Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business and Financial Overview

The Company has two operating segments: Waters® and TA®. Waters products and services primarily consist of high performance liquid chromatography (“HPLC”), ultra performance liquid chromatography (“UPLC®” and together with HPLC, referred to as “LC”), mass spectrometry (“MS”) and chemistry consumable products and related services. TA products and services primarily consist of thermal analysis, rheometry and calorimetry instrument systems and service sales. The Company’s products are used by pharmaceutical, biochemical, industrial, nutritional safety, environmental, academic and governmental customers. These customers use the Company’s products to detect, identify, monitor and measure the chemical, physical and biological composition of materials and to predict the suitability and stability of fine chemicals, pharmaceuticals, water, polymers, metals and viscous liquids in various industrial, consumer goods and healthcare products.

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The Company’s operating results are as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share data):

		Year Ended December 31,												% change
		2016				2015				2014				2016 vs. 2015				2015 vs. 2014
Revenues:
Product sales		$	1,460,296			$	1,385,256			$	1,346,729				5	%			3	%
Service sales			707,127				657,076				642,615				8	%			2	%
Total net sales			2,167,423				2,042,332				1,989,344				6	%			3	%
Costs and operating expenses:
Cost of sales			891,453				842,672				824,913				6	%			2	%
Selling and administrative expenses			513,031				495,747				512,707				3	%			(3	%)
Research and development expenses			125,187				118,545				107,726				6	%			10	%
Purchased intangibles amortization			9,889				10,123				10,634				(2	%)			(5	%)
Litigation provisions			3,524				3,939				—				(11	%)			—
Acquired in-process research and development			—				3,855				15,456				(100	%)			(75	%)
Operating income			624,339				567,451				517,908				10	%			10	%
Operating income as a % of sales			28.8	%			27.8	%			26.0	%
Interest expense, net			(24,225	)			(25,532	)			(27,168	)			(5	%)			(6	%)
Income from operations before income taxes			600,114				541,919				490,740				11	%			10	%
Provision for income taxes			78,611				72,866				59,120				8	%			23	%
Net income		$	521,503			$	469,053			$	431,620				11	%			9	%
Net income per diluted common share		$	6.41			$	5.65			$	5.07				13	%			11	%

In 2016, the Company’s sales increased 6% as compared to 2015. The growth was mainly driven by continued strength in our pharmaceutical market followed by growth in our industrial market, which includes sales to industrial chemical, nutritional safety and environmental customers, offset by a decline in sales to our governmental and academic customers. Instrument systems produced mid-single-digit sales growth during 2016 and our chemistry and service businesses continued to generate high-single-digit growth rates due to higher instrument utilization and a growing base of installed instrument systems. Geographically, the Company experienced positive sales growth in all major regions on a world-wide basis, led by Asia, which generated double-digit growth during 2016. This double-digit sales growth rate in Asia was primarily attributed to strong demand for the Company’s products and services in China and a favorable effect of foreign currency translation in Japan. Sales growth in 2016 in Europe and the U.S. was 4% and 1%, respectively. In 2015, the Company’s sales grew 3% as compared to 2014 as the effect of foreign currency translation significantly reduced the sales growth rate experienced by the pharmaceutical and industrial end-markets. The effect of foreign currency translation negatively impacted sales by 1% and 6% across all products and services in 2016 and 2015, respectively. Based on current foreign exchange rates, the Company expects that foreign currency translation may negatively affect sales growth in 2017. Recent acquisitions had a minimal impact on sales growth in both 2016 and 2015.

Sales to pharmaceutical customers grew 9% and 4% in 2016 and 2015, respectively. The increase in 2016 was driven by the increasing need for global access to prescription drugs and the testing of newer and more complex biologic drugs. Geographically, the growth within our pharmaceutical market was driven by double-digit growth in China and Japan, while sales growth in 2015 was driven by double-digit growth in the U.S., China and India offset by the negative effects of foreign currency translation.

Combined sales to industrial customers grew 6% and 4% in 2016 and 2015, respectively. The growth in 2016 was driven by the increasing need for food quality and food safety testing and fine chemical applications. Geographically, industrial market sales growth was highest in Europe, followed by Asia and offset by weakness

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in the U.S. Before the effects of foreign currency translation, the Company’s industrial customer sales in 2015 grew at a higher rate than 2016. This overall weaker demand from the Company’s industrial customers in 2016 was primarily attributed to the decline in TA instrument system sales and the overall soft demand for the Company products and services in the U.S.

Combined sales to governmental and academic customers decreased 4% and 5% in 2016 and 2015, respectively, as a result of these institutions reducing their spending on the Company’s products and the negative effects of foreign currency translation in 2015. In 2016, combined sales to governmental and academic customers grew in China and India but declined in all other regions. In 2015, combined sales to governmental and academic customers grew in the U.S. and China but declined in all other regions.

Instrument system sales increased 4% and 3% in 2016 and 2015, respectively, due to higher demand for LC and LC-MS instrument systems. This strength in demand was driven by HPLC, UPLC®, ACQUITY ArcTM, QDa® and Vion® IMS Q-TofTM instrument systems, as well as other LC-MS systems that incorporate the Company’s benchtop tandem quadrupole technologies. Recurring revenues (combined sales of chemistry consumables and services) increased 8% and 2% in 2016 and 2015, respectively, as a result of a larger installed base of customers and higher billing demand for service sales. Foreign currency translation lowered the 2015 recurring revenues by 6%.

Geographically, sales in Asia increased 13% and 9% in 2016 and 2015, respectively. The sales growth in Asia was a result of the broad-based increase in China’s sales across all product and customer classes and the favorable effect of foreign currency in Japan, where foreign currency translation increased sales by 12% in 2016 after decreasing sales by 12% in 2015. Sales in the U.S. in 2016 increased 1% after the U.S. delivered sales growth of 10% in 2015, when the Company experienced greater demand for its products and services in the U.S.

