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ADOBE INC._10-Q_2021-09-29 00:00:00_796343-0000796343-21-000210.html

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ALBEMARLE CORP_10-Q_2021-08-04 00:00:00_915913-0000915913-21-000149.html

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ALTRIA GROUP, INC._10-Q_2021-07-29 00:00:00_764180-0000764180-21-000108.html

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AMERIPRISE FINANCIAL INC_10-Q_2021-08-09 00:00:00_820027-0000820027-21-000075.html

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AMPHENOL CORP -DE-_10-Q_2021-07-30 00:00:00_820313-0001558370-21-009700.html

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AT&T INC._10-Q_2021-08-05 00:00:00_732717-0000732717-21-000067.html

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ATMOS ENERGY CORP_10-Q_2021-08-04 00:00:00_731802-0000731802-21-000036.html

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AUTOMATIC DATA PROCESSING INC_10-K_2021-08-04 00:00:00_8670-0000008670-21-000027.html

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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsTabular dollars are presented in millions, except per share amountsThe following section discusses our year ended June 30, 2021 (“fiscal 2021”), as compared to year ended June 30, 2020 (“fiscal 2020”). A detailed review of our fiscal 2020 performance compared to our fiscal 2019 performance is set forth in Part II, Item 7 of our Form 10-K for the fiscal year ended June 30, 2020. FORWARD-LOOKING STATEMENTSThis document and other written or oral statements made from time to time by ADP may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could” “is designed to” and other words of similar meaning, are forward-looking statements. These statements are based on 25management’s expectations and assumptions and depend upon or refer to future events or conditions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements or that could contribute to such difference include: ADP's success in obtaining and retaining clients, and selling additional services to clients; the pricing of products and services; the success of our new solutions; compliance with existing or new legislation or regulations; changes in, or interpretations of, existing legislation or regulations; overall market, political and economic conditions, including interest rate and foreign currency trends and inflation; competitive conditions; our ability to maintain our current credit ratings and the impact on our funding costs and profitability; security or cyber breaches, fraudulent acts, and system interruptions and failures; employment and wage levels; changes in technology; availability of skilled technical associates; the impact of new acquisitions and divestitures; the adequacy, effectiveness and success of our business transformation initiatives; and the impact of any uncertainties related to major natural disasters or catastrophic events, including the coronavirus (“COVID-19”) pandemic. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. These risks and uncertainties, along with the risk factors discussed under “Item 1A. Risk Factors,” and in other written or oral statements made from time to time by ADP, should be considered in evaluating any forward-looking statements contained herein.NON-GAAP FINANCIAL MEASURESIn addition to our U.S. GAAP results, we use adjusted results and other non-GAAP metrics to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods. Adjusted EBIT, adjusted EBIT margin, adjusted net earnings, adjusted diluted earnings per share, adjusted effective tax rate and organic constant currency are all non-GAAP financial measures. Please refer to the accompanying financial tables in the “Non-GAAP Financial Measures” section for a discussion of why ADP believes these measures are important and for a reconciliation of non-GAAP financial measures to their comparable GAAP financial measures.EXECUTIVE OVERVIEW Highlights from the year ended June 30, 2021 include:3%60 basis points6%Revenue GrowthEarnings Before Income Taxes Margin ExpansionDiluted EPS Growth2%(40) basis points2%Organic Constant CurrencyRevenue GrowthAdjusted EBIT Margin ExpansionAdjusted Diluted EPS Growth 23%Employer ServicesNew Business Bookings Growth2%PEO ServicesAverage Worksite Employee Growth$3.0BCash Returned via Shareholder Friendly Actions$1.6B Dividends | $1.4B Share RepurchasesWe are a leading global provider of cloud-based Human Capital Management (“HCM”) technology solutions to employers around the world. The global COVID-19 pandemic has had a significant impact on the global business environment and on our clients, but our priority has been and continues to be the safety of our associates and the needs of our clients. We have continued to provide HCM services, including the processing of payroll and tax obligations, to our clients during this time. ADP's efforts have also been focused on providing information and tools to help clients understand and navigate the governmental relief that has been adopted globally. In addition, we released a Return to Workplace solution that assists our clients in bringing their employees back to work safely through a comprehensive set of tools designed to streamline the entire process.26During the fiscal year, we continued to advance our market-leading solutions and achieved some new milestones. Earlier this year, our next-gen payroll solution earned ADP its 6th consecutive “Top HR Product Award” at the annual HR Technology Conference. This solution features a highly scalable, policy-based framework that enables easy self-service and powerful transparency. In February, we announced the launch of Roll, a new mobile-first payroll and tax filing product aimed at small businesses, which combines an AI-driven chat-based interface with the power and scale of our payroll and tax filing expertise. We continued to add to our robust DataCloud platform by introducing the Diversity, Equity and Inclusion (DEI) Dashboard which can help businesses analyze their diversity landscape through a simple Q&A format and user interface that allows them to better set, track and expand their DEI goals. For our RUN platform, which is a leading solution in the market with approximately 750,000 clients, we began to roll out a new user experience and launched TimeKeeping Plus, an entirely new, native workforce management solution. This year, we reached 100,000 clients across our workforce management solutions for the first time, as the pandemic reinforced the need for robust workforce management solutions for our clients while they navigate the new norm of increasingly flexible schedules and work arrangements.Our suite of HRO solutions also continued to deliver steady growth this year, despite the dynamic economic environment. Within PEO, the average worksite employee count grew 12% in the fourth quarter resulting in annual growth of 2%. We also have over 2 million worksite employees on our other HRO solutions within our Employer Services segment, as clients look for ways to outsource parts of the HR function to a best-in-class provider like ADP.We continue to drive innovation by anticipating our clients' evolving needs and always designing for people as the world of work changes. We lead the HCM industry by driving growth through our strategic, cloud-based HCM solutions and developing innovations like our next gen platforms. We further enable these solutions by supplementing them with organic, differentiated investments such as the ADP Datacloud and ADP Marketplace, and through our compliance expertise.For fiscal 2021, we drove solid revenue growth of 3% for the year, continued to invest for sustainable growth despite market conditions, and managed any non-essential spend prudently. Employer Services New Business Bookings was up 23% for fiscal 2021. In addition, the Employer Services client revenue retention rate for fiscal 2021 improved 170 basis points to 92.2% as compared to our rate for fiscal 2020. The PEO average number of Worksite Employees increased 2% for fiscal 2021. Our pays per control metric, which represents the number of employees on ADP clients' payrolls in the United States when measured on a same-store-sales basis for a subset of clients ranging from small to large businesses, turned positive in the fourth quarter resulting in annual growth of negative 3% for fiscal 2021.We have a strong business model, a highly cash generative business with low capital intensity, and offer a suite of products that provide critical support to our clients’ HCM functions. We generate sufficient free cash flow to satisfy our cash dividend and our modest debt obligations, which enables us to absorb the impact of downturns and remain steadfast in our reinvestments, our longer term strategy, and our commitments to shareholder friendly actions. We are committed to building upon our past successes by investing in our business through enhancements in research and development and by driving meaningful transformation in the way we operate. Our financial condition remains solid at June 30, 2021 and we remain well positioned to support our associates and our clients.27RESULTS AND ANALYSIS OF CONSOLIDATED OPERATIONSTotal RevenuesFor the year ended June 30, respectively: á3% YoY Growthá2% YoY Growth, Organic Constant CurrencyRevenues for fiscal 2021 increased due to strong retention, new business started from New Business Bookings, an increase in zero-margin benefits pass-throughs and one percentage point of favorability from foreign currency. This increase is partially offset by a one percentage point of pressure from our interest earned on funds held for clients discussed below. Refer to “Analysis of Reportable Segments” for additional discussion of the increases in revenue for both of our reportable segments, Employer Services and Professional Employer Organization (“PEO”) Services. Total revenues in fiscal 2021 include interest on funds held for clients of $422.4 million, as compared to $545.2 million in fiscal 2020. The decrease in the consolidated interest earned on funds held for clients resulted from the decrease in our average interest rate earned to 1.5% in fiscal 2021, as compared to 2.1% in fiscal 2020. The decrease is partially offset by an increase in our average client funds balances of 5.2% to $27.4 billion in fiscal 2021 as compared to fiscal 2020. 28Total ExpensesYears EndedJune 30, 20212020%ChangeCosts of revenues: Operating expenses$7,520.7 $7,404.1 2 %Systems development and programming costs716.6 674.1 6 %Depreciation and amortization403.0 366.9 10 %Total costs of revenues8,640.3 8,445.1 2 %Selling, general and administrative expenses3,040.5 3,003.0 1 %Interest expense59.7 107.1 (44)%Total expenses$11,740.5 $11,555.2 2 %For the year ended June 30, 2021, operating expenses increased due to the increase in our PEO Services zero-margin benefits pass-through costs to $3,092.0 million from $2,907.7 million for the year ended June 30, 2021 and 2020, respectively, the impact of foreign currency, and an increase in incentive compensation costs due to decreases in the prior year. These increases were partially offset by reduced costs as a result of our broad-based transformation initiatives and excess capacity headcount actions in the prior year, a change of $52.5 million in our estimated losses related to ADP Indemnity compared to prior year, reduced travel expenses and decreased pension costs as a result of U.S. pension service costs that were eliminated with the July 1, 2020 cessation of U.S. participants accruing any future service benefits (“U.S. pension freeze”). Systems development and programming costs increased for fiscal 2021 due to increased investments and costs to develop, support, and maintain our products, partially offset by capitalization of costs related to our strategic projects, including our next gen platforms. Depreciation and amortization expense increased related to the amortization of our acquisitions of intangibles and internally developed software. Selling, general and administrative expenses increased for the year ended June 30, 2021 due to an increase inincentive compensation costs, investments in our sales organization, and the impact of foreign currency, partially offset by a decrease in charges related to transformation initiatives, reduced costs as a result of our broad-based transformation initiatives and excess capacity headcount actions in the prior year for non-sales associates, capitalization of costs to obtain a contract under ASC 606, reduced travel expenses, legal settlements, and a decrease in bad debt expense.Interest expense decreased for the year ended June 30, 2021 primarily due to a decrease in average interest rates for commercial paper borrowings to 0.1% for the year ended June 30, 2021, as compared to 1.6% for the year ended June 30, 2020. This was coupled with a decrease in average daily borrowings under our commercial paper program to $1.6 billion for the year ended June 30, 2021, as compared to $2.7 billion for the year ended June 30, 2020. Other (Income)/Expense, net(In millions)Years ended June 30,20212020$ ChangeInterest income on corporate funds$(36.5)$(84.5)$(48.0)Realized (gains)/losses on available-for-sale securities, net(11.3)(12.9)(1.6)Impairment of assets19.9 29.9 10.0 Gain on sale of assets(8.1)(5.8)2.3 Gain on sale of investment(1.7)(0.2)1.5 Non-service components of pension income, net(58.6)(74.5)(15.9)Other (income)/expense, net$(96.3)$(148.0)$(51.7)29Other (income)/expense, net, decreased $51.7 million in fiscal 2021, as compared to fiscal 2020 as a result of a decrease in interest income on corporate funds due to lower interest rates earned and the change in non-service components of pension income, net, and the items described below. See Note 10 of our Consolidated Financial Statements for further details on non-service components of pension income, net.In fiscal 2021, the Company recorded impairment charges of $19.9 million which is comprised of a write down of $10.5 million related to internally developed software which was determined to have no future use, impairment charges of $9.4 million related to operating right-of-use assets and certain related fixed assets associated with vacating certain leased locations early, and recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale. In fiscal 2020, the Company recorded impairment charges of $29.9 million, which is comprised of $25.3 million as a result of recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale and vacating certain leased locations early and recorded total impairment charges of $4.6 million related to operating right-of-use assets and certain related fixed assets associated with the vacated locations.Earnings Before Income TaxesFor the year ended June 30, respectively: á6% YoY Growthá60 bps YoY GrowthEarnings before income taxes increased in fiscal 2021 due to the increases in revenues partially offset by the increases in expenses discussed above. Overall margin increased in fiscal 2021 as a result of operational efficiencies, coupled with a decrease in charges related to transformation initiatives, legal settlements, reduced costs as a result of our broad-based transformation initiatives and excess capacity headcount actions in the prior year, a change of $52.5 million in our estimated losses related to ADP Indemnity compared to prior year, decreased selling expense, and decreased interest expense. These were partially offset by an increase in incentive compensation costs, a decrease in interest earned on funds held for clients, and incremental pressure from growth in our zero-margin benefits pass-throughs.30Adjusted Earnings before certain Interest and Taxes ("Adjusted EBIT")For the year ended June 30, respectively: á1% YoY Growthâ40 bps YoY GrowthAdjusted EBIT and Adjusted EBIT margin exclude certain interest amounts, legal settlements, gain on sale of assets, net charges related to our broad-based transformation initiatives and the impact of the net severance charges as applicable in the respective periods.Provision for Income TaxesThe effective tax rate in fiscal 2021 and 2020 was 22.7% and 22.5%, respectively. The increase in the effective tax rate is primarily due to combined benefits from a valuation allowance release related to foreign tax credit carryforwards and a foreign tax law change during fiscal 2020 as well as a decrease in the excess tax benefit on stock-based compensation, partially offset by favorable adjustments to prior year tax liabilities during fiscal 2021. Refer to Note 11, Income Taxes, within the Notes to the Consolidated Financial Statements for further discussion.Adjusted Provision for Income TaxesThe adjusted effective tax rate in fiscal 2021 and 2020 was 22.7% and 22.6%, respectively. The drivers of the adjusted effective tax rate are the same as the drivers of the effective tax rate discussed above.31Net Earnings and Diluted Earnings per Share For the year ended June 30, respectively: á5% YoY Growthá6% YoY GrowthFor fiscal 2021, adjusted net earnings and adjusted diluted EPS reflect the changes in components described above.For fiscal 2021, diluted EPS increased as a result of the impact of fewer shares outstanding resulting from the repurchase of approximately 8.2 million shares during fiscal 2021 and 6.2 million shares during fiscal 2020, partially offset by the issuances of shares under our employee benefit plans.Adjusted Net Earnings and Adjusted Diluted Earnings per ShareFor the year ended June 30, respectively: á1% YoY Growthá2% YoY GrowthFor fiscal 2021, adjusted net earnings and adjusted diluted EPS reflect the changes in components described above.32ANALYSIS OF REPORTABLE SEGMENTSRevenuesYears EndedJune 30,% Change 20212020As ReportedOrganic Constant CurrencyEmployer Services$10,195.2 $10,086.6 1 %— %PEO Services4,818.3 4,511.5 7 %7 %Other(8.1)(8.3)n/mn/m$15,005.4 $14,589.8 3 %2 %Earnings before Income TaxesYears EndedJune 30,% Change 20212020As ReportedEmployer Services$3,052.1 $3,058.2 — %PEO Services 718.8 609.3 18 %Other(409.7)(484.9)n/m$3,361.2 $3,182.6 6 %n/m - not meaningfulEmployer ServicesRevenuesRevenues increased in fiscal 2021 due to strong retention, business started from New Business Bookings and one percentage point of favorability from foreign currency. Employer Services client revenue retention rate for fiscal 2021 improved 170 basis points to 92.2% as compared to our rate for fiscal 2020. Increases in revenues were partially offset by a decrease in interest earned on funds held for clients.Earnings before Income TaxesEmployer Services’ earnings before income taxes was flat in fiscal 2021 due to increased revenues discussed above offset by increases in expenses. The increases in expenses were due to an increase in incentive compensation costs, investments in our sales organization, an increase in amortization expense, and the impact of foreign currency. The increases in expenses were offset by reduced costs as a result of our broad-based transformation initiatives and excess capacity headcount actions for non-sales associates, reduced travel expenses, and a decrease in bad debt expense. 33For the year ended June 30, respectively: â40 bps YoY GrowthEmployer Services' overall margin decreased for fiscal 2021 due to an increase in incentive compensation costs, a decrease in interest earned on funds held for clients, and an increase in amortization expense. This decrease was partially offset by reduced costs as a result of our broad-based transformation initiatives and excess capacity headcount actions in the prior year, and a decrease in bad debt expense.RevenuesPEO RevenuesYears EndedChangeJune 30, 20212020$%PEO Services' revenues$4,818.3 $4,511.5 $306.8 7 %Less: PEO zero-margin benefits pass-throughs3,092.0 2,907.7 184.3 6 %PEO Services' revenues excluding zero-margin benefits pass-throughs$1,726.3 $1,603.8 $122.5 8 %PEO Services' revenues increased 7% and PEO Services' revenues excluding zero-margin benefits pass-through costs increased 8% in fiscal 2021. PEO Services' revenues increased due to a 2% increase in the average number of Worksite Employees in fiscal 2021 driven by an increase in the number of new PEO Services clients, partially offset by a modest decline in pays per control. Earnings before Income TaxesPEO Services’ earnings before income taxes increased 18% in fiscal 2021 due to increased revenues discussed above, partially offset by increases in expenses. The increases in expenses were due to the increase in zero-margin benefits pass-through costs of $184.3 million described above, partially offset by a change of $52.5 million in our estimated losses related to ADP Indemnity compared to the prior year, and a decrease in selling expenses.34For the year ended June 30, respectively: á140 bps YoY GrowthPEO Services' overall margin increased for fiscal 2021 due to an increase in revenues as discussed above, a change in our estimated losses related to ADP Indemnity compared to the prior year, and a decrease in selling expenses. ADP Indemnity provides workers’ compensation and employer’s liability deductible reimbursement insurance protection for PEO Services’ worksite employees up to $1 million per occurrence. PEO Services has secured a workers’ compensation and employer’s liability insurance policy that caps the exposure for each claim at $1 million per occurrence and has also secured aggregate stop loss insurance that caps aggregate losses at a certain level in fiscal years 2012 and prior from an admitted and licensed insurance company of AIG. We utilize historical loss experience and actuarial judgment to determine the estimated claim liability, and changes in estimated ultimate incurred losses are included in the PEO segment. Additionally, starting in fiscal year 2013, ADP Indemnity paid premiums to enter into reinsurance arrangements with ACE American Insurance Company, a wholly-owned subsidiary of Chubb Limited (“Chubb”), to cover substantially all losses incurred by the Company up to the $1 million per occurrence related to the workers' compensation and employer's liability deductible reimbursement insurance protection for PEO Services' worksite employees. Each of these reinsurance arrangements limits our overall exposure incurred up to a certain limit. The Company believes the likelihood of ultimate losses exceeding this limit is remote. During fiscal 2021, ADP Indemnity paid a premium of $240 million to enter into a reinsurance arrangement with Chubb to cover substantially all losses incurred by ADP Indemnity for the fiscal 2021 policy year up to $1 million per occurrence. ADP Indemnity recorded a pre-tax benefit of approximately $32 million in fiscal 2021 and a pre-tax loss of approximately $20 million in fiscal 2020, which were primarily a result of changes in our estimated actuarial losses. ADP Indemnity paid a premium of $260 million in July 2021 to enter into a reinsurance agreement with Chubb to cover substantially all losses incurred by ADP Indemnity for fiscal 2022 policy year on terms substantially similar to the fiscal 2021 reinsurance policy.OtherThe primary components of “Other” are certain corporate overhead charges and expenses that have not been allocated to the reportable segments, including corporate functions, costs related to our transformation office, legal settlements, severance costs, non-recurring gains and losses, the elimination of intercompany transactions, and other interest expense.35Non-GAAP Financial MeasuresIn addition to our GAAP results, we use the adjusted results and other non-GAAP metrics set forth in the table below to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods: Adjusted Financial MeasuresU.S. GAAP MeasuresAdjusted EBITNet earnings Adjusted provision for income taxes Provision for income taxesAdjusted net earnings Net earnings Adjusted diluted earnings per share Diluted earnings per shareAdjusted effective tax rate Effective tax rateOrganic constant currencyRevenuesWe believe that the exclusion of the identified items helps us reflect the fundamentals of our underlying business model and analyze results against our expectations and against prior period, and to plan for future periods by focusing on our underlying operations. We believe that the adjusted results provide relevant and useful information for investors because it allows investors to view performance in a manner similar to the method used by management and improves their ability to understand and assess our operating performance. The nature of these exclusions is for specific items that are not fundamental to our underlying business operations. Since these adjusted financial measures and other non-GAAP metrics are not measures of performance calculated in accordance with U.S. GAAP, they should not be considered in isolation from, as a substitute for, or superior to their corresponding U.S. GAAP measures, and they may not be comparable to similarly titled measures at other companies.36Years EndedJune 30,% Change20212020As ReportedNet earnings$2,598.5 $2,466.5 5 %Adjustments:Provision for income taxes762.7 716.1 All other interest expense (a)57.3 59.2 All other interest income (a)(6.5)(20.5)Gain on sale of assets— (0.2)Transformation initiatives (b)— 77.4 Excess capacity severance charges (c)2.9 25.4 Legal settlements (d)(30.7)25.0 Adjusted EBIT$3,384.2 $3,348.9 1 %Adjusted EBIT Margin22.6 %23.0 %Provision for income taxes$762.7 $716.1 7 %Adjustments:Gain on sale of assets (e)— (0.1)Transformation initiatives (e)— 19.2 Excess capacity severance charges (e)0.5 6.3 Legal settlements (e)(7.5)6.2 Adjusted provision for income taxes$755.7 $747.7 1 %Adjusted effective tax rate (f)22.7 %22.6 %Net earnings$2,598.5 $2,466.5 5 %Adjustments:Gain on sale of assets— (0.2)Income tax provision on gain on sale of assets (e)— 0.1 Transformation initiatives (b)— 77.4 Income tax benefit for transformation initiatives (e)— (19.2)Excess capacity severance charges (c)2.9 25.4 Income tax benefit for excess capacity severance charges (e)(0.5)(6.3)Legal settlements (d)(30.7)25.0 Income tax provision/ (benefit) for legal settlements (e)7.5 (6.2)Adjusted net earnings$2,577.7 $2,562.5 1 %Diluted EPS$6.07 $5.70 6 %Adjustments:Gain on sale of assets (e)— — Transformation initiatives (b) (e)— 0.13 Excess capacity severance charges (c) (e)0.01 0.04 Legal settlements (d) (e)(0.05)0.04 Adjusted diluted EPS$6.02 $5.92 2 %(a) We include the interest income earned on investments associated with our client funds extended investment strategy and interest expense on borrowings related to our client funds extended investment strategy as we believe these amounts to be fundamental to the underlying operations of our business model. The adjustments in the table above represent the interest income and interest expense that are not related to our client funds extended investment strategy and are labeled as “All other interest expense” and “All other interest income.”(b) In fiscal 2021, transformation initiatives include impairment charges as a result of recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale and lease asset impairment charges, offset by gain on sale of assets and net reversals of charges related to other transformation initiatives, including severance.Unlike other severance charges which are not included as an adjustment to get to adjusted results, these specific charges relate to actions taken as part of our broad-based, company-wide transformation initiative.37(c) Represents net severance cost related to excess capacity. Unlike certain other severance charges in prior periods that are notincluded as an adjustment to get to adjusted results, these specific charges relate to actions that are part of our broad-based,company-wide initiatives to address excess capacity across our business and functions, including charges in fiscal 2020 due to the COVID-19 pandemic.(d) Represents legal settlements including an insurance recovery in fiscal 2021.(e) The income tax provision/(benefit) was calculated based on the marginal rate in effect for the year ended June 30, 2021.(f) The Adjusted effective tax rate is calculated as our Adjusted provision for income taxes divided by the sum of our Adjusted net earnings plus our Adjusted provision for income taxes.The following table reconciles our reported growth rates to the non-GAAP measure of organic constant currency, which excludes the impact of acquisitions, the impact of dispositions, and the impact of foreign currency. The impact of acquisitions and dispositions is calculated by excluding the current year revenues of acquisitions until the one-year anniversary of the transaction and by excluding the prior year revenues of divestitures for the one-year period preceding the transaction. The impact of foreign currency is determined by calculating the current year result using foreign exchange rates consistent with the prior year. The PEO segment is not impacted by acquisitions, dispositions or foreign currency. Year EndedJune 30,2021Consolidated revenue growth as reported3 %Adjustments:Impact of acquisitions— %Impact of foreign currency(1)%Consolidated revenue growth, organic constant currency2 %Employer Services revenue growth as reported1 %Adjustments:Impact of acquisitions— %Impact of foreign currency(1)%Employer Services revenue growth, organic constant currency— %FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCESAs of June 30, 2021, cash and cash equivalents were $2.6 billion, which were primarily invested in time deposits and money market funds.For corporate liquidity, we expect existing cash, cash equivalents, long-term marketable securities, cash flow from operations together with our $9.7 billion of committed credit facilities and our ability to access both long-term and short-term debt financing from the capital markets will be adequate to meet our operating, investing, and financing activities such as regular quarterly dividends, share repurchases, and capital expenditures for the foreseeable future. Our financial condition remains solid at June 30, 2021 and we have sufficient liquidity as noted above; however, given the uncertainty in the rapidly changing market and economic conditions related to the COVID-19 pandemic, we will continue to evaluate the nature and extent of the impact to our financial condition and liquidity. For client funds liquidity, we have the ability to borrow through our financing arrangements under our U.S. short-term commercial paper program and our U.S., Canadian and United Kingdom short-term reverse repurchase agreements, together with our $9.7 billion of committed credit facilities and our ability to use corporate liquidity when necessary to meet short-term funding requirements related to client funds obligations. Please see “Quantitative and Qualitative Disclosures about Market Risk” for a further discussion of the risks, including with respect to the COVID-19 pandemic, related to our client funds extended investment strategy. See Note 8 of our Consolidated Financial Statements for a description of our short-term financing including commercial paper. 38Operating, Investing and Financing Cash FlowsOur cash flows from operating, investing, and financing activities, as reflected in the Statements of Consolidated Cash Flows are summarized as follows: Years ended June 30,20212020$ ChangeCash provided by (used in):Operating activities$3,093.3 $3,026.2 $67.1 Investing activities(3,515.0)3,156.3 (6,671.3)Financing activities6,437.5 (5,890.6)12,328.1 Effect of exchange rate changes on cash, cash equivalents, restricted cash, and restricted cash equivalents73.8 (34.5)108.3 Net change in cash, cash equivalents, restricted cash, and restricted cash equivalents$6,089.6 $257.4 $5,832.2 Net cash flows provided by operating activities increased due to a net favorable change in the components of operating assets and liabilities as compared to the year ended June 30, 2020.Net cash flows from investing activities changed due to the timing of proceeds and purchases of corporate and client funds marketable securities of $6,771.2 million.Net cash flows from financing activities changed due to a net increase in the cash flow from client funds obligations of $11,549.4 million, which is due to the timing of impounds from our clients and payments to our clients' employees and other payees, and proceeds from debt issuances. These were partially offset by payments of debt, more cash returned to shareholders via share repurchases and dividends, and settlement of cash flow hedges in fiscal 2021. We purchased approximately 8.2 million shares of our common stock at an average price per share of $170.04 during fiscal 2021, as compared to purchases of 6.2 million shares at an average price per share of $160.61 during fiscal 2020. From time to time, the Company may repurchase shares of its common stock under its authorized share repurchase program. The Company considers several factors in determining when to execute share repurchases, including, among other things, actual and potential acquisition activity, cash balances and cash flows, issuances due to employee benefit plan activity, and market conditions. Capital Resources and Client Fund ObligationsWe have $3.0 billion of senior unsecured notes with maturity dates in 2025, 2028, and 2030. We may from time to time revisit the long-term debt market to refinance existing debt, finance investments including acquisitions for our growth, and maintain the appropriate capital structure. However, there can be no assurance that volatility in the global capital and credit markets would not impair our ability to access these markets on terms acceptable to us, or at all. See Note 9 of our Consolidated Financial Statements for a description of our notes.Our U.S. short-term funding requirements related to client funds are sometimes obtained on an unsecured basis through the issuance of commercial paper, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. This commercial paper program provides for the issuance of up to $9.7 billion in aggregate maturity value. Our commercial paper program is rated A-1+ by Standard and Poor’s, Prime-1 (“P-1”) by Moody’s and F1+ by Fitch. These ratings denote the highest quality commercial paper securities. Maturities of commercial paper can range from overnight to up to 364 days. At June 30, 2021 and 2020, we had no commercial paper borrowing outstanding. Details of the borrowings under the commercial paper program are as follows:Years ended June 30,20212020Average daily borrowings (in billions)$1.6 $2.7 Weighted average interest rates0.1 %1.6 %Weighted average maturity (approximately in days)1 day2 daysOur U.S., Canadian, and United Kingdom short-term funding requirements related to client funds obligations are sometimes obtained on a secured basis through the use of reverse repurchase agreements, which are collateralized principally by 39government and government agency securities, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. These agreements generally have terms ranging from overnight to up to five business days. We have successfully borrowed through the use of reverse repurchase agreements on an as-needed basis to meet short-term funding requirements related to client funds obligations. At June 30, 2021 and 2020, there were $23.5 million and $13.6 million, respectively, of outstanding obligations related to the reverse repurchase agreements. Details of the reverse repurchase agreements are as follows: Years ended June 30,20212020Average outstanding balances$136.7 $263.4 Weighted average interest rates0.2 %1.6 %We vary the maturities of our committed credit facilities to limit the refinancing risk of any one facility. We have a $3.75 billion, 364-day credit agreement that matures in June 2022 with a one year term-out option. In addition, we have a five-year $2.75 billion credit facility and a five-year $3.2 billion credit facility maturing in June 2024 and June 2026, respectively, each with an accordion feature under which the aggregate commitment can be increased by $500 million, subject to the availability of additional commitments. The primary uses of the credit facilities are to provide liquidity to the commercial paper program and funding for general corporate purposes, if necessary. We had no borrowings through June 30, 2021 under the credit facilities. We believe that we currently meet all conditions set forth in the revolving credit agreements to borrow thereunder, and we are not aware of any conditions that would prevent us from borrowing part or all of the $9.7 billion available to us under the revolving credit agreements. See Note 8 of our Consolidated Financial Statements for a description of our short-term financing including credit facilities.Our investment portfolio does not contain any asset-backed securities with underlying collateral of sub-prime mortgages, alternative-A mortgages, sub-prime auto loans or sub-prime home equity loans, collateralized debt obligations, collateralized loan obligations, credit default swaps, derivatives, auction rate securities, structured investment vehicles or non-investment grade fixed-income securities. We own AAA-rated senior tranches of primarily fixed rate auto loan, credit card, equipment lease, and rate reduction receivables, secured predominantly by prime collateral. All collateral on asset-backed securities is performing as expected through June 30, 2021. In addition, we own U.S. government securities which primarily include debt directly issued by Federal Farm Credit Banks and Federal Home Loan Banks. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). This investment strategy is supported by our short-term financing arrangements necessary to satisfy short-term funding requirements relating to client funds obligations. See Note 4 of our Consolidated Financial Statements for a description of our corporate investments and funds held for clients.Capital expenditures for fiscal 2021 were $178.3 million, as compared to $168.3 million for fiscal 2020. We expect capital expenditures in fiscal 2022 to be between $200 million and $225 million.Contractual Obligations The following table provides a summary of our contractual obligations at June 30, 2021:(In millions)Payments due by periodContractual ObligationsLess than 1 year1-3years3-5 yearsMore than 5 yearsUnknownTotalDebt Obligations (1)$64.2 $128.5 $1,111.8 $2,092.1 $— $3,396.6 Operating Lease Obligations (2)$103.2 $160.7 $102.5 $100.9 $— $467.3 Purchase Obligations (3)$448.5 $184.8 $25.3 $— $— $658.6 Obligations Related to Unrecognized Tax Benefits (4)$14.8 $— $— $— $85.1 $99.9 Other Long-Term Liabilities Reflected on our Consolidated Balance Sheets:Compensation and Benefits (5)$49.0 $64.9 $57.4 $267.2 $33.9 $472.4 Total$679.7 $538.9 $1,297.0 $2,460.2 $119.0 $5,094.8 (1)These amounts represent the principal and interest payments of our debt. 40(2)Included in these amounts are various facilities and equipment leases. We enter into operating leases in the normal course of business relating to facilities and equipment. The majority of our lease agreements have fixed payment terms based on the passage of time. Certain facility and equipment leases require payment of maintenance and real estate taxes and contain escalation provisions based on future adjustments in price indices. Our future operating lease obligations could change if we exit certain contracts or if we enter into additional operating lease agreements. (3)Purchase obligations are comprised of a $260 million reinsurance premium with Chubb for the fiscal 2022 policy year, as well as obligations related to software subscription licenses and purchase and maintenance agreements on our software, equipment, and other assets. (4)Based on current estimates, we expect to make cash payments up to $14.8 million in the next twelve months for obligations related to unrecognized tax benefits across various jurisdictions and tax periods. For $85.1 million of obligations related to unrecognized tax benefits we are unable to make reasonably reliable estimates as to the period in which cash payments are expected to be paid.(5)Compensation and benefits primarily relates to amounts associated with our employee benefit plans and other compensation arrangements. These amounts exclude the estimated contributions to our defined benefit plans, which are expected to be $10.0 million in fiscal 2022.In addition to the obligations quantified in the table above, we had obligations for the remittance of funds relating to our payroll and payroll tax filing services. As of June 30, 2021, the obligations relating to these matters, which are expected to be paid in fiscal 2022, total $34,403.8 million and were recorded in client funds obligations on our Consolidated Balance Sheets. We had $34,905.8 million of cash and cash equivalents and marketable securities that were impounded from our clients to satisfy such obligations recorded in funds held for clients on our Consolidated Balance Sheets as of June 30, 2021.Separately, ADP Indemnity paid a premium of $260 million in July 2021 to enter into a reinsurance agreement with Chubb to cover substantially all losses incurred by ADP Indemnity for the fiscal 2022 policy year. At June 30, 2021, ADP Indemnity had total assets of $564.2 million to satisfy the actuarially estimated unpaid losses of $487.4 million for the policy years since July 1, 2003. ADP Indemnity paid claims of $3.3 million and $4.4 million, net of insurance recoveries, in fiscal 2021 and 2020, respectively. Refer to the “Analysis of Reportable Segments - PEO Services” above for additional information regarding ADP Indemnity. In the normal course of business, we also enter into contracts in which we make representations and warranties that relate to the performance of our services and products. We do not expect any material losses related to such representations and warranties. Quantitative and Qualitative Disclosures about Market RiskOur overall investment portfolio is comprised of corporate investments (cash and cash equivalents, short-term and long-term marketable securities) and client funds assets (funds that have been collected from clients but have not yet been remitted to the applicable tax authorities or client employees).Our corporate investments are invested in cash and cash equivalents and highly liquid, investment-grade marketable securities. These assets are available for our regular quarterly dividends, share repurchases, capital expenditures and/or acquisitions, as well as other corporate operating purposes. All of our short-term and long-term fixed-income securities are classified as available-for-sale securities.Our client funds assets are invested with safety of principal, liquidity, and diversification as the primary objectives. Consistent with those objectives, we also seek to maximize interest income and to minimize the volatility of interest income. Client funds assets are invested in highly liquid, investment-grade marketable securities, with a maximum maturity of 10 years at the time of purchase, and money market securities and other cash equivalents. We utilize a strategy by which we extend the maturities of our investment portfolio for funds held for clients and employ short-term financing arrangements to satisfy our short-term funding requirements related to client funds obligations. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). As part of our client funds investment strategy, we use the daily collection of funds from our clients to satisfy other unrelated client funds obligations, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. In circumstances where we experience a reduction in employment levels due to a slowdown in the economy, we may make tactical decisions to sell certain securities in order to reduce the size of the funds held for clients to correspond to client funds obligations. We minimize the risk of not having funds collected from a client available at the time such client’s obligation becomes due by impounding, in virtually all instances, the client’s funds in advance of the timing of payment of such client’s 41obligation. As a result of this practice, we have consistently maintained the required level of client funds assets to satisfy all of our obligations.There are inherent risks and uncertainties involving our investment strategy relating to our client funds assets. Such risks include liquidity risk, including the risk associated with our ability to liquidate, if necessary, our available-for-sale securities in a timely manner in order to satisfy our client funds obligations. However, our investments are made with the safety of principal, liquidity, and diversification as the primary goals to minimize the risk of not having sufficient funds to satisfy all of our client funds obligations. We also believe we have significantly reduced the risk of not having sufficient funds to satisfy our client funds obligations by consistently maintaining access to other sources of liquidity, including our corporate cash balances, available borrowings under our $9.7 billion commercial paper program (rated A-1+ by Standard and Poor’s, P-1 by Moody’s, and F1+ by Fitch, the highest possible short-term credit ratings), and our ability to engage in reverse repurchase agreement transactions and available borrowings under our $9.7 billion committed credit facilities. The reduced availability of financing during periods of economic turmoil, including the COVID-19 pandemic, even to borrowers with the highest credit ratings, may limit our ability to access short-term debt markets to meet the liquidity needs of our business. In addition to liquidity risk, our investments are subject to interest rate risk and credit risk, as discussed below.We have established credit quality, maturity, and exposure limits for our investments. The minimum allowed credit rating at time of purchase for corporate, Canadian government agency and Canadian provincial bonds is BBB, for asset-backed securities is AAA, and for municipal bonds is A. The maximum maturity at time of purchase for BBB-rated securities is 5 years, for single A rated securities is 10 years, and for AA-rated and AAA-rated securities is 10 years. Time deposits and commercial paper must be rated A-1 and/or P-1. Money market funds must be rated AAA/Aaa-mf.Details regarding our overall investment portfolio are as follows:Years ended June 30, 20212020Average investment balances at cost: Corporate investments$3,525.6 $4,560.3 Funds held for clients27,353.1 25,990.3 Total$30,878.7 $30,550.6 Average interest rates earned exclusive of realized (gains)/losses on: Corporate investments1.0 %1.9 %Funds held for clients1.5 %2.1 %Total1.5 %2.1 %Net realized (gains)/losses on available-for-sale securities$(11.3)$(12.9) As of June 30:Net unrealized pre-tax gains on available-for-sale securities$502.2 $876.8 Total available-for-sale securities at fair value$24,371.7 $21,576.6 We are exposed to interest rate risk in relation to securities that mature, as the proceeds from maturing securities are reinvested. Factors that influence the earnings impact of interest rate changes include, among others, the amount of invested funds and the overall portfolio mix between short-term and long-term investments. This mix varies during the fiscal year and is impacted by daily interest rate changes. The annualized interest rate earned on our entire portfolio decreased from 2.1% for fiscal 2020 to 1.5% for fiscal 2021. A hypothetical change in both short-term interest rates (e.g., overnight interest rates or the federal funds rate) and intermediate-term interest rates of 25 basis points applied to the estimated average investment balances and any related short-term borrowings would result in approximately a $22 million impact to earnings before income taxes over the ensuing twelve-month period ending June 30, 2022. A hypothetical change in only short-term interest rates of 25 basis points applied to the estimated average short-term investment balances and any related short-term borrowings would result in approximately an $10 million impact to earnings before income taxes over the ensuing twelve-month period ending June 30, 2022.42We are exposed to credit risk in connection with our available-for-sale securities through the possible inability of the borrowers to meet the terms of the securities. We limit credit risk by investing in investment-grade securities, primarily AAA-rated and AA- rated securities, as rated by Moody’s, Standard & Poor’s, DBRS for Canadian dollar denominated securities, and Fitch for asset-backed and commercial-mortgage-backed securities. Approximately 72% of our available-for-sale securities held a AAA-rating or AA-rating at June 30, 2021. In addition, we limit amounts that can be invested in any security other than U.S. government and government agency, Canadian government, and United Kingdom government securities.We operate and transact business in various foreign jurisdictions and are therefore exposed to market risk from changes in foreign currency exchange rates that could impact our consolidated results of operations, financial position, or cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We may use derivative financial instruments as risk management tools and not for trading purposes.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTSSee Note 1, Recently Issued Accounting Pronouncements, of Notes to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.CRITICAL ACCOUNTING POLICIESOur Consolidated Financial Statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and other comprehensive income. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. In addition, as the duration and severity of COVID-19 pandemic are uncertain, certain of our estimates could require further judgment or modification and therefore carry a higher degree of variability and volatility. As events continue to evolve, our estimates may change materially in future periods. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are Revenue Recognition (including Deferred Costs), Goodwill and Income Taxes. Refer to Note 1, Summary of Significant Accounting Policies, of Notes to the Consolidated Financial Statements for discussion of our policies for Revenue Recognition (including Deferred Costs), Goodwill and Income Taxes. Goodwill. Goodwill represents the excess of purchase price over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is tested annually for impairment or more frequently when an event or circumstance indicates that goodwill might be impaired.The Company’s annual goodwill impairment assessment as of June 30, 2021 was performed for all reporting units using a quantitative approach by comparing the fair value of each reporting unit to its carrying value. We estimated the fair value of each reporting unit using, as appropriate, the income approach, which is derived using the present value of future cash flows discounted at a risk-adjusted weighted-average cost of capital, and the market approach, which is based upon using market multiples of companies in similar lines of business. Significant assumptions used in determining the fair value of our reporting units include projected revenue growth rates, profitability projections, working capital assumptions, the weighted average cost of capital, the determination of appropriate market comparison companies, and terminal growth rates. Several of these assumptions including projected revenue growth rates and profitability projections are dependent on our ability to upgrade, enhance, and expand our technology and services to meet client needs and preferences. As such, the determination of fair value requires management to make significant estimates and assumptions related to forecasts of future revenue and operating margins. Based upon the quantitative assessment, the Company has concluded that goodwill is not impaired. As the assumptions used in the income approach and market approach can have a material impact on the fair value determinations, we performed a sensitivity analysis and determined that a one percentage point increase in the weighted-average cost of capital would not result in an impairment of goodwill for all reporting units and their fair values substantially exceeded their carrying values. Item 7A. Quantitative and Qualitative Disclosures About Market RiskThe information called for by this item is provided under the caption “Quantitative and Qualitative Disclosures About Market Risk” under “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation.”43

