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} | https://cdla.io/permissive-1-0/ | [] | overall_image/7188edf47d42fe59582bdb90f34e022c49eaa6177cbe173c700c72c73579e86f.png | ## Accounts Receivable
## NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
## EARTHSTONE ENERGY, INC.
Accounts receivable include estimated amounts due from crude oil, natural gas, and natural gas liquids purchasers, other operators for which the Company holds an interest, and from non-operating working interest owners. Accrued crude oil, natural gas, and natural gas liquids sales from purchasers and operators consist of accrued revenues due under normal trade terms, generally requiring payment within 60 days of production. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover any non- payment of joint interest billings.
An allowance for doubtful accounts is established based on reviews of individual customer accounts, recent loss experience, current economic conditions, and other pertinent factors. Accounts deemed uncollectible are charged to the allowance.
Provisions for bad debts and recoveries on accounts previously charged off are added to the allowance. The Company routinely assesses the recoverability of all material trade receivables and other receivables to determine their collectability. Allowance for uncollectible accounts receivable was $0.1 million and $0.1 million at December 31, 2019 and 2018, respectively.
## Derivative Instruments
The Company utilizes derivative instruments in order to manage exposure to commodity price risk associated with future oil and natural gas production. The Company recognizes all derivatives as either assets or liabilities, measured at fair value, and recognizes changes in the fair value of derivatives in current earnings. The Company has elected to not designate any of its positions under the hedge accounting rules. Accordingly, these derivative contracts are mark-to-market and any changes in the estimated values of derivative contracts held at the balance sheet date are recognized in (Loss) gain on derivative contracts, net in the Consolidated Statements of Operations as unrealized gains or losses on derivative contracts. Realized gains or losses on derivative contracts are also recognized in (Loss) gain on derivative contracts, net in the Consolidated Statements of Operations.
## Oil and Natural Gas Properties
The method of accounting for oil and natural gas properties determines what costs are capitalized and how these costs are ultimately matched with revenues and expenses. The Company uses the successful efforts method of accounting for oil and natural gas properties. For more information see Note 7. Oil and Natural Gas Properties .
## Goodwill
Goodwill represents the excess of the purchase price of assets acquired over the fair value of those assets and is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. Such test includes an assessment of qualitative and quantitative factors. There were no impairments to Goodwill recorded in the years ended December 31, 2019 and 2018, respectfully. For further discussion, see Note 8. Goodwill .
## Noncontrolling Interest
Noncontrolling Interest represents third-party equity ownership of EEH and is presented as a component of equity in the Consolidated Balance Sheet as of December 31, 2019 and 2018, as well as an adjustment to Net income in the Consolidated Statement of Operations for the years ended December 31, 2019 and 2018. As of December 31, 2019, Earthstone and Lynden US owned a 45.5% membership interest in EEH while Bold Energy Holdings, LLC (“Bold Holdings”), the noncontrolling third party, owned the remaining 54.5%. See further discussion in Note 9. Noncontrolling Interest .
## Segment Reporting
Operating segments are components of an enterprise that (i) engage in activities from which it may earn revenues and incur expenses (ii) for which separate operational financial information is available and is regularly evaluated by the chief operating decision maker for the purpose of allocating resources and assessing performance.
Based on the Company’s organization and management, it has only one reportable operating segment, which is oil and natural gas exploration and production.
## Comprehensive Income
The Company has no elements of comprehensive income other than net income.
## Asset Retirement Obligations
Asset retirement obligations associated with the retirement of long-lived assets are recognized as liabilities with an increase to the carrying amounts of the related long-lived assets in the period incurred. The cost of the asset, including the asset retirement cost, is depreciated over the useful life of the asset. Asset retirement obligations are recorded at estimated fair value, measured by
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## Contract Balances
Under the Company’s product sales contracts, the Company invoices customers once performance obligations have been satisfied, at which point payment is unconditional. Accordingly, the Company’s product sales contracts do not give rise to contract assets or liabilities under ASC 606.
## Transaction Price Allocated to Remaining Performance Obligations
Substantially all of the Company’s product sales are short-term in nature, with a contract term of one year or less. For these contracts, the Company has utilized the practical expedient in ASC 606 which exempts the Company from the requirements to disclose the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.
For the Company’s product sales that have a contract term greater than one year, the Company has utilized the practical expedient in ASC 606 which states the Company is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Under these contracts, each unit of product generally represents a separate performance obligation; therefore, future volumes are wholly unsatisfied, and disclosure of the transaction price allocated to remaining performance obligations is not required.
## Prior-Period Performance Obligations
The Company records revenue in the month that product is delivered to the purchaser. Settlement statements for certain natural gas and NGLs sales, however, may not be received for 30 to 90 days after the date the product is delivered, and as a result the Company is required to estimate the amount of product delivered to the purchaser and the price that will be received for the sale of the product. In these situations, the Company records the differences between its estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. Any identified differences between the Company’s revenue estimates and actual revenue received have historically been insignificant. For the years ended December 31, 2019 and 2018, revenue recognized in the reporting period related to performance obligations satisfied in prior reporting periods was not material.
## Concentration of Credit Risk
Credit risk represents the actual or perceived financial loss that the Company would record if its purchasers, operators, or counterparties failed to perform pursuant to contractual terms.
The purchasers of the Company’s oil, natural gas, and natural gas liquids production consist primarily of independent marketers, major oil and natural gas companies and natural gas pipeline companies. Historically, the Company has not experienced any significant losses from uncollectible accounts. In 2019, three purchasers accounted for 30%, 14% and 12%, respectively, of the Company’s oil, natural gas, and natural gas liquids revenues. In 2018, three purchasers accounted for 27%, 11% and 10%, respectively, of the Company’s oil, natural gas, and natural gas liquids revenues. No other purchaser accounted for 10% or more of the Company’s oil, natural gas, and natural gas liquids revenues during 2019 and 2018. Additionally, at December 31, 2019, three purchasers accounted for 46%, 14% and 10%, respectively, of the Company’s oil, natural gas and natural gas liquids receivables. At December 31, 2018, five purchasers accounted for 22%, 17%, 13%, 11% and 11% respectively, of the Company’s oil, natural gas, and natural gas liquids receivables. No other purchaser accounted for 10% or more of the Company’s oil, natural gas, and natural gas liquids receivables at December 31, 2019 and 2018.
The Company holds working interests in oil and natural gas properties for which a third party serves as operator. The operator sells the oil, natural gas, and NGLs to the purchaser, collects the cash, and distributes the cash to the Company. In 2019 and 2018, no operator distributed 10% or more of the Company’s oil, natural gas and natural gas liquids revenues.
The derivative instruments of the Company are with a small number of counterparties and, from time-to-time, may represent material assets in the Consolidated Balance Sheets. At December 31, 2019, the Company had a net derivative asset position of $2.7 million. At December 31, 2018, the Company had $62.6 million of derivative contracts that were in a material asset position.
The Company regularly maintains its cash in bank deposit accounts. Balances held by the Company at its banks typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to the amounts of deposit in excess of FDIC insurance coverage.
## Stock-Based Compensation
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] | overall_image/a76c7d8da52f08ef6d6f791b6c110dff6b4713ad5feac3e931973916a8db8e74.png | ## EARTHSTONE ENERGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Level 3 – Prices or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable. Valuation under Level 3 generally involves a significant degree of judgment from management.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the year ended December 31, 2019.
## Fair Value on a Recurring Basis
Derivative financial instruments are carried at fair value and measured on a recurring basis. The derivative financial instruments consist of swaps for crude oil and natural gas. The Company’s swaps are valued based on a discounted future cash flow model. The primary input for the model is published forward commodity price curves. The swaps are also designated as Level 2 within the valuation hierarchy.
The fair values of commodity derivative instruments in an asset position include a measure of counterparty nonperformance risk, and the fair values of commodity derivative instruments in a liability position include a measure of the Company’s nonperformance risk. These measurements were not material to the Consolidated Financial Statements.
The following table summarizes the fair value of the Company’s financial assets and liabilities, by level within the fair-value hierarchy (in thousands) :
<img src='content_image/1022074.jpg'>
Other financial instruments include cash, accounts receivable and payable, and revenue royalties. The carrying amount of these instruments approximates fair value because of their short-term nature. The Company’s long-term debt obligation bears interest at floating market rates, therefore carrying amounts and fair value are approximately equal.
## Fair Value on a Nonrecurring Basis
The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including oil and gas properties and goodwill. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances.
## Proved Oil and Natural Gas Properties
Proved oil and natural gas properties are reviewed for impairment on a nonrecurring basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/783a8369e993fb570c9034df39d7344d020d25fa73a8a3e3777486582a7853e2.png | • pursuing value-accretive acquisition and corporate merger opportunities, which could increase the scale of our operations;
• maximizing operating margins and corporate level cash flows by minimizing operating and overhead costs;
• expanding our acreage positions and drilling inventory in our primary areas of interest through acquisitions and farm-in opportunities, with an emphasis on operated positions;
• blocking up acreage to allow for longer horizontal lateral drilling locations which provide higher economic returns; and
• maintaining a strong balance sheet and financial flexibility.
## Our Strengths
We believe that the following strengths are beneficial in achieving our business goals:
• extensive horizontal development potential in one of the most oil rich basins of the United States;
• experienced management team with substantial technical and operational expertise;
• ability to attract technical personnel with experience in our core area of operations;
• history of successful acquisition and merger transactions;
• operating control over the majority of our production and development activities;
• conservative balance sheet; and
• commitment to cost efficient operations.
## 2019 Highlights
In addition to our drilling program described above, the following are additional highlights of our 2019 activities compared to activity in 2018:
• Full year 2019 average daily sales volumes of 13,429 Boepd exceeded our production goals and increased 35%
• Increased drilling efficiencies by drilling multi-well pads and longer lateral length wells averaging 10,700 feet in the Midland Basin
• Improved frac efficiency from 8 to 12 stages per day
• Reduced total drilling and completion costs by approximately 16%
• Increased Proved Developed reserves by 33%
• Increased Adjusted EBITDAX by 51% (reconciled in “Non-GAAP Measures” below)
• Improved our operating margins by 10%
• Realized $15.9 million from our hedge positions thereby mitigating commodity price volatility
• Strong balance sheet and liquidity position with $155 million of undrawn capacity on a $325 million senior secured revolving credit facility and a cash balance of $13.8 million as of December 31, 2019
## Recent Developments
## Sharp Decline in Oil Prices
Subsequent to December 31, 2019, oil prices have declined sharply in response to drastic price cutting and increased production by Saudi Arabia coupled with reduced demand caused by the global coronavirus outbreak. Prior to the recent decline in oil prices, we announced our 2020 capital budget of $160-170 million which assumed a one-rig operated program in the Midland Basin as well as non-operated activity currently in progress, which was expected to result in bringing 19 gross / 16.2 net operated wells and 3.1 net non-operated wells online in 2020. Due to the recent oil price volatility, we are currently evaluating our 2020 capital program.
## New Credit Agreement
On November 21, 2019, we entered into a new credit agreement with respect to our senior secured revolving credit facility (the “Credit Agreement”). The Credit Agreement has a maturity date of November 21, 2024 with a maximum credit amount of $1.5
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] | overall_image/4040628d92363ed1fa1e2a9b4f3b76e4482b8213584613c4b0f6dda560f1c798.png | The table below summarizes unvested RSU activity for the year ended December 31, 2019:
<img src='content_image/1028475.jpg'>
During the year ended December 31, 2019, Earthstone granted 1,005,350 RSUs to employees and 73,800 RSUs to certain members of the Board with vesting periods ranging from 12 to 36 months. The total grant date fair value of the RSUs granted during the years ended December 31, 2019 and 2018 were $6.5 million and $4.8 million, respectively, with a weighted average grant date fair value per share of $6.04 and $8.41, respectively. The total vesting date fair value of the RSUs that vested during 2019 and 2018 was $4.2 million and $6.2 million, respectively. As of December 31, 2019, there was approximately $6.8 million of total unrecognized stock-based compensation expense related to unvested RSUs, which will be amortized over the remaining vesting periods. The weighted average remaining vesting period of the unrecognized compensation expense is 1.03 years.
For the years ended December 31, 2019 and 2018, stock-based compensation related to RSUs was $5.9 million and $6.1 million, respectively.
Performance Units
The table below summarizes performance unit (“PSU”) activity for the year ended December 31, 2019:
<img src='content_image/1028476.jpg'>
On January 28, 2019, the Board of Directors of Earthstone (the “Board”) granted 669,550 PSUs to certain executive officers pursuant to the 2014 Plan. The PSUs are payable in shares of Class A Common Stock based upon the achievement by the Company over a period commencing on February 1, 2019 and ending on January 31, 2022 (the “Performance Period”) of performance criteria established by the Board.
The number of shares of Class A Common Stock that may be issued will be determined by multiplying the number of PSUs granted by the Relative Total Shareholder Return (“TSR”) Percentage (0% to 200%). The “Relative TSR Percentage” is the percentage, if any, achieved by attainment of a certain predetermined range of targets for the Performance Period.
TSR for the Company and each of the peer companies is generally determined by dividing (A) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the last calendar day of the Performance Period minus the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period plus cash dividends paid over the Performance Period by (B) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period.
The Company accounts for these awards as market-based awards which are valued utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes grant date fair value based on the most likely outcome. For the PSUs granted on January 28, 2019, assuming a risk-free rate of 2.6% and volatilities ranging from 40.1% to 114.1%, the Company calculated the weighted average grant date fair value per PSU to be $9.30.
As of December 31, 2019, there was $5.1 million of unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of 0.97 years.
For the years ended December 31, 2019 and 2018, stock-based compensation related to the PSUs was approximately $2.7 million and $1.0 million, respectively.
## Note 13. Long-Term Debt
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] | overall_image/cb853512ab58a760549755482cdf29f83132e0e4dba1df3350cb7f937674d5c4.png | ## EARTHSTONE ENERGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company capitalized $1.6 million and $0.5 million, respectively, of costs associated with the credit agreements for the years ended December 31, 2019 and 2018. These capitalized costs are included in Other noncurrent assets in the Consolidated Balance Sheets. The Company’s policy is to capitalize the financing costs associated with its debt and amortize those costs on a straight-line basis over the term of the associated debt, which approximates the effective interest method over the term of the related debt.
## Note 14. Asset Retirement Obligations
The Company has asset retirement obligations associated with the future plugging and abandonment of oil and natural gas properties and related facilities. Revisions to the liability typically occur due to changes in the estimated abandonment costs, well economic lives, and the discount rate.
The following table summarizes the Company’s asset retirement obligation transactions recorded during the years ended December 31, 2019 and 2018 (in thousands) :
<img src='content_image/1028779.jpg'>
(1) See Note 3. Acquisitions and Divestitures for additional information on the Company’s acquisition and property disposition activities.
## Note 15. Related Party Transactions
FASB ASC Topic 850 , Related Party Disclosures , requires that information about transactions with related parties that would make a difference in decision making shall be disclosed so that users of the financial statements can evaluate their significance.
Flatonia Energy, LLC (“Flatonia”), which owns approximately 7% of the outstanding Class A Common Stock and approximately 3.2% of the combined voting power of the Company’s outstanding Class A and Class B Common Stock as of December 31, 2019, is a party to a joint operating agreement (the “Operating Agreement”) with the Company. The Operating Agreement covers certain jointly owned oil and natural gas properties located in the Eagle Ford Trend of south Texas. In connection with the Operating Agreement, the Company made payments to Flatonia of $15.3 million and $12.4 million, and received payments from Flatonia of $6.4 million and $6.1 million, respectively, for the years ended December 31, 2019 and 2018. At December 31, 2019 and 2018, amounts receivable due from Flatonia in connection with the Operating Agreement were $0.6 million and $0.8 million, respectively. Payables related to revenues outstanding and due to Flatonia as of December 31, 2019 and 2018 were $1.1 million and $1.6 million, respectively.
Earthstone’s majority shareholder consists of various investment funds managed by a venture capital firm who may manage other investments in entities with which the Company interacts in the normal course of business. On October 31, 2019, the Company sold certain of its interests in oil and natural gas leases and wells located in Martin County, Texas in an arm’s length transaction to a portfolio company of Earthstone’s majority shareholder (not under common control) for cash consideration of approximately $3.6 million. In connection with Olenik v. Lodzinski et al. (described below), Earthstone’s majority shareholder was also named in the lawsuit. The Company is currently in negotiations with its insurance carrier around an allocation of litigation costs above its deductible for all the parties named in the lawsuit. Once the allocation is agreed upon, cost will be assigned to each party affected. As of December 31, 2019, the Company has not recorded a receivable for prospective insurance settlement proceeds. Charges associated with this legal action are included in Transaction costs in the Consolidated Statements of Operations. Any proceeds received from the Company’s insurance carrier will be recorded as a reduction of Transactions costs in the period received.
## Note 16. Commitments and Contingencies
## Contractual Commitments
Future minimum contractual commitments as of December 31, 2019 under non-cancelable agreements having initial or remaining terms in excess of one year are as follows:
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] | overall_image/91319e82d34aa7232a8f3539ada073a93e65ef10e3c7000165bc8f53444a1627.png | ## EARTHSTONE ENERGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
by a $0.5 million discrete income tax benefit related to refundable AMT tax credits resulting from the TCJA, (2) deferred income tax expense for Earthstone of $7.4 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $1.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the year ended December 31, 2018.
## Deferred Tax Assets and Liabilities
The Company’s deferred tax position reflects the net tax effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting. Significant components of the deferred tax assets and liabilities at December 31, 2019 and 2018 are as follows ( in thousands ):
<img src='content_image/1036515.jpg'>
As of December 31, 2019, the Company had a valuation allowance recorded against its deferred tax assets of $16.5 million which is in excess of its net deferred noncurrent tax assets of $1.3 million, as presented above. The Company’s corporate organizational structure requires the filing of two separate consolidated U.S. Federal corporate income tax returns, one separate U.S. Federal partnership income tax return and one Canadian income tax return. As a result, tax attributes of one group cannot be offset by the tax attributes of another. At December 31, 2019, the deferred tax assets and liabilities related to the two U.S. Federal corporate income tax returns, one Canadian income tax return and one related to the Texas Margin Tax are a $12.7 million deferred tax asset, a $9.7 million deferred tax liability, a $3.8 million deferred tax asset and a $5.5 million deferred tax liability, respectively, before considering the valuation allowance of $16.5 million.
As of December 31, 2018, the Company had a valuation allowance recorded against its deferred tax assets of $16.9 million which is in excess of its Net deferred noncurrent tax assets of $3.4 million, as presented above. The Company’s corporate organizational structure requires the filing of two separate consolidated U.S. Federal income tax returns, one separate U.S. Federal partnership income tax return and one Canadian income tax return. As a result, tax attributes of one group cannot be offset by the tax attributes of another. At December 31, 2018, the deferred tax assets and liabilities related to the two U.S. Federal income tax returns, one Canadian income tax and one related to the Texas Margin Tax were a $13.1 million deferred tax asset, a $9.6 million deferred tax liability, a $3.8 million deferred tax asset and a $3.9 million deferred tax liability, respectively, before considering the valuation allowance of $16.9 million.
As of December 31, 2019, the Company had estimated U.S. net operating loss carryforwards of $56.5 million, the first expiring in 2034 and the last in 2039, and estimated Canadian net operating loss carryforwards of $10.0 million, the first expiring in 2024 and the last in 2037. The ability to utilize net operating losses and other tax attributes could be subject to a significant limitation if the Company were to undergo an ownership change for the purposes of Section 382 (“Sec 382”) of the Internal Revenue Code of 1986, as amended (the “Code”). The Company has an additional estimated U.S. net operating loss carryforward of $28.2 million limited by Sec 382 resulting from the Lynden Arrangement. The Company continues to evaluate the impact, if any, of potential Sec 382 limitations.
The Company’s tax returns are subject to periodic audits by the various jurisdictions in which the Company operates. These audits can result in adjustments of taxes due or adjustments of the NOL carryforwards that are available to offset future taxable income. Generally, the Company’s income tax years 2013 through 2018 remain open and subject to examination by the Internal Revenue Service or state tax jurisdictions where it conducts operations. In certain jurisdictions, the Company operates through more than one legal entity, each of which may have different open years subject to examination.
## Uncertain Tax Positions
FASB ASC Topic 740, Income Taxes (“ASC 740”) prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of income tax positions taken or expected to be taken in an income tax return. For those
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] | overall_image/5db1dc7dda74940f39ab2edc78dc60546af26e8ccd75a80f46a3bc98489ba223.png | Minimum contractual obligations for the Company’s leases (undiscounted) as of December 31, 2019 were as follows (in thousands) :
<img src='content_image/1051154.jpg'>
Cash payments for the Company’s operating and finance leases for the year ended December 31, 2019 were $0.8 million and $0.4 million, respectively. For the year ended December 31, 2019, there were $3.2 million of right-of-use assets obtained in exchange for lease obligations for operating leases. The amounts related to the Company’s finance leases were not material to the consolidated financial statements.
As of December 31, 2019, the weighted average remaining lease terms of the Company’s operating and finance leases were 4.8 years and 1.4 years, respectively. The weighted average discount rates used to determine the lease liabilities as of December 31, 2019 for the Company’s operating and finance leases were 4.35% and 6.75%, respectively. The discount rate used for operating leases is based on the Company’s incremental borrowing rate. The discount rate used for finance leases is based on the rates implicit in the leases.
As of December 31, 2018, minimum future contractual payments for long-term leases under ASC 840 were as follows (in thousands) :
<img src='content_image/1051155.jpg'>
## Note 20. Supplemental Information On Oil And Gas Exploration And Production Activities (Unaudited)
## Costs Incurred Related to Oil and Gas Activities
Capitalized costs include the cost of properties, equipment, and facilities for oil and natural gas producing activities. Capitalized costs for proved properties include costs for oil and natural gas leaseholds where proved reserves have been identified, development wells, and related equipment and facilities, including development wells in progress. Capitalized costs for unproved properties include costs for acquiring oil and natural gas leaseholds where no proved reserves have been identified, including costs of exploratory wells that are in the process of drilling or in active completion, and costs of exploratory wells suspended or waiting on completion.
The Company’s oil and natural gas activities for 2019 and 2018 were entirely within the United States of America. Costs incurred in oil and natural gas producing activities were as follows ( in thousands ):
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(1) Acquisition costs incurred during 2019 consisted primarily of purchase price adjustments related to 2018 acquisitions and during 2018 consisted primarily of an acreage trade in the Midland Basin.
During the years ended December 31, 2019 and 2018, additions to oil and natural gas properties of $0.1 million and $0.3 million, respectively, were recorded for estimated costs of future abandonment related to new wells drilled or acquired.
During the years ended December 31, 2019 and 2018, the Company had no capitalized exploratory well costs, nor costs related to share-based compensation, general corporate overhead or similar activities.
## Capitalized Costs
Capitalized costs, impairment, and depreciation, depletion and amortization relating to the Company’s oil and natural gas properties producing activities, all of which are conducted within the continental United States as of December 31, 2019 and 2018, are summarized below ( in thousands ):
<img src='content_image/1023835.jpg'>
## Oil and Natural Gas Reserves
Users of this information should be aware that the process of estimating quantities of “proved” and “proved developed” oil and natural gas reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. As a result, revisions to existing reserve estimates may occur from time to time. Although every reasonable effort is made to ensure reserve estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various reservoirs make these estimates generally less precise than other estimates included in the financial statement disclosures.
Proved reserves represent estimated quantities of oil, natural gas and natural gas liquids that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions in effect when the estimates were made. Proved developed reserves represent estimated quantities expected to be recovered through wells and equipment in place and under operating methods used when the estimates were made.
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] | overall_image/8873d20e6f063aff2099aac5eecfbf74797285066c4a9bf3f548f17255d3e990.png | table may not represent realistic assessments of future cash flows, nor should the Standardized Measure be viewed as representative of the current value of the Company.
The Company believes that the following factors should be taken into account when reviewing the following information:
• Future costs and commodity prices will probably differ from those required to be used in these calculations;
• Due to future market conditions and governmental regulations, actual rates of production in future years may vary significantly from the rate of production assumed in the calculations;
• A 10% discount rate may not be reasonable as a measure of the relative risk inherent in realizing future net oil and natural gas revenues; and
• Future net revenues may be subject to different rates of income taxation.
At December 31, 2019 and 2018, as specified by the SEC, the prices for oil and natural gas used in this calculation were the unweighted 12-month average of the first day of the month prices, except for volumes subject to fixed price contracts. Prices used to estimate reserves are included in Oil and Natural Gas Reserves above. Future production costs include per-well overhead expenses allowed under joint operating agreements, abandonment costs (net of salvage value), and a non-cancelable fixed cost agreement to reserve pipeline capacity of 10,000 MMBtu per day for gathering and processing. Estimates of future income taxes are computed using current statutory income tax rates including consideration for estimated future statutory depletion and tax credits. The resulting net cash flows are reduced to present value amounts by applying a 10% discount factor.
The Standardized Measure is as follows ( in thousands ):
<img src='content_image/1033794.jpg'>
(1) At December 31, 2019 and 2018, the portion of the standardized measure of discounted future net cash flows attributable to noncontrolling interests was $430.4 million and $530.2 million, respectively.
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/c2f329de3869981896fd4c295687ccba281c2f06879876bed891771fa20a20ba.png | insurance could have a material effect on our operating results, financial position and cash flows. For further discussion of these risks see Item 1A. Risk Factors of this report.
## Marketing and Customers
We market the majority of the production from properties we operate for both our account and the account of the other working interest owners in these properties. We sell our production to purchasers at market prices.
