WATERS CORP /DE/ (WAT) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Results of Operations
Sales by Geography
Geographic sales information is presented below for the years ended December 31, 2021, 2020 and 2019 (dollars in thousands):
| Year Ended December 31, | % change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | 2021 vs. 2020 | 2020 vs. 2019 | ||||||||||||||||
| Net Sales: | ||||||||||||||||||||
| Asia: | ||||||||||||||||||||
| China | $ | 521,128 | $ | 404,352 | $ | 439,557 | 29 | % | (8 | %) | ||||||||||
| Japan | 182,597 | 179,815 | 180,707 | 2 | % | — | % | |||||||||||||
| Asia Other | 372,040 | 315,010 | 318,848 | 18 | % | (1 | %) | |||||||||||||
| Total Asia | 1,075,765 | 899,177 | 939,112 | 20 | % | (4 | %) | |||||||||||||
| Americas: | ||||||||||||||||||||
| United States | 774,014 | 678,313 | 692,277 | 14 | % | (2 | %) | |||||||||||||
| Americas Other | 151,206 | 119,529 | 137,964 | 27 | % | (13 | %) | |||||||||||||
| Total Americas | 925,220 | 797,842 | 830,241 | 16 | % | (4 | %) | |||||||||||||
| Europe | 784,889 | 668,346 | 637,243 | 17 | % | 5 | % | |||||||||||||
| Total net sales | $ | 2,785,874 | $ | 2,365,365 | $ | 2,406,596 | 18 | % | (2 | %) |
In 2021, sales increased 18% as compared to 2020, due to stronger demand for our products and services across most major geographies and customer classes as a result of our customers resuming laboratory and manufacturing operations, as well as
the pent-up
demand from 2020 caused by
the COVID-19 pandemic.
The sales strength was broad-based, driven by continued growth in recurring revenues and the strong sales growth in instruments, particularly in LC instrument system sales. Foreign currency translation increased sales by 2% in 2021 and had minimal impact on sales in 2020.
In 2020, sales decreased 2% as compared to 2019, as the
COVID-19 pandemic
caused interruptions in business activities and uncertainties that resulted in our customers reducing purchases of our products and services. The sales declines in 2020 were broad-based across all geographies and were a result of the weaker demand and disruption of business activities caused by
the COVID-19 lockdowns,
except in Europe where sales increased 5% as compared to the prior year. The most significant decline in sales in 2020 occurred in China, where sales declined 8%, as well as declines of 2% in the U.S. and 13% in the Americas Other region.
Sales by Trade Class
Net sales by customer class are presented below for the years ended December 31, 2021, 2020 and 2019 (dollars in thousands):
| Year Ended December 31, | % change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | 2021 vs. 2020 | 2020 vs. 2019 | ||||||||||||||||
| Pharmaceutical | $ | 1,667,061 | $ | 1,386,966 | $ | 1,365,275 | 20 | % | 2 | % | ||||||||||
| Industrial | 829,204 | 707,772 | 719,377 | 17 | % | (2 | %) | |||||||||||||
| Academic and governmental | 289,609 | 270,627 | 321,944 | 7 | % | (16 | %) | |||||||||||||
| Total net sales | $ | 2,785,874 | $ | 2,365,365 | $ | 2,406,596 | 18 | % | (2 | %) |
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In 2021, sales to pharmaceutical customers increased 20% with foreign currency translation positively impacting sales by 1%. The increase in sales to pharmaceutical customers was broad-based with double-digit sales growth across most major geographies, primarily due to stronger demand for our products and services as a result of our customers continuing to resume laboratory and manufacturing operations. Sales also benefited from the demand from certain pharmaceutical customers involved
with COVID-19
diagnostic testing and the increase in the development of new drugs and therapies. Sales to industrial customers in 2021 increased 17%, primarily due to customers continuing to resume laboratory and manufacturing operations during the year and this growth was driven by the increased customer demand for our TA products. Foreign currency translation increased sales to industrial customers by 2% in 2021. Sales to academic and government customers increased 7% in 2021, with foreign currency translation increasing sales by 2%.
In 2020, sales to pharmaceutical customers increased 2% with foreign currency translation positively impacting sales by 1%. The lower sales volumes to pharmaceutical customers in 2020, particularly in the first half of the year, can be attributed to the disruption in business activities caused
by COVID-19, despite
increased demand for our products and services from certain pharmaceutical customers who are
involved with COVID-19 diagnostic testing
and the development of new drugs and therapies. Sales to industrial customers in 2020 declined 2%, which were significantly impacted by the TA sales declines of 8% in 2020. The sales declines to academic and government customers were broad-based across all product classes as academic and governmental customers adjusted their spending to mitigate the effects of
the COVID-19 pandemic,
which significantly impacted sales in China.