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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOverviewW. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates worldwide in two business segments of the property and casualty business: Insurance and Reinsurance & Monoline Excess. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance and enterprise risk management, and actuarial, financial and corporate legal staff support. The Company's primary sources of revenues and earnings are its insurance operations and its investments.An important part of our strategy is to form new operating units to capitalize on various business opportunities. Over the years, the Company has formed numerous new operating units that are focused on important parts of the economy in the U.S., including healthcare, cyber security, energy and agriculture, and on growing international markets, including the Asia-Pacific region, South America and Mexico. The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic or social inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of capital employed in the industry, and the industry’s willingness to deploy that capital.The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments have been at low levels for an extended period.The Company also invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company's share of the earnings or losses from investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements.Effective January 1, 2020, the Company adopted new accounting standard ASU 2016-13 Financial Instruments - Credit Losses. Refer to Note 1 in the financial statements for further information on the accounting guidance and impact of its adoption on the Company's results and financial position.The ongoing COVID-19 pandemic, including the related impact on the U.S. and global economies, has materially and adversely affected our results of operations. For the year ended December 31, 2020, the Company recorded approximately $171 million for COVID-19-related losses, net of reinsurance, and reinstatement premiums of approximately $18 million. The ultimate impact of COVID-19 on the economy and on the Company’s results of operations, financial position and liquidity is uncertain and not within the Company’s control. The scope, duration and magnitude of the direct and indirect effects of COVID-19 continue to evolve in ways that are difficult or impossible to anticipate. Despite the effects of COVID-19 to date, the Company’s financial position and liquidity improved commencing in the second quarter.The impact of the COVID-19 pandemic on our results of operations, financial position and liquidity is expected to include, among others:Adverse Legislative and Regulatory Action. Legislative and regulatory initiatives taken or that may be taken in response to COVID-19, such as those that seek to retroactively mandate or provide a presumption of coverage for losses which our insurance policies would not otherwise cover and were not priced to cover, may adversely affect us, particularly in our workers’ compensation and property coverages businesses.Claim Losses Related to COVID-19 May Exceed Reserves. Given the great uncertainties associated with COVID-19 and its impact and the limited information upon which our current assumptions and assessments have been made, our reserves and underlying estimated level of claim losses and costs arising from COVID-19 may materially change.33Claim Losses and Adjustment Expenses May Increase. As the effects of COVID-19 on industry practices and economic, legal, judicial, social and other environmental conditions continue to evolve, unexpected and unintended issues related to claims and coverages may emerge (including in the area of property coverages where physical damage requirements and communicable disease exclusions are currently being challenged).Reinsurance. Reinsurers may dispute the applicability of reinsurance to COVID-19 related losses (including the application of reinsurance reinstatements) and, as a result, our reinsurers may refuse to pay reinsurance recoverables related thereto or they may not pay them on a timely basis. In addition, we may be unable to renew our current reinsurance coverages or purchase new coverages with respect to certain exposures under our policies, including COVID-19-related exposures.Premium Volumes May Be Negatively Impacted. Reduced economic activity relating to the COVID-19 pandemic will likely decrease demand for our insurance products and services. In addition, we may alter our view on the insurance coverages that are appropriate to offer in various jurisdictions, which could further negatively impact our premium volumes.Investments. Further disruptions in global financial markets due to the continuing impact of COVID-19 could cause us to incur additional unrealized and/or realized investment losses, including impairments in our fixed income portfolio and other investments.Credit Risk. As credit risk is generally a function of the economy, we face greater credit risk from our policyholders, independent agents and brokers in connection with the payment and remittance of premiums as a result of the economic conditions caused by COVID-19. Similarly, our credit risk related to the reimbursement of deductibles from policyholders and in connection with reinsurance recoverables has increased.Operational Disruptions and Costs. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or other third party service providers are unable to continue to work because of illness, government directives or otherwise. In response to the COVID-19 pandemic, we have implemented remote working policies which have resulted in disruptions to our business routines, heightened risk to cybersecurity attacks and data security incidents and a greater dependency on internet and telecommunication access and capabilities.34Critical Accounting EstimatesThe following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed reinsurance premiums and other-than-temporary impairments of investments. Management believes these policies and estimates are the most critical to its operations and require the most difficult, subjective and complex judgments. Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss. In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment based upon known information about the claim at that time. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided. In examining reserve adequacy, several factors are considered in estimating the ultimate economic value of losses. These factors include, among other things, historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed. Reserves do not represent a certain calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing reserves are well tested over time, the major assumptions about anticipated loss emergence patterns are subject to uncertainty. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot provide assurance that its current reserves will prove adequate in light of subsequent events. Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. For example, the paid loss and incurred loss development methods rely on historical paid and incurred loss data. For new lines of business, where there is insufficient history of paid and incurred claims data, or in circumstances where there have been significant changes in claim practices, the paid and incurred loss development methods would be less credible than other actuarial methods. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit. The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits, and changes in deductibles and attachment points. 35The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is priced and written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider. Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags. The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2020: (In thousands)Frequency (+/-)Severity (+/-)1%5%10%1%$89,102 $268,193 $492,056 5%268,193 454,376 687,105 10%492,056 687,105 930,917 Our net reserves for losses and loss expenses of approximately $11.6 billion as of December 31, 2020 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. The impact of such changes would likely be manifested gradually over the course of many years, as the magnitude of the changes became evident.Approximately $2.6 billion, or 22%, of the Company’s net loss reserves as of December 31, 2020 relate to the Reinsurance & Monoline Excess segment. There is a higher degree of uncertainty and greater variability regarding estimates of excess workers' compensation and assumed reinsurance loss reserves. In the case of excess workers’ compensation, our policies generally attach at $1 million or higher. The claims which reach our layer therefore tend to involve the most serious injuries and many remain open for the lifetime of the claimant, which extends the claim settlement tail. These claims also occur less frequently but tend to be larger than primary claims, which increases claim variability. In the case of assumed reinsurance our loss reserve estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to 36delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is also extended. Management considers the impact of delayed reporting and the extended tail in its selection of loss development factors for these lines of business.Information received from ceding companies is used to set initial expected loss ratios, to establish case reserves and to estimate reserves for incurred but not reported losses on assumed reinsurance business. This information, which is generally provided through reinsurance intermediaries, is gathered through the underwriting process and from periodic claim reports and other correspondence with ceding companies. The Company performs underwriting and claim audits of selected ceding companies to determine the accuracy and completeness of information provided to the Company. The information received from the ceding companies is supplemented by the Company’s own loss development experience with similar lines of business as well as industry loss trends and loss development benchmarks.37Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2020 and 2019: (In thousands)20202019Insurance$9,034,969 $8,193,381 Reinsurance & Monoline Excess2,585,424 2,504,617 Net reserves for losses and loss expenses11,620,393 10,697,998 Ceded reserves for losses and loss expenses2,164,037 1,885,251 Gross reserves for losses and loss expenses$13,784,430 $12,583,249 Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business as of December 31, 2020 and 2019: (In thousands)Reported CaseReservesIncurred ButNot ReportedTotalDecember 31, 2020Other liability$1,534,514 $2,864,760 $4,399,274 Workers’ compensation (1)977,035 873,072 1,850,107 Professional liability414,104 875,163 1,289,267 Commercial automobile442,975 398,688 841,663 Short-tail lines (2)295,313 359,345 654,658 Total Insurance3,663,941 5,371,028 9,034,969 Reinsurance & Monoline Excess (1) (3)1,442,099 1,143,325 2,585,424 Total$5,106,040 $6,514,353 $11,620,393 December 31, 2019Other liability$1,421,378 $2,522,957 $3,944,335 Workers’ compensation (1)918,619 964,102 1,882,721 Professional liability399,411 713,433 1,112,844 Commercial automobile412,036 300,339 712,375 Short-tail lines (2)271,192 269,914 541,106 Total Insurance3,422,636 4,770,745 8,193,381 Reinsurance & Monoline Excess (1) (3)1,469,363 1,035,254 2,504,617 Total$4,891,999 $5,805,999 $10,697,998 ____________________(1)Reserves for excess and assumed workers’ compensation business are net of an aggregate net discount of $483 million and $530 million as of December 31, 2020 and 2019, respectively.(2)Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.(3)Reinsurance & Monoline Excess includes property and casualty reinsurance as well as operations that solely retain risk on an excess basis.The Company evaluates reserves for losses and loss expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends. Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss expenses for prior years may be fully or partially offset by additional or return premiums. Net prior year development (i.e, the sum of prior year reserve changes and prior year earned premiums changes) for each of the last three years ended December 31, are as follows:38(In thousands)202020192018Increase in prior year loss reserves$(627)$(34,079)$(6,831)Increase in prior year earned premiums16,807 53,511 45,638 Net favorable prior year development$16,180 $19,432 $38,807 The ongoing COVID-19 global pandemic has impacted, and will likely continue to impact, the Company’s results through its effect on claim frequency and severity. Loss cost trends have been impacted and will likely be further impacted by COVID-19-related claims in certain lines of business, as well as by other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules, for example. Although it is still too early to determine the net impact, it appears that the losses incurred due to COVID-19-related claims are being offset, to a certain extent, by lower claim frequency in certain lines of our businesses, including commercial auto, workers’ compensation, and other liability. However, given the continuing nature of the pandemic, the impact of COVID-19 could ultimately increase or decrease overall loss cost trends and is likely to have differing impacts on the Company's different lines of business.Most of the COVID-19-related claims reported to the Company to date involve certain short-tailed lines of business, including contingency and event cancellation, business interruption, and film production delay. The Company expects additional claims to be reported for these lines of business. The Company has also received COVID-19-related claims for longer-tailed casualty lines of business such as workers’ compensation and other liability; however, the estimated incurred loss impact for these reported claims appears to be modest at this time. Given the continuing uncertainty regarding the pandemic's pervasiveness, the future impact that the pandemic may have on claim frequency and severity remains uncertain at this time. In workers’ compensation, for example, nearly two-thirds of the states have enacted rules, legislation or administrative orders creating a presumption that certain “essential” workers who contract COVID-19 did so through the course of their employment. Several other states are considering similar actions, including varying the definition of “essential” workers. While the ultimate impact of these presumptions are unknown at this time, the Company believes that such state actions will likely increase workers’ compensation claims with respect to workers deemed “essential,” although this impact may be partially offset by lower workers’ compensation claim frequency with respect to non-essential workers.The Company has estimated the potential COVID-19 impact to its contingency and event cancellation, workers’ compensation, and other lines of business under a number of possible scenarios; however, due to COVID-19’s evolving impact and the still limited amount of available data, there remains a high degree of uncertainty around the Company’s COVID-19 reserves. In addition, several states (and international jurisdictions), through regulation, legislation and/or judicial action, continue to seek to expand policy coverage terms beyond the policy’s intended coverage, including, for example, but not limited to, property coverages, where there are attempts to extend business interruption coverage where there is no physical damage or loss to property, and attempts to disregard policy exclusions for communicable disease. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company’s reserves established for those related policies.For the year ended December 31, 2020, the Company recognized losses for COVID-19-related claims activity, net of reinsurance, of approximately $171 million, of which $161 million related to the Insurance segment and $10 million related to the Reinsurance & Monoline Excess segment. Such $171 million of COVID-19-related losses included $95 million of reported losses and $76 million of IBNR.Favorable prior year development (net of additional and return premiums) was $16 million in 2020.Insurance - Reserves for the Insurance segment developed favorably by $24 million in 2020 (net of additional and return premiums). Continuing the pattern seen in recent years, the overall favorable development in 2020 resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability, including excess professional liability. For workers’ compensation, the favorable development was spread across almost all prior accident years, including prior to 2011, but was most significant in accident years 2016 through 2019. The favorable workers’ compensation development reflects a continuation of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers’ compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Reported workers’ compensation losses in 2020 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates for most prior accident years. For professional liability business, unfavorable development was driven mainly by large losses reported in the directors and officers (“D&O”), lawyers professional and excess hospital professional liability lines of business. For these lines of 39business, we continue to see an increase in the number of large losses reported and a lengthening of the reporting “tail” beyond historical levels. We believe a contributing cause is rising social inflation in the form of, for example, higher jury awards on cases that go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for professional liability affected mainly accident years 2016 through 2018.Reinsurance & Monoline Excess – Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by $8 million in 2020. The unfavorable development in the segment was driven by non-proportional assumed liability business written in both the U.S. and U.K., and was partially offset by favorable development on excess workers’ compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2014 through 2018, and related primarily to accounts insuring construction projects and professional liability exposures.Favorable prior year development (net of additional and return premiums) was $19 million in 2019. Insurance - Reserves for the Insurance segment developed favorably by $21 million in 2019 (net of additional and return premiums). This overall favorable development resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability and general liability business.For workers’ compensation, the favorable development was spread across many accident years, including prior to 2010, but was most significant in accident years 2014 through 2018, and particularly 2017 and 2018. The favorable workers’ compensation development reflects a continuation during 2019 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers’ compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Our initial loss ratio “picks” for this line of business over the past few accident years have contemplated an increase in loss cost trends and reflect decreasing premium rates in the marketplace; reported workers’ compensation losses in 2019 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates. For professional liability business, the unfavorable development was driven mainly by an increase in the number of large losses reported in the lawyers professional liability and directors and officers (“D&O”) liability lines of business. Many of the lawyers large losses involved claims made against insured law firms relating to work performed on matters stemming from the 2008 financial crisis. These claims affected mainly accident years 2013 through 2016. In addition, for both of these lines of business, we have seen evidence of social inflation in the form of higher jury awards on cases that go to trial, and corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for D&O affected mainly accident years 2014 through 2017.For general liability business, most of the unfavorable development emanated from our excess and surplus lines (E&S) businesses, and was driven by an increase in the number of large losses reported. Many of these large losses were from construction and contracting classes of business, which have also been impacted by social inflation. The general liability unfavorable development impacted mainly accident years 2015 through 2018.Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by $2 million in 2019. The unfavorable development in the segment was driven by non-proportional assumed liability business in both the U.S. and U.K., and was largely offset by favorable development on excess workers’ compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2015 through 2018, and included an adjustment for the Ogden discount rate in the U.K.Favorable prior year development (net of additional and return premiums) was $39 million in 2018. Insurance - Reserves for the Insurance segment developed favorably by $19 million in 2018. The favorable development was primarily attributable to workers’ compensation business, and was partially offset by unfavorable development for professional liability business.For workers’ compensation, the favorable development was spread across many accident years, but was most significant in accident years 2015 through 2017. The favorable workers’ compensation development reflects a continuation during 2018 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers' compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks. Reported 40workers’ compensation losses in 2018 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our previous reserve estimates. For professional liability business, adverse development was primarily related to unexpected large directors and officers (“D&O”) liability losses at one of our U.S. operating units, as well as lawyers professional liability losses at another operating unit. The adverse development stemmed primarily from accident years 2015 and 2016, and was driven by a higher frequency of large losses than we had experienced in previous years.Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed favorably by $20 million in 2018. The favorable development was primarily due to excess workers’ compensation business, and was spread across many accident years, including years prior to 2009. This favorable excess workers’ compensation development was partially offset by unfavorable development on U.S. casualty facultative assumed business from accident years 2009 and prior related to construction projects.Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,655 million and $1,731 million at December 31, 2020 and 2019, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $483 million and $530 million at December 31, 2020 and 2019, respectively. At December 31, 2020, discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.6%.Substantially all discounted workers’ compensation reserves (97% of total discounted reserves at December 31, 2020) are excess workers’ compensation reserves. In order to properly match loss expenses with income earned on investment securities supporting the liabilities, reserves for excess workers’ compensation business are discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These rates are determined annually based on the weighted average rate for the period. Once established, no adjustments are made to the discount rate for that period, and any increases or decreases in loss reserves in subsequent years are discounted at the same rate, without regard to when any such adjustments are recognized. The expected loss and loss expense payout patterns subject to discounting are derived from the Company’s loss payout experience.The Company also discounts reserves for certain other long-duration workers’ compensation reserves (representing approximately 3% of total discounted reserves at December 31, 2020), including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates prescribed or permitted by the Department of Insurance of the State of Delaware.Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $44 million and $43 million at December 31, 2020 and 2019, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.Allowance for Expected Credit Losses on Investments.Fixed Maturity Securities – For fixed maturity securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains (losses). For fixed maturity securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains (losses), limited by the amount that the fair value is less than the amortized cost basis. Effective January 1, 2020, the allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains (losses). The impairment related to non-credit factors is recognized in other comprehensive income (loss) .41 The Company’s credit assessment of allowance for expected credit losses uses a third party model for available for sale and held to maturity securities, as well as loans receivable. The allowance for expected credit losses is generally based on the performance of the underlying collateral under various economic and default scenarios that involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. A discounted cash flow analysis is used to ascertain the amount of the allowance for expected credit losses, if any. In general, the model reverts to the rating-level long-term average marginal default rates based on 10 years of historical data, beyond the forecast period. For other inputs, the model in most cases reverts to the baseline long-term assumptions linearly over 5 years beyond the forecast period. The long-term assumptions are based on the historical averages. The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company’s own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis.A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2020 is presented in the table below. ($ in thousands)Number ofSecuritiesAggregateFair ValueUnrealizedLossForeign government18 $75,555 $44,310 Corporate11 26,617 3,025 Mortgage-backed securities7 1,393 31 Total36 $103,565 $47,366 As of December 31, 2020, the Company has recorded an allowance for expected credit losses on fixed maturity securities of $3 million. The Company has evaluated the remaining fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due.Loans Receivable – For loans receivable, the Company estimates an allowance for expected credit losses based on relevant information about past events, including historical loss experience, current conditions and forecasts that affect the expected collectability of the amortized cost of the financial asset. The allowance for expected credit losses is presented as a reduction to amortized cost of the financial asset in the consolidated balance sheet and changes to the estimate for expected credit losses are recognized through net investment gains (losses). Loans receivable are reported net of an allowance for expected credit losses of $5 million and $2 million as of December 31, 2020 and December 31, 2019, respectively.Fair Value Measurements. The Company’s fixed maturity available for sale securities, equity securities, and its trading account securities are carried at fair value. Fair value is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date". The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of the vast majority of the Company’s portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2.In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy.42Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2020: (In thousands)CarryingValuePercentof TotalPricing source:Independent pricing services$13,910,209 98.7 %Syndicate manager44,612 0.3 Directly by the Company based on:Observable data130,774 0.9 Cash flow model1,000 0.1 Total$14,086,595 100.0 %Independent pricing services - Substantially all of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of December 31, 2020, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.Syndicate manager – The Company has a 15% participation in a Lloyd’s syndicate, and the Company’s share of the securities owned by the syndicate is priced by the syndicate’s manager. The majority of the securities are liquid, short duration fixed maturity securities. The Company reviews the syndicate manager’s pricing methodology and audited financial statements and holds discussions with the syndicate manager as necessary to confirm its understanding and agreement with security prices. Based upon the Company’s review of the methodologies used by the syndicate manager, these securities were classified as Level 2.Observable data – If independent pricing is not available, the Company prices the securities directly. Prices are based on observable market data where available, including current trading levels for similar securities and non-binding quotations from brokers. The Company generally requests two or more quotes. If more than one quote is received, the Company sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes obtained from brokers. Since these securities were priced based on observable data, they were classified as Level 2.Cash flow model – If the above methodologies are not available, the Company prices securities using a discounted cash flow model based upon assumptions as to prevailing credit spreads, interest rates and interest rate volatility, time to maturity and subordination levels. Discount rates are adjusted to reflect illiquidity where appropriate. These securities were classified as Level 3.43Results of Operations for the Years Ended December 31, 2020 and 2019 Business Segment ResultsFollowing is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2020 and 2019. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. (In thousands)20202019InsuranceGross premiums written$7,837,496 $7,398,573 Net premiums written6,347,101 6,086,009 Net premiums earned6,067,669 5,919,819 Loss ratio64.9 %62.4 %Expense ratio30.3 31.1 GAAP combined ratio95.2 93.5 Reinsurance & Monoline ExcessGross premiums written$1,010,151 $863,646 Net premiums written915,336 777,490 Net premiums earned863,174 713,469 Loss ratio61.3 %61.5 %Expense ratio31.8 35.0 GAAP combined ratio93.1 96.5 ConsolidatedGross premiums written$8,847,647 $8,262,219 Net premiums written7,262,437 6,863,499 Net premiums earned6,930,843 6,633,288 Loss ratio64.5 %62.3 %Expense ratio30.4 31.5 GAAP combined ratio94.9 93.8 Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2020 and 2019. (In thousands, except per share data)20202019Net income to common stockholders$530,670 $681,944 Weighted average diluted shares188,763 193,521 Net income per diluted share$2.81 $3.52 The Company reported net income of $531 million in 2020 compared to $682 million in 2019. The $151 million decrease in net income was primarily due to an after-tax decrease in net investment income of $47 million mainly due to reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, an after-tax decrease in underwriting income of $46 million resulted from COVID-19-related losses and other catastrophe losses, a $39 million increase in tax expense due to change in effective tax rate, a $23 million decrease in after-tax foreign currency gains as the U.S. dollar weakened against a wide spectrum of currencies, a decrease in after-tax net investment gains of $13 million, a $6 million debt extinguishment expense on debt redeemed in 2020 and an after-tax decrease in other income of $1 million, partially offset by an after-tax reduction in corporate expenses of $12 million, an after-tax increase in insurance service fee income of $9 million, an after-tax reduction of $2 million from interest expense, and an after-tax increase in income from non-insurance businesses of $1 million. The number of weighted average diluted shares decreased by approximately 5 million for 2020 compared to 2019, mainly reflecting shares repurchased in 2020.Premiums. Gross premiums written were $8,848 million in 2020, an increase of 7% from $8,262 million in 2019. The increase was due to the growth in the Insurance segment of $439 million and $147 million in the Reinsurance & Monoline Excess segment. Approximately 79% of premiums expiring in 2020 were renewed, and 80% of premiums expiring in 2019 were renewed. 44Average renewal premium rates for insurance and facultative reinsurance increased 11.3% in 2020 and 4.8% in 2019, when adjusted for changes in exposures. Average renewal premium rates for insurance and facultative reinsurance excluding workers' compensation increased 13.6% in 2020 and 6.9% in 2019, when adjusted for changes in exposures. A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows:•Insurance gross premiums increased 6% to $7,837 million in 2020 from $7,398 million in 2019. Gross premiums increased $270 million (11%) for other liability, $196 million (20%) for professional liability, and $92 million (5%) for short-tail lines and $74 million (9%) for commercial auto, and decreased $193 million (15%) for workers' compensation.•Reinsurance & Monoline Excess gross premiums increased 17% to $1,010 million in 2020 from $864 million in 2019. Gross premiums written increased $105 million (22%) for casualty lines, $27 million (14%) for property lines, and $14 million (7%) for monoline excess. Net premiums written were $7,262 million in 2020, an increase of 6% from $6,863 million in 2019. Ceded reinsurance premiums as a percentage of gross written premiums were 18% in 2020 and 17% in 2019. Premiums earned increased 4% to $6,931 million in 2020 from $6,633 million in 2019. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly recent rate increases will be earned over the upcoming quarters. Premiums earned in 2020 are related to business written during both 2020 and 2019. Audit premiums were $128 million in 2020 compared with $199 million in 2019.Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2020 and 2019:AmountAverage AnnualizedYield(In thousands)2020201920202019Fixed maturity securities, including cash and cash equivalents and loans receivable$426,563 $517,925 2.7 %3.4 %Investment funds54,253 69,194 4.5 5.2 Arbitrage trading account77,931 34,585 14.6 7.8 Real estate24,027 24,218 1.2 1.2 Equity securities10,172 5,439 2.7 2.0 Gross investment income592,946 651,361 3.0 3.4 Investment expenses(9,125)(5,747)— — Total$583,821 $645,614 2.9 %3.4 %Net investment income decreased 10% to $584 million in 2020 from $646 million in 2019 primarily due to a $92 million decrease in income from fixed maturity securities driven by lower investment yields and repositioning a larger portion of the investment portfolio to cash and cash equivalents, a $15 million decrease in income from investment funds and an increase in investment expenses of $3 million, partially offset by a $43 million increase in arbitrage trading account and a $5 million increase in equity securities. Investment funds are reported on a one quarter lag. The average annualized yield for fixed maturity securities was 2.7% in 2020 and 3.4% in 2019. The effective duration of the fixed maturity portfolio was 2.4 years at December 31, 2020 and 2.8 years at December 31, 2019. The Company shortened the duration of its fixed maturity security portfolio, thereby reducing the potential impact of mark-to-market on the portfolio and positioning the Company to react quickly to changes in the current interest rate environment. Average invested assets, at cost (including cash and cash equivalents), were $20.0 billion in 2020 and $19.1 billion in 2019.Insurance Service Fees. The Company earns fees from an insurance distribution business, a third-party administrator, and as a servicing carrier of workers' compensation assigned risk plans for certain states. Insurance service fees were $89 million in 2020 and $93 million in 2019. The decrease was primarily due to a reduction of assigned risk plan business.Net Realized and Unrealized Gains on Investments. The Company buys and sells securities and other investment assets on a regular basis in order to maximize its total return on investments. Decisions to sell securities and other investment assets are based on management’s view of the underlying fundamentals of specific investments as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized and unrealized gains on investments were $74 million in 2020 compared with $121 million in 2019. In 2020, the gains reflected net realized gains on investment of $99 million, including the sale of a building for a gain of $105 million, and decreased by a change in unrealized 45losses on equity securities of $25 million. In 2019, the gains reflected net realized gains on investment sales of $36 million and increased by a change in unrealized gains on equity securities of $85 million. Change in Allowance for Expected Credit Losses on Investments. Effective January 1, 2020, the Company adopted accounting guidance for credit losses on financial instruments. The cumulative effect adjustment from the change in accounting principle was $25 million after-tax, which decreased opening retained earnings and increased AOCI. Based on credit factors, the allowance for expected credit losses is increased or decreased depending on the percentage of unrealized loss relative to amortized cost by security, changes in rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. For the year ended December 31, 2020, the pre-tax change in allowance for expected credit losses on investments decreased by $29 million ($23 million after-tax), which is reflected in net investment gains (losses).Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses were derived from businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that provide services to aviation markets, including (i) the distribution, manufacturing, repair and overhaul of aircraft parts and components, (ii) the sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage and charter services. Revenues from non-insurance businesses were $390 million in 2020 and $407 million in 2019. The decrease mainly relates to a reduction in revenues from the aviation-related businesses impacted by COVID-19.Losses and Loss Expenses. Losses and loss expenses increased to $4,469 million in 2020 from $4,131 million in 2019. The consolidated loss ratio was 64.5% in 2020 and 62.3% in 2019. Catastrophe losses, net of reinsurance recoveries, were $340 million (including losses of approximately $171 million related to COVID-19) in 2020 compared with $90 million in 2019. Favorable prior year reserve development (net of premium offsets) was $16 million in 2020 compared with $19 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.4 points to 59.8% in 2020 from 61.2% in 2019.A summary of loss ratios in 2020 compared with 2019 by business segment follows:•Insurance - The loss ratio of 64.9% in 2020 was 2.5 points higher than the loss ratio of 62.4% in 2019. Catastrophe losses were $307 million in 2020 compared with $68 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $161 million, which was included in catastrophe losses and primarily related to contingency and event cancellation coverage, workers’ compensation and short-tail lines. Favorable prior year reserve development was $24 million in 2020 compared with $21 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.4 points to 60.2% in 2020 from 61.6% in 2019. •Reinsurance & Monoline Excess - The loss ratio of 61.3% in 2020 was 0.2 points lower than the loss ratio of 61.5% in 2019. Catastrophe losses were $33 million in 2020 compared with $22 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $10 million, which was included in catastrophe losses and primarily related to excess workers’ compensation and short-tail lines. Adverse prior year reserve development was $8 million in 2020 compared with adverse prior year reserve development of $2 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.5 points to 56.6% in 2020 from 58.1% in 2019. Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses: (In thousands)20202019Policy acquisition and insurance operating expenses$2,111,013 $2,090,301 Insurance service expenses85,724 101,317 Net foreign currency losses (gains)363 (30,715)Debt extinguishment costs8,440 — Other costs and expenses184,852 201,179 Total$2,390,392 $2,362,082 Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 1% and net premiums earned increased 4% from 2019. The expense ratio (policy acquisition and insurance operating expenses expressed as a percentage of premiums earned) was 30.4% in 2020 and 31.5% in 2019. The improvement is primarily attributable to higher net premiums earned and lower travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase.46Service expenses, which represent the costs associated with the fee-based businesses, decreased 15% to $86 million in 2020 from $101 million in 2019. The decrease is primarily due to a reduction of assigned risk plan business.Net foreign currency losses (gains) result from transactions denominated in a currency other than an operating unit’s functional currency. Net foreign currency losses were $0.4 million in 2020 compared to gains of $31 million in 2019, mainly due to U.S. dollar weakening in relation to a wide spectrum of currencies in 2020.Debt extinguishment costs of $8 million in 2020 related to the redemption of subordinated debentures that were due in 2053. Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses decreased to $185 million in 2020 from $201 million in 2019 primarily due to a reduction in non-recurring performance-based compensation costs which occurred in 2019 and reduced travel-related expenses due to COVID-19 in 2020. Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided and (ii) general and administrative expenses. Expenses from non-insurance businesses were $384 million in 2020 compared to $403 million in 2019. The decrease mainly relates to a reduction of aviation-related business impacted by COVID-19 in 2020.Interest Expense. Interest expense was $151 million in 2020 compared with $153 million in 2019. During 2019, the Company repaid at maturity $489 million aggregate principal amount of senior notes and other debt. In December 2019, the Company issued $300 million aggregate principal amount of 5.10% subordinated debentures due 2059. In May 2020, the Company issued $300 million aggregate principal amount of 4.00% senior notes due 2050. In September 2020, the Company issued an additional $170 million aggregate principal amount of 4.00% senior notes due 2050 and issued $250 million aggregate principal amount of 4.25% subordinated debentures due 2060 and repaid $300 million aggregate principal amount of 5.375% senior notes at maturity. In October 2020, the Company redeemed $350 million aggregate principal amount of 5.625% subordinated debentures due 2053. Accordingly, the timing of the repayments of debt at maturity and redemption that took place throughout 2019 and 2020 and issuances in 2019 and 2020 led to the decrease in interest expense for the year ended December 31, 2020 compared to 2019. The redemption of debentures and issuance of additional debentures in 2021, as described below in "Liquidity and Capital Resources -- Debt," are also expected to impact interest expense in 2021.Income Taxes. The effective income tax rate was 24.4% in 2020 and 19.8% in 2019. The effective income tax rate differs from the federal income tax rate of 21% principally because the utilization of losses in certain foreign jurisdictions was limited, which was partially offset by tax-exempt investment income and tax benefits related to equity-based compensation. See Note 16 of the Consolidated Financial Statements for a reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 21%.The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $111 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial.Results of Operations for the Years Ended December 31, 2019 and 2018For a comparison of the Company’s results of operations for the year ended December 31, 2019 to the year ended December 31, 2018, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the Securities and Exchange Commission on February 20, 2020.47InvestmentsAs part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company also attempts to maintain an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration of the investment portfolio was 2.4 years at December 31, 2020 and 2.8 years at December 31, 2019. The Company’s investment portfolio and investment-related assets as of December 31, 2020 were as follows:($ in thousands)CarryingValuePercentof TotalFixed maturity securities:U.S. government and government agencies$603,871 2.9 %State and municipal:Special revenue2,252,067 10.8 State general obligation493,147 2.4 Local general obligation450,624 2.2 Pre-refunded (1)276,672 1.3 Corporate backed214,473 1.0 Total state and municipal3,686,983 17.7 Mortgage-backed securities:Agency630,784 3.0 Residential-Prime199,481 1.0 Commercial187,717 0.9 Residential-Alt A8,803 — Total mortgage-backed securities1,026,785 4.9 Asset-backed securities3,194,586 15.3 Corporate:Industrial2,564,475 12.3 Financial1,575,903 7.6 Utilities421,165 2.0 Other110,038 0.5 Total corporate4,671,581 22.4 Foreign government975,563 4.7 Total fixed maturity securities14,159,369 67.9 Equity securities available for sale:Common stocks350,181 1.7 Preferred stocks275,486 1.3 Total equity securities available for sale625,667 3.0 Cash and cash equivalents2,372,366 11.4 Real estate1,960,914 9.4 Investment funds1,309,430 6.3 Arbitrage trading account341,473 1.6 Loans receivable84,913 0.4 Total investments$20,854,132 100.0 % ______________(1)Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively with U.S. Treasury and U.S. government agency securities.Fixed Maturity Securities. The Company’s investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale 48portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations.The Company’s philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.Equity Securities. Equity securities primarily represent investments in common and preferred stocks in companies with potential growth opportunities in different sectors, mainly in the financial institutions sector.Investment Funds. At December 31, 2020, the carrying value of investment funds was $1,309 million, including investments in financial services funds of $434 million, real estate funds of $311 million, transportation funds of $190 million, energy funds of $141 million, and other funds of $233 million. Investment funds are primarily reported on a one-quarter lag.Real Estate. Real estate is directly owned property held for investment. At December 31, 2020, real estate properties in operation included a long-term ground lease in Washington D.C., an office complex in New York City, office buildings in West Palm Beach and Palm Beach, Florida, an office building in London, and the completed portion of a mixed-use project in Washington D.C. In addition, part of the previously mentioned mixed-use project in Washington D.C. is under development. The Company expects to fund further development costs for the project with a combination of its own funds and external financing. During the fourth quarter of 2020, the Company sold an office complex in New York City. Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers.Loans Receivable. Loans receivable, which are carried at amortized cost (net of allowance for expected credit losses), had an amortized cost of $85 million and an aggregate fair value of $87 million at December 31, 2020. The amortized cost of loans receivable is net of an allowance for expected credit losses of $5 million as of December 31, 2020. Loans receivable include real estate loans of $52 million that are secured by commercial real estate located primarily in New York. Real estate loans receivable generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. Loans receivable include commercial loans of $33 million that are secured by business assets and have fixed interest rates and floating LIBOR-based interest rates with varying maturities not exceeding 10 years.49Liquidity and Capital ResourcesCash Flow. Cash flow provided from operating activities increased to $1,617 million in 2020 from $1,144 million in 2019, primarily due to an increase in premium receipts, net of reinsurance and commissions settled and the timing of loss and loss expense payments as well as payments to tax authorities.The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally targets an average duration for its investment portfolio that is within 1.5 years of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed maturity securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 79% invested in cash, cash equivalents and marketable fixed maturity securities as of December 31, 2020. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized. Debt. At December 31, 2020, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,725 million and a face amount of $2,743 million, including $300 million aggregate principal amount of its 4.00% senior notes due 2050 issued in May 2020 as well as an additional $170 million aggregate principal amount of its 4.00% senior notes due 2050 and $250 million aggregate principal amount of its 4.25% subordinated debentures due 2060 issued in September 2020. The Company redeemed $350 million aggregate principal amount of its subordinated debentures due 2053 in October 2020. The maturities of the outstanding debt are $3 million in 2021, $427 million in 2022, $6 million in 2025, $102 million in 2028, $250 million in 2037, $350 million in 2044, $470 million in 2050, $400 million in 2056, $185 million in 2058, $300 million in 2059 and $250 million in 2060.In January 2021, the Company called its $110 million aggregate principal amount of 5.90% subordinated debentures for redemption on March 1, 2021. Additionally in February 2021, the Company issued $300 million aggregate principal amount of 4.125% subordinated debentures due 2061. Equity. The Company repurchased 6,363,301 and 269,072 shares of its common stock in 2020 and 2019, respectively. The aggregate cost of the repurchases was $346 million in 2020 and $18 million in 2019. In 2020, the Board declared regular quarterly cash dividends of $0.11 per share in the first quarter, and $0.12 per share in each of the remaining three quarters for a total of $84 million in aggregate dividends in 2020. At December 31, 2020, total common stockholders’ equity was $6.3 billion, common shares outstanding were 177,825,150 and stockholders’ equity per outstanding share was $35.49. Total Capital. Total capitalization (equity, debt and subordinated debentures) was $9.0 billion at December 31, 2020. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 30% at December 31, 2020 and December 31, 2019.Federal and Foreign Income TaxesThe Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2020, the Company had a gross deferred tax asset (net of valuation allowance) of $414 million (which primarily relates to loss and loss expense reserves and unearned premium reserves) and a gross deferred tax liability of $427 million (which primarily relates to deferred policy acquisition costs, unrealized investment gains and investment funds). The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. 50Reinsurance The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company’s reinsurance purchases include the following:•Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2021: The Company’s property per risk reinsurance generally covers losses between $2.5 million and $65 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses between $17.5 million and $395 million for the majority of business written by its U.S. Insurance segment operating units and Lloyd's Syndicate, excluding offshore energy, but some perils are protected above $15 million. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums.•Casualty reinsurance treaties - The Company purchases casualty reinsurance to reduce its exposure to large individual casualty losses, workers’ compensation catastrophe losses and casualty losses involving multiple claimants or insureds for the majority of business written by its U.S. companies. A significant casualty treaty (casualty catastrophe) in effect as of January 1, 2021 provides significant protection for losses between $5 million and $75 million from single events with claims involving two or more insurable interests or for systemic events involving multiple insureds and/or policy years. The treaty also covers casualty contingency losses in excess of $5 million and up to $100 million. For losses involving two or more claimants for primary workers’ compensation business, coverage is generally in place for losses between $10 million and $270 million. For excess workers’ compensation business, such coverage is generally in place for losses between $25 million and $545 million. •Facultative reinsurance - The Company also purchases facultative reinsurance on certain individual policies or risks that are in excess of treaty reinsurance capacity. •Other reinsurance - Depending on the operating unit, the Company purchases specific additional reinsurance to supplement the above programs.•Effective January 1, 2021, Lifson Re will be a participant on the majority of the Company’s reinsurance placements for a 22.5% share of the placed amounts. This pertains to all traditional treaty reinsurance/retrocessional placements for both property and casualty business where there is more than one open market reinsurer participating. Lifson Re has been capitalized with more than $250 million of equity from a small group of sophisticated global investors with long-term investment horizons, including a minority participation by the Company. Lifson Re will participate on a fully collateralized basis.The Company places a number of its casualty treaties on a “risk attaching” basis. Under risk attaching treaties, all claims from policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. If the Company is unable to renew or replace its existing reinsurance coverage, protection for unexpired policies would remain in place until their expiration. In such case, the Company could revise its underwriting strategy for new business to reflect the absence of reinsurance protection. The casualty catastrophe treaty highlighted above was purchased on a losses discovered basis. Property catastrophe and workers’ compensation catastrophe reinsurance is generally placed on a “losses occurring basis,” whereby only claims occurring during the period are covered. If the Company is unable to renew or replace these reinsurance coverages, unexpired policies would not be protected, though we frequently have the option to purchase run-off coverage in our treaties. Following is a summary of earned premiums and loss and loss expenses ceded to reinsurers for each of the three years ended December 31, 2020: Year Ended December 31,(In thousands)202020192018Earned premiums$1,499,948 $1,328,843 $1,236,049 Losses and loss expenses955,630 836,831 829,742 Ceded earned premiums increased 12.9% in 2020 to $1,500 million. The ceded losses and loss expenses ratio increased 1 point to 64% in 2020 from 63% in 2019. 51The following table presents the credit quality of amounts due from reinsurers as of December 31, 2020. Amounts due from reinsurers are net of reserves for uncollectible reinsurance of $1 million in the aggregate.(In thousands)ReinsurerRating(1)AmountAmounts due in excess of $20 million:Munich ReAA-$275,841 Lloyd’s of LondonA+255,184 Swiss ReAA-182,532 Alleghany GroupA+182,015 Partner ReA+164,535 Hannover Re GroupAA-129,752 Berkshire HathawayAA+104,775 Everest ReA+102,085 Renaissance ReA+101,014 Axis CapitalA+87,948 Liberty MutualA66,263 Korean ReA56,091 Fairfax FinancialA-37,310 Axa InsuranceAA-35,012 Validus Holdings Ltd.A29,599 Arch Capital GroupA+27,739 Qatar ReA20,321 Other reinsurers: Rated A- or better178,473 Secured (2)122,573 All Others29,883 Subtotal $2,188,945 Residual market pools (3)243,358 Allowance for expected credit losses(7,801)Total $2,424,502 _________________(1)S&P rating, or if not rated by S&P, A.M. Best rating.(2)Secured by letters of credit or other forms of collateral.(3)Many states require licensed insurers that provide workers' compensation insurance to participate in programs that provide workers' compensation to employers that cannot procure coverage from an insurer on a voluntary basis. Insurers can fulfill this residual market obligation by participating in pools where results are shared by the participating companies. The Company acts as a servicing carrier for workers' compensation pools in certain states. As a servicing carrier, the Company writes residual market business directly and then cedes 100% of this business to the respective pool. As a servicing carrier, the Company receives fee income for its services. The Company does not retain underwriting risk, and credit risk is limited as ceded balances are jointly shared by all the pool members. 52Contractual ObligationsFollowing is a summary of the Company's contractual obligations as of December 31, 2020:(In thousands)Estimated Payments By Periods20212022202320242025 ThereafterGross reserves for losses$3,709,874 $2,561,830 $1,897,638 $1,371,187 $991,655 $3,753,226 Operating lease obligations47,477 41,442 37,843 31,283 22,452 58,124 Purchase obligations132,006 50,629 47,413 44,070 44,478 3,534 Subordinated debentures— — — — — 1,135,000 Senior notes and other debt2,852 426,503 — — 6,385 1,171,750 Interest payments120,211 105,461 97,368 97,368 97,368 2,578,101 Other long-term liabilities2,113 3,049 2,696 2,425 2,169 22,986 Total$4,014,533 $3,188,914 $2,082,958 $1,546,333 $1,164,507 $8,722,721 The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2020. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns.The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves. In addition, at December 31, 2020, the Company had commitments to invest up to $124 million and $200 million in certain investment funds and real estate construction projects, respectively. These amounts are not included in the above table.The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were $4 million as of December 31, 2020. The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels. Off-Balance Sheet Arrangements An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging or research and development arrangements with the Company. The Company has no arrangements of these types that management believes may have a material current or future effect on our financial condition, liquidity or results of operations.53ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMarket Risk. The fair value of the Company’s investments is subject to risks of fluctuations in credit quality and interest rates. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration for the fixed maturity portfolio (including cash and cash equivalents) was 2.4 years at December 31, 2020 and 2.8 years at December 31, 2019. In addition, the fair value of the Company’s international investments is subject to currency risk. The Company attempts to manage its currency risk by matching its foreign currency assets and liabilities where considered appropriate.The following table outlines the groups of fixed maturity securities and their effective duration at December 31, 2020:EffectiveDuration($ in thousands)(Years)Fair ValueState and municipal3.9$3,700,200 Mortgage-backed securities3.51,027,828 Corporate3.14,671,581 Foreign government3.0975,563 U.S. government and government agencies1.9603,871 Loans receivable1.086,596 Asset-backed securities0.93,194,586 Cash and cash equivalents—2,372,366 Total2.4$16,632,591 Duration is a common measure of the price sensitivity of fixed maturity securities to changes in interest rates. The Company determines the estimated change in fair value of the fixed maturity securities, assuming parallel shifts in the yield curve for treasury securities while keeping spreads between individual securities and treasury securities static. The estimated fair value at specified levels at December 31, 2020 would be as follows:(In thousands)Estimated Fair ValueChange in Fair ValueChange in interest rates:300 basis point rise$15,429,092 $(1,203,499)200 basis point rise15,823,862 (808,729)100 basis point rise16,226,841 (405,750)Base scenario16,632,591 — 100 basis point decline17,074,947 442,356 200 basis point decline17,521,813 889,222 300 basis point decline18,005,098 1,372,507 Arbitrage investing differs from other types of investments in that its focus is on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general stock market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales.Additionally, the arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. The Company's merger arbitrage securities are primarily exposed to the risk of completion of announced deals, which are subject to regulatory as well as transactional and other risks.54