Sales in Europe and in the rest of the world increased by 4% and 6%, respectively, in 2016 as compared to an 8% decline in both Europe and the rest of the world sales in 2015. The negative effects of foreign currency translation on the 2016 sales growth in Europe and the rest of the world was approximately 3%, which was significantly less than the 14% decrease in Europe and the 5% decrease in the rest of the world sales in 2015, when the U.S. dollar strengthened substantially against all currencies throughout the world.

Operating income was $624 million in 2016, an increase of 10% as compared to 2015. This increase was primarily a result of the effect of higher sales volume achieved in 2016 and the positive impact of foreign currency translation on our U.K. manufacturing and research and development costs as a result of the significantly weaker British Pound. Operating income increased 10% in 2015 as compared to 2014 as a result of higher sales volumes achieved in 2015 being partly offset by a $56 million reduction in operating income from the adverse effects of foreign currency translation.

The Company generated $629 million, $560 million and $512 million of net cash flows from operations in 2016, 2015 and 2014, respectively. The increases in operating cash flow in each year were primarily a result of the increase in sales and net income.

Cash flows used in investing activities included capital expenditures related to property, plant, equipment and software capitalization of $95 million, $100 million and $91 million in 2016, 2015 and 2014, respectively. In September 2016, the Company acquired Rubotherm GmbH for approximately $6 million in cash and the Company made payments of $3 million and $15 million to acquire and license intellectual property during 2015 and 2014, respectively. These acquisitions did not have a significant impact on the Company’s sales and profits in 2016.

During 2016 and 2014, the Company issued and sold senior unsecured notes for an aggregate principal amount of $250 million and $200 million, respectively. During 2016, 2015 and 2014, the Company repurchased $318 million, $327 million and $329 million of the Company’s outstanding common stock, respectively, under

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authorized share repurchase programs. The Company believes that it has the financial flexibility to fund these share repurchases given current cash and investment levels and debt borrowing capacity, as well as to invest in research, technology and business acquisitions to further grow the Company’s sales and profits.

Results of Operations

Sales by Geography

Geographic sales information is presented below for the years ended December 31, 2016, 2015 and 2014 (in thousands):

		Year Ended December 31,												% change
		2016				2015				2014				2016 vs. 2015				2015 vs. 2014
Net Sales:
United States		$	665,280			$	656,361			$	596,549				1	%			10	%
Europe			577,257				555,886				607,080				4	%			(8	%)
Asia:
China			331,354				278,600				238,892				19	%			17	%
Japan			167,977				145,184				163,468				16	%			(11	%)
Asia Other			283,653				272,179				237,668				4	%			15	%
Total Asia			782,984				695,963				640,028				13	%			9	%
Other			141,902				134,122				145,687				6	%			(8	%)
Total net sales		$	2,167,423			$	2,042,332			$	1,989,344				6	%			3	%

In 2016, sales growth in the U.S. sales was driven by increases in recurring revenues, which were offset by declines in instrument systems sales. U.S. sales increased to pharmaceutical customers but declined to non-pharmaceutical end-markets. Europe’s sales in 2016 were also driven by recurring revenues and primarily due to increases to pharmaceutical and industrial customers. China achieved strong sales growth in all product and customer classes in 2016, with double-digit growth in LC-MS instrument systems and chemistry consumables as well as double-digit growth to pharmaceutical customers. Japan’s increase in sales in 2016 was largely driven by the benefit of foreign currency translation, which increased sales by 12%. The increase in sales in the rest of Asia in 2016 was driven by LC-MS instrument systems and chemistry consumables sales to pharmaceutical and industrial customers. Sales to the rest of Asia decreased 6% due to the negative effect of foreign currency translation. Sales in the rest of the world in 2016 were broad-based across all product classes as sales increased to industrial customers but declined across all other customer classes.

In 2015, the U.S. sales growth was broad-based across all products and was driven by pharmaceutical and industrial customers. Europe’s sales in 2015 were broad-based across all product and customer classes, but declined as a result of the negative effects of foreign currency. China achieved strong double-digit sales growth in all product and customer classes in 2015. Japan’s 2015 sales were negatively impacted by foreign currency translation, which decreased sales by 12%. The increase in sales in the rest of Asia in 2015 was driven by pharmaceutical and industrial customers across all product classes. Sales in the rest of the world in 2015 increased to pharmaceutical customers but declined across all other customer and product classes. The decline in sales in the rest of the world in 2015 was significantly attributable to a reduction in customer demand in Latin America caused by the strengthening of the U.S. dollar and the weak Brazilian economy.

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Waters Products and Services Net Sales

Net sales for Waters products and services are as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands):

		Year Ended December 31,																								% change
		2016				% of Total				2015				% of Total				2014				% of Total				2016 vs. 2015				2015 vs. 2014
Waters instrument systems		$	943,218				49	%		$	895,626				50	%		$	871,048				49	%			5	%			3	%
Chemistry			345,413				18	%			317,941				17	%			312,890				18	%			9	%			2	%
Total Waters product sales			1,288,631				67	%			1,213,567				67	%			1,183,938				67	%			6	%			3	%
Waters service			639,432				33	%			593,301				33	%			579,759				33	%			8	%			2	%
Total Waters net sales		$	1,928,063				100	%		$	1,806,868				100	%		$	1,763,697				100	%			7	%			2	%

The increase in Waters instrument system sales (LC and MS technology-based) in both 2016 and 2015 is primarily attributable to higher sales of HPLC, UPLC, ACQUITY Arc, QDa and Vion IMS Q-Tof instrument systems, as well as other LC-MS systems that incorporate the Company’s benchtop tandem quadrupole technologies. Chemistry consumables sales increased in both 2016 and 2015 on the uptake in ACQUITY columns, CORTECS® columns and application-specific testing kits. Waters service sales in both 2016 and 2015 benefited from increased sales of service plans and higher service demand billings to a higher installed base of customers. The effect of foreign currency translation had a minimal impact on Waters sales in 2016 and decreased Waters sales across all products and services by 7% in 2015.

