What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-02-11 compared with 2020-02-13 · 241 added, 221 removed, 192 unchanged (71% of the section changed)

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Readers can identify these forward-looking statements by our use of the words “expects,” “anticipates,” “estimates,” “believes,” “projects,” “intends,” “plans,” “will,” “may,” “shall,” “could,” “should,” and similar words and other statements of a similar sense.

These statements are based upon our current estimates and expectations as to prospective events and circumstances, which may or may not be in our control and as to which there can be no firm assurances given.

These forward-looking statements, which include statements regarding business and market trends, future financial performance, customer order rates and timing of related revenue, expected areas of growth, emerging markets, future product mix, research and development activities, investments, strategic plans, expected benefits from acquisitions, dividends, stock repurchases, and tax matters, involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected.

These statements are based on our current estimates and expectations as to prospective events and circumstances, which may or may not be in our control and as to which there can be no firm assurances given.

These forward-looking statements, which include statements regarding business and market trends, future financial performance, the expected impact of the COVID-19 pandemic on our assets, business and results of operations, customer order rates and timing of related revenue, future product mix, restructuring and other cost-savings initiatives, research and development activities, capital projects, investments, acquisitions, liquidity, dividends and stock repurchases, strategic plans, and estimated tax benefits and expenses and other tax matters, involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected.

Such risks and uncertainties include:

(1) current and future conditions in the global economy, including the imposition of tariffs or export controls and the impact of the coronavirus outbreak;

(2) the loss of, or curtailment of purchases by, a large customer;

(3) the reliance on revenue from the consumer electronics or automotive industries;

(4) the inability to penetrate the logistics industry and other new markets;

(5) the inability to achieve significant international revenue;

(6) fluctuations in foreign currency exchange rates and the use of derivative instruments;

(7) information security breaches or business system disruptions;

(8) the inability to attract and retain skilled employees;

(9) the failure to effectively manage our growth;

(10) the reliance upon key suppliers to manufacture and deliver critical components for our products;

(1) the impact, duration, and severity of the COVID-19 pandemic;

(2) potential disruptions to our business due to restructuring activities;

(3) the loss of, or curtailment of purchases by, large customers in the consumer electronics and logistics industries;

(4) the reliance on revenue from the automotive industry;

(5) the reliance on key suppliers to manufacture and deliver critical components for our products;

(6) the failure to effectively manage product transitions or accurately forecast customer demand;

(7) the inability to design and manufacture high-quality products;

(8) the inability to attract and retain skilled employees and maintain our unique corporate culture;

(9) the failure to effectively manage our growth;

(10) the inability to achieve growth in revenue and profits from the logistics industry;

(11) the technological obsolescence of current products and the inability to develop new products;

(12) the failure to properly manage the distribution of products and services;

(13) the impact of competitive pressures;

(14) the challenges in integrating and achieving expected results from acquired businesses;

(15) potential disruptions in our business systems;

(16) information security breaches;

(17) the inability to protect our proprietary technology and intellectual property;

(18) potential impairment charges with respect to our investments or acquired intangible assets;

(19) exposure to additional tax liabilities;

(20) fluctuations in foreign currency exchange rates and the use of derivative instruments;

(21) our involvement in time-consuming and costly litigation;

(17) the impact of competitive pressures;

(18) the challenges in integrating and achieving expected results from acquired businesses, including the recent acquisition of Sualab;

(19) potential impairment charges with respect to our investments or for acquired intangible assets or goodwill;

and (20) exposure to additional tax liabilities.

(22) unfavorable global economic conditions;

and (23) economic, political, and other risks associated with international sales and operations.

The foregoing list should not be construed as exhaustive and we encourage readers to refer to the detailed discussion of risk factors included in Part I - Item 1A of this Annual Report on Form 10-K.

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Cognex machine vision is used to automate manufacturing and distribution processes in a variety of industries, where the technology is widely recognized as an important component of automated production and quality assurance.

Virtually every manufacturer can achieve better quality and manufacturing efficiency by using machine vision, and therefore, Cognex products are used by a broad base of customers across a variety of industries, including consumer electronics, automotive, consumer products, food and beverage, pharmaceuticals, and medical devices.

Cognex products are also used to automate distribution processes in the logistics industry, including for applications in retail distribution and ecommerce to scan, track, and sort goods through distribution centers.

Revenue for the year ended December 31, 2019 totaled $725,625,000, representing a decrease of 10% from 2018 driven by significantly lower revenue in the consumer electronics industry related to smartphone manufacturing.

Gross margin as a percentage of revenue was 74% for both years.

Operating expenses increased by 4% over 2018, as the impact of additional headcount to support our future growth plans was offset by lower expenses related to incentive compensation plans.

As a result of the lower revenue level and continued investments, operating income was 20% of revenue in 2019 compared to 27% of revenue in 2018.

A higher level of discrete tax benefits in 2019 related to tax structure changes resulted in net income of 28% of revenue in 2019 compared to 27% of revenue in 2018.

Net income per diluted share was $1.16 in 2019 compared to $1.24 in 2018.

Revenue for the year ended December 31, 2020 totaled $811,020,000, representing an increase of 12% from 2019.

This increase was driven largely by higher revenue from certain customers in the consumer electronics industry and ecommerce customers in the logistics industry.

We believe that both of these industries benefited in 2020 from higher consumer demand during the COVID-19 pandemic.

These increases were partially offset by lower revenue from customers in the automotive industry, which was our largest market in 2019 and continues to be negatively impacted by global economic conditions resulting from the COVID-19 pandemic.

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Gross margin improved to 75% of revenue in 2020 from 74% of revenue in 2019.

Gross margin expansion was due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix.

Operating expenses increased by 10% from the prior year due primarily to one-time restructuring charges and intangible asset impairment charges.

Excluding these charges, operating expenses were relatively flat with the prior year, as higher incentive compensation costs were offset by lower travel expenses resulting from COVID-19 restrictions and savings from restructuring actions.

Operating income expanded to 21% of revenue in 2020 compared to 20% of revenue in 2019.

A higher level of discrete tax benefits in 2019 related to tax structure changes resulted in net income of 22% of revenue in 2020 compared to 28% of revenue in 2019, and net income per diluted share of $1.00 in 2020 compared to $1.16 in 2019.

The following table sets forth certain consolidated financial data as a percentage of revenue:

Year Ended December 31,

2020 2019 2018

Revenue 100 % 100 % 100 %

Cost of revenue 25 26 26

Gross margin 75 74 74

Research, development, and engineering expenses 16 16 14

Selling, general, and administrative expenses 33 38 33

Restructuring charges 2 — —

Intangible asset impairment charges 3 — —

Operating income 21 20 27

Non-operating income 2 3 2

Income before income tax expense

Income before income tax expense (benefit) 23 23 29

Income tax expense (benefit) 1 (5) 2

Net income 22 % 28 % 27 %

RESULTS OF OPERATIONS

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Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

Revenue for the year ended December 31, 2020 was $811,020,000 compared to $725,625,000 for the prior year, representing an increase of 12%.