We normally sell production to a relatively small number of customers, as is customary in the exploration, development and production business. For the year ended December 31, 2020, three purchasers accounted for 32%, 15% and 12%, respectively, of our revenue during the period. For the year ended December 31, 2019, three purchasers accounted for 30%, 14% and 12%, respectively, of our revenue during the period. No other customer accounted for more than 10% of our revenue during these periods. If a major customer stopped purchasing oil and natural gas from us, revenue could decline and our operating results and financial condition could be harmed. However, we believe that the loss of any one or all of our major purchasers would not have a materially adverse effect on our financial condition or results of operations, as crude oil and natural gas are fungible products with well-established markets and numerous purchasers.
## Transportation
During the planning stage of our prospective and productive units and acreage, we consider required flow-lines, gathering and delivery infrastructure. Our oil is transported from the wellhead to our tank batteries or delivery points through our flow-lines or gathering systems. Purchasers of our oil take delivery at (i) our tank batteries and transport the oil by truck, or (ii) at a pipeline delivery point. Our natural gas is transported from the wellhead to the purchaser’s meter and pipeline interconnection point through our gathering systems. We have implemented a Leak Detection and Repair program, or LDAR, to locate and repair leaking components including valves, pumps and connectors in order to minimize the emission of fugitive volatile organic compounds and hazardous air pollutants. In addition, we install vapor recovery units in our newer tank batteries which also reduces emissions.
We are party to a buy/sell arrangement for a certain portion of our oil production that effects a change in location with required repurchase of oil at a delivery point. This activity is recorded on a net basis and the residual transportation fee is included in Lease operating expenses in the Consolidated Statements of Operations. Arrangements such as this not only reduce our transportation costs by eliminating truck transportation but also provide additional flexibility in delivery points for our product. The decrease in transportation by truck also translates into reduced truck emissions.
Our produced salt water is generally moved by pipeline connected to our operated salt water disposal wells or by pipeline to commercial disposal facilities.
## Commodity Hedging
Consistent with our disciplined approach to financial management, we have an active commodity hedging program through which we seek to hedge a meaningful portion of our expected oil and gas production, reducing our exposure to downside commodity prices and enabling us to protect cash flows and maintain liquidity to fund our capital program.
## Competition
The domestic oil and natural gas industry is intensely competitive in the acquisition of acreage, production and oil and gas reserves and in producing, transporting and marketing activities. Our competitors include national oil companies, major oil and natural gas companies, independent oil and natural gas companies, drilling partnership programs, individual producers, natural gas marketers, and major pipeline companies, as well as participants in other industries supplying energy and fuel to consumers. Many of our competitors are large, well-established companies. They may be able to pay more for seismic information and lease rights on oil and natural gas properties and to define, evaluate, bid for and purchase a greater number of properties, than our financial or human resources permit. Our ability to acquire additional properties in the future, and our ability to fund the acquisition of such properties, will be dependent upon our ability to evaluate and select suitable properties and to consummate related transactions in a highly competitive environment.
There is also competition between oil and natural gas producers and other industries producing energy and fuel. Furthermore, competitive conditions may be substantially affected by various forms of energy legislation and/or regulation considered from time to time by the governments of the United States and the jurisdictions in which we operate. It is not possible to predict the nature of any such legislation or regulation which may ultimately be adopted or its effects upon our future operations. Such laws and regulations may substantially increase the costs of exploring for, developing or producing oil and natural gas and may prevent or delay the commencement or continuation of a given operation. Our larger competitors may be able to absorb the burden of existing and any changes to, federal, state and local laws and regulations more easily than we can, which would adversely affect our competitive position.
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• easements, restrictions, rights-of-way and other matters that commonly affect property.
To the extent that such burdens and obligations affect our rights to production revenues, they have been taken into account in calculating our net revenue interests and in estimating the quantity and value of our reserves. We believe that the burdens and obligations affecting our oil and natural gas properties are common in our industry with respect to the types of properties we own.
## Operational Regulations
All of the jurisdictions in which we own or operate producing oil and natural gas properties have statutory and regulatory provisions affecting drilling, completion, and production activities, including, but not limited to, provisions related to permits for the drilling of wells, bonding requirements to drill or operate wells, the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, sourcing and disposal of water used in the drilling and completion process, and the plugging and abandonment of wells. Our operations are also subject to various conservation laws and regulations. These laws and regulations govern the size of drilling and spacing units, the density of wells that may be drilled in oil and natural gas properties and the unitization or pooling of oil and natural gas properties. In this regard, while some states allow the forced pooling or integration of land and leases to facilitate development, other states including Texas, where we operate, rely primarily or exclusively on voluntary pooling of land and leases. Accordingly, it may be difficult for us to form spacing units and therefore difficult to develop a project if we own or control less than 100% of the leasehold. In addition, state conservation laws establish maximum rates of production from oil and natural gas wells, generally prohibit the venting or flaring of natural gas, and impose specified requirements regarding the ratability of production. On some occasions, local authorities have imposed moratoria or other restrictions on exploration, development and production activities pending investigations and studies addressing potential local impacts of these activities before allowing oil and natural gas exploration, development and production to proceed.
The effect of these regulations is to limit the amount of oil and natural gas that we can produce from our wells and to limit the number of wells or the locations at which we can drill, although we can apply for exceptions to such regulations or to have reductions in well spacing. Failure to comply with applicable laws and regulations can result in substantial penalties. The regulatory burden on the industry increases the cost of doing business and affects profitability. Moreover, each state generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and natural gas liquids within its jurisdiction.
## Regulation of Transportation of Natural Gas
The transportation and sale, or resale, of natural gas in interstate commerce are regulated by the Federal Energy Regulatory Commission (“FERC”) under the Natural Gas Act of 1938 (“NGA”), the Natural Gas Policy Act of 1978 (“NGPA”) and regulations issued under those statutes. FERC regulates interstate natural gas transportation rates and service conditions, which affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas.
Intrastate natural gas transportation is also subject to regulation by state regulatory agencies. The basis for intrastate regulation of natural gas transportation and the degree of regulatory oversight and scrutiny given to intrastate natural gas pipeline rates and services varies from state to state. Insofar as such regulation within a particular state will generally affect all intrastate natural gas shippers within the state on a comparable basis, we believe that the regulation of similarly situated intrastate natural gas transportation in any states in which we operate and ship natural gas on an intrastate basis will not affect our operations in any way that is of material difference from those of our competitors. Like the regulation of interstate transportation rates, the regulation of intrastate transportation rates affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas.
## Regulation of Sales of Oil, Natural Gas and Natural Gas Liquids
The prices at which we sell oil, natural gas and natural gas liquids are not currently subject to federal regulation and, for the most part, are not subject to state regulation. FERC, however, regulates interstate natural gas transportation rates, and terms and conditions of transportation service, which affects the marketing of the natural gas we produce, as well as the prices we receive for sales of our natural gas. Similarly, the price we receive from the sale of oil and natural gas liquids is affected by the cost of transporting those products to market. FERC regulates the transportation of oil and liquids on interstate pipelines under the provision of the Interstate Commerce Act, the Energy Policy Act of 1992 and regulations issued under those statutes. Intrastate transportation of oil, natural gas liquids, and other products, is dependent on pipelines whose rates, terms and conditions of service are subject to regulation by state regulatory bodies under state statutes. In addition, while sales by producers of natural gas and all sales of crude oil, condensate, and natural gas liquids can currently be made at uncontrolled market prices, Congress could reenact price controls in the future.
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In addition, on June 28, 2016, the EPA published a final rule prohibiting the discharge of wastewater from onshore unconventional oil and natural gas extraction facilities to publicly owned wastewater treatment plants. The EPA is also conducting a study of private wastewater treatment facilities (also known as centralized waste treatment (“CWT”) facilities) accepting oil and natural gas extraction wastewater. The EPA is collecting data and information related to the extent to which CWT facilities accept such wastewater, available treatment technologies (and their associated costs), discharge characteristics, financial characteristics of CWT facilities, and the environmental impacts of discharges from CWT facilities.
Furthermore, there are certain governmental reviews either underway or being proposed that focus on environmental aspects of hydraulic fracturing practices. On December 13, 2016, the EPA released a study examining the potential for hydraulic fracturing activities to impact drinking water resources, finding that, under some circumstances, the use of water in hydraulic fracturing activities can impact drinking water resources. Also, on February 6, 2015, the EPA released a report with findings and recommendations related to public concern about induced seismic activity from disposal wells. The report recommends strategies for managing and minimizing the potential for significant injection-induced seismic events. Other governmental agencies, including the U.S. Department of Energy, the U.S. Geological Survey, and the U.S. Government Accountability Office, have evaluated or are evaluating various other aspects of hydraulic fracturing. These ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing and could ultimately make it more difficult or costly for us to perform fracturing and increase our costs of compliance and doing business.
Several states, including Texas, have adopted or are considering adopting regulations that could restrict or prohibit hydraulic fracturing in certain circumstances, impose more stringent operating standards and/or require the disclosure of the composition of hydraulic fracturing fluids. For example, Texas law requires that the well operator disclose the list of chemical ingredients subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) for disclosure on a website and also file the list of chemicals with the RRC with the well completion report. The total volume of water used to hydraulically fracture a well must also be disclosed to the public and filed with the RRC. If new or more stringent state or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where we operate, we could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development or production activities, and perhaps even be precluded from drilling wells.
There has been increasing public controversy regarding hydraulic fracturing with regard to the use of fracturing fluids, induced seismic activity, impacts on drinking water supplies, use of water and the potential for impacts to surface water, groundwater and the environment generally. A number of lawsuits and enforcement actions have been initiated across the country implicating hydraulic fracturing practices. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations as well as make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process could adversely affect groundwater. In addition, if hydraulic fracturing is further regulated at the federal, state or local level, our fracturing activities could become subject to additional permitting and financial assurance requirements, more stringent construction specifications, increased monitoring, reporting and recordkeeping obligations, plugging and abandonment requirements and also to attendant permitting delays and potential increases in costs. Such legislative changes could cause us to incur substantial compliance costs, and compliance or the consequences of any failure to comply by us could have a material adverse effect on our financial condition and results of operations. At this time, it is not possible to estimate the impact on our business of newly enacted or potential federal, state or local laws governing hydraulic fracturing.
From time to time, legislation has been introduced, but not enacted, in the U.S. Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. On January 28, 2020, Senate Bill 3247 was introduced and if enacted as proposed, would ban hydraulic fracturing nationwide by 2025.
## Air Emissions
The federal Clean Air Act (“CAA”) and comparable state laws restrict emissions of various air pollutants through permitting programs and the imposition of other requirements. In addition, the EPA has developed and continues to develop stringent regulations governing emissions of toxic air pollutants at specified sources, including oil and natural gas production. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. Our operations, or the operations of service companies engaged by us, may in certain circumstances and locations be subject to permits and restrictions under these statutes for emissions of air pollutants.
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Certain statements contained in this report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in this report are forward-looking statements. These forward-looking statements can generally be identified by the use of words such as “may,” “will,” “could,” “should,” “project,” “intends,” “plans,” “pursue,” “target,” “continue,” “believes,” “anticipates,” “expects,” “estimates,” “guidance,” “predicts,” or “potential,” the negative of such terms or variations thereon, or other comparable terminology. Statements that describe our future plans, strategies, intentions, expectations, objectives, goals, potential acquisitions or mergers or prospects are also forward-looking statements. Actual results could differ materially from those anticipated in this filing or these forward-looking statements. Readers should consider carefully the risks described under the “Risk Factors” section of this report and other sections of this report which describe factors that could cause our actual results to differ from those anticipated in forward-looking statements, including, but not limited to, the following factors:
• continued volatility and weakness in commodity prices for oil, natural gas and natural gas liquids and the effect of prices set or influenced by action of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil and natural gas producing countries;
• the effect of existing and future laws, governmental regulations and the political and economic climates of the United States particularly with respect to climate change, alternative energy and similar topical movements;
• substantial changes in estimates of our proved reserves;
• substantial declines in the estimated values of our proved oil and natural gas reserves;
• our ability to replace our oil and natural gas reserves;
• impacts of world health events, including the coronavirus (“COVID-19”) pandemic;
• the risk of the actual presence or recoverability of oil and natural gas reserves and that future production rates will be less than estimated;
• the potential for production decline rates and associated production costs for our wells to be greater than we forecast;
• the timing and extent of our success in acquiring, discovering, developing and producing oil and natural gas reserves;
• the financial ability and willingness of our partners under our joint operating agreements to join in our plans for future exploration, development and production activities;
• our ability to acquire additional mineral leases;
• the cost and availability of high-quality equipment and services with fully trained and adequate personnel, such as contract drilling rigs and completion equipment on a timely basis and at reasonable prices;
• risks in connection with potential acquisitions and the integration of significant acquisitions or assets acquired through merger or otherwise;
• the possibility that acquisitions and divestitures may involve unexpected costs or delays, and that acquisitions may not achieve intended benefits;
• the possibility that potential divestitures may not occur or could be burdened with unforeseen costs;
• unanticipated reductions in the borrowing base under the credit agreement we are party to;
• risks incidental to the drilling and operation of oil and natural gas wells including mechanical failures;
• our dependence on the availability, use and disposal of water in our drilling, completion and production operations;
• the availability of sufficient pipeline and other transportation facilities to carry our production to market and the impact of these facilities on realized prices;
• significant competition for oil and natural gas acreage and acquisitions;
• our ability to retain key members of senior management and key technical and financial employees;
• changes in environmental laws and the regulation and enforcement related to those laws;
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The prices we receive for our oil, natural gas and natural gas liquids production heavily influence our revenues, profitability, access to capital and future rate of growth. These hydrocarbons are commodities, and therefore, their prices may be subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the market for oil, natural gas and natural gas liquids has been volatile. For example, during the period from January 1, 2014 through December 31, 2020, the WTI spot price for oil declined from a high of $107.95 per Bbl in June 2014 to -$36.98 per Bbl in April 2020. The Henry Hub spot price for natural gas has declined from a high of $8.15 per MMBtu in February 2014 to a low of $1.33 per MMBtu in September 2020. During 2020, WTI spot prices ranged from -$36.98 to $63.27 per Bbl and the Henry Hub spot price of natural gas ranged from $1.33 to $3.14 per MMBtu. Likewise, natural gas liquids, which are made up of ethane, propane, isobutane, normal butane and natural gasoline, each of which have different uses and different pricing characteristics, have experienced significant declines in realized prices since the fall of 2014. The prices we receive for oil, natural gas and natural gas liquids we produce and our production levels depend on numerous factors beyond our control, including:
• worldwide, regional and local economic and financial conditions impacting supply and demand;
• the level of global exploration, development and production;
• the level of global supplies, in particular due to supply growth from the United States;
• the price and quantity of oil, natural gas and NGLs imports to and exports from the U.S.;
• political conditions in or affecting other oil, natural gas and natural gas liquids producing countries and regions, including the current conflicts in the Middle East, Asia and Eastern Europe;
• actions of the OPEC and state-controlled oil companies relating to production and price controls;
• the extent to which U.S. shale producers become swing producers adding or subtracting to the world supply totals;
• future regulations prohibiting or restricting our ability to apply hydraulic fracturing to our wells;
• current and future regulations regarding well spacing;
• prevailing prices and pricing differentials on local oil, natural gas and natural gas liquids price indices in the areas in which we operate;
• localized and global supply and demand fundamentals and transportation, gathering and processing availability;
• weather conditions;
• technological advances affecting fuel economy, energy supply and energy consumption;
• the effect of energy conservation measures, alternative fuel requirements and increasing demand for alternatives to oil and natural gas;
• global or national health concerns, including health epidemics such as the COVID-19 pandemic at the beginning of 2020;
• the price and availability of alternative fuels; and
• domestic, local and foreign governmental regulation and taxes.
Lower oil, natural gas and natural gas liquids prices have and may continue to reduce our cash flows and borrowing capacity. We may be unable to obtain needed capital or financing on satisfactory terms, which could lead to a decline in our hydrocarbon reserves as existing reserves are depleted. A decrease in prices could render development projects and producing properties uneconomic, potentially resulting in a loss of mineral leases. Low commodity prices have, at times, caused significant downward adjustments to our estimated proved reserves, and may cause us to make further downward adjustments in the future. Furthermore, our borrowing capacity could be significantly affected by decreased prices. A sustained decline in oil, natural gas and natural gas liquids prices could adversely impact our borrowing base in future borrowing base redeterminations, which could trigger repayment obligations under the Credit Agreement to the extent our outstanding borrowings exceed the redetermined borrowing base and could otherwise materially and adversely affect our future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures. In addition, lower oil, natural gas and natural gas liquids gas prices may cause a decline in the market price of our shares.
As a result of low prices for oil, natural gas and natural gas liquids, we may be required to take significant future write-downs of the financial carrying values of our properties.
Accounting rules require that we periodically review the carrying value of our proved and unproved properties for possible impairment. Based on prevailing commodity prices and specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to significantly write-down the financial carrying value of our oil and natural gas properties, which constitutes a non-cash charge to earnings. We may incur impairment charges in the future, which could have a material adverse effect on our results of operations for the periods in which such charges are recorded.
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• legislative or regulatory changes, including retroactive royalty or production tax regimes, hydraulic-fracturing regulations, derivatives reform, and changes in federal and state income taxes;
• general economic conditions, whether internationally, nationally or in the regional and local market areas in which we conduct business, may be less favorable than expected, including the possibility that economic conditions in the United States could deteriorate and that capital markets for equity and debt could be disrupted or unavailable;
• social unrest, political instability or armed conflict in major oil and natural gas producing regions outside the United States and acts of terrorism or sabotage;
• our insurance coverage may not adequately cover all losses that may be sustained in connection with our business activities;
• other economic, competitive, governmental, regulatory, legislative, including federal, state and tribal regulations and laws, geopolitical and technological factors that may negatively impact our business, operations or oil and natural gas prices;
• the effect of our oil and natural gas derivative activities;
• title to the properties in which we have an interest may be impaired by title defects;
• our dependency on the skill, ability and decisions of third-party operators of oil and natural gas properties in which we have non- operated working interests; and
• possible adverse results from litigation and the use of financial resources to defend ourselves.
All forward-looking statements are expressly qualified in their entirety by the cautionary statements in this section and elsewhere in this report. Other than as required under the securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise. You should not place undue reliance on these forward- looking statements. All forward-looking statements speak only as of the date of this report or, if earlier, as of the date they were made.
For further information regarding these and other factors, risks and uncertainties affecting us, see Part I, Item 1A. Risk Factors of this report.
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From time to time, for example, legislation has been proposed in Congress to amend the SDWA to require federal permitting of hydraulic fracturing and the disclosure of chemicals used in the hydraulic fracturing process. Further, the EPA completed a study finding that hydraulic fracturing could potentially harm drinking water resources under adverse circumstances such as injection directly into groundwater or into production wells lacking mechanical integrity. Other governmental reviews have also been recently conducted or are under way that focus on environmental aspects of hydraulic fracturing. At this time, it is uncertain when, or if, the rules will be implemented, and what impact they would have on our operations. Further, legislation to amend the SDWA to repeal the exemption for hydraulic fracturing (except when diesel fuels are used) from the definition of “underground injection” and require federal permitting and regulatory control of hydraulic fracturing, as well as legislative proposals to require disclosure of the chemical constituents of the fluids used in the fracturing process, have been proposed in recent sessions of Congress. Several states and local jurisdictions in which we operate also have adopted or are considering adopting regulations that could restrict or prohibit hydraulic fracturing in certain circumstances, impose more stringent operating standards and/or require the disclosure of the composition of hydraulic fracturing fluids.
More recently, federal and state governments have begun investigating whether the disposal of produced water into underground injection wells has caused increased seismic activity in certain areas. For example, in December 2016, the EPA released its final report regarding the potential impacts of hydraulic fracturing on drinking water resources, concluding that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources under certain circumstances such as water withdrawals for fracturing in times or areas of low water availability, surface spills during the management of fracturing fluids, chemicals or produced water, injection of fracturing fluids into wells with inadequate mechanical integrity, injection of fracturing fluids directly into groundwater resources, discharge of inadequately treated fracturing wastewater to surface waters, and disposal or storage of fracturing wastewater in unlined pits. The results of these studies could lead federal and state governments and agencies to develop and implement additional regulations. In addition, on June 28, 2016, the EPA published a final rule prohibiting the discharge of wastewater from onshore unconventional oil and natural gas extraction facilities to publicly owned wastewater treatment plants. The EPA is also conducting a study of private wastewater treatment facilities (also known as centralized waste treatment (“CWT”) facilities) accepting oil and natural gas extraction wastewater. The EPA is collecting data and information related to the extent to which CWT facilities accept such wastewater, available treatment technologies (and their associated costs), discharge characteristics, financial characteristics of CWT facilities, and the environmental impacts of discharges from CWT facilities.
The proliferation of regulations may limit our ability to operate. If the use of hydraulic fracturing is limited, prohibited or subjected to further regulation, these requirements could delay or effectively prevent the extraction of oil and natural gas from formations which would not be economically viable without the use of hydraulic fracturing. This could have a material adverse effect on our business, financial condition, results of operations and cash flows.
## Extreme weather conditions could adversely affect our ability to conduct drilling, completion and production activities in the areas where we operate.
Our exploitation and development activities and equipment could be adversely affected by extreme weather conditions, such as hurricanes or freezing temperatures, which may cause a loss of production from temporary cessation of activity from regional power outages or lost or damaged facilities and equipment. Such extreme weather conditions could also impact access to our drilling and production facilities for routine operations, maintenance and repairs and the availability of and our access to, necessary third-party services, such as gathering, processing, compression and transportation services. These constraints and the resulting shortages or high costs could delay or temporarily halt our operations and materially increase our operation and capital costs, which could have a material adverse effect on our business, financial condition and results of operations.
## The adoption of climate change legislation or regulations restricting emission of greenhouse gases, investor pressure concerning climate-related disclosures, and lawsuits could result in increased operating costs and reduced demand for the oil and gas we produce as well as reductions in the availability of capital.
Studies have found that emission of certain gases, commonly referred to as greenhouse gases (“GHGs”), impact the earth’s climate. The U.S. Congress and various states have been evaluating, and in some cases implementing, climate-related legislation and other regulatory initiatives that restrict emissions of GHGs. On January 20, 2021, President Biden’s first day in office, he signed an executive order on climate action and reconvened an interagency working group to establish interim and final social costs of three GHGs: carbon dioxide, nitrous oxide, and methane. Carbon dioxide is released during the combustion of fossil fuels, including oil, natural gas, and NGLs, and methane is a primary component of natural gas. The Biden administration stated it will use updated social cost figures to inform federal regulations and major agency actions and to justify
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The following are abbreviations and definitions of terms commonly used in the oil and natural gas industry and within this report.
3-D seismic – An advanced technology method of detecting accumulation of hydrocarbons identified through a three-dimensional picture of the subsurface created by the collection and measurement of the intensity and timing of sound waves transmitted into the earth as they reflect back to the surface.
Bbl – One barrel or 42 U.S. gallons liquid volume of oil or other liquid hydrocarbons.
Boe – Barrel of oil equivalent, determined using a ratio of six Mcf of natural gas equal to one barrel of oil equivalent. The ratio does not assume price equivalency and, given price differentials, the price for a barrel of oil equivalent for natural gas differs significantly from the price for a barrel of oil. A barrel of NGLs also differs significantly in price from a barrel of oil.
Btu – British thermal unit, the quantity of heat required to raise the temperature of one pound of water by one-degree Fahrenheit.
Completion – The process of treating and hydraulically fracturing a drilled well followed by the installation of permanent equipment for the production of oil or natural gas, or in the case of a dry hole, the reporting of abandonment to the appropriate regulatory agency.
Developed acreage – The number of acres which are allotted or assignable to producing wells or wells capable of production.
Development activities – Activities following exploration including the drilling and completion of additional wells and the installation of production facilities.
Development well – A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive.
Dry hole or well – A well found to be incapable of producing hydrocarbons economically.
Exploitation – A development or other project which may target proven or unproven reserves (such as probable or possible reserves), but which generally has a lower risk than that associated with exploration projects.
Exploratory well – A well drilled to find and produce oil or natural gas reserves in an area or a potential reservoir not classified as proved.
Farm-in or Farm-out – An agreement whereby the owner of a working interest in an oil and natural gas lease assigns or contractually conveys, subject to future assignment, the working interest or a portion thereof to another party who desires to drill on the leased acreage. Generally, the farmee is required to drill one or more wells in order to earn its interest in the acreage. The farmor usually retains a royalty and/or an after-payout interest in the lease. The interest received by the farmee is a “farm-in” while the interest transferred by the farmor is a “farm-out.”
Field – An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.
Gross acres or gross wells – The total acres or wells, as the case may be, in which a working interest is owned.
Horizontal drilling – A drilling technique that permits the operator to drill horizontally within a specified targeted reservoir and thus exposes a larger portion of the producing horizon to a wellbore than would otherwise be exposed through conventional vertical drilling techniques.
Hydraulic fracture or Frac – A well stimulation method by which fluid, comprised largely of water and proppant (purposely sized particles used to hold open an induced fracture) is injected downhole and into the producing formation at high pressures and rates in order to exceed the rock strength and create a fracture such that the proppant material can be placed into the fracture to enhance the productive capability of the formation.
Injection well – A well which is used to inject gas, water, or liquefied petroleum gas under high pressure into a producing formation to maintain sufficient pressure to produce the recoverable reserves.
Joint Operating Agreement or JOA – Any agreement between working interest owners concerning the duties and responsibilities of the operator and rights and obligations of the non-operators.
MBbls – One thousand barrels of crude oil or other liquid hydrocarbons.
MBoe – One thousand barrels of oil equivalent, determined using a ratio of six Mcf of natural gas equal to one barrel of oil equivalent.