In 2016, Waters sales increased 2% in the U.S., 4% in Europe, 14% in Asia and 5% in the rest of the world. Waters sales increased 21% in China and were broad-based across all product and customer classes. Waters sales in Japan increased 15%, primarily due to the benefit of foreign currency translation, which increased sales by 12%. Waters sales in the rest of Asia increased 6% and were driven by product sales to pharmaceutical and industrial customers, offset by weakness within governmental and academic markets.

In 2015, Waters sales increased 10% in the U.S. and 8% in Asia, while sales decreased 8% in Europe and the rest of the world. The increase in sales in the U.S. in 2015 was across all customer classes. Waters sales in China increased 16% in 2015, but decreased 11% in Japan due to the effects of foreign currency translation. Waters sales in the rest of Asia increased 14% and were driven by sales to pharmaceutical and industrial customers.

TA Product and Services Net Sales

Net sales for TA products and services are as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands):

		Year Ended December 31,																								% change
		2016				% of Total				2015				% of Total				2014				% of Total				2016 vs. 2015				2015 vs. 2014
TA instrument systems		$	171,665				72	%		$	171,689				73	%		$	162,791				72	%			—				5	%
TA service			67,695				28	%			63,775				27	%			62,856				28	%			6	%			1	%
Total TA net sales		$	239,360				100	%		$	235,464				100	%		$	225,647				100	%			2	%			4	%

TA instrument system sales were flat in 2016 primarily due to weaker demand for its instrument systems. The increase in TA instrument system sales growth in 2015 was primarily attributable to TA’s thermal physical properties instruments. In addition, TA’s core thermal analysis instrument systems sales rebounded in 2015 after a decrease in 2014 in comparison to stronger sales in 2013. TA service sales increased in both 2016 and 2015 due to sales of service plans and billings to a higher installed base of customers. The effect of foreign currency translation had a minimal impact on sales in 2016 and decreased TA’s sales by 5% in 2015. Recent acquisitions added approximately 1% and 3% to TA’s sales in 2016 and 2015, respectively.

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In 2016, TA sales increased 2% in both the Americas and Asia and increased 1% in Europe. TA sales were flat in the U.S. in 2016 but TA achieved a double-digit increase in the rest of the Americas. TA’s sales in Japan in 2016 increased 19%, with a 10% increase due to the benefit of foreign currency translation. In 2015, TA showed sales growth in the U.S. and Asia, excluding Japan, but sales declined in Europe, Japan and the rest of the world as a result of negative foreign currency translation.

Cost of Sales

The increase in cost of sales for both 2016 and 2015 were consistent with the increase in sales volumes. In 2016, cost of sales included the benefit of a weaker British pound, which reduced the Company’s U.K. manufacturing costs when translated into U.S. dollars. The weakening of the British pound began with the announcement that the U.K. would be exiting the European Union. The effect of foreign currency translation benefited cost of sales in 2015, but increased cost of sales in 2014.

Cost of sales are affected by many factors, including, but not limited to, foreign currency translation, product mix, product costs of instrument systems and amortization of software platforms. At current foreign currency exchange rates, the Company expects that the impact of foreign currency translation may negatively impact gross profit in 2017, as the benefits from the weakening of the British pound are expected to be offset by the impact of the weakening of all other major currencies.

Selling and Administrative Expenses

Selling and administrative expenses increased 3% in 2016 and decreased 3% in 2015. Selling and administrative expenses in 2016 and 2015 were impacted by headcount additions and higher merit compensation costs and the effect of foreign currency translation, which lowered selling and administrative expenses by 2% and 7% in 2016 and 2015, respectively. In addition, the Company incurred $7 million of stock compensation expense in 2016 related to the modification of certain stock awards upon the retirement of senior executives. Severance-related costs in 2016, 2015 and 2014 were $3 million, $3 million and $6 million, respectively, in connection with a reduction in workforce. In 2014, the Company incurred a $5 million impairment charge related to a write-down in the fair value of a building held for sale in the U.K. This building was sold in 2015 for $5 million in cash.

As a percentage of net sales, selling and administrative expenses were 23.7%, 24.3% and 25.8% for 2016, 2015 and 2014, respectively.

Research and Development Expenses

Research and development expenses increased 6% and 10% in 2016 and 2015, respectively. Research and development expenses in both 2016 and 2015 were impacted by additional headcount, merit compensation and costs associated with new products and the development of new technology initiatives. In addition, the effect of foreign currency translation reduced research and development expenses by 7% and 5% in 2016 and 2015, respectively, primarily due to the weakening of the British pound on the Company’s U.K. research and development costs. In 2016 and 2015, research and development expenses also included a benefit of $2 million and $3 million, respectively, from a government grant. In 2014, the effect of foreign currency translation was unfavorable and increased expenses.

Acquired In-Process Research and Development

During 2015 and 2014, the Company incurred charges of $4 million and $15 million, respectively, for acquired in-process research and development related to milestone payments associated with a licensing arrangement for certain intellectual property relating to mass spectrometry technologies yet to be commercialized and for which there was no future alternative use as of the acquisition date. These licensing arrangements are significantly related to new, biologically-focused applications, as well as other applications, and require the Company to make additional future payments of up to $12 million if certain milestones are achieved, as well as royalties on future net sales. These future payments may be significant and occur over multiple years.