The increase was due largely to higher revenue from customers in the consumer electronics and logistics industries, which were our two largest markets in 2020.

It appears that manufacturers of electronics products and ecommerce providers in the logistics industry both benefited from the "stay-at-home" conditions that arose from the COVID-19 pandemic in 2020.

Revenue from customers in the consumer electronics and logistics industries increased by approximately 30% and 40%, respectively, from the prior year, and a significant portion of this growth came from large customers in these industries.

Our total revenue and quarterly timing of revenue is impacted by the purchasing cycles of these large customers.

In contrast, our results indicate that other industries we serve have experienced significantly lower demand during the COVID-19 pandemic, most notably the automotive industry, which was our largest market in 2019.

Although revenue from customers in the automotive industry for the full year 2020 decreased by approximately 20% from the prior year, automotive revenue for the fourth quarter of 2020 was slightly higher than the fourth quarter of 2019 and increased sequentially each of the last two quarters.

In addition, revenue from customers in certain industries in which we have a smaller presence, including medical-related industries, increased for the full year 2020 from the

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prior year, due in part to COVID-19 applications for Cognex products.

Although we continue to experience certain disruptions to our business from COVID-19 and the situation is continuously changing, the impact of these conditions on our business to date appears to have been most severe in the second quarter of 2020.

From a geographic perspective, revenue from customers based in the Americas increased by 12% from the prior year driven by higher revenue in the logistics industry, partially offset by lower revenue in the automotive industry.

A significant portion of our logistics business currently comes from customers based in the Americas.

Although this region had the largest dollar growth of logistics revenue in 2020, we are making investments to grow our logistics business outside of the Americas and our logistics revenue increased in all of our major regions in 2020.

Revenue from customers based in Europe decreased by 8% from the prior year due to lower revenue in the automotive and consumer electronics industries, partially offset by higher revenue in the logistics industry.

Revenue from customers based in Greater China increased by 46% from the prior year due largely to higher revenue in the consumer electronics industry, partially offset by lower revenue in the automotive industry.

In recent years, there has been a shift in procurement for certain electronics orders for Cognex products used on assembly lines in China.

This procurement shift has resulted in an increase in consumer electronics revenue reported in Greater China that was previously reported in Europe.

Revenue from other countries in Asia increased by 17% from the prior year due primarily to higher revenue in the consumer electronics and logistics industries.

As of the date of this report, we expect revenue for the first quarter of 2021 to be higher than revenue reported for fourth quarter of 2020 of $223,615,000.

We anticipate the majority of this increase to come from higher revenue in the logistics industry.

Gross margin as a percentage of revenue improved to 75% in 2020 compared to 74% in 2019.

The increase in the gross margin percentage was primarily due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix.

In 2020, revenue from customers in the consumer electronics and logistics industries each represented a greater percentage of our total revenue than the prior year.

Although our logistics margins are lower relative to our total gross margin, these margins improved from 2019 and the impact of logistics on our gross margin was more than offset by a greater contribution of relatively higher-margin consumer electronics revenue.

The favorable impact of sales volume and product mix was partially offset by higher provisions for excess and obsolete inventories, which totaled $9,908,000 in 2020 compared to $5,296,000 in 2019.

The higher level of provisions in 2020 was due to lower projected sales of excess inventories as a result of the deteriorating global economic conditions from the COVID-19 pandemic.

As of the date of this report, we expect gross margin as a percentage of revenue for the first quarter of 2021 to be in the mid 70 percent range, but likely lower than the 75% reported for the fourth quarter of 2020.

The decrease is anticipated to be due to a greater percentage of total revenue coming from the logistics industry, which has relatively lower gross margins.

Operating Expenses

Research, Development, and Engineering Expenses

Research, development, and engineering (RD&E) expenses in 2020 increased by $11,555,000, or 10%, from the prior year as detailed in the table below (in thousands).

RD&E expenses in 2019 $ 119,427

Acquisition-related compensation costs 7,963

Incentive compensation 7,912

Stock-based compensation expense (2,405)

Travel expenses (2,083)

RD&E expenses in 2020 $ 130,982

RD&E expenses increased due to higher compensation costs related to the Company's acquisition of Sualab Co., Ltd.

in the fourth quarter of 2019.

These incremental compensation costs included a new team of deep learning engineers, as well as deferred payments from the acquisition that are being recorded as compensation expense over four years from the closing date that accounted for $4,189,000 of this increase.

Excluding the addition of the Sualab deep learning team, RD&E personnel-related costs decreased slightly from 2019 to 2020, as the impact of

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incremental resources added largely in 2019 were offset by savings from a workforce reduction in the second quarter of 2020.

RD&E expenses also increased due to higher expenses for annual incentive compensation plans.

Relevant performance goals for these plans are set at the beginning of each year, with the ability to earn upside if the goals are exceeded.

The Company did not achieve its performance goal to earn a company bonus in 2019, while the goal set for 2020 was exceeded based on the Company's operating income margin.

Expenses for the fourth quarter of 2020 included a true-up of the annual liability to reflect the upside achievement based on our strong operating results for this quarter that exceeded our prior estimates.

These annual incentive compensation plans will be reset with relevant performance goals for 2021 and incentive compensation expenses will reflect our estimates of achievement throughout the year, which we expect will result in lower expense for the first quarter of 2021 as compared to the fourth quarter of 2020.

These increases were partially offset by lower stock-based compensation expense as a result of a lower total value of awards granted in 2020 as compared to 2019, as well as the impact on the timing of expense recognition due to changes in restricted stock unit vesting schedules.

In addition, credits were recorded to stock-based compensation expense in the second quarter of 2020 for awards canceled as a result of a workforce reduction.

The Company also incurred lower travel expenses resulting from COVID-19 restrictions.

We expect these restrictions to continue into 2021.

RD&E expenses as a percentage of revenue were 16% for both 2020 and 2019.

We believe that a continued commitment to RD&E activities is essential in order to maintain or achieve product leadership with our existing products and to provide innovative new product offerings, as well as to provide engineering support for large customers.

In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth.

We currently expect to continue to make significant RD&E investments to support our product development plans during the COVID-19 pandemic and other business disruptions generally.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses decreased in 2020 by $6,249,000, or 2%, from the prior year as detailed in the table below (in thousands).

SG&A expenses in 2019 $ 273,842

Travel expenses (13,980)

Contract labor (2,444)

Marketing programs (1,813)

Recruiting fees (1,077)

Incentive compensation 19,079

Other (6,014)

SG&A expenses in 2020 $ 267,593

SG&A expenses decreased due to lower travel expenses resulting from COVID-19 restrictions.

The majority of these savings came from sales activities, which were redirected to online efforts due to shutdowns of customer facilities for portions of 2020.

We expect these restrictions to continue into 2021.