Waters Products and Services Net Sales
Net sales for Waters products and services were as follows for the years ended December 31, 2021, 2020 and 2019 (dollars in thousands):
| Year Ended December 31, | % change | |||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | % of Total | 2020 | % of Total | 2019 | % of Total | 2021 vs. 2020 | 2020 vs. 2019 | |||||||||||||||||||||||||
| Waters instrument systems | $ | 1,089,248 | 44 | % | $ | 890,855 | 42 | % | $ | 963,871 | 45 | % | 22 | % | (8 | %) | ||||||||||||||||
| Chemistry consumables | 507,209 | 21 | % | 432,080 | 20 | % | 412,018 | 19 | % | 17 | % | 5 | % | |||||||||||||||||||
| Total Waters product sales | 1,596,457 | 65 | % | 1,322,935 | 62 | % | 1,375,889 | 64 | % | 21 | % | (4 | %) | |||||||||||||||||||
| Waters service | 876,626 | 35 | % | 794,189 | 38 | % | 761,594 | 36 | % | 10 | % | 4 | % | |||||||||||||||||||
| Total Waters net sales | $ | 2,473,083 | 100 | % | $ | 2,117,124 | 100 | % | $ | 2,137,483 | 100 | % | 17 | % | (1 | %) |
Waters products and service sales increased 17% in 2021 and declined 1% in 2020, with the effect of foreign currency translation increasing Waters sales by 2% and 1% in 2021 and 2020, respectively. Waters instrument system sales (LC and MS technology-based) increased 22% in 2021 primarily due to customer demand continuing to increase to
pre-pandemic
levels as customer laboratories and manufacturing facilities continued to return to normal operations. Precision chemistry consumables sales increased double-digits due to the strong demand across most major geographies driven by the uptake in columns and application-specific testing kits to pharmaceutical customers. Waters service sales increased 10% due to higher service demand billings as
COVID-19
business closures and restrictions began to ease. In addition, sales growth in 2021 benefited from the growing contributions made by the Company’s recent introductions of new higher-performing products which included the ACQUITY PREMIER System, Arc Premier HPLC System and Multi-Reflecting ToF mass spectrometers.
In 2020 Waters instrument system sales (LC and MS technology-based) decreased 8%, primarily attributed to the weaker demand for our products and services by our customers due to the disruption and uncertainty caused
by the COVID-19 pandemic.
Precision chemistry consumables sales increased 5% in 2020, despite the disruption in business activities caused
by COVID-19.
Waters service sales increased 4%, primarily due to increased sales of service plans and higher service demand billings to a higher installed base of customers
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respectively, with sales in 2020 being partially offset by the weaker demand and disruption of business activities caused by
the COVID-19 lockdowns.
TA Product and Services Net Sales
Net sales for TA products and services were as follows for the years ended December 31, 2021, 2020 and 2019 (dollars in thousands):
| Year Ended December 31, | % change | |||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | % of Total | 2020 | % of Total | 2019 | % of Total | 2021 vs. 2020 | 2020 vs. 2019 | |||||||||||||||||||||||||
| TA instrument systems | $ | 225,613 | 72 | % | $ | 174,398 | 70 | % | $ | 191,300 | 71 | % | 29 | % | (9 | %) | ||||||||||||||||
| TA service | 87,178 | 28 | % | 73,843 | 30 | % | 77,813 | 29 | % | 18 | % | (5 | %) | |||||||||||||||||||
| Total TA net sales | $ | 312,791 | 100 | % | $ | 248,241 | 100 | % | $ | 269,113 | 100 | % | 26 | % | (8 | %) |
TA instrument system and service sales growth in 2021 was broad-based across all geographies increasing 26%, and was primarily driven by stronger demand as a result of our customers continuing to resume laboratory and manufacturing operations. In 2021, the increase in TA instrument system sales was primarily driven by strength in all major regions. The increase in TA service sales was attributable to customers continuing to resume their operations after the restrictions caused
by COVID-19 during
2020, as well as sales of service plans and billings to a higher installed base of customers. The effect of foreign currency translation increased TA’s sales by 1% in 2021.
TA product and service sales declines in 2020 were primarily due to lower customer demand resulting from the
COVID-19 pandemic.
TA’s instrument system sales declined in 2019 primarily due to lower customer demand resulting from macroeconomic conditions, tariff posturing and political instability. TA service sales increased in 2019 due to sales of service plans and billings to a higher installed base of customers. TA sales declined in all major regions in 2020, with foreign currency translation having minimal impact on TA’s sales.
Cost of Sales
Cost of sales increased 15% in 2021 as compared to 2020, primarily due to the increase in sales volumes during the year, the reinstatement in 2021 of expenses that had been reduced as a result of the
COVID-19
pandemic in 2020 that consisted of salary reductions, furloughs and reductions in
non-essential
spending as well as an increase in freight costs.
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 decrease sales and gross profit during 2022.
Selling and Administrative Expenses
Selling and administrative expenses increased 13% and 4% in 2021 and 2020, respectively. The increase in selling and administrative expenses in 2021 can be attributed to the higher salary merit and variable incentive compensation costs as well as the impact of the reinstatement of salary reductions, furloughs and reductions in
non-essential
spending that occurred in 2020. The increase in selling and administrative expenses in 2020 can be attributed to the salary merit and incentive compensation increases along with the severance-related costs in connection with a reduction in workforce and lease-termination and exit costs. Severance and lease termination and exit costs were $27 million and $10 million in 2020 and 2019, respectively. Offsetting these increases in selling and administrative expenses were $70 million of savings in 2020, which
includes COVID-19 and
restructuring cost saving actions that reduced planned salaries
and non-essential spending.
