 | |||
2021 |
16,426 | |||
2022 |
11,579 | |||
2023 |
6,039 | |||
2024 and thereafter |
23,816 | |||
|
|
|||
Total future minimum lease payments |
105,546 | |||
Less: amount of lease payments representing interest |
(10,832 | ) | ||
|
|
|||
Present value of future minimum lease payments |
94,714 | |||
Less: current operating lease liabilities |
(26,926 | ) | ||
|
|
|||
Long-term operating lease liabilities |
$ | 67,788 | ||
|
|
9 Stock-Based Compensation
The Company maintains various shareholder-approved, stock-based compensation plans which allow for the issuance of incentive or non-qualified stock options, stock appreciation rights, restricted stock or other types of awards (e.g. restricted stock units and performance stock units).
The Company accounts for stock-based compensation costs in accordance with the accounting standards for stock-based compensation, which require that all share-based payments to employees be recognized in the statements of operations, based on their grant date fair values. The Company recognizes the expense using the straight-line attribution method. The stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest; therefore, the amount of expense has been reduced for estimated forfeitures. Forfeitures are estimated based on historical experience. If actual results differ significantly from these estimates, stock-based compensation expense and the Companys results of operations could be materially impacted. In addition, if the Company employs different assumptions in the application of these standards, the compensation expense that the Company records in the future periods may differ significantly from what the Company has recorded in the current period.
The consolidated statements of operations for the three months ended March 30, 2019 and March 31, 2018 include the following stock-based compensation expense related to stock option awards, restricted stock awards, restricted stock unit awards, performance stock unit awards and the employee stock purchase plan (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Cost of sales |
$ | 575 | $ | 605 | ||||
Selling and administrative expenses |
8,125 | 8,483 | ||||||
Research and development expenses |
1,241 | 804 | ||||||
|
|
|
|
|||||
Total stock-based compensation |
$ | 9,941 | $ | 9,892 | ||||
|
|
|
|
Stock Options
In determining the fair value of the stock options, the Company makes a variety of assumptions and estimates, including volatility measures, expected yields and expected stock option lives. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model. The Company uses implied volatility on its publicly-traded options as the basis for its estimate of expected volatility. The Company believes that implied volatility is the most appropriate indicator of expected volatility because it is generally reflective of historical volatility and expectations of how future volatility will differ from historical volatility. The expected life assumption for grants is based on historical experience for the population of non-qualified stock option exercises. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term used as the input to the Black-Scholes model. The relevant data used to determine the value of the stock options granted during the three months ended March 30, 2019 and March 31, 2018 are as follows:
21
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Three Months Ended | ||||||||
Options Issued and Significant Assumptions Used to Estimate Option Fair Values |
March 30, 2019 | March 31, 2018 | ||||||
Options issued in thousands |
136 | 133 | ||||||
Risk-free interest rate |
2.5 | % | 2.7 | % | ||||
Expected life in years |
5 | 6 | ||||||
Expected volatility |
24.2 | % | 23.2 | % | ||||
Expected dividends |
| |
Three Months Ended | ||||||||
Weighted-Average Exercise Price and Fair Value of Options on the Date of Grant |
March 30, 2019 | March 31, 2018 | ||||||
Exercise price |
$ | 232.08 | $ | 206.66 | ||||
Fair value |
$ | 61.97 | $ | 58.38 |
The following table summarizes stock option activity for the plans for the three months ended March 30, 2019 (in thousands, except per share data):
Number of Shares | Exercise Price per Share | Weighted-Average Exercise Price per Share |
||||||||||||||||||
Outstanding at December 31, 2018 |
1,790 | $ | 38.09 | to | $ | 208.47 | $ | 142.47 | ||||||||||||
Granted |
136 | $ | 183.41 | to | $ | 238.52 | $ | 232.08 | ||||||||||||
Exercised |
(239 | ) | $ | 38.09 | to | $ | 208.47 | $ | 108.57 | |||||||||||
|
|
|||||||||||||||||||
Outstanding at March 30, 2019 |
1,687 | $ | 61.63 | to | $ | 238.52 | $ | 154.42 | ||||||||||||
|
|
Restricted Stock
During the three months ended March 30, 2019, the Company granted five thousand shares of restricted stock. The weighted-average fair value per share of these awards on the grant date was $183.41.
Restricted Stock Units
The following table summarizes the unvested restricted stock unit award activity for the three months ended March 30, 2019 (in thousands, except per share data):
Shares | Weighted-Average Fair Value per Share |
|||||||
Unvested at December 31, 2018 |
304 | $ | 153.31 | |||||
Granted |
78 | $ | 238.52 | |||||
Vested |
(102 | ) | $ | 138.48 | ||||
Forfeited |
(6 | ) | $ | 158.22 | ||||
|
|
|||||||
Unvested at March 30, 2019 |
274 | $ | 182.98 | |||||
|
|
Restricted stock units are generally granted annually in February and vest in equal annual installments over a five-year period.
22
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Performance Stock Units
The Companys performance stock units are equity compensation awards with a market vesting condition based on the Companys Total Shareholder Return (TSR) relative to the TSR of the components of the S&P Health Care Index. TSR is the change in value of a stock price over time, including the reinvestment of dividends. The vesting schedule ranges from 0% to 200% of the target shares awarded.