In addition, the Company reduced spending on contract labor, marketing programs, and recruiting activities as part of actions taken to reduce operating costs during the global pandemic.

These decreases were partially offset by higher expenses for annual incentive compensation plans.

Relevant performance goals for these plans are set at the beginning of each year, with the ability to earn upside if the goals are exceeded.

The Company did not achieve its performance goal to earn a company bonus in 2019, while the goal set for 2020 was exceeded based on the Company's operating income margin.

Likewise, sales commissions were higher than the prior year due to a greater portion of our sales team exceeding the performance goals set in their commission plans in 2020 versus 2019.

SG&A personnel-related costs were relatively flat from the prior year, as the impact of incremental resources added largely in 2019 were offset by savings from a workforce reduction in the second quarter of 2020.

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Restructuring Charges

In May 2020, the Company's Board of Directors approved a restructuring plan intended to reduce the Company's operating costs, optimize its business model, and address the impact of the COVID-19 pandemic.

The restructuring plan included a global workforce reduction of approximately 8% and office closures.

The Company recorded restructuring charges from these actions totaling $15,924,000 in 2020.

As of December 31, 2020, the majority of these actions were completed and no additional charges are expected to be incurred in future periods in relation to this restructuring plan.

These restructuring actions, together with other actions to reduce the Company's overall costs, were designed to generate an aggregate annualized cost savings of approximately $25 million versus the Company's original planned cost structure.

As of the date of this report, we are on track to achieve this target for 2021, with actual savings from these restructuring and other cost-saving actions in 2020 estimated to be approximately $16 million.

Intangible Asset Impairment Charges

Deteriorating global economic conditions from the COVID-19 pandemic triggered a review of long-lived assets for potential impairment in the second quarter of 2020.

This review resulted in intangible asset impairment charges totaling $19,571,000 recorded in the second quarter of 2020, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab.

Non-operating Income (Expense)

The Company recorded foreign currency gains of $3,697,000 in 2020 and foreign currency losses of $509,000 in 2019.

Foreign currency gains and losses result primarily from the revaluation of cash, accounts receivable, accounts payable, and intercompany balances that are reported in one currency and denominated in another.

In 2020, the Company recognized foreign currency gains related to the revaluation of intercompany payables reported on the Company's China entity that are denominated in U.S.

The Company currently does not hedge its Chinese Yuan exposures due to limitations in hedging instruments available for this currency.

Investment income decreased by $6,695,000, or 34%, from the prior year.

The decrease was due to lower yields on the Company's portfolio of debt securities, and to a lesser extent, lower average investment balances.

The Company recorded other expense of $309,000 in 2020 and other income of $1,212,000 in 2019.

Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions.

In 2019, the Company recorded favorable fair value adjustments related to its acquisition of GVi Ventures, Inc., resulting from a lower level of revenue in the Americas' automotive industry.

Income Tax Expense (Benefit)

The Company’s effective tax rate was an expense of 6% of pre-tax income in 2020 compared to a benefit of 25% of pre-tax income in 2019.

The effective tax rate in both years reflected several discrete tax items described below.

The effective tax rate included a decrease in tax expense of $12,788,000 in 2020 and $6,472,000 in 2019 related to stock options, primarily from the excess tax benefit arising from the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes from stock option exercises.

The Company cannot predict the level of stock option exercises by employees in future periods.

In 2020, the Company recorded discrete tax items related to the final true-up of the prior year tax accrual upon filing the related tax return.

This included a decrease in tax expense of $13,984,000 primarily to recognize a foreign tax benefit on certain gains taxed outside of the United States based on clarifications to rules related to the use of foreign tax credits.

This benefit was partially offset by tax expense for a transfer price adjustment in China of $3,267,000 and smaller tax expense adjustments related to foreign tax filings of $843,000.

In 2020, interpretations of a German law relating to withholding taxes on intellectual property rights emerged.

The Company conducted a careful review of the interpretation and believes it has adequate reserves for this German tax exposure.

Management will continue to monitor this law and court rulings in Germany.

In 2019, the Company made changes to its international tax structure as a result of European Union tax reform legislation, and as a result, recorded a net discrete tax benefit of $87,500,000.

Also, in 2019, the Company migrated acquired intellectual property to certain subsidiaries, and as a result, recorded a discrete tax expense of $28,528,000.

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Other discrete tax items, none of which were individually material, resulted in a net decrease in tax expense of $307,000 in 2020 and $1,932,000 in 2019.

Excluding the impact of all discrete tax items, the Company’s effective tax rate was an expense of 17% of pre-tax income in 2020 and 16% of pre-tax income in 2019.

The increase in the effective tax rate excluding discrete tax items was due to more of the Company's profits being earned and taxed in higher tax jurisdictions, as well as the impact of changes in 2019 to the Company's international tax structure.

Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

Revenue for the year ended December 31, 2019 was $725,625,000 compared to $806,338,000 for the prior year, representing a decrease of $80,713,000, or 10%.

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Excluding revenue from this major customer, logistics revenue increased by approximately 50% from the prior year.

We expect this customer to grow at a lower rate than our total logistics business in 2020.

From a geographic perspective, revenue from customers based in the Americas increased by 5% driven by higher sales in the logistics industry, partially offset by lower sales in the automotive industry.

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Revenue from customers based in other regions in Asia were relatively flat.

As of the date of this report, we expect revenue for the first quarter of 2020 to be lower than the fourth quarter of 2019 due to continued weakness in the automotive industry and the estimated impact of the recent coronavirus outbreak on our business.

This decrease is expected to be partially offset by higher sales to customers in the logistics industry from the prior quarter.

Gross margin as a percentage of revenue was 74% for both years.

Gross margin as a percentage of revenue was 74% for both 2019 and 2018.

The unfavorable absorption of manufacturing overhead costs over the lower level of revenue was offset by favorable product mix.

As of the date of this report, we expect gross margin as a percentage of revenue for the first quarter of 2020 to be relatively consistent with the gross margin reported in the fourth quarter of 2019.

Operating Expenses

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Personnel-related costs 5,782

Incentive compensation plans

Incentive compensation (3,852)

RD&E expenses in 2019 $ 119,427

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These increases were partially offset by lower expenses related to incentive compensation plans resulting from lower levels of achievement on performance plans that were set at the beginning of the year.

These annual incentive compensation plans will be reset with relevant performance goals for 2020, which would result in higher expense if the targeted achievements are met.

RD&E expenses as a percentage of revenue were 16% in 2019 compared to 14% in 2018.

In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth.

Therefore, we expect to continue to make significant RD&E investments in the future, and currently intend to continue our product development plans during periods of lower revenue levels, which would result in a higher level of RD&E expenses as a percentage of revenue in the first quarter of 2020 than the 16% in 2019.

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Selling, General, and Administrative Expenses

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Personnel-related costs 23,811

Incentive compensation plans

Incentive compensation (8,742)

Foreign currency exchange rate changes (5,085)

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These annual incentive compensation plans will be reset with relevant performance goals for 2020, which would result in higher expense if the targeted achievements are met.