The effect of foreign currency translation increased selling and administrative expenses by 1% in 2021 and had a minimal impact on selling and administrative expenses in 2020.
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As a percentage of net sales, selling and administrative expenses were 22.5%, 23.4% and 22.2% for 2021, 2020 and 2019, respectively.
Research and Development Expenses
Research and development expenses increased 20% in 2021 and decreased 2% in 2020. The increase in research and development expenses was impacted by additional headcount, merit compensation and costs associated with new products and the development of new technology initiatives as well as the reinstatement of
COVID-19
cost actions implemented in 2020. Research and development expenses in 2020 include $15 million of cost action savings from salary reductions, furloughs and reductions
in non-essential spending.
Foreign currency translation decreased research and development expenses in 2021 by 1% and had minimal impact on research and development costs in 2020.
Asset Impairments
During 2020, due to a shift in strategic priorities, the Company recorded a
non-cash
charge of $10 million for the impairment of certain intangible assets associated with the acquisition of Medimass Research Development and Service Kft (“Medimass”). In conjunction with the intangible asset impairment, the Company also reduced its liability for contingent consideration of $3 million during 2020 as the carrying value of this liability is based on the future sales of the Medimass intangible assets that were impaired. See Note 2, Basis of Presentation and Summary of Significant Accounting Policies, under the heading “Asset Impairments” in the Notes to Consolidated Financial Statements for a description of the impairment charge.
Other Income (Expense), Net
In 2021, the Company executed a settlement agreement to resolve patent infringement litigation with Bruker Corporation and Bruker Daltronik GmbH regarding their timsTOF product line. In connection with the settlement, the Company is entitled to receive $10 million in guaranteed payments, including minimum royalty payments, which were recognized within other income in our consolidated statement of operations. In 2021, the Company also recorded an unrealized gain of $10 million due to an observable change in the fair value of an existing investment the Company does not have the ability to exercise significant influence over.
Interest Expense, Net
Net interest expense in 2021 remained consistent with 2020 as the increase in the average debt balance in 2021 was offset by the impact of lower interest rates. The increase in net interest expense from 2019 to 2020 is due to higher debt balances in 2020.
Provision for Income Taxes
The Company’s effective tax rates were 14.1%, 14.6% and 12.7% in 2021, 2020 and 2019, respectively.
The Company’s effective income tax rate differs from the U.S. federal statutory rate each year due to differences in the proportionate amounts of
pre-tax
income recognized in jurisdictions with different effective tax rates and the items discussed below.
The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the U.K. and Singapore, where the statutory tax rates were 21%, 12.5%, 19% and 17%, respectively, as of December 31, 2021. The Company entered into a new Development and Expansion Incentive in Singapore that provides a concessionary income tax rate of 5% on certain types of income for the period of April 1, 2021 through March 31, 2026. Prior to April 1, 2021, the Company had a tax exemption on income arising from qualifying activities in Singapore, based upon the achievement of certain contractual milestones, which the Company met as of December 31, 2020 and maintained through March 2021. The effect of applying these concessionary income tax rates rather than the statutory tax rate to income arising from qualifying activities in Singapore increased the
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Company’s net income during the years ended December 31, 2021, 2020 and 2019 by $20 million, $21 million and $24 million, respectively, and increased the Company’s net income per diluted share by $0.32, $0.33 and $0.35, respectively.
During 2021, the Company’s effective tax rate differed from the 21% U.S. statutory tax rate primarily due to the jurisdictional mix of earnings, a $10 million provision related to the Global Intangible
Low-Taxed
Income (“GILTI”) tax and a tax benefit of $7 million on stock-based compensation.
The 2020 effective tax rate differed from the U.S. federal statutory tax rate primarily due to the jurisdictional mix of earnings, a $13 million provision related to the GILTI tax and a tax benefit of $7 million on stock-based compensation.
The 2019 effective tax rate differed from the U.S. federal statutory tax rate primarily due to the jurisdictional mix of earnings, an $11 million provision related to the GILTI tax and tax benefit of $9 million related to stock-based compensation.
The Company’s effective tax rate is influenced by many significant factors, including, but not limited to, the wide range of income tax rates in jurisdictions in which the Company operates; sales volumes and profit levels in each tax jurisdiction; changes in tax laws, tax rates and policies; the outcome of various ongoing tax audit examinations; and the impact of foreign currency transactions and translation. As a result of variability in these factors, the Company’s effective tax rates in the future may not be similar to the effective tax rates for the current or prior years, or for previously forecasted periods.