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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management discussion and analysis (“MD&A”) provides information that we believe is useful in understanding our operating results, cash flows and financial condition. We provide quantitative information about the material sales drivers including the effect of acquisitions and changes in foreign currency at the corporate and segment level. We also provide quantitative information about discrete tax items and other significant factors we believe are useful for understanding our results. The MD&A should be read in conjunction with the consolidated financial information and related notes included in this Form 10-K. This discussion contains various “Non-GAAP Financial Measures” and also contains various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We refer readers to the statements entitled “Non-GAAP Financial Measures” located at the end of this MD&A and “Forward-Looking Information and Cautionary Statements” and “Risk Factors” within Items 1 and 1A of this Form 10-K. OVERVIEW Bio-Techne develops, manufactures and sells life science reagents, instruments and services for the research and clinical diagnostic markets worldwide. With our deep product portfolio and application expertise, we sell integral components of scientific investigations into biological processes and molecular diagnostics, revealing the nature, diagnosis, etiology and progression of specific diseases. Our products aid in drug discovery efforts and provide the means for accurate clinical tests and diagnoses. During our fiscal year 2021, we operated with two operating segments – our Protein Sciences segment and our Diagnostics and Genomics segment. Our Protein Sciences segment is a leading developer and manufacturer of high-quality purified proteins and reagent solutions, most notably cytokines and growth factors, antibodies, immunoassays, biologically active small molecule compounds, tissue culture reagents and T-Cell activation technologies. This segment also includes protein analysis solutions that offer researchers efficient and streamlined options for automated western blot and multiplexed ELISA workflow. Our Genomics and Diagnostics segment develops and manufactures diagnostic products, including FDA-regulated controls, calibrators, blood gas and clinical chemistry controls and other reagents for OEM and clinical customers, as well as a portfolio of clinical molecular diagnostic oncology assays, including the ExoDx® Prostate test (EPI) for prostate cancer diagnosis. This segment also manufactures and sells advanced tissue-based in-situ hybridization assays (ISH) for spatial genomics research and clinical use. OVERALL RESULTS Operational Update For fiscal 2021, consolidated net sales increased 26% as compared to fiscal 2020. Organic growth was 22%, with currency translation and acquisitions having a 3% and 1% impact on revenue respectively. Organic revenue growth was broad based and driven by accelerated momentum of the Company's long-term growth strategy as well as customer site closures in the latter half of fiscal 2020 due to the COVID-19 pandemic. For fiscal 2021, consolidated earnings, including non-controlling interest, decreased 39% compared to fiscal 2020. The decrease in earnings was primarily due to a non-operating loss of approximately $67.9 million on our ChemoCentryx investment, compared to a gain on investment of $137 million in the last fiscal year. After adjusting for acquisition related costs, intangibles amortization, stock-based compensation, restructuring costs, the loss on investment, certain income tax items in both years, and non-controlling interest, adjusted net earnings increased 52% in fiscal 2021 as compared to fiscal 2020. Adjusted earnings growth was driven by volume leverage, operational productivity, and product mix. For fiscal 2020, consolidated net sales increased 4% as compared to fiscal 2019. Organic growth was 4%, with currency translation and acquisitions having an immaterial impact on revenue. The Company experienced broad-based organic revenue growth in most major geographic regions and end-markets prior to the onset of the COVID-19 pandemic. This broad-based organic growth was partially offset by the negative impacts associated with the COVID-19 pandemic experienced by the Company in the latter half of fiscal year 2020. For fiscal 2020, consolidated earnings, including non-controlling interest, increased 139% compared to fiscal 2019. The increase in earnings was primarily due to a non-operating gain of approximately $137 million on our ChemoCentryx investment and a gain of approximately $7 million on the settlement of the escrow balance associated with the Exosome acquisition. After adjusting for acquisition related costs, stock-based compensation, and certain income tax items in both years, adjusted net earnings increased 2% in fiscal 2020 as compared to fiscal 2019. Adjusted earnings growth was driven by volume leverage, which was partially offset by business impacts associated with the COVID-19 pandemic. 27 COVID-19 Business Update The global spread of COVID-19 in the past 18 months has led to unprecedented restrictions on, and disruptions in, business and personal activities, including as a result of preventive and precautionary measures that we, other businesses, our communities and governments have taken and are taking to mitigate the spread of the virus and to manage its impact. While a number of vaccines developed in response to the pandemic appear to be effective in mitigating spread of the disease, we continue to actively monitor the pandemic on a global scale. We have taken and intend to continue taking steps to identify and mitigate the adverse impacts on, and risks to, our business (including but not limited to our employees, customers, business partners, manufacturing capabilities and capacity, and supply and distribution channels) posed by the spread of COVID-19 and the governmental and community responses thereto. The Company has responded to the pandemic by leveraging our deep product portfolio and scientific expertise to develop robust COVID-19 product and service offerings providing critical support for both clinical care and therapeutic development. While our sales related to COVID-19 specific products have been modest, fiscal 2021 growth benefited from the reopening of customer sites initially closed in the latter half of fiscal 2021 and our ongoing efforts to utilize our portfolio of products and services to enable solutions for this evolving pandemic. We are unable to forecast the impact of COVID-19 on future revenue given the uncertainty that some customer sites may close again due to increases in COVID-19 cases occurring in their region and over the duration of the COVID-19 pandemic, especially if current vaccines prove to be ineffective against new strains of the Coronavirus that may develop over time. We anticipate a positive long-term outlook for sales growth resulting from expected future funding increases within life-science research in response to the current pandemic. Similar to current periods, we anticipate the impact on EPS to be similar to that of sales growth. The Company remains in a strong financial position with sufficient available cash as well as access to additional funding, if necessary, through our long-term debt agreement. We did not experience any material changes to our June 30, 2021 nor our June 30, 2020 Balance Sheet, resulting from COVID-19 for items such as additional reserves or asset impairments resulting from the pandemic. The Company has remained fully operational as we abided by local COVID-19 safety regulations across the world this past year. As the pandemic has eased, in most locations we will be returning all employees to on site work, although in certain instances we will continue to operate with appropriate safety measures, including staggered shifts, social distancing and hygiene best practices recommended by public health officials. In addition, the Company has taken and will continue to take additional steps to monitor and strengthen our supply chain to maintain an uninterrupted supply of our critical products and services. 28 Table of Contents RESULTS OF OPERATIONS Net Sales Consolidated organic net sales exclude the impact of companies acquired during the first 12 months post-acquisition and the effect of the change from the prior year in exchange rates used to convert sales in foreign currencies (primarily the euro, British pound sterling, and Chinese yuan) into U.S. dollars. Consolidated net sales growth was as follows: Year Ended June 30, 2021 2020 2019 Organic sales growth 22 % 4 % 10 % Acquisitions sales growth 1 % 0 % 2 % Impact of foreign currency fluctuations 3 % 0 % (1 )% Consolidated net sales growth 26 % 4 % 11 % Consolidated net sales by segment were as follows (in thousands): Year Ended June 30, 2021 2020 2019 Protein Sciences $ 704,564 $ 555,352 $ 543,159 Diagnostics and Genomics 227,744 184,549 171,674 Intersegment (1,276 ) (1,210 ) (827 ) Consolidated net sales $ 931,032 $ 738,691 $ 714,006 In fiscal 2021, Protein Sciences segment net sales increased 27% compared to fiscal 2020. Organic growth for the segment was 24% for the fiscal year, with foreign currency translation having a favorable impact of 3%, and acquisitions contributing an immaterial amount. Overall segment growth was driven by continued market acceptance of our portfolio of productivity enhancing solutions across end-markets and geographies combined with the reopening of customer sites that were closed in the latter half of fiscal 2020 due to COVID-19. In fiscal 2021, Diagnostics and Genomics segment net sales increased 23% compared to fiscal 2020. Organic growth was 18% with acquisitions and foreign currency having a favorable impact of 4% and 1% impact on revenue, respectively. Overall segment revenue growth was broad based across product lines and geographies. RNAscope products had an exceptional year in both the Academia and Bio-Pharma end markets, while the Exosome product line also provided year over year growth despite navigating limitations and/or customer avoidance of non-essential medical procedures throughout fiscal 2021 associated with the COVID-19 pandemic. In fiscal 2020, Protein Sciences segment net sales increased 2% compared to fiscal 2019. Organic growth for the segment was 3% for the fiscal year, with foreign currency translation having an unfavorable impact of 1%, and acquisitions contributing an immaterial amount. Overall segment growth was driven by strong Bio-Pharma sales in North America and strong overall performance in China, which was partially offset by the disruption in research markets due to numerous customer site closures relating to the COVID-19 pandemic that occurred in the second half of fiscal 2020. In fiscal 2020, Diagnostics and Genomics segment net sales increased 8% compared to fiscal 2019. Organic growth was 8% with acquisitions and foreign currency having an immaterial impact on revenue. Overall segment revenue growth was driven by strong performance in our ExoDx Prostate Test, RNAscope, hematology, and assay development products lines prior to the onset of the COVID-19 pandemic. The closure of academic site labs and limitation of non-essential medical procedures resulting from the COVID-19 pandemic significantly impacted sales of our RNAscope product line and our ExoDx Prostate Test, respectively, in the latter portion of the fiscal year. These negative sales impacts were partially offset through growth in supplying specialty diagnostic antibodies and other raw materials to COVID-19 testing manufacturers. 29 Table of Contents Gross Margins Consolidated gross margins were 68.0%, 65.4%, and 66.3% in fiscal 2021, 2020, and 2019. Consolidated gross margins were positively impacted as a result of broad based revenue growth and cost management. Excluding the impact of acquired inventory sold, amortization of intangibles, and stock compensation expense, adjusted gross margins were 72.2%, 70.3%, and 71.5% in fiscal 2021, 2020, and 2019 respectively. Fiscal 2021 adjusted gross margin was positively impacted by volume leverage and product mix when compared to fiscal 2020 and fiscal 2019. A reconciliation of the reported consolidated gross margin percentages, adjusted for acquired inventory sold and intangible amortization included in cost of sales, is as follows: Year Ended June 30, 2021 2020 2019 Consolidated gross margin percentage 68.0 % 65.4 % 66.3 % Identified adjustments: Costs recognized upon sale of acquired inventory 0.2 % - % 0.5 % Amortization of intangibles 3.8 % 4.7 % 4.7 % Stock compensation expense - COGS 0.2 % 0.2 % - % Non-GAAP adjusted gross margin percentage 72.2 % 70.3 % 71.5 % Fluctuations in adjusted gross margins, as a percentage of net sales, have primarily resulted from changes in foreign currency exchange rates and changes in product mix. We expect that, in the future, gross margins will continue to be impacted by the mix of our portfolio growing at different rates as well as future acquisitions. Management uses adjusted operating results to monitor and evaluate performance of the Company’s two segments. Segment gross margins, as a percentage of net sales, were as follows: Year Ended June 30, 2021 2020 2019 Protein Sciences 76.0 % 75.0 % 76.8 % Diagnostics and Genomics 60.5 % 55.6 % 54.4 % The changes in the Protein Sciences segment’s gross margin percentage for fiscal 2021 as compared to fiscal 2020 and 2019 was primarily attributable to mix of product sales within the segment. The increase in Diagnostics and Genomics in gross margin for fiscal 2021 as compared to fiscal 2020 was primarily due to volume leverage. The increase in Diagnostics and Genomics in gross margin for fiscal 2020 as compared to fiscal 2019 was primarily due to volume leverage, operational productivity, and revenue growth against a similar cost base in recent acquisitions. 30 Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses increased $64.4 million (25%) in fiscal 2021 when compared to fiscal 2020. Selling, general, and administrative expenses increased primarily due to investments made by the Company to support volume growth within each of the segments as well as additional expenses related to the acquisition of Asuragen, Inc. Selling, general and administrative expenses decreased $3.8 million (1%) in fiscal 2020 when compared to fiscal 2019. Selling, general, and administrative expenses decreased primarily due to a reduction in corporate expenses and a gain resulting from a settlement of amounts held in escrow from the ExosomeDx acquisition between the Company and the former shareholders. These reductions to our selling, general, and administrative expenses were partially offset by an increase in expense within the segments. Consolidated selling, general and administrative expenses were composed of the following (in thousands): Year Ended June 30, 2021 2020 2019 Protein Sciences $ 159,489 $ 138,792 $ 135,513 Diagnostics and Genomics 75,160 65,407 61,646 Total segment expenses 234,649 204,199 197,159 Amortization of intangibles 27,788 26,358 25,210 Acquisition related expenses 7,097 415 2,282 Gain on escrow litigation - (7,159 ) - Restructuring costs 142 87 - Stock-based compensation 50,200 32,667 33,057 Corporate selling, general and administrative expenses 5,075 4,016 6,651 Total selling, general and administrative expenses $ 324,951 $ 260,583 $ 264,359 Research and Development Expenses Research and development expenses increased $5.4 million (8%) and $2.8 million (4%) in fiscal 2021 and 2020, respectively, as compared to prior year periods. The increase in research and development expenses in fiscal 2021 as compared to fiscal 2020 was primarily attributable to continued investment in future growth platforms of the Company and recent acquisitions. The increase in research and development expenses in fiscal 2020 as compared to fiscal 2019 was primarily attributable to continued investment in future growth platforms of the Company, recent acquisitions, and the development of new COVID-19 products. Year Ended June 30, 2021 2020 2019 Protein Sciences $ 46,361 $ 43,022 $ 40,735 Diagnostics and Genomics 24,242 22,170 21,678 Total segment expenses 70,603 65,192 62,413 Unallocated corporate expenses - - - Total research and development expenses $ 70,603 $ 65,192 $ 62,413 31 Table of Contents Net Interest Income / (Expense) Net interest income/(expense) for fiscal 2021, 2020, and 2019 was $(13.5) million, $(18.6) million, and $(21.1) million, respectively. Net interest expense in fiscal 2021 decreased when compared to fiscal 2020 due to a reduction in our average long-term debt, which coincided with a reduction in the notional amount on our variable interest derivative. Net interest expense in fiscal 2020 decreased when compared to fiscal 2019 due to a reduction in our average long-term debt. Other Non-Operating Expense, Net Other non-operating expense, net, consists of foreign currency transaction gains and losses, rental income, building expenses related to rental property and the Company's gains and losses on investments as follows (in thousands): Year Ended June 30, 2021 2020 2019 Foreign currency gains (losses) $ (6,650 ) $ 1,703 $ (455 ) Rental income 1,036 1,140 1,141 Real estate taxes, depreciation and utilities (1,845 ) (1,915 ) (1,897 ) Gain (loss) on investment (68,047 ) 137,508 (12,370 ) Miscellaneous (expense) income (136 ) (786 ) 13 Other non-operating income (expense), net $ (75,642 ) $ 137,650 $ (13,568 ) During fiscal 2021, the Company recognized losses of $67.9 million related to changes in fair value associated with changes in the stock price of our ChemoCentryx, Inc. (CCXI) investment. During fiscal 2020, the Company recognized gains of $137.5 million related to changes in fair value associated with changes in the stock price of our ChemoCentryx, Inc. (CCXI) investment. During fiscal 2019, the Company recognized losses of $16.1 million related to changes in fair value associated with changes in the stock price of our ChemoCentryx, Inc. (CCXI) investment, which were partially offset by a $3.7 million gain realized upon acquisition from our historical investment in B-MoGen. Income Taxes Income taxes for fiscal 2021, 2020, and 2019 were at effective rates of 5.8%, 17.1%, and 14.2%, respectively, of consolidated earnings before income taxes. The change in the effective tax rate was driven by discrete tax items. The Company's discrete tax benefits in fiscal 2021 primarily related to share-based compensation excess tax benefits of $28.1 million. The Company's discrete tax benefits in fiscal 2020 primarily related to share-based compensation excess tax benefits of $17.7 million. The Company's discrete tax benefits in fiscal 2019 primarily related to share-based compensation excess tax benefits of $7.2 million, $3.2 million related to deductible acquisition payments made to employees and third parties, and $2.0 million for tax refunds relating to certain state apportionments. 32 Table of Contents Net Earnings Non-GAAP adjusted consolidated net earnings and earnings per share are as follows (in thousands): Year Ended June 30, 2021 2020 2019 Earnings before taxes - GAAP $ 148,175 $ 276,477 $ 112,015 Identified adjustments attributable to Bio-Techne: Costs recognized upon sale of acquired inventory 1,565 - 3,739 Amortization of intangibles 64,239 60,865 58,550 Acquisition related expenses 7,489 793 2,656 Gain on escrow settlement - (7,170 ) - Restructuring costs 142 87 - Stock-based compensation, inclusive of employer taxes 51,846 34,262 33,057 Realized (gain) loss on investments and other 68,391 (136,716 ) 12,370 Impact of non-controlling interest (pre-tax) 680 - - Earnings before taxes - Adjusted $ 342,527 $ 228,598 $ 222,387 Non-GAAP tax rate 20.2 % 21.6 % 21.1 % Non-GAAP tax expense 69,334 49,280 46,931 Non-GAAP adjusted net earnings attributable to Bio-Techne $ 273,193 179,318 175,456 Earnings per share - diluted - Adjusted 6.75 4.55 4.51 Depending on the nature of discrete tax items, our reported tax rate may not be consistent on a period to period basis. The Company independently calculates a non-GAAP adjusted tax rate considering the impact of discrete items and jurisdictional mix of the identified non-GAAP adjustments. The following table summarizes the reported GAAP tax rate and the effective Non-GAAP adjusted tax rate for the periods ended June 30, 2021, 2020, and 2019. Year Ended June 30, 2021 2020 2019 GAAP effective tax rate 5.8 % 17.1 % 14.2 % Discrete items 19.0 7.0 11.2 Long-term GAAP tax rate 24.8 % 24.1 % 25.4 Rate impact items Stock based compensation (5.7 )% (2.4 )% (4.8 )% Acquisition costs (0.2 ) 0.4 0.5 Change in fair value of investments 0.5 (0.4 ) - Other 0.8 (0.1 ) - Total rate impact items (4.6 )% (2.5 )% (4.3 )% Non-GAAP tax rate 20.2 % 21.6 % 21.1 % Refer to Note 11 for additional discussion relating to the change in discrete tax items between fiscal 2021 and fiscal 2020. 33 Table of Contents LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and available-for-sale investments at June 30, 2021 were $231.6 million compared to $270.9 million at June 30, 2020. Included in available-for-sale investments at June 30, 2021 and June 30, 2020 was the fair value of the Company's investment in CCXI of $20.0 million and $87.8 million, respectively. At June 30, 2021, approximately 12% of the Company's cash and equivalent account balances of $199.1 million were located in the U.S., with the remainder located in primarily in Canada, China, the U.K. and other European countries. At June 30, 2021, approximately 61% of the Company's available-for-sale investment account balances of $32.5 million were located in the U.S., with the remaining 39% in China. The Company has either paid U.S. taxes on its undistributed foreign earnings or intends to indefinitely reinvest the undistributed earnings in the foreign operations or expects the earnings will be remitted in a tax neutral transaction. Management of the Company expects to be able to meet its cash and working capital requirements for operations, facility expansion, capital additions, and cash dividends for the foreseeable future, and at least the next 12 months, through currently available funds, including funds available through our line-of-credit and cash generated from operations. Future acquisition strategies may or may not require additional borrowings under the line-of-credit facility or other outside sources of funding. Cash Flows From Operating Activities The Company generated cash from operations of $352.2 million, $205.2 million, and $181.6 million in fiscal 2021, 2020, and 2019 respectively. The increase in cash generated from operating activities in fiscal 2021 as compared to fiscal 2020 was mainly a result of an increase in year over year operating income of $79.9 million and a $29.3 million benefit to operating cash from year-over-year changes in operating assets and liabilities as well as a non-cash stock-based compensation expense of $16.6 million. The increase in cash generated from operating activities in fiscal 2020 as compared to fiscal 2019 was mainly a result of higher GAAP earnings and lower accounts receivable balances in fiscal 2020, which were partially offset by the gain on investments included within earnings. Cash Flows From Investing Activities We continue to make investments in our business, including capital expenditures. The Company acquired Eminence Biotechnology and Asuragen, Inc. during fiscal year 2021 for a total of approximately $225.4 million, net of cash acquired. The Company did not make any acquisitions in fiscal 2020. Net cash paid for acquisitions of Quad, Exosome, and B-MoGen was $289.5 million in fiscal 2019. The Company's net proceeds (outflow) from the purchase, sale and maturity of available-for-sale investments in fiscal 2021, 2020, and 2019 were $26.7 million, $76.9, and ($21.9 million) million, respectively. The decrease in fiscal 2021 compared to fiscal 2020 was driven by the sale of a portion of the CCXI investment in fiscal year 2020, which did not reoccur in fiscal year 2021. The increase in fiscal 2020 compared to fiscal 2019 was driven by the sale of a portion of the Company’s investment in CCXI in fiscal 2020.The Company's investment policy is to place excess cash in certificates of deposit with the objective of obtaining the highest possible return while minimizing risk and keeping the funds accessible. Capital additions in fiscal year 2021, 2020, and 2019 were $44.3 million, $51.7 million, and $25.4 million. Fiscal 2021 capital expenditures related to investments in new buildings, in particular, the Company's GMP manufacturing facility. Capital additions planned for fiscal 2022 are approximately $68.4 million and are expected to be financed through currently available cash and cash generated from operations. Increase in expected additions in fiscal 2022 is related to increasing capacity to meet expected sales growth across the Company and reduced expenditures in the comparable period, fiscal year 2021, due to the COVID-19 pandemic. 34 Cash Flows From Financing Activities In fiscal 2021, 2020, and 2019, the Company paid cash dividends of $49.6 million, $48.9 million, $48.4 million, respectively. The Board of Directors periodically considers the payment of cash dividends. The Company received $65.1 million, $71.0 million, $38.0 million, for the exercise of options for 627,000, 743,000, 382,000 shares of common stock in fiscal 2021, 2020 and 2019, respectively. During fiscal 2021, 2020, and 2019, the Company repurchased $43.2 million, $50.1 million, and $15.4 million, respectively, in share repurchases included as a cash outflow within Financing Activities. During fiscal 2021, 2020, and 2019, the Company drew $256.0 million, $40.0 million, and $580.0 million, respectively, under its revolving line-of-credit facility. Repayments of $271.5 million, $188.5 million, and $413.5 million were made on its line-of-credit in fiscal 2021, 2020, and 2019, respectively. During fiscal 2021, there were no payments related to contingent consideration classified as financing activities. The Company made $0.3 million in contingent consideration payments, which were classified within operating activities. During fiscal 2020, the Company made $4.4 million ($4 million for Quad and $0.4 million for B-MoGen) in cash payments towards the Quad, Exosome, and B-MoGen contingent consideration liabilities. Of the $4.4 million in total payments, $3.4 million is classified as financing on the statement of cash flows. The remaining $1 million is recorded as operating on the statement of cash flows as it represents the consideration liability that exceeds the amount of the contingent consideration liability recognized at the acquisition date. During fiscal 2019, the Company made no cash payments towards the Quad, Exosome, and B-MoGen contingent consideration liabilities. During fiscal 2021 and 2020, the Company paid $19.3 million and $3.8 million, respectively, for net share settlements. During fiscal 2019, other financial activities includes payments for net share settlements as well as the final payment of $1.4 million related to Eurocell. This is included as a cash outflow within the other financing activities line of the consolidated statements of cash flows. 35 Table of Contents CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of the Company's financial condition and results of operations are based upon the Company's Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company has identified the policies outlined below as critical to its business operations and an understanding of results of operations. The listing is not intended to be a comprehensive list of all accounting policies; investors should also refer to Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Business Combinations We allocate the purchase price of acquired businesses to the estimated fair values of the assets acquired and liabilities assumed as of the date of the acquisition. The calculations used to determine the fair value of the long-lived assets acquired, primarily intangible assets, can be complex and require significant judgment. We weigh many factors when completing these estimates including, but not limited to, the nature of the acquired company’s business; its competitive position, strengths, and challenges; its historical financial position and performance; estimated customer retention rates; discount rates; and future plans for the combined entity. We may also engage independent valuation specialists, when necessary, to assist in the fair value calculations for significant acquired long-lived assets. The fair value of acquired technology is generally the primary asset identified and therefore estimated using the multi-period excess earnings method. The multi-period excess earnings method model estimates revenues and cash flows derived from the primary asset and then deducts portions of the cash flow that can be attributed to supporting assets, such as Trade Names and in-process research and development, that contributed to the generation of the cash flows. The resulting cash flow, which is attributable solely to the primary asset acquired, is then discounted at a rate of return commensurate with the risk of the asset to calculate a present value. The Trade Name is generally calculated using the relief from royalty method, which calculates the cost savings associated with owning rather than licensing the technology. Assumed royalty rates are applied to the projected revenues for the remaining useful life of the technology to estimate the royalty savings. In-process research and development assets are valued using the multi-period excess earnings method when the cash flows from the in-process research and development assets are separately identifiable from the primary asset. In circumstances that Customer Relationship assets are identified that are not the primary asset, they are valued using the distributor model income approach, which isolates revenues and cash flow associated with the sales and distribution function of the entity and attributable to customer-related assets, which are then discounted at a rate of return commensurate with the risk of the asset to calculate a present value. We estimate the fair value of liabilities for contingent consideration by discounting to present value the probability weighted contingent payments expected to be made. For potential payments related to financial performance based milestones, projected revenue and/or EBITDA amounts, volatility and discount rates assumptions are included in the estimated amounts. For potential payments related to product development milestones, the fair value is based on the probability of achievement of such milestones. The excess of the purchase price over the estimated fair value of the net assets acquired is recorded as goodwill. Goodwill is not amortized, but is subject to impairment testing on at least an annual basis. We are also required to estimate the useful lives of the acquired intangible assets, which determines the amount of acquisition-related amortization expense we will record in future periods. Each reporting period, we evaluate the remaining useful lives of our amortizable intangibles to determine whether events or circumstances warrant a revision to the remaining period of amortization. While we use our best estimates and assumptions, our fair value estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Any adjustments required after the measurement period are recorded in the consolidated statements of earnings. The judgments required in determining the estimated fair values and expected useful lives assigned to each class of assets and liabilities acquired can significantly affect net income. For example, different classes of assets will have useful lives that differ. Consequently, to the extent a longer-lived asset is ascribed greater value than a shorter-lived asset, net income in a given period may be higher. Additionally, assigning a lower value to amortizable intangibles would result in a higher amount assigned to goodwill. As goodwill is not amortized, this would benefit net income in a given period, although goodwill is subject to annual impairment analysis. 36 Impairment of Goodwill Goodwill Goodwill was $843.1 million as of June 30, 2021, which represented 37.3% of total assets. Goodwill is tested for impairment on an annual basis in the fourth quarter of each year, or more frequently if events occur or circumstances change that could indicate a possible impairment. To analyze goodwill for impairment, we must assign our goodwill to individual reporting units. Identification of reporting units includes an analysis of the components that comprise each of our operating segments, which considers, among other things, the manner in which we operate our business and the availability of discrete financial information. Components of an operating segment are aggregated to form one reporting unit if the components have similar economic characteristics. We periodically review our reporting units to ensure that they continue to reflect the manner in which we operate our business. There has been no impairment of goodwill since the adoption of Financial Accounting Standards Board (“FASB”) ASC 350 guidance for goodwill and other intangibles on July 1, 2002. 2021 Goodwill Impairment Analyses In completing our 2021 annual goodwill impairment analyses, we elected to perform a quantitative assessment for each of our five reporting units. A quantitative assessment involves comparing the carrying value of the reporting unit, including goodwill, to its estimated fair value. Carrying value is based on the assets and liabilities associated with the operations of the reporting unit, which often requires the allocation of shared or corporate items among reporting units. In accordance with ASU 2017-04, a goodwill impairment charge is recorded for the amount by which the carrying value of a reporting unit exceeds the fair value of the reporting unit. In determining the fair values of our reporting units, we utilized the income approach. The income approach is a valuation technique under which we estimated future cash flows using the reporting unit's financial forecast from the perspective of an unrelated market participant. Using historical trending and internal forecasting techniques, we projected revenue and applied our fixed and variable cost experience rates to the projected revenue to arrive at the future cash flows. A terminal value was then applied to the projected cash flow stream. Future estimated cash flows were discounted to their present value to calculate the estimated fair value. The discount rate used was the value-weighted average of our estimated cost of capital derived using both known and estimated customary market metrics. In determining the estimated fair value of a reporting unit, we were required to estimate a number of factors, including projected operating results, terminal growth rates, economic conditions, anticipated future cash flows, the discount rate and the allocation of shared or corporate items. Because our 2021 quantitative analyses included all of our reporting units, the summation of our reporting units' fair values, as indicated by our discounted cash flow calculations, were compared to our consolidated fair value, as indicated by our market capitalization, to evaluate the reasonableness of our calculations. This impairment assessment is sensitive to changes in forecasted cash flows, as well as our selected discount rate. Changes in the reporting unit's results, forecast assumptions and estimates could materially affect the estimation of the fair value of the reporting units. The quantitative assessment completed as of April 1, 2021 indicated that all of the reporting units had a substantial amount of headroom. Accordingly, the Company determined there was no indication of impairment of goodwill in our annual goodwill impairment analysis. Further, no triggering events were identified in the year ended June 30, 2021 that would require an additional goodwill impairment assessment beyond our required annual goodwill impairment assessment. 2020 Goodwill Impairment Analyses In completing our 2020 annual goodwill impairment analyses, we elected to perform a quantitative assessment for all of our reporting units. A quantitative assessment involves comparing the carrying value of the reporting unit, including goodwill, to its estimated fair value. Carrying value is based on the assets and liabilities associated with the operations of the reporting unit, which often requires the allocation of shared or corporate items among reporting units. In accordance with ASU 2017-04, a goodwill impairment charge is recorded for the amount by which the carrying value of a reporting unit exceeds the fair value of the reporting unit. In determining the fair values of our reporting units, we utilized the income approach. The income approach is a valuation technique under which we estimated future cash flows using the reporting unit's financial forecast from the perspective of an unrelated market participant. Using historical trending and internal forecasting techniques, we projected revenue and applied our fixed and variable cost experience rates to the projected revenue to arrive at the future cash flows. A terminal value was then applied to the projected cash flow stream. Future estimated cash flows were discounted to their present value to calculate the estimated fair value. The discount rate used was the value-weighted average of our estimated cost of capital derived using both known and estimated customary market metrics. In determining the estimated fair value of a reporting unit, we were required to estimate a number of factors, including projected operating results, terminal growth rates, economic conditions, anticipated future cash flows, the discount rate and the allocation of shared or corporate items. Because our 2020 quantitative analyses included all of our reporting units, the summation of our reporting units' fair values, as indicated by our discounted cash flow calculations, were compared to our consolidated fair value, as indicated by our market capitalization, to evaluate the reasonableness of our calculations. This impairment assessment is sensitive to changes in forecasted cash flows, as well as our selected discount rate. Changes in the reporting unit's results, forecast assumptions and estimates could materially affect the estimation of the fair value of the reporting units. The quantitative assessment completed as of April 1, 2020 indicated that all of the reporting units had a substantial amount of headroom. Accordingly, the Company determined there was no indication of impairment of goodwill in our annual goodwill impairment analysis. Further, no triggering events were identified in the year ended June 30, 2020 that would require an additional goodwill impairment assessment beyond our required annual goodwill impairment assessment. 2019 Goodwill Impairment Analyses At the beginning of the quarter ended March 31, 2019, the Company realigned the management of certain business processes between reporting units within the same segment. A goodwill allocation was performed between the impacted reporting units based on the relative fair value of the processes realigned. In conjunction with the realignment, a quantitative goodwill impairment assessment was performed both prior to and subsequent to the realignment. The quantitative impairment assessments performed utilized a consistent process with our fiscal 2021 quantitative goodwill impairment assessment described above. The quantitative assessment indicated that all of the impacted reporting units had substantial headroom both prior to and subsequent to the realignment. This impairment assessment performed was sensitive to changes in forecasted cash flows, as well as our selected discount rate. Changes in the reporting unit's results, forecast assumptions and estimates could materially affect the estimation of the fair value of the reporting units. In conducting our annual goodwill impairment test as of April 1, 2019, we elected to perform a qualitative assessment to determine whether changes in events or circumstances since our most recent quantitative test for goodwill impairment indicated that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on its annual analysis, the Company determined there was no indication of impairment of goodwill. 37 NEW ACCOUNTING PRONOUNCEMENTS Information regarding the accounting policies adopted during fiscal 2021 and those not yet adopted can be found under caption “Note 1: Description of Business and Summary of Significant Accounting Policies” of the Notes to the Consolidated Financial Statements appear in Item 8 of this report. SUBSEQUENT EVENTS None NON-GAAP FINANCIAL MEASURES This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains financial measures that have not been calculated in accordance with accounting principles generally accepted in the U.S. (GAAP). These non-GAAP measures include: ● Organic growth ● Adjusted gross margin ● Adjusted operating margin ● Adjusted net earnings ● Adjusted effective tax rate We provide these measures as additional information regarding our operating results. We use these non-GAAP measures internally to evaluate our performance and in making financial and operational decisions, including with respect to incentive compensation. We believe that our presentation of these measures provides investors with greater transparency with respect to our results of operations and that these measures are useful for period-to-period comparison of results. Our non-GAAP financial measure of organic growth represents revenue growth excluding revenue from acquisitions within the preceeding 12 months as well as the impact of foreign currency. Excluding these measures provides more useful period-to-period comparison of revenue results as it excludes the impact of foreign currency exchange rates, which can vary significantly from period to period, and revenue from acquisitions that would not be included in the comparable prior period. Our non-GAAP financial measures for adjusted gross margin, adjusted operating margin, and adjusted net earnings, in total and on a per share basis, exclude stock-based compensation, the costs recognized upon the sale of acquired inventory, amortization of acquisition intangibles, acquisition related expenses inclusive of the changes in fair value of contingent consideration, and other non-recurring items including non-recurring costs and gains. Stock-based compensation is excluded from non-GAAP adjusted net earnings because of the nature of this charge, specifically the varying available valuation methodologies, subjective assumptions, variety of award types, and unpredictability of amount and timing of employer related tax obligations. The Company excludes amortization of purchased intangible assets, purchase accounting adjustments, including costs recognized upon the sale of acquired inventory and acquisition-related expenses inclusive of the changes in fair value contingent consideration, and other non-recurring items including gains or losses on legal settlements and one-time assessments from this measure because they occur as a result of specific events, and are not reflective of our internal investments, the costs of developing, producing, supporting and selling our products, and the other ongoing costs to support our operating structure. Additionally, these amounts can vary significantly from period to period based on current activity. The Company’s non-GAAP adjusted operating margin and adjusted net earnings, in total and on a per share basis, also excludes stock-based compensation expense, which is inclusive of the employer portion of payroll taxes on those stock awards, restructuring, impairments of equity method investments, gain and losses from investments, and certain adjustments to income tax expense. Impairments of equity investments are excluded as they are not part of our day-to-day operating decisions. Additionally, gains and losses from other investments that are either isolated or cannot be expected to occur again with any predictability are excluded. Costs related to restructuring activities, including reducing overhead and consolidating facilities, are excluded because we believe they are not indicative of our normal operating costs. The Company independently calculates a non-GAAP adjusted tax rate to be applied to the identified non-GAAP adjustments considering the impact of discrete items on these adjustments and the jurisdictional mix of the adjustments. In addition, the tax impact of other discrete and non-recurring charges which impact our reported GAAP tax rate are adjusted from net earnings. We believe these tax items can significantly affect the period-over-period assessment of operating results and not necessarily reflect costs and/or income associated with historical trends and future results. The Company periodically reassesses the components of our non-GAAP adjustments for changes in how we evaluate our performance, changes in how we make financial and operational decisions, and considers the use of these measures by our competitors and peers to ensure the adjustments are still relevant and meaningful. Readers are encouraged to review the reconciliations of the adjusted financial measures used in management's discussion and analysis of the financial condition of the Company to their most directly comparable GAAP financial measures provided within the Company's consolidated financial statements. 38 Table of Contents ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company operates internationally, and thus is subject to potentially adverse movements in foreign currency exchange rates. Approximately 31% of the Company's consolidated net sales in fiscal 2021 were made in foreign currencies, including 13% in euro, 5% in British pound sterling, 7% in Chinese yuan and the remaining 6% in other currencies. The Company is exposed to market risk primarily from foreign exchange rate fluctuations of the euro, British pound sterling, Chinese yuan and Canadian dollar as compared to the U.S. dollar as the financial position and operating results of the Company's foreign operations are translated into U.S. dollars for consolidation. Month-end exchange rates between the euro, British pound sterling, Chinese yuan, Canadian dollar and the U.S. dollar, which have not been weighted for actual sales volume in the applicable months in the periods, were as follows: Year Ended June 30, 2021 2020 2019 Euro: High $ 1.23 $ 1.12 $ 1.17 Low 1.16 1.09 1.12 Average 1.20 1.11 1.14 British pound sterling: High $ 1.42 $ 1.32 $ 1.32 Low 1.29 1.22 1.27 Average 1.35 1.26 1.29 Chinese yuan: High $ 0.16 $ 0.15 $ 0.15 Low 0.14 0.14 0.14 Average 0.15 0.14 0.15 Canadian dollar: High $ 0.83 $ 0.77 $ 0.77 Low 0.75 0.71 0.74 Average 0.78 0.74 0.76 The Company's exposure to foreign exchange rate fluctuations also arises from trade receivables and intercompany payables denominated in one currency in the financial statements, but receivable or payable in another currency. The Company does not enter into foreign currency forward contracts to reduce its exposure to foreign currency rate changes on forecasted intercompany sales transactions or on intercompany foreign currency denominated balance sheet positions. Foreign currency transaction gains and losses are included in "Other non-operating expense, net" in the Consolidated Statement of Earnings and Comprehensive Income. The effect of translating net assets of foreign subsidiaries into U.S. dollars are recorded on the Consolidated Balance Sheet as part of "Accumulated other comprehensive income (loss)." The effects of a hypothetical simultaneous 10% appreciation in the U.S. dollar from June 30, 2021 levels against the euro, British pound sterling, Chinese yuan and Canadian dollar are as follows (in thousands): Decrease in translation of 2021 earnings into U.S. dollars $ 4,456 Decrease in translation of net assets of foreign subsidiaries 56,008 Additional transaction losses 1,755 39 Table of Contents