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Litigation Provision

The Company recorded $4 million of litigation settlement provisions and related costs in both 2016 and 2015.

Interest Expense, Net

The decreases in net interest expense in 2016 and 2015 were primarily attributable to higher income earned on increased cash, cash equivalents and investment balances.

Provision for Income Taxes

The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the U.K. and Singapore, where the marginal effective tax rates were approximately 37.5%, 12.5%, 20% and 0%, respectively, as of December 31, 2016. The Company has a contractual tax rate in Singapore of 0% through March 2021, based upon the achievement of certain contractual milestones, which the Company expects to continue to meet. The current statutory tax rate in Singapore is 17%. 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 in 2016, 2015 and 2014 by $23 million, $20 million and $20 million, respectively and increased the Company’s net income per diluted share by $0.29, $0.25 and $0.24, respectively.

The Company’s effective tax rate is influenced by many significant factors, including, but not limited to, the wide range of income tax rates in jurisdictions in which the Company operates; sales volumes and profit levels in each tax jurisdiction; changes in tax laws, tax rates and policies; the outcome of various ongoing tax audit examinations; and the impact of foreign currency transactions and translation. As a result of variability in these factors, the Company’s effective tax rates in the future may not be similar to the effective tax rates for the current or prior years.

The Company’s effective tax rates were 13.1%, 13.4% and 12.0% in 2016, 2015 and 2014, respectively. The change in 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. In addition, the income tax provision for 2016 included a $3 million tax benefit related to a release of a valuation allowance on certain net operating loss carryforwards. In 2015, the income tax provision included a $3 million tax benefit related to the completion of tax audit examinations.

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Liquidity and Capital Resources

Condensed Consolidated Statements of Cash Flows (in thousands):

		Year Ended December 31,
		2016				2015				2014
Net income		$	521,503			$	469,053			$	431,620
Depreciation and amortization			96,449				89,987				94,231
Stock-based compensation			40,998				33,368				32,998
Deferred income taxes			1,204				6,581				1,583
Gain on sale of assets/building impairment			(1,500	)			(1,377	)			4,718
In-process research and development and other non-cash charges			—				4,638				16,481
Change in accounts receivable			(31,721	)			(49,888	)			(29,435	)
Change in inventories			(20,147	)			(19,967	)			(15,984	)
Change in accounts payable and other current liabilities			6,842				27,451				(13,687	)
Change in deferred revenue and customer advances			9,974				16,172				9,566
Other changes			5,474				(15,725	)			(20,443	)
Net cash provided by operating activities			629,076				560,293				511,648
Net cash used in investing activities			(487,918	)			(399,739	)			(402,030	)
Net cash used in financing activities			(101,857	)			(69,594	)			(107,221	)
Effect of exchange rate changes on cash and cash equivalents			(21,335	)			(25,472	)			(21,016	)
Increase (decrease) in cash and cash equivalents		$	17,966			$	65,488			$	(18,619	)

Cash Flow from Operating Activities

Net cash provided by operating activities was $629 million, $560 million and $512 million in 2016, 2015 and 2014, respectively. The changes within net cash provided by operating activities include the following significant changes in the sources and uses of net cash provided by operating activities, aside from the changes in net income:

	•		The changes in accounts receivable were primarily attributable to timing of payments made by customers and timing of sales. Days sales outstanding was 71 days at both December 31, 2016 and 2015 and 68 days at December 31, 2014.

	•		The changes in inventory were primarily attributable to anticipated annual increases in sales volumes, as well as new product launches.

	•		The changes in accounts payable and other current liabilities were a result of timing of payments to vendors.

	•		Net cash provided from deferred revenue and customer advances results from annual increases in new service contracts as a higher installed base of customers renew annual service contracts.

	•		Other changes were attributable to variation in the timing of various provisions, expenditures, prepaid income taxes and accruals in other current assets, other assets and other liabilities. In addition, the Company made one-time contributions totaling $21 million to certain Non-U.S. pension plans during 2014.

Cash Used in Investing Activities

Net cash used in investing activities totaled $488 million, $400 million and $402 million in 2016, 2015 and 2014, respectively. Additions to fixed assets and capitalized software were $95 million, $100 million and $91 million in 2016, 2015 and 2014, respectively. During 2016, 2015 and 2014, the Company purchased $2.4 billion, $2.0 billion and $2.2 billion of investments, respectively, while $2.0 billion, $1.7 billion and $1.9 billion of

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investments matured, respectively. Business acquisitions, net of cash acquired, were $6 million, $23 million and $27 million during 2016, 2015 and 2014, respectively. In 2016, the Company sold an equity investment for $4 million and, in 2015, the Company received $5 million cash from the sale of a building in the U.K. During 2015 and 2014, the Company made payments of $3 million and $15 million, respectively, to acquire and license intellectual property.

Cash Used in Financing Activities

The Company issued and sold senior unsecured notes with an aggregate principal amount of $250 million and $200 million in May 2016 and June 2014, respectively. The proceeds from the issuance of the senior unsecured notes in 2016 were used to repay existing debt and for general corporate purposes. 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 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 June 2013, the Company entered into a credit agreement that provides for a $1.1 billion revolving facility and a $300 million term loan facility. In April 2015, Waters Corporation entered into an amendment to this agreement (the “Amended Credit Agreement”). The Amended Credit Agreement provides for an increase of the revolving commitments from $1.1 billion to $1.3 billion and extends the maturity of the original credit agreement from June 25, 2018 until April 23, 2020. The Company plans to use future proceeds from the revolving facility for general corporate purposes.