Liquidity and Capital Resources
Condensed Consolidated Statements of Cash Flows (in thousands):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||||
| Net income | $ | 692,843 | $ | 521,571 | $ | 592,198 | ||||||
| Depreciation and amortization | 131,680 | 125,361 | 105,296 | |||||||||
| Stock-based compensation | 29,918 | 36,865 | 38,577 | |||||||||
| Deferred income taxes | 16,633 | (2,693 | ) | 9,620 | ||||||||
| Asset impairments | — | 6,945 | — | |||||||||
| Observable unrealized gain on investment | (9,707 | ) | — | — | ||||||||
| Change in accounts receivable | (62,448 | ) | 37,467 | (22,195 | ) | |||||||
| Change in inventories | (67,250 | ) | 18,940 | (31,854 | ) | |||||||
| Change in accounts payable and other current liabilities | 46,110 | 140,598 | 9,784 | |||||||||
| Change in deferred revenue and customer advances | 37,845 | 11,073 | 12,189 | |||||||||
| Effect of the 2017 Tax Cuts and Jobs Act | — | — | (3,229 | ) | ||||||||
| Other changes | (68,350 | ) | (105,620 | ) | (67,299 | ) | ||||||
| Net cash provided by operating activities | 747,274 | 790,507 | 643,087 | |||||||||
| Net cash (used in) provided by investing activities | (231,630 | ) | (264,094 | ) | 768,802 | |||||||
| Net cash used in financing activities | (438,275 | ) | (440,502 | ) | (1,872,678 | ) | ||||||
| Effect of exchange rate changes on cash and cash equivalents | (12,830 | ) | 15,069 | 224 | ||||||||
| Increase (decrease) in cash and cash equivalents | $ | 64,539 | $ | 100,980 | $ | (460,565 | ) |
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Cash Flow Provided By Operating Activities
Net cash provided by operating activities was $747 million, $791 million and $643 million in 2021, 2020 and 2019, respectively. The changes within net cash provided by operating activities include the following significant changes in the sources and uses of net cash provided by operating activities, aside from the changes in net income:
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | The changes in accounts receivable were primarily attributable to the increase in sales volumes as well as the timing of sales and the timing of payments made by customers. Days sales outstanding was 66 days at December 31, 2021, 70 days at December 31, 2020 and 77 days at December 31, 2019. |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | The increase in inventory in 2021 can be attributed to higher sales volumes and the increase in safety stock levels to mitigate logistic and supply chain issues. The change in inventory in 2020 compared to 2019 is a result of the Company’s efforts to reduce its inventory levels during the COVID-19 pandemic to preserve its liquidity. |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | The changes in accounts payable and other current liabilities were the result of timing of payments to vendors. In addition, the changes in 2021, 2020 and 2019 include $38 million, $38 million and $29 million, respectively, of income tax payments made in the U.S. relating to the Company’s estimated 2017 tax reform liability. In addition, in 2021, the change was impacted by the normalization of COVID-19 cost actions, as well as higher variable incentive compensation costs. |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | 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. |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | Other changes were attributable to variation in the timing of various provisions, expenditures, prepaid income taxes and accruals in other current assets, other assets, other liabilities and an income tax payment related to the 2017 Tax Act. In addition, in 2019, the Company made $11 million of contributions to certain defined benefit pension plans. |
Cash (Used in) Provided By Investing Activities
Net cash used in investing activities totaled $232 million and $264 million in 2021 and 2020, respectively, while net cash provided by investing activities was $769 million in 2019. Additions to fixed assets and capitalized software were $161 million, $172 million and $164 million in 2021, 2020 and 2019, respectively. The cash flows from investing activities in 2021 also included $49 million of capital expenditures related to the expansion of the Company’s precision chemistry consumable operations in the United States. The Company has incurred costs of $200 million on this facility through the end of 2021, and anticipates spending approximately $50 million to complete this new state-of-the-art facility in 2022.
During 2021, 2020 and 2019, the Company purchased $280 million, $26 million and $37 million of investments, respectively. During 2021, 2020 and 2019, $218 million, $21 million and $1.0 billion of investments matured, respectively.
In January 2020, the company entered into a definitive agreement to acquire Andrew Alliance, an innovator in specialty laboratory automation technology, including software and robotics for approximately $80 million in cash. The Company had an equity investment in Andrew Alliance that was valued at $4 million and included as part of the total consideration. This acquisition did not have a material effect on the Company’s sales and expenses in 2020.
In December 2020, the company entered into a definitive agreement to acquire ISS, a provider of clinical laboratory software systems, for $4 million in cash. This acquisition did not have a material effect on the Company’s sales and expenses in 2020.
There were no business acquisitions in 2021 and 2019.
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During 2021, 2020 and 2019, the Company made $2 million, $6 million and $9 million of investments in unaffiliated companies, respectively.
Cash Used in Financing Activities
On September 17, 2021, the Company entered into an amended and restated credit agreement (the “2021 Credit Agreement”), which amended the Company’s existing credit agreement entered into in 2017 (the “2017 Credit Agreement”). The 2021 Credit Agreement provides for a $1.8 billion revolving facility (the “2021 Credit Facility”) and converted the $300 million term loan under the 2017 Credit Agreement into part of the new revolving facility. As of December 31, 2021, the 2021 Credit Facility had a total of $210 million outstanding. As of December 31, 2020, the revolving credit facility and the term loan governed by the 2017 Credit Agreement had a total of $100 million and $300 million, respectively, outstanding. The 2021 Credit Facility matures on September 17, 2026 and requires no scheduled prepayments before that date.