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] | overall_image/6b71e3bf0180bb2b1441519e0b736022575a2cab2082e9533b7e611610326d77.png | ## Net Oil, Natural Gas and Natural Gas Liquids Production, Average Price and Average Production Cost
The net quantities of oil, natural gas and natural gas liquids produced and sold by us for the years ended December 31, 2020 and 2019, the average sales price per unit sold (excluding hedges) and the average production cost per unit are presented below:
<img src='content_image/1026279.jpg'>
* Barrels of oil equivalent have been calculated on the basis of six thousand cubic feet (Mcf) of natural gas equal to one barrel of oil equivalent (BOE).
** Amounts exclude the impact of cash paid/received on settled derivative contracts as we did not elect to apply hedge accounting. Our derivatives for 2020 and 2019 have been marked-to-market in our Consolidated Statements of Operations and both the realized and unrealized amounts are reported as other income/expense.
The following tables summarize the net quantities of oil, natural gas and natural gas liquids produced and sold by us, the average sales price per unit sold (excluding hedges) and the average production cost per unit for each of our core areas for the years ended December 31, 2020 and 2019.
## Midland Basin
<img src='content_image/1026280.jpg'>
* Barrels of oil equivalent have been calculated on the basis of six thousand cubic feet (Mcf) of natural gas equal to one barrel of oil equivalent (BOE).
** Amounts exclude the impact of cash paid/received on settled derivative contracts as we did not elect to apply hedge accounting.
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] | overall_image/62db46a2d517b3fd879803e1110c759613b7360209096090d289168e10752af9.png | anticipate moving the rig to Upton County and drilling 10-11 wells. Consistent with previously released guidance, we anticipate drilling 16 gross / 14.8 net operated wells and spudding an additional 5 gross / 3.7 net operated wells during 2021.
Additionally, we are focused on efficiently integrating the recently acquired IRM assets into our operations. As a result of the IRM Acquisition, we added 43,400 additional net acres in the Midland Basin of which 99% is operated and 1% is non-operated, as well as adding 70 potential gross horizontal drilling locations on core acreage located in Midland and Ector counties.
## Impairments
We recorded impairments in 2020 as follows:
<img src='content_image/1021989.jpg'>
(1) Impairments in unproved properties resulting from acreage deemed expired (not planned to be renewed).
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] | overall_image/d886bc7e7ebc190559bbc8205af9b4d9fc208d33c846c1c93b78ce03182bee22.png | ## Results of Operations
Year ended December 31, 2020 compared to the year ended December 31, 2019
<img src='content_image/1054426.jpg'>
(1) Barrels of oil equivalent have been calculated on the basis of six thousand cubic feet (Mcf) of natural gas equals one barrel of oil equivalent (BOE).
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During the year ended December 31, 2020, we recorded transaction costs primarily due to legal, consulting and other fees of approximately $1.0 million related to the business combination which was consummated on January 7, 2021 and $0.3 million related to other potential transactions, offset by net reimbursements of $0.7 million related to the business combination (the “Bold Transaction”) pursuant to the Bold Contribution Agreement (as defined below) which closed on May 9, 2017. During the year ended December 31, 2019, the Company recorded transaction costs totaling approximately $1.1 million primarily due to the Bold Transaction.
## Gain on sale of oil and gas properties, net
During the years ended December 31, 2020 and 2019, we sold certain oil and gas properties located in the Midland Basin, recording gains totaling $0.2 million and $3.6 million, respectively. See Note 3. Acquisitions and Divestitures in the Notes to Consolidated Financial Statements.
## Interest expense, net
Interest expense includes commitment fees, amortization of deferred financing costs, and interest on outstanding indebtedness. Interest expense decreased from $6.6 million for the year ended December 31, 2019, to $5.2 million for the year ended December 31, 2020 primarily due to lower effective interest rates, as well as lower outstanding borrowings compared to the prior year. See Note 13. Long-Term Debt in the Notes to Consolidated Financial Statements.
## Write-off of deferred financing costs
During the year ended December 31, 2019, in connection with the termination of the prior credit agreement, $1.2 million of remaining unamortized deferred financing costs were expensed and included in Write-off of deferred financing costs in the Consolidated Statements of Operations. See Note 13. Long-Term Debt in the Notes to Consolidated Financial Statements.
## Gain (loss) on derivative contracts, net
For the year ended December 31, 2020, we recorded a net gain on derivative contracts of $59.9 million, consisting of net realized gains on settlements of $56.0 million and unrealized mark-to-market gains of $3.9 million. For the year ended December 31, 2019, we recorded a net loss on derivative contracts of $44.0 million, consisting of unrealized mark-to-market losses of $59.8 million, partially offset by net realized gains on settlements of $15.9 million.
## Income tax benefit (expense)
During the year ended December 31, 2020, the Company recorded total income tax benefit of $0.11 million which included (1) deferred income tax expense for Lynden US of $0.15 million as a result of its share of the distributable income from EEH, (2) deferred income tax benefit for Earthstone of $0.61 million as a result of its share of the distributable loss from EEH, which was offset by a valuation allowance as future realization of the net deferred tax asset cannot be assured and (3) current income tax expense of $0.55 million, offset by deferred income tax benefit of $0.51 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the year ended December 31, 2020.
During the year ended December 31, 2019, the Company recorded a total income tax expense of $1.7 million which included (1) deferred income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.4 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $1.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the year ended December 31, 2019.
## Liquidity and Capital Resources
We have significant undeveloped acreage and future drilling locations. Drilling horizontal wells, generally consisting of 7,500 to 12,000-foot lateral lengths, in the Midland Basin is capital intensive. As of December 31, 2020, we had $1.5 million in cash and $115 million of long-term debt outstanding under our Credit Agreement with a borrowing base of $240 million. With the $125 million of undrawn borrowing base capacity and $1.5 million in cash, we had total liquidity of approximately $126.5 million. Subsequent to year-end, Earthstone closed on its previously announced acquisition of IRM and amended the Credit Agreement. As of March 1, 2021, we had $10.1 million in cash and $227.5 million of long-term debt outstanding under our Credit Agreement, as amended, with a borrowing base of $360 million. With the $132.5 million of undrawn borrowing base capacity and $10.1 million in cash, we had total liquidity of approximately $142.6 million.
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] | overall_image/4f42a67631e9cbf5dbd030d62cdf48ebfeceb5c59ba07a239dce3901223a0c2d.png | As oil prices have recovered recently from their 2020 lows, we are preparing to resume drilling operations with the deployment of a rig late in the first quarter of 2021 and we expect to spend $90-$100 million based on our current 2021 drilling plan. We believe we will have sufficient liquidity with cash flows from operations and borrowings under the Credit Agreement to meet our cash requirements for the next 12 months.
## Working Capital
Working Capital (presented below) was a deficit of $20.8 million as of December 31, 2020 compared to a deficit of $39.9 million as of December 31, 2019, representing an improvement of $19.2 million. The improvement was primarily due to the reduction of liabilities resulting from reduced drilling activity. The components of working capital are presented below:
<img src='content_image/1045289.jpg'>
We expect that changes in receivables and payables related to our pace of development, production volumes, changes in our hedging activities, realized commodity prices and differentials to NYMEX prices for our oil and natural gas production will continue to be the largest variables affecting our working capital.
We expect to finance future development activities with cash flows from operating activities, borrowings under the Credit Agreement and, various means of corporate and project financing. Additionally, we may continue to partially finance our drilling activities through the sale of participating rights to financial institutions or industry participants, and we could structure such arrangements on a promoted basis, whereby we may earn working interests in reserves and production greater than our proportionate share of capital costs.
In July 2019, we entered into a Wellbore Development Agreement (“WDA”) with a non-affiliated industry partner. This WDA reduced our working interest in certain wells in Reagan County. The industry partner paid a promoted (proportionately higher) share of the capital expenditures on eight wells, to earn 35% of the working interest in these wells.
Capital Expenditures
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## Internal Control Over Financial Reporting
## Evaluation of Disclosure Controls and Procedures
## (a) Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit to the SEC under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and that information is accumulated and communicated to our management, including our Chief Executive Officer and Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.
In accordance with Rules 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures (as defined by Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. As described below under paragraph (b) within Management’s Annual Report on Internal Control over Financial Reporting, our Chief Executive Officer and Principal Accounting Officer have concluded that, as of the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.
The audit report of our independent registered public accounting firm, which is included in this Annual Report on Form 10-K, expressed an unqualified opinion on our consolidated financial statements.
## (b) Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
While “reasonable assurance” is a high level of assurance, it does not mean absolute assurance. Because of its inherent limitations, internal control over financial reporting may not prevent or detect every misstatement and instance of fraud. Controls are susceptible to manipulation, especially in instances of fraud caused by collusion of two or more people. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our Chief Executive Officer and Principal Accounting Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2020. In making this evaluation, management used the Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the results of our evaluation, our management concluded that our internal control over financial reporting was effective, at the reasonable assurance level, as of December 31, 2020.
Our independent registered public accounting firm that audited our consolidated financial statements, has also issued its own audit report on the effectiveness of our internal control over financial reporting as of December 31, 2020, which is included herein.
## (c) Changes in Internal Control over Financial Reporting
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The principal considerations for our determination that performing procedures relating to the impact of proved oil and natural gas reserves on proved net oil and natural gas properties is a critical audit matter are there was significant judgment by management, including the use of specialists, when developing the estimates of proved oil and natural gas reserves. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating the significant assumptions used in developing those estimates, including future production, future oil and natural gas prices, future pricing differentials, and future development costs.
The primary procedures we performed to address this critical audit matter included:
• Testing the operating effectiveness of controls relating to management’s estimates of proved oil and natural gas reserves, the calculation of DD&A expense, and the impairment assessment of proved oil and natural gas properties.
• Evaluating the significant assumptions used by management in developing these estimates, including future production, future oil and gas prices, future pricing differentials, and future development costs.
• Utilizing the work of management’s specialists to evaluate the reasonableness of the estimates of proved oil and natural gas reserves. As a basis for this work, the specialists’ qualifications and objectivity were assessed, as well as the reasonableness of methods and assumptions used by the specialists. The procedures performed also included testing the data used by the specialists and evaluating the specialists’ findings. Evaluating the significant assumptions relating to the estimates of proved oil and natural gas reserves also involved obtaining evidence to support the reasonableness of the assumptions, including whether the assumptions used were reasonable considering the past performance of the Company, and whether they were consistent with evidence obtained in other areas of the audit.
• Testing management’s impairment assessment of proved oil and natural gas properties. This included evaluating management’s cash flow analysis related to the proved oil and natural gas properties. In addition, we involved internal valuation professionals with specialized skills and knowledge, who assisted in evaluating the discount rate used in the valuation by comparing it against a discount rate range that was independently developed using publicly available market data for comparable entities.
• Testing the inputs of and recalculating management’s DD&A calculation.
/s/ Moss Adams LLP
Houston, Texas March 10, 2021
We have served as the Company’s auditor since 2018.
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] | overall_image/d3928dad793c48ed709000dd5e1761b90322c124f1fd475af184c5bcd399b3e0.png | ## EARTHSTONE ENERGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
<img src='content_image/1033605.jpg'>
The accompanying notes are an integral part of these consolidated financial statements.
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The Company has no elements of comprehensive income other than net income.
## Asset Retirement Obligations
Asset retirement obligations associated with the retirement of long-lived assets are recognized as liabilities with an increase to the carrying amounts of the related long-lived assets in the period incurred. The cost of the asset, including the asset retirement cost, is depreciated over the useful life of the asset. Asset retirement obligations are recorded at estimated fair value, measured by reference to the expected future cash outflows required to satisfy the retirement obligations discounted at the Company’s credit-adjusted risk-free interest rate. Accretion expense is recognized over time as the discounted liabilities are accreted to their expected settlement value. If estimated future costs of asset retirement obligations change, an adjustment is recorded to both the asset retirement obligations and the long-lived asset. Revisions to estimated asset retirement obligations can result from changes in retirement cost estimates, revisions to estimated inflation rates, and changes in the estimated timing of abandonment. For further discussion, see Note 14. Asset Retirement Obligations .
## Business Combinations
The Company accounts for its acquisitions of oil and gas properties not commonly controlled in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, which, among other things, requires the Company to determine if an asset or a business has been acquired. If the Company determines an asset(s) has been acquired, the asset(s) acquired, as well as any liabilities assumed, are measured and recorded at the acquisition date cost. If the Company determines a business has been acquired, the assets acquired and liabilities assumed are measured and recorded at their fair values as of the acquisition date, recording goodwill for amounts paid in excess of fair value.
## Revenue Recognition
The Company’s revenues are comprised solely of revenues from customers and include the sale of oil, natural gas and natural gas liquids. The Company believes that the disaggregation of revenue into these three major product types, as presented in the Consolidated Statements of Operations, appropriately depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors based on its single geographic region. Revenues are recognized when the recognition criteria of ASC 606 “Revenue from Contracts with Customers,” (“ASC 606”) are met, which generally occurs at a point in time when production is sold to a purchaser at a determinable price, delivery has occurred, control has transferred and collection of the revenue is probable . The Company fulfills its performance obligations under its customer contracts through delivery of oil, natural gas and natural gas liquids and revenues are recorded on a monthly basis and the Company receives payment from one to three months after delivery. Generally, each unit of product represents a separate performance obligation. The prices received for oil, natural gas and natural gas liquids sales under the Company’s contracts are generally derived from stated market prices which are then adjusted to reflect deductions including transportation, fractionation and processing. As a result, revenues from the sale of oil, natural gas and natural gas liquids will decrease if market prices decline. The sales of oil, natural gas and natural gas liquids, as presented on the Consolidated Statements of Operations, represent the Company’s share of revenues net of royalties and excluding revenue interests owned by others. When selling oil, natural gas and natural gas liquids on behalf of royalty or working interest owners, the Company is acting as an agent and thus reports the revenue on a net basis. To the extent actual volumes and prices of oil and natural gas sales are unavailable for a given reporting period because of timing or information not received from third parties, the expected sales volumes and prices for those properties are estimated and recorded. Variances between the Company’s estimated revenue and actual payment are recorded in the month the payment is received. Historically, however, differences have been insignificant.
At the end of each month when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from customers are recorded in “Accounts receivable: oil, natural gas, and natural gas liquids revenues” in the Consolidated Balance Sheets. As of December 31, 2020 and 2019 , amounts receivable from contracts with customers were $16.3 million and $29.0 million, respectively. Taxes assessed by governmental authorities on oil, natural gas and NGL sales are presented separately from such revenues in the Consolidated Statements of Operations.
## Oil Sales
Oil production is transported from the wellhead to tank batteries or delivery points through flow-lines or gathering systems. Purchasers of the oil take delivery at (i) the tank batteries and transport the oil by truck, or (ii) at a pipeline delivery point and the Company collects a market price, net of pricing differentials. Revenue is recognized when control transfers to the purchaser at the net price received by the Company. Starting in October 2019, certain of the Company’s oil sales activity involves buy/sell arrangements that effect a change in location with required repurchase of oil at a delivery point. Because the Company acts as
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The Company holds working interests in oil and natural gas properties for which a third-party serves as operator. The operator sells the oil, natural gas, and NGLs to the purchaser, collects the cash, and distributes the cash to the Company. In the year ended December 31, 2020, one operator distributed 15% of the Company’s oil, natural gas and natural gas liquids revenues. In the year ended December 31, 2019, no operator distributed 10% or more of the Company’s oil, natural gas and natural gas liquids revenues.
The derivative instruments of the Company are with a small number of counterparties and, from time-to-time, may represent material assets in the Consolidated Balance Sheets. At December 31, 2020, the Company had a net derivative asset position of $6.6 million. At December 31, 2019, the Company had $2.7 million of derivative contracts that were in a material asset position.
The Company regularly maintains its cash in bank deposit accounts. Balances held by the Company at its banks typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to the amounts of deposit in excess of FDIC insurance coverage.
## Stock-Based Compensation
The Company recognized stock-based compensation expense associated with restricted stock units, which include both time- and performance-based awards. The Company accounts for forfeitures of equity-based incentive awards as they occur. Stock-based compensation expense related to time- based restricted stock units is based on the price of the Class A common stock, $0.001 par value per share of Earthstone (“Class A Common Stock”), on the grant date and recognized over the vesting period using the straight-line method. Stock-based compensation expense related to performance- based restricted stock units, which cliff vest, is based on a grant date Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes fair value based on the most likely outcome, and is recognized over the vesting period using the straight-line method. See Note 12. Stock-Based Compensation for further details.
## Income Taxes
The Company is a U.S. company operating in Texas, as of December 31, 2020, as well as one foreign legal entity, Lynden Corp, which is a Canadian company. Consequently, the Company’s tax provision is based upon the tax laws and rates in effect in the applicable jurisdiction in which its operations are conducted and income is earned. The income tax rates imposed and methods of computing taxable income in these jurisdictions vary. Therefore, as a part of the process of preparing the Consolidated Financial Statements, the Company is required to estimate the income taxes in each of these jurisdictions. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation, amortization and certain accrued liabilities for tax and accounting purposes. The Company’s effective tax rate for financial statement purposes will continue to fluctuate from year to year as its operations are conducted in different taxing jurisdictions.
The Company records an income tax provision consistent with its status as a corporation. The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return resulting from Earthstone’s acquisition of Lynden Corp in May 2016 (the “Lynden Arrangement”) that includes Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the noncontrolling interest, as well as any standalone income or loss generated by each company. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.
The Company’s deferred tax expense or benefit represents the change in the balance of deferred tax assets or liabilities reported in the Consolidated Balance Sheets. Valuation allowances are established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. At December 31, 2020 and 2019, the Company has recorded a valuation allowance for its deferred tax assets in the Consolidated Balance Sheets.
The Company applies the accounting standards related to uncertainty in income taxes. This accounting guidance clarifies the accounting for uncertainties in income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the Consolidated Financial Statements. It requires that the Company recognize in the Consolidated Financial Statements the financial effects of a tax position, if that position is more likely than not of being sustained upon examination, including resolution of any appeals or litigation processes, based upon the technical merits of the position. It also provides guidance on measurement, classification, interest, penalties and disclosure. The Company’s tax positions related to its pass-through status and state income tax liability, including deductibility of expenses, have been reviewed by the Company’s management and they believe those positions would more likely than not be sustained upon
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<img src='content_image/1050247.jpg'>
## Note 10. Net (Loss) Income Per Common Share
Net (loss) income per common share—basic is calculated by dividing Net (loss) income by the weighted average number of shares of common stock outstanding during the period. Net (loss) income per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net (loss) income by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.
A reconciliation of Net (loss) income per common share is as follows:
<img src='content_image/1050248.jpg'>
The Class B common stock, $0.001 par value per share of Earthstone (the “Class B Common Stock”), has been excluded, as its conversion would eliminate noncontrolling interest and Net loss attributable to noncontrolling interest of $15.9 million for the year ended December 31, 2020 and Net income attributable to noncontrolling interest of $0.9 million for the year ended December 31, 2019 would be added back to Net (loss) income attributable to Earthstone Energy, Inc. for the years then ended, having no dilutive effect on Net (loss) income per common share attributable to Earthstone Energy, Inc.
## Note 11. Common Stock
## Class A Common Stock
At December 31, 2020 and 2019, there were 30,343,421 and 29,421,131 shares of Class A Common Stock issued and outstanding, respectively. During the years ended December 31, 2020 and 2019, as a result of the vesting and settlement of restricted stock units under the 2014 Plan, Earthstone issued 914,905 and 736,706 shares of Class A Common Stock, respectively, of which 243,924 and 203,394 shares of Class A Common Stock, respectively, were retained as treasury stock and canceled to satisfy the related employee income tax liability.
## Class B Common Stock
At December 31, 2020 and 2019, there were 35,009,371 and 35,260,680 shares of Class B Common Stock issued and outstanding, respectively. Each share of Class B Common Stock, together with one EEH Unit, is convertible into one share of Class A Common Stock. During the years ended December 31, 2020 and 2019, 251,309 and 191,498 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock.
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A reconciliation of the effective tax rate to the statutory rate for the years ended December 31, 2020 and 2019 is as follows ( in thousands, except percentages ):
<img src='content_image/1027523.jpg'>
During the year ended December 31, 2020, the Company recorded total income tax benefit of $0.11 million which included (1) deferred income tax benefit for Lynden US of $0.15 million as a result of its share of the distributable income from EEH, (2) deferred income tax benefit for Earthstone of $0.61 million as a result of its share of the distributable loss from EEH, which was offset by a valuation allowance as future realization of the net deferred tax asset cannot be assured and (3) current income tax expense of $0.55 million, offset by deferred income tax benefit of $0.51 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the year ended December 31, 2020.
During the year ended December 31, 2019, the Company recorded total income tax expense of $1.7 million which included (1) deferred income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.4 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $1.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the year ended December 31, 2019.
## Deferred Tax Assets and Liabilities
The Company’s deferred tax position reflects the net tax effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting. Significant components of the deferred tax assets and liabilities at December 31, 2020 and 2019 are as follows ( in thousands ):
<img src='content_image/1027528.jpg'>
As of December 31, 2020, the Company had a valuation allowance recorded against its deferred tax assets of $17.0 million which is in excess of its net deferred noncurrent tax assets of $2.5 million, as presented above. The Company’s corporate organizational structure requires the filing of two separate consolidated U.S. Federal corporate income tax returns, one separate U.S. Federal partnership income tax return and one Canadian income tax return. As a result, tax attributes of one group cannot be offset by the tax attributes of another. At December 31, 2020, the deferred tax assets and liabilities related to the two U.S.
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] | overall_image/7dc55c396a90db2bf27a353adfa6bdf8627d21b4f2b07f6626a5fb00ddb4c543.png | ## Notes to Consolidated Financial Statements — (Continued)
## Becton, Dickinson and Company
The Company’s future minimum rental commitments on non-cancelable leases at September 30, 2019, prior to the adoption of the new lease accounting standard, were estimated as follows:
## Note 19 — Supplemental Financial Information
## Other Income, Net
<img src='content_image/1031305.jpg'>
<img src='content_image/1031306.jpg'>
(a) The amount in 2020 primarily represents licensing income. The amounts in 2019 and 2018 primarily represent the royalty income stream acquired in the Bard transaction, net of non-cash purchase accounting amortization. The royalty income stream was previously reported by Bard as revenues.
(b) Represents all components of the Company’s net periodic pension and postretirement benefit costs, aside from service cost, as a result of the adoption of an accounting standard as further discussed in Note 2.
(c) Represents losses recognized upon the extinguishment of certain senior notes, as further discussed in Note 16.
(d) The amount in 2019 represents income from transition services agreements (“TSA”) related to the Company’s 2018 and 2017 divestitures. The amount in 2018 includes the gain on the sale of the remaining ownership interest in its former Respiratory Solutions business and subsequent TSA income, net of the Company's share of equity investee results in the business. Additional disclosures regarding the Company’s divestiture transactions are provided in Note 11.
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] | overall_image/a20e320df1251ae1deec40edf2a4b9ce55679b69ccb0eb2910ddb25bb776ddd6.png | ## SUPPLEMENTARY QUARTERLY DATA (UNAUDITED)
<img src='content_image/1044928.jpg'>
(a) Quarterly amounts may not add to the year-to-date totals due to rounding. Earnings per share amounts are calculated from the underlying whole-dollar amounts.
(b) The sum of diluted earnings per share for the quarters of 2020 do not equal the year-to-date amount due to the impact of shares issued during this fiscal year on the weighted average common shares included in the calculations of diluted earnings per share. Additional disclosures regarding shares issued are provided in Note 3.
## Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
## Item 9A. Controls and Procedures.
An evaluation was conducted by BD’s management, with the participation of BD’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of BD’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of September 30, 2020. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were, as of the end of the period covered by this report, effective and designed to ensure that material information relating to BD and its consolidated subsidiaries would be made known to them by others within these entities. There were no changes in our internal control over financial reporting during the fiscal quarter ended September 30, 2020 identified in connection with the above- referenced evaluation that have materially affected, or are reasonably likely to materially affect, BD’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm are contained in Item 8. Financial Statements and Supplementary Data, and are incorporated herein by reference.
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BD also routinely posts important information for investors on its website at www.bd.com/investors. BD may use this website as a means of disclosing material, non-public information and for complying with its disclosure obligations under Regulation FD adopted by the SEC. Accordingly, investors should monitor the Investor Relations portion of BD’s website noted above, in addition to following BD’s press releases, SEC filings, and public conference calls and webcasts. Our website and the information contained therein or connected thereto shall not be deemed to be incorporated into this Annual Report.
## Forward-Looking Statements
BD and its representatives may from time-to-time make certain forward-looking statements in publicly-released materials, both written and oral, including statements contained in filings with the SEC and in its reports to shareholders. Additional information regarding BD’s forward-looking statements is contained in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
## Item 1A. Risk Factors.
An investment in BD involves a variety of risks and uncertainties. The following describes some of the material risks that could adversely affect BD’s business, financial condition, operating results or cash flows. We may also be adversely impacted by other risks not presently known to us or that we currently consider immaterial.
## Business, Economic and Industry Risks
We are subject to risks associated with public health threats, including the ongoing COVID-19 pandemic, which has had, and we expect will continue to have, a material adverse effect on our business. The nature and extent of future impacts are highly uncertain and unpredictable.
We are subject to risks associated with public health threats, including the COVID-19 pandemic. The outbreak of COVID-19 and the travel restrictions, quarantines and other actions taken by governments and the private sector to slow the spread of the virus resulted in a global economic slowdown, and caused healthcare systems to divert resources to manage the pandemic. These measures led to unprecedented restrictions on and disruptions in businesses and personal activities. As a result, we experienced significant reductions in the demand for certain of our products, resulting from reductions in elective and non-essential procedures, lower utilization of routine testing and related specimen collection, reduced capital spend by customers and a decrease in research activity due to laboratory closures and reduced clinical testing.