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CADENCE DESIGN SYSTEMS INC_10-Q_2021-07-26 00:00:00_813672-0000813672-21-000028.html

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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (dollars in thousands, except share and per share data). Year Ended December 31,2020 2019 (1)2018 (2)20172016STATEMENTS OF OPERATIONS DATA:Revenue$23,826,195 $23,894,091 $21,340,088 $18,628,787 $17,369,108 Operating income969,759 1,259,875 1,087,989 1,078,682 816,831 Interest expense, net of interest income67,753 85,754 98,685 126,961 136,800 Write-off of financing costs on extinguished debt75,592 2,608 27,982 — — Net income755,868 1,291,450 1,065,948 703,576 585,170 Net income attributable to non-controlling interests3,879 9,093 2,729 6,467 12,091 Net income attributable to CBRE Group, Inc.751,989 1,282,357 1,063,219 697,109 573,079 Income per share attributable to CBRE Group, Inc. (3)Basic income per share$2.24 $3.82 $3.13 $2.06 $1.71 Diluted income per share2.22 3.77 3.10 2.05 1.69 Weighted average shares:Basic335,196,296 335,795,654 339,321,056 337,658,017 335,414,831 Diluted338,392,210 340,522,871 343,122,741 340,783,556 338,424,563 STATEMENTS OF CASH FLOWS DATA (4):Net cash provided by operating activities$1,830,779 $1,223,380 $1,131,249 $894,411 $616,985 Net cash used in investing activities(341,585)(721,024)(560,684)(302,600)(150,524)Net cash used in financing activities(625,256)(271,949)(506,600)(627,742)(220,677)OTHER DATA:Adjusted EBITDA (5)$1,892,385 $2,063,783 $1,905,168 $1,716,774 $1,562,347 BALANCE SHEET DATA:Cash and cash equivalents$1,896,188 $971,781 $777,219 $751,774 $762,576 Total assets18,039,143 16,197,196 13,456,793 11,718,396 10,994,338 Long-term debt, including current portion, net1,381,716 1,763,059 1,770,406 1,999,611 2,548,137 Total liabilities10,533,483 9,924,084 8,446,891 7,543,782 7,848,438 Non-controlling interest subject to possible redemption - special purpose acquisition company (6)385,573 — — — — Total CBRE Group, Inc. stockholders’ equity7,078,326 6,232,693 4,938,797 4,114,496 3,103,142 _______________Note: We have not declared any cash dividends on common stock for the periods shown.(1)We adopted new lease accounting guidance effective January 1, 2019 using the optional transitional method. Accordingly, no adjustments were made to the financial statements presented for prior periods. As a result of the adoption of the leasing guidance, the consolidated balance sheet as of January 1, 2019 included $1.2 billion of additional lease liabilities, along with corresponding right-of-use assets of $1.0 billion, reflecting adjustments for items such 30Table of Contentsas prepaid and deferred rent, unamortized initial direct costs, and unamortized lease incentive balances. The adoption of the leasing guidance did not have a material impact on our consolidated statement of operations. See Note 2 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.(2)We adopted new revenue recognition guidance in 2018 and restated the 2017 and 2016 consolidated financial statements to conform with the new guidance. See our Annual Report for the year ended December 31, 2018 filed with the SEC on March 1, 2019 for additional information. (3)See Income Per Share information in Note 17 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.(4)In the first quarter of 2018, we adopted Accounting Standards Update (ASU) 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” Certain reclassifications were made to the 2017 and 2016 consolidated statements of cash flows to conform with the 2018 presentation.(5)Adjusted EBITDA is not a recognized measurement under accounting principles generally accepted in the United States, (GAAP). When analyzing our operating performance, investors should use this measure in addition to, and not as an alternative for, the most directly comparable financial measure calculated and presented in accordance with GAAP. We generally use this non-GAAP financial measure to evaluate operating performance and for other discretionary purposes. We believe this measure provides a more complete understanding of ongoing operations, enhances comparability of current results to prior periods and may be useful for investors to analyze our financial performance because it eliminates the impact of selected charges that may obscure trends in the underlying performance of our business. Because not all companies use identical calculations, our presentation of adjusted EBITDA may not be comparable to similarly titled measures of other companies.EBITDA represents earnings before depreciation and amortization, asset impairments, interest expense, net of interest income, write-off of financing costs on extinguished debt, and provision for income taxes. Amounts shown for adjusted EBITDA further remove (from EBITDA) the impact of costs associated with transformation initiatives, costs associated with workforce optimization efforts, fair value adjustments to real estate assets acquired in the Telford Acquisition (purchase accounting) that were sold in the period, costs incurred related to legal entity restructuring, integration and other costs related to acquisitions, carried interest incentive compensation expense (reversal) to align with the timing of associated revenue, costs associated with our reorganization, including cost-savings initiatives, costs incurred in connection with litigation settlement, a one-time gain associated with remeasuring an investment in an unconsolidated subsidiary to fair value as of the date the remaining controlling interest was acquired, and cost-elimination expenses. We believe that investors may find these measures useful in evaluating our operating performance compared to that of other companies in our industry because their calculations generally eliminate the effects of acquisitions, which would include impairment charges of goodwill and intangibles created from acquisitions, the effects of financings and income taxes and the accounting effects of capital spending.Adjusted EBITDA is not intended to be a measure of free cash flow for our discretionary use because it does not consider certain cash requirements such as tax and debt service payments. This measure may also differ from the amounts calculated under similarly titled definitions in our credit facilities and debt instruments, which are further adjusted to reflect certain other cash and non-cash charges and are used by us to determine compliance with financial covenants therein and our ability to engage in certain activities, such as incurring additional debt. We also use adjusted EBITDA as a significant component when measuring our operating performance under our employee incentive compensation programs. See below for a reconciliation of adjusted EBITDA to net income attributable to CBRE Group, Inc.(6)See Non-controlling interest subject to possible redemption - special purpose acquisition company in Note 2 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.31Table of ContentsAdjusted EBITDA is calculated as follows (dollars in thousands):Year Ended December 31,20202019201820172016Net income attributable to CBRE Group, Inc.$751,989 $1,282,357 $1,063,219 $697,109 $573,079 Add:Depreciation and amortization501,728 439,224 451,988 406,114 366,927 Asset impairments88,676 89,787 — — — Interest expense, net of interest income67,753 85,754 98,685 126,961 136,800 Write-off of financing costs on extinguished debt75,592 2,608 27,982 — — Provision for income taxes214,101 69,895 313,058 467,757 296,900 EBITDA1,699,839 1,969,625 1,954,932 1,697,941 1,373,706 Adjustments:Costs associated with transformation initiatives (1)155,148 — — — — Costs associated with workforce optimization efforts (2)37,594 — — — — Impact of fair value adjustments to real estate assets acquired in the Telford Acquisition (purchase accounting) that were sold in the period11,598 9,301 — — — Costs incurred related to legal entity restructuring9,362 6,899 — — — Integration and other costs related to acquisitions1,756 15,292 9,124 27,351 125,743 Carried interest incentive compensation (reversal) expense to align with the timing of associated revenue(22,912)13,101 (5,261)(8,518)(15,558)Costs associated with our reorganization, including cost-savings initiatives (3)— 49,565 37,925 — — Costs incurred in connection with litigation settlement— — 8,868 — — One-time gain associated with remeasuring an investment in an unconsolidated subsidiary to fair value as of the date the remaining controlling interest was acquired— — (100,420)— — Cost-elimination expenses— — — — 78,456 Adjusted EBITDA$1,892,385 $2,063,783 $1,905,168 $1,716,774 $1,562,347 _______________(1)Commencing during the third quarter of 2020, management began the implementation of certain transformation initiatives to enable the company to reduce costs, streamline operations and support future growth. The majority of expenses incurred were cash in nature and primarily related to employee separation benefits, lease termination costs and professional fees. See Note 21 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report. (2)Primarily represents costs incurred related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic. The charges are cash expenditures primarily for severance costs incurred related to this effort. Of the total costs, $7.4 million was included within the “Cost of revenue” line item and $30.2 million was included in the “Operating, administrative and other” line item in the accompanying consolidated statement of operations for the year ended December 31, 2020. (3)Primarily represents severance costs related to headcount reductions in connection with our reorganization announced in the third quarter of 2018 that became effective January 1, 2019.32Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report. Discussion regarding our financial condition and results of operations for the year ended December 31, 2018 and comparisons between the years ended December 31, 2019 and 2018 is included in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the company’s Annual Report filed with the SEC on March 2, 2020.OverviewWe are the world’s largest commercial real estate services and investment firm, based on 2020 revenue, with leading global market positions in our leasing, property sales, occupier outsourcing and valuation businesses. As of December 31, 2020, the company has more than 100,000 employees (excluding affiliates) serving clients in more than 100 countries.Our business is focused on providing services to real estate investors and occupiers. For investors, we provide capital markets (property sales, mortgage origination, sales and servicing), property leasing, investment management, property management, valuation and development services, among others. For occupiers, we provide facilities management, project management, transaction (both property sales and leasing) and consulting services, among others. We provide services under the following brand names: “CBRE” (real estate advisory and outsourcing services); “CBRE Global Investors” (investment management); “Trammell Crow Company” (U.S. development); “Telford Homes” (U.K. development) and “Hana” (flexible-space solutions). In 2020, CBRE sponsored a SPAC, CBRE Acquisition Holdings, which has the sole purpose of acquiring a privately held company with significant growth potential and to create value by supporting the company in the public markets. The company that it acquires is expected to operate in an industry that will benefit from the experience, expertise and operating skills of CBRE. CBRE Acquisition Holdings trades on the NYSE under the symbols “CBAH,” “CBAH.U,” and “CBAH.W.”Our revenue mix has shifted toward more stable revenue sources, particularly occupier outsourcing, and our dependence on highly cyclical property sales and lease transaction revenue has declined markedly over the past decade. We believe we are well-positioned to capture a substantial and growing share of market opportunities at a time when investors and occupiers increasingly prefer to purchase integrated, account-based services on a national and global basis. We generate revenue from both management fees (large multi-year portfolio and per-project contracts) and commissions on transactions. In 2020, we generated revenue from a highly diversified base of clients, including more than 90 of the Fortune 100 companies. We have been an S&P 500 company since 2006 and in 2020 we were ranked #128 on the Fortune 500. We have been voted the most recognized commercial real estate brand in the Lipsey Company survey for 20 years in a row (including 2021). We have also been rated a World’s Most Ethical Company by the Ethisphere Institute for eight consecutive years (including 2021), and are included in both the Dow Jones World Sustainability Index and the Bloomberg Gender-Equality Index for two years in a row.Critical Accounting PoliciesOur consolidated financial statements have been prepared in accordance with GAAP, which require us to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and on other factors that we believe to be reasonable. Actual results may differ from those estimates. We believe that the following critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our consolidated financial statements.Revenue RecognitionTo recognize revenue in a transaction with a customer, we evaluate the five steps of the Accounting Standards Codification (ASC) Topic 606 revenue recognition framework: (1) identify the contract; (2) identify the performance obligations(s) in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligation(s) and (5) recognize revenue when (or as) the performance obligations are satisfied.33Table of ContentsOur revenue recognition policies are consistent with this five step framework. Understanding the complex terms of agreements and determining the appropriate time, amount, and method to recognize revenue for each transaction requires significant judgement. These significant judgements include: (i) determining what point in time or what measure of progress depicts the transfer of control to the customer; (ii) applying the series guidance to certain performance obligations satisfied over time; (iii) estimating how and when contingencies, or other forms of variable consideration, will impact the timing and amount of recognition of revenue and (iv) determining whether we control third party services before they are transferred to the customer in order to appropriately recognize the associated fees on either a gross or net basis. The timing and amount of revenue recognition in a period could vary if different judgments were made. Our revenues subject to the most judgment are brokerage commission revenue, incentive-based management fees, development fees and third party fees associated with our occupier outsourcing and property management services. For a detailed discussion of our revenue recognition policies, see the Revenue Recognition section within Note 2 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Goodwill and Other Intangible AssetsOur acquisitions require the application of purchase accounting, which results in tangible and identifiable intangible assets and liabilities of the acquired entity being recorded at fair value. The difference between the purchase price and the fair value of net assets acquired is recorded as goodwill. In determining the fair values of assets and liabilities acquired in a business combination, we use a variety of valuation methods including present value, depreciated replacement cost, market values (where available) and selling prices less costs to dispose. We are responsible for determining the valuation of assets and liabilities and for the allocation of purchase price to assets acquired and liabilities assumed.Assumptions must often be made in determining fair values, particularly where observable market values do not exist. Assumptions may include discount rates, growth rates, cost of capital, royalty rates, tax rates and remaining useful lives. These assumptions can have a significant impact on the value of identifiable assets and accordingly can impact the value of goodwill recorded. Different assumptions could result in different values being attributed to assets and liabilities. Since these values impact the amount of annual depreciation and amortization expense, different assumptions could also impact our statement of operations and could impact the results of future asset impairment reviews.We are required to test goodwill and other intangible assets deemed to have indefinite useful lives for impairment at least annually, or more often if circumstances or events indicate a change in the impairment status, in accordance with Financial Accounting Standards Board (FASB) ASC Topic 350, “Intangibles – Goodwill and Other” (Topic 350). We have the option to perform a qualitative assessment with respect to any of our reporting units to determine whether a quantitative impairment test is needed. We are permitted to assess based on qualitative factors whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the quantitative goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we would conduct a quantitative goodwill impairment test. If not, we do not need to apply the quantitative test. The qualitative test is elective and we can go directly to the quantitative test rather than making a more-likely-than-not assessment based on an evaluation of qualitative factors. When performing a quantitative test, we use a discounted cash flow approach to estimate the fair value of our reporting units. Management’s judgment is required in developing the assumptions for the discounted cash flow model. These assumptions include revenue growth rates, profit margin percentages, discount rates, etc. Due to the many variables inherent in the estimation of a business’s fair value and the relative size of our goodwill, if different assumptions and estimates were used, it could have an adverse effect on our impairment analysis.For additional information on goodwill and intangible asset impairment testing, see Notes 2 and 9 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.34Table of ContentsIncome TaxesIncome taxes are accounted for under the asset and liability method in accordance with the “Accounting for Income Taxes,” Topic of the FASB ASC (Topic 740). Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured by applying enacted tax rates and laws and are released in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.Accounting for tax positions requires judgments, including estimating reserves for potential uncertainties. We also assess our ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. We do not record valuation allowances for deferred tax assets that we believe will be realized in future periods. While we believe the resulting tax balances as of December 31, 2020 and 2019 are appropriately accounted for in accordance with Topic 740, as applicable, the ultimate outcome of such matters could result in favorable or unfavorable adjustments to our consolidated financial statements and such adjustments could be material.On December 22, 2017, the Tax Cuts and Jobs Act (the Tax Act) was signed into law making significant changes to the Internal Revenue Code, including a decrease to the U.S. corporate tax rate from 35% to 21% and a one-time transition tax (i.e. toll charge or, the Transition Tax) on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We are paying the federal tax liability for the Transition Tax in annual interest-free installments over a period of eight years through 2025 as allowed by the Tax Act. On March 18, 2020, the Families First Coronavirus Response Act (FFCR Act), and on March 27, 2020, the CARES Act were each enacted in response to the Covid-19 pandemic. The FFCR Act and the CARES Act contain numerous tax provisions, such as net operating loss carry-back periods, alternative minimum tax credit refunds, deferral of employer payroll taxes deferring payroll tax payments, establishing a credit for the retention of certain employees, relaxing limitations on the deductibility of interest, and updating the definition of qualified improvement property. This legislation currently has no material impact to income tax expense on the company’s financial statements. Our future effective tax rate could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items.See Note 15 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report for further information regarding income taxes.New Accounting PronouncementsSee New Accounting Pronouncements discussion within Note 3 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.SeasonalityIn a typical year, a significant portion of our revenue is seasonal, which an investor should keep in mind when comparing our financial condition and results of operations on a quarter-by-quarter basis. Historically, our revenue, operating income, net income and cash flow from operating activities have tended to be lowest in the first quarter and highest in the fourth quarter of each year. Revenue, earnings and cash flow have generally been concentrated in the fourth calendar quarter due to the focus on completing sales, financing and leasing transactions prior to year-end. The severe and ongoing impact of the Covid-19 pandemic may cause seasonality to deviate from historical patterns.35Table of ContentsInflationOur commissions and other variable costs related to revenue are primarily affected by commercial real estate market supply and demand, which may be affected by inflation. However, to date, we believe that general inflation has not had a material impact upon our operations.Items Affecting ComparabilityWhen you read our financial statements and the information included in this Annual Report, you should consider that we have experienced, and continue to experience, several material trends and uncertainties (particularly those caused or exacerbated by Covid-19) that have affected our financial condition and results of operations that make it challenging to predict our future performance based on our historical results. We believe that the following material trends and uncertainties are crucial to an understanding of the variability in our historical earnings and cash flows and the potential for continued variability in the future.Macroeconomic ConditionsEconomic trends and government policies affect global and regional commercial real estate markets as well as our operations directly. These include overall economic activity and employment growth, with specific sensitivity to growth in office-based employment; interest rate levels and changes in interest rates; the cost and availability of credit; and the impact of tax and regulatory policies. Periods of economic weakness or recession, significantly rising interest rates, fiscal uncertainty, declining employment levels, decreasing demand for commercial real estate, falling real estate values, disruption to the global capital or credit markets, or the public perception that any of these events may occur, will negatively affect the performance of our business.Compensation is our largest expense and our sales and leasing professionals generally are paid on a commission and/or bonus basis that correlates with their revenue production. As a result, the negative effects on our operating margins of difficult market conditions, such as we are currently experiencing with the Covid-19 pandemic, is partially mitigated by the inherent variability of our compensation cost structure. In addition, when negative economic conditions have been particularly severe, like during the current Covid-19 pandemic, we have moved decisively to lower operating expenses to improve financial performance, and then have restored certain expenses as economic conditions improved. Additionally, our contractual revenue has increased primarily as a result of growth in our outsourcing business, and we believe this contractual revenue should help offset the negative impacts that macroeconomic deterioration could have on other parts of our business. Nevertheless, adverse global and regional economic trends could pose significant risks to the performance of our consolidated operations and financial condition.From 2010 to early 2020, commercial real estate markets had generally been characterized by increased demand for space, falling vacancies, higher rents and strong capital flows, leading to solid property sales and leasing activity. This healthy backdrop changed abruptly in the first quarter of 2020 with the emergence of the Covid-19 pandemic and resultant sharp contraction of economic activity across much of the world. Since then, there has been a severe impact on commercial real estate markets, as many property owners and occupiers have put transactions on hold and withdrawn existing mandates, sharply reducing sales and leasing volumes. We expect to see the highly challenging operating environment continue, as Covid-19 caseloads remain elevated across our major markets, business travel and face-to-face business dealings are limited and the overwhelming majority of workers remain out of their offices. The recovery of real estate markets around the world remain uncertain as of the date of this report.Covid-19 is putting downward pressure on parts of our business and creating larger opportunities in other parts. The severe economic effects of the pandemic continued to weigh most heavily on higher-margin property lease and sales revenue in the Advisory Services segment. However, global industrial leasing revenue, fueled by e-commerce, grew strongly during the fourth quarter, reflecting the resiliency of this asset type. Also, during the fourth quarter, we saw improvement in sales activity in the U.S. and certain North Asia markets, but transaction volumes there and elsewhere in the world remain well below pre-pandemic levels.36Table of ContentsThe future performance of our global real estate services and investment businesses depends on a recovery of global market conditions, including restored business and consumer confidence, sustained economic growth, solid and consistent job creation, stable, functioning global credit markets and a receding of the Covid-19 pandemic.Effects of AcquisitionsWe have historically made significant use of strategic acquisitions to add and enhance service capabilities around the world. Most recently, we acquired Telford Homes Plc (Telford), a leading developer of multifamily residential properties in the London area, in October 2019. Telford, which is reported in our Real Estate Investments segment, expanded our real estate development business outside the U.S. for the first time.In June 2018, we acquired FacilitySource Holdings, LLC (FacilitySource) to help us build a tech-enabled supply chain capability for the occupier outsourcing industry, which would drive meaningfully differentiated outcomes for leading occupiers of real estate. FacilitySource results are reflected in our Global Workplace Solutions segment.Strategic in-fill acquisitions have also played a key role in strengthening our service offerings. The companies we acquired have generally been regional or specialty firms that complement our existing platform, or independent affiliates, which, in some cases, we held a small equity interest. In early 2021, we acquired a construction and project management firm based in Southern California.During 2020, we completed six in-fill acquisitions: leading local facilities management firms in Spain and Italy, a U.S. firm that helps companies reduce telecommunications costs, a technology-focused project management firm based in Florida, a firm specializing in performing real estate valuations in South Korea, and a facilities management and technical maintenance firm in Australia. During 2019, in addition to the Telford strategic acquisition, we completed eight in-fill acquisitions: a leading advanced analytics software company based in the U.K., a commercial and residential real estate appraisal firm in Florida, our former affiliate in Omaha, a project management firm in Australia, a valuation and consulting business in Switzerland, a leading project management firm in Israel, a full-service real estate firm in San Antonio with a focus on retail, office, medical office and land, and a debt-focused real estate investment management business in the U.K.We believe strategic acquisitions can significantly decrease the cost, time and resources necessary to attain a meaningful competitive position – or expand our capabilities – within targeted markets or business lines. In general, however, most acquisitions will initially have an adverse impact on our operating income and net income as a result of transaction-related expenditures, including severance, lease termination, transaction and deferred financing costs, as well as costs and charges associated with integrating the acquired business and integrating its financial and accounting systems into our own.Our acquisition structures often include deferred and/or contingent purchase consideration in future periods that are subject to the passage of time or achievement of certain performance metrics and other conditions. As of December 31, 2020, we have accrued deferred purchase consideration totaling $82.5 million, which is included in “Accounts payable and accrued expenses” and in “Other long-term liabilities” in the accompanying consolidated balance sheets set forth in Item 8 of this Annual Report.International OperationsWe conduct a significant portion of our business and employ a substantial number of people outside of the U.S. and, as a result, we are subject to risks associated with doing business globally. Our Real Estate Investments business has a significant amount of euro-denominated assets under management, as well as associated revenue and earnings in Europe. In addition, our Global Workplace Solutions business also has a significant amount of its revenue and earnings denominated in foreign currencies, such as the euro and British pound sterling. Fluctuations in foreign currency exchange rates have resulted and may continue to result in corresponding fluctuations in our AUM, revenue and earnings.37Table of ContentsWe are closely monitoring the impact of the Covid-19 pandemic on business conditions across all regions worldwide. Covid-19 has significantly impacted our operations and has the potential to further constrain our business activity. See “The Covid-19 pandemic could have a material adverse effect on our business, results of operations, cash flows and financial condition” in Part I, Item 1A. “Risk Factors” for additional risks related to the Covid-19 pandemic. Our businesses could also suffer from political or economic disruptions (or the perception that such disruptions may occur) that affect interest rates or liquidity or create financial, market or regulatory uncertainty. For example, we are continuing to monitor the trade and economic effects of the U.K.’s withdrawal from the European Union (Brexit), particularly its impact on sales and office and retail leasing activity in the U.K. Any currency volatility associated with the Covid-19 pandemic, Brexit or other economic dislocations could impact our results of operations. During the year ended December 31, 2020, approximately 44% of our revenue was transacted in foreign currencies. The following table sets forth our revenue derived from our most significant currencies (U.S. dollars in thousands): Year Ended December 31,20202019United States dollar$13,472,013 56.5 %$13,852,018 58.0 %British pound sterling3,083,810 13.0 %2,972,704 12.5 %euro2,612,421 11.0 %2,492,952 10.4 %Canadian dollar788,497 3.3 %774,825 3.2 %Indian rupee469,977 2.0 %503,630 2.1 %Australian dollar417,060 1.8 %453,847 1.9 %Chinese yuan387,099 1.6 %349,762 1.5 %Japanese yen341,447 1.4 %325,558 1.4 %Swiss franc334,558 1.4 %194,354 0.8 %Singapore dollar259,721 1.1 %300,116 1.3 %Other currencies (1)1,659,592 6.9 %1,674,325 6.9 %Total revenue$23,826,195 100.0 %$23,894,091 100.0 %_______________(1)Approximately 40 currencies comprise 6.9% of our revenue for the years ended December 31, 2020 and 2019.Although we operate globally, we report our results in U.S. dollars. As a result, the strengthening or weakening of the U.S. dollar may positively or negatively impact our reported results. For example, we estimate that had the British pound sterling-to-U.S. dollar exchange rates been 10% higher during the year ended December 31, 2020, the net impact would have been a decrease in pre-tax income of $3.1 million. Had the euro-to-U.S. dollar exchange rates been 10% higher during the year ended December 31, 2020, the net impact would have been an increase in pre-tax income of $9.3 million. These hypothetical calculations estimate the impact of translating results into U.S. dollars and do not include an estimate of the impact that a 10% change in the U.S. dollar against other currencies would have had on our foreign operations.Fluctuations in foreign currency exchange rates may result in corresponding fluctuations in revenue and earnings as well as the assets under management for our investment management business, which could have a material adverse effect on our business, financial condition and operating results. Due to the constantly changing currency exposures to which we are subject and the volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations upon future operating results. In addition, fluctuations in currencies relative to the U.S. dollar may make it more difficult to perform period-to-period comparisons of our reported results of operations. Our international operations also are subject to, among other things, political instability and changing regulatory environments, which affect the currency markets and which as a result may adversely affect our future financial condition and results of operations. We routinely monitor these risks and related costs and evaluate the appropriate amount of oversight to allocate towards business activities in foreign countries where such risks and costs are particularly significant.38Table of ContentsResults of OperationsThe following table sets forth items derived from our consolidated statements of operations for the years ended December 31, 2020 and 2019 (dollars in thousands):Year Ended December 31,20202019Revenue:Fee revenue:Global workplace solutions$3,307,083 13.9 %$3,126,931 13.1 %Property and advisory project management1,257,569 5.3 %1,259,222 5.3 %Valuation614,307 2.6 %630,399 2.6 %Loan servicing239,596 1.0 %206,736 0.9 %Advisory leasing2,404,273 10.1 %3,269,993 13.7 %Capital markets:Advisory sales1,658,702 7.0 %2,130,979 8.9 %Commercial mortgage origination577,851 2.4 %575,963 2.4 %Investment management474,939 2.0 %424,882 1.8 %Development services356,591 1.4 %235,740 0.9 %Total fee revenue10,890,911 45.7 %11,860,845 49.6 %Pass through costs also recognized as revenue12,935,284 54.3 %12,033,246 50.4 %Total revenue23,826,195 100.0 %23,894,091 100.0 %Costs and expenses:Cost of revenue19,047,620 79.9 %18,689,013 78.2 %Operating, administrative and other3,306,205 13.9 %3,436,009 14.4 %Depreciation and amortization501,728 2.1 %439,224 1.8 %Asset impairments88,676 0.4 %89,787 0.4 %Total costs and expenses22,944,229 96.3 %22,654,033 94.8 %Gain on disposition of real estate87,793 0.4 %19,817 0.1 %Operating income969,759 4.1 %1,259,875 5.3 %Equity income from unconsolidated subsidiaries126,161 0.5 %160,925 0.7 %Other income17,394 0.1 %28,907 0.1 %Interest expense, net of interest income67,753 0.3 %85,754 0.4 %Write-off of financing costs on extinguished debt75,592 0.3 %2,608 0.0 %Income before provision for income taxes969,969 4.1 %1,361,345 5.7 %Provision for income taxes214,101 0.9 %69,895 0.3 %Net income755,868 3.2 %1,291,450 5.4 %Less: Net income attributable to non-controlling interests3,879 0.0 %9,093 0.0 %Net income attributable to CBRE Group, Inc.$751,989 3.2 %$1,282,357 5.4 %Adjusted EBITDA$1,892,385 7.9 %$2,063,783 8.6 %Fee revenue and adjusted EBITDA are not recognized measurements under GAAP. When analyzing our operating performance, investors should use these measures in addition to, and not as an alternative for, their most directly comparable financial measure calculated and presented in accordance with GAAP. We generally use these non-GAAP financial measures to evaluate operating performance and for other discretionary purposes. We believe these measures provide a more complete understanding of ongoing operations, enhance comparability of current results to prior periods and may be useful for investors to analyze our financial performance because they eliminate the impact of selected charges that may obscure trends in the underlying performance of our business. Because not all companies use identical calculations, our presentation of fee revenue and adjusted EBITDA may not be comparable to similarly titled measures of other companies.39Table of ContentsFee revenue is gross revenue less both client reimbursed costs largely associated with employees that are dedicated to client facilities and subcontracted vendor work performed for clients. We believe that investors may find this measure useful to analyze the company’s overall financial performance because it excludes costs reimbursable by clients, and as such provides greater visibility into the underlying performance of our business.EBITDA represents earnings before depreciation and amortization, asset impairments, interest expense, net of interest income, write-off of financing costs on extinguished debt, and provision for income taxes. Amounts shown for adjusted EBITDA further remove (from EBITDA) the impact of costs associated with transformation initiatives, costs associated with workforce optimization efforts, fair value adjustments to real estate assets acquired in the Telford Acquisition (purchase accounting) that were sold in the period, costs incurred related to legal entity restructuring, integration and other costs related to acquisitions, carried interest incentive compensation expense (reversal) to align with the timing of associated revenue, and costs associated with our reorganization, including cost-savings initiatives. We believe that investors may find these measures useful in evaluating our operating performance compared to that of other companies in our industry because their calculations generally eliminate the effects of acquisitions, which would include impairment charges of goodwill and intangibles created from acquisitions, the effects of financings and income taxes and the accounting effects of capital spending.Adjusted EBITDA is not intended to be a measure of free cash flow for our discretionary use because it does not consider certain cash requirements such as tax and debt service payments. This measure may also differ from the amounts calculated under similarly titled definitions in our credit facilities and debt instruments, which are further adjusted to reflect certain other cash and non-cash charges and are used by us to determine compliance with financial covenants therein and our ability to engage in certain activities, such as incurring additional debt. We also use adjusted EBITDA as a significant component when measuring our operating performance under our employee incentive compensation programs.Adjusted EBITDA is calculated as follows (dollars in thousands):Year Ended December 31,20202019Net income attributable to CBRE Group, Inc.$751,989 $1,282,357 Add:Depreciation and amortization501,728 439,224 Asset impairments88,676 89,787 Interest expense, net of interest income67,753 85,754 Write-off of financing costs on extinguished debt75,592 2,608 Provision for income taxes214,101 69,895 EBITDA1,699,839 1,969,625 Adjustments:Costs associated with transformation initiatives (1)155,148 — Costs associated with workforce optimization efforts (2)37,594 — Impact of fair value adjustments to real estate assets acquired in the Telford Acquisition (purchase accounting) that were sold in the period11,598 9,301 Costs incurred related to legal entity restructuring9,362 6,899 Integration and other costs related to acquisitions1,756 15,292 Carried interest incentive compensation (reversal) expense to align with the timing of associated revenue(22,912)13,101 Costs associated with our reorganization, including cost-savings initiatives (3)— 49,565 Adjusted EBITDA$1,892,385 $2,063,783 _______________(1)During 2020, management began the implementation of certain transformation initiatives to enable the company to reduce costs, streamline operations and support future growth. The majority of expenses incurred were cash in nature and primarily related to employee separation benefits, lease termination costs and professional fees. See Note 21 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.40Table of Contents(2)Primarily represents costs incurred related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic. The charges are cash expenditures primarily for severance costs incurred related to this effort. Of the total costs, $7.4 million was included within the “Cost of revenue” line item and $30.2 million was included in the “Operating, administrative, and other” line item in the accompanying consolidated statements of operations for the year ended December 31, 2020.