In March 2021, the Company issued senior unsecured notes with an aggregate principal amount of $500 million. The Series N $100 million notes have a five-year term and a fixed interest rate of 1.68%. The Series O $400 million notes have
a 10-year term
and a fixed interest rate of 2.25%.
The Company’s net debt borrowings increased by $160 million in 2021, decreased by $325 million in 2020 and increased by $535 million in 2019. As of December 31, 2021, the Company had a total of $1.5 billion in outstanding debt, which consisted of $1.3 billion in outstanding senior unsecured notes and $210 million borrowed under a revolving credit facility, with both the term loan and revolving credit facilities under the 2017 Credit Agreement. As of December 31, 2021, the Company had a total amount available to borrow under the 2017 Credit Agreement of $1.6 billion after outstanding letters of credit. As of December 31, 2021, the Company was in compliance with all debt covenants.
As of December 31, 2021, the Company has entered into three-year interest rate cross-currency swap derivative agreements with a notional value of $230 million to hedge the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. As a result of entering into these agreements, the Company lowered its net interest expense by $11 million, $15 million and $12 million during 2021, 2020 and 2019, respectively. The Company anticipates that these swap agreements will lower net interest expense by approximately $1 million in 2022, as the three-year term of the agreements expire. During 2021, the Company entered into a new cross-currency swap derivative agreement with a notional value of $40 million.
In January 2019, the Company’s Board of Directors authorized the Company to repurchase up to $4 billion of its outstanding common stock over a
two-year
period. During 2021, 2020 and 2019, the Company repurchased 2.0 million, 0.8 million and 11.1 million shares of the Company’s outstanding common stock at a cost of $640 million, $167 million and $2.5 billion, respectively, under the January 2019 authorization and other previously announced programs. In December 2020, the Company’s Board of Directors authorized the extension of the share repurchase program through January 21, 2023. In addition, the Company repurchased $9 million, $9 million and $8 million of common stock related to the vesting of restricted stock units during the years ended December 31, 2021, 2020 and 2019, respectively.
The Company received $56 million, $66 million and $54 million of proceeds from the exercise of stock options and the purchase of shares pursuant to the Company’s employee stock purchase plan in 2021, 2020 and 2019, respectively.
The Company had cash, cash equivalents and investments of $569 million as of December 31, 2021. The majority of the Company’s cash and cash equivalents are generated from foreign operations, with $440 million held by foreign subsidiaries at December 31, 2021, of which $298 million was held in currencies other than U.S. dollars.
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As of December 31, 2021, the Company’s material cash requirements include the following contractual and other obligations:
Long-term debt.
As of December 31, 2021, the Company had $1.5 billion of cash requirements for the principal on long-term debt that will mature and be paid as follows: $50 million in 2023; $100 million in 2024; $670 million in 2026; $300 million in 2029 and $400 million in 2031.
Interest on Senior Unsecured Notes.
As of December 31, 2021, the Company had $240 million of cash requirements for the interest on senior unsecured notes that is to be paid as follows: $39 million in 2022; $38 million in 2023; $35 million in 2024; $33 million in 2025; $27 million in 2026; $20 million in both 2027 and 2028; $17 million in 2029; $9 million in 2030; and $2 million in 2031. See also Note 9 in the Notes to the Consolidated Financial Statements for financial information about interest payable.
2017 Tax Act liabilities.
As a result of the 2017 Tax Act, the Company incurred a Transition Toll Tax, that would be paid over an eight-year period, starting in 2018, and will not accrue interest. As of December 31, 2021, the Company had a remaining cash requirement of $327 million of which $38 million, $72 million, $96 million and $121 million will be paid in 2022, 2023, 2024 and 2025, respectively. See also Note 10 in the Notes to the Consolidated Financial Statements for financial information about tax liabilities.
Operating Leases.
The Company’s 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. 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 Company’s leases include rental escalation clauses, renewal options and/or termination options that are factored into our determination of lease payments. A certain number of these leases contain rent escalation clauses, either fixed or adjusted periodically for inflation of market rates, that are factored into the Company’s 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 real estate taxes and other expenses, which are recorded as variable costs when incurred. The Company’s cash requirements for future lease payments were approximately $94 million as of December 31, 2021. See also Note 12 in the Notes to the Consolidated Financial Statements for financial information about lease liabilities.
Long-term Software Contract Commitments.
For contracts the Company is committed to that are not cancelable without penalties. The Company’s contractual obligation with these vendors was approximately $28 million as of December 31, 2021.
Management believes, as of the date of this report, that the Company’s financial position, along with expected future cash flows from earnings based on historical trends and the ability to raise funds from external sources and the borrowing capacity from existing, committed credit facilities, will be sufficient to service debt and fund working capital and capital spending requirements, authorized share repurchase amounts and potential acquisitions for at least the next twelve months.