While the United States and other countries have begun to reopen their economies, utilization rates for many of our products have not returned to pre-pandemic levels. There may also be continued pressure on our margins due to manufacturing variances resulting from lower demand for certain of our products. In addition, in response to the pandemic, we developed and launched multiple products for the detection and identification of COVID-19, including tests for our BD Max™ molecular System and BD Veritor™ Plus System, and there are a number of factors, including the timing and availability of any COVID-19 vaccine and the entry of additional competitive products, that could impact the level of demand and pricing for our COVID-19 diagnostics testing.
Moreover, any resurgence in COVID-19 infections could result in the imposition of new governmental lockdowns, quarantine requirements or other restrictions to slow the spread of the virus, which could weaken demand for certain of our products, as discussed above. Such measures have begun to be implemented again in certain European countries and in the United States as infections have begun to increase again, in some cases
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## We are subject to foreign currency exchange risk.
A substantial amount of our revenues are derived from international operations, and we anticipate that a significant portion of our sales will continue to come from outside the U.S. in the future. The revenues we report with respect to our operations outside the United States may be adversely affected by fluctuations in foreign currency exchange rates. A discussion of the financial impact of exchange rate fluctuations and the ways and extent to which we may attempt to address any impact is contained in Item 7. Management’s Discussion of Financial Condition and Results of Operations. Any hedging activities we engage in may only offset a portion of the adverse financial impact resulting from unfavorable changes in foreign currency exchange rates. We cannot predict with any certainty changes in foreign currency exchange rates or the degree to which we can mitigate these risks.
## Changes in reimbursement practices of third-party payers or other cost containment measures could affect the demand for our products and the prices at which they are sold.
Our sales depend, in part, on the extent to which healthcare providers and facilities are reimbursed by government authorities (including Medicare, Medicaid and comparable foreign programs) and private insurers for the costs of our products. The coverage policies and reimbursement levels of third-party payers, which can vary among public and private sources and by country, may affect which products customers purchase and the prices they are willing to pay for those products in a particular jurisdiction. Reimbursement rates can also affect the market acceptance rate of new technologies and products. Reforms to reimbursement systems in the United States or abroad, changes in coverage or reimbursement rates by private payers, or adverse decisions relating to our products by administrators of these systems could significantly reduce reimbursement for procedures using our products or result in denial of reimbursement for those products, which would adversely affect customer demand or the price customers are willing to pay for such products. See “Third-Party Reimbursement” under Item 1. Business.
Initiatives to limit the growth of healthcare costs in the U.S. and other countries where we do business may also put pressure on medical device pricing. In the U.S., these include, among others, value-based purchasing and managed care arrangements. Governments in China and other countries are also using various mechanisms to control healthcare expenditures, including increased use of competitive bidding and tenders, and price regulation.
## Our future growth is dependent in part upon the development of new products, and there can be no assurance that such products will be developed.
A significant element of our strategy is to increase revenue growth by focusing on innovation and new product development. New product development requires significant investment in research and development, clinical trials and regulatory approvals. The results of our product development efforts may be affected by a number of factors, including our ability to anticipate customer needs, innovate and develop new products and technologies, successfully complete clinical trials, obtain regulatory approvals and reimbursement in the United States and abroad, manufacture products in a cost-effective manner, obtain appropriate intellectual property protection, and gain and maintain market acceptance of our products. In addition, patents attained by others can preclude or delay our commercialization of a product. There can be no assurance that any products now in development or that we may seek to develop in the future will achieve technological feasibility, obtain regulatory approval or gain market acceptance.
## Our international operations subject us to certain business risks.
A substantial amount of our sales come from our operations outside the United States, and we intend to continue to pursue growth opportunities in foreign markets, especially in emerging markets. Our foreign operations subject us to certain risks relating to, among other things, fluctuations in foreign currency exchange (discussed above), local economic and political conditions, competition from local companies, increases in trade
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In addition, our international operations are governed by the U.S. Foreign Corrupt Practices Act and similar anti-corruption laws outside the U.S. Global enforcement of anti-corruption laws has increased substantially in recent years, with more enforcement proceedings by U.S. and foreign governmental agencies and the imposition of significant fines and penalties. While we have implemented policies and procedures to enhance compliance with these laws, our international operations, which often involve customer relationships with foreign governments, create the risk that there may be unauthorized payments or offers of payments made by employees, consultants, sales agents or distributors. Any alleged or actual violations of these laws may subject us to government investigations and significant criminal or civil sanctions and other liabilities, and negatively affect our reputation.
Changes in U.S. policy regarding international trade, including import and export regulation and international trade agreements, could also negatively impact our business. The U.S. has imposed tariffs on steel and aluminum as well as on goods imported from China and certain other countries, which has resulted in retaliatory tariffs by China and other countries. Additional tariffs imposed by the U.S. on a broader range of imports, or further retaliatory trade measures taken by China or other countries in response, could result in an increase in supply chain costs that we may not be able to offset or that otherwise adversely impact our results of operations.
The United Kingdom’s (“UK”) departure from the European Union (“EU”) (commonly known as “Brexit”) has created uncertainties affecting business operations in the UK, the EU and a number of other countries, including with respect to compliance with the regulatory regimes regarding the labeling and registration of the products we sell in these markets. The UK formally left the EU on January 31, 2020. Pursuant to the withdrawal arrangement agreed between the UK and the EU, there is a transition period through December 31, 2020 for the parties to negotiate their future trading relationship. During this transition period, the UK continues to follow the EU’s rules and its trading relationship with the EU remains the same. While we have taken proactive steps to mitigate any disruption to our operations, we could face increased costs, volatility in exchange rates, market instability and other risks, depending on the outcome of the negotiations regarding the future EU/UK trading relationship.
## Reductions in customers’ research budgets or government funding may adversely affect our business.
We sell products to researchers at pharmaceutical and biotechnology companies, academic institutions, government laboratories and private foundations. Research and development spending of our customers can fluctuate based on spending priorities and general economic conditions. A number of these customers are also dependent for their funding upon grants from U.S. government agencies, such as the U.S. National Institutes of Health (“NIH”) and agencies in other countries. The level of government funding of research and development is unpredictable. For instance, there have been instances where NIH grants have been frozen or otherwise unavailable for extended periods. The availability of governmental research funding may be adversely affected by economic conditions and governmental spending reductions. Any reduction or delay in governmental funding could cause our customers to delay or forego purchases of our products.
## We need to attract and retain key employees to be competitive.
Our ability to compete effectively depends upon our ability to attract and retain executives and other key employees. Competition for experienced employees, particularly for persons with specialized skills, can be
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## Operational Risks
## Breaches of our information systems could have a material adverse effect on our operations.
We rely on information systems to process, transmit, and store electronic information in our day-to-day operations, including sensitive personal or proprietary information. In addition, some of our products include information systems that collects data regarding patients and patient therapy on behalf of our customers and some connect to our systems for maintenance purposes. Our information systems have been subjected to attack via malicious code execution, and cyber- or phishing- attacks, and we have experienced instances of unauthorized access to our systems in the past and expect to be subject to similar cyberattacks in the future. In addition to our own information, in the course of doing business, we sometimes store information with third parties that could be subject to attacks.
Cyberattacks could result in our intellectual property and other confidential information being accessed, destroyed or stolen, which could adversely affect our competitive position in the market. Likewise, we could suffer disruption of our operations and other significant negative consequences, including increased costs for security measures or remediation, diversion of management attention, litigation and damage to our relationships with vendors, business partners and customers. Unauthorized tampering, adulteration or interference with our products may also create issues with product functionality that could result in a loss of data, risk to patient safety, and product recalls or field actions. Cyberattacks could result in unauthorized access to our systems and products which could also impact our compliance with privacy and other laws and regulations, and result in actions by regulatory bodies or civil litigation. While we will continue to dedicate significant resources to protect against unauthorized access to our systems and products, and work with government authorities and third party providers to detect and reduce the risk of future cyber incidents, cyberattacks are becoming more sophisticated, frequent and adaptive. There can be no assurances that these protective measures will prevent future attacks that could have a material adverse impact on our business.
## Cost volatility could adversely affect our operations .
Our results of operations could be negatively impacted by volatility in the cost of raw materials, components, freight and energy that, in turn, increases the costs of producing and distributing our products. New laws or regulations adopted in response to climate change could also increase energy and transportation costs, as well as the costs of certain raw materials and components. In particular, we purchase supplies of resins, which are oil-based components used in the manufacture of certain products, and any significant increases in resin costs could adversely impact future operating results. Increases in oil prices can also increase our packaging and transportation costs. We may not be able to offset any increases in our operational costs.
## A reduction or interruption in the supply of certain raw materials and components could adversely affect our operating results.
We purchase many different types of raw materials and components used in our products. Certain raw materials and components are not available from multiple sources. In addition, for quality assurance, cost-effectiveness and other reasons, certain raw materials and components are purchased from sole suppliers. The price and supply of these materials and components may be impacted or disrupted for reasons beyond our control. While we work with suppliers to ensure continuity of supply, no assurance can be given that these efforts will be successful. In addition, due to regulatory requirements relating to the qualification of suppliers, we may not be able to establish additional or replacement sources on a timely basis or without excessive cost. The termination, reduction or interruption in supply of these raw materials and components could adversely impact our ability to manufacture and sell certain of our products.
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We have manufacturing sites all over the world. In some instances, however, the manufacturing of certain of our product lines is concentrated in one or more of our plants. Interruption to our manufacturing operations resulting from weather or natural disasters, regulatory requirements or issues in our manufacturing process, equipment failure or other factors, could adversely affect our ability to manufacture our products. In some instances, we may not be able to transition manufacturing to other BD sites or a third party to replace the lost production. A significant interruption of our manufacturing operations could result in lost revenues and damage to our relationships with customers.
In addition, many of our products require sterilization prior to sale, and we utilize both BD facilities and third-parties for this process. In some instances, only a few facilities are qualified under applicable regulations to conduct this sterilization. To the extent we or third-parties are unable to sterilize our products, whether due to lack of capacity, regulatory requirements or otherwise, we may be unable to transition sterilization to other sites or modalities in a timely or cost effective manner, or at all, which could have an adverse impact on our operating results.
## Legal, Quality and Regulatory Risks
## We are subject to lawsuits.
We are or have been a defendant in a number of lawsuits, including, among others, purported class action lawsuits for alleged antitrust violations and violations of federal securities laws, product liability claims (which may involve lawsuits seeking class action status or seeking to establish multi-district litigation proceedings, including claims relating to our hernia repair implant products, surgical continence and pelvic organ prolapse products for women and vena cava filter products), and suits alleging patent infringement. We have also been subject to government subpoenas and civil investigative demands seeking information with respect to alleged violations of law, including in connection with federal and/or state healthcare programs (such as Medicare or Medicaid), federal contracting requirements and/or sales and marketing practices. A more detailed description of certain litigation to which we are a party is contained in Note 5 to the consolidated financial statements included in Item 8. Financial Statements and Suppl ementary Data. We could be subject to additional lawsuits or governmental investigations in the future.
Reserves established for estimated losses with respect to legal proceedings do not represent an exact calculation of our actual liability, but instead represent our estimate of the probable loss at the time the reserve is established. Due to the inherent uncertainty of litigation and our underlying loss reserve estimates, additional reserves may be established or current reserves may be significantly increased from time-to-time. Also, in some instances, we are not able to estimate the amount or range of loss that could result from an unfavorable outcome of the litigation to which we are a party. In view of these uncertainties, we could incur charges materially in excess of any currently established accruals and, to the extent available, excess liability insurance. Any such future charges, individually or in the aggregate, could have a material adverse effect on our results of operations, financial condition and/or liquidity.
With respect to our existing product liability litigation, we believe that some settlements and judgments, as well as legal defense costs, may be covered in whole or in part under our product liability insurance policies with a limited number of insurance companies, or, in some circumstances, indemnification obligations to us from other parties. However, amounts recovered under these arrangements may be less than the stated coverage limits or less than otherwise expected and may not be adequate to cover damages and/or costs. In addition, there is no guarantee that insurers or other parties will pay claims or that coverage or indemnity will be otherwise available. For certain product liability claims or lawsuits, BD does not maintain or has limited remaining insurance coverage, and we may not be able to obtain additional insurance on acceptable terms or at all that will provide adequate protection against potential liabilities.
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In addition, our credit ratings affect the cost and availability of future borrowings and, accordingly, our cost of capital. Our ratings reflect each rating organization’s opinion of our financial strength, operating performance and ability to meet our debt obligations. There can be no assurance that we will achieve a particular rating or maintain a particular rating in the future or that we will be able to maintain our current rating. Furthermore, our combined company’s credit ratings were lowered following the Bard acquisition, including below “investment grade” by Moody’s Investors Service, Inc., which may further increase our future borrowing costs and reduce our access to capital.
Moreover, in the future we may be required to raise substantial additional financing to fund the repayment or refinancing of our indebtedness, acquisitions, or working capital, capital expenditures or other general corporate requirements. Our ability to arrange additional financing or refinancing will depend on, among other factors, our financial position and performance, as well as prevailing market conditions and other factors beyond our control. No assurance can be provided that we will be able to obtain additional financing or refinancing on terms acceptable to us or at all.
## We may not be able to service all of our indebtedness.
We depend on cash on hand and cash flows from operations to make scheduled debt payments. However, our ability to generate sufficient cash flow from operations of the combined company and to utilize other methods to make scheduled payments will depend on a range of economic, competitive and business factors, many of which are outside of our control. There can be no assurance that these sources will be adequate. If we are unable to service our indebtedness and fund our operations, we will be forced to reduce or delay capital expenditures, seek additional capital, sell assets or refinance our indebtedness. Any such action may not be successful and we may be unable to service our indebtedness and fund our operations, which could have a material adverse effect on our business, financial condition or results of operations.
## The agreements that govern the indebtedness incurred in connection with the Bard acquisition impose restrictions that may affect our ability to operate our businesses.
The agreements that govern the indebtedness incurred in connection with the Bard acquisition contain various affirmative and negative covenants that may, subject to certain significant exceptions, restrict the ability of certain of our subsidiaries to incur debt and the ability of us and certain of our subsidiaries to, among other things, have liens on our property, and/or merge or consolidate with any other person or sell or convey certain of our assets to any one person, engage in certain transactions with affiliates and change the nature of our business. In addition, the agreements also require us to comply with certain financial covenants, including financial ratios. Our ability and the ability of our subsidiaries to comply with these provisions may be affected by events beyond our control. Failure to comply with these covenants could result in an event of default, which, if not cured or waived, could accelerate our repayment obligations and could result in a default and acceleration under other agreements containing cross-default provisions. Under these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations.
## General Business Risks
## We cannot guarantee that any of our strategic acquisitions, investments or alliances will be successful.
We may seek to supplement our internal growth through strategic acquisitions, investments and alliances. Such transactions are inherently risky, and the integration of any newly-acquired business requires significant effort and management attention. The success of any acquisition, investment or alliance may be affected by a number of factors, including our ability to properly assess and value the potential business opportunity or to successfully integrate any business we may acquire into our existing business. There can be no assurance that any past or future transaction will be successful.
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] | overall_image/b6c24490c406193f88885d36bf16b6a0b9b176a037bebdc28d93bc6360068084.png | ## PART II
## Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
BD’s common stock is listed on the New York Stock Exchange under the symbol "BDX". As of October 31, 2020, there were approximately 12,656 shareholders of record.
The table below sets forth certain information regarding BD’s purchases of its common stock during the fiscal quarter ended September 30, 2020.
<img src='content_image/1057792.jpg'>
(1) Includes shares purchased during the quarter in open market transactions by the trust relating to BD’s Deferred Compensation and Retirement Benefit Restoration Plan and 1996 Directors’ Deferral Plan.
(2) Represents shares available under the repurchase program authorized by the Board of Directors on September 24, 2013 for 10 million shares, for which there is no expiration date.
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] | overall_image/a6ef63917e1cdcbcfe3d38a955340a32a248e388bbaa0ec07042cbd81e83b11b.png | market sales. This growth was partially offset by an unfavorable impact related to a letter issued in March 2019 by the FDA to healthcare professionals regarding the use of paclitaxel-coated devices in the treatment of peripheral artery disease, which impacted sales of our drug-coated balloon products.
Interventional segment operating income was as follows:
<img src='content_image/1046375.jpg'>
As discussed in greater detail below, the Interventional segment's operating income in 2020 was primarily driven by a decline in gross profit margin. Operating income in 2019 was driven by improved gross profit margin and operating expense performance.
• Gross profit margin was lower in 2020 as compared with 2019 primarily due to unfavorable product mix and increased levels of manufacturing overhead costs that were recognized in the period, rather than capitalized within inventory, as a result of the COVID-19 pandemic. Gross profit margin was higher in 2019 as compared with 2018 primarily due to the unfavorable prior-year impact of recognizing a fair value step-up adjustment relating to Bard's inventory on the acquisition date and lower manufacturing costs resulting from continuous improvement projects, which enhanced the efficiency of our operations, and synergy initiatives. These favorable impacts to the Interventional segment's gross margin were partially offset by unfavorable product mix and unfavorable foreign currency translation.
• Selling and administrative expense as a percentage of revenues in 2020 was lower compared with 2019 primarily due to lower expenses resulting from cost containment measures. Selling and administrative expense as a percentage of revenues in 2019 was relatively flat compared with 2018.
• Lower research and development expense as a percentage of revenues in 2020 as compared with 2019 primarily reflected the prior-period impact of a write-down recorded by the Surgery unit. This write-down drove higher research and development expense as a percentage of revenues in 2019 as compared with 2018.
• The Interventional segment's lower income in 2020 additionally reflected the expiration in 2019 of a royalty income stream acquired in the Bard transaction.
## Geographic Revenues
BD’s worldwide revenues by geography were as follows:
<img src='content_image/1046376.jpg'>
U.S. revenues in 2020 were relatively flat compared with 2019 as the Life Sciences segment's Integrated Diagnostic Solutions unit's sales related to COVID-19 diagnostic testing largely offset the declines noted above for the Medical segment's Medication Management Solutions and Medication Delivery Solutions units, as well as for the Interventional segment's Surgery and Peripheral Intervention units.
U.S. revenues in 2019 reflected growth in all three segments. U.S. revenues in 2019 were favorably impacted by the inclusion of revenues associated with Bard's products in results for the first quarter of fiscal year 2019, as noted above. Revenue growth in 2019 was also attributable to sales in the Medical segment's Medication Management Solutions unit as well as to sales in the Interventional segment's Urology and Critical Care and Surgery units. U.S. revenue growth in 2019 was unfavorably impacted by results in the Medical
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] | overall_image/a56898c71f296dc42c080b5380e20b1eea28c6685ebf14a3bc8de88c39151e45.png | million relating to a product recall in the Medical segment, as further discussed above, and a pre-tax gain of $336 million recognized on BD's sale of its Advanced Bioprocessing business. Additional disclosures regarding the product liability matters and divestiture transaction are provided in Notes 5 and 11, respectively, to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
## Net Interest Expense
<img src='content_image/1024912.jpg'>
Lower interest expense in 2020 and 2019 compared with the prior-year periods reflected debt repayments during fiscal year 2019, as well as lower overall interest rates on debt outstanding as a result of refinancing activities. The decrease in interest expense in 2019 compared with 2018 also reflected higher fees incurred in 2018 to draw from a term loan facility we entered in September 2018. Additional disclosures regarding our financing arrangements and debt instruments are provided in Note 16 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
The decrease in interest income in 2019 compared with 2018 reflected higher levels of cash on hand in the first quarter of fiscal year 2018 in anticipation of closing the Bard acquisition at the end of the quarter.
## Income Taxes
The income tax rates in 2020, 2019 and 2018 were as follows:
<img src='content_image/1024913.jpg'>
The impact from specified items in 2020 was less favorable compared with the benefit associated with specified items in 2019. The effective income tax rate in 2019 reflected a favorable impact relating to the timing of certain discrete items, as well as the recognition of $50 million of tax benefit recorded for the impacts of U.S. tax legislation that was enacted in December 2017, compared with additional tax expense of $640 million that was recognized as a result of this legislation in 2018. For further disclosures regarding our accounting for this U.S. tax legislation, refer to Note 17 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
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] | overall_image/37ef546bfbbabd5441d52cc35e6306e21121ddaef25bce3b932c5914aef951ec.png | ## Net Cash Flows from Investing Activities
## Capital expenditures
Our investments in capital expenditures are focused on projects that enhance our cost structure and manufacturing capabilities, and support our strategy of geographic expansion with select investments in growing markets. Capital expenditures of $810 million, $957 million and $895 million in 2020, 2019 and 2018, respectively, primarily related to manufacturing capacity expansions. Details of spending by segment are contained in Note 7 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
## Acquisitions
Cash outflows for acquisitions in 2020 primarily reflected our acquisition of Straub Medical AG in the third quarter of 2020. Cash outflows for acquisitions in 2018 primarily related to our acquisition of Bard. For further discussion regarding the Bard acquisition, refer to Note 10 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
## Divestitures
Cash inflows relating to divestitures in 2019 and 2018 were $477 million and $534 million, respectively. For further discussion, refer to Note 11 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
## Net Cash Flows from Financing Activities
Net cash from financing activities in 2020, 2019 and 2018 included the following significant cash flows:
<img src='content_image/1054533.jpg'>
Additional disclosures regarding the equity and debt-related financing activities detailed above are provided in Notes 3 and 16 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
## Debt-Related Activities
Certain measures relating to our total debt were as follows:
<img src='content_image/1054534.jpg'>
(a) Represents shareholders’ equity, net non-current deferred income tax liabilities, and debt.
The decreases in our total debt at September 30, 2020 and September 30, 2019 reflected repayments and redemptions of certain notes, partially offset by issuances of long-term notes in 2020 and 2019. Additional disclosures regarding our debt instruments are provided in Note 16 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data.
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] | overall_image/dc603734b2d4f5a0cfa50363090ee1440ad5051d90077ae27bc5329c14877da2.png | ## Cash and Short-term Investments
At September 30, 2020, total worldwide cash and short-term investments were $2.937 billion, including restricted cash, which were largely held in the United States.
## Financing Facilities
We have a five-year senior unsecured revolving credit facility in place which will expire in December 2022. The facility agreement includes a provision that enabled BD, subject to additional commitments made by the lenders, to access up to an additional $500 million in financing through the facility for a maximum aggregate commitment of $2.75 billion. In April 2020, we entered into a supplement to the facility agreement which increased the revolving commitments available under the facility by $381 million. As such, borrowings provided for under the agreement increased from $2.25 billion to $2.63 billion. We are also able to issue up to $100 million in letters of credit under this revolving credit facility. We use proceeds from this facility to fund general corporate needs. There were no borrowings outstanding under the revolving credit facility at September 30, 2020.
The agreement for our revolving credit facility and the supplement entered into in April 2020 contained the following financial covenants. We were in compliance with these covenants as of September 30, 2020.
• We are required to maintain an interest expense coverage ratio of not less than 4-to-1 as of the last day of each fiscal quarter.
• We are required to have a leverage coverage ratio of no more than:
◦ 6-to-1 from the closing date of the Bard acquisition until and including the first fiscal quarter-end thereafter;
In March 2020, we entered into a 364-day senior unsecured term loan facility with borrowing capacity available of $2.0 billion. During the third quarter of fiscal year 2020, we repaid $1.9 billion of borrowings outstanding under this term loan with cash on hand and terminated the facility. We also have informal lines of credit outside the United States. We may, from time to time, access the commercial paper market as we manage working capital over the normal course of our business activities. We had no commercial paper borrowings outstanding as of September 30, 2020. Also over the normal course of our business activities, we transfer certain trade receivable assets to third parties under factoring agreements. Additional disclosures regarding these sales of trade receivable assets are provided in Note 15 to the consolidated financial statements contained in Item 8.
Financial Statements and Supplementary Data.
## Access to Capital and Credit Ratings
◦ 5.75-to-1 for the subsequent four fiscal quarters thereafter;
◦ 5.25-to-1 for the subsequent four fiscal quarters thereafter;
◦ 4.5-to-1 for the subsequent four fiscal quarters thereafter;
◦ 4-to-1 for the subsequent four fiscal quarters thereafter;
◦ 3.75-to-1 thereafter.
Our corporate credit ratings with the rating agencies Standard & Poor's Ratings Services ("S&P"), Moody's Investor Service (Moody's) and Fitch Ratings ("Fitch") were as follows at September 30, 2020:
<img src='content_image/1055304.jpg'>
In March 2020, Standard & Poor's Ratings Services affirmed our September 30, 2019 ratings and revised the agency's outlook regarding the likely direction of these ratings from Stable to Negative.
Lower corporate debt ratings and further downgrades of our corporate credit ratings or other credit ratings may increase our cost of borrowing. We believe that given our debt ratings, our financial management policies, our ability to generate cash flow and the non-cyclical, geographically diversified nature of our businesses, we would have access to additional short-term and long-term capital should the need arise. A rating reflects only the view of a rating agency and is not a recommendation to buy, sell or hold securities. Ratings can be revised
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This report includes forward-looking statements within the meaning of the federal securities laws. BD and its representatives may also, from time to time, make certain forward-looking statements in publicly released materials, both written and oral, including statements contained in filings with the Securities and Exchange Commission, press releases, and our reports to shareholders. Forward-looking statements may be identified by the use of words such as “plan,” “expect,” “believe,” “intend,” “will,”, “may”, “anticipate,” “estimate” and other words of similar meaning in conjunction with, among other things, discussions of future operations and financial performance (including volume growth, pricing, sales and earnings per share growth, and cash flows) and statements regarding our strategy for growth, future product development, regulatory approvals, competitive position and expenditures. All statements that address our future operating performance or events or developments that we expect or anticipate will occur in the future are forward-looking statements.