The interest rates applicable to the Amended Credit Agreement are, at the Company’s option, equal to either the alternate base rate calculated daily (which is a rate per annum equal to the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 1/2% per annum, or (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, in each case, plus an interest rate margin based upon the Company’s leverage ratio, which can range between 0 to 12.5 basis points for alternate base rate loans and between 80 basis points and 117.5 basis points for adjusted LIBO rate loans. The facility fee on the Amended Credit Agreement ranges between 7.5 basis points and 20 basis points. The Amended 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 Amended Credit Agreement includes negative covenants, affirmative covenants, representations and warranties and events of default that are customary for investment grade credit facilities.

During 2016, 2015 and 2014, the Company’s net debt borrowings increased by $160 million, $205 million and $142 million, respectively. As of December 31, 2016, the Company had a total of $1,827 million in outstanding debt, which consisted of $700 million in outstanding senior unsecured notes, $300 million borrowed under a term loan facility under the Amended Credit Agreement, $830 million borrowed under a revolving credit facility under the Amended Credit Agreement and less than $1 million borrowed under various other short-term lines of credit, offset by $3 million of unamortized debt issuance costs. At December 31, 2016, $125 million of the outstanding portion of the revolving facility was classified as short-term liabilities in the consolidated balance sheet due to the fact that the Company expects to repay this portion of the borrowing under the revolving line of credit within the next twelve months. The remaining $705 million of the outstanding portion of the revolving

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facility was classified as long-term liabilities in the consolidated balance sheet, as this portion is not expected to be repaid within the next twelve months. As of December 31, 2016, the Company had a total amount available to borrow under the Amended Credit Agreement of $468 million after outstanding letters of credit. As of December 31, 2016, the Company was in compliance with all debt covenants.

In May 2014, the Company’s Board of Directors authorized the Company to repurchase up to $750 million of its outstanding common stock over a three-year period. During 2016, 2015 and 2014, the Company repurchased 2.3 million, 2.6 million and 3.1 million shares of the Company’s outstanding common stock at a cost of $318 million, $327 million and $329 million, respectively, under the May 2014 authorization and other previously announced programs. At December 31, 2016, the Company had a total of $123 million authorized for future repurchases under the May 2014 plan. In addition, the Company repurchased $8 million, $7 million and $8 million of common stock related to the vesting of restricted stock units during the years ended December 31, 2016, 2015 and 2014, respectively.

The Company received $62 million, $52 million and $74 million of proceeds from the exercise of stock options and the purchase of shares pursuant to the Company’s employee stock purchase plan in 2016, 2015 and 2014, respectively.

The Company had cash, cash equivalents and investments of $2,813 million as of December 31, 2016. The majority of the Company’s cash, cash equivalents and investments are generated from foreign operations, with $2,766 million held by foreign subsidiaries at December 31, 2016, of which $261 million was held in currencies other than the U.S. dollar. Due to the fact that most of the Company’s cash, cash equivalents and investments are held outside of the U.S., the Company must manage and maintain sufficient levels of cash flow in the U.S. to fund operations and capital expenditures, service debt interest, finance potential U.S. acquisitions and continue the authorized stock repurchase program in the U.S. These U.S. cash requirements are managed by the Company’s cash flow from U.S. operations and the use of the Company’s revolving credit facility.

Management believes, as of the date of this report, that its financial position, particularly in the U.S., along with expected future cash flows from earnings based on historical trends and the ability to raise funds from external sources and the borrowing capacity from existing, committed credit facilities, will be sufficient to service debt and fund working capital and capital spending requirements, authorized share repurchase amounts and potential acquisitions. In addition, there have been no recent significant changes to the Company’s financial position, nor are there any anticipated changes, that warrant a material adjustment related to indefinitely reinvested foreign earnings.

Contractual Obligations and Commercial Commitments

The following is a summary of the Company’s known contractual obligations as of December 31, 2016 (in thousands):

		Payments Due by Year (1)
		Total				2017				2018				2019				2020				2021				2022				After 2022
Notes payable and debt		$	125,297			$	125,297			$	—			$	—			$	—			$	—			$	—			$	—
Interest on senior unsecured notes			134,609				24,699				22,150				21,479				16,896				13,208				11,094				25,083
Long-term debt			1,705,000				—				100,000				—				1,105,000				150,000				—				350,000
Operating leases			90,109				21,864				16,877				13,361				10,855				7,144				6,014				13,994
Total		$	2,055,015			$	171,860			$	139,027			$	34,840			$	1,132,751			$	170,352			$	17,108			$	389,077

(1)	Does not include normal purchases made in the ordinary course of business and uncertain tax positions discussed below.

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The interest rates applicable to the Amended Credit Agreement are, at the Company’s option, equal to either the alternate base rate calculated daily (which is a rate per annum equal to the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 1/2% per annum, or (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, in each case, plus an interest rate margin based upon the Company’s leverage ratio, which can range between 0 to 12.5 basis points for alternate base rate loans and between 80 basis points and 117.5 basis points for adjusted LIBO rate loans. The facility fee on the Amended Credit Agreement ranges between 7.5 basis points and 20 basis points. The Amended 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 Amended Credit Agreement includes negative covenants, affirmative covenants, representations and warranties and events of default that are customary for investment grade credit facilities. As of December 31, 2016, the Company was in compliance with all such covenants.

The following is a summary of the Company’s known commercial commitments as of December 31, 2016 (in thousands):

		Amount of Commitments Expiration Per Period
		Total				2017				2018				2019				2020				2021				2022				After 2022
Letters of credit		$	1,818			$	1,818			$	—			$	—			$	—			$	—			$	—			$	—

From time to time, the Company and its subsidiaries are involved in various litigation matters arising in the ordinary course of business. The Company believes it has meritorious arguments in its current litigation matters and believes any outcome, either individually or in the aggregate, will not be material to the Company’s financial position or results of operations.