Critical Accounting Policies and Estimates
Summary
The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results of operations that require management to make estimates about matters that are highly uncertain and that would have a material impact on the Company’s results of operations given changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that reasonably could have been used in the current period. On an ongoing basis, the Company evaluates its policies and estimates. The Company bases its estimates on historical experience and on various other assumptions that are
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believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts may differ from these estimates under different assumptions or conditions. There are other items within the Company’s consolidated financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could potentially have a material impact on the Company’s consolidated financial statements.
Revenue Recognition
The Company recognizes revenue upon transfer of control of promised products and services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company generally enters into contracts that include a combination of products and services. Revenue is allocated to distinct performance obligations and is recognized net of allowances for returns and discounts.
The Company recognizes revenue on product sales at the time control of the product transfers to the customer. In substantially all of the Company’s arrangements, title of the product transfers at shipping point and, as a result, the Company determined control transfers at the point of shipment. In more limited cases, there are destination-based shipping terms and, thus, control is deemed to transfer when the products arrive at the customer site. All incremental costs of obtaining a contract are expensed as and when incurred if the expected amortization period of the asset that would have been recognized is one year or less. Shipping and handling costs are included as a component of cost of sales. In situations where the control of the goods transfers prior to the completion of the Company’s obligation to ship the products to its customers, the Company has elected the practical expedient to account for the shipping services as a fulfillment cost. Accordingly, such costs are recognized when control of the related goods is transferred to the customer. In more rare situations, the Company has revenue associated with products that contain specific customer acceptance criteria and the related revenue is not recognized before the customer acceptance criteria are satisfied. The Company elected to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with specific revenue-producing transactions and collected by the Company from a customer.
Generally, the Company’s contracts for products include a performance obligation related to installation. The Company has determined that the installation represents a distinct performance obligation and revenue is recognized separately upon the completion of installation. The Company determines the amount of the transaction price to allocate to the installation service based on the standalone selling price of the product and the service, which requires judgment. The Company determines the relative standalone selling price of installation based upon a number of factors, including hourly service billing rates and estimated installation hours. In developing these estimates, the Company considers past history, competition, billing rates of current services and other factors.
The Company has sales from standalone software, which are included in instrument systems revenue. These arrangements typically include software licenses and maintenance contracts, both of which the Company has determined are distinct performance obligations. The Company determines the amount of the transaction price to allocate to the license and maintenance contract based on the relative standalone selling price of each performance obligation. Software license revenue is recognized at the point in time when control has been transferred to the customer. The revenue allocated to the software maintenance contract is recognized on a straight-line basis over the maintenance period, which is the contractual term of the contract, as a time-based measure of progress best reflects the Company’s performance in satisfying this obligation. Unspecified rights to software upgrades are typically sold as part of the maintenance contract on a
when-and-if-available
basis.
Payment terms and conditions vary among the Company’s revenue streams, although terms generally include a requirement of payment within 30 to 60 days of product shipment. Prior to providing payment terms to customers, an evaluation of their credit risk is performed. Returns and customer credits are infrequent and insignificant and are recorded as a reduction to sales. Rights of return are not included in sales arrangements and, therefore, there is minimal variable consideration included in the transaction price of our products.
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Service revenue includes (i) service and software maintenance contracts and (ii) service calls (time and materials). Instrument service contracts and software maintenance contracts are typically annual contracts, which are billed at the beginning of the contract or maintenance period. The amount of the service and software maintenance contract is recognized on a straight-line basis to revenue over the maintenance service period, which is the contractual term of the contract, as a time-based measure of progress best reflects the Company’s performance in satisfying this obligation. There are no deferred costs associated with the service contract, as the cost of the service is recorded when the service is performed. Service calls are recognized to revenue at the time a service is performed.
The Company’s deferred revenue liabilities at December 31, 2021 of $274 million on the consolidated balance sheets consist of the obligation on instrument service contracts and customer payments received in advance, prior to transfer of control of the instrument. The Company records deferred revenue primarily related to its service contracts, where consideration is billable at the beginning of the service period.
Allowance for credit losses on Accounts Receivable
The Company adopted new accounting guidance regarding the accounting for credit losses as of January 1, 2020 using a modified retrospective transition approach that was applied to our trade receivable balances. The allowance for credit losses policies described below were effective as of January 1, 2020.
The Company maintains allowances for expected credit losses based on applying a historical loss rate to trade receivable aging balances to estimate a general reserve balance on current receivables along with an additional adjustment for any specific receivables with known or anticipated issues affecting the likelihood of recovery. The historical loss rate is calculated by comparing the prior year actual sales and accounts receivable balances to estimate the period of collection of trade receivables by aging category. This collection information by aging category is then compared to write offs over the same prior year period to estimate the amount of allowance that is attributable to each category of our accounts receivable aging. Past due balances with a probability of default based on historical data as well as relevant available forward-looking information are included in the specific adjustment. If the financial condition of the Company’s customers were to deteriorate beyond what is estimated in the current expected credit loss model, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company does not request collateral from its customers, but collectibility is enhanced through the use of credit card payments and letters of credit. The Company assesses collectibility based on a number of factors, including, but not limited to, past transaction history with the customer, the credit-worthiness of the customer, industry trends and the macro-economic environment. Historically, the Company has not experienced significant credit losses. Sales returns and allowances are estimates of future product returns related to current period revenue. Material differences may result in the amount and timing of revenue for any period if management made different judgments or utilized different estimates for sales returns and allowances for expected credit losses. The Company’s accounts receivable balance at December 31, 2021 was $613 million, net of allowances for expected credit losses of $13 million.