In determining the fair value of the performance stock units, the Company makes a variety of assumptions and estimates, including volatility measures, expected yields and expected terms. The fair value of each performance stock unit grant was estimated on the date of grant using the Monte Carlo simulation model. The Company uses implied volatility on its publicly-traded options as the basis for its estimate of expected volatility. The Company believes that implied volatility is the most appropriate indicator of expected volatility because it is generally reflective of historical volatility and expectations of how future volatility will differ from historical volatility. The expected life assumption for grants is based on the performance period of the underlying performance stock units. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term used as the input to the Monte Carlo simulation model. The correlation coefficient is used to model the way in which each company in the S&P Health Care Index tends to move in relation to each other during the performance period. The relevant data used to determine the value of the performance stock units granted during the three months ended March 30, 2019 and March 31, 2018 are as follows:
Three Months Ended | ||||||||
Performance Stock Units Issued and Significant Assumptions Used to Estimate Fair Values |
March 30, 2019 | March 31, 2018 | ||||||
Performance stock units issued (in thousands) |
12 | 15 | ||||||
Risk-free interest rate |
2.4 | % | 2.0 | % | ||||
Expected life in years |
2.8 | 2.9 | ||||||
Expected volatility |
23.5 | % | 18.0 | % | ||||
Average volatility of peer companies |
26.2 | % | 25.8 | % | ||||
Correlation coefficient |
34.2 | % | 37.4 | % | ||||
Expected dividends |
| |
The following table summarizes the unvested performance stock unit award activity for the three months ended March 30, 2019 (in thousands, except per share data):
Shares | Weighted-Average Fair Value per Share |
|||||||
Unvested at December 31, 2018 |
100 | $ | 212.34 | |||||
Granted |
12 | $ | 391.21 | |||||
|
|
|||||||
Unvested at March 30, 2019 |
112 | $ | 231.50 | |||||
|
|
23
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
10 Earnings Per Share
Basic and diluted EPS calculations are detailed as follows (in thousands, except per share data):
Three Months Ended March 30, 2019 | ||||||||||||
Net Income | Weighted- Average Shares |
Per Share | ||||||||||
(Numerator) | (Denominator) | Amount | ||||||||||
Net income per basic common share |
$ | 108,986 | 71,704 | $ | 1.52 | |||||||
Effect of dilutive stock option, restricted stock, performance stock unit and restricted stock unit securities |
| 711 | (0.01 | ) | ||||||||
|
|
|
|
|
|
|||||||
Net income per diluted common share |
$ | 108,986 | 72,415 | $ | 1.51 | |||||||
|
|
|
|
|
|
Three Months Ended March 31, 2018 | ||||||||||||
Net Income | Weighted- Average Shares |
Per Share | ||||||||||
(Numerator) | (Denominator) | Amount | ||||||||||
Net income per basic common share |
$ | 111,951 | 78,883 | $ | 1.42 | |||||||
Effect of dilutive stock option, restricted stock, performance stock unit and restricted stock unit securities |
| 832 | (0.02 | ) | ||||||||
|
|
|
|
|
|
|||||||
Net income per diluted common share |
$ | 111,951 | 79,715 | $ | 1.40 | |||||||
|
|
|
|
|
|
For the three months ended March 30, 2019 and March 31, 2018, the Company had 0.1 million and 0.3 million stock options that were antidilutive, respectively, due to having higher exercise prices than the Companys average stock price during the period. These securities were not included in the computation of diluted EPS. The effect of dilutive securities was calculated using the treasury stock method.
11 Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income (loss) are detailed as follows (in thousands):
Currency Translation |
Unrealized Gain (Loss) on Retirement Plans |
Unrealized Gain (Loss) on Investments |
Accumulated Other Comprehensive Income (Loss) |
|||||||||||||
Balance at December 31, 2018 |
$ | (105,697 | ) | $ | (9,869 | ) | $ | (2,405 | ) | $ | (117,971 | ) | ||||
Other comprehensive income, net of tax |
7,522 | 8 | 1,797 | 9,327 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Balance at March 30, 2019 |
$ | (98,175 | ) | $ | (9,861 | ) | $ | (608 | ) | $ | (108,644 | ) | ||||
|
|
|
|
|
|
|
|
24
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
12 Retirement Plans
The Company sponsors various retirement plans. The components of net periodic benefit cost other than the service cost component are included in other (expense) income in the consolidated statements of operations. The summary of the components of net periodic pension costs for the plans for the three months ended March 30, 2019 and March 31, 2018 is as follows (in thousands):
Three Months Ended | ||||||||||||||||||||||||
March 30, 2019 | March 31, 2018 | |||||||||||||||||||||||
U.S. | U.S. Retiree | Non-U.S. | U.S. | U.S. Retiree | Non-U.S. | |||||||||||||||||||
Pension | Healthcare | Pension | Pension | Healthcare | Pension | |||||||||||||||||||
Plans | Plan | Plans | Plans | Plan | Plans | |||||||||||||||||||
Service cost |
$ | | $ | 142 | $ | 1,082 | $ | 142 | $ | 132 | $ | 1,374 | ||||||||||||
Interest cost |
13 | 159 | 434 | 1,619 | 156 | 428 | ||||||||||||||||||
Expected return on plan assets |
| (177 | ) | (543 | ) | (2,785 | ) | (178 | ) | (493 | ) | |||||||||||||
Net amortization: |
||||||||||||||||||||||||
Prior service credit |
| (5 | ) | (37 | ) | | (8 | ) | (31 | ) | ||||||||||||||
Net actuarial loss |
| | 135 | 769 | | 177 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net periodic pension cost (benefit) |
$ | 13 | $ | 119 | $ | 1,071 | $ | (255 | ) | $ | 102 | $ | 1,455 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
In 2018, the Company terminated and settled its frozen U.S. defined benefit pension plan, the Waters Retirement Plan, by making lump-sum cash payments and purchasing annuity contracts for participants to permanently extinguish the pension plans obligations. The Company also anticipates that it will settle the Waters Retirement Restoration Plan during 2019, and the Company may incur pension accounting charges in connection with the termination of this plan.
During fiscal year 2019, the Company expects to contribute a total of approximately $3 million to $6 million to the Companys defined benefit plans.
13 Business Segment Information
The Companys business activities, for which discrete financial information is available, are regularly reviewed and evaluated by the chief operating decision maker. As a result of this evaluation, the Company determined that it has two operating segments: WatersTM and TATM.
The Waters operating segment is primarily in the business of designing, manufacturing, selling and servicing LC and MS instruments, columns and other precision chemistry consumables that can be integrated and used along with other analytical instruments. The TA operating segment is primarily in the business of designing, manufacturing, selling and servicing thermal analysis, rheometry and calorimetry instruments. The Companys two operating segments have similar economic characteristics; product processes; products and services; types and classes of customers; methods of distribution; and regulatory environments. Because of these similarities, the two segments have been aggregated into one reporting segment for financial statement purposes. Please refer to the consolidated financial statements for financial information regarding the one reportable segment of the Company.