(3)Primarily represents severance costs related to headcount reductions in connection with our reorganization announced in the third quarter of 2018 that became effective January 1, 2019.Year Ended December 31, 2020 Compared to Year Ended December 31, 2019We reported consolidated net income of $752.0 million for the year December 31, 2020 on revenue of $23.8 billion as compared to consolidated net income of $1.3 billion on revenue of $23.9 billion for the year ended December 31, 2019.Our revenue on a consolidated basis for the year ended December 31, 2020 decreased by $67.9 million, or 0.3%, as compared to the year ended December 31, 2019. The revenue decrease reflects decreases in our Advisory Services segment due to the impact of Covid-19, including lower sales (down 22.2% as compared to the same period in 2019) and leasing revenue (down 26.5% as compared to the same period in 2019). These decreases were partially offset by increases in revenue in our Global Workplace Solutions segment (up 8.0% as compared to the same period in 2019) led by growth in our facilities management line of business, driven by its contractual nature, and improved revenue in our Real Estate Investments segment (up 25.9% as compared to the same period in 2019) largely due to the Telford Acquisition and an increase in investment management fees. Foreign currency translation had a negligible impact on total revenue during the year ended December 31, 2020.Our cost of revenue on a consolidated basis increased by $358.6 million, or 1.9%, during the year ended December 31, 2020 as compared to the same period in 2019. This increase was primarily due to higher costs associated with our Global Workplace Solutions segment due to growth in our facilities management business and higher costs in our Real Estate Investments segment due to the Telford Acquisition. We also incurred $42.1 million of costs (primarily employee separation benefits) related to the company’s transformation initiatives during 2020 to enable the company to reduce costs, streamline operations and support future growth. These items were partially offset by lower commission expense incurred during the year ended December 31, 2020. Our sales and leasing professionals generally are paid on a commission basis, which substantially correlates with our sales and lease revenue performance. Accordingly, the decrease in advisory sales and leasing revenue led to a corresponding decrease in commission expense. These items were partially offset by the impact of foreign currency translation which had a 0.12% positive impact on total cost of revenue during the year ended December 31, 2020. Cost of revenue as a percentage of revenue increased from 78.2% for the year ended December 31, 2019 to 79.9% for the year ended December 31, 2020, primarily driven by our mix of revenue, with revenue from our Global Workplace Solutions segment, which has a lower margin than our other revenue streams, comprising a higher percentage of revenue than in the prior period.Our operating, administrative and other expenses on a consolidated basis decreased by $129.8 million, or 3.8%, during the year ended December 31, 2020 as compared to the same period in 2019. The negative impact of Covid-19 on our operating results led to a corresponding reduction in certain operating expenses such as travel and entertainment, marketing and employee events to manage financial performance as well as reduced stock compensation expense. These items were partially offset by $113.0 million of costs, primarily related to employee separation benefits, lease termination costs and professional fees related to the company’s transformation initiatives mentioned above, as well as $30.2 million of costs related to workforce optimization efforts executed primarily in the second quarter of 2020. We also incurred higher incremental costs associated with Telford, which we acquired on October 1, 2019, rent expense for our new flexible space offering, higher bad debt expense as a result of Covid-19, and higher charitable contributions due to donations to our Covid-19 relief fund. Foreign currency translation had a negligible impact on total operating, administrative and other expenses during the year ended December 31, 2020. Operating expenses as a percentage of revenue decreased from 14.4% for the year ended December 31, 2019 to 13.9% for the year ended December 31, 2020, reflecting the operating leverage inherent in our business and reduced discretionary spending.Our depreciation and amortization expense on a consolidated basis increased by $62.5 million, or 14.2%, during the year ended December 31, 2020 as compared to the same period in 2019. This increase was primarily attributable to a rise in depreciation expense of $60.5 million during the year ended December 31, 2020 driven by technology-related capital expenditures and accelerated depreciation related to lease terminations included in our transformation initiatives.41Table of ContentsOur asset impairments on a consolidated basis totaled $88.7 million and $89.8 million during the years ended December 31, 2020 and 2019, respectively. For the year ended December 31, 2020, asset impairments comprised the following: $50.2 million of non-cash asset impairment charges in our Global Workplace Solutions segment; a non-cash goodwill impairment charge of $25.0 million and non-cash asset impairment charges of $13.5 million in our Real Estate Investments segment. Primarily as a result of the recent global economic disruption and uncertainty due to Covid-19, we deemed there to be triggering events during 2020 that required testing of goodwill and certain assets for impairment. Based on these events, we recorded the aforementioned non-cash impairment charges, which were primarily driven by lower anticipated cash flows in certain businesses directly resulting from a downturn in forecasts as well as increased forecast risk due to Covid-19 and changes in our business going forward. During the year ended December 31, 2019, we recorded a non-cash intangible asset impairment charge of $89.8 million in our Real Estate Investments segment. This non-cash write-off resulted from a review of the anticipated cash flows and the decrease in assets under management in our public securities business driven in part by a continued industry-wide shift in investor preference for passive investment programs.Our gain on disposition of real estate on a consolidated basis increased by $68.0 million, or 343.0%, during the year ended December 31, 2020 as compared to the same period in 2019. These gains resulted from property sales within our Real Estate Investments segment.Our equity income from unconsolidated subsidiaries on a consolidated basis decreased by $34.8 million, or 21.6%, during the year ended December 31, 2020 as compared to the same period in 2019, primarily driven by lower equity earnings associated with gains on property sales reported in our Real Estate Investments segment.Our other income on a consolidated basis was $17.4 million for the year ended December 31, 2020 versus $28.9 million for the same period in the prior year. The decrease was primarily due to higher net unrealized gains in the prior year compared to the current year on certain of our co-investments.Our consolidated interest expense, net of interest income, decreased by $18.0 million, or 21.0%, for the year ended December 31, 2020 as compared to the same period in 2019. This decrease was primarily due to lower interest expense on borrowings associated with our credit agreement (driven by lower interest rates) as well as reduced net interest expense overseas associated with cash pooling arrangements.Our write-off of financing costs on extinguished debt on a consolidated basis was $75.6 million for the year ended December 31, 2020 as compared to $2.6 million for the year ended December 31, 2019. The costs for the year ended December 31, 2020 included a $73.6 million premium paid and the write-off of $2.0 million of unamortized premium and debt issuance costs in connection with the redemption, in full, of the $425.0 million aggregate outstanding principal amount of our 5.25% senior notes. The costs for the year ended December 31, 2019 were incurred in connection with the refinancing of our credit agreement. Our provision for income taxes on a consolidated basis was $214.1 million for the year ended December 31, 2020 as compared to $69.9 million for the same period in 2019. Our effective tax rate increased from 5.1% for the year ended December 31, 2019 to 22.1% for the year ended December 31, 2020. The lower tax rate for year ended December 31, 2019 was primarily driven by a $277.2 million net tax benefit recorded in 2019 attributable to outside basis differences recognized as a result of a legal entity restructuring.Segment OperationsWe organize our operations around, and publicly report our financial results on, three global business segments: (1) Advisory Services; (2) Global Workplace Solutions; and (3) Real Estate Investments. For additional information on our segments, see Note 19 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.42Table of ContentsAdvisory ServicesThe following table summarizes our results of operations for our Advisory Services operating segment for the years ended December 31, 2020 and 2019 (dollars in thousands):Year Ended December 31,20202019Revenue:Fee revenue:Property and advisory project management$1,257,569 16.3 %$1,259,222 13.9 %Valuation614,307 7.9 %630,399 6.9 %Loan servicing239,596 3.1 %206,736 2.3 %Advisory leasing2,404,273 31.1 %3,269,993 36.0 %Capital markets:Advisory sales1,658,702 21.5 %2,130,979 23.5 %Commercial mortgage origination577,851 7.5 %575,963 6.4 %Total fee revenue6,752,298 87.7 %8,073,292 89.0 %Pass through costs also recognized as revenue946,694 12.3 %996,176 11.0 %Total revenue7,698,992 100.0 %9,069,468 100.0 %Costs and expenses:Cost of revenue4,693,684 61.0 %5,465,391 60.3 %Operating, administrative and other2,030,873 26.4 %2,169,980 23.9 %Depreciation and amortization348,669 4.5 %304,766 3.4 %Operating income625,766 8.1 %1,129,331 12.4 %Equity income from unconsolidated subsidiaries2,245 0.0 %6,894 0.1 %Other income17,329 0.2 %7,532 0.1 %Less: Net income attributable to non-controlling interests887 0.0 %1,021 0.0 %Add-back: Depreciation and amortization348,669 4.5 %304,766 3.4 %EBITDA993,122 12.9 %1,447,502 16.0 %Adjustments:Costs associated with transformation initiatives (1)113,987 1.5 %— 0.0 %Costs associated with workforce optimization efforts (2)27,418 0.4 %— 0.0 %Costs incurred related to legal entity restructuring9,362 0.1 %6,899 0.1 %Costs associated with our reorganization, including cost-savings initiatives (3)— 0.0 %11,088 0.1 %Integration and other costs related to acquisitions— 0.0 %303 0.0 %Adjusted EBITDA and Adjusted EBITDA on revenue margin$1,143,889 14.9 %$1,465,792 16.2 %Adjusted EBITDA on fee revenue margin16.9 %18.2 %_______________(1)During 2020, management began the implementation of certain transformation initiatives to enable the company to reduce costs, streamline operations and support future growth. The majority of expenses incurred were cash in nature and primarily related to employee separation benefits, lease termination costs and professional fees. See Note 21 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report. (2)Primarily represents costs incurred related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic. The charges are cash expenditures primarily for severance costs incurred related to this effort. Of the total costs, $6.1 million was included within the “Cost of revenue” line item and $21.3 million was included in the “Operating, administrative, and other” line item in the accompanying consolidated statements of operations for the year ended December 31, 2020.(3)Primarily represents severance costs related to headcount reductions in connection with our reorganization announced in the third quarter of 2018 that became effective January 1, 2019.43Table of ContentsYear Ended December 31, 2020 Compared to Year Ended December 31, 2019Revenue decreased by $1.4 billion, or 15.1%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The revenue decrease primarily reflects the impact of Covid-19, which resulted in lower sales and leasing revenue. Foreign currency translation had a negligible impact on total revenue during the year ended December 31, 2020.Cost of revenue decreased by $771.7 million, or 14.1%, for the year ended December 31, 2020 as compared to the same period in 2019, primarily due to reduced commission expense resulting from lower sales and leasing revenue as a result of Covid-19. Foreign currency translation had a negligible impact on total cost of revenue during the year ended December 31, 2020. Cost of revenue as a percentage of revenue increased to 61.0% for the year ended December 31, 2020 versus 60.3% for the same period in 2019, primarily as a result of costs incurred during the year ended December 31, 2020 for the transformation initiatives and workforce optimization that were not incurred during the year ended December 31, 2019.Operating, administrative and other expenses decreased by $139.1 million, or 6.4%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The negative impact of Covid-19 on our operating results led to corresponding decreases in bonus and stock compensation expense. In addition, to manage financial performance, we reduced certain operating expenses such as travel and entertainment, marketing and employee events. These items were partially offset by $80.8 million of costs, primarily related to employee separation benefits, lease termination costs and professional fees, as management commenced the implementation of certain transformation initiatives during the year ended December 31, 2020 to enable the company to reduce costs, streamline operations and support future growth. Lastly, we saw an increase in charitable donations largely driven by a sizeable donation by the company to its Covid-19 relief fund. Foreign currency translation had a negligible impact on total operating expenses during the year ended December 31, 2020.For the year ended December 31, 2020, mortgage servicing rights (MSRs) contributed to operating income $207.8 million of gains recognized in conjunction with the origination and sale of mortgage loans, offset by $134.3 million of amortization of related intangible assets. For the year ended December 31, 2019, MSRs contributed to operating income $182.4 million of gains recognized in conjunction with the origination and sale of mortgage loans, offset by $123.0 million of amortization of related intangible assets.44Table of ContentsGlobal Workplace SolutionsThe following table summarizes our results of operations for our Global Workplace Solutions operating segment for the years ended December 31, 2020 and 2019 (dollars in thousands):Year Ended December 31,20202019Revenue:Fee revenue:Global workplace solutions$3,307,083 21.6 %$3,126,931 22.1 %Pass through costs also recognized as revenue11,988,590 78.4 %11,037,070 77.9 %Total revenue15,295,673 100.0 %14,164,001 100.0 %Costs and expenses:Cost of revenue14,180,395 92.7 %13,138,627 92.8 %Operating, administrative and other643,207 4.2 %637,282 4.5 %Depreciation and amortization125,692 0.8 %120,975 0.9 %Asset impairments50,171 0.3 %— 0.0 %Operating income296,208 2.0 %267,117 1.8 %Equity income (loss) from unconsolidated subsidiaries368 0.0 %(1,423)0.0 %Other income (loss)1,192 0.0 %(1,170)0.0 %Less: Net loss attributable to non-controlling interests— 0.0 %(271)0.0 %Add-back: Depreciation and amortization125,692 0.8 %120,975 0.9 %Add-back: Asset impairments50,171 0.3 %— 0.0 %EBITDA473,631 3.1 %385,770 2.7 %Costs associated with transformation initiatives (1)38,179 0.2 %— 0.0 %Costs associated with workforce optimization efforts (2)5,004 0.0 %— 0.0 %Costs associated with our reorganization, including cost savings initiatives (3)— 0.0 %38,256 0.3 %Adjusted EBITDA and Adjusted EBITDA on revenue margin$516,814 3.3 %$424,026 3.0 %Adjusted EBITDA on fee revenue margin15.6 %13.6 %_______________(1)During 2020, management began the implementation of certain transformation initiatives to enable the company to reduce costs, streamline operations and support future growth. The majority of expenses incurred were cash in nature and primarily related to employee separation benefits, lease termination costs and professional fees. See Note 21 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report. (2)Primarily represents costs incurred related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic. The charges are cash expenditures primarily for severance costs incurred related to this effort. Of the total costs, $1.2 million was included within the “Cost of revenue” line item and $3.8 million was included in the “Operating, administrative, and other” line item in the accompanying consolidated statements of operations for the year ended December 31, 2020.(3)Primarily represents severance costs related to headcount reductions in connection with our reorganization announced in the third quarter of 2018 that became effective January 1, 2019.Year Ended December 31, 2020 Compared to Year Ended December 31, 2019Revenue increased by $1.1 billion, or 8.0%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The revenue increase was primarily attributable to growth in our facilities management line of business, which is contractual in nature. Foreign currency translation had a 0.13% negative impact on total revenue during the year ended December 31, 2020, primarily driven by weakness in the Argentine peso and Brazilian real partially offset by strength in the British pound sterling and euro.45Table of ContentsCost of revenue increased by $1.0 billion, or 7.9%, for the year ended December 31, 2020 as compared to the same period in 2019, driven by the higher revenue leading to higher pass through costs. Foreign currency translation had a 0.14% positive impact on total cost of revenue during the year ended December 31, 2020. Cost of revenue as a percentage of revenue was relatively consistent at 92.7% for the year ended December 31, 2020 versus 92.8% for the same period in 2019.Operating, administrative and other expenses increased by $5.9 million, or 0.9%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This increase was attributable to costs incurred as a result of Covid-19, including higher bad debt expense, $3.8 million of costs incurred (mainly severance) primarily related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic, and increased staff bonus accruals. During the year ended December 31, 2020, investments were also made in both people and technology associated with ongoing efforts to remediate material weaknesses in our Europe, Middle East and Africa (EMEA) region. These increases were partially offset by a targeted reduction in certain operating expenses, such as travel and entertainment costs, during the year ended December 31, 2020 as a result of Covid-19. Foreign currency translation had a negligible impact on total operating expenses during the year ended December 31, 2020.Real Estate InvestmentsThe following table summarizes our results of operations for our Real Estate Investments operating segment for the years ended December 31, 2020 and 2019 (dollars in thousands):Year Ended December 31,20202019Revenue:Investment management$474,939 57.1 %$424,882 64.3 %Development services356,591 42.9 %235,740 35.7 %Total revenue831,530 100.0 %660,622 100.0 %Costs and expenses:Cost of revenue173,541 20.9 %84,995 12.9 %Operating, administrative and other632,125 76.0 %628,747 95.2 %Depreciation and amortization27,367 3.3 %13,483 2.0 %Asset impairments38,505 4.6 %89,787 13.6 %Gain on disposition of real estate87,793 10.6 %19,817 3.0 %Operating income (loss)47,785 5.8 %(136,573)(20.7)%Equity income from unconsolidated subsidiaries123,548 14.9 %155,454 23.5 %Other (loss) income(1,127)(0.1)%22,545 3.4 %Less: Net income attributable to non-controlling interests2,992 0.3 %8,343 1.2 %Add-back: Depreciation and amortization27,367 3.3 %13,483 2.0 %Add-back: Asset impairments38,505 4.6 %89,787 13.6 %EBITDA233,086 28.0 %136,353 20.6 %Adjustments:Impact of fair value adjustments to real estate assets acquired in the Telford Acquisition (purchase accounting) that were sold in the period11,598 1.4 %9,301 1.4 %Costs associated with workforce optimization efforts (1)5,172 0.6 %— 0.0 %Costs associated with transformation initiatives (2)2,982 0.4 %— 0.0 %Integration and other costs related to acquisitions1,756 0.2 %14,989 2.3 %Carried interest incentive compensation (reversal) expense to align with the timing of associated revenue(22,912)(2.8)%13,101 2.0 %Costs associated with our reorganization, including cost-savings initiatives (3)— 0.0 %221 0.0 %Adjusted EBITDA$231,682 27.8 %$173,965 26.3 %46Table of Contents_______________(1)Primarily represents costs incurred related to workforce optimization initiated and executed in the second quarter of 2020 as part of management’s cost containment efforts in response to the Covid-19 pandemic. The charges are cash expenditures primarily for severance costs incurred related to this effort and were included in the “Operating, administrative and other” line in the accompanying consolidated statements of operations for the year ended December 31, 2020. (2)During 2020, management began the implementation of certain transformation initiatives to enable the company to reduce costs, streamline operations and support future growth. The majority of expenses incurred were cash in nature and primarily related to employee separation benefits, lease termination costs and professional fees. See Note 21 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.(3)Primarily represents severance costs related to headcount reductions in connection with our reorganization announced in the third quarter of 2018 that became effective January 1, 2019.Year Ended December 31, 2020 Compared to Year Ended December 31, 2019Revenue increased by $170.9 million, or 25.9%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, primarily driven by the Telford Acquisition in our development services line of business and an increase in investment management fees primarily related to growth in AUM. Foreign currency translation had a 0.7% positive impact on total revenue during the year ended December 31, 2020 primarily driven by strength in the British pound sterling and euro.Cost of revenue increased by $88.5 million, or 104.2%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, driven by the Telford Acquisition, which we acquired on October 1, 2019.Operating, administrative and other expenses increased by $3.4 million, or 0.5%, for the year ended December 31, 2020 as compared to the same period in 2019, primarily driven by incremental costs associated with Telford which we acquired on October 1, 2019, increased results driven bonus expense in our development services line of business (driven by higher property sales in 2020), rent expense for our new flexible space offering, workforce optimization costs, and transformation initiative costs. These increases are partially offset by decreases in certain operating expenses, such as travel and entertainment costs, as a result of Covid-19, a reduction in integration and transaction costs for Telford, and a reduction in carried interest expense. Foreign currency translation had a negligible impact on total operating expenses during the year ended December 31, 2020.A roll forward of our AUM by product type for the year ended December 31, 2020 is as follows (dollars in billions):FundsSeparate AccountsSecuritiesTotalBalance at January 1, 2020$40.1 $64.9 $7.9 $112.9 Inflows5.3 9.1 1.4 15.8 Outflows(2.1)(7.5)(1.6)(11.2)Market appreciation (depreciation)3.9 1.4 (0.1)5.2 Balance at December 31, 2020$47.2 $67.9 $7.6 $122.7 AUM generally refers to the properties and other assets with respect to which we provide (or participate in) oversight, investment management services and other advice, and which generally consist of real estate properties or loans, securities portfolios and investments in operating companies and joint ventures. Our AUM is intended principally to reflect the extent of our presence in the real estate market, not the basis for determining our management fees. Our assets under management consist of:•the total fair market value of the real estate properties and other assets either wholly-owned or held by joint ventures and other entities in which our sponsored funds or investment vehicles and client accounts have invested or to which they have provided financing. Committed (but unfunded) capital from investors in our sponsored funds is not included in this component of our AUM. The value of development properties is included at estimated completion cost. In the case of real estate operating companies, the total value of real properties controlled by the companies, generally through joint ventures, is included in AUM; and47Table of Contents•the net asset value of our managed securities portfolios, including investments (which may be comprised of committed but uncalled capital) in private real estate funds under our fund of funds investments.Our calculation of AUM may differ from the calculations of other asset managers, and as a result, this measure may not be comparable to similar measures presented by other asset managers.Liquidity and Capital ResourcesWe believe that we can satisfy our working capital and funding requirements with internally generated cash flow and, as necessary, borrowings under our revolving credit facility. Our expected capital requirements for 2021 include up to approximately $235 million of anticipated capital expenditures, net of tenant concessions. As of December 31, 2020, we had aggregate commitments of $76.5 million to fund future co-investments in our Real Estate Investments business, $30.1 million of which is expected to be funded in 2021. Additionally, as of December 31, 2020, we are committed to fund $34.8 million of additional capital to unconsolidated subsidiaries within our Real Estate Investments business, which we may be required to fund at any time. As of December 31, 2020, we had $2.8 billion of borrowings available under our revolving credit facility and $1.8 billion of cash and cash equivalents available for general corporate use.We have historically relied on our internally generated cash flow and our revolving credit facility to fund our working capital, capital expenditure and general investment requirements (including strategic in-fill acquisitions) and have not sought other external sources of financing to help fund these requirements. In the absence of extraordinary events or a large strategic acquisition, we anticipate that our cash flow from operations and our revolving credit facility would be sufficient to meet our anticipated cash requirements for the foreseeable future, and at a minimum for the next 12 months. Given compensation is our largest expense and our sales and leasing professionals are generally paid on a commission and/or bonus basis that correlates with their revenue production, the negative effect of difficult market conditions is partially mitigated by the inherent variability of our compensation cost structure. In addition, when negative economic conditions have been particularly severe, we have moved decisively to lower operating expenses to improve financial performance, and then have restored certain expenses as economic conditions improved. We may seek to take advantage of market opportunities to refinance existing debt instruments, as we have done in the past, with new debt instruments at interest rates, maturities and terms we deem attractive. We may also, from time to time in our sole discretion, purchase, redeem, or retire our existing senior notes, through tender offers, in privately negotiated or open market transactions, or otherwise. On December 28, 2020, we redeemed the $425.0 million aggregate outstanding principal amount of our 5.25% senior notes due 2025 in full. We funded this redemption using cash on hand.As noted above, we believe that any future significant acquisitions we may make could require us to obtain additional debt or equity financing. In the past, we have been able to obtain such financing for material transactions on terms that we believed to be reasonable. However, it is possible that we may not be able to obtain acquisition financing on favorable terms, or at all, in the future if we decide to make any further significant acquisitions.Our long-term liquidity needs, other than those related to ordinary course obligations and commitments such as operating leases, are generally comprised of three elements. The first is the repayment of the outstanding and anticipated principal amounts of our long-term indebtedness. If our cash flow is insufficient to repay our long-term debt when it comes due, then we expect that we would need to refinance such indebtedness or otherwise amend its terms to extend the maturity dates. We cannot make any assurances that such refinancing or amendments would be available on attractive terms, if at all.The second long-term liquidity need is the payment of obligations related to acquisitions. Our acquisition structures often include deferred and/or contingent purchase consideration in future periods that are subject to the passage of time or achievement of certain performance metrics and other conditions. As of December 31, 2020 and 2019, we had accrued deferred purchase consideration totaling $82.5 million ($14.3 million of which was a current liability) and $111.7 million ($41.6 million of which was a current liability), respectively, which was included in “Accounts payable and accrued expenses” and in “Other liabilities” in the accompanying consolidated balance sheets set forth in Item 8 of this Annual Report.48Table of ContentsLastly, as described in Note 16 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report, our board of directors authorized a program for the repurchase of up to $500.0 million of our Class A common stock over three years. During the year ended December 31, 2020, we spent $50.0 million to repurchase 1,050,084 shares of our Class A common stock at an average price of $47.62 per share using cash on hand. Our stock repurchases have been funded with cash on hand and we intend to continue funding future repurchases with existing cash. We may utilize our stock repurchase program to continue offsetting the impact of our stock-based compensation program and on a more opportunistic basis if we believe our stock presents a compelling investment compared to other discretionary uses. The timing of any future repurchases and the actual amounts repurchased will depend on a variety of factors, including the market price of our common stock, general market and economic conditions and other factors. As of December 31, 2020, we had $350.0 million of capacity remaining under our repurchase program. Historical Cash FlowsYear Ended December 31, 2020 Compared to Year Ended December 31, 2019Operating ActivitiesNet cash provided by operating activities totaled $1.8 billion for the year ended December 31, 2020, an increase of $607.4 million as compared to the year ended December 31, 2019. The company experienced an overall increase in net working capital of approximately $1.1 billion, partially offset by lower net income of $535.6 million as compared to the same period in the previous year. The positive impact from net working capital was largely attributable to a decrease in accounts receivable due to a heightened focus on cash collections across our businesses, and lower net income tax payments due to the refunds received in the current year related to the prior year tax restructuring, partially offset by a net decrease to accounts payable and accrued expenses, as well as compensation payable and accrued bonus.Investing ActivitiesNet cash used in investing activities totaled $341.6 million for the year ended December 31, 2020, a decrease of $379.4 million as compared to the year ended December 31, 2019. This decrease was largely driven by a decrease of $26.9 million in capital expenditures during 2020 and lower amounts paid for acquisitions compared to 2019 which was driven primarily by the Telford Acquisition.Financing ActivitiesNet cash used in financing activities totaled $625.3 million for the year ended December 31, 2020, an increase of $353.3 million as compared to the year ended December 31, 2019. This increase was primarily due to the impact of the full redemption of the $425.0 million aggregate outstanding principal amount of our 5.25% senior notes (including a premium of $73.6 million) and due to $44.8 million in lower net contributions received from non-controlling interests during the year ended December 31, 2020. This was partially offset by the impact of repayment of debt assumed in the Telford Acquisition of $110.7 million during 2019. In addition, we used $95.1 million less for repurchase of common stock during the year ended December 31, 2020.49Table of ContentsSummary of Contractual Obligations and Other CommitmentsThe following is a summary of our various contractual obligations and other commitments as of December 31, 2020 (dollars in thousands):Payments Due by PeriodContractual ObligationsTotalLess than1 year1 - 3 years3 - 5 yearsMore than5 yearsTotal gross long-term debt (1)$1,390,273 $1,514 $488,759 $300,000 $600,000 Short-term borrowings (2)1,389,294 1,389,294 — — — Operating leases (3)1,517,258 214,887 411,882 338,828 551,661 Financing leases (3)539,243 64,363 87,077 23,702 364,101 Total gross notes payable on real estate (4)80,064 — 65,064 — 15,000 Deferred purchase consideration (5)82,539 14,301 52,754 10,934 4,550 Total contractual obligations$4,998,671 $1,684,359 $1,105,536 $673,464 $1,535,312 Amount of Other Commitments ExpirationOther CommitmentsTotalLess than1 year1 - 3 years3 - 5 yearsMore than5 yearsSelf-insurance reserves (6)$140,458 $140,458 $— $— $— Tax liabilities (7)54,761 — 24,328 30,433 — Co-investments (8) (9)111,252 64,845 27,317 5,472 13,618 Letters of credit (8)154,484 154,484 — — — Guarantees (8) (10)42,078 42,078 — — — Total other commitments$503,033 $401,865 $51,645 $35,905 $13,618 The table above excludes estimated payment obligations for our qualified defined benefit pension plans. For information about our future estimated payment obligations for these plans, see Note 14 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report._______________(1)Reflects gross outstanding long-term debt balances as of December 31, 2020, assumed to be paid at maturity, excluding unamortized discount, premium and deferred financing costs. See Note 11 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report. Figures do not include scheduled interest payments. Assuming each debt obligation is held until maturity, we estimate that we will make the following interest payments (dollars in thousands): 2021 – $36,380; 2022 to 2023 – $72,649; 2024 to 2025 – $59,098 and thereafter – $4,808.(2)The majority of this balance represents our warehouse lines of credit, which are recourse only to our wholly-owned subsidiary CBRE Capital Markets, Inc. (CBRE Capital Markets) and are secured by our related warehouse receivables. See Notes 5 and 11 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(3)See Note 12 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(4)Reflects gross outstanding notes payable on real estate as of December 31, 2020 (none of which is recourse to us, beyond being recourse to the single-purpose entity that held the real estate asset and was the primary obligor on the note payable), assumed to be paid at maturity, excluding unamortized deferred financing costs. Amounts do not include scheduled interest payments. The notes have either fixed or variable interest rates, ranging from 2.00% to 4.00% at December 31, 2020.(5)Represents deferred obligations related to previous acquisitions, which are included in accounts payable and accrued expenses and other long-term liabilities in the consolidated balance sheets at December 31, 2020 set forth in Item 8 of this Annual Report.(6)Represents outstanding reserves for claims under certain insurance programs, which are included in other current and other long-term liabilities in the consolidated balance sheets at December 31, 2020 set forth in Item 8 of this Annual Report. Due to the nature of this item, payments could be due at any time upon the occurrence of certain events. Accordingly, the entire balance has been reflected as expiring in less than one year.(7)As of December 31, 2020, we have a remaining federal tax liability of $54.8 million associated with the Transition Tax on mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We are paying the federal tax liability for the Transition Tax in annual interest-free installments over a period of eight years through 2025 as allowed by the Tax Act.In addition, as of December 31, 2020, our current and non-current tax liabilities (including interest and penalties) for uncertain tax positions, totaled $168.5 million. Of this amount, we can reasonably estimate that none will require cash settlement in less than one year. We are unable to reasonably estimate the timing of the effective settlement of tax positions for the remaining $168.5 million. See Note 15 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.50Table of Contents(8)See Note 13 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(9)Includes $76.5 million to fund future co-investments in our Real Estate Investments segment, $30.1 million of which is expected to be funded in 2021, and $34.8 million committed to invest in unconsolidated real estate subsidiaries as a principal, which is callable at any time.(10)Due to the nature of guarantees, payments could be due at any time upon the occurrence of certain triggering events, including default. Accordingly, all guarantees are reflected as expiring in less than one year.IndebtednessOur level of indebtedness increases the possibility that we may be unable to pay the principal amount of our indebtedness and other obligations when due. In addition, we may incur additional debt from time to time to finance strategic acquisitions, investments, joint ventures or for other purposes, subject to the restrictions contained in the documents governing our indebtedness. If we incur additional debt, the risks associated with our leverage, including our ability to service our debt, would increase.Long-Term DebtWe maintain credit facilities with third-party lenders, which we use for a variety of purposes. On March 4, 2019, CBRE Services, Inc. (CBRE Services) entered into an incremental assumption agreement with respect to its credit agreement, dated October 31, 2017 (such agreement, as amended by a December 20, 2018 incremental loan assumption agreement and such March 4, 2019 incremental assumption agreement, is collectively referred to in this Annual Report as the 2019 Credit Agreement), which (i) extended the maturity of the U.S. dollar tranche A term loans under such credit agreement, (ii) extended the termination date of the revolving credit commitments available under such credit agreement and (iii) made certain changes to the interest rates and fees applicable to such tranche A term loans and revolving credit commitments under such credit agreement. The proceeds from the new tranche A term loan facility under the 2019 Credit Agreement were used to repay the $300.0 million of tranche A term loans outstanding under the credit agreement in effect prior to the entry into the 2019 incremental assumption agreement.The 2019 Credit Agreement is a senior unsecured credit facility that is jointly and severally guaranteed by us and certain of our subsidiaries. As of December 31, 2020, the 2019 Credit Agreement provided for the following: (1) a $2.8 billion incremental revolving credit facility, which includes the capacity to obtain letters of credit and swingline loans and terminates on March 4, 2024; (2) a $300.0 million incremental tranche A term loan facility maturing on March 4, 2024, requiring quarterly principal payments unless our leverage ratio (as defined in the 2019 Credit Agreement) is less than or equal to 2.50 to 1.00 on the last day of the fiscal quarter immediately preceding any such payment date and (3) a €400.0 million term loan facility due and payable in full at maturity on December 20, 2023.On August 13, 2015, CBRE Services issued $600.0 million in aggregate principal amount of 4.875% senior notes due March 1, 2026 at a price equal to 99.24% of their face value. The 4.875% senior notes are unsecured obligations of CBRE Services, senior to all of its current and future subordinated indebtedness, but effectively subordinated to all of its current and future secured indebtedness. The 4.875% senior notes are jointly and severally guaranteed on a senior basis by us and each domestic subsidiary of CBRE Services that guarantees our 2019 Credit Agreement. Interest accrues at a rate of 4.875% per year and is payable semi-annually in arrears on March 1 and September 1.On September 26, 2014, CBRE Services issued $300.0 million in aggregate principal amount of 5.25% senior notes due March 15, 2025. On December 12, 2014, CBRE Services issued an additional $125.0 million in aggregate principal amount of 5.25% senior notes due March 15, 2025 at a price equal to 101.5% of their face value, plus interest deemed to have accrued from September 26, 2014. The 5.25% senior notes were unsecured obligations of CBRE Services, senior to all of its current and future subordinated indebtedness, but effectively subordinated to all of its current and future secured indebtedness. The 5.25% senior notes were jointly and severally guaranteed on a senior basis by us and each domestic subsidiary of CBRE Services that guaranteed our 2019 Credit Agreement. Interest accrued at a rate of 5.25% per year and was payable semi-annually in arrears on March 15 and September 15. We redeemed these notes in full on December 28, 2020 and incurred charges of $75.6 million, including a premium of $73.6 million and the write-off of $2.0 million of unamortized premium and debt issuance costs. We funded this redemption using cash on hand.51Table of ContentsOn March 14, 2013, CBRE Services issued $800.0 million in aggregate principal amount of 5.00% senior notes due March 15, 2023. The 5.00% senior notes were unsecured obligations of CBRE Services, senior to all of its current and future subordinated indebtedness, but effectively subordinated to all of its current and future secured indebtedness. The 5.00% senior notes were jointly and severally guaranteed on a senior basis by us and each domestic subsidiary of CBRE Services that guaranteed our 2017 Credit Agreement. Interest accrued at a rate of 5.00% per year and was payable semi-annually in arrears on March 15 and September 15. The 5.00% senior notes were redeemable at our option, in whole or in part, on March 15, 2018 at a redemption price of 102.5% of the principal amount on that date. We redeemed these notes in full on March 15, 2018 and incurred charges of $28.0 million, including a premium of $20.0 million and the write-off of $8.0 million of unamortized deferred financing costs. We funded this redemption with $550.0 million of borrowings from our tranche A term loan facility and $270.0 million of borrowings from our revolving credit facility under our 2017 Credit Agreement.The indenture governing our 4.875% senior notes contains restrictive covenants that, among other things, limit our ability to create or permit liens on assets securing indebtedness, enter into sale/leaseback transactions and enter into consolidations or mergers. In addition, this indenture requires that the 4.875% senior notes be jointly and severally guaranteed on a senior basis by CBRE Group, Inc. and each domestic subsidiary of CBRE Services that guarantees the 2019 Credit Agreement.Our 2019 Credit Agreement and 4.875% senior notes are fully and unconditionally and jointly and severally guaranteed by us and certain subsidiaries (see Exhibit 22.1 to this Annual Report for a listing of all such subsidiary guarantors). Combined summarized financial information for CBRE Group, Inc. (parent); CBRE Services (subsidiary issuer); and the guarantor subsidiaries (collectively referred to as the obligated group), which excludes investment balances in non-guarantor subsidiaries as well as income from consolidated non-guarantor subsidiaries, is as follows (dollars in thousands):December 31,20202019Balance Sheet Data:Current assets$3,307,147 $2,901,618 Noncurrent assets (1)5,252,455 5,610,084 Total assets (1)8,559,602 8,511,702 Current liabilities$3,241,264 $2,893,775 Noncurrent liabilities1,884,629 2,201,269 Total liabilities5,125,893 5,095,044 Year Ended December 31,20202019Statement of Operations Data:Revenue$13,117,846 $13,550,005 Operating income363,829 670,145 Net income353,068 998,319 _______________(1)Includes $360.0 million and $574.6 million of intercompany loan receivables from non-guarantor subsidiaries as of December 31, 2020 and 2019, respectively. All intercompany balances and transactions between CBRE Group, CBRE Services and the guarantor subsidiaries have been eliminated.The €400.0 million term loan facility under our 2019 Credit Agreement is jointly and severally guaranteed by five of our foreign subsidiaries. Such subsidiaries have been omitted from the table above given they do not jointly and severally guarantee other amounts under the 2019 Credit Agreement or the 4.875% senior notes. Additionally, such subsidiaries, if considered in the aggregate as if they were a single subsidiary, would not constitute a significant subsidiary.For additional information on all of our long-term debt, see Note 11 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.52Table of ContentsShort-Term BorrowingsWe maintain a $2.8 billion revolving credit facility under the 2019 Credit Agreement and warehouse lines of credit with certain third-party lenders. For additional information on all of our short-term borrowings, see Notes 5 and 11 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Subsequent EventAs described in Note 10 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report, the company made a $50.0 million non-controlling investment in Industrious in the fourth quarter of 2020. On February 19, 2021, the company made an additional non-controlling investment in Industrious, for approximately $150.0 million in the form of primary and secondary shares, as well as shares issued in anticipation of Industrious closing on the transfer of Hana in the second quarter of 2021. Following this transaction, CBRE holds a 35% interest in Industrious. In addition, CBRE has entered into a series of agreements to acquire additional shares, whereby the company will increase its interest in Industrious from 35% to 40%.Item 7A. Quantitative and Qualitative Disclosures About Market Risk.Our exposure to market risk primarily consists of foreign currency exchange rate fluctuations related to our international operations and changes in interest rates on debt obligations. We manage such risk primarily by managing the amount, sources, and duration of our debt funding and by using derivative financial instruments. We apply FASB ASC (Topic 815), “Derivatives and Hedging,” when accounting for derivative financial instruments. In all cases, we view derivative financial instruments as a risk management tool and, accordingly, do not use derivatives for trading or speculative purposes. Exchange RatesOur foreign operations expose us to fluctuations in foreign exchange rates. These fluctuations may impact the value of our cash receipts and payments in terms of our functional (reporting) currency, which is the U.S. dollar. See the discussion of international operations, which is included in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “International Operations” and is incorporated by reference herein.Interest RatesWe manage our interest expense by using a combination of fixed and variable rate debt. Historically, we have entered into interest rate swap agreements to attempt to hedge the variability of future interest payments due to changes in interest rates. As of December 31, 2020, we do not have any outstanding interest rate swap agreements.The estimated fair value of our senior term loans was approximately $772.2 million at December 31, 2020. Based on dealers’ quotes, the estimated fair value of our 4.875% senior notes was $702.5 million at December 31, 2020.We utilize sensitivity analyses to assess the potential effect on our variable rate debt. If interest rates were to increase 100 basis points on our outstanding variable rate debt at December 31, 2020, the net impact of the additional interest cost would be a decrease of $7.5 million on pre-tax income and a decrease of $7.5 million in cash provided by operating activities for the year ended December 31, 2020.53Table of Contents