Changes in foreign currency exchange rates also resulted in a lower level of expenses, as costs denominated in foreign currencies

were translated to U.S.

Changes in foreign currency exchange rates also resulted in a lower level of expenses, as costs denominated in foreign currencies were translated to U.S.

Dollars at a lower rate.

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The Company recorded foreign currency losses of $509,000 in 2019 and $1,064,000 in 2018.

Foreign currency gains and losses result primarily from the revaluation and settlement of accounts receivable, accounts payable, and intercompany balances that are reported in one currency and collected in another.

Investment income increased by $4,974,000 or 34%, from the prior year.

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A higher level of fair value adjustments to income was recorded in 2019 related to the Company's acquisition of GVi Ventures, Inc., resulting from a lower level of revenue in the Americas' automotive industry.

Income Tax Expense

Income Tax Expense (Benefit)

The Company’s effective tax rate was a benefit of 25% of pre-tax income in 2019 compared to an expense of 7% in 2018.

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The Company made changes to its international tax structure in the fourth quarter of 2019 as a result of this legislation, and as a result, recorded a net discrete tax benefit of $87,500,000.

Management expects its current effective tax rate excluding discrete events to increase slightly in future years as a result of this change.

On October 16, 2019, the Company acquired Sualab Co., Ltd., a provider of deep learning-based vision software based in Korea.

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In addition, the effective tax rate included a decrease in tax expense of $6,472,000 in 2019 and $8,488,000 in 2018 related to stock options, primarily from the excess tax benefit arising from the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes from stock option exercises.

The Company cannot predict the level of stock option exercises by employees in future periods.

Other discrete tax events included a net decrease in tax expense of $1,932,000 in 2019 and $1,847,000 in 2018, consisting primarily of the expiration of the statutes of limitations for certain reserves for income tax uncertainties and the final true-up of the prior year's tax accrual upon filing the related tax returns.

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This represents an increase in the effective tax rate excluding discrete events from 14% in 2018 due to more of the Company's profits being earned and taxed in higher tax jurisdictions.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Revenue for the year ended December 31, 2018 was $806,338,000 compared to $766,083,000 for the prior year, representing an increase of $40,255,000, or 5%.

Revenue in 2018 was impacted by lower sales in the consumer electronics industry primarily due to significantly lower revenue from a few large customers in OLED (organic light-emitting diode) display and smartphone manufacturing following a high level of investment from these customers in 2017.

Excluding sales to customers in the consumer electronics industry, revenue increased by approximately 18% from the prior year, driven by growth in the logistics industry of over 50%.

Changes in foreign currency exchange rates accounted for approximately 2% of the revenue increase from 2017 to 2018, primarily related to the translation of Euro-denominated and Chinese Yuan-denominated revenue to U.S.

Revenue from customers based in the Americas increased by 24% in 2018 from the prior year driven by strong sales in the logistics industry.

Revenue from customers based in Greater China increased by 14% in 2018 from 2017, although this business was relatively flat in the fourth quarter of 2018 over the fourth quarter of 2017.

Revenue from customers based in Europe decreased by 5% and revenue from customers based in other Asia regions decreased by 8% in 2018 from the prior year.

Revenue for both the Europe and Asia regions outside of Greater China was impacted by the lower sales in the consumer electronics industry noted above.

Gross margin as a percentage of revenue was 74.4% in 2018 compared to 75.6% in 2017.

The decrease in gross margin was due primarily to a higher percentage of total revenue from the logistics industry.

Certain sales in this industry are for application-specific customer solutions, which typically have lower gross margins due to deployment services.

Unfavorable product mix for sales in the logistics industry also contributed to the lower gross margin percentage.

Operating Expenses

Research, Development, and Engineering Expenses

Research, development, and engineering (RD&E) expenses in 2018 increased by $17,240,000, or 17%, from the prior year as detailed in the table below (in thousands).

RD&E expenses in 2017

Personnel-related costs

Stock-based compensation expense

RD&E expenses in 2018

RD&E expenses increased due to higher personnel-related costs resulting primarily from headcount additions to support new product initiatives.

Stock-based compensation expense was higher than the prior year due to a higher valuation of stock options granted, as well as a decrease in the estimated forfeiture rate in 2018.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses in 2018 increased by $41,971,000, or 19%, from the prior year as detailed in the table below (in thousands).

SG&A expenses in 2017

Personnel-related costs

Stock-based compensation expense

Depreciation expense

Incentive compensation plans

SG&A expenses in 2018

SG&A expenses increased due to higher personnel-related costs resulting primarily from headcount additions, principally sales personnel.

In addition to salaries and fringe benefits, these personnel-related costs included sales commissions and travel expenses related to the additional headcount.

Stock-based compensation expense was higher than the prior year due to a higher valuation of stock options granted, as well as a decrease in the estimated forfeiture rate in 2018.

Depreciation expense increased from the prior year due primarily to information technology investments in infrastructure, security, and business applications, including a new Enterprise Resource Planning (ERP) system that was placed into service in the middle of 2018.

Offsetting these increases were lower expenses related to incentive compensation plans, including company bonuses and sales commissions, resulting from lower levels of achievement on performance plans that were set at the beginning of the year.

Non-operating Income (Expense)

The Company recorded foreign currency losses of $1,064,000 in 2018 and $1,601,000 in 2017.

The foreign currency gains and losses result primarily from the revaluation and settlement of accounts receivable, accounts payable, and intercompany balances that are reported in one currency and collected or paid in another.

Investment income increased by $5,173,000, or 54%, from the prior year.

The increase was primarily due to higher yields on the Company's portfolio of debt securities.

The Company recorded other expense of $219,000 in 2018 and $338,000 in 2017.

Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions, as well as rental income, net of associated expenses, from leasing space in buildings adjacent to the Company’s corporate headquarters.

Income Tax Expense

The Company’s effective tax rate was 7% of the Company’s pre-tax income in 2018 compared to 34% in 2017.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (Tax Act) was signed into law.

The Tax Act resulted in a decrease in the U.S.

federal statutory corporate tax rate from 35% to 21%.

As a result of the reduction in anticipated tax rate, the Company remeasured its deferred tax positions as of December 31, 2017 at the new enacted tax rate, and accordingly, recorded tax expense of $12,523,000 in 2017 from the associated write-down of its deferred tax assets.

In 2018, the Company recorded an increase in tax expense of $3,240,000 from the write-down of its deferred tax assets primarily relating to guidance under the Tax Act regarding stock-based compensation.

The Tax Act subjects unrepatriated foreign earnings to a one-time transition tax, regardless of the Company's financial statement assertion related to indefinite reinvestment or whether the Company ultimately repatriates any of the foreign earnings, for which the Company recorded estimated tax expense of $101,379,000 in 2017.

In 2018, the Company revised its estimate of the one-time transition tax and recorded a decrease in tax expense of $11,028,000, which resulted in a revised estimate for the one-time transition tax of $90,351,000.