25
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Net sales for the Companys products and services are as follows for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Product net sales: |
||||||||
Waters instrument systems |
$ | 184,612 | $ | 198,103 | ||||
Chemistry consumables |
99,253 | 98,710 | ||||||
TA instrument systems |
36,638 | 42,304 | ||||||
|
|
|
|
|||||
Total product sales |
320,503 | 339,117 | ||||||
Service net sales: |
||||||||
Waters service |
176,049 | 174,333 | ||||||
TA service |
17,310 | 17,220 | ||||||
|
|
|
|
|||||
Total service sales |
193,359 | 191,553 | ||||||
|
|
|
|
|||||
|
|
|
|
|||||
Total net sales |
$ | 513,862 | $ | 530,670 | ||||
|
|
|
|
Net sales are attributable to geographic areas based on the region of destination. Geographic sales information is presented below for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Net Sales: |
||||||||
Asia: |
||||||||
China |
$ | 90,091 | $ | 93,828 | ||||
Japan |
43,504 | 42,765 | ||||||
Asia Other |
66,917 | 63,687 | ||||||
|
|
|
|
|||||
Total Asia |
200,512 | 200,280 | ||||||
Americas: |
||||||||
United States |
149,157 | 146,821 | ||||||
Americas Other |
32,711 | 34,889 | ||||||
|
|
|
|
|||||
Total Americas |
181,868 | 181,710 | ||||||
Europe |
131,482 | 148,680 | ||||||
|
|
|
|
|||||
Total net sales |
$ | 513,862 | $ | 530,670 | ||||
|
|
|
|
Net sales by customer class are as follows for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Pharmaceutical |
$ | 294,512 | $ | 305,328 | ||||
Industrial |
155,218 | 162,330 | ||||||
Academic and governmental |
64,132 | 63,012 | ||||||
|
|
|
|
|||||
Total net sales |
$ | 513,862 | $ | 530,670 | ||||
|
|
|
|
26
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
Net sales for the Company recognized at a point in time versus over time are as follows for the three months ended March 30, 2019 and March 31, 2018 (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Net sales recognized at a point in time: |
||||||||
Instrument systems |
$ | 221,250 | $ | 240,407 | ||||
Chemistry consumables |
99,253 | 98,710 | ||||||
Service sales recognized at a point in time (time & materials) |
72,759 | 72,518 | ||||||
|
|
|
|
|||||
Total net sales recognized at a point in time |
393,262 | 411,635 | ||||||
Net sales recognized over time: |
||||||||
Service and software sales recognized over time (contracts) |
120,600 | 119,035 | ||||||
|
|
|
|
|||||
Total net sales |
$ | 513,862 | $ | 530,670 | ||||
|
|
|
|
14 Recent Accounting Standard Changes and Developments
Recently Adopted Accounting Standards
In February 2016, accounting guidance was issued regarding the accounting for leases. This new comprehensive lease standard amends various aspects of existing accounting guidance for leases. The core principle of the new guidance requires lessees to present the assets and liabilities that arise from leases on their balance sheets. This guidance was effective for annual and interim reporting periods beginning after December 15, 2018. The Company has adopted this standard using a modified retrospective transition approach to be applied to leases existing as of, or entered into after, January 1, 2019. The adoption of this standard did have a material effect on the Companys balance sheet by recording a right-of-use lease asset and lease liabilities in the amount $100 million as of January 1, 2019; however, it did not have a material impact on the Companys results of operations, cash flows and retained earnings.
In March 2017, accounting guidance was issued to amend the amortization period for certain purchased callable debt securities held at a premium. Specifically, the amortization period for certain callable debt securities was shortened to end at the earliest call date. This guidance was effective for annual and interim periods beginning after December 15, 2018. The Company adopted this standard as of January 1, 2019 and the adoption of this standard did not have a material impact on the Companys financial position, results of operations and cash flows.
In February 2018, accounting guidance was issued to address the impact of the 2017 Tax Act on items recorded in accumulated other comprehensive income. Current accounting guidance requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect recorded in income from continuing operations, even if the related tax effects were originally recognized in other comprehensive income, the new guidance allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Act. This guidance was effective for annual and interim periods beginning after December 15, 2018. The Company adopted this standard as of January 1, 2019 and the adoption of this standard did not have a material impact on the Companys financial position, results of operations and cash flows.
Recently Issued Accounting Standards
In June 2016, accounting guidance was issued that modifies the recognition of credit losses related to financial assets, such as debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, and other financial assets that have the contractual right to receive cash. Current guidance requires the recognition of a credit loss when it is considered probable that a loss event has occurred. The new guidance requires the measurement of expected credit losses to be based upon relevant information, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the asset. As such, expected credit losses may be recognized sooner under the new guidance due to the broader range of information that will be required to determine credit loss estimates. The new guidance also amends the current other-than-temporary impairment model used for debt securities classified as available-for-sale. When the fair value of an available-for-sale debt security is below its amortized cost, the new guidance requires the total unrealized loss to be bifurcated into its credit and non-credit
27
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Continued)
components. Any expected credit losses or subsequent recoveries will be recognized in earnings and any changes not considered credit related will continue to be recognized within other comprehensive income. This guidance is effective for annual and interim periods beginning after December 15, 2019. The Company currently does not expect that the adoption of this standard will have a material effect on the Companys financial position, results of operations and cash flows.
In January 2017, accounting guidance was issued that simplifies the accounting for goodwill impairment. The guidance eliminates step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. This guidance is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted. The Company currently does not expect that the adoption of this standard will have a material effect on the Companys financial position, results of operations and cash flows.
In August 2018, accounting guidance was issued that modifies the disclosure requirements of fair value measurements. The amendments remove disclosures that are no longer considered cost beneficial, clarify the specific requirements of disclosure and add disclosure requirements identified as relevant. This guidance is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted. The Company does not expect that the adoption of this standard will have a material impact on the Companys financial position, results of operations and cash flows.
In August 2018, accounting guidance was issued that modifies the disclosure requirements of retirement benefit plans. The amendments remove disclosures that are no longer considered cost beneficial, clarify the specific requirements of disclosure and add disclosure requirement identified as relevant. This guidance is effective for annual and interim periods beginning after December 15, 2020 and early adoption is permitted. The Company does not expect that the adoption of this standard will have a material impact on the Companys financial position, results of operations and cash flows.
