Basis of Presentation and Summary of Significant Accounting Policies

9 Months Ended

Sep. 28, 2019

Basis of Presentation and Summary of Significant Accounting Policies

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 (“UPLC

” 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 TA

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 Company’s instruments, as well as other manufacturers’ instruments.

The Company’s interim fiscal quarter typically ends on the thirteenth Saturday of each quarter. Since the Company’s fiscal year end is December 31, the first and fourth fiscal quarters may have more or less than thirteen complete weeks. The Company’s third fiscal quarters for 2019 and 2018 ended on September 28, 2019 and September 29, 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 (“

U.S.

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

U.S.

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 management’s 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 Company’s 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 Company’s foreign operating subsidiaries is the local currency of its country of domicile, except for the Company’s 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 entity’s cash flows.

For most of the Company’s 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.

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 September 28, 2019 and December 31, 2018, $303 million out of $405 million and $471 million out of $1,735 million, respectively, of the Company’s total cash, cash equivalents and investments were held by foreign subsidiaries. In addition, $235 million out of $

405

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 September 28, 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 customer’s 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 Company’s allowance for doubtful accounts for the nine months ended September 28, 2019 and September 29, 2018 (in thousands):


	Balance at Beginning of Period		Additions		Deduction			Balance at End of Period
Allowance for Doubtful Accounts
September 28, 2019	$	7,663	$	6,014	$	(5,461	)	$	8,216
September 29, 2018	$	6,109	$	2,752	$	(2,175	)	$	6,686

Other Investments

During the nine months ended September 28, 2019 and September 29, 2018, the Company made investments in unaffiliated companies of $7 million and $8 million, respectively.

Fair Value Measurements

In accordance with the accounting standards for fair value measurements and disclosures, certain of the Company’s assets and liabilities are measured at fair value on a recurring basis as of September 28, 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.

The following table represents the Company’s assets and liabilities measured at fair value on a recurring basis at September 28, 2019 (in thousands):


	Total at September 28, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Time deposits		213		—		213		—
Waters 401(k) Restoration Plan assets		32,796		32,796		—		—
Foreign currency exchange contracts		66		—		66		—
Interest rate cross-currency swap agreements		16,945		—		16,945		—

Total	$	50,020	$	32,796	$	17,224	$	—

Liabilities:
Contingent consideration	$	2,822	$	—	$	—	$	2,822
Foreign currency exchange contracts		826		—		826		—

Total	$	3,648	$	—	$	826	$	2,822

The following table represents the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2018 (in thousands):


	Total at December 31, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
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

Total	$	1,034,175	$	33,104	$	1,001,071	$	—

Liabilities:
Contingent consideration	$	2,476	$	—	$	—	$	2,476
Foreign currency exchange contracts		224		—		224		—

Total	$	2,700	$	—	$	224	$	2,476

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 Company’s 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 Company’s 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 Company’s 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 September 28, 2019 and December 31, 2018, respectively, based on the Company’s 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 Company’s 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 Company’s fixed interest rate debt was

$1.0 billion and

$510 million at September 28, 2019 and December 31, 2018, respectively. The fair value of the Company’s 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 Company’s fixed interest rate debt was estimated to be $1.0

illion and $502 million at September 28, 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 Company’s net sales, cost of sales, operating expenses and balance sheet amounts are significantly impacted by fluctuations in foreign currency exchange rates. The Company is exposed to currency price risk on foreign currency exchange rate fluctuations when it translates its

non-U.S.

dollar foreign subsidiaries’ financial statements into U.S. dollars and when any of the Company’s subsidiaries purchase or sell products or services in a currency other than its own currency.

The Company’s principal strategies in managing exposures to changes in foreign currency exchange rates are to (1) naturally hedge the foreign-currency-denominated liabilities on the Company’s balance sheet against corresponding assets of the same currency, such that any changes in liabilities due to fluctuations in foreign currency exchange rates are typically offset by corresponding changes in assets and (2) mitigate foreign exchange risk exposure of international operations by hedging the variability in the movement of foreign currency exchange rates on a portion of its Euro-denominated net asset investments. The Company presents the derivative transactions in financing activities in the statement of cash flows.

Foreign Currency Exchange Contracts

The Company does not specifically enter into any derivatives that hedge foreign-currency-denominated operating assets, liabilities or commitments on its balance sheet, other than a portion of certain third-party accounts receivable and accounts payable, and the Company’s net worldwide intercompany receivables and payables, which are eliminated in consolidation. The Company periodically aggregates 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 Company’s currency price risk exposure. The foreign currency exchange contracts are not designated for hedge accounting treatment. Principal hedged currencies include the Euro, Japanese yen, British pound, Mexican peso and Brazilian real.

Interest Rate Cross-Currency Swap Agreements

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 2019, the Company entered into additional interest rate cross-currency swap derivative agreements with an aggregate notional value of $110 million and contract terms between one and three years. 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 Company’s foreign currency exchange contracts and interest rate cross-currency swap agreements included in the consolidated balance sheets are classified as follows (in thousands):


	September 28, 2019				December 31, 2018
	Notional Value		Fair Value		Notional Value		Fair Value
Foreign currency exchange contracts:
Other current assets	$	24,000	$	66	$	112,212	$	503
Other current liabilities	$	121,580	$	826	$	40,175	$	224
Interest rate cross-currency swap agreements:
Other assets	$	410,000	$	16,945	$	300,000	$	1,093
Accumulated other comprehensive income			$	16,945			$	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	Three Months Ended						Nine Months Ended
	Statement Classification	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018
Foreign currency exchange contracts:
Realized losses on closed contracts	Cost of sales	$	(3,340	)	$	(23	)	$	(5,858	)	$	(2,158	)
Unrealized losses on open contracts	Cost of sales		(633	)		(5	)		(1,040	)		(1,092	)

Cumulative net pre-tax losses	Cost of sales	$	(3,973	)	$	(28	)	$	(6,898	)	$	(3,250	)

Interest rate cross-currency swap agreements:
Interest earned	Interest income	$	2,698		$	927		$	7,848		$	927
Unrealized gains on open contracts	Stockholders’ equity	$	15,847		$	767		$	15,852		$	767

Stockholders’ Equity

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. This new program replaced the remaining amounts available from the

pre-existing

program. During the nine months ended September 28, 2019 and September 29, 2018, the Company repurchased 8.6 million and 4.1 million shares of the Company’s outstanding common stock at a cost of $1.9 billion and $809 million, respectively, under the January 2019 authorization and other previously announced programs. As of September 28, 2019, the Company had repurchased an aggregate of 7.8 million shares at a cost of $1.7 billion under the January 2019 repurchase program and had a total of $2.3 billion authorized for future repurchases. In addition, the Company repurchased

$8 million and

$9 million of common stock related to the vesting of restricted stock units during the nine months ended September 28, 2019 and September 29, 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 September 28, 2019, the Company accrued $18 million as a result of treasury stock purchases that were settled in the

fourth

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 Company’s 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 Company’s accrued warranty liability for the nine months ended September 28, 2019 and September 29, 2018 (in thousands):


	Balance at Beginning of Period		Accruals for Warranties		Settlements Made			Balance at End of Period
Accrued warranty liability:
September 28, 2019	$	12,300	$	5,271	$	(6,094	)	$	11,477
September 29, 2018	$	13,026	$	6,068	$	(6,901	)	$	12,193

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 Company’s employees.

Severance an

d related

costs to the Company were immaterial

and $9 million during the three and nine months ended September 28, 2019, respectively.