The Tax Act replaces the current system of taxing U.S.

corporations on repatriated foreign earnings with a partial territorial system that provides a 100% dividends-received deduction to domestic corporations for foreign-source dividends received from 10% or more owned foreign corporations.

The Company recorded a decrease in tax expense of $3,843,000 in 2017 from the reversal of the tax effect of a 2016 dividend paid in 2017 from a wholly-owned foreign subsidiary to its domestic entity.

Other Discrete Tax Events

The effective tax rate also included a decrease in tax expense of $8,488,000 in 2018 and $38,569,000 in 2017 from the excess tax benefit arising from the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes from stock option exercises.

In 2018, tax expense included a provision for state income taxes of $620,000 from a change in management's financial statement assertion related to the indefinite reinvestment of foreign earnings.

Management has determined that earnings from its legal entity in China will remain indefinitely reinvested to provide local funding for growth, and that earnings from all other jurisdictions will not be indefinitely reinvested, resulting in the additional state income tax provision.

Other discrete tax events resulted in a net decrease in tax expense of $2,467,000 in 2018 and $2,502,000 in 2017, consisting primarily of the final true-up of the prior year's tax accrual upon filing the related tax returns and the expiration of the statutes of limitations for certain reserves for income tax uncertainties.

Excluding the impact of these discrete tax events, the Company's effective tax rate was 14% in 2018.

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LIQUIDITY AND CAPITAL RESOURCES

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The Company has established guidelines relative to credit ratings, diversification, and maturities of its investments that maintain liquidity.

The Company’s cash requirements in 2019 were primarily met with positive cash flows from operations and the proceeds from stock option exercises.

Cash requirements consisted of operating activities, the repurchase of common stock, the payment of dividends, the acquisition of Sualab Co., Ltd., and capital expenditures.

The Company’s cash requirements in 2020 were primarily met with positive cash flows from operations, maturities and sales of investments, and the proceeds from stock option exercises.

Cash requirements consisted of operating activities, the payment of dividends, the repurchase of common stock, and capital expenditures.

Working capital requirements included an increase in accounts receivable resulting from the higher business level and the timing of invoicing for a material customer, as well as an increase in gross inventories to support the higher business level and build safety stock to mitigate the Company's exposure to demand changes or supply disruptions.

Cash outlays in the first quarter of 2021 are planned to include incentive compensation payments that were earned and accrued in 2020.

Capital expenditures in 2020 totaled $13,303,000 and consisted primarily of computer hardware and software, manufacturing test equipment related to new product introductions, and improvements made to the Company's headquarters building in Natick, Massachusetts and various leased facilities.

In 2021, the Company is making significant investments in business systems related to its sales process, including systems to help our sales team more efficiently manage customer relationships and sales opportunities.

As of the date of this report, the Company estimates cash outlays for this initiative to be up to $10 million, a large portion of which we expect will be capitalized and placed into service in the first quarter of 2022.

The Company implemented a variety of cost-cutting measures in the second quarter of 2020 to address the impact of the COVID-19 pandemic, including a workforce reduction and office closures.

The Company estimates the total restructuring charges from these actions to be approximately $15,924,000, of which $3,938,000 represents non-cash charges and adjustments, $9,597,000 was paid in 2020, and the remainder of $2,389,000 expected to be paid in 2021.

The following table summarizes the Company’s material contractual obligations, both fixed and contingent (in thousands):

Year Ended December 31,

Inventory Purchase Commitments

Year Ended December 31, Inventory Purchase Commitments Leases Total

2021 $ 32,315 $ 9,101 $ 41,416

2022 — 6,863 6,863

2023 — 5,072 5,072

2024 — 2,074 2,074

2025 — 1,317 1,317

Thereafter — 4,960 4,960

$ 32,315 $ 29,387 $ 61,702

In addition to the obligations described above, the following items may also result in future material uses of cash:

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In October 2018, the Company's Board of Directors authorized the repurchase of $200,000,000 of the Company's common stock.

As of December 31, 2019, the Company repurchased 1,601,000 shares at a cost of $70,312,000 under this program, including 1,398,000 shares at a cost of $61,690,000 in 2019.

The Company may repurchase shares under this program in future periods, up to the remaining balance of $129,688,000, depending on a variety of factors, including, among other things, the impact of dilution from employee stock options, stock price, share availability, and cash requirements.

The Company’s Board of Directors declared and paid cash dividends of $0.050 per share in the first, second, and third quarters of 2019.

As of December 31, 2020, the Company repurchased 2,816,000 shares at a cost of $121,348,000 under this program, including 1,215,000 shares at a cost of $51,036,000 during 2020, leaving a remaining balance of $78,652,000.

On March 12, 2020, the Company's Board of Directors authorized the repurchase of an additional $200,000,000 of the Company's common stock.

Purchases under this March 2020 program will commence upon completion of the October 2018 program.

The Company may repurchase shares under this program in future periods depending on a variety of factors, including, among other things, the impact of dilution from employee stock awards, stock price, share availability, and cash requirements.

The Company is authorized to make repurchases of its common stock through open market purchases, pursuant to Rule 10b5-1 trading plans, or in privately negotiated transactions.

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The Company’s Board of Directors declared and paid cash dividends of $0.050 per share in the first, second, and third quarters of 2019, and $0.055 in the fourth quarter of 2019, as well as in the first, second, and third quarters of 2020.

The dividend was increased to $0.060 per share in the fourth quarter of 2020.

Total dividends amounted to $35,124,000 in 2019.

Future dividends will be declared at the discretion of the Company’s Board of Directors and will depend upon such factors as the Board deems relevant including, among other things, the Company’s ability to generate positive cash flows from operations.

Also, in the fourth quarter of 2020, an additional special cash dividend of $2.00 per share was declared and paid.

Total dividends amounted to $390,508,000 in 2020, which included $351,428,000 paid for the special cash dividend, $35,124,000 in 2019, and $31,865,000 in 2018.

Future dividends will be declared at the discretion of the Company's Board of Directors and will depend upon such factors as the Board deems relevant, including, among other things, the Company's ability to generate positive cash flow from operations.

Business Acquisitions

On October 16, 2019, the Company acquired Sualab Co., Ltd.

for cash payments of $170,602,000 upon closing and deferred payments of $24,040,000 that may become payable on the fourth anniversary date of the closing, contingent upon the continued employment of key talent.

Certain of the Company's business acquisitions that closed in 2017 and 2016 have contractual obligations for deferred cash payments, contingent cash payments tied to performance, and special incentive cash payments tied to employment, none of which are material individually or in the aggregate to the Company's cash flows.

In conjunction with the acquisition of Sualab, the Company migrated acquired intellectual property to certain subsidiaries in the fourth quarter of 2019, which is expected to result in a foreign tax payment of approximately $30,000,000 in early 2020.

The Tax Act subjected unrepatriated foreign earnings to a one-time transition tax, which is expected to result in tax payments of $51,113,000 starting in 2021 through 2025.