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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsUnless otherwise indicated or the context otherwise requires, as used in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," the terms "we," "us," "the Company," "our," "CDW" and similar terms refer to CDW Corporation and its subsidiaries. "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the Consolidated Financial Statements and the related notes included elsewhere in this report. This discussion contains forward-looking statements that are subject to numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statements. See "Forward-Looking Statements" above.OverviewCDW Corporation, a Fortune 500 company and member of the S&P 500 Index, is a leading multi-brand provider of information technology ("IT") solutions to small, medium and large business, government, education and healthcare customers in the US, the UK and Canada. Our broad array of offerings ranges from discrete hardware and software products to integrated IT solutions and services that include on-premise, hybrid and cloud capabilities across data center and networking, digital workspace, security and virtualization.We are vendor, technology, and consumption model "agnostic", with a solutions portfolio including more than 100,000 products and services from more than 1,000 leading and emerging brands. Our solutions are delivered in physical, virtual and cloud-based environments through approximately 7,000 customer-facing coworkers, including sellers, highly-skilled technology specialists and advanced service delivery engineers. We are a leading sales channel partner for many original equipment manufacturers ("OEMs"), software publishers and cloud providers (collectively, our "vendor partners"), whose products we sell or include in the solutions we offer. We provide our vendor partners with a cost-effective way to reach customers and deliver a consistent brand experience through our established end-market coverage, technical expertise and extensive customer access.We have three reportable segments, Corporate, Small Business and Public. Our Corporate segment primarily serves US private sector business customers with more than 250 employees. Our Small Business segment primarily serves US private sector business customers with up to 250 employees. Our Public segment is comprised of government agencies and education and healthcare institutions in the US. We also have two other operating segments: CDW UK and CDW Canada, each of which do not meet the reportable segment quantitative thresholds and, accordingly, are included in an all other category ("Other").We may sell all or only select products that our vendor partners offer. Each vendor partner agreement provides for specific terms and conditions, which may include one or more of the following: product return privileges, price protection policies, purchase discounts and vendor incentive programs, such as purchase or sales rebates and cooperative advertising reimbursements. We also resell software for major software publishers. Our agreements with software publishers allow the end-user customer to acquire software or licensed products and services. In addition to helping our customers determine the best software solutions for their needs, we help them manage their software agreements, including warranties and renewals. A significant portion of our advertising and marketing expenses are reimbursed through cooperative advertising programs with our vendor partners. These programs are at the discretion of our vendor partners and are typically tied to sales or other commitments to be met by us within a specified period of time.For a discussion of results for the year ended December 31, 2019, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission on February 28, 2020.Trends and Key Factors Affecting our Financial PerformanceWe believe the following key factors may have a meaningful impact on our business performance, influencing our ability to generate sales and achieve our targeted financial and operating results:•General economic conditions are a key factor affecting our results as they impact our customers' willingness to spend on information technology. This is particularly the case for our Corporate and Small Business customers, as their purchases tend to reflect confidence in their business prospects, which are driven by their discrete perceptions of business and general economic conditions. Additionally, changes in trade policy and product constraints from suppliers could have an adverse impact on our business.29Table of Contents•The global spread of the novel coronavirus ("COVID-19") pandemic continues to create significant macroeconomic uncertainty, volatility and disruption. The extent to which the COVID-19 pandemic continues to impact our business, results of operations, cash flows, financial condition and liquidity will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration, severity and further spread of the outbreak, future resurgences and reimplementation of closures, the availability, efficacy and acceptance of a vaccine, and the actions taken to contain the virus, and the effectiveness of these actions and how quickly and to what extent normal economic and operating conditions can resume and be sustained. We have mobilized our resources to help ensure the well-being and safety of our coworkers, business continuity, a strong capital position and adequate liquidity. Our efforts have included:•Continued focus on the well-being and safety of our coworkers, leveraging standing crisis management protocols and following guidelines from public health authorities and state and local governments. During 2020, we implemented precautions to help keep our coworkers healthy and safe, including activating a cross-functional response team led by senior leadership, moving to remote work for our office coworkers, and implementing safety protocols at our distribution centers, including social distancing measures, segmented shifts, additional personal protective equipment, enhanced facility cleanings, and temperature screening for anyone entering the facilities. All distribution and configuration centers are considered essential businesses and continue to be operational. Our office coworkers continue to work remotely. •Remote enablement, operations continuity, and security are customer focus areas to manage remote environments at scale and to prepare to be remote longer. Customers are focused on initiatives to reduce costs, optimize resources, and leverage technology for better customer and employee experiences through digital transformation. We have orchestrated solutions by leveraging client devices, accessories, collaboration tools, security, software and hybrid and cloud offerings to help customers build these capabilities and achieve their objectives.•Increasing our provision for credit losses during the year ended December 31, 2020 as a result of the expected economic impact of the COVID-19 pandemic. We continue to monitor cash collections and credit limits of our customers to manage the risk of uncollectible receivables.•Closely monitoring our cost structure and liquidity position relative to the overall demand environment. We took measures to enhance liquidity, including completing a $600 million senior notes issuance in April 2020, leveraging the lower interest rate environment by refinancing one of our higher interest rate senior notes in August 2020, implementing cost savings initiatives and suspending temporarily share repurchases from March 2020 through October 2020. •Changes in spending policies, budget priorities and funding levels are a key factor influencing the purchasing levels of Government, Healthcare and Education customers. Given the COVID-19 pandemic, Education customers have prioritized their budgets towards IT spending while Healthcare customer budgets have been pressured. As the duration and ongoing economic impacts of the COVID-19 pandemic remain uncertain, current and future budget priorities and funding levels for Government, Healthcare and Education customers may be adversely affected.•Technology trends drive customer purchasing behaviors in the market. Current technology trends are focused on delivering greater flexibility and efficiency, as well as designing IT securely. These trends are driving customer adoption of solutions such as those delivered via cloud, software defined architectures and hybrid on-premise and off-premise combinations, as well as the evolution of the IT consumption model to more "as a service" offerings, including Device as a Service and managed services. Technology trends could also change as customers consider the impact of the COVID-19 pandemic on their operations.•The new UK/European Union ("EU") trade deal due to the UK’s exit from the EU (referred to as "Brexit") that came into effect on January 1, 2021 eased concerns over restrictions of imports and exports, but it increased regulatory complexities that may adversely impact our business.Key Business MetricsWe monitor a number of financial and non-financial measures and ratios on a regular basis in order to track the progress of our business and make adjustments as necessary. We believe that the most important of these measures and ratios include average daily sales, gross margin, operating margin, Net income, Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income, Net sales growth on a constant currency basis, Net income per diluted share, Non-GAAP net income per diluted share, free cash flow, return on working capital, Cash and cash equivalents, net working capital, cash conversion cycle, debt levels including available credit, sales per coworker and coworker 30Table of Contentsturnover. These measures and ratios are compared to standards or objectives set by management, so that actions can be taken, as necessary, in order to achieve the standards and objectives.In this report, we discuss Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income and Net Sales growth on a constant currency basis, which are non-GAAP financial measures.We believe these measures provide analysts, investors and management with helpful information regarding the underlying operating performance of our business, as they remove the impact of items that management believes are not reflective of underlying operating performance. Management uses these measures to evaluate period-over-period performance as management believes they provide a more comparable measure of the underlying business. For the definitions of Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income and Net sales growth on a constant currency basis and reconciliations to the most directly comparable US GAAP measure, see "Results of Operations - Non-GAAP Financial Measure Reconciliations."The results of certain key business metrics are as follows:Year Ended December 31,(dollars in millions)202020192018Net sales$18,467.5 $18,032.4 $16,240.5 Gross profit3,210.1 3,039.9 2,706.9 Operating income1,179.2 1,133.6 987.3 Net income788.5 736.8 643.0 Non-GAAP operating income1,404.6 1,368.4 1,216.6 Non-GAAP net income954.4 902.1 794.3 Average daily sales(1)72.7 71.0 63.9 Net debt(2)2,517.0 3,163.3 3,002.8 Cash conversion cycle (in days)(3)17 18 19 (1) There were 254 selling days for each of the years ended December 31, 2020, 2019, and 2018.(2) Defined as Total debt minus Cash and cash equivalents.(3) Cash conversion cycle is defined as days of sales outstanding in Accounts receivable and certain receivables due from vendors plus days of supply in Merchandise inventory minus days of purchases outstanding in Accounts payable and Accounts payable-inventory financing, based on a rolling three-month average.31Table of ContentsResults of OperationsResults of operations, in dollars and as a percentage of Net sales are as follows:Year Ended December 31,20202019Dollars inMillionsPercentage ofNet SalesDollars inMillionsPercentage ofNet SalesNet sales$18,467.5 100.0 %$18,032.4 100.0 %Cost of sales15,257.4 82.6 14,992.5 83.1 Gross profit3,210.1 17.4 3,039.9 16.9 Selling and administrative expenses2,030.9 11.0 1,906.3 10.6 Operating income1,179.2 6.4 1,133.6 6.3 Interest expense, net(154.9)(0.8)(159.4)(0.9)Other expense, net(22.0)(0.1)(24.5)(0.1)Income before income taxes1,002.3 5.4 949.7 5.3 Income tax expense(213.8)(1.2)(212.9)(1.2)Net income$788.5 4.3 %$736.8 4.1 %Net salesNet sales by segment, in dollars and as a percentage of total Net sales, and the year-over-year dollar and percentage change in Net sales are as follows:Year Ended December 31,20202019(dollars in millions)Net SalesPercentageof Total Net SalesNet SalesPercentageof Total Net SalesDollarChangePercentChange(1)Corporate$6,846.0 37.1 %$7,499.0 41.6 %$(653.0)(8.7)%Small Business1,397.1 7.6 1,510.3 8.4 (113.2)(7.5)Public:Government2,978.5 16.1 2,519.3 14.0 459.2 18.2 Education3,458.1 18.7 2,411.6 13.4 1,046.5 43.4 Healthcare1,701.1 9.2 1,933.9 10.7 (232.8)(12.0)Total Public8,137.7 44.0 6,864.8 38.1 1,272.9 18.5 Other2,086.7 11.3 2,158.3 12.0 (71.6)(3.3)Total Net sales$18,467.5 100.0 %$18,032.4 100.0 %$435.1 2.4 %(1)There were 254 selling days for both the years ended December 31, 2020 and 2019.Total Net sales for the year ended December 31, 2020 increased $435 million, or 2.4%, to $18,468 million, compared to the prior year. The impact of foreign currency fluctuations did not have an impact to Net sales growth. For additional information, see "Non-GAAP Financial Measure Reconciliations" below regarding constant currency Net sales growth.For the year ended December 31, 2020, Net sales growth was driven by Education and Government customers prioritizing integrated solutions including notebooks, accessories and services to support remote enablement and the Census project. These Public customer increases were partially offset by decreases in most hardware categories in our other business segments due to the impact of the COVID-19 pandemic on customer demand. For additional information, see Note 18 (Segment Information) to the accompanying Consolidated Financial Statements.32Table of ContentsCorporate segment Net sales for the year ended December 31, 2020 decreased $653 million, or 8.7%, compared to the year ended December 31, 2019. The decrease was primarily driven by decreases across all major hardware categories due to the impact of the COVID-19 pandemic on customer demand, partially offset by an increase in software.Small Business segment Net sales for the year ended December 31, 2020 decreased by $113 million, or 7.5%, compared to the year ended December 31, 2019. The decrease was primarily driven by decreases across all major hardware categories due to the impact of the COVID-19 pandemic on customer demand.Public segment Net sales for the year ended December 31, 2020 increased $1,273 million, or 18.5%, compared to the year ended December 31, 2019. The increase was primarily driven by growth in Education and Government customers. Net sales to Education customers increased 43.4% primarily driven by notebooks/mobile devices as schools invested in remote enablement. Net sales to Government customers increased 18.2% primarily driven by the continued delivery on the Census project comprised of other hardware, including accessories and smartphones, and services. Increases in notebooks/mobile devices also contributed to growth in Government customers due to agencies investing in remote enablement and device refreshes. Net sales to Healthcare customers decreased 12.0% primarily driven by decreases across most hardware categories, as well as decreases in software and services as hospitals experienced budget pressures and delayed projects. Net sales in Other, which is comprised of results from our UK and Canadian operations, for the year ended December 31, 2020 decreased $72 million, or 3.3%, compared to the year ended December 31, 2019. Net sales for Canadian operations decreased across all hardware categories, with the exception of notebooks/mobile devices. Net sales for UK operations increased primarily driven by increases in notebooks/mobile devices and software, partially offset by decreases across most other major hardware categories. The impact of foreign currency exchange decreased Other Net sales by approximately 10 basis points, primarily due to the unfavorable translation of the Canadian dollar and British pound to the US dollar.Gross profitGross profit increased $170 million, or 5.6%, to $3,210 million for the year ended December 31, 2020, compared to $3,040 million for the year ended December 31, 2019. As a percentage of Net sales, Gross profit margin increased 50 basis points to 17.4% for the year ended December 31, 2020. Gross profit margin was positively impacted by product margin and the mix of netted down revenues that are booked net of cost of goods sold, primarily software as a service.Selling and administrative expensesSelling and administrative expenses increased $125 million, or 6.5%, to $2,031 million for the year ended December 31, 2020, compared to $1,906 million for the year ended December 31, 2019. The increase was primarily due to higher payroll expenses consistent with higher Gross profit, higher average coworker count and coworker compensation investments, and a higher provision for credit losses driven by increased reserves reflecting the expected economic impact of the COVID-19 pandemic. The increase was partially offset by cost saving measures, including decreased travel and entertainment. Total coworker count was 9,982, up 86 from 9,896 at December 31, 2019 due to our recent acquisition.As a percentage of total Net sales, Selling and administrative expenses increased 40 basis points to 11.0% for the year ended December 31, 2020, compared to 10.6% for the year ended December 31, 2019 primarily due to higher payroll expenses and a higher provision for credit losses, partially offset by lower travel and entertainment.33Table of ContentsOperating incomeOperating income by segment, in dollars and as a percentage of Net sales, and the year-over-year percentage change was as follows:Year Ended December 31,20202019Dollars inMillionsOperatingMarginDollars inMillionsOperatingMarginPercent Changein Operating IncomeSegments:(1)Corporate$489.5 7.2 %$585.1 7.8 %(16.3)%Small Business99.0 7.1 107.5 7.1 (7.8)Public678.2 8.3 475.0 6.9 42.8 Other(2)65.9 3.2 101.6 4.7 (35.0)Headquarters(3)(153.4)nm*(135.6)nm*13.6 Total Operating income$1,179.2 6.4 %$1,133.6 6.3 %4.0 %* Not meaningful(1)Segment operating income includes the segment's direct operating income, allocations for certain Headquarters' costs, allocations for income and expenses from logistics services, certain inventory adjustments and volume rebates and cooperative advertising from vendors.(2)Includes the financial results for our other operating segments, CDW UK and CDW Canada, which do not meet the reportable segment quantitative thresholds.(3)Includes Headquarters' function costs that are not allocated to the segments.Operating income was $1,179 million for the year ended December 31, 2020, an increase of $46 million, or 4.0%, compared to $1,134 million for the year ended December 31, 2019. Operating income increased primarily due to higher Gross profit dollars and cost saving measures implemented during the year, partially offset by higher payroll expenses and a higher provision for credit losses. Total operating margin percentage increased 10 basis points to 6.4% for the year ended December 31, 2020, from 6.3% for the year ended December 31, 2019 primarily due to higher Gross profit margin and cost saving measures implemented during the year, partially offset by higher payroll expenses and a higher provision for credit losses as percentage of Net sales.Corporate segment Operating income was $490 million for the year ended December 31, 2020, a decrease of $96 million, or 16.3%, compared to $585 million for the year ended December 31, 2019. Corporate segment Operating income decreased primarily due to lower Gross profit dollars and higher payroll expenses due to coworker compensation investments. Corporate segment operating margin percentage decreased 60 basis points to 7.2% for the for the year ended December 31, 2020, from 7.8% for the year ended December 31, 2019 primarily due higher payroll expenses and a higher provision for credit losses as a percentage of Net sales, partially offset by the mix of netted down revenue and cost saving measures.Small Business segment Operating income was $99 million for the year ended December 31, 2020, a decrease of $9 million, or 7.8%, compared to $108 million for the year ended December 31, 2019. Small Business segment Operating income decreased primarily due to lower Gross profit dollars, a higher provision for credit losses and higher payroll expenses due to coworker compensation investments. Small Business segment operating margin percentage remained flat at 7.1% for both the year ended December 31, 2020 and 2019 primarily due to the mix of netted down revenue, partially offset by increased payroll expenses and a higher provision for credit losses as a percentage of Net sales.Public segment Operating income was $678 million for the year ended December 31, 2020, an increase of $203 million, or 42.8%, compared to $475 million for the year ended December 31, 2019. Public segment Operating income increased primarily due to higher Gross profit dollars, partially offset by higher sales payroll expenses. Public segment operating margin percentage increased 140 basis points to 8.3% for the year ended December 31, 2020, from 6.9% for the year ended December 31, 2019, primarily due to a mix into more profitable product offerings and services and by cost saving measures as a percentage of Net sales.Other Operating income was $66 million for the year ended December 31, 2020, a decrease of $36 million, or 35.0%, compared to $102 million for the year ended December 31, 2019. Other Operating income decreased primarily due to lower Gross profit dollars, higher payroll expenses due to higher average coworker count and coworker compensation investments in addition to a 34Table of Contentshigher provision for credit losses. Other operating margin percentage decreased 150 basis points to 3.2% for the year ended December 31, 2020, from 4.7% for the year ended December 31, 2019, primarily due to higher payroll expenses and a higher provision for credit losses as a percentage of Net sales.Interest expense, netInterest expense, net in 2020 was $155 million, a decrease of $4 million, compared to $159 million in 2019. This decrease was primarily due to paying a lower effective interest rate on the term loan in 2020 compared to the capped rate in 2019, partially offset by additional interest expense on the senior notes issued in April 2020. Income tax expenseIncome tax expense was $214 million in 2020, compared to $213 million in 2019. The effective income tax rate, expressed by calculating income tax expense as a percentage of Income before income taxes, was 21.3% and 22.4% for 2020 and 2019, respectively.For 2020, the effective tax rate differed from the US federal statutory rate primarily due to state income taxes, a discrete deferred tax expense as a result of an increase in the UK corporate tax rate, partially offset by excess tax benefits on equity-based compensation and tax benefits associated with new IRS regulations for global intangible low taxed income ("GILTI") and non-deductible expenses for the current and prior years. For 2019, the effective tax rate differed from the US federal statutory rate primarily due to state income taxes, partially offset by tax credits, excess tax benefits on equity-based compensation and a tax benefit related to CDW Canada’s acquisition of Scalar. The 2020 effective tax rate was lower than 2019 primarily due to the tax benefits associated with the new IRS regulations for GILTI and lower non-deductible expenses. Non-GAAP Financial Measure ReconciliationsWe have included reconciliations of Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income, and Net sales growth on a constant currency basis for the years ended December 31, 2020 and 2019 below.Non-GAAP operating income excludes, among other things, charges related to the amortization of acquisition-related intangible assets, equity-based compensation and the associated payroll taxes, a workforce reduction program and acquisition and integration expenses. Non-GAAP operating income margin is defined as Non-GAAP operating income as a percentage of Net sales. Non-GAAP income before income taxes and Non-GAAP net income exclude, among other things, charges related to acquisition-related intangible asset amortization, equity-based compensation, net loss on extinguishment of long-term debt, a workforce reduction program, acquisition and integration expenses, and the associated tax effects of each. Net sales growth on a constant currency basis is defined as Net sales growth excluding the impact of foreign currency translation on net sales compared to the prior period.Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income and Net sales growth on a constant currency basis are considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company's performance or financial position that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with US GAAP. Non-GAAP measures used by management may differ from similar measures used by other companies, even when similar terms are used to identify such measures.We believe these measures provide analysts, investors and management with helpful information regarding the underlying operating performance of our business, as they remove the impact of items that management believes are not reflective of underlying operating performance. Management uses these measures to evaluate period-over-period performance as management believes they provide a more comparable measure of the underlying business.35Table of ContentsNon-GAAP operating incomeNon-GAAP operating income was $1,405 million for the year ended December 31, 2020, an increase of $37 million, or 2.6%, compared to $1,368 million for the year ended December 31, 2019. As a percentage of Net sales, Non-GAAP operating income was 7.6% for each of the years ended December 31, 2020 and 2019.Year Ended December 31,(dollars in millions)20202019Operating income$1,179.2 $1,133.6 Amortization of intangibles(1)158.1 178.5 Equity-based compensation42.5 48.5 Workforce reduction charges8.5 — Other adjustments(2)16.3 7.8 Non-GAAP operating income$1,404.6 $1,368.4 Non-GAAP operating income margin7.6 %7.6 %(1)Includes amortization expense for acquisition-related intangible assets, primarily customer relationships, customer contracts and trade names.(2)Includes other expenses such as payroll taxes on equity-based compensation, expenses related to the relocation of the downtown Chicago office, and acquisition and integration expenses.Non-GAAP net incomeNon-GAAP net income was $954 million for the year ended December 31, 2020, an increase of $52 million, or 5.8%, compared to $902 million for the year ended December 31, 2019.Year Ended December 31, 2020Year Ended December 31, 2019(dollars in millions)Income before income taxesIncome tax expense(1)Net incomeIncome before income taxesIncome tax expense(1)Net incomeUS GAAP, as reported$1,002.3 $(213.8)$788.5 $949.7 $(212.9)$736.8 Amortization of intangibles(2)158.1 (36.8)121.3 178.5 (44.6)133.9 Equity-based compensation42.5 (37.0)5.5 48.5 (36.6)11.9 Net loss on extinguishments of long-term debt27.3 (6.8)20.5 22.1 (5.5)16.6 Workforce reduction charges8.5 (2.1)6.4 — — — Other adjustments(3)16.3 (4.1)12.2 7.8 (4.9)2.9 Non-GAAP$1,255.0 $(300.6)$954.4 $1,206.6 $(304.5)$902.1 (1)Income tax on non-GAAP adjustments includes excess tax benefits associated with equity-based compensation.(2)Includes amortization expense for acquisition-related intangible assets, primarily customer relationships, customer contracts and trade names.(3)Includes other expenses such as payroll taxes on equity-based compensation, expenses related to the relocation of the downtown Chicago office, and acquisition and integration expenses.36Table of ContentsNet sales growth on a constant currency basisNet sales increased $435 million, or 2.4%, to $18,468 million for the year ended December 31, 2020, compared to $18,032 million for the year ended December 31, 2019. Net sales on a constant currency basis, which excludes the impact of foreign currency translation, increased $438 million, or 2.4%.Year Ended December 31,(dollars in millions)20202019% Change(1)Net sales, as reported$18,467.5 $18,032.4 2.4 %Foreign currency translation(2)— (2.5)Net sales, on a constant currency basis$18,467.5 $18,029.9 2.4 %(1)There were 254 selling days for both the years ended December 31, 2020 and 2019. (2)Represents the effect of translating the prior period results of CDW UK and CDW Canada at the average exchange rates applicable in the current year.SeasonalityWhile we have not historically experienced significant seasonality throughout the year, sales in our Corporate segment, which primarily serves US private sector business customers with more than 250 employees, are typically higher in the fourth quarter than in other quarters due to customers spending their remaining technology budget dollars at the end of the year. Additionally, sales in our Public segment have historically been higher in the third quarter than in other quarters primarily due to the buying patterns of the federal government and education customers. During 2020, we experienced variability compared to historic seasonality trends. As uncertainty due to COVID-19 remains, seasonality is expected to continue to be different than historical experience.Liquidity and Capital ResourcesOverviewWe finance our operations and capital expenditures with internally generated cash from operations and borrowings under our revolving credit facility. As of December 31, 2020, we also had $1.0 billion of availability for borrowings under our senior secured asset-based revolving credit facility and an additional £50 million ($68 million) under the CDW UK revolving credit facility. Our liquidity and borrowing plans are established to align with our financial and strategic planning processes and ensure we have the necessary funding to meet our operating commitments, which primarily include the purchase of inventory, payroll and general expenses. We also take into consideration our overall capital allocation strategy, which includes investment for future growth, dividend payments, acquisitions and share repurchases. During 2020, we bolstered our liquidity position by completing a $600 million senior notes issuance in April 2020, and leveraging the lower interest rate environment by refinancing one of our higher interest rate senior notes in August 2020. We also temporarily suspended share repurchases from March 2020 through October 2020. We took additional measures to enhance our liquidity by implementing various cost savings initiatives. We believe we have adequate sources of liquidity and funding available for at least the next year; however, there are a number of factors that may negatively impact our available sources of funds. The amount of cash generated from operations will be dependent upon factors such as the successful execution of our business plan, general economic conditions and working capital management, including accounts receivable.Long-Term Debt and Financing ArrangementsOn April 21, 2020, we completed the issuance of $600 million aggregate principal amount of 4.125% Senior Notes due May 2025 at par.On August 13, 2020, we completed the refinance of $600 million aggregate principal amount of 5.000% Senior Notes due September 2025 through the issuance of $700 million aggregate principal amount of 3.250% Senior Notes due February 2029 at par.As of December 31, 2020, we had total indebtedness of $3.9 billion, of which $1.5 billion was secured indebtedness. At December 31, 2020, we were in compliance with the covenants under our various credit agreements and indentures.For additional information regarding our debt and refinancing activities, see Note 10 (Long-Term Debt) to the accompanying Consolidated Financial Statements.37Table of ContentsInventory Financing AgreementsWe have entered into agreements with certain financial intermediaries to facilitate the purchase of inventory from various suppliers under certain terms and conditions. These amounts are classified separately as Accounts payable-inventory financing on the Consolidated Balance Sheets. We do not incur any interest expense associated with these agreements as balances are paid when they are due. For additional information, see Note 7 (Inventory Financing Agreements) to the accompanying Consolidated Financial Statements.Share Repurchase ProgramDuring 2020, we repurchased 2.6 million shares of our common stock for $341 million under the previously announced share repurchase program. During 2020, we temporarily suspended share repurchases from March 2020 through October 2020 as a precautionary measure in light of the COVID-19 pandemic. For additional information, see "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."DividendsA summary of 2020 dividend activity for our common stock is as follows:Dividend AmountDeclaration DateRecord Date Payment Date$0.380February 6, 2020February 25, 2020March 10, 2020$0.380May 6, 2020May 25, 2020June 10, 2020$0.380August 4, 2020August 25, 2020September 10, 2020$0.400November 2, 2020November 25, 2020December 10, 2020$1.540On February 10, 2021, we announced that our Board of Directors declared a quarterly cash dividend on our common stock of $0.400 per share. The dividend will be paid on March 10, 2021 to all stockholders of record as of the close of business on February 25, 2021.The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon our results of operations, financial condition, business prospects, capital requirements, contractual restrictions, any potential indebtedness we may incur, restrictions imposed by applicable law, tax considerations and other factors that our Board of Directors deems relevant. In addition, our ability to pay dividends on our common stock will be limited by restrictions on our ability to pay dividends or make distributions to our stockholders and on the ability of our subsidiaries to pay dividends or make distributions to us, in each case, under the terms of our current and any future agreements governing our indebtedness.Coronavirus Aid, Relief, and Economic Security ActOn March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted into law. The primary impact to our financial statements as a result of the CARES Act was the deferral of US corporate income tax payments from the second quarter of 2020 to July 2020 as well as the deferral of employer related payroll tax payments from the second, third and fourth quarters of 2020 with 50% to be paid in the fourth quarter of 2021 and the remaining 50% to be paid in the fourth quarter of 2022.38Table of ContentsCash FlowsCash flows from operating, investing and financing activities are as follows:Year Ended December 31,(dollars in millions)20202019Net cash provided by (used in):Operating activities$1,314.3 $1,027.2 Investing activities(201.0)(331.4)Net change in accounts payable - inventory financing93.0 (1.3)Other financing activities45.8 (748.5)Financing activities138.8 (749.8)Effect of exchange rate changes on cash and cash equivalents4.1 2.2 Net increase (decrease) in cash and cash equivalents$1,256.2 $(51.8)Operating ActivitiesCash flows from operating activities are as follows:Year Ended December 31,(dollars in millions)20202019ChangeNet income$788.5 $736.8 $51.7 Adjustments for the impact of non-cash items(1)520.9 256.7 264.2 Net income adjusted for the impact of non-cash items(2)1,309.4 993.5 315.9 Changes in assets and liabilities:Accounts receivable(3)(226.4)(244.8)18.4 Merchandise inventory(4)(71.4)(153.0)81.6 Accounts payable-trade(5)253.7 194.1 59.6 Other(6)49.0 237.4 (188.4)Net cash provided by operating activities$1,314.3 $1,027.2 $287.1 (1)Includes items such as deferred income taxes, depreciation and amortization, and equity-based compensation expense.(2)The change is due to stronger operating results driven by Gross profit growth and higher depreciation and amortization.(3)The change is primarily due to improved collection performance partially offset by increased sales.(4)The change is due to lower customer-driven and strategic stocking positions partially offset by timing of receipts and shipments.(5)The change is primarily due to mixing into vendors with extended payment terms in 2021, increased sales and year-end inventory purchases.(6)The change is primarily due to lower contract liabilities partially offset by higher accrued compensation expense in 2020 compared to 2019.39Table of ContentsIn order to manage our working capital and operating cash needs, we monitor our cash conversion cycle, defined as days of sales outstanding in accounts receivable plus days of supply in inventory minus days of purchases outstanding in accounts payable, based on a rolling three-month average. Components of our cash conversion cycle are as follows:December 31,(in days)20202019Days of sales outstanding (DSO)(1)57 57 Days of supply in inventory (DIO)(2)14 14 Days of purchases outstanding (DPO)(3)(54)(53)Cash conversion cycle17 18 (1)Represents the rolling three-month average of the balance of Accounts receivable, net at the end of the period, divided by average daily Net sales for the same three-month period. Also incorporates components of other miscellaneous receivables.(2)Represents the rolling three-month average of the balance of Merchandise inventory at the end of the period divided by average daily Cost of sales for the same three-month period.(3)Represents the rolling three-month average of the combined balance of Accounts payable-trade, excluding cash overdrafts, and Accounts payable-inventory financing at the end of the period divided by average daily Cost of sales for the same three-month period.The cash conversion cycle decreased to 17 days at December 31, 2020, compared to 18 days at December 31, 2019. DSO and DIO both remained unchanged at 57 days and 14 days, respectively. DPO increased by 1 day to 54 days driven by mixing into vendors with extended payment terms during the quarter compared to 2019.Investing ActivitiesNet cash used in investing activities decreased $130 million in 2020 compared to 2019. The decrease was primarily due to decreased Capital expenditures of $78 million from fewer purchases of devices for the Census program and lower investments in acquisitions.Financing ActivitiesNet cash provided by financing activities increased $889 million in the year ended December 31, 2020 compared to year ended December 31, 2019. The increase was primarily driven by the $600 million debt offering completed in April 2020, lower share repurchases and increased volume through our inventory financing arrangements, partially offset by decreased borrowings under our revolving credit facilities and higher dividend payments. For additional information regarding our debt activities, see Note 10 (Long-Term Debt) to the accompanying Consolidated Financial Statements.Contractual ObligationsWe have future obligations under various contracts relating to debt and interest payments and operating leases. Our estimated future payments, based on undiscounted amounts, under contractual obligations that existed as of December 31, 2020, are as follows:Payments Due by Period(dollars in millions)Total20212022-20232024-20252026 & ThereafterTerm Loan(1)$1,577.4 $42.2 $83.6 $82.5 $1,369.1 CDW UK Term Loan(1)56.5 56.5 — — — Senior Notes due 2024(2)701.5 31.6 63.3 606.6 — Senior Notes due 2025(2)711.4 24.8 49.5 637.1 — Senior Notes due 2028(2)791.3 25.5 51.0 51.0 663.8 Senior Notes due 2029(2)893.5 22.9 45.5 45.5 779.6 Operating leases(3)243.2 32.8 49.2 37.8 123.4 Total$4,974.8 $236.3 $342.1 $1,460.5 $2,935.9 40Table of Contents(1)Includes future principal and cash interest payments on long-term borrowings through scheduled maturity dates. Interest payments for variable rate debt were calculated using interest rates as of December 31, 2020. Excluded from these amounts are the amortization of debt issuance and other costs related to indebtedness.(2)Includes future principal and cash interest payments on long-term borrowings through scheduled maturity dates. Interest on the Senior Notes is calculated using the stated interest rates. Excluded from these amounts are the amortization of debt issuance and other costs related to indebtedness.(3)For additional information, see Note 12 (Leases) to the accompanying Consolidated Financial Statements.Off-Balance Sheet ArrangementsWe have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, results of operations or liquidity.Issuers and Guarantors of Debt SecuritiesEach series of our outstanding unsecured senior notes (the "Notes") are issued by CDW LLC and CDW Finance Corporation (the "Issuers") and are guaranteed by CDW Corporation ("Parent") and each of CDW LLC's direct and indirect, 100% owned, domestic subsidiaries (the "Guarantor Subsidiaries" and, together with Parent, the "Guarantors"). All guarantees by Parent and the Guarantors are joint and several, and full and unconditional; provided that guarantees by the Guarantor Subsidiaries are subject to certain customary release provisions contained in the indentures governing the Notes. The Notes and the related guarantees are the Issuers’ and the Guarantors’ senior unsecured obligations and are:•structurally subordinated to all existing and future indebtedness and other liabilities of our non-guarantor subsidiaries and•rank equal in right of payment with all of the Issuers' and the Guarantors’ existing and future unsecured senior debt.The following tables set forth Balance Sheet information as of December 31, 2020 and December 31, 2019, and Statement of Operations information for the years ended December 31, 2020 and 2019 for the accounts of the Issuers and the accounts of the Guarantors (the "Obligor Group"). The financial information of the Obligor Group is presented on a combined basis and the intercompany balances and transactions between the Obligor Group have been eliminated.Balance Sheet InformationDecember 31,(dollars in millions)20202019Current assets$5,161.3 $3,601.6 Goodwill2,239.1 2,206.1 Other assets572.1 903.1 Total Non-current assets2,811.2 3,109.2 Current liabilities3,265.0 2,975.3 Long-term debt3,856.5 3,229.5 Other liabilities209.8 188.3 Total Long-term liabilities4,066.3 3,417.8 Statements of Operations InformationYear Ended December 31,(dollars in millions)20202019Net sales$16,380.8 $15,874.1 Gross profit2,851.8 2,666.8 Operating income1,113.2 1,032.1 Net income738.8 656.7 41Table of ContentsInflationInflation has not had a material impact on our operating results. We generally have been able to pass along price increases to our customers, though certain economic factors and technological advances in recent years have tended to place downward pressure on pricing. We also have been able to generally offset the effects of inflation on operating costs by continuing to emphasize productivity improvements. There can be no assurances, however, that inflation would not have a material impact on our sales or operating costs in the future.Commitments and ContingenciesThe information set forth in Note 17 (Commitments and Contingencies) to the accompanying Consolidated Financial Statements included in Part II, Item 8 of this report is incorporated herein by reference.Critical Accounting Policies and EstimatesThe preparation of the Consolidated Financial Statements in accordance with US GAAP requires management to make use of certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities in the Consolidated Financial Statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Historically, we have not made significant changes to the methods for determining these estimates as our actual results have not differed materially from our estimates. We do not believe it is reasonably likely that the estimates and related assumptions will change materially in the foreseeable future; however, actual results could differ from those estimates under different assumptions, judgments or conditions. We have reviewed our critical accounting policies with the Audit Committee of our Board of Directors.Critical accounting policies and estimates are those that are most important to the portrayal of our financial condition and results of operations, and which require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and estimates addressed below. For additional information related to significant accounting policies used in the preparation of our Consolidated Financial Statements, see Note 1 (Description of Business and Summary of Significant Accounting Policies) to the accompanying Consolidated Financial Statements.Revenue RecognitionWe sell some of our products and services as part of bundled contract arrangements containing multiple deliverables, which may include a combination of different products and services. Significant judgment may be required when determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together.For contracts consisting of multiple performance obligations, the total transaction price is allocated to each performance obligation based upon its standalone selling price. Judgment is required to determine the standalone selling price for each distinct performance obligation. For certain performance obligations, we will use a combination of methods to estimate the standalone selling price based on recent transactions. When evidence from recent transactions is not available to confirm that the prices are representative of the standalone selling price, an expected cost plus margin approach is used.Additional judgment is required in determining whether we are the principal, and report revenues on a gross basis, or agent, and report revenues on a net basis. For each identified performance obligation in a transaction, we evaluate the facts and circumstances present to determine whether or not we control the specified good or service prior to transfer to the customer. This evaluation includes, but is not limited to, assessing indicators such as whether: (i) we are primarily responsible for fulfilling the promise to provide the specified goods or service, (ii) we have inventory risk before the specified good or service has been transferred to a customer and (iii) we have discretion in establishing the price for the specified good or service. When the evaluation indicates we control the specified good or service prior to transfer to the customer, we are acting as a principal. When the evaluation indicates we do not control the specified good or service prior transfer to the customer, we are acting as an agent.The nature of our contracts give rise to variable consideration in the form of volume rebates and sales returns and allowances. We estimate variable consideration at the most likely amount to which we expect to be entitled. The estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based on an assessment of our anticipated performance and all information that is reasonably available.We recognize revenue on performance obligations when the customer obtains control over the specified good or service. That is, when the customer has the ability to direct the use of and obtain substantially all of the benefits from the good or service. For the sale of hardware and software, this is generally upon delivery to the customer. As a result, we perform an analysis to 42Table of Contentsestimate the amount of Net sales in-transit at the end of the period and adjust revenue and the related costs to reflect only what has been delivered to the customer. This analysis requires judgment whereby we perform an analysis of the estimated number of days of sales in-transit to customers at the end of each reporting period based on a weighted-average analysis of commercial delivery terms that include drop-shipment arrangements. Changes in delivery patterns may result in a different number of business days estimated to make this adjustment.Vendor ProgramsWe receive incentives from certain vendors related to cooperative advertising, volume rebates, bid programs, price protection and other programs. These incentives generally relate to written agreements with specified performance requirements with the vendors and are recorded as adjustments to Cost of sales or Merchandise inventory, depending on the nature of the incentive. We record vendor partner receivables related to these programs when the amounts are probable and reasonably estimable. Some programs are based on the achievement of specific targets, and we base our estimates on information provided by our vendors and internal information to assess our progress toward achieving those targets.We also record reserves for vendor partner receivables for estimated losses due to vendors' inability to pay or rejections by vendors of claims. In estimating the required allowance, we take into consideration collections performance and the aging of the incentive receivables, as well as specific vendor circumstances.Goodwill Goodwill is allocated to reporting units expected to benefit from the business combination. Goodwill is not amortized but is subject to periodic testing for impairment at the reporting unit level on an annual basis each December 1, or more frequently if events or changes in circumstances indicate that the asset may be impaired. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition or sale or disposition of a significant portion of a reporting unit.We may elect to utilize a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. As part of our qualitative assessment, judgment is required in weighing the effect of various positive and negative factors that may affect the fair value. We consider various factors, including the excess of fair value over carrying value from the last quantitative test, macroeconomic conditions, industry and market considerations, the projected financial performance and actual financial performance compared to prior year projected financial performance.If we elect to bypass the qualitative assessment, or if indicators of impairment exist, a quantitative impairment test is performed. As part of the quantitative assessment, application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. Fair value of a reporting unit is determined by using a weighted combination of an income approach and a market approach, as this combination is considered the most indicative of our fair value in an orderly transaction between market participants. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, determination of our weighted average cost of capital, future market conditions and profitability of future business strategies. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. However, our past estimates of fair value would not have indicated an impairment when revised to include subsequent years' actual results.Intangible AssetsIntangible assets include customer relationships, trade names, internally developed software and other intangibles. Intangible assets are amortized on a straight-line basis over the estimated useful life of the asset and reviewed for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The valuation and classification of these assets and the assignment of useful lives involve significant judgment and the use of estimates. The valuation, classification and assignment of useful lives are derived using market inputs, historic experience and third-party guidance.Income TaxesThe determination of our provision for income taxes and evaluating our tax positions requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. Our provision for income taxes primarily reflects a combination of income earned and taxed in the various US federal and state, as well as foreign, jurisdictions. Our annual 43Table of Contentseffective tax rate is based on our income, the jurisdiction(s) in which the income is earned and subjected to taxation, the tax laws in those various jurisdictions which can be affected by tax law changes, increases or decreases in permanent differences between book and tax items, and accruals or adjustments of accruals for unrecognized tax benefits or valuation allowances.We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following: (1) the tax position is not more likely than not to be sustained, (2) the tax position is more likely than not to be sustained, but for a lesser amount, or (3) the tax position is more likely than not to be sustained, but not in the financial period in which the tax position was originally taken. Reserves related to tax accruals and valuation allowances related to deferred tax assets can be impacted by changes in tax law in the relevant jurisdiction(s) and our future taxable income levels in the relevant jurisdiction(s) with respect to valuation allowances.Allowance for Credit LossesWe estimate an allowance for credit losses related to accounts receivable for future expected credit losses by using relevant information such as historical information, current conditions, and reasonable and supportable forecasts. The allowance is measured on a pool basis when similar risk characteristics exist, and a loss-rate for each pool is determined using historical credit loss experience as the basis for the estimation of expected credit losses. Adjustments to historical loss information involves making informed judgments to reflect our expectations for differences in current conditions, as well as changes in forecasted macroeconomic conditions, such as changes in the unemployment rate or gross domestic product growth, when applicable. We also consider internal information on pool specific factors to inform our decision making. We typically observe a higher loss-rate experience with customers in the pools associated with our Corporate and Small Business segments, as compared to the pools associated with the Public segment. During the year ended December 31, 2020, we recognized an increase in the allowance to reflect the forecasted credit deterioration due to the COVID-19 pandemic, which considered geographic-specific factors, customer makeup and the overall size of our pools, as well as the impacts experienced to date and the impacts from the last significant economic downturn in 2008-2009. As the overall impact and duration of the COVID-19 pandemic remains uncertain, our estimates and assumptions may evolve as conditions change.Recent Accounting PronouncementsThe information set forth in Note 2 (Recent Accounting Pronouncements) to the accompanying Consolidated Financial Statements included in Part II, Item 8 of this report is incorporated herein by reference.Item 7A. Quantitative and Qualitative Disclosures of Market RisksInterest Rate RiskOur market risks relate primarily to changes in interest rates. The interest rates on borrowings under our senior secured asset-based revolving credit facility, our senior secured term loan facility and the CDW UK term loan are floating and, therefore, are subject to fluctuations. In order to manage the risk associated with changes in interest rates on borrowings under our senior secured term loan facility, we have entered into interest rate caps to add stability to interest expense and to manage our exposure to interest rate fluctuations.As of December 31, 2020, we have an interest rate cap agreement in effect with a notional amount of $1.4 billion. For additional information, see Note 9 (Financial Instruments) to the accompanying Consolidated Financial Statements.See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Contractual Obligations" for information on cash flows, interest rates and maturity dates of our debt obligations.Foreign Currency RiskWe transact business in foreign currencies other than the US dollar, primarily the British pound and the Canadian dollar, which exposes us to foreign currency exchange rate fluctuations. Revenue and expenses generated from our international operations are generally denominated in the local currencies of the corresponding countries. The functional currency of our international operating subsidiaries is the same as the corresponding local currency. Upon consolidation, as results of operations are translated, operating results may differ from expectations. The direct effect of foreign currency fluctuations on our results of operations has not been material as the majority of our results of operations are denominated in US dollars.44Table of Contents