The Company has long-term liabilities for deferred employee compensation, including pension and supplemental executive retirement plans. The payments related to the supplemental retirement plan are not included above since they are dependent upon when the employee retires or leaves the Company and whether the employee elects lump-sum or annuity payments. During fiscal year 2017, the Company expects to contribute approximately $6 million to $11 million to the Company’s defined benefit plans.

The Company has contingent consideration for an earnout pertaining to the Medimass acquisition. The earnout payments are not included above since they are dependent upon many factors that cannot be predicted with any certainty. The estimated fair value of the contingent consideration as of December 31, 2016 is $3 million.

The Company licenses certain technology and software from third parties. Future minimum license fees payable under existing license agreements as of December 31, 2016 are immaterial. The Company enters into licensing arrangements with third parties that require future milestone or royalty payments contingent upon future events. Upon the achievement of certain milestones in existing agreements, the Company could make additional future payments of up to $12 million, as well as royalties on future net sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table above.

The Company accounts for its uncertain tax return reporting positions in accordance with the accounting standards for income taxes, which require financial statement reporting of the expected future tax consequences of uncertain tax reporting positions on the presumption that all concerned tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances, but prohibit any discounting of unrecognized tax benefits associated with those reporting positions for the time value of money. The Company classified interest and penalties related to unrecognized tax benefits as a component of the

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provision for income taxes. If all of the Company’s unrecognized tax benefits accrued as of December 31, 2016 were to become recognizable in the future, the Company would record a total reduction of approximately $10 million in its income tax provision.

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, 2012. However, carryforward tax attributes that were generated in years beginning on or before January 1, 2013 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.

During the year ended December 31, 2016, the Company concluded tax audit disputes outside the U.S. that, in part, related to matters for which the Company had recorded net uncertain tax benefits. The resolution of these tax disputes resulted in a $1 million reduction in the measurement of its unrecognized tax benefits for the year ended December 31, 2016.

During the year ended December 31, 2015, the Company concluded U.S. tax audit disputes that, in part, related to matters for which the Company had recorded net uncertain tax benefits. The resolution of these tax disputes resulted in a $2 million reduction in the measurement of its unrecognized tax benefits and a $2 million decrease in its provision for income taxes for the year ended December 31, 2015.

As of December 31, 2016, the Company expects to record additional reductions in the measurement of its unrecognized tax benefits and related net interest and penalties of approximately $5 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.

The Company has not paid any dividends and has no plans, at this time, to pay any dividends in the future.

Off-Balance Sheet Arrangements

The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of its business that are not consolidated (to the extent of the Company’s ownership interest therein) into the consolidated financial statements. The Company has not entered into any transactions with unconsolidated entities whereby it has subordinated retained interests, derivative instruments or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company.

The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company’s business partners or customers, in connection with patent, copyright or other intellectual property infringement claims by any third party with respect to its current products, as well as claims relating to property damage or personal injury resulting from the performance of services by the Company or its subcontractors. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, the Company’s costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and management accordingly believes the estimated fair value of these agreements is immaterial.

Critical Accounting Policies and Estimates

Summary

The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent

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liabilities. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results of operations that require management to make estimates about matters that are highly uncertain and that would have a material impact on the Company’s results of operations given changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that reasonably could have been used in the current period. On an ongoing basis, the Company evaluates its policies and estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts may differ from these estimates under different assumptions or conditions. There are other items within the Company’s consolidated financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could potentially have a material impact on the Company’s consolidated financial statements.

Revenue Recognition

Sales of products and services are generally recorded based on product shipment and performance of service, respectively. The Company’s deferred revenue on the consolidated balance sheets consists of the obligation on instrument service contracts and customer payments received in advance, prior to shipment of the instrument. At December 31, 2016, the Company had current and long-term deferred revenue liabilities of $149 million and $25 million, respectively. Revenue is recognized when all of the following revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery or performance has occurred; the vendor’s fee is fixed or determinable; collectibility is reasonably assured and, if applicable, upon acceptance when acceptance criteria with contractual cash holdback are specified. Shipping and handling costs are included in cost of sales, net of amounts invoiced to the customer per the order.

Product shipments, including those for demonstration or evaluation, and service contracts are not recorded as revenue until a valid purchase order or master agreement is received, specifying fixed terms and prices. The Company generally recognizes product revenue when legal title has transferred and risk of loss passes to the customer. The Company generally structures its sales arrangements as shipping point or international equivalent and, accordingly, recognizes revenue upon shipment. In some cases, destination-based shipping terms are included in sales arrangements, in which cases revenue is generally recognized when the products arrive at the customer site.

The Company’s method of revenue recognition for certain products requiring installation is accounted for in accordance with multiple-element revenue recognition accounting standards. With respect to the installation obligations, the larger of the contractual cash holdback or the best estimate of selling price of the installation service is deferred when the product is shipped and revenue is recognized as a multiple-element arrangement when installation is complete. The Company determines the best estimate of selling price of installation based upon a number of factors, including hourly service billing rates and estimated installation hours.

Instrument service contracts are typically billed at the beginning of the maintenance period. The amount of the service contract is amortized ratably to revenue over the instrument maintenance period. There are no deferred costs associated with the service contract, as the cost of the service is recorded when the service is performed. No revenue is recognized until all revenue recognition criteria have been met.

Sales of standalone software are accounted for in accordance with the accounting standards for software revenue recognition. The Company’s software arrangements typically include software licenses and maintenance contracts. Software license revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, collection is probable, and there are no significant post-delivery obligations remaining. The revenue associated with the software maintenance contract is recognized ratably over the maintenance term. Unspecified rights to software upgrades are typically sold as part of the maintenance contract on a when-and-if-available basis. The Company uses the residual method to allocate software revenue

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when a transaction includes multiple elements and vendor specific objective evidence of fair value of undelivered elements exists. Under the residual method, the fair value of the undelivered element (maintenance) is deferred and the remaining portion of the arrangement fee is allocated to the delivered element (software license) and recognized as revenue.