The total consideration for the 2019 acquisition of Sualab Co., Ltd.

included deferred payments of $24,040,000 that may become payable on the fourth anniversary date of the closing, contingent upon the continued employment of key talent.

In conjunction with the acquisition of Sualab, the Company migrated acquired intellectual property to certain subsidiaries in 2019, which resulted in a foreign tax payment of approximately $27,000,000 in 2020.

The Tax Cuts and Jobs Act of 2017 subjected unrepatriated foreign earnings to a one-time transition tax, which is expected to result in tax payments of $51,113,000 starting in 2021 through 2025.

The Company believes that its existing cash and investment balances, together with cash flow from operations, will be sufficient to meet its operating, investing, and financing activities for the next twelve months.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of the Company’s financial condition and results of operations are based upon the consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States.

Our discussion and analysis of the Company’s financial condition and results of operations are based on the consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States.

The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities.

We base our estimates on historical experience and various other assumptions 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 results could differ from these estimates under different assumptions or circumstances resulting in charges that could be material in future reporting periods.

Changes in accounting estimates are reasonably likely to occur from period to period.

Accordingly, actual results could differ from these estimates under different assumptions or circumstances resulting in charges that could be material in future reporting periods.

We believe the following critical accounting policies require the use of significant estimates and judgments in the preparation of our consolidated financial statements.

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The Company identifies contracts with customers as agreements that create enforceable rights and obligations, which typically take the form of customer contracts or purchase orders.

The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectibility of consideration is probable.

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Identifying the Performance Obligations in the Contract

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On-site support services that are provided to the customer after the solution is deployed are accounted for as a separate performance obligation.

These solutions are provided to customers in a variety of industries, including the consumer electronics, logistics, and automotive industries.

These solutions are provided to customers in a variety of industries, including the consumer electronics and logistics industries.

Shipping and handling activities for which the Company is responsible under the terms and conditions of the sale are not accounted for as performance obligations but as fulfillment costs.

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The Company updates its estimate of variable consideration at the end of each reporting period to reflect changes in facts and circumstances.

The Company does not grant customers the explicit right to return product.

However, from time to time, the Company may allow a customer to return a product.

As a practical expedient, the Company estimates the transaction price using the expected value based on its history of return experience using a portfolio approach in which the Company’s total revenue is reduced by an estimate of total customer returns.

Management reasonably expects that the effect of applying a portfolio approach to a group of contracts would not differ materially from considering each contract separately.

Allocating the Transaction Price to the Performance Obligations

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If acceptance provisions are presumed to be substantive, then revenue is deferred until customer acceptance.

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For the Company’s standard products and services, revenue recognition and billing typically occur at the same time.

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As of December 31, 2020, the Company’s investment portfolio of debt securities totaled $498,365,000.

The debt securities are reported at fair value, with unrealized gains and losses, net of tax, recorded in shareholders’ equity as other comprehensive income (loss) since these securities are designated as available-for-sale securities.

As of December 31, 2019 , the Company’s portfolio of debt securities had a net unrealized gain of $2,351,000.

Included in this net gain were gross unrealized losses totaling $65,000 of which $39,000 were in a loss position for less than twelve months and $26,000 were in a loss position for greater than twelve months.

The Company applies a three-level valuation hierarchy for fair value measurements.

The categorization of assets and liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value.

Level 1 inputs to the valuation methodology utilize unadjusted quoted market prices in active markets for identical assets and liabilities.

Level 2 inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets and liabilities, quoted prices for identical and similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3 inputs to the valuation methodology are unobservable inputs based upon management’s best estimate of the inputs that market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.

Changes in the valuation methodology, interest rates, credit rates, or the market for these investments could result in changes to their fair values.

Changes to the Level of an investment within the fair value hierarchy are determined at the end of the reporting period.

The Company’s debt securities are reported at fair value based upon model-driven valuations in which all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term

of the asset, and are therefore classified as Level 2.

Management is responsible for estimating the fair value of these financial assets and liabilities, and in doing so, considers valuations provided by a large, third-party pricing service.

These debt securities are reported at fair value, with unrealized gains and losses, net of tax, included in shareholders’ equity as other comprehensive income (loss) since these securities are designated as available-for-sale securities.

As of December 31, 2020, the Company’s portfolio of debt securities had an unrealized gain of $5,690,000, and no unrealized losses.

The fair value of the Company's debt securities is based on model-driven valuations in which all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset.

Management is responsible for estimating the fair value of these financial assets, and in doing so, considers valuations provided by a large, third-party pricing service.

This service maintains regular contact with market makers, brokers, dealers, and analysts to gather information on market movement, direction, trends, and other specific data.

They use this information to structure yield curves for various types of debt securities and arrive at the daily valuations.

Management monitors the carrying value of its debt securities compared to their fair value to determine whether an other-than-temporary impairment has occurred.

In considering whether a decline in fair value is other-than-temporary, we consider many factors, both qualitative and quantitative in nature, including the type of security, the credit rating of the security, the length of time the security has been in a loss position, the size of the loss position, our ability and intent to hold the security to expected recovery of value, and other meaningful information.

If a decline in fair value is determined to be other-than-temporary, an impairment charge would be recorded in current operations to reduce the carrying value of the investment to its fair value.

There were no other-than-temporary impairments of investments in 2019, 2018, or 2017.

Accounts Receivable

The Company maintains reserves against its accounts receivable for potential credit losses.

Ongoing credit evaluations of customers are performed and the Company has historically not experienced significant losses related to the collection of its accounts receivable.

Allowances for specific accounts determined to be at risk for collection are estimated by management taking into account the length of time the receivable has been outstanding, the customer’s current ability to pay its obligations to the Company, general economic and industry conditions, as well as various other factors.

Global economic uncertainty may result in longer payment cycles and challenges in collecting accounts receivable balances, which make these estimates more judgmental.

An adverse change in any of these factors could result in higher than expected customer defaults and may result in the need for additional bad debt provisions.

As of December 31, 2019 , the Company’s reserve against accounts receivable was $1,821,000, or 2% of the gross accounts receivable balance.

A 10% difference in the reserve against accounts receivable as of December 31, 2019 would have affected net income by approximately $153,000.

Management monitors its debt securities that are in an unrealized loss position to determine whether a loss exists related to the credit quality of the issuer.

When developing an estimate of expected credit losses, management considers all relevant information including historical experience, current conditions, and reasonable forecasts that project the expected future cash flows.

Credit losses on debt securities were not material in 2020, 2019, or 2018.

Inventories are stated at the lower of cost and net realizable value.

Net realizable value is the estimated selling price in the ordinary course of business, less readily predictable costs of completion, disposal, and transportation.

Management estimates excess and obsolescence exposures based upon assumptions about future demand, product transitions, and market conditions, and records reserves to reduce the carrying value of inventories to their net realizable value.