Loss Provision on Inventory
The Company values all of its inventories at the lower of cost or net realizable value on a
first-in,
first-out
basis (“FIFO”). The Company estimates revisions to its inventory valuations based on technical obsolescence, historical demand, projections of future demand, including that in the Company’s current backlog of orders, and industry and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional write-downs may be required. The Company’s inventory balance at December 31, 2021 was recorded at its net realizable value of $356 million, which is net of write-downs of $32 million.
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Long-Lived Assets, Intangible Assets and Goodwill
The Company assesses the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger impairment include, but are not limited to, the following:
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant underperformance relative to historical or projected future operating results, particularly as it pertains to capitalized software and patent costs; |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant negative industry or economic trends, competitive products and technologies; and |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant changes or developments in strategic technological collaborations or legal matters which affect the Company’s capitalized patents, purchased technology, trademarks and intellectual properties, such as licenses. |
When the Company determines that the carrying value of an individual intangible asset, long-lived asset or goodwill may not be recoverable based upon the existence of one or more of the above indicators, an estimate of undiscounted future cash flows produced by that intangible asset, long-lived asset or goodwill, including its eventual residual value, is compared to the carrying value to determine whether impairment exists. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the asset is written-down to its estimated fair value. Net intangible assets, long-lived assets and goodwill amounted to $242 million, $548 million and $438 million, respectively, as of December 31, 2021.
The Company performs annual impairment reviews of its goodwill on December 31 of each year. For goodwill impairment review purposes, the Company has two reporting units: Waters and TA. The Company currently does not expect to record an impairment charge in the foreseeable future as the estimated fair values of the reporting units significantly exceeds the carrying value of the reporting units; however, there can be no assurance that, at the time future reviews are completed, a material impairment charge will not be recorded. The factors that could cause a material goodwill impairment charge in the future include, but are not limited to, the following:
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant decline in the Company’s projected revenue, earnings or cash flows; |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant adverse change in legal factors or business climate; |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | significant decline in the Company’s stock price or the stock price of comparable companies; |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | adverse action or assessment by a regulator; and |
| Column 1 | Column 2 | Column 3 | Column 4 |
|---|---|---|---|
| • | unanticipated competition. |
Income Taxes
As part of the process of preparing the consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves the Company estimating its income taxes, taking into account the amount, timing and character of taxable income, tax deductions and credits and assessing changes in tax laws, regulations, agreements and treaties. Differing treatment of items for tax and accounting purposes, such as depreciation, amortization and inventory reserves, result in deferred tax assets and liabilities, which are included within the consolidated balance sheets. In the event that actual results differ from these estimates, or the Company adjusts these estimates in future periods, such changes could materially impact the Company’s financial position and results of operations.
The accounting standards for income taxes require that a company continually evaluate the necessity of establishing or changing a valuation allowance for deferred tax assets depending on whether it is more likely than not that the actual benefit of those assets will be realized in future periods.
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Uncertain Tax Positions
The Company accounts for its uncertain tax return positions in accordance with the accounting standards for income taxes, which require financial statement reporting of the expected future tax consequences of uncertain tax positions on the presumption that all concerned tax authorities possess full knowledge of those tax positions, as well as all of the pertinent facts and circumstances, but prohibit any discounting of unrecognized tax benefits associated with those positions for the time value of money. The Company classified interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes. At December 31, 2021, the Company had unrecognized tax benefits, excluding interest and penalties, of $29 million.
The Company has a new Development and Expansion Incentive in Singapore that provides a concessionary income tax rate of 5% on certain types of income for the period April 1, 2021 through March 31, 2026. This new incentive has similar requirements for business spending targets, attaining and sustaining employment targets and performance of certain research and manufacturing activities as previous agreements. Prior to April 1, 2021, the Company had a tax exemption on income arising from qualifying activities in Singapore, based upon the achievement of certain contractual milestones, which the Company met as of December 31, 2020 and maintained through March 2021. These milestones include the following types of objectives: reaching and maintaining annual revenue and business spending targets; meeting capital expenditures targets; attaining and sustaining employment targets; and establishing a local research and development and service center. The Company determined that it was more likely than not to realize the tax exemption in Singapore and, accordingly, did not recognize any reserves for unrecognized tax benefits on its balance sheet related to this exemption. In the event that any of the milestone targets were not met, the Company would not be entitled to the tax exemption on income earned in Singapore and all the tax benefits previously recognized would be reversed, resulting in the recognition of income tax expense equal to the statutory tax of 17% on income earned during that period.