Returns and customer credits are infrequent and are recorded as a reduction to sales. Rights of return are not included in sales arrangements. Revenue associated with products that contain specific customer acceptance criteria is not recognized before the customer acceptance criteria are satisfied. Discounts from list prices are recorded as a reduction to sales.

Loss Provisions on Accounts Receivable and Inventory

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company does not request collateral from its customers, but collectibility is enhanced through the use of credit card payments and letters of credit. The Company assesses collectibility based on a number of factors, including, but not limited to, past transaction history with the customer, the credit-worthiness of the customer, industry trends and the macro-economic environment. Historically, the Company has not experienced significant bad debt losses. Sales returns and allowances are estimates of future product returns related to current period revenue. Material differences may result in the amount and timing of revenue for any period if management made different judgments or utilized different estimates for sales returns and allowances for doubtful accounts. The Company’s accounts receivable balance at December 31, 2016 was $489 million, net of allowances for doubtful accounts and sales returns of $9 million.

The Company values all of its inventories at the lower of cost or market on a first-in, first-out basis (“FIFO”). The Company estimates revisions to its inventory valuations based on technical obsolescence, historical demand, projections of future demand, including that in the Company’s current backlog of orders, and industry and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional write-downs may be required. The Company’s inventory balance at December 31, 2016 was recorded at its net realizable value of $263 million, which is net of write-downs of $23 million.

Long-Lived Assets, Intangible Assets and Goodwill

The Company assesses the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger impairment include, but are not limited to, the following:

	•		significant underperformance relative to historical or projected future operating results, particularly as it pertains to capitalized software and patent costs;

	•		significant negative industry or economic trends, competitive products and technologies; and

	•		significant changes or developments in strategic technological collaborations or legal matters which affect the Company’s capitalized patents, purchased technology, trademarks and intellectual properties, such as licenses.

When the Company determines that the carrying value of an individual intangible asset, long-lived asset or goodwill may not be recoverable based upon the existence of one or more of the above indicators, an estimate of undiscounted future cash flows produced by that intangible asset, long-lived asset or goodwill, including its eventual residual value, is compared to the carrying value to determine whether impairment exists. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the asset is written-down to its estimated fair value. Net intangible assets, long-lived assets and goodwill amounted to $207 million, $337 million and $352 million, respectively, as of December 31, 2016.

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The Company performs annual impairment reviews of its goodwill on January 1 of each year. For goodwill impairment review purposes, the Company has two reporting units, Waters and TA. The Company currently does not expect to record an impairment charge in the foreseeable future; however, there can be no assurance that, at the time future reviews are completed, a material impairment charge will not be recorded. The factors that could cause a material goodwill impairment charge in the future include, but are not limited to, the following:

	•		significant decline in the Company’s projected revenue, earnings or cash flows;

	•		significant adverse change in legal factors or business climate;

	•		significant decline in the Company’s stock price or the stock price of comparable companies;

	•		adverse action or assessment by a regulator; and

	•		unanticipated competition.

Income Taxes

As part of the process of preparing the consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves the Company estimating its actual current tax exposure, taking into account the amount, timing and character of taxable income, tax deductions and credits, and assessing changes in tax laws, regulations, agreements and treaties. Differing treatment of items for tax and accounting purposes, such as depreciation, amortization and inventory reserves, result in deferred tax assets and liabilities, which are included within the consolidated balance sheets. In the event that actual results differ from these estimates, or the Company adjusts these estimates in future periods, such changes could materially impact the Company’s financial position and results of operations.

The accounting standards for income taxes require that a company continually evaluate the necessity of establishing or changing a valuation allowance for deferred tax assets depending on whether it is more likely than not that the actual benefit of those assets will be realized in future periods.

Uncertain Tax Positions

The Company accounts for its uncertain tax return reporting positions in accordance with the accounting standards for income taxes, which require financial statement reporting of the expected future tax consequences of uncertain tax reporting positions on the presumption that all concerned tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances, but prohibit any discounting of unrecognized tax benefits associated with those reporting positions for the time value of money. The Company classified interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes. At December 31, 2016, the Company had unrecognized tax benefits of $10 million.

The Company has been granted a 0% contractual tax rate in Singapore that requires the achievement of certain operational and financial milestones that the Company expects to meet, to the extent not already achieved, by December 31, 2020 and maintain through at least March 31, 2021. As part of the Company’s determination of uncertain tax positions, the Company regularly assesses its progress against these operational and financial milestone targets to determine whether the milestones can be reasonably achieved. These milestones were negotiated with the Singaporean tax authorities and established based on the Company’s historical financial performance; the anticipated customer end-market demand, particularly in certain regions in the world, and the Company’s anticipated future operating plans. These assessments require significant judgments and estimates about the Company’s ability to meet the milestone targets for the following types of objectives: reaching and maintaining annual revenue and business spending targets; meeting capital expenditures targets; attaining and sustaining employment targets; and establishing a local research and development and service center. The Company regularly monitors its actual and forecasted sales and operating results against these milestones and the Company makes the determination as to whether the future forecasted financial results are most likely to be achieved. These milestones are very similar in nature to the previous Singaporean tax holiday contractual agreements that the Company successfully completed. These milestones are not required to be met until December 21, 2020, at the earliest, which gives the Company sufficient time to make any necessary adjustments to its operating plans to achieve the milestones.