Forward-looking statements are, and will be, based on management’s then-current views and assumptions regarding future events, developments and operating performance, and speak only as of their dates. Investors should realize that if underlying assumptions prove inaccurate, or risks or uncertainties materialize, actual results could vary materially from our expectations and projections. Investors are therefore cautioned not to place undue reliance on any forward-looking statements. Furthermore, we undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events and developments or otherwise, except as required by applicable law or regulations.
The following are some important factors that could cause our actual results to differ from our expectations in any forward-looking statements. For further discussion of certain of these factors, see Item 1A. Risk Factors in this report.
• Any impact of the COVID-19 pandemic on our business, including, without limitation, continued decreases in the demand for our products or disruptions to our operations and our supply chain, and factors that could impact the demand and pricing for our COVID-19 diagnostics testing.
• Weakness in the global economy and financial markets, which could increase the cost of operating our business, weaken demand for our products and services, negatively impact the prices we can charge for our products and services, or impair our ability to produce our products.
• Competitive factors that could adversely affect our operations, including new product introductions and technologies (for example, new forms of drug delivery) by our current or future competitors, consolidation or strategic alliances among healthcare companies, distributors and/or payers of healthcare to improve their competitive position or develop new models for the delivery of healthcare, increased pricing pressure due to the impact of low-cost manufacturers, patents attained by competitors (particularly as patents on our products expire), new entrants into our markets and changes in the practice of medicine.
• Risks relating to the significant additional indebtedness we incurred in connection with the financing of the Bard acquisition and the impact it may have on our ability to operate the combined company.
• The adverse financial impact resulting from unfavorable changes in foreign currency exchange rates.
• Regional, national and foreign economic factors, including inflation, deflation, and fluctuations in interest rates, and their potential effect on our operating performance.
• Our ability to achieve our projected level or mix of product sales, as our earnings forecasts are based on projected sales volumes and pricing of many product types, some of which are more profitable than others.
• Changes in reimbursement practices of governments or third-party payers, or adverse decisions relating to our products by such payers, which could reduce demand for our products or the price we can charge for such products.
• Cost containment efforts in the U.S. or in other countries in which we do business, such as alternative payment reform and increased use of competitive bidding and tenders, including, without limitation, any expansion of the volume-based procurement process in China.
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The information required by this item is included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Notes 1, 14 and 15 to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data, and is incorporated herein by reference.
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## Management’s Responsibilities
## Reports of Management
The following financial statements have been prepared by management in conformity with U.S. generally accepted accounting principles and include, where required, amounts based on the best estimates and judgments of management. The integrity and objectivity of data in the financial statements and elsewhere in this Annual Report are the responsibility of management.
In fulfilling its responsibilities for the integrity of the data presented and to safeguard the Company’s assets, management employs a system of internal accounting controls designed to provide reasonable assurance, at appropriate cost, that the Company’s assets are protected and that transactions are appropriately authorized, recorded and summarized. This system of control is supported by the selection of qualified personnel, by organizational assignments that provide appropriate delegation of authority and division of responsibilities, and by the dissemination of written policies and procedures. This control structure is further reinforced by a program of internal audits, including a policy that requires responsive action by management.
The Board of Directors monitors the internal control system, including internal accounting and financial reporting controls, through its Audit Committee, which consists of eight independent Directors. The Audit Committee meets periodically with the independent registered public accounting firm, the internal auditors and management to review the work of each and to satisfy itself that they are properly discharging their responsibilities. The independent registered public accounting firm and the internal auditors have full and free access to the Audit Committee and meet with its members, with and without management present, to discuss the scope and results of their audits including internal control, auditing and financial reporting matters.
## Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Act of 1934. Management conducted an assessment of the effectiveness of internal control over financial reporting based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework).
Based on the Company's assessment of the effectiveness of internal control over financial reporting and the criteria noted above, management concluded that internal control over financial reporting was effective as of September 30, 2020.
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/s/ Thomas E. Polen
Thomas E. Polen Chief Executive Officer and President
/s/ Christopher Reidy
Christopher Reidy Executive Vice President, Chief Financial Officer and Chief Administrative Officer
/s/ Thomas J. Spoerel
Thomas J. Spoerel Vice President, Controller and Chief Accounting Officer
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## Income taxes - Uncertain tax positions
As discussed in Notes 1 and 17 of the consolidated financial statements, the Company has recorded a liability of $719 million related to uncertain tax positions as of September 30, 2020. The Company conducts business in numerous countries and is therefore subject to income taxes in multiple jurisdictions, which impacts the provision for income taxes. Due to the multinational operations of the Company, changes in global income tax laws and regulation result in complexity in the accounting for and monitoring of income taxes including the provision for uncertain tax positions.
Auditing the completeness of management’s identification of uncertain tax positions involved complex analysis and auditor judgment related to the evaluation of the income tax consequences of significant transactions, including internal restructurings, and changes in income tax law and regulations in various jurisdictions, which is often subject to interpretation.
## How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s income tax provision process, such as controls over management’s identification and assessment of changes to tax laws and income tax positions to account for uncertain tax positions, including management’s review of the related tax technical analyses.
We performed audit procedures, among others, to evaluate the Company’s assumptions used to develop its uncertain tax positions and related unrecognized income tax benefit amounts by jurisdiction. We obtained an understanding of the Company’s legal structure through our review of organizational charts and related legal documents. We further considered the income tax consequences of significant transactions, including internal restructurings, and assessed management’s interpretation of those changes under the relevant jurisdiction’s tax law. Due to the complexity of tax law, we involved our tax subject matter professionals to assess the Company’s interpretation of and compliance with tax laws in these jurisdictions, as well as to identify tax law changes. We also involved our tax subject matter professionals to evaluate the technical merits of the Company’s accounting for its tax positions, including assessing the Company’s correspondence with the relevant tax authorities and evaluating third-party advice obtained by the Company. We also evaluated the Company’s income tax disclosures included in Note 17 to the consolidated financial statements in relation to these matters.
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## Goodwill impairment - Interventional segment
At September 30, 2020, the Company’s goodwill assigned to the Interventional segment was $12.7 billion. As discussed in Note 1 of the consolidated financial statements, goodwill is tested for impairment at least annually at the reporting unit level using quantitative models.
Auditing management’s annual goodwill impairment test was complex and highly judgmental due to the significant estimation required in determining the fair value of the reporting units. In particular, the fair value estimates were sensitive to significant assumptions such as the discount rate, revenue growth rate, operating margin, and terminal value, which are affected by expectations about future market or economic conditions, including the impact of the pandemic.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s goodwill impairment review process. For example, we tested controls over management’s review of the inputs and assumptions to the goodwill impairment analysis.
To test the estimated fair value of the Company’s reporting units, our audit procedures included, among others, assessing fair value methodology, evaluating the prospective financial information used by the Company in its valuation analysis and involving our valuation specialists to assist in testing the significant assumptions discussed above. We compared the significant assumptions used by management to current industry and economic trends, historical financial results, and other relevant factors that would affect the significant assumptions. We assessed the historical accuracy of management’s estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the reporting units. In addition, we tested the reconciliation of the fair value of the reporting units to the market capitalization of the Company.
/s/ ERNST & YOUNG LLP
We have served as the Company's auditor since 1959.
New York, New York November 25, 2020
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## Becton, Dickinson and Company Years Ended September 30
<img src='content_image/1039724.jpg'>
Amounts may not add due to rounding.
See notes to consolidated financial statements.
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## Notes to Consolidated Financial Statements — (Continued)
## Becton, Dickinson and Company
The Company’s unamortized intangible assets include goodwill which arise from acquisitions of businesses. The Company currently reviews goodwill for impairment using quantitative models. Goodwill is reviewed at least annually for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. The Company’s reporting units generally represent one level below reporting segments. Potential impairment of goodwill is generally identified by comparing the fair value of a reporting unit, estimated using an income approach, with its carrying value. The annual impairment review performed on July 1, 2020 indicated that all identified reporting units’ fair values exceeded their respective carrying values.
Amortized intangible assets include developed technology assets which arise from acquisitions. These assets represent acquired intellectual property that is already technologically feasible upon the acquisition date or acquired in-process research and development assets that are completed subsequent to acquisition. Developed technology assets are generally amortized over periods ranging from 15 to 20 years, using the straight-line method. Customer relationship assets are generally amortized over periods ranging from 10 to 15 years, using the straight-line method. Other intangibles with finite useful lives, which include patents, are amortized over periods principally ranging from one to 40 years, using the straight-line method. Finite-lived intangible assets, including developed technology assets, are periodically reviewed when impairment indicators are present to assess recoverability from future operations using undiscounted cash flows. The carrying values of these finite-lived assets are compared to the undiscounted cash flows they are expected to generate and an impairment loss is recognized in operating results to the extent any finite-lived intangible asset’s carrying value exceeds its calculated fair value.
## Foreign Currency Translation
Generally, foreign subsidiaries’ functional currency is the local currency of operations and the net assets of foreign operations are translated into U.S. dollars using current exchange rates. The U.S. dollar results that arise from such translation, as well as exchange gains and losses on intercompany balances of a long-term investment nature, are included in the foreign currency translation adjustments in Accumulated other comprehensive income (loss).
## Revenue Recognition
The Company recognizes revenue from product sales when the customer obtains control of the product, which is generally upon shipment or delivery, depending on the delivery terms specified in the sales agreement. Revenues associated with certain instruments and equipment for which installation is complex, and therefore significantly affects the customer’s ability to use and benefit from the product, are recognized upon customer acceptance of these installed products. Revenue for certain service arrangements, including extended warranty and software maintenance contracts, is recognized ratably over the contract term. When arrangements include multiple performance obligations, the total transaction price of the contract is allocated to each performance obligation based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. Variable consideration such as rebates, sales discounts and sales returns are estimated and treated as a reduction of revenue in the same period the related revenue is recognized. These estimates are based on contractual terms, historical practices, and current trends, and are adjusted as new information becomes available. Revenues exclude any taxes that the Company collects from customers and remits to tax authorities.
Equipment lease transactions with customers are evaluated and classified as either operating or sales-type leases. Generally, these arrangements are accounted for as operating leases and therefore, revenue is recognized at the contracted rate over the rental period defined within the customer agreement.
Additional disclosures regarding the Company's accounting for revenue recognition are provided in Note 6.
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BD operates in the increasingly complex and challenging medical technology marketplace. Technological advances and scientific discoveries have accelerated the pace of change in medical technology, the regulatory environment of medical products is becoming more complex and vigorous, and economic conditions have resulted in a challenging market. Companies of varying sizes compete in the global medical technology field.
Some are more specialized than BD with respect to particular markets, and some have greater financial resources than BD. New companies have entered the field, particularly in the areas of molecular diagnostics, safety-engineered devices and in the life sciences, and established companies have diversified their business activities into the medical technology area. Other firms engaged in the distribution of medical technology products have become manufacturers of medical devices and instruments as well. Acquisitions and collaborations by and among companies seeking a competitive advantage also affect the competitive environment. In addition, the entry into the market of low-cost manufacturers has created increased pricing pressures. BD competes in this evolving marketplace on the basis of many factors, including price, quality, innovation, service, reputation, distribution and promotion. The impact of these factors on BD’s competitive position varies among BD’s various product offerings. In order to remain competitive in the industries in which it operates, BD continues to make investments in research and development, quality management, quality improvement, product innovation and productivity improvement in support of its core strategies. See further discussion of the risks relating to competition in the medical technology industry in Item 1A. Risk Factors.
## Third-Party Reimbursement
Reimbursement is an important strategic consideration in the development and marketing of medical technology. Obtaining coverage, coding and payment is critical to the commercial success of a new product or procedure. Difficulty in achieving market access can lead to slow adoption in the marketplace and inadequate payment levels that can continue for months or even years.
A majority of BD’s customers rely on third-party payers, including government programs and private health insurance plans, to reimburse some or all of the cost of the procedures, products and services they provide. Vertical integration has created a very concentrated market among commercial third-party payers in the U.S. Global payers are increasingly focused on strategies to control spending on healthcare and reward improvements in quality and patient outcomes.
BD is actively engaged in identifying and communicating value propositions of its products for payer, provider, and patient stakeholders, and it employs various efforts and resources to attempt to positively impact coverage, coding and payment pathways. However, BD has no direct control over payer decision-making with respect to coverage and payment levels for BD products. The manner and level of reimbursement in any given case may depend on the site of care, the procedure(s) performed, the final patient diagnosis, the device(s) and/or drug(s) utilized, the available budget, or a combination of these factors, and coverage and payment levels are determined at each payer’s discretion. As BD’s product offerings are diverse across a variety of healthcare settings, they are affected to varying degrees by the many payment pathways that impact the decisions of healthcare providers regarding which medical products they purchase and the prices they are willing to pay for those products. Therefore, changes in reimbursement levels or methods may either positively or negatively impact sales of BD products in any given country for any given product.
As government programs expand healthcare coverage for their citizens, they have at the same time sought to control costs by limiting the amount of reimbursement they will pay for particular procedures, products or services. In addition, most payers are seeking price predictability in order to mitigate future exposure to manufacturer price increases. This is coupled with an increase in high deductible private insurance plans, which transfer more pricing exposure and burden directly to the patient.
Many payers both in the U.S. and globally have developed specific payment and delivery mechanisms to support these cost control efforts and to focus on paying for value. These mechanisms include payment reductions, pay for performance measures, quality-based performance payments, restrictive coverage policies, bidding and tender mechanics, studies to compare the effectiveness of therapies and use of technology
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## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
The Company considers its shipping and handling costs to be contract fulfillment costs and records them within Selling and administrative expense. Shipping expense was $551 million, $511 million and $479 million in 2020, 2019 and 2018, respectively.
## Derivative Financial Instruments
All derivatives are recorded in the balance sheet at fair value and changes in fair value are recognized currently in earnings unless specific hedge accounting criteria are met. Any deferred gains or losses associated with derivative instruments are recognized in income in the period in which the underlying hedged transaction is recognized. Additional disclosures regarding the Company's accounting for derivative instruments are provided in Note 14.
## Income Taxes
The Company has reviewed its needs in the United States for possible repatriation of undistributed earnings of its foreign subsidiaries and continues to invest foreign subsidiaries earnings outside of the United States to fund foreign investments or meet foreign working capital and property, plant and equipment expenditure needs. As a result, the Company is permanently reinvested with respect to all of its historical foreign earnings as of September 30, 2020. Deferred taxes are not provided on undistributed earnings of foreign subsidiaries that are indefinitely reinvested. The determination of the amount of the unrecognized deferred tax liability related to the undistributed earnings is not practicable because of the complexities associated with its hypothetical calculation.
The Company conducts business and files tax returns in numerous countries and currently has tax audits in progress in a number of tax jurisdictions. In evaluating the exposure associated with various tax filing positions, the Company records accruals for uncertain tax positions based on the technical support for the positions, past audit experience with similar situations, and the potential interest and penalties related to the matters.
The Company maintains valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances are included in the tax provision in the period of change. In determining whether a valuation allowance is warranted, management evaluates factors such as prior earnings history, expected future earnings, carryback and carryforward periods and tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset. Additional disclosures regarding the Company's accounting for income taxes are provided in Note 17.
## Earnings per Share
Basic earnings per share are computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. In computing diluted earnings per share, only potential common shares that are dilutive (i.e., those that reduce earnings per share or increase loss per share) are included in the calculation.
## Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. These estimates or assumptions affect reported assets, liabilities, revenues and expenses as reflected in the consolidated financial statements. Actual results could differ from these estimates.
## Note 2 — Accounting Changes
## New Accounting Principles Adopted
In February 2016, the Financial Accounting Standards Board ("FASB") issued a new lease accounting standard which requires lessees to recognize lease assets and lease liabilities on the balance sheet, as well as
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expanded disclosures regarding leasing arrangements. The Company adopted this standard on October 1, 2019, and elected certain practical expedients permitted under the transition guidance, including a transition method which allows application of the new standard at its adoption date, rather than at the earliest comparative period presented in the financial statements. The Company also elected not to perform any reassessments relative to its expired and existing leases upon its adoption of the new requirements. The Company's adoption of this standard did not materially impact its consolidated financial statements. Additional disclosures regarding the Company’s lease arrangements are provided in Note 18.
In August 2018, the FASB issued a new accounting standard to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The Company early adopted this standard as of April 1, 2020 on a prospective basis. The adoption of this standard did not materially impact the Company's consolidated financial statements.
In July 2018, the FASB issued accounting standard update (“ASU”) ASU 2018-09, "Codification Improvements", which, among other items, amended an illustrative example of a fair value hierarchy disclosure to indicate that a certain type of investment should not always be considered to be eligible to use the net asset value ("NAV") per share practical expedient. Also, it further clarified that an entity should evaluate whether a readily determinable fair value exists or whether its investments qualify for the NAV practical expedient. The Company early adopted this standard in the fourth quarter of fiscal year 2020 on a prospective basis, which is reflected in the fair value hierarchy classification of pension assets in Note 9, but does not change the fair value measurements of the investments.
On October 1, 2018, the Company adopted Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers" ("ASC 606") using the modified retrospective method. Under ASC 606, revenue is recognized upon the transfer of control of goods or services to customers and reflects the amount of consideration to which a reporting entity expects to be entitled in exchange for those goods or services. The Company assessed the impact of this new standard on its consolidated financial statements based upon a review of contracts that were not completed as of October 1, 2018. Amounts presented in the Company's financial statements for the prior-year periods were not revised and are reflective of the revenue recognition requirements which were in effect for those periods. This accounting standard adoption, which is further discussed in Note 6, did not materially impact any line items of the Company's consolidated income statements and balance sheet.
On October 1, 2018, the Company retrospectively adopted an accounting standard update which requires all components of net periodic pension and postretirement benefit costs to be disaggregated from the service cost component and to be presented on the income statement outside a subtotal of income from operations, if one is presented. Upon the Company's adoption of the accounting standard update, which did not have a material impact on its consolidated financial statements, all components of the Company’s net periodic pension and postretirement benefit costs, aside from service cost, are recorded to Other income, net on its consolidated income statements for all periods presented. Revisions of prior-year amounts were estimated based upon previously disclosed amounts.
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## Becton, Dickinson and Company
sales representatives. End-users of the Company's products include healthcare institutions, physicians, life science researchers, clinical laboratories, the pharmaceutical industry and the general public.
## Timing of Revenue Recognition
The Company's revenues are primarily recognized when the customer obtains control of the product sold, which is generally upon shipment or delivery, depending on the delivery terms specified in the sales agreement. Revenues associated with certain instruments and equipment for which installation is complex, and therefore significantly affects the customer’s ability to use and benefit from the product, are recognized when customer acceptance of these installed products has been confirmed. For certain service arrangements, including extended warranty and software maintenance contracts, revenue is recognized ratably over the contract term. The majority of revenues relating to extended warranty contracts associated with certain instruments and equipment is generally recognized within a few years whereas deferred revenue relating to software maintenance contracts is generally recognized over a longer period.
## Measurement of Revenues
The Company acts as the principal in substantially all of its customer arrangements and as such, generally records revenues on a gross basis. Revenues exclude any taxes that the Company collects from customers and remits to tax authorities. The Company considers its shipping and handling costs to be costs of contract fulfillment and has made the accounting policy election to record these costs within Selling and administrative expense .
Payment terms extended to the Company's customers are based upon commercially reasonable terms for the markets in which the Company's products are sold. Because the Company generally expects to receive payment within one year or less from when control of a product is transferred to the customer, the Company does not generally adjust its revenues for the effects of a financing component. The Company’s estimate of probable credit losses relating to trade receivables is determined based on historical experience and other specific account data. Amounts are written off against the allowances for doubtful accounts when the Company determines that a customer account is uncollectable. Such amounts are not material to the Company's consolidated financial results.
The Company's gross revenues are subject to a variety of deductions which are recorded in the same period that the underlying revenues are recognized. Such variable consideration includes rebates, sales discounts and sales returns. Because these deductions represent estimates of the related obligations, judgment is required when determining the impact of these revenue deductions on gross revenues for a reporting period. Rebates provided by the Company are based upon prices determined under the Company's agreements with its end-user customers. Additional factors considered in the estimate of the Company's rebate liability include the quantification of inventory that is either in stock at or in transit to the Company's distributors, as well as the estimated lag time between the sale of product and the payment of corresponding rebates. The impact of other forms of variable consideration, including sales discounts and sales returns, is not material to the Company's revenues. Additional disclosures relating to sales discounts and sales returns are provided in Note 19.
The Company's agreements with customers within certain organizational units including Medication Management Solutions, Integrated Diagnostic Solutions and Biosciences, contain multiple performance obligations including both products and certain services noted above. The transaction price for these agreements is allocated to each performance obligation based upon its relative standalone selling price. Standalone selling price is the amount at which the Company would sell a promised good or service separately to a customer. The Company generally estimates standalone selling prices using its list prices and a consideration of typical discounts offered to customers.
## Effects of Revenue Arrangements on Consolidated Balance Sheets
Due to the nature of the majority of the Company's products and services, the Company typically does not incur costs to fulfill a contract in advance of providing the customer with goods or services. Capitalized
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] | overall_image/539229d3df9507266aa7f69b8bd3956c2dcf59eff8d7ebfdb6432e4e658c14f6.png | ## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
Financial information for the Company’s segments is detailed below. The Company has no material intersegment revenues. As discussed in Note 10, the Company completed its acquisition of Bard on December 29, 2017. Bard's operating results were included in the Company’s consolidated results of operations beginning on January 1, 2018.
<img src='content_image/1052114.jpg'>
(a) The amounts in fiscal years 2019 and 2018 reflect the reclassification of U.S. revenues of $11 million and $17 million, respectively, associated with the movement, effective on October 1, 2019, of certain products from the Medication Delivery Solutions unit to the Medication Management Solutions unit.
(b) The amounts in fiscal years 2019 and 2018 reflect the total reclassifications of $130 million and $134 million, respectively, of U.S. revenues and $55 million and $60 million, respectively, of international revenues associated with the movement, effective on October 1, 2019, of certain products from the Surgery unit and the Urology and Critical Care unit to the Peripheral Intervention unit.
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] | overall_image/ed6420ac47d5935c6392c3e80870b8834885c4f25cc31f0b43cf3d1147fa0a1c.png | ## Notes to Consolidated Financial Statements — (Continued)
## Becton, Dickinson and Company
The fair value of share-based payments is recognized as compensation expense in net income. The amounts and location of compensation cost relating to share-based payments included in the consolidated statements of income is as follows:
<img src='content_image/1027798.jpg'>
Upon the Company's acquisition of Bard in 2018, certain pre-acquisition equity awards of Bard were converted into either BD SARs or BD restricted stock awards, as applicable. These awards have substantially the same terms and conditions as the converted Bard awards immediately prior to the acquisition date. Compensation expense of $16 million, $40 million and $126 million associated with these replacement awards was recorded in Acquisitions and other restructurings in 2020, 2019 and 2018, respectively.
## Stock Appreciation Rights
SARs represent the right to receive, upon exercise, shares of common stock having a value equal to the difference between the market price of common stock on the date of exercise and the exercise price on the date of grant. SARs vest over a period of four years and have a term of ten years. The fair value was estimated on the date of grant using a lattice-based binomial option valuation model that uses the following weighted- average assumptions:
<img src='content_image/1027802.jpg'>
Expected volatility is based upon historical volatility for the Company’s common stock and other factors. The expected life of SARs granted is derived from the output of the lattice-based model, using assumed exercise rates based on historical exercise and termination patterns, and represents the period of time that SARs granted are expected to be outstanding. The risk-free interest rate used is based upon the published U.S. Treasury yield curve in effect at the time of grant for instruments with a similar life. The dividend yield is based upon the most recently declared quarterly dividend as of the grant date. The Company issued 0.8 million shares during 2020 to satisfy the SARs exercised.
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] | overall_image/58fa62764b1af94de923c32d38352565d261a1d1c4d8e056297707558ba33c18.png | ## Note 9 — Benefit Plans
## Notes to Consolidated Financial Statements — (Continued)
## Becton, Dickinson and Company
The Company has defined benefit pension plans covering certain employees in the United States and certain international locations. Postretirement healthcare and life insurance benefits provided to qualifying domestic retirees as well as other postretirement benefit plans in international countries are not material. The measurement date used for the Company’s employee benefit plans is September 30.
As a result of the Company’s conclusion to merge the legacy Bard pension plan into the BD defined benefit cash balance pension plan, the assets and liabilities of the legacy Bard U.S. defined pension benefit plan will be remeasured as of October 31, 2020. Amendments to this plan were approved and communicated to affected employees in the first quarter of fiscal year 2021. The legacy Bard U.S. pension plan has been frozen to prevent new participants since January 1, 2011.
Effective January 1, 2018, the legacy BD U.S. pension plan was frozen to limit the participation of employees who are hired or re-hired by the Company, or who transfer employment to the Company, on or after January 1, 2018.
Net pension cost for the years ended September 30 included the following components:
<img src='content_image/1028279.jpg'>
The amounts provided above for amortization of prior service credit and amortization of loss represent the reclassifications of prior service credits and net actuarial losses that were recognized in Accumulated other comprehensive income (loss) in prior periods. The settlement losses recorded in 2020, 2019 and 2018 included lump sum benefit payments associated with certain plans. The Company recognizes pension settlements when payments from the plan exceed the sum of service and interest cost components of net periodic pension cost associated with the plan for the fiscal year.