Management estimates excess and obsolescence exposures based on assumptions about future demand, product transitions, and market conditions, and records reserves to reduce the carrying value of inventories to their net realizable value.

Volatility in the global economy makes these assumptions about future demand more judgmental.

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In addition, we may strategically enter into non-cancelable commitments with vendors to purchase materials for products in advance of demand to take advantage of favorable pricing or address concerns about the availability of future supplies and long lead times.

Estimates in 2020 took into account the global economic conditions resulting from the COVID-19 pandemic.

As of December 31, 2020, the Company’s reserve for excess and obsolete inventory totaled $14,578,000, or 19% of the gross inventory balance.

A 10% difference in inventory reserves as of December 31, 2020 would have affected net income by approximately $1,210,000.

The Company accounts for leases in accordance with Accounting Standard Codification (ASC) 842, "Leases." The core principle of ASC 842 is that a lessee should recognize on the balance sheet the assets and liabilities that arise from leases.

The application of this rule requires the Company to determine whether a contract is or contains a lease by assessing whether there is an identified asset and whether the contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration.

In the determination of the lease term, the Company considers the existence of extension or termination options and the probability of those options being exercised.

The Company must also determine whether the lease meets the criteria for classification as a finance lease by assessing whether the lease transfers ownership of the underlying asset to the Company by the end of the lease term, the lease grants the Company an option to purchase the underlying asset that the Company is reasonably certain to exercise, the lease term is for the major part of the remaining economic life of the underlying asset, the present value of the sum of the lease payments and any residual value guaranteed by the Company equals or exceeds substantially all of the fair value of the underlying asset, and the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Long-lived Assets

The Company has long-lived assets, including property, plant, and equipment and acquired intangible assets.

These assets are susceptible to shortened estimated useful lives and changes in fair value due to changes in their use, market or economic changes, or other events or circumstances.

The Company evaluates the potential impairment of these long-lived assets whenever events or circumstances indicate their carrying value may not be recoverable.

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Intangible Assets

The Company's intangible assets are susceptible to shortened estimated useful lives and changes in fair value due to changes in their use, market or economic changes, or other events or circumstances.

The Company evaluates the potential impairment of intangible assets whenever events or circumstances indicate the carrying value may not be recoverable.

Factors that could trigger an impairment review include historical or projected results that are less than the assumptions used in the original valuation of an acquired asset, a change in the Company’s business strategy or its use of an acquired asset, or negative economic or industry trends.

If an event or circumstance indicates the carrying value of long-lived assets may not be recoverable, the Company assesses the recoverability of the assets by comparing the carrying value of the assets to the sum of the undiscounted future cash flows that the assets are expected to generate over their remaining economic lives.

If the carrying value exceeds the sum of the undiscounted future cash flows, the Company compares the fair value of the long-lived assets to the carrying value and records an impairment loss for the difference.

The Company generally estimates the fair value of its long-lived assets using the income approach based upon a discounted cash flow model.

If an event or circumstance indicates the carrying value of intangible assets may not be recoverable, the Company assesses the recoverability of the assets by comparing the carrying value of the assets to the sum of the undiscounted future cash flows that the assets are expected to generate over their remaining economic lives.

If the carrying value exceeds the sum of the undiscounted future cash flows, the Company compares the fair value of the intangible assets to the carrying value and records an impairment loss for the difference.

The Company generally estimates the fair value of its intangible assets using the income approach based on a discounted cash flow model.

The income approach requires the use of many assumptions and estimates including future revenues and expenses, discount factors, income tax rates, the identification of groups of assets with highly independent cash flows, and assets’ economic lives.

Volatility in the global economy makes these assumptions and estimates more judgmental.

In 2017, the Company determined that the carrying value of the customer relationships arising from the acquisition of AQSense S.L.

was impaired and reduced this value to zero, resulting in an impairment charge of $469,000.

The Company did not record an impairment charge related to long-lived assets in 2019 or 2018.

Actual future operating results and the remaining economic lives of our long-lived assets could differ from those used in assessing the recoverability of these assets and could result in an impairment of long-lived assets in future periods.

Internal-use Software

The accounting treatment for computer software developed for internal use depends upon the nature of activities performed at each stage of development.

The preliminary project stage includes conceptual formulation of design alternatives, determination of system requirements, vendor demonstrations, and final selection of vendors, and during this stage costs are expensed as incurred.

The application development stage includes software configuration, coding, hardware installation, and testing.

During this stage, certain costs are capitalized, including external direct costs of materials and services, as well as payroll and payroll-related costs for employees who are directly associated with the project, while certain costs are expensed as incurred, including training and data conversion costs.

The post-implementation stage includes support and maintenance, and during this stage costs are expensed as incurred.

Capitalization begins when both the preliminary project stage is completed and management commits to funding the project.

Capitalization ceases at the point the project is substantially complete and ready for its intended use, that is, after all substantial testing is completed.

The application of these rules requires the use of judgment to determine when the project has reached the next stage of development, which costs are directly associated with the project, and when the asset is ready for its intended use.

Management evaluates the potential impairment of goodwill annually each fourth quarter and whenever events or circumstances indicate the carrying value may not be recoverable.

Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit exceeds its fair value.

The Company currently operates under one reporting unit which is the level at which the goodwill impairment analysis is performed.

Determining the Company’s reporting units requires judgments regarding what constitutes a business and at what level discrete financial information is available and reviewed by management.

The Company performs a qualitative assessment of goodwill to determine whether further impairment testing is necessary.

If this qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity would proceed to perform a quantitative impairment test.

Under this quantitative analysis, the Company compares the fair value of the reporting unit with its carrying value, including goodwill.

If the carrying amount exceeds the fair value of the reporting unit, the Company recognizes an impairment charge.

The Company estimates the fair value of its reporting unit using the income approach based upon a discounted cash flow model.

In addition, the Company uses the market approach, which compares the reporting unit to publicly-traded companies and transactions involving similar businesses, to support the conclusions based upon the income approach.

The income approach requires the use of many assumptions and estimates including future revenues, expenses, capital expenditures, and working capital, as well as discount factors and income tax rates.

Factors that management considered in the qualitative assessment include macroeconomic conditions, industry and market considerations, overall financial performance (both current and projected), changes in management or strategy,

changes in the composition or carrying amount of net assets, and market capitalization.

Based on the qualitative assessment, management does not believe that it is more likely than not that the carrying value of its reporting unit exceeds its fair value.

No impairment losses were recorded in 2019, 2018, or 2017.

Warranty Obligations

The Company records the estimated cost of fulfilling product warranties at the time of sale based upon historical costs to fulfill claims.

Obligations may also be recorded subsequent to the time of sale whenever specific events or circumstances impacting product quality become known that would not have been taken into account using historical data.

While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers and third-party contract manufacturers, the Company’s warranty obligation is affected by product failure rates, material usage, and service delivery costs incurred in correcting a product failure.

An adverse change in any of these factors may result in the need for additional warranty provisions.