Warranty
Product warranties are recorded at the time revenue is recognized for certain product shipments. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s previous estimates, revisions to the estimated warranty liability would be required. At December 31, 2021, the Company’s warranty liability was $11 million.
Litigation
As described in Part I, Item 3, Legal Proceedings, of this
Form 10-K,
the Company is a party to various pending litigation matters. With respect to each pending claim, management determines whether it can reasonably estimate whether a loss is probable and, if so, the probable range of that loss. If and when management has determined, with respect to a particular claim, both that a loss is probable and that it can reasonably estimate the range of that loss, the Company records a charge equal to either its best estimate of that loss or the lowest amount in that probable range of loss. The Company will disclose additional exposures when the range of loss is subject to considerable uncertainty.
Pension and Other Retirement Benefits
In 2018, the Company settled its defined benefit pension plan in the United States. As a result of this settlement, the Company’s defined benefit pension obligations were significantly reduced in 2018 and 2019. The Company still maintains a number of smaller defined benefit pension plans and other retirement benefits throughout the world. Assumptions used in determining projected benefit obligations and the fair values of plan assets for the Company’s remaining less significant pension plans and other retirement benefits are evaluated periodically by management. Changes in assumptions are based on relevant Company data. Critical assumptions, such as the
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discount rate used to measure the benefit obligations and the expected long-term rate of return on plan assets, are evaluated and updated annually. The Company has assumed that the weighted-average expected long-term rate of return on plan assets will be 6.25% for its U.S. benefit plans and 2.58% for its
non-U.S.
benefit plans.
At the end of each year, the Company determines the discount rate that reflects the current rate at which the pension liabilities could be effectively settled. The Company utilized Milliman’s Bond Matching model to determine the discount rate for its U.S. benefit plans. The Company determined the discount rate for its
non-U.S.
benefit plans based on the analysis of the Mercer Pension Discount Curve for high quality investments as of December 31, 2021 that best matched the timing of the plan’s future cash flows for the period to maturity of the pension benefits. Once the interest rates were determined, the plan’s cash flow was discounted at the spot interest rate back to the measurement date. At December 31, 2021, the Company determined the weighted-average discount rate to be 2.70% for the U.S. benefit plans and 1.40% for the
non-U.S.
benefits plans.
A
one-quarter
percentage point increase in the assumed long-term rate of return would decrease the Company’s net periodic benefit cost by less than $1 million. A
one-quarter
percentage point increase in the discount rate would decrease the Company’s net periodic benefit cost by less than $1 million.
Stock-based Compensation
The accounting standards for stock-based compensation require that all share-based payments to employees be recognized in the statements of operations based on their fair values. The Company has used the Black-Scholes option pricing model and Monte Carlo simulation model to determine the fair value of its stock option awards and performance stock unit awards, respectively. Under the fair-value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating stock price volatility and employee stock option exercise behaviors. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest, the amount of the expense has been reduced for estimated forfeitures. These accounting standards require forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If factors change and the Company employs different assumptions in the application of these accounting standards, the compensation expense that the Company records in future periods may differ significantly from what the Company has recorded in the current period. The Company recognizes the expense using the straight-line attribution method.
As of December 31, 2021, unrecognized compensation costs and related weighted-average lives over which the costs will be amortized were as follows (in millions):
| Unrecognized Compensation Costs | Weighted-Average Life in Years | ||||||
|---|---|---|---|---|---|---|---|
| Stock options | $ | 20 | 3.5 | ||||
| Restricted stock units | 44 | 3.3 | |||||
| Performance stock units | 12 | 2.0 | |||||
| Total | $ | 76 | 3.1 |
Business Combinations and Asset Acquisitions
The Company accounts for business acquisitions under the accounting standards for business combinations. The results of each acquisition are included in the Company’s consolidated results as of the acquisition date and the purchase price of an acquisition is allocated to tangible and intangible assets and assumed liabilities based on
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their estimated fair values. Any excess of the fair value consideration transferred over the estimated fair values of the net assets acquired is recognized as goodwill. Acquired
in-process
research and development (“IPR&D”) included in a business combination is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred and acquired IPR&D is tested for impairment annually until completion of the acquired programs. Upon commercialization, this indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life, subject to periodic impairment reviews. If the research and development project is abandoned, the indefinite-lived asset is charged to expense. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred.
The Company also acquires intellectual property through licensing arrangements. These arrangements often require upfront payments and may include additional milestone or royalty payments, contingent upon certain future events. IPR&D acquired in an asset acquisition (as opposed to a business combination) is expensed immediately unless there is an alternative future use. Subsequent payments made for the achievement of milestones are evaluated to determine whether they have an alternative future use or should be expensed. Payments made to third parties subsequent to commercialization are capitalized and amortized over the remaining useful life of the related asset, and are classified as intangible assets.
Recent Accounting Standard Changes and Developments
Information regarding recent accounting standard changes and developments is incorporated by reference from Part II, Item 8, Financial Statements and Supplementary Data, of this document and should be considered an integral part of this Item 7. See Note 2 in the Notes to the Consolidated Financial Statements for recently adopted and issued accounting standards.