All components of the Company’s net periodic pension and postretirement benefit costs, aside from service cost, are recorded to Other income, net on its consolidated statements of income.
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] | overall_image/bfec45b56daa0e9e70591530b82594c7d0b023d89077b272dfc53cc2ebd17cd1.png | ## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
The benefit obligation associated with postretirement healthcare and life insurance plans provided to qualifying domestic retirees, which was largely recorded to Long-Term Employee Benefit Obligations, was $148 million and $153 million at September 30, 2020 and 2019, respectively.
Pension plans with accumulated benefit obligations in excess of plan assets and plans with projected benefit obligations in excess of plan assets consist of the following at September 30:
<img src='content_image/1056907.jpg'>
The estimated net actuarial loss and prior service credit that will be amortized from Accumulated other comprehensive income (loss) into net pension costs over the next fiscal year for pension benefits and other postretirement benefits are not material.
The weighted average assumptions used in determining pension plan information were as follows:
<img src='content_image/1056908.jpg'>
(a) The Company calculated the service and interest components utilizing an approach that discounts the individual expected cash flows using the applicable spot rates derived from the yield curve over the projected cash flow period.
## Expected Rate of Return on Plan Assets
The expected rate of return on plan assets is based upon expectations of long-term average rates of return to be achieved by the underlying investment portfolios. In establishing this assumption, the Company considers many factors, including historical assumptions compared with actual results; benchmark data; expected returns on various plan asset classes, as well as current and expected asset allocations.
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] | overall_image/b1bedad2f5deaaff962084e9e0278b1c3d16c289d6bb8c70e9afa8383d6ceee7.png | ## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
2017 were not material to the Company’s consolidated results of operations. As such, Bard's operating results were included in the Company’s consolidated results of operations beginning on January 1, 2018.
The acquisition-date fair value of consideration transferred consisted of the components below. The fair value of the shares and equity awards issued as consideration was recognized as a $6.5 billion increase to Capital in excess of par value and a $2.1 billion decrease to Common stock in treasury.
## Transaction Costs
<img src='content_image/1053084.jpg'>
Transaction costs related to this acquisition incurred during the years ended September 30, 2018 were approximately $56 million. These transaction costs were recorded as Acquisitions and other restructurings and consisted of legal, advisory and other costs. See Note 12 for discussion regarding restructuring costs incurred relative to the Bard acquisition.
## Unaudited Pro Forma Information
As noted above, Bard's operating activities from the acquisition date through December 31, 2017 were not material and the Company included Bard in its consolidated results of operations beginning on January 1, 2018. Revenues in 2018 were $3 billion. Net Income in 2018 included loss attributable to Bard of $(107) million. The following table provides the pro forma results for the fiscal year 2018 as if Bard had been acquired as of October 1, 2016.
<img src='content_image/1053085.jpg'>
The pro forma results above include the impact of the following adjustments, as necessary: additional amortization and depreciation expense relating to assets acquired; interest and other financing costs relating to the acquisition transaction; and the elimination of one-time or nonrecurring items. The one-time or nonrecurring items eliminated for the year ended September 30, 2018 were primarily comprised of fair value step-up adjustments of $478 million recorded relative to Bard's inventory on the acquisition date, the transaction costs discussed above, as well as certain Bard-related restructuring costs disclosed in Note 12. In addition, amounts previously reported by Bard as revenues related to a royalty income stream have been reclassified to Other income (expense), net to conform to the Company's reporting classification.
The pro forma results do not include any anticipated cost savings or other effects of the planned integration of Bard. Accordingly, the pro forma results above are not necessarily indicative of the results that would have been if the acquisition had occurred on the dates indicated, nor are the pro forma results indicative of results which may occur in the future.
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] | overall_image/f770d07fdd9a9fe76ef5b7e6238e4cd194a8fef08f848c02276903ee8ef348e1.png | ## Human Capital Management
As of September 30, 2020, we had approximately 72,000 associates located in over 70 different countries in a variety of different roles. We compete in the highly competitive medical technology industry. Attracting, developing and retaining talented people in techni cal, marketing, sales, research and other positions is crucial to executing our strategy and our ability to compete effectively. Our ability to recruit and retain such talent depends on a number of factors, including compensation and benefits, talent development and career opportunities, and work environment. To that end, we invest in our associates in order to be an employer of choice.
## Diversity & Inclusion
Our associates reflect the communities we live and work in, the customers and patients we serve, and possess a broad range of thought and experiences that have helped BD achieve our leadership position in the medical technology industry and the global marketplace. A key component of our journey to continually build a better BD is our commitment to global inclusion and diversity ("I&D"). We believe this commitment allows us to better our understanding of patient and customer needs and develop technologies to meet those needs. Our I&D efforts have garnered recognitions, including Best Places to Work for Disability and LGBTQ Inclusion, Bloomberg’s Gender Equality Index, and Diversity Inc’s Noteworthy Companies.
Although we have made progress in our workforce diversity representation, we seek to continuously improve in this area. Each year, we establish annual corporate I&D goals to continue improving our hiring, development, advancement, and retention of diverse talent and our overall diversity representation. In addition, our executive leaders serve as sponsors of our nine associate-led resource groups ("ARGs") in support of their efforts to provide meaningful professional development for our workforce, drive business improvement and innovation and contribute to BD's role as a socially responsible community member.
Externally, we are involved in industry I&D efforts as one of several companies taking a leadership role in AdvaMed’s efforts to improve diversity in the medical technology industry. We have also committed to leadership in I&D through our support for the Equality Act and the United Nations’ Open for Business program and organizations like The Human Rights Campaign, Equal Justice Initiative, and The United Negro College Fund.
Through the BD Helping Build Healthy Communities initiative, we committed $22.6 million to support Direct Relief and the National Association of Community Health Centers in expanding the innovative practices of U.S. community health centers, which collectively serve more than 30 million U.S. patients – the majority of which are in underrepresented communities.
## BD 2020 Workforce Diversity Representation
<img src='content_image/1056864.jpg'>
For the above table, we define “executives” as associates in positions of vice president and above. “Management” positions are defined as those in manager, director or equivalent roles. Information regarding race and gender is based on information provided by associates.
## Associate Growth and Development
We invest significant resources to develop talent with the right capabilities to deliver the growth and innovation needed to support our strategy.
We have launched an enhanced Strategic Organizational Planning process to ensure we build the organizational capabilities required in the years to come. We offer associates and their managers a number of tools to help in their personal and professional development, including career development plans, mentoring programs and in-house learning opportunities, including BD University, our in-house continuing education program that follows a "leaders-as-teachers" approach. We also have a deeply-rooted practice of investing in our next generation of leaders and offer associates a number of leadership
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For interest rate swaps designated as fair value hedges (i.e., hedges against the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk), changes in the fair value of the interest rate swaps offset changes in the fair value of the fixed rate debt due to changes in market interest rates.
The total notional amount of the Company’s outstanding interest rate swaps designated as fair value hedges was $375 million at September 30, 2020 and 2019. The outstanding swaps represent fixed-to-floating interest rate swap agreements the Company entered into to convert the interest payments on certain long-term notes from the fixed rate to a floating interest rate based on LIBOR. Changes in the fair value of the interest rate swaps offset changes in the fair value of the fixed rate debt. The amounts recorded during the years ended September 30, 2020 and 2019 for changes in the fair value of these hedges were immaterial to the Company's consolidated financial results.
Changes in the fair value of the interest rate swaps designated as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk) are recorded in Other comprehensive income (loss) . If interest rate derivatives designated as cash flow hedges are terminated, the balance in Accumulated other comprehensive income (loss) attributable to those derivatives is reclassified into earnings over the remaining life of the hedged debt. The net realized loss related to terminated interest rate swaps expected to be reclassified and recorded in Interest expense within the next 12 months is $6 million, net of tax.
The total notional amount of the Company's outstanding forward starting interest rate swaps was $1.5 billion at September 30, 2020 and 2019. The Company entered into these contracts in the fourth quarter of fiscal year 2019 to mitigate its exposure to interest rate risk. The Company recorded after-tax losses of $75 million in Other comprehensive income (loss) relating to these interest rate hedges during the year ended September 30, 2020. The amounts recognized in other comprehensive income relating to interest rate hedges during the year ended 2019 were immaterial.
## Other Risk Exposures
The Company purchases resins, which are oil-based components used in the manufacture of certain products. Significant increases in world oil prices that lead to increases in resin purchase costs could impact future operating results. From time to time, the Company has managed price risks associated with these commodity purchases through commodity derivative forward contracts. The Company had no outstanding commodity derivative forward contracts at September 30, 2020. The Company's outstanding commodity derivative forward contracts at September 30, 2019 were immaterial to the Company's consolidated financial results.
## Financial Statement Effects
The fair values of derivative instruments outstanding at September 30, 2020 and 2019 were not material to the Company's consolidated balance sheets.
The amounts reclassified from accumulated other comprehensive income relating to cash flow hedges during 2020, 2019 and 2018 were not material to the Company's consolidated financial results.
## Note 15 — Financial Instruments and Fair Value Measurements
The following reconciles cash and equivalents and restricted cash reported within the Company's consolidated balance sheets at September 30, 2020 and 2019 to the total of these amounts shown on the Company's consolidated statements of cash flows:
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] | overall_image/fbbab01d08a0a3a7ee18b1d78ec6d2e450421d6fd0437a599ffbea7485565a17.png | ## Long-term debt
## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
The carrying value of Long-Term Debt , net of unamortized debt issuance costs, at September 30 consisted of:
<img src='content_image/1032504.jpg'>
(a) All of the aggregate principal amount outstanding was redeemed during 2020, as further discussed below.
(b) Represents notes issued during 2020, as further discussed below.
The aggregate annual maturities of debt including interest during the fiscal years ending September 30, 2021 to 2025 are as follows: 2021 — $1.2 billion; 2022 — $3.8 billion; 2023 — $2.6 billion; 2024 — $2.3 billion; 2025 — $2.0 billion.
## Other current credit facilities
The Company has a five-year senior unsecured revolving credit facility in place which will expire in December 2022. The facility agreement includes a provision that enabled BD, subject to additional
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## Becton, Dickinson and Company
commitments made by the lenders, to access up to an additional $500 million in financing through the facility for a maximum aggregate commitment of $2.75 billion. In April 2020, the Company entered into a supplement to the facility agreement which increased the revolving commitments available under the facility by $381 million. As such, borrowings provided for under the agreement increased from $2.25 billion to $2.63 billion. The Company is also able to issue up to $100 million in letters of credit under this revolving credit facility. Proceeds from this facility are used to fund general corporate needs. There were no borrowings outstanding under the revolving credit facility at September 30, 2020 and borrowings outstanding at September 30, 2019 were $485 million. In addition, the Company has informal lines of credit outside of the United States.
The Company had no commercial paper borrowings outstanding as of September 30, 2020.
## 2020 Debt-Related Transactions
In March 2020, the Company entered into a 364-day senior unsecured term loan facility with borrowing capacity available of $2.0 billion. During the third quarter of fiscal year 2020, the Company repaid $1.9 billion of borrowings outstanding under this term loan with cash on hand and terminated the facility.
In May 2020, the Company issued $750 million of 2.823% notes due May 20, 2030 and $750 million of 3.794% notes due May 20, 2050. The Company used the net proceeds from this long-term debt offering, together with cash on hand, to repay the entire $1.000 billion aggregate principal outstanding on the 2.404% notes due June 5, 2020, and to redeem $500 million of the aggregate principal outstanding on the 3.250% notes due November 12, 2020, as well as accrued interest, related premiums, fees and expenses related to these repaid amounts. The Company redeemed this long-term debt at an aggregate market price of $506 million. The carrying value of these long-term notes was $500 million, and the Company recognized a loss on this debt extinguishment of $6 million, which was recorded in June 2020 within Other income, net , on the Company’s consolidated statements of income.
In September 2020, the Company redeemed the remaining $200 million of its outstanding 3.25% notes due November 12, 2020, and $750 million of its floating rate notes due December 29, 2020. Based upon the aggregate $950 million carrying value of the notes redeemed and the $951 million the Company paid to redeem the aggregate principal amount of the notes, the Company recorded a loss on these debt extinguishment transactions in the fourth quarter of fiscal year 2020 of $1 million within Other income, net , on its consolidated statements of income.
## 2019 Debt-Related Transactions
In March 2019, the Company redeemed an aggregate principal amount of $250 million of its outstanding floating rate senior unsecured U.S. notes due December 29, 2020. Based upon the $249 million carrying value of the notes redeemed and the $250 million the Company paid to redeem the aggregate principal amount of the notes, the Company recorded a loss on this debt extinguishment transaction in the second quarter of fiscal year 2019 of $1 million within Other income, net , on its consolidated statements of income.
In June 2019, Becton Dickinson Euro Finance S.à r.l., a private limited liability company (société à responsabilité limitée), which is an indirect, wholly-owned finance subsidiary of the Company, issued Euro-denominated debt consisting of 600 million Euros ($672 million) of 0.174% notes due June 4, 2021, 800 million Euros ($896 million) of 0.632% notes due June 4, 2023, and 600 million Euros ($672 million) of 1.208% notes due June 4, 2026. The notes are fully and unconditionally guaranteed on a senior unsecured basis by the Company. No other of the Company's subsidiaries provide any guarantees with respect to these notes. The indenture covenants included a limitation on liens and a restriction on sale and leasebacks, change of control and consolidation, merger and sale of assets covenants. These covenants are subject to a number of exceptions, limitations and qualifications. The indenture did not restrict the Company, Becton Dickinson Euro Finance S.à r.l., or any other of the Company's subsidiaries from incurring additional debt or other liabilities, including additional senior debt. Additionally, the indenture did not restrict Becton Dickinson Euro Finance S.à r.l. and the Company from granting security interests over its assets.
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] | overall_image/608c5b0d07eea2b7d3166511e2a3de2cbcec5cc58299b9459892478e436c5b11.png | ## Note 17 — Income Taxes
## Provision for Income Taxes
The provision (benefit) for income taxes the years ended September 30 consisted of:
## Notes to Consolidated Financial Statements — (Continued)
## Becton, Dickinson and Company
<img src='content_image/1030842.jpg'>
The components of Income Before Income Taxes for the years ended September 30 consisted of:
<img src='content_image/1030843.jpg'>
U.S. tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the "Act"), was enacted on December 22, 2017. The Act reduced the U.S. federal corporate tax rate from 35% to 21%, required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and created new taxes on certain foreign-sourced earnings. The Act subjects a U.S. shareholder to tax on global intangible low-taxed income ("GILTI") earned by certain foreign subsidiaries. The Company has elected to account for its GILTI tax due as a period expense in the year the tax is incurred.
During fiscal year 2019, the Company finalized its accounting for the income tax effects of the Act, and all adjustments related to finalization of its calculations were included as a component of Income tax provision (benefit) in fiscal year 2019. The Company recognized additional tax benefit of $50 million and additional tax cost of $640 million in 2019 and 2018, respectively, as a result of this legislation. These amounts are reflected in the Company's consolidated statements of income within Income tax provision (benefit) . During fiscal year 2019, the Company also changed its assertion with respect to historical unremitted foreign earnings, which resulted in a total tax benefit of $138 million, of which $67 million is related to the tax legislation benefit previously recorded, and is included as a component of Income tax provision (benefit) in fiscal 2019. The Company asserts indefinite reinvestment for all historical unremitted foreign earnings as of September 30, 2020.
## Unrecognized Tax Benefits
The table below summarizes the gross amounts of unrecognized tax benefits without regard to reduction in tax liabilities or additions to deferred tax assets and liabilities if such unrecognized tax benefits were settled. The Company believes it is reasonably possible that the amount of unrecognized benefits will change due to one or more of the following events in the next twelve months: expiring statutes, audit activity, tax payments, other activity, or final decisions in matters that are the subject of controversy in various taxing jurisdictions in which we operate.
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] | overall_image/4c1d7c37f13e2bf8cc8c7f59e6f5ff42942fa876d04ddc54451db9aca19d87a9.png | ## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
<img src='content_image/1036631.jpg'>
Upon the Company's acquisition of CareFusion in 2015, the Company became a party to a tax matters agreement with Cardinal Health resulting from Cardinal Health's spin-off of CareFusion in fiscal year 2010. Under the tax matters agreement, the Company is obligated to indemnify Cardinal Health for certain tax exposures and transaction taxes prior to CareFusion’s spin-off from Cardinal Health. The indemnification payable is approximately $164 million at September 30, 2020 and is included in Deferred Income Taxes and Other Liabilities on the consolidated balance sheet.
At September 30, 2020, 2019 and 2018, there are $719 million, $624 million and $632 million of unrecognized tax benefits that if recognized, would affect the effective tax rate. During the fiscal years ended September 30, 2020, 2019 and 2018, the Company reported interest and penalties associated with unrecognized tax benefits of $1 million, $26 million and $20 million on the consolidated statements of income as a component of Income tax provision (benefit) . The Company conducts business and files tax returns in numerous countries and currently has tax audits in progress in a number of tax jurisdictions. The IRS has completed its audit for fiscal year 2014 for the BD business prior to its acquisition of CareFusion. The IRS has also completed its audit for fiscal years 2015 and 2017 for the combined BD and CareFusion business. The IRS is currently examining the CareFusion legacy fiscal year 2014 and short period 2015, as well as BD's combined company for fiscal years 2016, 2018, and 2019. With regard to Bard, all examinations have been completed through calendar year 2014, and calendar years 2015, 2016, and 2017 are currently under examination by the IRS. For the other major tax jurisdictions where the Company conducts business, tax years are generally open after 2012.
## Deferred Income Taxes
Deferred income taxes at September 30 consisted of:
<img src='content_image/1036632.jpg'>
(a) Net deferred tax assets are included in Other Assets and net deferred tax liabilities are included in Deferred Income Taxes and Other Liabilities on the consolidated balance sheets .
Deferred tax assets and liabilities are netted on the balance sheet by separate tax jurisdictions. Deferred taxes have not been provided on undistributed earnings of foreign subsidiaries as of September 30, 2020 since the determination of the total amount of unrecognized deferred tax liability is not practicable.
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] | overall_image/480c338cbe2659ef20c0cf53abb6017322da5ede9078c9ceaf644dc222615fc1.png | ## Notes to Consolidated Financial Statements — (Continued) Becton, Dickinson and Company
Generally, deferred tax assets have been established as a result of net operating losses and credit carryforwards with expiration dates from 2021 to an unlimited expiration date. Valuation allowances have been established as a result of an evaluation of the uncertainty associated with the realization of certain deferred tax assets on these losses and credit carryforwards. The valuation allowance at September 30, 2020 is primarily the result of foreign losses due to the Company’s global re-organization of its foreign entities and these generally have no expiration date. Valuation allowances are also maintained with respect to deferred tax assets for certain federal and state carryforwards that may not be realized and that principally expire in 2022.
## Tax Rate Reconciliation
A reconciliation of the federal statutory tax rate to the Company’s effective income tax rate was as follows:
<img src='content_image/1026229.jpg'>
The fluctuations in the Company’s reported tax rates are primarily due to the Act, the effects of which were recorded in fiscal years 2018 and 2019, as well as the geographical mix of income attributable to foreign countries that have income tax rates that vary from the U.S. tax rate.
## Tax Holidays and Payments
The approximate tax impact related to tax holidays in various countries in which the Company does business were $136 million, $(43) million and $107 million, in 2020, 2019 and 2018, respectively. The impact of the tax holiday on diluted earnings per share was approximately $0.48, $(0.16) and $0.40 for fiscal years 2020, 2019 and 2018, respectively. The tax holidays expire at various dates through 2028.
The Company made income tax payments, net of refunds, of $518 million in 2020, $536 million in 2019 and $235 million in 2018.
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☑
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
# UNITED STATES SECURITIES AND EXCHANGE COMMISSION
# For the fiscal year ended December 31, 2020
Washington, D.C. 20549 _______________________________
# FORM 10-K
or
☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________________ to ____________________
## Securities registered pursuant to Section 12(b) of the Act:
(Address of principal executive offices)
Delaware
(State of organization)
One American Road Dearborn, Michigan
# Ford Motor Credit Company LLC
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code )
Commission file number 1-6368
(313) 322-3000
(I.R.S. employer identification no.)
38-1612444
48126
(Zip code)
<img src='content_image/1054025.jpg'>
*Issued under Euro Medium Term Notes due Nine Months or More from The Date of Issue Program
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## REDUCED DISCLOSURE FORMAT
The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format.
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As a finance company, we are highly regulated by the governmental authorities in the locations where we operate.
## United States
Within the United States, our operations are subject to regulation and supervision under various federal, state, and local laws.
Federal Regulation. We are subject to federal regulation, including the Truth-in-Lending Act, the Consumer Leasing Act, the Equal Credit Opportunity Act, and the Fair Credit Reporting Act. These laws require us to provide certain disclosures to prospective purchasers and lessees in consumer retail financing and operating lease transactions and prohibit discriminatory credit practices. The principal disclosures required under the Truth-in-Lending Act for retail financing transactions include the terms of repayment, the amount financed, the total finance charge, and the annual percentage rate. For operating lease transactions, under the Consumer Leasing Act, we are required to disclose the amount due at lease inception, the terms for payment, and information about lease charges, insurance, excess mileage, wear and use charges, and liability on early termination. The Equal Credit Opportunity Act prohibits creditors from discriminating against credit applicants and customers on a variety of factors, including race, color, sex, age, or marital status. Pursuant to the Equal Credit Opportunity Act, creditors are required to make certain disclosures regarding consumer rights and advise consumers whose credit applications are not approved of the reasons for being denied. In addition, any of the credit scoring systems we use during the application process or other processes must comply with the requirements for such systems under the Equal Credit Opportunity Act. The Fair Credit Reporting Act requires us to provide certain information to consumers whose credit applications are not approved on the basis of a consumer credit report obtained from a national credit bureau and sets forth requirements related to identity theft, privacy, and accuracy in credit reporting. In addition, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), it is unlawful for us to engage in any unfair, deceptive, or abusive act or practice. We are also subject to the Servicemembers Civil Relief Act that provides additional protections for certain customers in the military such as prohibiting us from charging interest in excess of 6% on transactions with those customers, limiting our ability to collect future payments from those operating lease customers who terminate their lease early, and limiting our use of self-help repossession of the vehicle for those customers. We are subject to other federal regulation, including the Gramm-Leach-Bliley Act, which requires us to maintain confidentiality and safeguard certain consumer data in our possession and to communicate periodically with consumers on privacy matters. In addition, the Consumer Financial Protection Bureau (“CFPB”) has broad rule-making and enforcement authority for a wide range of consumer financial protection laws that regulate consumer finance businesses, such as Ford Credit’s financing business. For additional discussion of the CFPB, see “Item 1A. Risk Factors”.
We are also subject to regulation in our funding and securitization activities, including requirements under federal securities laws and specific rules and requirements for asset-backed securities. Derivative activities are regulated under the Commodities Exchange Act and Dodd-Frank Act. These regulations also impose operational and reporting requirements for these funding transactions.
State Regulation - Licensing. In most states, a consumer credit regulatory agency regulates and enforces laws relating to finance companies. Rules and regulations generally provide for licensing of finance companies, limitations on the amount, duration, and charges, including interest rates, that can be included in finance contracts, requirements as to the form and content of finance contracts and other documentation, and restrictions on collection practices and creditors’ rights. We must renew these licenses periodically. In periods of high interest rates, rate limitations could have an adverse effect on our operations if we were unable to purchase retail installment sale contracts with finance charges that reflect our increased costs. In certain states, we are subject to periodic examination by state regulatory authorities.
State Regulation - Repossessions. To mitigate our credit losses, sometimes we repossess a financed or leased vehicle. Repossessions are subject to prescribed legal procedures, including peaceful repossession, one or more customer notifications, a prescribed waiting period prior to disposition of the repossessed vehicle, and return of personal items to the customer. Some states provide the customer with reinstatement rights that require us to return a repossessed vehicle to the customer in certain circumstances. Our ability to repossess and sell a repossessed vehicle is restricted if a customer declares bankruptcy.
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We have listed below the material risk factors applicable to Ford or Ford Credit grouped into the following categories: Operational Risks; Macroeconomic, Market, and Strategic Risks; Financial Risks; and Legal and Regulatory Risks.
## Operational Risks
Ford and Ford Credit’s financial condition and results of operations have been and may continue to be adversely affected by public health issues, including epidemics or pandemics such as COVID-19. Ford and Ford Credit face various risks related to public health issues, including epidemics, pandemics, and other outbreaks, including the global outbreak of COVID-19. The impact of COVID-19, including changes in consumer behavior, pandemic fears and market downturns, and restrictions on business and individual activities, has created significant volatility in the global economy and led to reduced economic activity. There have been extraordinary actions taken by international, federal, state, and local public health and governmental authorities to contain and combat the outbreak and spread of COVID-19 in regions throughout the world, including travel bans, quarantines, “stay-at-home” orders, and similar mandates for many individuals to substantially restrict daily activities and for many businesses to curtail or cease normal operations. To the extent cases surge in any locations, stringent limitations on daily activities that may have been eased previously could be reinstated in those areas. Further, if new strains of COVID-19 develop or sufficient amounts of vaccines are not available, not widely administered for a significant period of time, or otherwise prove ineffective, the impact of COVID-19 on the global economy, and, in turn, Ford and Ford Credit’s financial condition, liquidity, and results of operations could be material.
Consistent with the actions taken by governmental authorities, in late March 2020, Ford idled its manufacturing operations in regions around the world other than China, where manufacturing operations were suspended in January and February before beginning to resume operations in March. By May 2020, taking a phased approach and after introducing new safety protocols at its plants, Ford resumed manufacturing operations around the world.