CHARLES RIVER LABORATORIES INTERNATIONAL, INC._10-K_2021-02-17 00:00:00_1100682-0001100682-21-000005.html

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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion should be read in conjunction with our consolidated financial statements and related notes appearing in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The following discussion contains forward-looking statements. Actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Certain percentage changes may not recalculate due to rounding.OverviewWe are a full service, early-stage contract research organization (CRO). For over 70 years, we have been in the business of providing the research models required in research and development of new drugs, devices, and therapies. Over this time, we have built upon our original core competency of laboratory animal medicine and science (research model technologies) to develop a diverse portfolio of discovery and safety assessment services, both Good Laboratory Practice (GLP) and non-GLP, that enable us to support our clients from target identification through non-clinical development. We also provide a suite of products and services to support our clients’ manufacturing activities. Utilizing our broad portfolio of products and services enables our clients to create a more flexible drug development model, which reduces their costs, enhances their productivity and effectiveness, and increases speed to market.Our client base includes all major global biopharmaceutical companies, many biotechnology companies, CROs, agricultural and industrial chemical companies, life science companies, veterinary medicine companies, contract manufacturing companies, medical device companies, and diagnostic and other commercial entities, as well as leading hospitals, academic institutions, and government agencies around the world. We currently operate in over 100 facilities and in over 20 countries worldwide, which numbers exclude our Insourcing Solutions (IS) sites.Segment ReportingOur three reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support (Manufacturing). Our RMS reportable segment includes the Research Models, Research Model Services, and Research Products businesses. Research Models includes the commercial production and sale of small research models, as well as the supply of large research models. Research Model Services includes: Genetically Engineered Models and Services (GEMS), which performs contract breeding and other services associated with genetically engineered models; Research Animal Diagnostic Services (RADS), which provides health monitoring and diagnostics services related to research models; and Insourcing Solutions (IS), which provides colony management of our clients’ research operations (including recruitment, training, staffing, and management services). Research Products supplies controlled, consistent, customized primary cells and blood components derived from normal and mobilized peripheral blood, bone marrow, and cord blood. Our DSA reportable segment includes services required to take a drug through the early development process including discovery services, which are non-regulated services to assist clients with the identification, screening, and selection of a lead compound for drug development, and regulated and non-regulated (GLP and non-GLP) safety assessment services. Our Manufacturing reportable segment includes Microbial Solutions, which provides in vitro (non-animal) lot-release testing products, microbial detection products, and species identification services; Biologics Testing Services (Biologics), which performs specialized testing of biologics; and Avian Vaccine Services (Avian), which supplies specific-pathogen-free chicken eggs and chickens.COVID-19OverviewOn March 11, 2020, the World Health Organization declared the outbreak of a strain of novel coronavirus disease, COVID-19, a global pandemic. The COVID-19 pandemic is dynamic and expanding, and its ultimate scope, duration and effects are uncertain. This pandemic has had and may continue to result in direct and indirect adverse effects on our industry and customers, which in turn has impacted our business, results of operations, and financial condition. Further, the COVID-19 pandemic may also affect our operating and financial results in ways that are and are not presently known to us, or that we currently do not expect to present significant risks to our operations or financial results but which may in fact turn out to negatively affect us to a magnitude greater than anticipated. Refer to Item 1A, “Risk Factors”, included herein for risk factors reflecting the impact of the COVID-19 pandemic. Giving consideration to each of these risk factors, the following is our current estimate and belief of the impact of the COVID-19 pandemic during fiscal year 2020 and how it may continue to affect us in subsequent periods.Business continuity34To date, we generally have not experienced significant challenges in implementing our business continuity plans. Many government agencies have provided guidance permitting “essential” or “critical” business operations to remain open. As of the date of this annual report, in the geographies where business restrictions have been imposed, we believe all of our business operations have satisfied the requirements to be designated to be “essential” or “critical” according to the guidance provided by government, health and other regulatory agencies with authority over such matters. As a result, all of our operating sites remain open and adequately staffed as of the date of this annual report. For certain operations or sites experiencing logistical delays, we have experienced some inefficiencies as it relates to completing work or fulfilling orders; however, we do not believe material expenditures will be required or material resource constraints will occur. Logistical delays include a small number of sites that have experienced reduced operations (including as a result of increased employee absenteeism) or voluntarily closed, as well as delays in transportation activities.We have comprehensive business continuity plans in place for each site globally and are continuously updating these to address the evolving COVID-19 pandemic situation. We implemented our initial plans in China beginning in January 2020, and have continuously refined our plans for other regions as the virus has spread. We have encouraged and expressed our expectations that employees work remotely whenever possible; and for those employees who need to come into our sites to fulfill their responsibilities, we are adhering to guidelines from government, health, and other regulatory agencies. This includes social distancing, flexible scheduling such as split shifts, restricting visitors, enhanced cleaning, and providing personal protective equipment (PPE), such as masks and gloves, to employees. Due to the nature of our business, many employees already work in biosecure environments that require PPE and adhere to other procedures to safely accomplish their daily responsibilities. Accordingly, to date, we believe we have been able to efficiently implement the additional safety precautions.Supply chainWe are focused on ensuring that we have adequate inventory and supplies on hand given the potential disruption of the COVID-19 pandemic to our suppliers and their supply chain. Accordingly, we have and expect to continue to increase inventory and supplies in 2021. We proactively engaged with our suppliers beginning in January 2020 to limit any potential disruption to our supply chain. However, notwithstanding generally successful efforts to maintain supply chain continuity, we have experienced increased costs and delays throughout our supply chain during the pandemic.Financial condition and results of our global operationsWe are a global company that operates in over 100 facilities and in over 20 countries worldwide. As we perform business across various borders, we are experiencing a continuum of impacts in each location as the COVID-19 pandemic has impacted the global economy in different phases. We are continuing to see demand for products and services across all of our businesses, although as described below the impact of the COVID-19 pandemic on the level of demand varies with our different businesses. While there is uncertainty, our clients are still in need of the products and services we provide to biomedical research to advance discovery and develop new therapies for the treatment of disease, including the COVID-19 pandemic. Due to certain restrictions in place at the various sites of our clients and suppliers (including client and supplier site closures), there have been challenges relating to timely receiving and shipping products globally in all businesses. Should these restrictions continue, demand/supply issues may persist and could impact revenue growth, operating income (including operating income margins) and cash flows. We have observed some impact due to constraints from internal site restrictions, remote work, resources, and productivity. However, we believe the impact to us has not been as significant as to companies in many other industries because of the nature of our businesses, the classification of our businesses as essential or critical, as the case may be, and our business continuity plans.Our RMS business was meaningfully impacted by the COVID-19 pandemic during fiscal year 2020. Demand for research models declined due primarily to the physical shutdown of our client’s facilities, principally academic institutions. While many of our clients are deemed essential businesses as well, we experienced a slowdown, initially in China in January 2020, and then across Europe and North America later in the first fiscal quarter of 2020, as measures were implemented by various governments to slow the spread of the COVID-19 pandemic. This trend of reduced demand for research models continued during the second fiscal quarter of 2020, which negatively impacted revenue, operating income, operating income margins, and cash flows. During the third fiscal quarter of 2020, we experienced an increase in demand as our clients reopened impacted sites and resumed their research activity, which positively impacted revenue, operating income, operating income margins, and cash flows, which continued through the fourth fiscal quarter of 2020. Research models services, specifically our GEMS and Insourcing Solutions businesses, experienced higher revenues during fiscal year 2020 compared to the corresponding prior period and were not as adversely impacted by the COVID-19 pandemic.Our DSA business was not significantly impacted by the COVID-19 pandemic during fiscal year 2020. Towards the end of the first fiscal quarter of 2020, we experienced some client work shifting towards subsequent quarters of fiscal year 2020 due to the 35various actions and restrictions put in place by governments around the world intended to slow the spread of the COVID-19 pandemic. The work performed in our Discovery Services and Safety Assessment businesses are largely dependent on our internal sites being open. Therefore, to the extent that clients require work to be completed, we have been able to continue to meet client demands and perform the work so long as our work force at the specific site the work is done is not significantly adversely impacted by the COVID-19 pandemic. This trend is expected to continue as government actions to slow the spread of the COVID-19 pandemic continues to subside, employees return to work, and economies across the world reopen. Costs of supply have and may continue to increase as we procure the materials required to perform our work.Our Manufacturing business was not significantly impacted by the COVID-19 pandemic during fiscal year 2020, however, some of our customers experienced disruptions in their manufacturing operations. This resulted in delays in instrument installations in our Microbial Solutions business, which began during the first half of fiscal 2020 and continued, to a lesser extent, during the second half of fiscal 2020. Demand for certain Manufacturing products was not significantly impacted, such as Microbial Solutions endotoxin products and Avian products. Our Biologics testing facilities remain open and performing services for our clients. Similar to our other services businesses, our ability to perform work is contingent on our internal facilities and our work force not being significantly adversely impacted by the COVID-19 pandemic.Liquidity, capital and financial resourcesWe require cash to fund working capital needs as well as capital expansion, acquisitions, venture capital and strategic investments, debt obligations, leases, and pension obligations. The principal sources of liquidity have been cash flows from operations, supplemented by long-term borrowings. In fiscal year 2019, we issued $500 million Senior Notes, repaid part of our term loan for $500 million, and increased our multi-currency revolving facility by $500 million, from $1.55 billion to $2.1 billion. As of December 26, 2020, we had $2.0 billion of debt and finance leases outstanding, of which $50.2 million is current. Available on the revolving line of credit (Revolver) is $1.2 billion, which matures on March 26, 2023 and does not require scheduled payments before that date should additional borrowings occur. The term loan facility matures in 19 quarterly installments with the last installment due March 26, 2023. The Senior Notes become due in 2026 and 2028. Due to the uncertainty resulting from the COVID-19 pandemic, we borrowed an additional $150 million from the Revolver during the first fiscal quarter of 2020 to protect against any prolonged adverse impacts on liquidity markets. While there remained uncertainty throughout fiscal 2020, we did not need to use these borrowings to fund operations and these funds were repaid during the third fiscal quarter of 2020. We expect to generate cash inflows from our operating activities sufficient to satisfy our working capital needs as well as to service our debt, pension, and venture capital obligations. Due to this higher debt, we incurred immaterially higher interest expense. We did not need to borrow additional funds during 2020. As of December 26, 2020 there is significant capacity on the remaining Revolver. Accordingly, we do not anticipate a material risk of non-compliance with our debt covenants based on our current estimate of future earnings.To protect against adverse liquidity concerns, there are various mechanisms for us to improve cash flows. During the second fiscal quarter of 2020 we implemented certain cost reduction plans including delaying compensation related increases, implementing hiring restrictions, reducing working hours, reducing all non-essential travel, and reducing certain discretionary spending. Beginning in the third fiscal quarter of 2020, we reinstated certain annual compensation increases, which had previously been delayed from the beginning of the second quarter of 2020. Additionally, we had temporarily slowed our investment activity, including acquisitions and capital projects, but have since resumed certain of those activities, including the acquisitions of Cellero, LLC (Cellero) during the third fiscal quarter of 2020 and Distributed Bio during the first fiscal quarter of 2021.As of the date these financial statements are issued, based on our current and expected liquidity position, we do not believe there is significant uncertainty in our ability to continue as a going concern.Recoverability and/or impairment of assetsThe COVID-19 pandemic did not, and is not expected to, impact the ability to timely account for assets on our balance sheet. There are judgments involved as it relates to reviewing our allowance for doubtful accounts, valuation of inventory, and valuations/recovery of investments. We believe we have the necessary support for estimates derived for these account balances. We have reviewed the collectability and valuation of the assets through the date of financial statement issuance, noting no significant recoverability concerns or any impairments identified. Gains and losses on certain investments in venture capital funds are recorded on a quarterly lag due to the availability of the funds’ financial information, which is consistent with our venture capital investment accounting policy described in this annual report. We did not identify any triggering events when reviewing impairment indicators for our goodwill and long-lived assets (tangible and intangible) that would indicate an impairment may exist. Should a prolonged disruption occur where there is a material change from our current expectation of future cash flows, we could experience additional write-offs of client receivables or impairments to certain asset balances due to 36collectability and valuation issues. Review of impairment indicators and quantifying any impact will continue to be a focus throughout fiscal year 2021.Internal controls over financial reporting in a remote work environmentInternal controls over financial reporting are a focus for us to ensure they continue to be designed and operating effectively. As of December 26, 2020 and through the issuance of these financial statements, we did not have any material changes to our internal controls over financial reporting. For personnel responsible for internal control activities and working remote, the ability to work effectively enabled us to continue to maintain effective internal control over financial reporting. System and efficiency programs implemented in recent years, as well as those implemented as part of business continuity plans, have enabled us to effectively complete our financial reporting process in a similar way we completed it prior to the COVID-19 pandemic despite a largely remote working environment. Although there is uncertainty over the duration of the COVID-19 pandemic disruption, we do not anticipate any adverse impact to relevant systems or to the operating effectiveness of internal controls over financial reporting.Recent AcquisitionsOur strategy is to augment internal growth of existing businesses with complementary acquisitions. We continued to make strategic acquisitions designed to expand our portfolio of products and services to support the drug discovery and development continuum. Our recent acquisitions are described below.On February 17, 2021, we announced that we signed a definitive agreement to acquire Cognate BioServices, Inc. for approximately $875 million in cash, subject to customary closing adjustments. Cognate BioServices, Inc. is a cell and gene therapy CDMO offering comprehensive manufacturing solutions for cell therapies, as well as for the development and production of plasmid DNA and viral vectors for gene therapies. The planned acquisition of Cognate BioServices, Inc. will create a scientific partner for cell and gene therapy development, testing, and manufacturing, providing clients with an integrated solution from basic research through cGMP production. The proposed transaction is expected to close by the end of the first quarter of 2021. The proposed acquisition and associated fees are expected to be financed through a combination of available cash and proceeds from our Credit Facility under the multi-currency revolving facility. This business is expected to be reported as part of our Manufacturing reportable segment. On December 31, 2020 (fiscal year 2021), we acquired Distributed Bio, Inc (Distributed Bio), a next-generation antibody discovery company with technologies specializing in enhancing the probability of success for delivering high-quality, readily formattable antibody fragments to support antibody and cell and gene therapy candidates to biopharmaceutical clients. The acquisition of Distributed Bio expands our capabilities with an innovative, large-molecule discovery platform, and creates an integrated, end-to-end platform for therapeutic antibody and cell and gene therapy discovery and development. The preliminary purchase price of Distributed Bio was approximately $83 million in cash, with additional contingent payments of up to $21 million based on future performance. The acquisition was funded through a combination of available cash and proceeds from our Credit Facility. This business will be reported as part of our DSA reportable segment. On August 6, 2020, we acquired Cellero, LLC (Cellero), a provider of cellular products for cell therapy developers and manufacturers worldwide. The addition of Cellero enhances our unique, comprehensive solutions for the high-growth cell therapy market, strengthening our ability to help accelerate clients’ critical programs from basic research and proof-of-concept to regulatory approval and commercialization. It also expands our access to high-quality, human-derived biomaterials with Cellero’s donor sites in the United States. The purchase price for Cellero was $37.4 million in cash. The acquisition was funded through available cash. This business is reported as part of our RMS reportable segment.On January 3, 2020, we acquired HemaCare Corporation (HemaCare), a business specializing in the production of human-derived cellular products for the cell therapy market. The acquisition of HemaCare expands our comprehensive portfolio of early-stage research and manufacturing support solutions to encompass the production and customization of high-quality, human derived cellular products to better support clients’ cell therapy programs. The purchase price of HemaCare was $379.8 million in cash. The acquisition was funded through a combination of available cash and proceeds from our Credit Facility. This business is reported as part of our RMS reportable segment. On April 29, 2019, we acquired Citoxlab, a non-clinical CRO, specializing in regulated safety assessment services, non-regulated discovery services, and medical device testing. With operations in Europe and North America, the acquisition of Citoxlab further strengthens our position as a leading, global, early-stage CRO by expanding our scientific portfolio and geographic footprint, which enhances our ability to partner with clients across the drug discovery and development continuum. The purchase price for Citoxlab was $527.1 million in cash. The acquisition was funded through a combination of available cash and proceeds from our Credit Facility. Citoxlab is reported as part of our DSA reportable segment.37On April 3, 2018, we acquired MPI Research, a non-clinical CRO providing comprehensive testing services to biopharmaceutical and medical device companies worldwide. The acquisition enhances our position as a leading global early-stage CRO by strengthening our ability to partner with clients across the drug discovery and development continuum. The purchase price for MPI Research was $829.7 million in cash. The acquisition was funded by borrowings on our Credit Facility as well as the issuance of $500.0 million of 5.5% Senior Notes due 2026 (2026 Senior Notes) in an unregistered offering. MPI Research is reported as part of our DSA reportable segment.Fiscal QuartersOur fiscal year is typically based on 52-weeks, with each quarter composed of 13 weeks ending on the last Saturday on, or closest to, March 31, June 30, September 30, and December 31. A 53rd week was included in the fourth quarter of fiscal year 2016, which is occasionally necessary to align with a December 31 calendar year-end.Business TrendsThe global economy faced unprecedented challenges in 2020 due to the COVID-19 pandemic, as did our Company, but we believe the resilience of our business model has enabled us to weather these challenges extremely well. This resilience was the result of comprehensive business continuity plans that enabled us to keep our operating sites open and adequately staffed; the global scale, broad scientific capabilities, and flexible outsourcing solutions that we are able to offer clients; and the commitment of our global employees. While several of our businesses experienced a significant, short-term decline in demand associated with COVID-19-related disruptions at our clients’ sites, primarily in the RMS reportable segment and principally in the second quarter of 2020, we also benefited from persistent client demand across many of our businesses, including in our DSA reportable segment, driven by robust biotech funding and continued innovation that is generating scientific breakthroughs across multiple therapeutic areas, including for COVID-19 therapeutics.Many of our pharmaceutical and biotechnology clients intensified their use of strategic outsourcing during 2020 to overcome challenges at their own sites and move their early-stage research programs forward during the pandemic. Small and mid-size biotechnology clients continued to be the primary driver of revenue growth as these clients benefited from record biotechnology funding levels in fiscal year 2020, from capital markets, partnering with large biopharmaceutical companies, and investment by venture capital, as the COVID-19 pandemic enhanced the global focus on scientific innovation and emphasized greater investment in their preclinical pipelines. Many of our large biopharmaceutical clients have continued to increase investments in their drug discovery and early-stage development efforts and have strengthened their relationships with both CROs, like us, and biotechnology companies to assist them in bringing new drugs to market. Clients continue to seek to outsource larger portions of their early-stage drug research programs to us, which is leading to new business opportunities as clients adopt more flexible and efficient research and development models.The primary result of these trends was robust revenue growth within our DSA reportable segment in fiscal year 2020, which experienced only a limited impact related to COVID-19 and benefited from incremental outsourcing activity from our clients as they sought a reliable CRO partner to help move their programs forward amidst the challenges of COVID-19. Robust Safety Assessment revenue growth in fiscal year 2020 was primarily driven by increased demand and pricing. We believe the acquisitions of Citoxlab (2019), MPI Research (2018), and WIL Research (2016) have solidified our scientific capabilities and global scale, and the breadth and depth of our scientific expertise, quality, and responsiveness remain key criteria when our clients make the decision to outsource to us. As biotechnology funding remains robust and our clients continue to pursue their goal of more efficient and effective drug research to bring innovative new therapies to market, they are evaluating outsourcing more of their research programs, such as discovery services. We continued to enhance our Discovery Services capabilities to provide clients with a comprehensive portfolio that enables them to start working with us at the earliest stages of the discovery process. We have accomplished this through acquisitions, including Distributed Bio in December 2020 (fiscal year 2021), Citoxlab’s discovery services, KWS BioTest in January 2018 and Brains On-Line in August 2017, and through adding cutting-edge capabilities to our discovery toolkit through partnerships, such as BitBio, Cypre, and Fios Genomics. In fiscal year 2020, demand in our Discovery Services business also increased significantly, as our efforts to enhance our scientific capabilities, provide clients with flexible partnering models, and become a trusted scientific partner for our clients’ early-stage programs have been successful.Overall, demand for our products and services that support our clients’ manufacturing activities was strong in fiscal year 2020. Our Biologics business continued to benefit from increased demand for services associated with the growing proportion of biologic drugs in the pipeline and on the market, including cell and gene therapies, as well as COVID-19 therapeutics. Demand for our Microbial Solutions was affected by delayed instrument installations, as certain client sites were inaccessible due to 38COVID-19 restrictions. We were able to complete additional instrument installations and the revenue growth rate for Microbial Solutions did improve as the year progressed.Demand for our Research Models and Services was negatively impacted in fiscal year 2020, particularly during the second quarter. Worldwide demand for research models declined sharply, principally in the second quarter, as COVID-19-related restrictions, such as stay-at-home orders, disrupted our clients’ research activities. Many academic clients closed their research sites temporarily, and there was also a significant reduction in order activity from both large biopharmaceutical and smaller biotechnology clients as these clients reduced their on-site activities. Clients began to resume more normalized research activities in the third quarter, and demand for research models began to rebound. Demand for research models services experienced very little impact from COVID-19 in fiscal year 2020, and these businesses performed very well, particularly for our IS and GEMS businesses. We are confident that research models and services will remain essential tools for our clients’ drug discovery and early-stage development efforts. In 2020, we enhanced the RMS business’ growth profile and portfolio of critical research tools that we are able to supply through the acquisitions of HemaCare and Cellero, premier providers of human-derived cellular products used in cell therapies. HemaCare and Cellero together generated revenue of $48.1 million in fiscal year 2020, as robust, underlying client demand in the cell therapy market was partially offset by COVID-19-related disruptions.Overview of Results of Operations and LiquidityRevenue for fiscal year 2020 was $2.9 billion compared to $2.6 billion in fiscal year 2019. The 2020 increase as compared to the corresponding period in 2019 was $302.7 million, or 11.5%, and was primarily due to both growth in our DSA and Manufacturing segments, as discussed in the above “Business Trends” section, as well as the recent acquisitions of HemaCare and Cellero in our RMS segment, and by the positive effect of changes in foreign currency exchange rates when compared to the corresponding period in 2019; partially offset by a reduction in RMS product revenue due to the impact of the COVID-19 pandemic when compared to the corresponding period in 2019.In fiscal year 2020, our operating income and operating income margin were $432.7 million and 14.8%, respectively, compared with $351.2 million and 13.4%, respectively, in fiscal year 2019. The increases in operating income and operating income margin were primarily due to contributions from our DSA and Manufacturing segments and lower acquisition related costs compared to the corresponding period in 2019, partially offset by lower RMS operating income and operating income margin due to the impact of the COVID-19 pandemic, as well as increased amortization of intangible assets related to our recent acquisitions of HemaCare and Cellero.Net income attributable to common shareholders increased to $364.3 million in fiscal year 2020, from $252.0 million in the corresponding period of 2019. The increase in net income attributable to common shareholders of $112.3 million was primarily due to higher operating income mentioned above and higher net gains on our venture capital investments compared to the corresponding period in 2019.During fiscal year 2020, our cash flows from operations was $546.6 million compared with $480.9 million for fiscal year 2019. The increase was driven by higher net income and certain favorable changes in working capital items, including favorable timing of certain government deferrals of payroll tax payments, and compensation related items; partially offset by the timing of vendor and supplier payments and collections of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits); and certain pension related payments compared to the same period in 2019.Critical Accounting Policies and EstimatesOur discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States (U.S.). The preparation of these financial statements requires us to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reported periods and related disclosures. These estimates and assumptions are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on our historical experience, trends in the industry, and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.We believe that the application of our accounting policies, each of which require significant judgments and estimates on the part of management, are the most critical to aid in fully understanding and evaluating our reported financial results. Our significant accounting policies are more fully described in Note 1, “Description of Business and Summary of Significant 39Accounting Policies”, to our consolidated financial statements contained in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.We believe the following represent our critical accounting policies and estimates used in the preparation of our financial statements:Revenue RecognitionRevenue is recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer (“transaction price”).To the extent the transaction price includes variable consideration, we estimate the amount of variable consideration that should be included in the transaction price utilizing the amount to which we expect to be entitled. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available. Sales, value add, and other taxes collected on behalf of third parties are excluded from revenue.When determining the transaction price of a contract, an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component. Generally, we do not extend payment terms beyond one year. Applying the practical expedient, we do not assess whether a significant financing component exists if the period between when we perform our obligations under the contract and when the customer pays is one year or less. Our contracts do not generally contain significant financing components.Contracts with customers may contain multiple performance obligations. For such arrangements, the transaction price is allocated to each performance obligation based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. We determine standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications exist when the modification either creates new, or changes existing, enforceable rights and obligations. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the impact on the existing transaction price and measure of progress for the performance obligation to which it relates is generally recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.Product revenue is generally recognized when the customer obtains control of our product, which occurs at a point in time, and may be upon shipment or upon delivery based on the contractual shipping terms of a contract. Service revenue is generally recognized over time as the services are delivered to the customer based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. Depending on which better depicts the transfer of value to the customer, we generally measure our progress using either cost-to-cost (input method) or right-to-invoice (output method). We use the cost-to-cost measure of progress when it best depicts the transfer of value to the customer which occurs as we incur costs on our contract, generally related to fixed fee service contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. The costs calculation includes variables such as labor hours, allocation of overhead costs, research model costs, and subcontractor costs. Revenue is recorded proportionally as costs are incurred. The right-to-invoice measure of progress is generally related to rate per unit contracts, as the extent of progress towards completion is measured based on discrete service or time-based increments, such as samples tested or labor hours incurred. Revenue is recorded in the amount invoiced since that amount corresponds directly to the value of our performance to date. During fiscal year 2020, $1.8 billion, or approximately 60%, of our total revenue recognized ($2.9 billion) is DSA service revenue transferred over time.Income TaxesWe prepare and file income tax returns based on our interpretation of each jurisdiction’s tax laws and regulations. In preparing our consolidated financial statements, we estimate our income tax liability in each of the jurisdictions in which we operate by estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of 40items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. Significant management judgment is required in assessing the realizability of our deferred tax assets. In performing this assessment, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making this determination, under the applicable financial accounting standards, we are allowed to consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and the effects of tax planning strategies. In the event that actual results differ from our estimates, we adjust our estimates in future periods and we may need to establish a valuation allowance, which could materially impact our financial position and results of operations. Our valuation allowance increased by $24.9 million from $310.0 million as of December 28, 2019 to $334.8 million as of December 26, 2020. The increase is primarily a result of foreign exchange impact on net operating losses and corresponding valuation allowances relating to the Company’s 2019 financing structure changes.We account for uncertain tax positions using a “more-likely-than-not” threshold for recognizing and resolving uncertain tax positions. We evaluate uncertain tax positions on a quarterly basis and consider various factors, that include, but are not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit, information obtained during in process audit activities and changes in facts or circumstances related to a tax position. We adjust the level of the liability to reflect any subsequent changes in the relevant facts surrounding the uncertain positions. Our liabilities for uncertain tax positions can be relieved only if the contingency becomes legally extinguished through either payment to the taxing authority or the expiration of the statute of limitations, the recognition of the benefits associated with the position meet the “more-likely-than-not” threshold or the liability becomes effectively settled through the controversy process. We consider matters to be effectively settled once the taxing authority has completed all of its required or expected examination procedures, including all appeals and administrative reviews; we have no plans to appeal or litigate any aspect of the tax position; and we believe that it is highly unlikely that the taxing authority would re-examine the related tax position. We also accrue for potential interest and penalties related to unrecognized tax benefits in income tax expense.We generally receive a tax deduction upon the exercise of non-qualified stock options by employees, or the vesting of restricted stock and performance share units held by employees. The stock price, timing, and amount of vesting and exercising of stock-based compensation could materially impact our current tax expense.In 2017, significant U.S. tax law changes from the Tax Cuts and Jobs Act of 2017 (U.S. Tax Reform) went into effect and reduced the U.S. federal statutory tax rate, broadened the corporate tax base through the elimination or reduction of deductions, exclusions and credits, limited the ability of U.S. corporations to deduct interest expense and allowed for the repatriation of foreign earnings to the U.S. with a 100% federal dividends received deduction prospectively. In addition, U.S. Tax Reform required a one-time transitional tax on foreign cash equivalents and previously unremitted earnings.Our accounting for the elements of U.S. Tax Reform is complete. We have made an accounting policy election to treat taxes due on the GILTI inclusion as a current period expense.Goodwill and Intangible AssetsWe use assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. The determination of the fair value of intangible assets, which represent a significant portion of the purchase price in many of our acquisitions, requires the use of significant judgment with regard to (i) the fair value; and (ii) whether such intangibles are amortizable or non-amortizable and, if the former, the period and the method by which the intangible asset will be amortized. We utilize commonly accepted valuation techniques, such as the income approach and the cost approach, as appropriate, in establishing the fair value of intangible assets. Typically, key assumptions include projections of cash flows that arise from identifiable intangible assets of acquired businesses as well as discount rates based on an analysis of the weighted average cost of capital, adjusted for specific risks associated with the assets.In our recent acquisitions, customer relationship intangible assets (also referred to as client relationships) have been the most significant identifiable assets acquired. To determine the fair value of the acquired client relationships, we utilized the multiple period excess earnings model (a commonly accepted valuation technique), which includes the following key assumptions: projections of cash flows from the acquired entities, which included future revenue growth rates, operating income margins, and customer attrition rates; as well as discount rates based on an analysis of the acquired entities’ weighted average cost of capital. The value of client relationships acquired were $170.4 million for HemaCare and $14.7 million for Cellero in fiscal year 2020, $134.6 million for Citoxlab in fiscal year 2019 and $264.9 million for MPI Research in fiscal year 2018.41We review definite-lived intangible assets for impairment when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Actual cash flows arising from a particular intangible asset could vary from projected cash flows which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such asset. No impairments were recognized during 2020, 2019 or 2018.We evaluate goodwill for impairment annually, during the fourth quarter, and when events occur or circumstances change that may reduce the fair value of the asset below its carrying amount. Events or circumstances that might require an interim evaluation include unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, loss of key personnel and acts by governments and courts. Estimates of future cash flows require assumptions related to revenue and operating income growth, asset-related expenditures, working capital levels and other factors. Different assumptions from those made in our analysis could materially affect projected cash flows and our evaluation of goodwill for impairment.We perform the quantitative impairment test where we compare the fair value of our reporting units to their carrying values. If the carrying values of the net assets assigned to the reporting units exceed the fair values of the reporting units, then we would record an impairment loss equal to the difference. In fiscal 2020 we adopted ASU 2017-04, “Simplifying the Test for Goodwill Impairment.” The standard simplifies the accounting for goodwill impairment by removing Step 2 of the quantitative goodwill impairment test, which previously required a hypothetical purchase price allocation to determine the amount of a goodwill impairment loss.In fiscal years 2020, 2019 and 2018, we performed the quantitative goodwill impairment test for our reporting units. Fair value was determined by using a weighted combination of a market-based approach and an income approach, as this combination was deemed to be the most indicative of our fair value in an orderly transaction between market participants. Under the market-based approach, we utilized information about our company as well as publicly available industry information to determine earnings multiples and sales multiples that are used to value our reporting units. Under the income approach, we determined fair value based on the estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of the reporting unit and the rate of return an outside investor would expect to earn.Our 2020, 2019 and 2018 impairment tests indicated that goodwill was not impaired.Valuation and Impairment of Long-Lived AssetsLong-lived assets to be held and used, including property, plant, and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets or asset group may not be recoverable. Factors we consider important that could trigger an impairment review include, but are not limited to, the following:•significant underperformance relative to expected historical or projected future operating results;•significant negative industry or economic trends; or•significant changes or developments in strategy or operations that negatively affect the utilization of our long-lived assets.Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset, net of any sublease income, if applicable, and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written-down to their fair values. We measure any impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in our current business model. Significant judgments are required to estimate future cash flows, including the selection of appropriate discount rates and other assumptions. We may also estimate fair value based on market prices for similar assets, as appropriate. Changes in these estimates and assumptions could materially affect the determination of fair value for these assets.Pension and Other Post-Retirement Benefit PlansSeveral of our U.S. and non-U.S. subsidiaries sponsor defined benefit pension and other post-retirement benefit plans. We recognize the funded status of our defined benefit pension and other postretirement benefit plans as an asset or liability. This amount is defined as the difference between the fair value of plan assets and the benefit obligation. We measure plan assets and benefit obligations as of the date of our fiscal year end.42The cost and obligations of these arrangements are calculated using many assumptions to estimate the benefits that the employee earns while working, the amount of which cannot be completely determined until the benefit payments cease. Major assumptions used in the accounting for these employee benefit plans include the expected return on plan assets, withdrawal and mortality rates, discount rate, and rate of increase in employee compensation levels. Assumptions are determined based on our data and appropriate market indicators, and are evaluated each year as of the plans’ measurement date. Should any of these assumptions change, they would have an effect on net periodic pension costs and the unfunded benefit obligation.The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for the benefits included in the projected benefit obligations. In determining the expected long-term rate of return on plan assets, we consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance.The discount rate reflects the rate we would have to pay to purchase high-quality investments that would provide cash sufficient to settle our current pension obligations. A 25-basis point change in the discount rate changes the projected benefit obligation by approximately $17 million for all our plans.The rate of compensation increase reflects the expected annual salary increases for the plan participants based on historical experience and the current employee compensation strategy.The Charles River Laboratories, Inc. Pension Plan (U.S. Pension Plan) is a qualified, non-contributory defined benefit plan covering certain U.S. employees. The U.S. Pension Plan was amended in 2002 to exclude new participants and in 2008 the accrual of benefits was frozen. In January 2019, we commenced the process to terminate this plan and received regulatory approval in April 2020. In October 2020, we settled all remaining benefits directly with vested participants through either lump sum payouts or the purchase of a group annuity contract from a qualified insurance company to administer all future payments. Prior to the settlement, the U.S. Pension Plan was underfunded with a benefit obligation of approximately $94 million and plan assets of approximately $93 million. In the fourth quarter of fiscal year 2020, we made a contribution of approximately $1 million to fully fund this plan to cover the lump sum payments, purchase the group annuity contract, and settle remaining termination costs. Upon settlement of the pension liability, we recognized a non-cash settlement charge of approximately $10 million related to pension losses, reclassified from accumulated other comprehensive loss to other expense in the consolidated statement of income.Stock-Based CompensationWe grant stock options, restricted stock, restricted stock units (RSUs), and performance share units (PSUs) to employees, and stock options, restricted stock, and RSUs to non-employee directors under stock-based compensation plans. We make certain assumptions in order to value and record expense associated with awards made under our stock-based compensation arrangements. Changes in these assumptions may lead to variability with respect to the timing and amount of expense we recognize in connection with share-based payments. Stock-based compensation is recognized as an expense in the consolidated statements of income based on the grant date fair value, adjusted for forfeitures when they occur, over the requisite service period. Determining the appropriate valuation model and related assumptions requires judgment. The fair value of stock options granted is calculated using the Black-Scholes option-pricing model and the fair value of PSUs is estimated using a lattice model with a Monte Carlo simulation, both of which require the use of subjective assumptions including volatility and expected term, among others.Determining the appropriate amount to expense based on the anticipated achievement of PSU’s performance targets requires judgment, including forecasting the achievement of future financial targets. The estimate of expense is revised periodically based on the probability of achieving the required performance targets. The cumulative impact of any changes to our estimates is reflected in the period of change.New Accounting PronouncementsFor a discussion of new accounting pronouncements, refer to Note 1, “Description of Business and Summary of Significant Accounting Policies” to our consolidated financial statements contained in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K.43Results of OperationsFiscal Year 2020 Compared to Fiscal Year 2019Revenue and Operating IncomeThe following tables present consolidated revenue by type and by reportable segment:Fiscal Year20202019$ change% change(in millions, except percentages)Service revenue$2,296.1 $2,029.4 $266.7 13.1 %Product revenue627.8 591.8 36.0 6.1 %Total revenue$2,923.9 $2,621.2 $302.7 11.5 %Fiscal Year20202019$ change% changeImpact of FX(in millions, except percentages)RMS$571.1 $537.1 $34.0 6.3 %0.6 %DSA1,837.4 1,619.0 218.4 13.5 %0.4 %Manufacturing515.4 465.1 50.3 10.8 %0.4 %Total revenue$2,923.9 $2,621.2 $302.7 11.5 %0.4 %The following table presents operating income by reportable segment:Fiscal Year20202019$ change% change(in millions, except percentages)RMS$102.7 $133.9 $(31.2)(23.3)%DSA325.9 258.9 67.0 25.9 %Manufacturing181.5 145.4 36.1 24.8 %Unallocated corporate(177.4)(187.0)9.6 (5.2)%Total operating income$432.7 $351.2 $81.5 23.2 %Operating income % of revenue14.8 %13.4 %1.4 %The following presents and discusses our consolidated financial results by each of our reportable segments:RMSFiscal Year20202019$ change% changeImpact of FX(in millions, except percentages)Revenue$571.1 $537.1 $34.0 6.3 %0.6 %Cost of revenue (excluding amortization of intangible assets)368.9 333.7 35.2 10.6 %Selling, general and administrative84.0 68.1 15.9 23.5 %Amortization of intangible assets15.5 1.4 14.1 1,019.3 %Operating income$102.7 $133.9 $(31.2)(23.3)%Operating income % of revenue18.0 %24.9 %(6.9)%RMS revenue increased $34.0 million, or 6.3%, due primarily to the recent acquisitions of HemaCare and Cellero, which contributed $43.0 million and $5.1 million, respectively; higher research model services revenue, specifically our GEMS and Insourcing Solutions businesses; and the effect of changes in foreign currency exchange rates. Partially offsetting these 44increases were lower research model product revenue in North America and Europe due to the impact of the COVID-19 pandemic.RMS operating income decreased $31.2 million, or 23.3%, compared to the corresponding period in 2019. RMS operating income as a percentage of revenue for fiscal year 2020 was 18.0%, a decrease of 6.9% from 24.9% for the corresponding period in 2019. Operating income and operating income as a percentage of revenue decreased primarily due to the lower sales volume for research model products due to the COVID-19 pandemic as described above and due to an increase in amortization of intangible assets associated with the recent acquisitions of HemaCare and Cellero.DSAFiscal Year20202019$ change% changeImpact of FX(in millions, except percentages)Revenue$1,837.4 $1,619.0 $218.4 13.5 %0.4 %Cost of revenue (excluding amortization of intangible assets)1,245.2 1,104.1 141.1 12.8 %Selling, general and administrative178.6 176.9 1.7 1.0 %Amortization of intangible assets87.7 79.1 8.6 10.8 %Operating income$325.9 $258.9 $67.0 25.9 %Operating income % of revenue17.7 %16.0 %1.7 %DSA revenue increased $218.4 million, or 13.5%, due primarily to service revenue increases in both the Safety Assessment and Discovery Services businesses due to demand from biotechnology clients and increased pricing of services; the acquisition of Citoxlab, which contributed $60.2 million to service revenue growth; and the effect of changes in foreign currency exchange rates. Additionally, DSA revenue was not significantly impacted by the COVID-19 pandemic during fiscal year 2020.DSA operating income increased $67.0 million, or 25.9%, compared to the corresponding period in 2019. DSA operating income as a percentage of revenue for fiscal year 2020 was 17.7%, an increase of 1.7% from 16.0% for the corresponding period in 2019. These increases were primarily attributable to the higher revenue described above, realizing the benefit from operating efficiency and cost control initiatives, and lower acquisition related costs and severance costs, primarily impacting selling, general and administrative costs. These increases were partially offset by increased costs in both cost of revenue and selling, general, and administrative expenses related to recent site closures, and higher amortization of intangible assets associated with our recent acquisitions.ManufacturingFiscal Year20202019$ change% changeImpact of FX(in millions, except percentages)Revenue$515.4 $465.1 $50.3 10.8 %0.4 %Cost of revenue (excluding amortization of intangible assets)236.2 225.0 11.2 5.0 %Selling, general and administrative88.9 85.6 3.3 3.8 %Amortization of intangible assets8.8 9.1 (0.3)(3.3)%Operating income$181.5 $145.4 $36.1 24.8 %Operating income % of revenue35.2 %31.3 %3.9 %Manufacturing revenue increased $50.3 million, or 10.8%, due primarily to higher service revenue in the Biologics business due to our facility in Pennsylvania being fully operational in 2020 compared to 2019 where work continued to be transitioned from a legacy facility; higher demand for products in both our Microbial Solutions’ Endotoxin business and our Avian business; and the effect of changes in foreign currency exchange rates; partially offset by lower product revenue in our Microbial Solutions’ Bioburden business, specifically due to the timing of a large stocking order from a strategic partner in 2019, which did not recur in 2020, and delays in instrument installations caused by the COVID-19 pandemic. Overall, Manufacturing revenue was not significantly impacted by the COVID-19 pandemic during fiscal year 2020.Manufacturing operating income increased $36.1 million, or 24.8%, compared to the corresponding period in 2019. Manufacturing operating income as a percentage of revenue for fiscal year 2020 was 35.2%, an increase of 3.9% from 31.3% 45for the corresponding period in 2019. The increases were due primarily to higher revenue as well as improved production efficiencies, including the absence of duplicative Biologics facilities in 2020 compared to 2019, and the impact of operating efficiencies realized during fiscal year 2020 compared to fiscal year 2019.Unallocated CorporateFiscal Year20202019$ change% change(in millions, except percentages)Unallocated corporate$177.4 $187.0 $(9.6)(5.2)%Unallocated corporate % of revenue6.1 %7.1 %(1.0)%Unallocated corporate costs consist of selling, general and administrative expenses that are not directly related or allocated to the reportable segments. The decrease in unallocated corporate costs of $9.6 million, or 5.2%, compared to the corresponding period in 2019 is predominantly associated with decreased costs associated with the evaluation and integration of our recent acquisition activity, as we temporarily slowed our acquisition activity during fiscal year 2020 in response to the COVID-19 pandemic. Costs as a percentage of revenue for fiscal year 2020 was 6.1%, a decrease of 1.0% from 7.1% for the corresponding period in 2019. Interest Income Interest income, which represents earnings on cash, cash equivalents, and time deposits was $0.8 million and $1.5 million for fiscal years 2020 and 2019, respectively. The decrease of $0.7 million was primarily due to lower interest rates on invested funds in 2020 as compared to 2019.Interest Expense Interest expense for fiscal year 2020 was $86.4 million, an increase of $25.5 million, or 42.0%, compared to $60.9 million for fiscal year 2019. The increase was due primarily to foreign currency losses recognized in connection with debt-related foreign exchange forward contracts in fiscal year 2020 compared to foreign currency gains recognized in fiscal year 2019.Other Income, Net Other income, net, was $100.0 million for fiscal year 2020, an increase of $87.7 million, or 713.3%, compared to $12.3 million for fiscal year 2019. The increase was due to net gains on our venture capital and strategic equity investments of $100.9 million in fiscal year 2020 compared to $20.7 million in fiscal year 2019, resulting primarily from increases in fair value from our publicly-held investments, which included initial public offerings of certain portfolio companies; and foreign currency gains recognized in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different functional currency in fiscal year 2020 as compared to foreign currency losses recognized in fiscal year 2019; partially offset by higher pension related costs recognized during fiscal year 2020, including a settlement loss of $10.3 million for the termination of the U.S. Pension Plan, as compared to fiscal year 2019.Income Taxes Income tax expense was $81.8 million for fiscal year 2020, an increase of $31.8 million, compared to $50.0 million for fiscal year 2019. Our effective tax rate was 18.3% for fiscal year 2020, compared to 16.5% for fiscal year 2019. The increase in our effective tax rate in the 2020 period compared to the 2019 period was primarily due to the recognition of $20.6 million of net operating loss deferred tax assets due to foreign finance structure changes in 2019, partially offset by state tax benefits from amended state tax returns and higher tax benefits from stock-based compensation deductions in 2020 compared to the corresponding period in 2019.Fiscal Year 2019 Compared to Fiscal Year 2018Revenue and Operating IncomeThe following tables present consolidated revenue by type and by reportable segment:Fiscal Year20192018$ change% change(in millions, except percentages)Service revenue$2,029.4 $1,687.9 $341.5 20.2 %Product revenue591.8 578.2 13.6 2.4 %Total revenue$2,621.2 $2,266.1 $355.1 15.7 %46Fiscal Year20192018$ change% changeImpact of FX(in millions, except percentages)RMS$537.1 $519.7 $17.4 3.3 %(1.9)%DSA1,619.0 1,316.9 302.1 22.9 %(1.1)%Manufacturing465.1 429.5 35.6 8.3 %(2.7)%Total revenue$2,621.2 $2,266.1 $355.1 15.7 %(1.5)%The following table presents operating income by reportable segment:Fiscal Year20192018$ change% change(in millions, except percentages)RMS$133.9 $136.5 $(2.6)(1.9)%DSA258.9 227.6 31.3 13.8 %Manufacturing145.4 136.2 9.2 6.8 %Unallocated corporate(187.0)(168.9)(18.1)10.8 %Total operating income$351.2 $331.4 $19.8 6.0 %Operating income % of revenue13.4 %14.6 %(1.2)%The following presents and discusses our consolidated results by each of our reportable segments:RMSFiscal Year20192018$ change% changeImpact of FX(in millions, except percentages)Revenue$537.1 $519.7 $17.4 3.3 %(1.9)%Cost of revenue (excluding amortization of intangible assets)333.7 319.8 13.9 4.3 %Selling, general and administrative68.1 61.8 6.3 10.1 %Amortization of intangible assets1.4 1.6 (0.2)(12.9)%Operating income$133.9 $136.5 $(2.6)(1.9)%Operating income % of revenue24.9 %26.3 %(1.4)%RMS revenue increased $17.4 million, or 3.3%, due primarily to higher research model services revenue and higher research model product revenue in China. Research model services benefited from a large government contract in the IS business and strong client demand in the GEMS business resulting from increased research and development activity conducted across biotechnology and academic institutional clients. Partially offsetting these increases were the effect of changes in foreign currency exchange rates and lower research model product revenue outside of China, particularly from large biopharmaceutical clients.RMS operating income decreased $2.6 million, or 1.9%, compared to the corresponding period in 2018. RMS operating income as a percentage of revenue for fiscal year 2019 was 24.9%, a decrease of 1.4% from 26.3% for the corresponding period in 2018. Operating income and operating income as a percentage of revenue decreased primarily due to higher cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: a $2.2 million charge recorded within selling, general and administrative costs in fiscal year 2019 in connection with the modification of the option to purchase the remaining 8% equity interest in Vital River, increased investments in personnel (staffing levels and hourly wage increases), higher severance charges in connection with certain global restructuring initiatives, and facility expansions (primarily in China). In addition, operating income as a percentage of revenue decreased due to lower operating income margins on the aforementioned large government contract, and lower sales volume for research models outside of China.47DSAFiscal Year20192018$ change% changeImpact of FX(in millions, except percentages)Revenue$1,619.0 $1,316.9 $302.1 22.9 %(1.1)%Cost of revenue (excluding amortization of intangible assets)1,104.1 903.9 200.2 22.2 %Selling, general and administrative176.9 131.2 45.7 34.8 %Amortization of intangible assets79.1 54.2 24.9 45.9 %Operating income$258.9 $227.6 $31.3 13.8 %Operating income % of revenue16.0 %17.3 %(1.3)%DSA revenue increased $302.1 million, or 22.9%, due primarily to the recent acquisitions of Citoxlab and MPI Research, which contributed $123.7 million and $73.0 million, respectively, to service revenue growth. Additionally, service revenue increased in both the Safety Assessment and Discovery Services businesses due to demand from biotechnology clients and increased pricing of services. These increases were partially offset by the effect of changes in foreign currency exchange rates.DSA operating income increased $31.3 million, or 13.8%, compared to the corresponding period in 2018. DSA operating income as a percentage of revenue for fiscal year 2019 was 16.0%, a decrease of 1.3% from 17.3% for the corresponding period in 2018. The increase to operating income was primarily attributable to contributions from our recent acquisitions of Citoxlab and MPI Research. This increase was partially offset by increased costs in both cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: increased investments in personnel (staffing levels and hourly wage increases); increased investments related to facility expansions; higher severance charges in connection with certain global restructuring initiatives, and higher amortization of intangible assets and acquisition and integration costs associated with our recent acquisitions. These increased costs collectively decreased operating income as a percentage of revenue in 2019 compared to 2018.ManufacturingFiscal Year20192018$ change% changeImpact of FX(in millions, except percentages)Revenue$465.1 $429.5 $35.6 8.3 %(2.7)%Cost of revenue (excluding amortization of intangible assets)225.0 202.3 22.7 11.2 %Selling, general and administrative85.6 82.0 3.6 4.4 %Amortization of intangible assets9.1 9.0 0.1 0.3 %Operating income$145.4 $136.2 $9.2 6.8 %Operating income % of revenue31.3 %31.7 %(0.4)%Manufacturing revenue increased $35.6 million, or 8.3%, due primarily to higher demand for endotoxin products, bioburden products and services, and species identification services in the Microbial Solutions business and higher service revenue in the Biologics business; partially offset by the effect of changes in foreign currency exchange rates.Manufacturing operating income increased $9.2 million, or 6.8%, compared to the corresponding period in 2018. Manufacturing operating income as a percentage of revenue for fiscal year 2019 was 31.3%, a decrease of 0.4% from 31.7% for the corresponding period in 2018. The increase to operating income was due primarily to the increase in revenue. This increase was partially offset by increased costs in both cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: increased investments in process improvements to further enhance Microbial Solutions’ operating efficiency; increased investments in personnel (staffing levels and hourly wage increases), and increased investments related to facility expansions (primarily in Biologics), and certain site consolidation costs. These increased costs collectively decreased operating income as a percentage of revenue in 2019 compared to 2018.48Unallocated CorporateFiscal Year20192018$ change% change(in millions, except percentages)Unallocated corporate$187.0 $168.9 $18.1 10.8 %Unallocated corporate % of revenue7.1 %7.5 %(0.4)%Unallocated corporate costs consist of selling, general and administrative expenses that are not directly related or allocated to the reportable segments. The increase in unallocated corporate costs of $18.1 million, or 10.8%, compared to the corresponding period in 2018 is related to an increase in compensation, benefits, and other employee-related expenses; costs associated with the evaluation and integration of our recent acquisition activity; and costs related to the remediation of the unauthorized access into our information systems. Costs as a percentage of revenue for fiscal year 2019 was 7.1%, a decrease of 0.4% from 7.5% for the corresponding period in 2018.Interest Income Interest income, which represents earnings on cash, cash equivalents, and time deposits was $1.5 million and $0.8 million for fiscal years 2019 and 2018, respectively. The increase of $0.7 million was primarily due to higher average cash balances in 2019 as compared to 2018.Interest Expense Interest expense for fiscal year 2019 was $60.9 million, a decrease of $2.9 million, or 4.5%, compared to $63.8 million for fiscal year 2018. The decrease was due primarily to a foreign currency gain recognized in connection with a debt-related foreign exchange forward contract and lower debt issuance costs incurred compared to the corresponding period in 2018; partially offset by higher interest expense from increased debt to fund our recent acquisitions.Other Income, Net Other income, net, was $12.3 million for fiscal year 2019, a decrease of $1.0 million, or 7.3%, compared to $13.3 million for fiscal year 2018. The decrease was due to higher foreign currency losses recognized in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different functional currency compared to the corresponding period in 2018 and higher pension-related costs as compared to the corresponding period in 2018; partially offset by higher net gains on our venture capital investments and our life insurance policy investments compared to the corresponding period in 2018.Income Taxes Income tax expense was $50.0 million for fiscal year 2019, a decrease of $4.5 million, compared to $54.5 million for fiscal year 2018. Our effective tax rate was 16.5% for fiscal year 2019, compared to 19.3% for fiscal year 2018. The decrease in our effective tax rate in the 2019 period compared to the 2018 period was primarily due to recognizing a $20.6 million deferred tax asset in fiscal year 2019 for net operating losses expected to be utilized in the future due to changes in our international financing structure.49Liquidity and Capital ResourcesWe currently require cash to fund our working capital needs, capital expansion, acquisitions, and to pay our debt, lease, venture capital investment, and pension obligations. Our principal sources of liquidity have been our cash flows from operations, supplemented by long-term borrowings. Based on our current business plan, we believe that our existing funds, when combined with cash generated from operations and our access to financing resources, are sufficient to fund our operations for the foreseeable future as previously discussed in our section on the COVID-19 pandemic impacts.The following table presents our cash, cash equivalents and short-term investments:December 26, 2020December 28, 2019(in millions)Cash and cash equivalents:Held in U.S. entities$11.8 $56.5 Held in non-U.S. entities216.6 181.5 Total cash and cash equivalents228.4 238.0 Short-term investments:Held in non-U.S. entities1.0 1.0 Total cash, cash equivalents and short-term investments$229.4 $239.0 BorrowingsOn March 26, 2018, we amended and restated our $1.65 billion credit facility, which extended the maturity date and provided for a $750.0 million term loan and a $1.55 billion multi-currency revolving facility (Credit Facility). The term loan facility matures in 19 quarterly installments with the last installment due March 26, 2023. The revolving facility matures on March 26, 2023, and requires no scheduled payment before that date. On October 23, 2019, we prepaid $500.0 million of the term loan with proceeds from a $500.0 million unregistered private offering (see 2028 Senior Notes below). Additionally, on November 4, 2019, we further amended and restated the Credit Facility to increase the multi-currency revolving facility by $500.0 million, from $1.55 billion to $2.05 billion. Under specified circumstances, we have the ability to increase the term loan and/or revolving facility by up to $1.0 billion in the aggregate.On April 3, 2018, we entered into an indenture (Base Indenture) with MUFG Union Bank, N.A. to allow for senior notes offerings under supplemental indentures. Concurrently on April 3, 2018, we entered into our first supplemental indenture and raised $500.0 million in aggregate principal amount of 5.5% Senior Notes due in 2026 (2026 Senior Notes) in an unregistered offering. Under the terms of the first supplemental indenture, interest on the 2026 Senior Notes is payable semi-annually on April 1 and October 1, beginning on October 1, 2018. On October 23, 2019, we entered into our second supplemental indenture and raised an additional $500.0 million in aggregate principal amount of 4.25% Senior Notes due in 2028 (2028 Senior Notes) in an unregistered offering. Under the terms of the second supplemental indenture, interest on the 2028 Senior Notes is payable semi-annually on May 1 and November 1, beginning on May 1, 2020.Amounts outstanding under our credit facilities and both the 2026 Senior Notes and the 2028 Senior Notes were as follows:December 26, 2020December 28, 2019(in millions)Term loans$146.9 $193.8 Revolving facility814.8 676.1 2026 Senior Notes500.0 500.0 2028 Senior Notes500.0 500.0 Total$1,961.7 $1,869.9 The interest rates applicable to the term loan and revolving facility under the Credit Facility are, at our option, equal to either the base rate (which is the higher of (1) the prime rate, (2) the federal funds rate plus 0.50%, or (3) the one-month adjusted LIBOR rate plus 1.0%) or the adjusted LIBOR rate, plus an interest rate margin based upon our leverage ratio.We entered into foreign exchange forward contracts during fiscal years 2020 and 2019 to limit our foreign currency exposure related to a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under the Credit Facility.50The acquisition of HemaCare on January 3, 2020 for $379.8 million in cash was funded through a combination of available cash and proceeds from our Credit Facility under the multi-currency revolving facility.The acquisition of Distributed Bio on December 31, 2020 (fiscal year 2021) for approximately $83 million in cash was funded through a combination of available cash and proceeds from our Credit Facility under the multi-currency revolving facility.The intended acquisition of Cognate BioServices, Inc. along with the associated fees are expected to be funded through a combination of available cash and proceeds from our Credit Facility under the multi-currency revolving facility.Repurchases of Common StockDuring fiscal year 2020, we did not repurchase any shares under our authorized $1.3 billion stock repurchase program. As of December 26, 2020, we had $129.1 million remaining on the authorized stock repurchase program. Our stock-based compensation plans permit the netting of common stock upon vesting of restricted stock, restricted stock units, and performance share units in order to satisfy individual statutory tax withholding requirements. During fiscal year 2020, we acquired 0.1 million shares for $24.0 million through such netting.Cash FlowsThe following table presents our net cash provided by operating activities:Fiscal Year202020192018(in millions)Income from continuing operations, net of income taxes$365.3 $254.1 $227.2 Adjustments to reconcile income from continuing operations, net of income taxes, to net cash provided by operating activities207.5 220.7 199.1 Changes in assets and liabilities(26.2)6.1 14.8 Net cash provided by operating activities$546.6 $480.9 $441.1 Net cash provided by cash flows from operating activities represents the cash receipts and disbursements related to all of our activities other than investing and financing activities. Operating cash flow is derived by adjusting our income from continuing operations for (1) non-cash operating items such as depreciation and amortization, stock-based compensation, deferred income taxes, gains and/or losses on venture capital and strategic equity investments, as well as (2) changes in operating assets and liabilities, which reflect timing differences between the receipt and payment of cash associated with transactions and when they are recognized in our results of operations. For fiscal year 2020, compared to fiscal year 2019, the increase in net cash provided by operating activities was driven by higher net income and certain favorable changes in working capital items, including favorable timing of certain government deferrals of payroll tax payments, and compensation related items; partially offset by the timing of vendor and supplier payments and collections of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits); and certain pension related payments compared to the same period in 2019. For fiscal year 2019, compared to fiscal year 2018, the increase in net cash provided by operating activities was primarily driven by an increase in income from continuing operations, net of income taxes and the favorable timing of vendor and supplier payments compared to the same period in 2018; partially offset by unfavorable changes in working capital items, specifically related to the timing of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits), increases in inventory levels in response to customer demand, and higher compensation payments compared to the prior year period.51The following table presents our net cash used in investing activities:Fiscal Year202020192018(in millions)Acquisitions of businesses and assets, net of cash acquired$(418.6)$(515.7)$(824.9)Capital expenditures(166.6)(140.5)(140.1)Investments, net(15.3)(21.4)10.7 Other, net(1.0)(3.9)(0.7)Net cash used in investing activities$(601.5)$(681.5)$(955.0)The primary use of cash used in investing activities in fiscal year 2020 related to the acquisitions of HemaCare and Cellero, capital expenditures to support the growth of the business, and investments in certain venture capital and strategic equity investments. The primary use of cash in fiscal year 2019 related to the acquisition of Citoxlab, the acquisition of a supplier, capital expenditures to support the growth of the business, and investments in certain venture capital and strategic equity investments. The primary use of cash in fiscal year 2018 related to our acquisitions of MPI Research and KWS BioTest, and our capital expenditures to support the growth of the business; partially offset by proceeds from net investments, which primarily relate to short-term investments held by our U.K. operations.The following table presents our net cash provided by financing activities:Fiscal Year202020192018(in millions)Proceeds from long-term debt and revolving credit facility$2,231.0 $3,358.5 $2,755.0 Payments on long-term debt, revolving credit facility, and finance lease obligations(2,200.4)(3,124.6)(2,201.0)Proceeds from exercises of stock options46.6 34.5 37.7 Payments on debt financing costs— (6.6)(18.3)Purchase of treasury stock(24.0)(18.1)(13.8)Other, net(6.0)(11.8)(1.5)Net cash provided by financing activities$47.2 $231.9 $558.1 For fiscal year 2020, net cash provided by financing activities reflected the net proceeds of $30.6 million on our long-term debt, revolving credit facility, and finance lease obligations. Included in the net proceeds are the following amounts:•Proceeds of approximately $415 million from our revolving Credit Facility to fund our recent acquisitions. Additionally, towards the end of the first fiscal quarter, we borrowed an additional $150 million from our revolving Credit Facility to secure available cash in response to uncertainties due to the COVID-19 pandemic; partially offset by,•Payments of approximately $47 million on our term loan and net payments of $476 million to our revolving Credit Facility throughout fiscal year 2020, which included the repayment of the $150 million additional borrowings during the first fiscal quarter of 2020;•Additionally, we had $1.6 billion of gross payments, partially offset by $1.6 billion of gross proceeds in connection with a non-U.S. Euro functional currency entity repaying Euro loans and replacing the Euro loans with U.S. dollar denominated loans. A series of forward currency contracts were executed to mitigate any foreign currency gains or losses on the U.S. dollar denominated loans. These proceeds and payments are presented as gross financing activities.Net cash provided by financing activities also reflected proceeds from exercises of employee stock options of $46.6 million, partially offset by treasury stock purchases of $24.0 million made due to the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements.For fiscal year 2019, net cash provided by financing activities reflected the net proceeds of $233.9 million on our long-term debt, revolving credit facility, and finance lease obligations. Included in the net proceeds are the following amounts:52•Proceeds of $494 million received from the issuance of the 2028 Senior Notes on October 23, 2019, proceeds of approximately $581 million from our revolving credit facility to fund our recent acquisitions; and $98 million of proceeds from our revolving credit facility to fund activities in the normal course of business; partially offset by,•Payments of $537.5 million on our term loan, which included the $500.0 million prepayment on November 4, 2019, and approximately $151 million of repayments to our revolving credit facility in the normal course of business;•Additionally, we had $2.4 billion of gross payments, partially offset by $2.2 billion of gross proceeds in connection with a non-U.S. Euro functional currency entity repaying Euro loans and replacing the Euro loans with U.S. dollar denominated loans. A series of forward currency contracts were executed to mitigate any foreign currency gains or losses on the U.S. dollar denominated loans. These proceeds and payments are presented as gross financing activities.Net cash provided by financing activities also reflected proceeds from exercises of employee stock options of $34.5 million. Net cash provided by financing activities was partially offset by treasury stock purchases of $18.1 million made due to the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements and the purchase of an additional 5% equity interest in Vital River for $7.9 million which is included in Other, net.For fiscal year 2018, net cash provided by financing activities reflected the incremental proceeds from the refinancing of our previous $1.65 Billion Credit Facility to the $2.3 Billion Credit Facility and the proceeds from our $500.0 million 2026 Senior Notes. Subsequent to refinancing our $2.3 Billion Credit Facility, we repaid €300 million of our revolving facility borrowed by a non-U.S. Euro functional currency entity and replaced the borrowing with a $343 million U.S. dollar denominated loan. A forward currency contract was then executed to mitigate any foreign currency gains or losses on the $343 million U.S. dollar denominated loan. Additionally, proceeds from exercises of employee stock options of $37.7 million; partially offset by payments on debt financing costs of $18.3 million, and treasury stock purchases of $13.8 million made due to the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements.Contractual Commitments and ObligationsMinimum future payments of our contractual obligations as of December 26, 2020 are as follows:Payments Due by PeriodTotalLess than1 Year1 - 3 Years3 - 5 YearsMore Than5 Years(in millions)Notes payable (1)$1,965.1 $47.2 $915.2 $0.7 $1,002.0 Operating leases (2)345.4 33.5 68.0 66.3 177.6 Finance leases 38.1 4.2 7.0 6.0 20.9 Redeemable noncontrolling interests (3)23.1 16.3 6.8 — — Venture capital investment commitments (4)44.6 36.5 8.1 — — Contingent payments (5)2.3 — 2.3 — — Unconditional purchase obligations (6)197.4 166.1 30.6 0.7 — Total contractual cash obligations$2,616.0 $303.8 $1,038.0 $73.7 $1,200.5 (1)Notes payable includes the principal payments on our debt, which include our $2.3B Credit Facility, our Senior Notes and Other debt.(2)We lease properties and equipment for use in our operations. In addition to rent, the leases may require us to pay additional amounts for taxes, insurance, maintenance, and other operating expenses. Amounts reflected within the table detail future minimum rental commitments under non-cancellable operating leases, net of income from subleases, for each of the periods presented. Approximately $130 million of contractually committed lease payments are reflected in the table for which leases have not yet commenced, as we do not yet control the underlying assets.(3)The estimated cash obligation for redeemable noncontrolling interests are based on the amount that would be paid if settlement occurred as of the balance sheet date based on the contractually defined redemption value as of December 26, 2020. (4)The timing of the remaining capital commitment payments to venture capital funds is subject to the procedures of the limited liability partnerships and limited liability companies; the above table reflects the earliest possible date the payment can be required under the relevant agreements.(5)In connection with certain business and asset acquisitions, we agreed to make additional payments aggregating to $2.3 million based upon the achievement of certain financial targets in connection with the respective acquisition. The contingent payment obligations included in the table above have not been probability adjusted or discounted.53(6)Unconditional purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions, and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancellable at any time without penalty.The above table excludes obligations related to our pension and other post-retirement benefit plans. Refer to Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K for more details.Tax Related ObligationsWe excluded liabilities pertaining to uncertain tax positions from our summary of contractual obligations presented above, as we cannot make a reliable estimate of the period of cash settlement with the respective taxing authorities. As of December 26, 2020, we had $25.0 million of liabilities associated with uncertain tax positions.Additionally, we excluded federal and state income tax liabilities of $48.8 million from our summary of contractual obligations presented above, relating to the one-time Transition Tax on unrepatriated earnings under U.S. Tax Reform. The Transition Tax will be paid, interest free, over an eight-year period through 2026.Off-Balance Sheet ArrangementsAs of December 26, 2020, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K promulgated under the Exchange Act, except as disclosed below.Venture Capital InvestmentsWe invest in several venture capital funds that invest in start-up companies, primarily in the life sciences industry. Our total commitment to the funds as of December 26, 2020 was $139.9 million, of which we funded $95.3 million through December 26, 2020. Refer to Note 6, “Venture Capital and Strategic Equity Investments,” to our consolidated financial statements contained in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K for further details.Letters of CreditOur off-balance sheet commitments related to our outstanding letters of credit as of December 26, 2020 were $16.0 million.Item 7A. Quantitative and Qualitative Disclosures about Market RiskWe are exposed to market risk from changes in interest rates and currency exchange rates, which could affect our future results of operations and financial condition. We manage our exposure to these risks through our regular operating and financing activities.Interest Rate RiskWe are exposed to changes in interest rates while conducting normal business operations as a result of ongoing financing activities. As of December 26, 2020, our debt portfolio was comprised primarily of floating interest rate borrowings. A 100-basis point increase in interest rates would increase our annual pre-tax interest expense by $9.6 million.Foreign Currency Exchange Rate RiskWe operate on a global basis and have exposure to some foreign currency exchange rate fluctuations for our financial position, results of operations, and cash flows.While the financial results of our global activities are reported in U.S. dollars, our foreign subsidiaries typically conduct their operations in their respective local currency. The principal functional currencies of the Company’s foreign subsidiaries are the Euro, British Pound, Canadian Dollar, and Chinese Yuan Renminbi. During fiscal year 2020, the most significant drivers of foreign currency translation adjustment the Company recorded as part of other comprehensive income (loss) were the Euro, British Pound, Canadian Dollar, Chinese Yuan Renminbi, Japanese Yen and Brazilian Real.Fluctuations in the foreign currency exchange rates of the countries in which we do business will affect our financial position, results of operations, and cash flows. As the U.S. dollar strengthens against other currencies, the value of our non-U.S. revenue, expenses, assets, liabilities, and cash flows will generally decline when reported in U.S. dollars. The impact to net income as a result of a U.S. dollar strengthening will be partially mitigated by the value of non-U.S. expenses, which will decline when reported in U.S. dollars. As the U.S. dollar weakens versus other currencies, the value of the non-U.S. revenue, expenses, assets, liabilities, and cash flows will generally increase when reported in U.S. dollars. For fiscal year 2020, our revenue would 54have increased by $96.1 million and our operating income would have increased by $0.4 million, if the U.S. dollar exchange rate had strengthened by 10%, with all other variables held constant.We attempt to minimize this exposure by using certain financial instruments in accordance with our overall risk management and our hedge policy. We do not enter into speculative derivative agreements.During fiscal years 2020, 2019 and 2018, we entered into foreign exchange forward contracts to limit our foreign currency exposure related to both intercompany loans and a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under our Credit Facility. Refer to Note 14, “Foreign Currency Contracts,” to our consolidated financial statements contained in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K for further details regarding these types of forward contracts.55