28
Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
Business and Financial Overview
The Company has two operating segments: WatersTM and TATM. Waters products and services primarily consist of high performance liquid chromatography (HPLC), ultra performance liquid chromatography (UPLCTM 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 Companys products are used by pharmaceutical, biochemical, industrial, nutritional safety, environmental, academic and governmental customers. These customers use the Companys 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.
The Companys operating results are as follows for the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands, except per share data):
Three Months Ended | ||||||||||||
March 30, 2019 | March 31, 2018 | % change | ||||||||||
Revenues: |
||||||||||||
Product sales |
$ | 320,503 | $ | 339,117 | (5 | %) | ||||||
Service sales |
193,359 | 191,553 | 1 | % | ||||||||
|
|
|
|
|
|
|||||||
Total net sales |
513,862 | 530,670 | (3 | %) | ||||||||
Costs and operating expenses: |
||||||||||||
Cost of sales |
221,031 | 221,421 | | |||||||||
Selling and administrative expenses |
134,339 | 130,407 | 3 | % | ||||||||
Research and development expenses |
35,060 | 34,480 | 2 | % | ||||||||
Purchased intangibles amortization |
2,281 | 1,659 | 37 | % | ||||||||
Litigation settlement |
| (1,672 | ) | 100 | % | |||||||
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Operating income |
121,151 | 144,375 | (16 | %) | ||||||||
Operating income as a % of sales |
23.6 | % | 27.2 | % | ||||||||
Other (expense) income |
(525 | ) | 346 | (252 | %) | |||||||
Interest expense, net |
(3,248 | ) | (4,172 | ) | (22 | %) | ||||||
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Income before income taxes |
117,378 | 140,549 | (16 | %) | ||||||||
Provision for income taxes |
8,392 | 28,598 | (71 | %) | ||||||||
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Net income |
$ | 108,986 | $ | 111,951 | (3 | %) | ||||||
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Net income per diluted common share |
$ | 1.51 | $ | 1.40 | 8 | % |
In the first quarter of 2019, the Companys net sales decreased 3% as compared to the first quarter of 2018, with foreign currency translation reducing sales growth by 3%. 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% in the quarter, as a result of weaker demand for our products by our customers due to uncertainty caused by macroeconomic impacts relating to Brexit and governmental policy changes in certain regions. Foreign currency translation decreased instrument system sales by 2%. Recurring revenues (combined sales of precision chemistry consumables and services) increased 1% in the quarter, as a result of a larger installed base of customers and higher billing demand for service sales. In the first quarter of 2019, recurring revenues were negatively impacted by foreign currency translation which lowered sales by 3% as well as one less calendar day as compared to the first quarter of 2018.
Geographically, the Companys sales were flat in Asia and the Americas, and decreased 12% in Europe, with the effect of foreign currency translation negatively impacting sales growth in Europe and Asia by 7% and 2%, respectively, during the first quarter of 2019. In the first quarter of 2019, China sales declined 4%, primarily as a result of economic uncertainty stemming from governmental policy in our food and pharmaceutical markets. Sales in the U.S. increased 2% and sales in Asia Other increased 5%, despite Indias sales declining 1%. Foreign currency translation negatively impacted Indias sales growth by 7% in the first quarter of 2019.
29
During the first quarter of 2019, sales to pharmaceutical customers declined 4%, with the effect of foreign currency translation decreasing sales growth by 4%, primarily driven by the negative effect of foreign currency translation in Europe and India of 8% and 10%, respectively. Combined sales to industrial customers, which include material characterization, food, environmental and fine chemical markets, declined 4% and were driven by a 9% decline in TA sales. During the first quarter of 2019, combined sales to academic and governmental customers increased 2%, which was driven by sales growth in the U.S. and Europe.
Operating income was $121 million in the first quarter of 2019, a decrease of 16% as compared to the first quarter of 2018. This decrease was primarily a result of the effect of lower sales volumes in the first quarter of 2019. Operating income in the first quarter of 2019 also included $8 million of severance-related costs in connection with a reduction in workforce. In addition, operating income in the first quarter of 2018 included the benefit of a $2 million litigation settlement.
The Company generated $176 million of net cash flows from operations in the first quarter of both 2019 and 2018. Cash flows used in investing activities included capital expenditures related to property, plant, equipment and software capitalization of $26 million and $16 million in the first quarter of 2019 and 2018, respectively. The first quarter of 2019 includes $7 million of capital expenditures related to the expansion of the Companys precision chemistry consumable operations in the U.S. The Company has incurred $26 million on this facility through the end of the first quarter of 2019 and anticipates spending a total of $215 million to build and equip this new state-of-the-art manufacturing facility.
In January 2019, the Companys Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a two-year period. During the first quarters of 2019 and 2018, the Company repurchased $747 million and $275 million of the Companys outstanding common stock, respectively, under authorized share repurchase programs. 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 Companys sales and profits.
Results of Operations
Sales by Geography
Geographic sales information is presented below for the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands):
Three Months Ended | ||||||||||||
March 30, 2019 | March 31, 2018 | % change | ||||||||||
Net Sales: |
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Asia: |
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China |
$ | 90,091 | $ | 93,828 | (4 | %) | ||||||
Japan |
43,504 | 42,765 | 2 | % | ||||||||
Asia Other |
66,917 | 63,687 | 5 | % | ||||||||
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Total Asia |
200,512 | 200,280 | | |||||||||
Americas: |
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United States |
149,157 | 146,821 | 2 | % | ||||||||
Americas Other |
32,711 | 34,889 | (6 | %) | ||||||||
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Total Americas |
181,868 | 181,710 | | |||||||||
Europe |
131,482 | 148,680 | (12 | %) | ||||||||
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Total net sales |
$ | 513,862 | $ | 530,670 | (3 | %) | ||||||
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In the first quarter of 2019, sales decreased in China primarily as a result of economic uncertainty caused by certain regulatory changes in our food and pharmaceutical markets. The increase in sales in Japan for the first quarter was
30
driven by TA products and services despite a 3% decrease due to the effect of foreign currency translation. Sales in the rest of Asia were driven by service revenues and LC-MS instrument systems, primarily to pharmaceutical customers. Sales growth in the U.S. was driven by recurring revenues and sales to industrial, academic and governmental customers. Sales declines in the rest of the Americas were broad-based across all product and customer classes, primarily in South America. The sales decline in Europe was primarily attributed to the effect of foreign currency translation, which decreased sales 7% for the quarter.