The economic slowdown attributable to COVID-19 led to a global decrease in vehicle sales in markets around the world. As described in more detail below under “ Industry sales volume in any of Ford’s key markets can be volatile and could decline if there is a financial crisis, recession, or significant geopolitical event, ” a sustained decline in vehicle sales would have a substantial adverse effect on Ford’s financial condition, results of operations, and cash flow.
The predominant share of Ford Credit’s business consists of financing Ford and Lincoln vehicles, and the duration or resurgence of COVID-19 or similar public health issues may negatively impact the level of originations at Ford Credit. For example, Ford’s suspension of manufacturing operations, a significant decline in dealer showroom traffic, and / or a reduction of operations at dealers may lead to a significant decline in Ford Credit’s consumer and non-consumer originations. Moreover, a sustained decline in sales could have a significant adverse effect on dealer profitability and creditworthiness. Further, COVID-19 has had a significant negative impact on many businesses and unemployment rates have increased sharply from pre-COVID-19 levels. Ford Credit expects the economic uncertainty and higher unemployment to result in higher defaults in its consumer portfolio, and prolonged unemployment is expected to have a negative impact on both new and used vehicle demand.
The global economic slowdown and stay-at-home orders enacted across the United States disrupted auction activity in many locations, which adversely impacted and caused delays in realizing the resale value for off-lease and repossessed vehicles. Although auction performance has improved, future or additional restrictions could have a similar adverse impact on Ford Credit. For more information about the impact of higher credit losses and lower residual values on Ford Credit’s business, see “ Ford Credit could experience higher-than-expected credit losses, lower-than- anticipated residual values, or higher-than-expected return volumes for leased vehicles ” below.
As described in more detail below under “ Ford and Ford Credit’s access to debt, securitization, or derivative markets around the world at competitive rates or in sufficient amounts could be affected by credit rating downgrades, market volatility, market disruption, regulatory requirements, or other factors, ” the volatility created by COVID-19 adversely affected Ford Credit’s access to the debt and securitization markets and its cost of funding, and any volatility in the capital markets as a result of a surge in cases of COVID-19, new outbreaks, or for any other reason could have an adverse impact on Ford Credit’s access to those markets and its cost of funding.
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The COVID-19 pandemic may also exacerbate other risks disclosed in our 2020 Form 10-K Report, including, but not limited to, Ford’s competitiveness, demand or market acceptance for its products, and shifting consumer preferences.
Ford is highly dependent on its suppliers to deliver components in accordance with Ford’s production schedule, and a shortage of key components, such as semiconductors, can disrupt Ford’s production of vehicles. Ford’s products contain components that it sources globally from suppliers who, in turn, source components from their suppliers. If there is a shortage of a key component in Ford’s supply chain, and the component cannot be easily sourced from a different supplier, the shortage may disrupt Ford’s production. For example, the automotive industry is facing a significant shortage of semiconductors. With up to fifty modules on a vehicle, Ford and its competitors who need integrated circuits are experiencing various levels of semiconductor impact. The semiconductor supply chain is complex, and a constrained wafer capacity is occurring deep in the chain. Global semiconductor makers allocated more capacity to meet surging demand for consumer electronics during the COVID-19 pandemic as automotive OEMs experienced industry-wide plant closures. At the same time, wafer foundries that support chipmakers have not invested enough in recent years to increase capacities to the levels needed to support demand from all of their customers. Wafers have a long lead time for production, in some cases up to 30 weeks, which further exacerbates the shortage. When global automakers resumed vehicle production in 2020 – even more quickly than some expected – semiconductor supplies became further strained. A combination of these factors, including increased demand for consumer electronics, automotive shutdowns due to COVID-19, the rapid recovery of demand for vehicles, and long lead times for wafer production, is contributing to the shortage of semiconductors. A shortage of semiconductors or other key components can cause a significant disruption to Ford’s production schedule and have a substantial adverse effect on Ford’s financial condition or results of operations.
Ford’s long-term competitiveness depends on the successful execution of its Plan. Ford previously announced its plan for the global redesign of its business, pursuant to which Ford is working to turn around automotive operations, compete like a challenger, and capitalize on its strengths by allocating more capital, more resources, and more talent to its strongest business and vehicle franchises. Ford plans to do so by becoming more customer centric, embracing technology, and adopting processes that emphasize simplicity, speed and agility, efficiency, and accountability. The restructurings involved in turning around Ford’s automotive operations have resulted in charges that have had an adverse impact on its financial condition and results of operations, and Ford expects to incur additional charges in the future. Moreover, such restructuring actions may subject Ford to potential claims from employees, suppliers, dealers, or governmental authorities or harm its reputation. In addition, to further improve its business and overall competitiveness, Ford is attempting to leverage relationships with third parties, including various alliances and joint ventures as discussed below under “ Ford may not realize the anticipated benefits of existing or pending strategic alliances, joint ventures, acquisitions, divestitures, or new business strategies .” Further, significant changes to Ford’s long-term business model in various regions may be necessary should they prove to be unviable. If Ford is not successful in executing the Plan or is delayed for reasons outside of its control, Ford may not be able to materially lower costs in the near term, improve its competitiveness in the long term, or realize the full benefits of its global redesign actions, which could have an adverse effect on Ford’s financial condition or results of operations.
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<img src='content_image/1054027.jpg'>
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Ford Credit could be subject to new or increased credit regulations, consumer protection regulations, or other regulations. As a finance company, Ford Credit is highly regulated by governmental authorities in the locations in which it operates, which can impose significant additional costs and / or restrictions on its business. In the United States, for example, Ford Credit’s operations are subject to regulation and supervision under various federal, state, and local laws, including the federal Truth-in-Lending Act, Consumer Leasing Act, Equal Credit Opportunity Act, and Fair Credit Reporting Act.
The Dodd-Frank Act directs federal agencies to adopt rules to regulate the finance industry and the capital markets and gives the CFPB broad rule-making and enforcement authority for a wide range of consumer financial protection laws that regulate consumer finance businesses, such as Ford Credit’s automotive financing business. Exercise of these powers by the CFPB may increase the costs of, impose additional restrictions on, or otherwise adversely affect companies in the automotive finance business. The CFPB has authority to supervise and examine the largest nonbank automotive finance companies, such as Ford Credit, for compliance with consumer financial protection laws.
Failure to comply with applicable laws and regulations could subject Ford Credit to regulatory enforcement actions, including consent orders or similar orders where Ford Credit may be required to revise practices, remunerate customers, or pay fines. An enforcement action against Ford Credit could harm Ford Credit’s reputation or lead to further litigation.
## ITEM 1B. Unresolved Staff Comments.
None.
## ITEM 2. Properties.
We own our world headquarters in Dearborn, Michigan. Most of our automotive finance operations are located in leased properties. The continued use of any of these leased properties is not material to our operations. At December 31, 2020, our total future rental commitment under leases of real property was $109 million.
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Various legal actions, proceedings, and claims (generally, “matters”) are pending or may be instituted or asserted against us. These include but are not limited to matters arising out of governmental regulations; tax matters; alleged illegal acts resulting in fines or penalties; financial services; employment-related matters; dealer and other contractual relationships; personal injury matters; investor matters; and financial reporting matters. Certain of the pending legal actions are, or purport to be, class actions. Some of the matters involve or may involve claims for compensatory, punitive, or antitrust or other treble damages in very large amounts, sanctions, assessments, or other relief, which, if granted, would require very large expenditures. At this time, we have no legal proceedings arising under any federal, state, or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primarily for the purpose of protecting the environment, in which (i) a governmental authority is a party, and (ii) we believe there is the possibility of monetary sanctions (exclusive of interest and costs) in excess of $1,000,000.
Our significant pending matter is summarized below:
European Competition Law Matter. On October 5, 2018, FCE Bank plc (“FCE”) received a notice from the Italian Competition Authority (the “ICA”) concerning an alleged violation of Article 101 of the Treaty on the Functioning of the European Union. The ICA alleged that FCE and other parties engaged in anti-competitive practices in relation to the automotive finance market in Italy. On January 9, 2019, FCE received a decision from the ICA, which included an assessment of a fine against FCE in the amount of €42 million. On March 8, 2019, FCE appealed the decision and the fine to the Italian administrative court, and on November 24, 2020, the Italian administrative court ruled in favor of FCE. On December 23, 2020, the ICA filed an appeal of the Italian administrative court’s decision to the Italian Council of State.
In addition, any litigation, investigation, proceeding, or claim against Ford that results in Ford incurring significant liability, expenditures, or costs could also have a material adverse effect on our operations, financial condition, or liquidity. For a discussion of pending significant cases against Ford, see Item 3 in Ford’s 2020 Form 10-K Report.
## ITEM 4. Mine Safety Disclosures.
Not applicable.
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At December 31, 2020, all of our Shares were owned by Ford Holdings LLC, a wholly owned subsidiary of Ford. We did not issue or sell any equity interests during 2020, and there is no market for our Shares. We paid cash distributions to our parent of $2.9 billion and $2.4 billion in 2019 and 2020, respectively.
## ITEM 6. Selected Financial Data.
Not required.
## ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
## Overview
Our primary focus is to profitably support the sale of Ford and Lincoln vehicles. We work with Ford to maximize customer and dealer satisfaction and loyalty, offering a wide variety of financing products and outstanding service. We strive to continually improve processes focusing on the customer and the dealer to manage costs and ensure the efficient use of capital. As a result, Ford Credit is uniquely positioned to drive incremental sales, improve customer satisfaction and owner loyalty to Ford, and direct profits and distributions back to Ford to support its overall business, including vehicle development.
We leverage three fundamental strategies in the management of our operations:
• To employ prudent origination practices while maintaining a managed level of risk;
• To have efficient and effective servicing and collection practices; and
• To fund the business efficiently while managing our balance sheet risk.
## Generation of Revenue, Income, and Cash
The principal factors that influence our earnings are the amount and mix of finance receivables, operating leases, and financing margins. The performance of these receivables and operating leases over time, mainly through the impact of credit losses and variations in the residual value of leased vehicles, also affects our earnings.
The amount of our finance receivables and operating leases depends on many factors, including:
• The volume of new and used vehicle sales and leases;
• The extent to which we purchase retail financing and operating lease contracts and the extent to which we provide wholesale financing;
• The sales price of the vehicles financed;
• The level of dealer inventories;
• Ford-sponsored special financing programs available exclusively through us; and
• The availability of cost-effective funding.
For finance receivables, financing margin equals the difference between revenue earned on finance receivables and the cost of borrowed funds. For operating leases, financing margin equals revenue earned on operating leases, less depreciation expense and the cost of borrowed funds. Interest rates earned on most receivables and rental charges on operating leases generally are fixed at the time the contracts are originated. On some receivables, primarily dealer wholesale financing, we charge interest at a floating rate that varies with changes in short-term interest rates.
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/521e81df3ee4ac22f4901ca46860e209ab21684c34b89dc937e6e931b199a400.png | ## Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
In addition, the following definitions and calculations apply to the charts contained in Item 7 of this Report:
• Cash (as shown in the Funding and Liquidity and Leverage sections) – Cash and cash equivalents and Marketable securities reported on Ford Credit’s balance sheets, excluding amounts related to insurance activities.
• Debt (as shown in the Key Metrics and Leverage tables) – Debt on Ford Credit’s balance sheets. Includes debt issued in securitizations and payable only out of collections on the underlying securitized assets and related enhancements. Ford Credit holds the right to receive the excess cash flows not needed to pay the debt issued by, and other obligations of, the securitization entities that are parties to those securitization transactions.
• Earnings Before Taxes (“EBT”) – Reflects Income before income taxes as reported on Ford Credit’s income statements.
• Return on Equity (“ROE”) (as shown in the Key Metrics table) – Reflects return on equity calculated by annualizing net income for the period and dividing by monthly average equity for the period.
• Securitization and Restricted Cash (as shown in the Liquidity table) – Securitization cash is held for the benefit of the securitization investors (for example, a reserve fund). Restricted cash primarily includes cash held to meet certain local governmental and regulatory reserve requirements and cash held under the terms of certain contractual agreements.
• Securitizations (as shown in the Public Term Funding Plan table) – Public securitization transactions, Rule 144A offerings sponsored by Ford Credit, and widely distributed offerings by Ford Credit Canada.
• Term Asset-Backed Securities (as shown in the Funding Structure table) – Obligations issued in securitization transactions that are payable only out of collections on the underlying securitized assets and related enhancements.
• Total Net Receivables (as shown in the Key Metrics and Financial Condition tables) – Includes finance receivables (retail financing and wholesale) sold for legal purposes and net investment in operating leases included in securitization transactions that do not satisfy the requirements for accounting sale treatment. These receivables and operating leases are reported on Ford Credit’s balance sheets and are available only for payment of the debt issued by, and other obligations of, the securitization entities that are parties to those securitization transactions; they are not available to pay the other obligations of Ford Credit or the claims of Ford Credit’s other creditors.
• Unallocated Other (as shown in the Segment Results table) – Items excluded in assessing segment performance because they are managed at the corporate level, including market valuation adjustments to derivatives and exchange-rate fluctuations on foreign currency-denominated transactions.
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] | overall_image/28dbb1f4f6d81aaf4bfd6eafb427051e4a99b555efad625fc2432e92bc0524dc.png | ## Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
## Financing Shares and Contract Placement Volume
Our focus is on supporting Ford and Lincoln dealers and customers. This includes going to market with Ford and our dealers to support vehicle sales with financing products and marketing programs. Ford’s marketing programs may encourage or require Ford Credit financing and influence the financing choices customers make. As a result, our financing share, volume, and contract characteristics vary from period to period as Ford’s marketing programs change.
The following table shows our retail financing and operating lease share of new Ford and Lincoln vehicle sales, wholesale financing share of new Ford and Lincoln vehicles acquired by dealers (in percent), and contract placement volume for new and used vehicles (in thousands) in several key markets:
<img src='content_image/1043094.jpg'>
__________ (a) United States and Canada exclude Fleet sales, other markets include Fleet.
In 2020, the United States and China contract placement volume were up compared with a year ago, primarily reflecting higher financing share. In 2020, Canada, the U.K., and Germany contract volume were down compared with a year ago, explained by lower Ford sales.
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] | overall_image/cd1305577efa974c3341b9e5ceab0136d60c0b9991545efd01bd3582dfb348ba.png | ## Financial Condition
Our receivables, including finance receivables and operating leases, were as follows (in billions):
<img src='content_image/1060300.jpg'>
At December 31, 2018, 2019, and 2020, total net receivables includes consumer receivables before allowance for credit losses of $40.7 billion, $38.3 billion, and $43.7 billion, respectively, and non-consumer receivables before allowance for credit losses of $25.7 billion, $26.8 billion, and $16.4 billion, respectively, that have been sold for legal purposes in securitization transactions but continue to be reported in our consolidated financial statements. In addition, at December 31, 2018, 2019, and 2020, total net receivables includes net investment in operating leases of $16.3 billion, $14.9 billion, and $12.8 billion, respectively, that have been included in securitization transactions but continue to be reported in our consolidated financial statements. These net receivables are available only for payment of the debt issued by, and other obligations of, the securitization entities that are parties to those securitization transactions; they are not available to pay the other obligations or the claims of Ford Credit’s other creditors. Ford Credit holds the right to receive the excess cash flows not needed to pay the debt issued by, and other obligations of, the securitization entities that are parties to those securitization transactions. For additional information on our securitization transactions, refer to the “Securitization Transactions” and “On-Balance Sheet Arrangements” sections and Note 6 of our Notes to the Financial Statements.
Total net receivables at December 31, 2020 were $10.3 billion lower compared with December 31, 2019 and $14.6 billion lower compared with December 31, 2018, primarily reflecting lower Ford vehicle production because of COVID-19.
Our operating lease portfolio was 20% of total net receivables at December 31, 2020. Leasing is an important product, and our leasing strategy balance sales, share, residuals, and long-term profitability. Operating leases in the United States and Canada represent 99% of our total operating lease portfolio.
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## Overview
## PART I
Ford Motor Credit Company LLC was incorporated in Delaware in 1959 and converted to a limited liability company in 2007. We are an indirect, wholly owned subsidiary of Ford Motor Company (“Ford”). Our principal executive offices are located at One American Road, Dearborn, Michigan 48126, and our telephone number is (313) 322-3000.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge through our website located at www.fordcredit.com/investor-center . These reports can also be found on the SEC’s website located at www.sec.gov .
Our website and its content are not deemed to be incorporated by reference into this Annual Report on Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K Report” or “Report”) nor filed with the SEC.
Products and Services. We offer a wide variety of automotive financing products to and through automotive dealers throughout the world. The predominant share of our business consists of financing Ford and Lincoln vehicles and supporting the dealers of those brands. We earn our revenue primarily from:
• Payments made under retail installment sale and finance lease (retail financing) and operating lease contracts that we originate and purchase;
• Interest rate supplements and other support payments from Ford and affiliated companies; and
• Payments made under dealer financing programs.
As a result of our financing activities, we have a large portfolio of finance receivables and operating leases which we classify into two portfolios – “consumer” and “non-consumer”.
Finance receivables and operating leases in the consumer portfolio include products offered to individuals and businesses that finance the acquisition of Ford and Lincoln vehicles from dealers for personal and commercial use. Retail financing includes retail installment sale contracts for new and used vehicles and finance leases (comprised of sales-type and direct financing leases) for new vehicles to retail and commercial customers, including leasing companies, government entities, daily rental companies, and fleet customers.
Finance receivables in the non-consumer portfolio include products offered to automotive dealers and receivables related to Ford and its affiliates. We make wholesale loans to dealers to finance the purchase of vehicle inventory, also known as floorplan financing, as well as loans to dealers to finance working capital and improvements to dealership facilities, finance the purchase of dealership real estate, and finance other dealer vehicle programs. We also purchase receivables from Ford and its affiliates, primarily related to the sale of parts and accessories to dealers and certain used vehicles from daily rental fleet companies. In addition, we provide financing to Ford for vehicles that Ford leases to its employees.
We also service the finance receivables and operating leases we originate and purchase, make loans to Ford affiliates, and provide insurance services related to our financing programs.
Geographic Scope of Operations and Segment Information. We conduct our financing operations directly and indirectly through our subsidiaries and affiliates. We offer substantially similar products and services throughout many different regions, subject to local legal restrictions and market conditions. We segment our business based on geographic regions: the United States and Canada, Europe, and All Other. Items excluded in assessing segment performance because they are managed at the corporate level, i.e., market valuation adjustments to derivatives and exchange-rate fluctuations on foreign currency-denominated transactions, are reflected in Unallocated Other. For additional financial information regarding our operations by business segment and operations by geographic region, see Note 14 of our Notes to the Financial Statements.
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] | overall_image/2b37a17d65143a20b646bd1bd230f81be6e62f920637eb608b93bb0af27aa746.png | ## Credit Ratings
Our short-term and long-term debt is rated by four credit rating agencies designated as nationally recognized statistical rating organizations (“NRSROs”) by the United States Securities and Exchange Commission: DBRS, Fitch, Moody’s, and S&P.
In several markets, locally recognized rating agencies also rate us. A credit rating reflects an assessment by the rating agency of the credit risk associated with a corporate entity or particular securities issued by that entity. Rating agencies’ ratings of us are based on information provided by us and other sources. Credit ratings assigned to us from all of the NRSROs are closely associated with their opinions on Ford. Credit ratings are not recommendations to buy, sell, or hold securities and are subject to revision or withdrawal at any time by the assigning rating agency. Each rating agency may have different criteria for evaluating company risk and, therefore, ratings should be evaluated independently for each rating agency.
There have been no rating actions taken by these NRSROs since the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2020.
The following table summarizes certain of the credit ratings and outlook presently assigned by these four NRSROs:
<img src='content_image/1040003.jpg'>
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] | overall_image/f956c65a975840d761bc8694eca6f91e741319368b003540ded967c4a8a2fb5d.png | ## Liquidity
We define gross liquidity as cash, cash equivalents, and marketable securities (excluding amounts related to insurance activities) and committed capacity (which includes our asset-backed facilities and unsecured credit facilities), less utilization of liquidity. Utilization of liquidity is the amount funded under our liquidity sources and also includes the cash required to support securitization transactions and restricted cash. Net liquidity available for use is defined as gross liquidity less certain adjustments as described below. While not included in available liquidity, these adjustments represent additional funding sources for future originations.
The following table shows our liquidity sources and utilization (in billions):
<img src='content_image/1046898.jpg'>
Our net liquidity available for use will fluctuate quarterly based on factors including near-term debt maturities, receivable growth, and timing of funding transactions. At December 31, 2020, our net liquidity available for use was $35.4 billion, $2.4 billion higher than year-end 2019. At December 31, 2020, our liquidity sources totaled $59.1 billion, up $4.8 billion from year-end 2019.
Cash. At December 31, 2020, our cash totaled $18.5 billion compared with $11.7 billion at year-end 2019. In the normal course of our funding activities, we may generate more proceeds than are required for our immediate funding needs. These excess amounts are held primarily in highly liquid investments, which provide liquidity for our anticipated and unanticipated cash needs and give us flexibility in the use of our other funding programs. Our Cash primarily includes United States Department of Treasury obligations, federal agency securities, bank time deposits with investment-grade institutions, investment-grade commercial paper, debt obligations of a select group of non-U.S. governments, non-U.S. governmental agencies, supranational institutions, non-U.S. central banks, and money market funds that carry the highest possible ratings.
The average maturity of these investments ranges from approximately three to six months and is adjusted based on market conditions and liquidity needs. We monitor our Cash levels and average maturity on a daily basis. Cash includes restricted cash and amounts to be used only to support our securitization transactions of $3.6 billion and $3.9 billion at December 31, 2019 and 2020, respectively.
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## Our Continuing Obligations
We are engaged as servicer to service the securitized assets and securitization transactions. Our servicing duties include collecting payments on the securitized assets, preparing monthly investor reports on the performance of the securitized assets and the securitization transaction, and facilitating payments to securitization investors. While servicing securitized assets, we apply the same servicing policies and procedures that we apply to our owned assets and maintain our normal relationship with our financing customers.
We generally have no obligation to repurchase or replace any securitized asset that becomes delinquent in payment or otherwise is in default. As the seller and servicer of the securitized assets and as the administrator of the securitization SPE, we are obligated to provide certain kinds of support to our securitization transactions, which are customary in the securitization industry. These obligations include performing administrative duties for the SPE and some transaction parties, indemnifications, repurchase obligations on assets that do not meet representations or warranties on eligibility criteria or that have been materially modified, the mandatory sale of additional assets in some revolving transactions, the payment or reimbursement of transaction party expenses, and, in some cases, servicer advances of certain amounts. Securitization investors have no recourse to us or our other assets and have no right to require us to repurchase the asset-backed securities. We generally have no obligation to provide liquidity or contribute cash or additional assets to our SPEs either due to the performance of the securitized assets or the credit rating of our short-term or long-term debt. We do not guarantee any asset-backed securities. We may be required to support the performance of certain securitization transactions, however, by increasing cash reserves.
For certain public offerings of asset-backed securities, we have obligations to report certain information, including asset-level data on the securitized assets, ensure the engagement of an independent asset representations reviewer, cooperate and provide access to information necessary for an asset representations review, and participate in dispute resolution proceedings for unresolved asset repurchase requests.
## Structural Features Under Certain Securitization Programs
The following securitization programs contain structural features that could prevent us from using these sources of funding in certain circumstances:
• Revolving Retail Program . Asset-backed securities under the FordREV program may be supported by a combination of a revolving pool of United States retail installment sale contracts and cash collateral. Cash generated by the receivables during the revolving period in excess of what is needed to pay certain expenses of the trust and interest on the notes may be used to purchase additional receivables provided that certain tests are met after the purchase. The revolving period ends upon the occurrence of certain events that include if credit losses or delinquencies on the pool of assets supporting the securities exceed specified levels, if certain segregated account balances are below their required levels, and if interest is not paid on the securities.
• Retail Committed Facilities . If credit losses or delinquencies on a pool of assets held by a facility exceed specified levels, or if the level of over-collateralization or other credit enhancement for that pool decreases below a specified level, we will not have the right to sell additional pools of assets to that facility.
• Lease Facility Program . If delinquencies in our portfolio of retail operating lease contracts exceed specified levels, we will be unable to obtain additional funding from the securitization of retail lease contracts through our committed lease facilities.
• Wholesale Program . If the payment rates on wholesale receivables in the securitization trust are lower than specified levels or if there are significant dealer defaults, we will be unable to obtain additional funding and any existing funding would begin to amortize.
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Our United States and Canada segment represented 79% and 80% of total managed receivables at year-end 2019 and 2020, respectively. Our United States operations accounted for 87% of the United States and Canada segment total managed receivables at both year-end 2019 and 2020. For additional information on how we review our business performance, including on a managed basis, refer to the “Overview” section of Item 7. Managed receivables are defined further in the “Financial Condition” section of Item 7.
Under the Ford Credit and Lincoln Automotive Financial Services brand names, we provide financing services to and through dealers of Ford and Lincoln vehicles. Operations in some markets may also include joint ventures with local financial institutions and other third parties. In addition, other private label operations and alternative business arrangements exist in some markets.
## Europe Segment
Our operations in Europe are managed primarily through a United Kingdom-based subsidiary, FCE Bank plc (“FCE”). This segment represented 18% and 17% of total managed receivables at year-end 2019 and 2020, respectively. FCE operates in the United Kingdom, has branches in eight other European countries, and has operating subsidiaries in Germany, Switzerland, the Czech Republic, and Hungary that provide a variety of retail and dealer financing. The United Kingdom and Germany are our largest markets in Europe, representing 61% and 62% of Europe segment managed receivables at year-end 2019 and 2020, respectively. Customers and dealers in Italy, France, and Spain were 23% and 27% of Europe segment managed receivables at year-end 2019 and 2020, respectively. FCE, through its Worldwide Trade Financing (“WWTF”) division, provides financing to distributors and importers in about 70 countries where Ford has no national sales company presence. In addition, other private label operations and alternative business arrangements exist in some markets.