As of December 31, 2019 , the Company’s accrued warranty obligations amounted to $4,713,000.

A 10% difference in accrued warranty obligations as of December 31, 2019 would have affected net income by approximately $397,000.

Contingencies

Estimated losses from contingencies are accrued by management based upon whether a loss is probable and whether management has the ability to reasonably estimate the amount of the loss.

Estimating potential losses, or even a range of losses, is difficult and involves a great deal of judgment.

Management relies primarily on assessments made by its internal and external legal counsel to make the determination as to whether a loss contingency arising from litigation should be recorded or disclosed.

This analysis is performed each reporting period or when facts and circumstances dictate.

Should the resolution of a contingency result in a loss that we did not accrue because management did not believe that the loss was probable or capable of being reasonably estimated, then this loss would result in a charge to income in the period the contingency was resolved.

The Company did not have any significant accrued contingencies as of December 31, 2019.

Derivative Instruments

In certain instances, the Company enters into forward contracts to hedge against foreign currency fluctuations.

The Company's forward contracts are reported at fair value based upon model-driven valuations in which all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset or liability, and are therefore classified as Level 2.

The Company's forward contracts are typically traded or executed in over-the-counter markets with a relatively high degree of pricing transparency.

The market participants are generally large commercial banks.

The Company may enter into two types of hedges to manage foreign currency exchange rate risk.

The first are economic hedges which utilize foreign currency forward contracts to manage the exposure to fluctuations in foreign currency exchange rates arising primarily from foreign-denominated receivables and payables.

The gains and losses on these derivatives are intended to be offset by the changes in the fair value of the assets and liabilities being hedged.

These economic hedges are not designated as effective hedges, and therefore, do not qualify for effective hedge accounting.

The second are cash flow hedges which utilize foreign currency forward contracts to protect our budgeted revenues and expenses against foreign currency exchange rate changes compared to our budgeted rates.

These cash flow hedges are designated for hedge accounting, and therefore, the effective portion of the forward contract's gain or loss is reported in shareholders' equity as other comprehensive income (loss) and is reclassified into current operations as the hedged transaction impacts current operations.

Should these hedges fail to qualify for hedge accounting or be ineffective, the gain or loss on the forward contract would be reported in current operations immediately as opposed to when the hedged transaction impacts current operations.

This may result in material foreign currency gains or losses.

Actual future operating results and the remaining economic lives of our intangible assets could differ from those used in assessing the recoverability of these assets and could result in an impairment of intangible assets in future periods.

Deteriorating global economic conditions from the COVID-19 pandemic triggered a review of intangible assets for potential impairment in the second quarter of 2020.

No impairment charges related to intangible assets were recorded in 2019 or 2018.

Stock-Based Compensation

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As a result, if factors change and different assumptions are used, stock-based compensation expense could be significantly different from what the Company recorded in the current period.

Significant judgment is required in determining worldwide income tax expense based upon tax laws in the various jurisdictions in which the Company operates.

Significant judgment is required in determining worldwide income tax expense based on tax laws in the various jurisdictions in which the Company operates.

The Company has established reserves for income taxes by applying the “more likely than not” criteria, under which the recognition threshold is met when an entity concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination by the relevant tax authority.

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These differences result in deferred tax assets and liabilities, which are recorded on the Consolidated Balance Sheets.

The Tax Act imposed a minimum tax on foreign earnings related to intangible assets, known as the Global Intangible Low-Taxed Income (GILTI) tax.

In the fourth quarter of 2019, the Company elected to account for the impact of the GILTI minimum tax in deferred taxes, a change from the Company’s initial election made in the third quarter of 2018 whereby the GILTI minimum tax was included in income tax expense as incurred on an annual basis.

Management has determined that this change is considered preferable, based upon the conclusion that it appropriately matches the Company’s current and deferred income tax implications related to the change in tax structure noted below.

In the fourth quarter of 2019, the Company made changes to its international tax structure as a result of tax reform legislation enacted by the European Union that resulted in an intercompany sale of intellectual property based upon the fair value of this intellectual property.

Also in the fourth quarter of 2019, in connection with the acquisition of Sualab Co.

The Tax Cuts and Jobs Act of 2017 imposed a minimum tax on foreign earnings related to intangible assets, known as the Global Intangible Low-Taxed Income (GILTI) tax.

In 2019, the Company elected to account for the impact of the GILTI minimum tax in deferred taxes, a change from the Company’s initial election made in 2018 whereby the GILTI minimum tax was included in income tax expense as incurred on an annual basis.

Management has determined that this change is considered preferable, based on the conclusion that it appropriately matches the Company’s current and deferred income tax implications related to the change in tax structure noted below.

In 2019, the Company made changes to its international tax structure as a result of tax reform legislation enacted by the European Union that resulted in an intercompany sale of intellectual property based on the fair value of this

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intellectual property.

Also in 2019, in connection with the acquisition of Sualab Co.

Ltd., the Company migrated acquired intellectual property to certain subsidiaries to align with its corporate tax structure.

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Management is responsible for determining the appropriate valuation model and estimated fair values, and in doing so, considers a number of factors, including information provided by an outside valuation advisor.

Management primarily establishes fair value using the income approach based upon a discounted cash flow model.

Management primarily establishes fair value using the income approach based on a discounted cash flow model.

The income approach requires the use of many assumptions and estimates including future revenues and expenses, as well as discount factors.

Contingent consideration liabilities are reported at their estimated fair values based upon probability-adjusted present values of the consideration expected to be paid, using significant inputs and estimates.

Contingent consideration liabilities are reported at their estimated fair values based on probability-adjusted present values of the consideration expected to be paid, using significant inputs and estimates.

Key assumptions used in these estimates include probability assessments with respect to the likelihood of achieving certain milestones and discount rates consistent with the level of risk of achievement.

The fair value of these contingent consideration liabilities are remeasured each reporting period, with changes in the fair value recorded in "Other income (expense)" on the Consolidated Statement of Operations.

The fair value of these contingent consideration liabilities are remeasured each reporting period, with changes in the fair value included in current operations.

The remeasured liability amount could be significantly different from the amount at the acquisition date, resulting in material charges or credits in future reporting periods.

Restructuring Charges

The restructuring plan included a global workforce reduction of approximately 8% and office closures.

The majority of these actions were completed as of December 31, 2020 and resulted in total restructuring charges of $15,924,000 in 2020.

The Company made significant estimates and judgments in the determination of the restructuring charges, including the assessment that the workforce reduction met the criteria to be accounted for as one-time termination benefits and the date the criteria were met to record this liability, severance estimates for employees who had not yet signed termination agreements, the date that closed offices were abandoned, and estimates of remaining lease obligations for abandoned offices.

As of December 31, 2020, the Company had trued up the majority of these estimates based on actual negotiated payments with employees or landlords, with adjustments recorded in the second half of 2020 based on the Company's revised estimates of these liabilities.

NEW PRONOUNCEMENTS

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

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Item 7. Management’s Discussion and Analysis