Net sales by customer class are presented below for the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands):
Three Months Ended | ||||||||||||
March 30, 2019 | March 31, 2018 | % change | ||||||||||
Pharmaceutical |
$ | 294,512 | $ | 305,328 | (4 | %) | ||||||
Industrial |
155,218 | 162,330 | (4 | %) | ||||||||
Academic and governmental |
64,132 | 63,012 | 2 | % | ||||||||
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Total net sales |
$ | 513,862 | $ | 530,670 | (3 | %) | ||||||
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In the first quarter of 2019, the decline in sales to pharmaceutical customers was primarily due to a negative impact from the effect of foreign currency translation, which decreased sales to pharmaceutical customers by 4%, as well as a slower release of capital budgets by our customers due to uncertain macroeconomic conditions due to Brexit, particularly in Europe, and regulatory changes in our food and pharmaceutical markets in China. The decline in sales to industrial customers in the quarter is primarily due to a 9% decline in TA sales. The increase in sales to academic and governmental customers was broad-based across all product classes, with increases in the U.S. and Europe being offset by declines in other regions.
Waters Products and Services Net Sales
Net sales for Waters products and services are as follows for the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands):
Three Months Ended | ||||||||||||||||||||
March 30, 2019 | % of Total |
March 31, 2018 | % of Total |
% change | ||||||||||||||||
Waters instrument systems |
$ | 184,612 | 40 | % | $ | 198,103 | 42 | % | (7 | %) | ||||||||||
Chemistry consumables |
99,253 | 22 | % | 98,710 | 21 | % | 1 | % | ||||||||||||
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Total Waters product sales |
283,865 | 62 | % | 296,813 | 63 | % | (4 | %) | ||||||||||||
Waters service |
176,049 | 38 | % | 174,333 | 37 | % | 1 | % | ||||||||||||
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Total Waters net sales |
$ | 459,914 | 100 | % | $ | 471,146 | 100 | % | (2 | %) | ||||||||||
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The effect of foreign currency translation decreased Waters sales by 3% for the quarter. Precision chemistry consumables sales increased in the first quarter of 2019 on the uptake in columns and application-specific testing kits and were driven by sales in the U.S. and China primarily to pharmaceutical customers. Waters service sales benefited from increased sales of service plans and higher service demand billings to a higher installed base of customers and broad-based across all geographic regions, except in Europe, where a 7% decline in service was impacted by a 6% decrease due to the effect of foreign currency translation. Waters recurring revenues were also negatively impacted by one less calendar day and the negative impact of foreign currency translation which lowered sales by 3% in the first quarter of 2019 as compared to the first quarter of 2018. Waters instrument system sales (LC and MS technology-based) decreased in all major geographical regions, primarily due to lower sales to pharmaceutical and industrial customers due to uncertainty caused by macroeconomic conditions relating to Brexit and other regulatory changes in certain regions.
In the first quarter of 2019, Waters sales increased 1% in the Americas, were flat in Asia and decreased 10% in Europe. Within Asia, Waters sales decreased 4% in China, were flat in Japan and increased 6% in the rest of Asia. Waters sales in Europe were negatively impacted by 7% due to the effect of foreign currency translation.
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TA Product and Services Net Sales
Net sales for TA products and services are as follows for the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands):
Three Months Ended | ||||||||||||||||||||
March 30, 2019 | % of Total |
March 31, 2018 | % of Total |
% change | ||||||||||||||||
TA instrument systems |
$ | 36,638 | 68 | % | $ | 42,304 | 71 | % | (13 | %) | ||||||||||
TA service |
17,310 | 32 | % | 17,220 | 29 | % | 1 | % | ||||||||||||
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Total TA net sales |
$ | 53,948 | 100 | % | $ | 59,524 | 100 | % | (9 | %) | ||||||||||
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The decline in TA instrument system sales in the first quarter of 2019 was primarily due to lower customer demand due to the timing of the release of capital budgets by our customers and was broad-based across all TA technologies. TA service sales increased in the quarter due to sales of service plans and billings to a higher installed base of customers. The effect of foreign currency translation decreased TAs sales 1% in the first quarter of 2019.
In the first quarter of 2019, TA sales were flat in Asia and decreased 5% and 30% in the Americas and Europe, respectively. Within Asia, a 25% increase in Japan was offset by declines of 8% and 2% in China and the rest of Asia, respectively.
Cost of Sales
Cost of sales for the first quarter of 2019 were flat as compared to the first quarter of 2018 due to a change in sales mix and lower manufacturing efficiencies on lower sales volumes. 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 negatively impact gross profit for the remainder of 2019.
Selling and Administrative Expenses
Selling and administrative expenses increased 3% in the first quarter of 2019 as compared to the first quarter of 2018. Selling and administrative expenses were impacted by higher merit compensation costs and $8 million of severance-related costs in connection with a reduction in workforce. In addition, the effect of foreign currency translation reduced selling and administrative expenses by 5% in the first quarter of 2019.
As a percentage of net sales, selling and administrative expenses were 26.1% and 24.6% for the first quarters of 2019 and 2018, respectively.
Research and Development Expenses
Research and development expenses increased 2% in the first quarter of 2019, primarily as a result of merit compensation and costs associated with new products and the development of new technology initiatives. In addition, the effect of foreign currency translation decreased research and development expenses by 2% in the quarter on the Companys U.K.-based research and development expenses, as the British pound weakened against the U.S. dollar as compared to the first quarter of 2018.
Litigation Settlement
In the second quarter of 2017, the Company incurred an $11 million litigation provision related to the issuance of a verdict in a patent litigation case. In the first quarter of 2018, the Company resolved the case with a final settlement that resulted in a gain of $2 million.
Interest Expense, Net
The decrease in net interest expense in 2019 was primarily attributable to lower interest income on lower cash, cash equivalents and investment balances, lower interest expense on lower outstanding debt balances and the additional interest income from the three-year U.S.-to-Euro interest rate cross-currency swap agreements entered into during the second half of 2018.
