Waters Earnings 2019-03-30

 

 

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

(Registrant’s 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 registrant’s common stock as of April 26, 2019: 69,475,245

 

 

 

WATERS CORPORATION AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

INDEX

 

PART I		FINANCIAL INFORMATION			Page
Item 1.		Financial Statements
		Consolidated Balance Sheets (unaudited) as of March 30, 2019 and December 31, 2018			3
		Consolidated Statements of Operations (unaudited) for the three months ended March 30, 2019 and March 31, 2018			4
		Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 30, 2019 and March 31, 2018			5
		Consolidated Statements of Cash Flows (unaudited) for the three months ended March 30, 2019 and March 31, 2018			6
		Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 30, 2019 and March 31, 2018			7
		Condensed Notes to Consolidated Financial Statements (unaudited)			8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			37
Item 4.		Controls and Procedures			38
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings			38
Item 1A.		Risk Factors			38
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			38
Item 6.		Exhibits			40
		Signature			41

Item 1: Financial Statements

WATERS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(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
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
Total assets		$	3,249,728			$	3,727,426
LIABILITIES AND STOCKHOLDERS’ EQUITY
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
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
Total long-term liabilities			1,678,707				1,711,237
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	)
Total stockholders’ equity			967,742				1,567,258
Total liabilities and stockholders’ equity		$	3,249,728			$	3,727,426

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
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	)
Total costs and operating expenses			392,711				386,295
Operating income			121,151				144,375
Other (expense) income			(525	)			346
Interest expense			(11,563	)			(13,838	)
Interest income			8,315				9,666
Income before income taxes			117,378				140,549
Provision for income taxes			8,392				28,598
Net income		$	108,986			$	111,951
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
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
Retirement liability adjustment before income taxes			32				522
Income tax expense			(24	)			(116	)
Retirement liability adjustment, net of tax			8				406
Other comprehensive income			9,327				21,436
Comprehensive income		$	118,313			$	133,387

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
Net cash provided by operating activities			175,779				175,841
Cash flows from investing activities:
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
Net cash provided by investing activities			434,039				895,839
Cash flows from financing activities:
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
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
(Decrease) increase in cash and cash equivalents			(111,310	)			74,203
Cash and cash equivalents at beginning of period			796,280				642,319
Cash and cash equivalents at end of period		$	684,970			$	716,522

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
Balance March 31, 2018			160,200			$	1,602			$	1,779,142			$	5,513,362			$	(5,090,581	)		$	(88,631	)		$	2,114,894
		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
Balance March 30, 2019			160,825			$	1,608			$	1,872,216			$	6,104,191			$	(6,901,629	)		$	(108,644	)		$	967,742

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 (“UPLC^TM” 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^TM 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 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 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.

 

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 Company’s 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 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 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
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 Company’s 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 Company’s 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				—
Total		$	563,606			$	33,951			$	529,655			$	—
Liabilities:
Contingent consideration		$	2,591			$	—			$	—			$	2,591
Foreign currency exchange contracts			619				—				619				—
Total		$	3,210			$	—			$	619			$	2,591

The following table represents the Company’s 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:
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

 

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 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 March 30, 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 $510 million at both March 30, 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 $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 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.

 

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 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. 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):

 

		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 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 three months ended March 30, 2019 and March 31, 2018, the Company repurchased 3.3 million and 1.3 million shares of the Company’s 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 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 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 Company’s 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 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

 

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 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 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 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 the customer’s credit risk is performed. Returns and customer credits are infrequent and insignificant and are recorded as a reduction to sales. Rights of return are not included in sales arrangements and, therefore, there is minimal variable consideration included in the transaction price of our products.

Service revenue includes (i) service and software maintenance contracts and (ii) service calls (time and materials). Instrument service contracts and software maintenance contracts are typically annual contracts, which are billed at the beginning of the contract or maintenance period. The amount of the service and software maintenance contract is recognized on a straight-line basis to revenue over the maintenance service period, which is the contractual term of the contract, as a time-based measure of progress best reflects the Company’s performance in satisfying this obligation. There are no deferred costs associated with the service contract, as the cost of the service is recorded when the service is performed. Service calls are recognized to revenue at the time a service is performed.

The Company’s deferred revenue liabilities 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 Company’s 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 Company’s 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 Company’s 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 Company’s option, equal to either the alternate base rate (which is a rate per annum equal to the greatest of (a) the prime rate in effect on such day, (b) the Federal Reserve Bank of New York Rate on such day plus 1/2 of 1% per annum and (c) the adjusted LIBO rate on such day (or if such day is not a business day, the immediately preceding business day) for a deposit in U.S. dollars with a maturity of one month plus 1% per annum) or the applicable 1, 2, 3 or 6 month adjusted LIBO rate or EURIBO rate for Euro-denominated loans, in each case, plus an interest rate margin based upon the Company’s leverage ratio, which can range between 0 and 12.5 basis points for alternate base rate loans and between 80 and 112.5 basis points for LIBO rate or EURIBO rate loans. The facility fee on the 2017 Credit Agreement ranges between 7.5 and 25 basis points per annum, based on the leverage ratio, of the amount of the revolving facility commitments and the outstanding term loan. The 2017 Credit Agreement requires that the Company comply with an interest coverage ratio test of not less than 3.50:1 as of the end of any fiscal quarter for any period of four consecutive fiscal quarters and a leverage ratio test of not more than 3.50:1 as of the end of any fiscal quarter. In addition, the 2017 Credit Agreement includes negative covenants, affirmative covenants, representations and warranties and events of default that are customary for investment grade credit facilities.

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 Company’s net income for the three months ended March 30, 2019 and March 31, 2018 by $4 million and $6 million, respectively, and increased the Company’s net income per diluted share by $0.06 and $0.07, respectively.

The Company’s 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 Company’s 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 Company’s 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 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. 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 Company’s 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 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 common area maintenance and real estate taxes, which are recorded as variable costs when incurred.

In addition, the Company’s 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 Company’s 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 Company’s 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 Company’s 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:

 

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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.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) – (Continued)

 

Performance Stock Units

The Company’s performance stock units are equity compensation awards with a market vesting condition based on the Company’s 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

 

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