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Currently, the Company has determined that it is more likely than not to realize the contractual tax rate in Singapore of 0% and has not recognized an uncertain tax benefit in its balance sheet related to the achievement of the contractual milestones in Singapore. However, these milestones can be significantly influenced by the business climate in Singapore and the Company’s overall financial performance and, in the event that the Company determines that the milestone targets are not expected to be met, the Company would no longer be able to record a tax benefit at a 0% contractual tax rate on income earned in Singapore from and after the April 1, 2016 start date of the contract period. At such time, the Company would record an income tax charge on the affected Singapore income earned back to April 1, 2016 at the Singapore statutory tax rate(s) (currently 17%), with a corresponding income tax liability recorded on the balance sheet. For the year ended 2016, 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 and net income per diluted share by $23 million and $0.29, respectively.

Warranty

Product warranties are recorded at the time revenue is recognized for certain product shipments. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s previous estimates, revisions to the estimated warranty liability would be required. At December 31, 2016, the Company’s warranty liability was $13 million.

Litigation

As described in Item 3, Legal Proceedings, of Part I of this Form 10-K, the Company is a party to various pending litigation matters. With respect to each pending claim, management determines whether it can reasonably estimate whether a loss is probable and, if so, the probable range of that loss. If and when management has determined, with respect to a particular claim, both that a loss is probable and that it can reasonably estimate the range of that loss, the Company records a charge equal to either its best estimate of that loss or the lowest amount in that probable range of loss. The Company will disclose additional exposures when the range of loss is subject to considerable uncertainty.

Pension and Other Retirement Benefits

Assumptions used in determining projected benefit obligations and the fair values of plan assets for the Company’s pension plans and other retirement benefits are evaluated periodically by management. Changes in assumptions are based on relevant Company data. Critical assumptions, such as the discount rate used to measure the benefit obligations and the expected long-term rate of return on plan assets, are evaluated and updated annually. The Company has assumed that the weighted-average expected long-term rate of return on plan assets will be 6.47% for its U.S. benefit plans and 2.74% for its non-U.S. benefit plans.

At the end of each year, the Company determines the discount rate that reflects the current rate at which the pension liabilities could be effectively settled. The Company utilized Milliman’s Bond Matching model to determine the discount rate for its U.S. benefit plans. The Company determined the discount rate for its non-U.S. benefit plans based on the analysis of the Mercer Pension Discount Curve for high quality investments as of December 31, 2016 that best matched the timing of the plan’s future cash flows for the period to maturity of the pension benefits. Once the interest rates were determined, the plan’s cash flow was discounted at the spot interest rate back to the measurement date. At December 31, 2016, the Company determined the weighted-average discount rate to be 4.41% for the U.S. benefit plans and 1.71% for the non-U.S. benefits plans.

A one-quarter percentage point increase in the assumed long-term rate of return would decrease the Company’s net periodic benefit cost for the Waters Retirement Plan by less than $1 million. A one-quarter percentage point increase in the discount rate would decrease the Company’s net periodic benefit cost for the Waters Retirement Plan by less than $1 million.

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Stock-based Compensation

The accounting standards for stock-based compensation require that all share-based payments to employees be recognized in the statements of operations based on their fair values. The Company has used the Black-Scholes option pricing model and Monte Carlo simulation model to determine the fair value of its stock option awards and performance stock unit awards, respectively. Under the fair-value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating stock price volatility and employee stock option exercise behaviors. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest, the amount of the expense has been reduced for estimated forfeitures. These accounting standards require forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If factors change and the Company employs different assumptions in the application of these accounting standards, the compensation expense that the Company records in future periods may differ significantly from what the Company has recorded in the current period. The Company recognizes the expense using the straight-line attribution method.

As of December 31, 2016, unrecognized compensation costs and related weighted-average lives over which the costs will be amortized were as follows (in millions):

		Unrecognized Compensation Costs				Weighted-Average Life in Years
Stock options		$	45				3.6
Restricted stock units			38				3.0
Performance stock units			4				3.0
Restricted stock			—				—
Total		$	87				3.3

Business Combinations and Asset Acquisitions

The Company accounts for business acquisitions under the accounting standards for business combinations. The results of each acquisition are included in the Company’s consolidated results as of the acquisition date and the purchase price of an acquisition is allocated to tangible and intangible assets and assumed liabilities based on their estimated fair values. Any excess of the fair value consideration transferred over the estimated fair values of the net assets acquired is recognized as goodwill. Acquired in-process research and development (“IPR&D”) included in a business combination is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred and acquired IPR&D is tested for impairment annually until completion of the acquired programs. Upon commercialization, this indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life, subject to periodic impairment reviews. If the research and development project is abandoned, the indefinite-lived asset is charged to expense. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred.

The Company also acquires intellectual property through licensing arrangements. These arrangements often require upfront payments and may include additional milestone or royalty payments, contingent upon certain future events. IPR&D acquired in an asset acquisition (as opposed to a business combination) is expensed immediately unless there is an alternative future use. Subsequent payments made for the achievement of milestones are evaluated to determine whether they have an alternative future use or should be expensed. Payments made to third parties subsequent to commercialization are capitalized and amortized over the remaining useful life of the related asset, and are classified as intangible assets.

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Contingent Consideration

In addition to the initial cash consideration paid to acquire Medimass, the Company is obligated to make additional earnout payments based on a royalty due on future sales of products containing the REIMS technology. In accordance with the accounting standards for business combinations, the Company determines the fair value of the liability for contingent consideration at each reporting date using a probability-weighted discounted cash flow model. 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 estimated future results and a discount rate reflective of 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, total future undiscounted contingent consideration payments were estimated to be $3 million as of December 31, 2016, based on the Company’s best estimate, as the earnout is based on future sales of certain products through 2034.

Recent Accounting Standard Changes and Developments

Information regarding recent accounting standard changes and developments is incorporated by reference from Part II, Item 8, Financial Statements and Supplementary Data, of this document and should be considered an integral part of this Item 7. See Note 2 in the Notes to the Consolidated Financial Statements for recently adopted and issued accounting standards.