32
Provision for Income Taxes
The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the U.K. and Singapore, where the statutory tax rates are 21%, 12.5%, 19% and 17%, respectively, as of March 30, 2019. The Company has a contractual tax rate of 0% on qualifying activities in Singapore through March 2021, based upon the achievement of certain contractual milestones, which the Company expects to continue to meet. The effect of applying the contractual tax rate rather than the statutory tax rate to income from qualifying activities in Singapore increased the Companys net income for the quarter in 2019 and 2018 by $4 million and $6 million, respectively, and increased the Companys net income per diluted share by $0.06 and $0.07, respectively.
The Companys effective tax rate for the 2019 and 2018 quarters was 7.1% and 20.3%, respectively. The income tax provision includes a $7 million and $6 million income tax benefit related to stock-based compensation for the three months ended March 30, 2019 and March 31, 2018, respectively. The effective tax rate for the 2019 quarter includes a $3 million income tax benefit related to the finalization of certain regulations relating to the Tax Cuts and Jobs Act (the 2017 Tax Act). This income tax benefit decreased the effective tax rate by 2.9 percentage points for the 2019 quarter. The effective tax rate for the 2018 quarter includes $12 million of additional income tax expense related to the change in foreign currency exchange rates on the earnings taxed in December 2017 under the toll charge of the 2017 Tax Act. This additional income tax expense increased the effective tax rate by 8.9 percentage points for the 2018 quarter. The remaining differences between the effective tax rates can primarily be attributed to differences in the proportionate amounts of pre-tax income recognized in jurisdictions with different effective tax rates.
Liquidity and Capital Resources
Condensed Consolidated Statements of Cash Flows (in thousands):
Three Months Ended | ||||||||
March 30, 2019 | March 31, 2018 | |||||||
Net income |
$ | 108,986 | $ | 111,951 | ||||
Depreciation and amortization |
24,764 | 28,640 | ||||||
Stock-based compensation |
9,941 | 9,892 | ||||||
Deferred income taxes |
1,442 | 1,071 | ||||||
Change in accounts receivable |
59,331 | 40,588 | ||||||
Change in inventories |
(44,438 | ) | (28,101 | ) | ||||
Change in accounts payable and other current liabilities |
(33,485 | ) | (34,258 | ) | ||||
Change in deferred revenue and customer advances |
57,539 | 45,096 | ||||||
Effect of the 2017 Tax Act |
(3,229 | ) | 12,450 | |||||
Other changes |
(5,072 | ) | (11,488 | ) | ||||
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|
|
|
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Net cash provided by operating activities |
175,779 | 175,841 | ||||||
Net cash provided by investing activities |
434,039 | 895,839 | ||||||
Net cash used in financing activities |
(723,134 | ) | (1,006,065 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
2,006 | 8,588 | ||||||
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(Decrease) increase in cash and cash equivalents |
$ | (111,310 | ) | $ | 74,203 | |||
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Cash Flow from Operating Activities
Net cash provided by operating activities was $176 million during both the three months ended March 30, 2019 and March 31, 2018. 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:
| The changes in accounts receivable were primarily attributable to timing of payments made by customers and timing of sales. Days sales outstanding increased to 88 days at March 30, 2019 as compared to 85 days at March 31, 2018. |
33
| The changes in inventory were primarily attributable to anticipated annual increases in sales volumes, as well as new product launches and a build of safety stock inventory in advance of the Brexit decision. |
| The changes in accounts payable and other current liabilities were a result of the timing of payments to vendors, as well as the annual payment of management incentive compensation. |
| Net cash provided from deferred revenue and customer advances results from annual increases in new service contracts as a higher installed base of customers renew annual service contracts. |
| Other changes were attributable to variation in the timing of various provisions, expenditures, prepaid income taxes and accruals in other current assets, other assets and other liabilities. |
Cash Flow from Investing Activities
Net cash provided by investing activities totaled $434 million in the three months ended March 30, 2019 compared to net cash provided by investing activities that totaled $896 million in the three months ended March 31, 2018. Additions to fixed assets and capitalized software were $26 million and $16 million in the first three months of 2019 and 2018, respectively. In February 2018, the Companys Board of Directors approved expanding its precision chemistry consumable manufacturing 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 and investments. The Company does not expect to issue any debt in relation to this expansion. The Company has incurred $11 million of costs associated with the construction of this facility during the first quarter of 2019, and has incurred a total of $26 million through the end of the first quarter 2019.
During the three months ended March 30, 2019 and March 31, 2018, the Company purchased $27 million and $170 million of investments, respectively, while $486 million and $1,085 million of investments matured, respectively, and were used for financing activities described below.
Cash Flow from Financing Activities
During the three months ended March 30, 2019 and March 31, 2018, the Companys net debt borrowings were flat and decreased by $750 million, respectively. During the three months ended March 31, 2018, the Company reduced its outstanding debt using cash repatriated under the 2017 Tax Cuts and Jobs Act (the 2017 Tax Act). As of March 30, 2019, the Company had a total of $1,149 million in outstanding debt, which consisted of $560 million in outstanding senior unsecured notes, $300 million borrowed under a term loan and $290 million borrowed under a revolving credit facility, with both the term loan and revolving credit facilities under the credit agreement dated November 2017 (2017 Credit Agreement). As of March 30, 2019, the Company had a total amount available to borrow under the 2017 Credit Agreement of $1,208 million after outstanding letters of credit. As of March 30, 2019, the Company was in compliance with all debt covenants.
In February 2019, certain defined terms related to the subsidiary guarantors were amended in the 2017 Credit Agreement and senior unsecured note agreements. In addition, the Company amended the senior unsecured note agreements to allow the Company to elect an increase in the permitted leverage ratio from 3.50:1 to 4.0:1, for a period of three consecutive quarters, for a material acquisition of $400 million or more. During the period of time where the leverage ratio exceeds 3.50:1, the interest payable on the senior unsecured notes shall increase by 0.50%. The debt covenants in the senior unsecured note agreements were also modified to address the change in accounting guidance for leases.