## All Other Segment
Our All Other segment includes operations in Mexico, Brazil, Argentina, China, India, and a joint venture in South Africa. This segment represented 3% of total managed receivables at both year-end 2019 and 2020. In addition, other private label operations and alternative business arrangements exist in some markets.
## Dependence on Ford
The predominant share of our business consists of financing Ford and Lincoln vehicles and supporting Ford and Lincoln dealers. Any extended reduction or suspension of Ford’s production or sale of vehicles due to a decline in consumer demand, work stoppage, governmental action, negative publicity, or other event, or significant changes to marketing programs sponsored by Ford, would have an adverse effect on our business. Additional information about Ford’s business, operations, production, sales, and risks can be found in Ford’s Annual Report on Form 10-K for the year ended December 31, 2020 (“Ford’s 2020 Form 10-K Report”), filed separately with the SEC.
Ford has sponsored special financing programs available only through us. Under these programs, Ford makes interest supplements or other support payments to us. These programs increase our financing volume and share of financing sales and operating leases of Ford and Lincoln vehicles. Similar programs may be offered in the future. For additional information regarding interest supplements and other support costs received from affiliated companies, see Notes 4 and 5 of our Notes to the Financial Statements.
## Competition
The automotive financing business is highly competitive, due in part to credit aggregation systems that permit dealers to send credit applications to multiple finance sources to evaluate financing options offered by these finance sources. Our principal competitors are:
• Banks;
• Independent finance companies;
• Credit unions;
• Leasing companies; and
• Other automobile manufacturers’ affiliated finance companies.
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] | overall_image/ae19084ad1423e1756fb69c8f6957ac9cf43a88ff640b09de0caadab68c02ae7.png | Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
## Aggregate Contractual Obligations
We are party to certain contractual obligations involving commitments to make payments to others. Most of these are debt obligations, which are recorded on our balance sheets and disclosed in our Notes to the Financial Statements. Long-term debt may have fixed or variable interest rates. For long-term debt with variable rate interest, we estimate the future interest payments based on projected market interest rates for various floating rate benchmarks received from third parties. In addition, we may enter into contracts with suppliers for purchases of certain services, including operating lease commitments. These arrangements may contain minimum levels of service requirements. Our aggregate contractual obligations at December 31, 2020 are shown below (in millions):
<img src='content_image/1046596.jpg'>
__________ (a) Excludes unamortized discounts, unamortized issuance costs, and fair value adjustments.
Liabilities recorded for unrecognized tax benefits of $109 million are excluded from the table above. Due to the high degree of uncertainty regarding the timing of future cash flows associated with income tax liabilities, we are unable to make a reasonably reliable estimate of the amount and period of payment. For additional information on income taxes, see Note 10 of our Notes to the Financial Statements.
For additional information on our long-term debt and operating lease obligations, see Notes 9 and 16, respectively, of our Notes to the Financial Statements.
## Critical Accounting Estimates
We consider an accounting estimate to be critical if (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made; and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations.
The accounting estimates that are most important to our business involve:
• Allowance for credit losses; and
• Accumulated depreciation on vehicles subject to operating leases.
Management has discussed the development and selection of these critical accounting estimates with Ford’s and our audit committees, and these audit committees have reviewed these estimates and disclosures.
## Allowance for Credit Losses
The allowance for credit losses represents our estimate of the expected lifetime credit losses inherent in finance receivables as of the balance sheet date. The adequacy of the allowance for credit losses is assessed quarterly and the assumptions and models used in establishing the allowance are evaluated regularly. Because credit losses can vary substantially over time, estimating credit losses requires a number of assumptions about matters that are uncertain. Changes in our assumptions affect Provision for credit losses on our income statements and the allowance for credit losses contained within Total finance receivables, net on our balance sheets. For additional information regarding our allowance for credit losses, see Note 4 of our Notes to the Financial Statements.
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] | overall_image/ef50e35f445fd334c2dca6d196b8739fb54bf126041f37403e6070476c3f7eaa.png | Sensitivity Analysis. For returned vehicles, we face a risk that the amount we obtain from the vehicle sold at auction will be less than our estimate of the expected residual value for the vehicle. The impact of the change in assumptions on future auction values and return volumes would increase or decrease accumulated supplemental depreciation and depreciation expense over the remaining terms of the operating leases. The effect of the indicated increase / decrease in the assumptions for our United States Ford and Lincoln brand operating lease portfolio is as follows (in millions):
<img src='content_image/1041321.jpg'>
Adjustments to the amount of accumulated supplemental depreciation on operating leases would be reflected on our balance sheets as Net investment in operating leases and on the income statements in Depreciation on vehicles subject to operating leases.
## Accounting Standards Issued But Not Yet Adopted
The Financial Accounting Standards Board has issued the following Accounting Standards Updates (“ASU”) which are not expected to have a material impact (with the exception of ASU 2019-12 which is being evaluated) to our financial statements or financial statement disclosures. For additional information, see Note 2 of the Notes to the Financial Statements.
<img src='content_image/1041330.jpg'>
__________ (a)
Early adoption for each of the standards is permitted. (b)
For additional information see Note 2 of our Notes to the Financial Statements.
## Outlook
We expect full-year 2021 EBT to be improved compared to 2020.
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<img src='content_image/1055161.jpg'>
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## Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
## Consumer Finance Receivables Allowance for Credit Losses
As described in Note 4 to the consolidated financial statements, the Company had consumer finance receivables of $78,170 million, for which a consumer allowance for credit losses of $1,245 million was recorded as of December 31, 2020. The consumer allowance for credit losses represents management’s estimate of the lifetime expected credit losses inherent in the consumer finance receivables as of the balance sheet date. For consumer receivables that share similar risk characteristics, the estimate of the lifetime expected credit losses is based on a collective assessment using measurement models and management judgment. The lifetime expected credit losses for the receivables is determined by applying probability of default and loss given default assumptions to monthly expected exposures, then discounting these cash flows to present value using the receivable’s original effective interest rate or the current effective interest rate for a variable rate receivable. If management does not believe the models reflect lifetime expected credit losses for the portfolio, an adjustment is made to reflect management judgment regarding qualitative factors including economic uncertainty, observable changes in portfolio performance, and other relevant factors.
The principal considerations for our determination that performing procedures relating to the consumer finance receivables allowance for credit losses is a critical audit matter are the significant judgment by management in determining the consumer finance receivables allowance for credit losses, which led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence relating to the probability of default and loss given default assumptions and management’s judgment regarding qualitative factors. In addition, the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the Company’s determination of the consumer finance receivables allowance for credit losses. These procedures also included, among others, testing management’s process for estimating the consumer finance receivables allowance for credit losses by, evaluating the appropriateness of the models used to estimate the allowance, evaluating the reasonableness of the probability of default and loss given default assumptions, testing the data used in the models, and evaluating the reasonableness of management’s judgment regarding qualitative factors related to economic uncertainty, observable changes in portfolio performance, and other relevant factors, which also involved the use of professionals with specialized skill and knowledge to perform these procedures to test management’s process.
/s/ PricewaterhouseCoopers LLP Detroit, Michigan February 4, 2021
We have served as the Company’s auditor since 1959.
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] | overall_image/cedb50a7b766311dff95ef42faec894e49cf953a48f12eea870e20a3c83c27d3.png | ## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
## Table of Contents
<img src='content_image/1040153.jpg'>
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## Principles of Consolidation
## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
The accompanying consolidated financial statements include Ford Motor Credit Company LLC, its controlled domestic and foreign subsidiaries and joint ventures, and consolidated VIEs in which Ford Motor Credit Company LLC is the primary beneficiary (collectively referred to herein as “Ford Credit,” “we,” “our,” or “us”). Affiliates that we do not consolidate, but for which we have significant influence over operating and financial policies, are accounted for using the equity method. We are an indirect, wholly owned subsidiary of Ford Motor Company (“Ford”). We prepare our financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”). We reclassify certain prior period amounts in our consolidated financial statements to conform to current year presentation.
## Global Pandemic
On March 11, 2020, the World Health Organization characterized the outbreak of COVID-19 as a global pandemic and recommended containment and mitigation measures. As a result, extraordinary actions were taken by international, federal, state, and local public health and governmental authorities to contain and combat the outbreak and spread of COVID-19 in regions throughout the world. These actions included travel bans, quarantines, “stay-at-home” orders, and similar mandates for many individuals to substantially restrict daily activities and for many businesses to curtail or cease normal operations. Consistent with the actions taken by governmental authorities, by late March 2020, nearly all of our employees, other than in China, began working remotely in order to reduce the spread of COVID-19. Our remote work arrangements have been designed to allow for continued operation of business functions, including originating and servicing customer contracts, financial reporting, and internal control.
Our results include adjustments due to the impact of COVID-19, the most significant of which was a charge to the provision for credit losses. The majority of this adjustment was recorded in the first quarter of 2020. See Note 4 for additional information.
## Separation and Restructuring Actions
We executed separation and restructuring actions associated with our plans to transform our business. The impact of these actions was a loss of $56 million and $55 million, primarily separation costs, for the years ended December 31, 2019 and 2020, respectively.
Related to these restructuring actions, we determined that it was not probable that we would hold certain assets and liabilities for more than the following twelve months, and these assets and liabilities were reported as held-for-sale. The total value of our Assets held-for-sale presented at fair value at December 31, 2019 and 2020 were $1,698 million and $36 million respectively, and Liabilities held-for-sale presented at fair value at December 31, 2019 were $45 million. There were no Liabilities held-for-sale at December 31, 2020.
In the fourth quarter of 2019, we committed to a plan to sell our operations in Forso Nordic AB (“Forso”), a wholly owned subsidiary, which provided retail and dealer financing in Denmark, Finland, Norway, and Sweden. Our Income before income taxes at December 31, 2019 included a loss of $20 million due to a fair value impairment as a result of the pending sale. In the first quarter of 2020, we completed the sale of Forso recognizing a pre-tax loss of $4 million in Other income, net and cash proceeds of $1,340 million. Forso related Assets held-for-sale and Liabilities held-for-sale presented at fair value at December 31, 2019 were $1,416 million and $45 million, respectively (excluding intercompany assets of $2 million and intercompany liabilities of $1,274 million (primarily debt) which are eliminated in the consolidated balance sheets). The nonrecurring fair value measurement was categorized within Level 3 of the fair value hierarchy. We determined fair value using a market approach, estimated based on our expected proceeds to be received which we concluded was most representative of the value of the assets.
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## Nature of Operations
## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
We offer a wide variety of automotive financing products to and through automotive dealers throughout the world. Our portfolio consists of finance receivables and net investment in operating leases. We also service the finance receivables and net investment in operating leases we originate and purchase, make loans to Ford affiliates, and provide insurance services related to our financing programs. See Notes 4, 5, and 11 for additional information. We conduct our financing operations directly and indirectly through our subsidiaries and affiliates. We offer substantially similar products and services throughout many different regions, subject to local legal restrictions and market conditions. See Note 14 for key operating data on our business segments and for geographic information on our regions.
The predominant share of our business consists of financing Ford and Lincoln vehicles and supporting Ford and Lincoln dealers. Any extended reduction or suspension of Ford’s production or sale of vehicles due to a decline in consumer demand, work stoppage, governmental action, negative publicity or other event, or significant changes to marketing programs sponsored by Ford, would have an adverse effect on our business.
Certain subsidiaries are subject to regulatory capital requirements that may limit the ability of those subsidiaries to pay dividends.
## NOTE 2. ACCOUNTING POLICIES
For each accounting topic that is addressed in its own note, the description of the accounting policy may be found in the related note. Other significant remaining accounting policies are described below.
## Use of Estimates
The preparation of financial statements requires us to make estimates and assumptions that affect our results. The accounting estimates that are most important to our business involve the allowance for credit losses related to finance receivables, and accumulated depreciation on vehicles subject to operating leases. Estimates are based on assumptions that we believe are reasonable under the circumstances. Due to the inherent uncertainty involved with estimates, actual results may differ.
## Foreign Currency
We remeasure monetary assets and liabilities denominated in a currency that is different than a reporting entity’s functional currency from the transactional currency to the legal entity’s functional currency. The effect of this remeasurement process and the results of our foreign currency hedging activities are reported in Other income, net .
Generally, our foreign subsidiaries use the local currency as their functional currency. We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars using end-of-period exchange rates. Changes in the carrying value of these assets and liabilities attributable to fluctuations in exchange rates are recognized in Foreign currency translation , a component of Other comprehensive income / (Ioss), net of tax . Upon sale or upon complete or substantially complete liquidation of an investment in a foreign subsidiary, the amount of accumulated foreign currency translation related to the entity is reclassified to income and recognized as part of the gain or loss on the investment.
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On a nonrecurring basis, we also measure at fair value retail contracts greater than 120 days past due or deemed to be uncollectible, and individual dealer loans probable of foreclosure. We use the fair value of collateral, adjusted for estimated costs to sell, to determine the fair value of these receivables. The collateral for a retail financing or wholesale receivable is the vehicle financed, and for dealer loans is real estate or other property.
The fair value of collateral for retail financing receivables is calculated as the outstanding receivable balances multiplied by the average recovery value percentage. The fair value of collateral for wholesale receivables is based on the wholesale market value or liquidation value for new and used vehicles. The fair value of collateral for dealer loans is determined by reviewing various appraisals, which include total adjusted appraised value of land and improvements, alternate use appraised value, broker’s opinion of value, and purchase offers.
Notes and accounts receivable from affiliated companies are presented separately on the balance sheets. These receivables are based on intercompany relationships and the balances are settled regularly. We do not assess these receivables for potential credit losses, nor are they subjected to aging analysis, credit quality reviews, or other formal assessments. As a result, Notes and accounts receivable from affiliated companies are not subject to the following disclosures contained herein.
## Finance Receivables Classification
Finance receivables are accounted for as held-for-investment (“HFI”) if we have the intent and ability to hold the receivables for the foreseeable future or until maturity or payoff. The determination of intent and ability to hold for the foreseeable future is highly judgmental and requires us to make good faith estimates based on all information available at the time of origination or purchase. If we do not have the intent and ability to hold the receivables, then the receivables are classified as held-for-sale (“HFS”).
Each quarter, we make a determination of whether it is probable that finance receivables originated or purchased during the quarter will be held for the foreseeable future based on historical receivables sale experience, internal forecasts and budgets, as well as other relevant, reliable information available through the date of evaluation. For purposes of this determination, probable means at least 70% likely and, consistent with our budgeting and forecasting period, we define foreseeable future to mean twelve months. We classify receivables as HFI or HFS on a receivable-by- receivable basis. Specific receivables included in off-balance sheet sale transactions are generally not identified until the month in which the sale occurs.
Held-for-Investment. Finance receivables classified as HFI are recorded at the time of origination or purchase at fair value and are subsequently reported at amortized cost, net of any allowance for credit losses. Cash flows from finance receivables that were originally classified as HFI are recorded as an investing activity since GAAP requires the statement of cash flows presentation to be based on the original classification of the receivables.
Held-for-Sale. Finance receivables classified as HFS are carried at the lower of cost or fair value. Cash flows resulting from the origination or purchase and sale of HFS receivables are recorded as an operating activity. Once a decision has been made to sell receivables that were originally classified as HFI, the receivables are reclassified as HFS and carried at the lower of cost or fair value. The valuation adjustment, if applicable, is recorded in Other income, net to recognize the receivables at the lower of cost or fair value.
The value of the finance receivables considered HFS at December 31, 2019 was $1,512 million, primarily Forso related finance receivables of $1,230 million. At December 31, 2020, there were $36 million of certain wholesale finance receivables specifically identified as HFS. These HFS values are reported in Assets held-for-sale on the consolidated balance sheets. See Note 1 for additional information.
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## NOTES TO THE FINANCIAL STATEMENTS
## NOTE 4. FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Non-Consumer Portfolio. We extend credit to dealers primarily in the form of lines of credit to purchase new Ford and Lincoln vehicles as well as used vehicles. Payment is required when the dealer has sold the vehicle. Each non-consumer lending request is evaluated by considering the borrower’s financial condition and the underlying collateral securing the loan. We use a proprietary model to assign each dealer a risk rating. This model uses historical dealer performance data to identify key factors about a dealer that we consider most significant in predicting a dealer’s ability to meet its financial obligations. We also consider numerous other financial and qualitative factors of the dealer’s operations, including capitalization and leverage, liquidity and cash flow, profitability, and credit history with ourselves and other creditors.
Dealers are assigned to one of four groups according to risk ratings as follows:
• Group I – strong to superior financial metrics;
• Group II – fair to favorable financial metrics;
• Group III – marginal to weak financial metrics; and
• Group IV – poor financial metrics, including dealers classified as uncollectible.
We generally suspend credit lines and extend no further funding to dealers classified in Group IV.
We regularly review our model to confirm the continued business significance and statistical predictability of the model and may make updates to improve the performance of the model. In addition, we regularly audit dealer inventory and dealer sales records to verify that the dealer is in possession of the financed vehicles and is promptly paying each receivable following the sale of the financed vehicle. The frequency of on-site vehicle inventory audits depends primarily on the dealer’s risk rating. Under our policies, on-site vehicle inventory audits of low-risk dealers are conducted only as circumstances warrant. On-site vehicle inventory audits of higher-risk dealers are conducted with increased frequency based primarily on the dealer’s risk rating, but also considering the results of our electronic monitoring of the dealer’s performance, including daily payment verifications and monthly analyses of the dealer’s financial statements, payoffs, aged inventory, over credit line, and delinquency reports. We typically perform a credit review of each dealer annually and more frequently review certain dealers based on the dealer’s risk rating and total exposure. We adjust the dealer’s risk rating, if necessary. The credit quality of dealer financing receivables is evaluated based on our internal dealer risk rating analysis. A dealer has the same risk rating for its entire dealer financing regardless of the type of financing.
The credit quality analysis of dealer financing receivables at December 31, 2019 was as follows (in millions):
<img src='content_image/1042484.jpg'>
__________ (a) Total past due dealer financing receivables at December 31, 2019 were $62 million.
The credit quality analysis of dealer financing receivables at December 31, 2020 was as follows (in millions):
<img src='content_image/1042485.jpg'>
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/a3a761e65710225481e1c2975aac73e0df57cf59e42e2fc7f61e6cc064dd9781.png | We promote our retail financing products primarily through pre-approved credit offers to prospective customers, point-of-sale information, and ongoing communications with existing customers. Our communications to these customers promote the advantages of our financing products, the availability of special plans and programs, and the benefits of affiliated products, such as extended warranties, service plans, insurance coverage, gap protection, and excess wear and use waivers. We also emphasize the quality of our customer service and the ease of making payments and transacting business with us. For example, through our website located at www.fordcredit.com or via our FordPass mobile application, a customer can make inquiries, review an account balance, examine current incentives, schedule an electronic payment, or qualify for a pre-approved credit offer.
We also market our non-consumer financing services with a specialized group of employees who make direct sales calls on dealers and, often at the request of such dealers, on potential high-volume commercial customers. This group also uses various materials to explain our flexible programs and services specifically directed at the needs of commercial and fleet vehicle customers.
## Servicing
## Consumer Financing
After we purchase retail financing contracts and operating leases from dealers and other customers, we manage the contracts during their contract terms. This management process is called servicing. We service the finance receivables and operating leases we originate and purchase. Our servicing duties include the following:
• Applying monthly payments from customers;
• Maintaining a security interest in the financed vehicle;
• Providing billing statements to customers;
• Responding to customer inquiries;
• Releasing our security interest on paid-off finance contracts;
• Contacting delinquent customers for payment;
• Arranging for the repossession of vehicles; and
• Selling repossessed and returned vehicles.
Customer Payment Operations. Customers may make payments by mailing checks to a bank for deposit in a lockbox account, through electronic payment services, a direct debit program, or a telephonic payment system.
Collections. We design our collection strategies and procedures to keep accounts current and to collect on delinquent accounts. We employ a combination of proprietary and non-proprietary tools to assess the probability and severity of default for all of our finance receivables and operating leases and implement our collection efforts based on our determination of the credit risk associated with each customer. As each customer develops a payment history, we use an internally developed behavioral scoring model to assist in determining the best collection strategies. Based on data from this scoring model, contracts are categorized by collection risk. Our centralized collection operations are supported by auto-dialing technology and proprietary collection and workflow operating systems. Through our auto-dialer program and our monitoring and call log systems, we target our efforts on contacting customers about missed payments and developing satisfactory solutions to bring accounts current.
Supplier Operations. We engage vendors to perform some of our servicing processes. These processes include depositing monthly payments from customers, monitoring, processing, and storing documents and certificates of title that reflect the perfection of security interests and ownership in financed and leased vehicles, imaging of contracts and electronic data file maintenance, storing and processing paper and electronic contracts, generating and sending billing statements and other written communications to customers, providing telephonic payment systems for retail customers, handling of some inbound and outbound collections calls, and recovering deficiencies for selected accounts.
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] | overall_image/e7f036ccb14c8bb935a3cb9aaad4e83fa7e08caf65e4421baafad4f05d48a62f.png | ## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
## NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
Fair Value Hedges . We use derivatives to reduce the risk of changes in the fair value of debt. We have designated certain receive-fixed, pay-float interest rate and cross-currency interest rate swaps as fair value hedges of fixed-rate debt. The risk being hedged is the risk of changes in the fair value of the hedged debt attributable to changes in the benchmark interest rate and foreign exchange. We report the change in fair value of the hedged debt related to the change in benchmark interest rate in Debt and Interest expense . We report the change in fair value of the hedged debt and hedging instrument related to foreign currency in Other income, net . Net interest settlements and accruals, and fair value changes on hedging instruments due to the benchmark interest rate change are reported in Interest expense . The cash flows associated with fair value hedges are reported in Net cash provided by / (used in) operating activities on our statements of cash flows.
When a fair value hedge is de-designated, or when the derivative is terminated before maturity, the fair value adjustment to the hedged debt continues to be reported as part of the carrying value of the debt and is recognized in Interest expense over its remaining life.
Derivatives Not Designated as Hedging Instruments. We report net interest settlements and accruals and changes in the fair value of interest rate swaps not designated as hedging instruments in Other income, net . Foreign currency revaluation on accrued interest along with gains and losses on foreign exchange contracts and cross-currency interest rate swaps are reported in Other income, net. Cash flows associated with non-designated or de-designated derivatives are reported in Net cash provided by / (used in) investing activities on our statements of cash flows.
## Income Effect of Derivative Financial Instruments
The gains / (losses), by hedge designation, reported in income for the years ended December 31 were as follows (in millions):
<img src='content_image/1054611.jpg'>
__________ (a) Reflects forward contracts between Ford Credit and an affiliated company.
|
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"content_image/1054460.jpg"
] | overall_image/e8ab12fc426cfd38be02cd9f999ab5aba7d6a9f124ba8915a918f067bb026d28.png | ## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
## NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
## Balance Sheet Effect of Derivative Financial Instruments
Derivative assets and liabilities are reported on the balance sheets at fair value and are presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the parties and are not a direct measure of our financial exposure. We also enter into master agreements with counterparties that may allow for netting of exposures in the event of default or breach of the counterparty agreement. Collateral represents cash received or paid under reciprocal arrangements that we have entered into with our derivative counterparties, which we do not use to offset our derivative assets and liabilities.
The fair value of our derivative instruments and the associated notional amounts at December 31 were as follows (in millions):
<img src='content_image/1054460.jpg'>
__________ (a) At December 31, 2019 and 2020, we held collateral of $18 million and $9 million, and we posted collateral of $78 million and $96 million, respectively. (b)
At December 31, 2019 and 2020, the fair value of assets and liabilities available for counterparty netting was $169 million and $204 million, respectively. All derivatives are categorized within Level 2 of the fair value hierarchy.
|
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} | https://cdla.io/permissive-1-0/ | [
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"content_image/1043239.jpg"
] | overall_image/573c2252e5f6bae202d668df21a62bb5421e46bd03c2ccb086fa28de44f5be40.png | ## NOTE 8. OTHER ASSETS AND OTHER LIABILITIES AND DEFERRED REVENUE
## FORD MOTOR CREDIT COMPANY LLC AND SUBSIDIARIES
## NOTES TO THE FINANCIAL STATEMENTS
Other assets and Other liabilities and deferred revenue consist of various balance sheet items that are combined for financial statement presentation due to their respective materiality compared with other individual asset and liability items.
Other assets at December 31 were as follows (in millions):
<img src='content_image/1043238.jpg'>
__________ (a) Includes income tax receivable from affiliated companies of $0 and $867 million at December 31, 2019 and 2020, respectively. (b) Accumulated depreciation was $393 million and $365 million at December 31, 2019 and 2020, respectively.
(c)
December 31, 2020 includes the adoption of ASU 2016-13, reducing investment in non-consolidated affiliates by $8 million. See Note 2 for additional information.
Other liabilities and deferred revenue at December 31 were as follows (in millions):
<img src='content_image/1043239.jpg'>
__________ (a) Includes tax and interest payable to affiliated companies of $294 million and $16 million at December 31, 2019 and 2020, respectively.
|
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} | https://cdla.io/permissive-1-0/ | [
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] | overall_image/ad4a2e9d4e251b682c26c0e1c6eba95c8875e5bcaf22e2f02270145c52152820.png | (Mark One)
# UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
# FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
# For the fiscal year ended December 31, 2019
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to_________
<img src='content_image/1034261.jpg'>
Securities registered pursuant to Section 12(b) of the Act:
<img src='content_image/1034262.jpg'>
|
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