In 2018 and April 2019, the Company entered into $410 million of U.S.-to-Euro interest rate cross-currency swap agreements that hedge the Companys net investment in its Euro denominated net assets. As a result of entering into these agreements, the Company anticipates lowering net interest expense by approximately $12 million annually over the three-year term of the agreements.
In January 2019, the Companys Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a two-year period. This new program replaced the remaining amounts available from the pre-existing program. During the first quarter of 2019 and 2018, the Company repurchased $745 million and $275 million, respectively, of the Companys outstanding common stock under authorized share repurchase programs. In addition, the Company repurchased $8 million of common stock related to the vesting of restricted stock units during both the three months ended March 30, 2019 and March 31, 2018. The Company expects to increase its share
34
repurchase activity in 2019 as compared to 2018 and intends to use existing cash and investments, cash flows from operations and, as needed, borrowings under its existing credit facilities to fund its repurchases under its share repurchase program.
The Company received $28 million and $24 million of proceeds from the exercise of stock options and the purchase of shares pursuant to the Companys employee stock purchase plan during the three months ended March 30, 2019 and March 31, 2018, respectively.
The Company had cash, cash equivalents and investments of $1,167 million as of March 30, 2019. The majority of the Companys cash, cash equivalents and investments are generated from foreign operations, with $411 million held by foreign subsidiaries at March 30, 2019, of which $263 million was held in currencies other than U.S. dollars. The Company believes it has sufficient levels of cash flow and access to its existing cash, cash equivalents and investments to fund operations and capital expenditures, service debt interest, finance potential acquisitions and continue the authorized stock repurchase program in the U.S. These cash requirements are managed by the Companys cash flow from operations, its existing cash, cash equivalents and investments, and the use of the Companys revolving credit facility.
Management believes, as of the date of this report, that the Companys 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. The Company has conducted a post-tax reform evaluation of its capital allocation strategy and the Company is currently planning to use its existing cash, cash equivalents and investments, cash flow from operations and available debt capacity to repurchase up to $4 billion of the Companys common stock over the next two years. The Company is currently planning to increase its outstanding debt balances up to approximately 2.5 times the Companys net debt-to-earnings before interest, taxes, depreciation and amortization ratio to fund a significant portion of these share repurchases. In addition, as of December 31, 2018, the Company determined that it will provide income taxes on all future foreign earnings and reverse its historical assertion that its foreign earnings were permanently invested. However, the Company will continue to be permanently reinvested in relation to the cumulative historical outside basis difference that is not related to the unremitted earnings. There have been no other significant changes to the Companys financial position.
Contractual Obligations, Commercial Commitments, Contingent Liabilities and Dividends
A summary of the Companys contractual obligations and commercial commitments is included in the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019. The Company reviewed its contractual obligations and commercial commitments as of March 30, 2019 and determined that there were no material changes outside the ordinary course of business from the information set forth in the Annual Report on Form 10-K.
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 that it has meritorious arguments in its current litigation matters and that any outcome, either individually or in the aggregate, will not be material to the Companys financial position or results of operations.
During fiscal year 2019, the Company expects to contribute a total of approximately $3 million to $6 million to its defined benefit plans, excluding the U.S. defined benefit pension plans.
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 Companys 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.
35
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 Companys business partners or customers, in connection with patent, copyright or other intellectual property infringement claims by any third party with 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 Companys 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
In the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019, the Companys most critical accounting policies and estimates upon which its financial status depends were identified as those relating to revenue recognition, loss provisions on accounts receivable and inventory, valuation of long-lived assets, intangible assets and goodwill, income taxes, uncertain tax positions, warranty, litigation, pension and other postretirement benefit obligations, stock-based compensation, business combinations and asset acquisitions and valuation of contingent consideration. The Company reviewed its policies and determined that those policies remain the Companys most critical accounting policies for the three months ended March 30, 2019. The Company did not make any changes in those policies during the three months ended March 30, 2019.
New Accounting Pronouncements
Please refer to Note 14, Recent Accounting Standard Changes and Developments, in the Condensed Notes to Consolidated Financial Statements.
Special Note Regarding Forward-Looking Statements
Certain of the statements in this Quarterly Report on Form 10-Q, including the information incorporated by reference herein, may contain forward-looking statements with respect to future results and events, including any statements regarding, among other items, anticipated trends or growth in the Companys business, including, but not limited to, the impact of new or proposed tariff or trade regulations or changes in the interpretation or enforcement of existing regulations; the impact of foreign currency translation on financial results; development of products by acquired businesses; the growth rate of sales and research and development expenses; the impact of costs associated with developing new technologies and bringing these new technologies to market; the impact of new product launches and the associated costs, such as the amortization expense related to software platforms; geographic sales mix of business; development of products by acquired businesses and the amount of contingent payments to the sellers of an acquired business; anticipated expenses, including interest expense, capitalized software costs and effective tax rates; the impact of the 2017 Tax Act in the U.S.; the impact and outcome of the Companys various ongoing tax audit examinations; the achievement of contractual milestones to preserve foreign tax rates; the impact and outcome of litigation matters; the impact of the loss of intellectual property protection; the impact of new accounting standards and pronouncements; the adequacy of the Companys supply chain and manufacturing capabilities and facilities; the impact of regulatory compliance; the Companys expected cash flow, borrowing capacity, debt repayment and refinancing; the Companys ability to fund working capital, capital expenditures, service debt, repay outstanding lines of credit, make authorized share repurchases, fund potential acquisitions and pay any adverse litigation or tax audit liabilities, particularly in the U.S.; future impairment charges; the Companys contributions to defined benefit plans; the Companys expectations regarding changes to its financial position; compliance with applicable environmental laws; and the impact of recent acquisitions on sales and earnings.
Many of these statements appear, in particular, under the heading Managements Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 of this Quarterly Report on Form 10-Q. Statements that are not statements of historical fact may be deemed forward-looking statements. You can identify these forward-looking statements by the use of the words feels, believes, anticipates, plans, expects, may, will, would, intends, suggests, appears, estimates, projects, should and similar expressions, whether in the negative or affirmative. These statements are subject to various risks and uncertainties, many of which are outside the control of the Company, including, and without limitation:
36
| Foreign currency exchange rate fluctuations that could adversely affect translation of the Companys future sales, financial operating results and the condition of its non-U.S. operations, especially when a currency weakens against the U.S. dollar. |
| Current global economic, sovereign and political conditions and uncertainties, particularly regarding the effect of new or proposed tariff or trade regulations or changes in the interpretation or enforcement of existing regulations; the U.K. voting to exit the European Union as well as the Chinese governments ongoing tightening of restrictions on procurement by government-funded customers; the Companys ability to access capital and maintain liquidity in volatile market conditions; changes in timing and demand for the Companys products among the Companys customers and various market sectors or geographies, particularly if they should reduce capital expenditures or are unable to obtain funding, as in the cases of governmental, academic and research institutions; the effect of mergers and acquisitions on customer demand for the Companys products; and the Companys ability to sustain and enhance service. |
| Negative industry trends; changes in the competitive landscape as a result of changes in ownership, mergers and continued consolidation among the Companys competitors; introduction of competing products by other companies and loss of market share; pressures on prices from customers or resulting from competition; regulatory, economic and competitive obstacles to new product introductions; lack of acceptance of new products; expansion of our business in developing markets; spending by certain end-markets; ability to obtain alternative sources for components and modules; and the possibility that future sales of new products related to acquisitions, which trigger contingent purchase payments, may exceed the Companys expectations. |
| Increased regulatory burdens as the Companys business evolves, especially with respect to the United States Food and Drug Administration and the United States Environmental Protection Agency, among others, as well as regulatory, environmental and logistical obstacles affecting the distribution of the Companys products, completion of purchase order documentation by our customers and ability of customers to obtain letters of credit or other financing alternatives. |
| Risks associated with lawsuits, particularly involving claims for infringement of patents and other intellectual property rights. |
| The impact and costs incurred from changes in accounting principles and practices; the impact and costs of changes in statutory or contractual tax rates in jurisdictions in which the Company operates, specifically as it relates to the 2017 Tax Act in the U.S.; shifts in taxable income among jurisdictions with different effective tax rates; and the outcome of and costs associated with ongoing and future tax audit examinations or changes in respective country legislation affecting the Companys effective rates. |
Certain of these and other factors are discussed under the heading Risk Factors under Part I, Item 1A of the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements, whether because of these factors or for other reasons. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this report. Except as required by law, the Company does not assume any obligation to update any forward-looking statements.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
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 March 30, 2019, 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 March 30, 2019 and December 31, 2018, $411 million out of $1,167 million and $471 million out of $1,735 million, respectively, of the Companys total cash, cash equivalents and investments were held by foreign subsidiaries. In addition, $263 million out of $1,167 million and $251 million out of $1,735 million of cash, cash equivalents and investments were held in currencies other than the U.S. dollar at March 30, 2019 and December 31, 2018, respectively. As of March 30, 2019, the Company had no holdings in auction rate securities or commercial paper issued by structured investment vehicles.
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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 Companys cash, cash equivalents and investments held in currencies other than the U.S. dollar as of March 30, 2019 would decrease by approximately $26 million, of which the majority would be recorded to foreign currency translation in other comprehensive income within stockholders equity.
There have been no other material changes in the Companys market risk during the three months ended March 30, 2019. For information regarding the Companys market risk, refer to Item 7A of Part II of the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019.
Item 4: Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Companys chief executive officer and chief financial officer (principal executive officer and principal financial officer), with the participation of management, evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Companys chief executive officer and chief financial officer concluded that the Companys disclosure controls and procedures were effective as of March 30, 2019 (1) to ensure that information required to be disclosed by the Company, including its consolidated subsidiaries, in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Companys management, including its chief executive officer and chief financial officer, to allow timely decisions regarding the required disclosure and (2) to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.
Changes in Internal Controls Over Financial Reporting
No change was identified in the Companys internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 30, 2019 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.
There have been no material changes in the Companys legal proceedings during the three months ended March 30, 2019 as described in Item 3 of Part I of the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019.
Information regarding risk factors of the Company is set forth under the heading Risk Factors under Part I, Item 1A in the Companys Annual Report on Form 10-K/A for the year ended December 31, 2018, as filed with the SEC on March 1, 2019. The Company reviewed its risk factors as of March 30, 2019 and determined that there were no material changes from the ones set forth in the Form 10-K. Note, however, the discussion under the subheading Special Note Regarding Forward-Looking Statements in Part I, Item 2 of this Quarterly Report on Form 10-Q. These risks are not the only ones facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Companys business, financial condition and operating results.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities by the Issuer
The following table provides information about purchases by the Company during the three months ended March 30, 2019 of equity securities registered by the Company under the Exchange Act (in thousands, except per share data):
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Period |
Total Number of Shares Purchased (1) |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Programs (2) |
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Programs (2) |
||||||||||||||
January 1, 2019 to January 26, 2019 |
923 | $ | 196.31 | 923 | $ | 3,968,621 | ||||||||||||
January 27, 2019 to February 23, 2019 |
1,085 | $ | 232.20 | 1,059 | $ | 3,722,869 | ||||||||||||
February 24, 2019 to March 30, 2019 |
1,324 | $ | 243.34 | 1,316 | $ | 3,402,436 | ||||||||||||
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|
|
|
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Total |
3,332 | $ | 226.68 | 3,298 | $ | 3,402,436 | ||||||||||||
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(1) | The Company repurchased 34 thousand shares of common stock at a cost of $8 million related to the vesting of restricted stock units during the three months ended March 30, 2019. |
(2) | In January 2019, the Companys Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock in open market or private transactions over a two-year period. This new program replaced the remaining amounts available under the pre-existing authorization. |
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Exhibit |
Description of Document | |
31.1 | Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(*) | |
32.2 | Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(*) | |
101 | The following materials from Waters Corporations Quarterly Report on Form 10-Q for the quarter ended March 30, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets (unaudited), (ii) the Consolidated Statements of Operations (unaudited), (iii) the Consolidated Statements of Comprehensive Income (unaudited), (iv) the Consolidated Statements of Cash Flows (unaudited) and (vi) Condensed Notes to Consolidated Financial Statements (unaudited). |
(*) | This exhibit shall not be deemed filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WATERS CORPORATION |
/s/ Sherry L. Buck |
Sherry L. Buck |
Senior Vice President and Chief Financial Officer |
Date: May 3, 2019
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