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+Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsForward-Looking StatementsThis Annual Report on Form 10-K, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “momentum,” “seeks,” “estimates,” “continues,” “endeavors,” “strives,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, future responses to and effects of the COVID-19 pandemic, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those under “Part I, Item 1A. Risk Factors,” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.OVERVIEWCisco designs and sells a broad range of technologies that power the Internet. We are integrating our platforms across networking, security, collaboration, applications and the cloud. These platforms are designed to help our customers manage more users, devices and things connecting to their networks. This will enable us to provide customers with a highly secure, intelligent platform for their digital business. A summary of our results is as follows (in millions, except percentages and per-share amounts):Three Months EndedYears EndedJuly 31, 2021July 25, 2020VarianceJuly 31, 2021July 25, 2020VarianceRevenue$13,126 $12,154 8 %$49,818 $49,301 1 %Gross margin percentage63.6 %63.2 %0.4 pts64.0 %64.3 %(0.3)ptsResearch and development$1,713 $1,565 9 %$6,549 $6,347 3 %Sales and marketing$2,448 $2,218 10 %$9,259 $9,169 1 %General and administrative$521 $494 5 %$2,152 $1,925 12 %Total R&D, sales and marketing, general and administrative$4,682 $4,277 9 %$17,960 $17,441 3 %Total as a percentage of revenue35.7 %35.2 %0.5 pts36.1 %35.4 %0.7 pts Amortization of purchased intangible assets included in operating expenses$79 $33 139 %$215 $141 52 %Restructuring and other charges included in operating expenses$8 $127 (94)%$886 $481 84 %Operating income as a percentage of revenue27.2 %26.7 %0.5 pts25.8 %27.6 %(1.8)ptsInterest and other income (loss), net$160 $59 171 %$429 $350 23 %Income tax percentage19.4 %20.3 %(0.9)pts20.1 %19.7 %0.4 ptsNet income$3,009 $2,636 14 %$10,591 $11,214 (6)%Net income as a percentage of revenue22.9 %21.7 %1.2 pts21.3 %22.7 %(1.4)ptsEarnings per share—diluted$0.71 $0.62 15 %$2.50 $2.64 (5)%30Table of ContentsFiscal 2021 Compared with Fiscal 2020In fiscal 2021, we delivered growth in revenue in a very challenging environment. As customers have accelerated their digitization and cloud investments stemming from the COVID-19 pandemic, we focused on executing and innovating to support and assist that transition. In the second half of fiscal 2021, we began to see customers prepare for office re-openings and hybrid work by increasing investments in their technologies. Total revenue increased by 1% compared with fiscal 2020. Our product revenue reflected growth in Security, partially offset by declines in Applications. Infrastructure Platforms was flat. We continued to make progress in the transition of our business model delivering increased software and subscriptions. We remain focused on accelerating innovation across our portfolio, and we believe that we have made continued progress on our strategic priorities. We continue to operate in a challenging macroeconomic and highly competitive environment. While the overall environment remains uncertain, we continue to aggressively invest in priority areas with the objective of driving profitable growth over the long term.Within total revenue, product revenue was flat and service revenue increased by 4%. Fiscal 2021 had 53 weeks, compared with 52 weeks in fiscal 2020, thus our results for fiscal 2021 reflect an extra week compared with fiscal 2020. We estimate that a majority of our revenue increase was attributable to the extra week. In fiscal 2021, total software revenue was $15.0 billion across all product areas and service, an increase of 7%. Within total software revenue, subscription revenue increased 15%. Total gross margin decreased by 0.3 percentage points. Product gross margin decreased by 0.2 percentage points, due to lower productivity benefits largely driven by ongoing costs related to supply chain constraints. The effect of pricing erosion was moderate. We have partnered with several of our key suppliers utilizing our volume purchasing and extending supply coverage, including revising supplier arrangements, to address supply chain challenges. As a percentage of revenue, research and development, sales and marketing, and general and administrative expenses, collectively, increased by 0.7 percentage points. The total impact associated with the extra week on our cost of sales and operating expenses was approximately $150 million (excluding the impact of share-based compensation expense). Operating income as a percentage of revenue decreased by 1.8 percentage points. We incurred restructuring and other charges of $886 million, which resulted in a decrease of 6% in net income and a decrease of 5% in diluted earnings per share. In terms of our geographic segments, revenue from the Americas decreased by $0.1 billion, EMEA revenue increased by $0.3 billion and revenue in our APJC segment increased by $0.4 billion. The “BRICM” countries experienced a product revenue decline of 6% in the aggregate, driven by a decrease in product revenue across each of the BRICM countries with the exception of India.From a customer market standpoint, we experienced product revenue growth in the public sector and service provider markets partially offset by declines in the enterprise and commercial markets. As fiscal 2021 progressed, we saw improvement in business momentum in our customer markets, which we believe was related to an improving global macroeconomic environment.From a product category perspective, total product revenue was flat year over year, driven by growth in revenue in Security of 7%, offset by a product revenue decline in Applications of 1%. Infrastructure Platforms was flat.31Table of ContentsFourth Quarter SnapshotFor the fourth quarter of fiscal 2021, as compared with the fourth quarter of fiscal 2020, total revenue increased by 8%. Within total revenue, product revenue increased by 10% and service revenue increased by 3%. With regard to our geographic segment performance, on a year-over-year basis, revenue in the Americas, EMEA and APJC increased by 8%, 6% and 13%, respectively. From a product category perspective, we experienced product revenue growth in Infrastructure Platforms and Security, offset by declines in Applications. Total gross margin increased by 0.4 percentage points, driven by productivity benefits, and to a lesser extent, favorable product mix, partially offset by pricing erosion. As a percentage of revenue, research and development, sales and marketing, and general and administrative expenses collectively increased by 0.5 percentage points. Operating income as a percentage of revenue increased by 0.5 percentage points. Net income increased by 14% and diluted earnings per share increased by 15%. COVID-19 Pandemic Response SummaryDuring this extraordinary time, our priority has been supporting our employees, customers, partners and communities, while positioning Cisco for the future. The pandemic has driven organizations across the globe to digitize their operations and support remote workforces at a faster speed and greater scale than ever before. We remain focused on providing the technology and solutions our customers need to accelerate their digital organizations. The actions we have taken and are taking include:Employees•Most of our global workforce is working from home.•Seamless transition to work from home with a long-standing flexible work policy, and we build the technologies that allow organizations to stay connected, secure and productive.•For the remainder who must be in the office to perform their roles, we are focused on their health and safety, and are taking all of the necessary precautions.Customer and Partners•Provided a variety of free offers and trials for our Webex and security technologies as they dramatically shifted entire workforces to be remote.Communities•Committed significant funds to support both global and local pandemic response efforts.•Provided technology and financial support for non-profits, first responders, and governments.•Donated personal protective equipment to hospital workers including N95 masks and face shields 3D-printed by Cisco volunteers around the world.We are moving towards a hybrid work model, giving our employees the flexibility to work offsite or at onsite Cisco locations.Strategy and PrioritiesAs our customers add billions of new connections to their enterprises, and as more applications move to a multicloud environment, the network becomes even more critical. Our customers are navigating change at an unprecedented pace and our mission is to shape the future of the Internet by inspiring new possibilities for them by helping transform their infrastructure, expand applications and analytics, address their security needs, and empower their teams. We believe that our customers are looking for outcomes that are data-driven and provide meaningful business value through automation, security, and analytics across private, hybrid, and multicloud environments. Our strategy is to help our customers connect, secure, and automate in order to accelerate their digital agility in a cloud-first world.For a full discussion of our strategy and priorities, see “Item 1. Business.”Other Key Financial MeasuresThe following is a summary of our other key financial measures for fiscal 2021 compared with fiscal 2020 (in millions): Fiscal 2021Fiscal 2020Cash and cash equivalents and investments$24,518$29,419Cash provided by operating activities$15,454$15,426Deferred revenue$22,164$20,446Repurchases of common stock—stock repurchase program$2,902$2,619Dividends paid$6,163$6,016Inventories$1,559$1,28232Table of ContentsCRITICAL ACCOUNTING ESTIMATESThe preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies.The inputs into certain of our judgments, assumptions and estimates considered the economic implications of the COVID-19 pandemic on our critical and significant accounting estimates. The COVID-19 pandemic did not have a material impact on our significant judgments, assumptions and estimates that are reflected in our results for fiscal 2021. These estimates include: goodwill and identified purchased intangible assets and income taxes, among other items. The actual results that we experience may differ materially from our estimates. As the COVID-19 pandemic continues, many of our estimates could require increased judgment and carry a higher degree of variability and volatility. As events continue to evolve our estimates may change materially in future periods.Revenue Recognition We enter into contracts with customers that can include various combinations of products and services which are generally distinct and accounted for as separate performance obligations. As a result, our contracts may contain multiple performance obligations. We determine whether arrangements are distinct based on whether the customer can benefit from the product or service on its own or together with other resources that are readily available and whether our commitment to transfer the product or service to the customer is separately identifiable from other obligations in the contract. We classify our hardware, perpetual software licenses, and SaaS as distinct performance obligations. Term software licenses represent multiple obligations, which include software licenses and software maintenance. In transactions where we deliver hardware or software, we are typically the principal and we record revenue and costs of goods sold on a gross basis.We recognize revenue upon transfer of control of promised goods or services in a contract with a customer in an amount that reflects the consideration we expect to receive in exchange for those products or services. Transfer of control occurs once the customer has the contractual right to use the product, generally upon shipment, electronic delivery (or when the software is available for download by the customer), or once title and risk of loss has transferred to the customer. Transfer of control can also occur over time for software maintenance and services as the customer receives the benefit over the contract term. Our hardware and perpetual software licenses are distinct performance obligations where revenue is recognized upfront upon transfer of control. Term software licenses include multiple performance obligations where the term licenses are recognized upfront upon transfer of control, with the associated software maintenance revenue recognized ratably over the contract term as services and software updates are provided. SaaS arrangements do not include the right for the customer to take possession of the software during the term, and therefore have one distinct performance obligation which is satisfied over time with revenue recognized ratably over the contract term as the customer consumes the services. On our product sales, we record consideration from shipping and handling on a gross basis within net product sales. We record our revenue net of any associated sales taxes.Revenue is allocated among these performance obligations in a manner that reflects the consideration that we expect to be entitled to for the promised goods or services based on standalone selling prices (SSP). SSP is estimated for each distinct performance obligation and judgment may be required in their determination. The best evidence of SSP is the observable price of a product or service when we sell the goods separately in similar circumstances and to similar customers. In instances where SSP is not directly observable, we determine SSP using information that may include market conditions and other observable inputs. We assess relevant contractual terms in our customer contracts to determine the transaction price. We apply judgment in identifying contractual terms and determining the transaction price as we may be required to estimate variable consideration when determining the amount of revenue to recognize. Variable consideration includes potential contractual penalties and various rebate, cooperative marketing and other incentive programs that we offer to our distributors, channel partners and customers. When determining the amount of revenue to recognize, we estimate the expected usage of these programs, applying the expected value or most likely estimate and update the estimate at each reporting period as actual utilization becomes available. We also consider the customers' right of return in determining the transaction price, where applicable. If actual credits received by distributors under these programs were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.See Note 3 to the Consolidated Financial Statements for more details. 33Table of ContentsLoss ContingenciesWe are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate information available to us to determine whether such accruals should be made or adjusted and whether new accruals are required. Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us. These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims assertions, particularly in the United States. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially and adversely affected.Goodwill and Purchased Intangible Asset ImpairmentsOur methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques. Goodwill represents a residual value as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquired company over the fair value of net assets acquired, including contingent consideration. We perform goodwill impairment tests on an annual basis in the fourth fiscal quarter and between annual tests in certain circumstances for each reporting unit. The assessment of fair value for goodwill and purchased intangible assets is based on factors that market participants would use in an orderly transaction in accordance with the new accounting guidance for the fair value measurement of nonfinancial assets.In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. There was no impairment of goodwill in fiscal 2021, 2020, and 2019. For the annual impairment testing in fiscal 2021, the excess of the fair value over the carrying value for each of our reporting units was $80.3 billion for the Americas, $73.0 billion for EMEA, and $33.2 billion for APJC. During the fourth quarter of fiscal 2021, we performed a sensitivity analysis for goodwill impairment with respect to each of our respective reporting units and determined that a hypothetical 10% decline in the fair value of each reporting unit would not result in an impairment of goodwill for any reporting unit. The fair value of acquired technology and patents, as well as acquired technology under development, is determined at acquisition date primarily using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations are typically derived from a weighted-average cost of capital analysis and then adjusted to reflect risks inherent in the development lifecycle as appropriate. We consider the pricing model for products related to these acquisitions to be standard within the high-technology communications industry, and the applicable discount rates represent the rates that market participants would use for valuation of such intangible assets. We make judgments about the recoverability of purchased intangible assets with finite lives whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of purchased intangible assets with finite lives is measured by comparing the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. We review indefinite-lived intangible assets for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Assumptions and estimates about future values and remaining useful lives of our purchased intangible assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. Our ongoing consideration of all the factors described previously could result in impairment charges in the future, which could adversely affect our net income. Income TaxesWe are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective tax rates differ from the statutory rate, primarily due to the tax impact of state taxes, foreign operations, R&D tax credits, foreign-derived intangible income deductions, global intangible low-taxed income, tax audit settlements, nondeductible compensation, international realignments, and transfer pricing adjustments. Our effective tax rate was 20.1%, 19.7%, and 20.2% in fiscal 2021, 2020, and 2019, respectively.34Table of ContentsSignificant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties.Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by changes to foreign-derived intangible income deduction, global intangible low-tax income and base erosion and anti-abuse tax laws, regulations, or interpretations thereof; by expiration of or lapses in tax incentives; by transfer pricing adjustments, including the effect of acquisitions on our legal structure; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations, treaties, or interpretations thereof, including changes to the taxation of earnings of our foreign subsidiaries, the deductibility of expenses attributable to foreign income, and the foreign tax credit rules. Significant judgment is required to determine the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The Organisation for Economic Co-operation and Development (OECD), an international association comprised of 38 countries, including the United States, has made changes and is contemplating additional changes to numerous long-standing tax principles. There can be no assurance that these changes and any contemplated changes if finalized, once adopted by countries, will not have an adverse impact on our provision for income taxes. As a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries was subject to reduced tax rates. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service (IRS) and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse impact on our operating results and financial condition. 35Table of ContentsRESULTS OF OPERATIONSA discussion regarding our financial condition and results of operations for fiscal 2021 compared to fiscal 2020 is presented below. A discussion regarding our financial condition and results of operations for fiscal 2020 compared to fiscal 2019 can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year ended July 25, 2020, filed with the SEC on September 3, 2020. RevenueThe following table presents the breakdown of revenue between product and service (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentRevenue:Product$36,014 $35,978 $39,005 $36 — %Percentage of revenue72.3 %73.0 %75.1 % Service13,804 13,323 12,899 481 4 %Percentage of revenue27.7 %27.0 %24.9 % Total$49,818 $49,301 $51,904 $517 1 %We manage our business primarily on a geographic basis, organized into three geographic segments. Our revenue, which includes product and service for each segment, is summarized in the following table (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentRevenue: Americas$29,161 $29,291 $30,927 $(130)— %Percentage of revenue58.5 %59.4 %59.6 % EMEA12,951 12,659 13,100 292 2 %Percentage of revenue26.0 %25.7 %25.2 % APJC7,706 7,352 7,877 354 5 %Percentage of revenue15.5 %14.9 %15.2 % Total$49,818 $49,301 $51,904 $517 1 %Amounts may not sum and percentages may not recalculate due to rounding. Total revenue in fiscal 2021 increased by 1% compared with fiscal 2020. Product revenue was flat and service revenue increased by 4%. Our total revenue reflected growth in EMEA and APJC. Americas was flat. Product revenue for the emerging countries of BRICM, in the aggregate, experienced a 6% product revenue decline, with decreases in each of these countries with the exception of India.In addition to the impact of macroeconomic factors, including the IT spending environment and the level of spending by government entities, revenue by segment in a particular period may be significantly impacted by several factors related to revenue recognition, including the complexity of transactions such as multiple performance obligations; the mix of financing arrangements provided to channel partners and customers; and final acceptance of the product, system, or solution, among other factors. In addition, certain customers tend to make large and sporadic purchases, and the revenue related to these transactions may also be affected by the timing of revenue recognition, which in turn would impact the revenue of the relevant segment. 36Table of ContentsProduct Revenue by SegmentThe following table presents the breakdown of product revenue by segment (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentProduct revenue: Americas$20,688 $21,006 $22,754 $(318)(2)%Percentage of product revenue57.5 %58.4 %58.3 % EMEA9,805 9,647 10,246 158 2 %Percentage of product revenue27.2 %26.8 %26.3 % APJC5,521 5,326 6,005 195 4 %Percentage of product revenue15.3 %14.8 %15.4 % Total$36,014 $35,978 $39,005 $36 — %Amounts may not sum and percentages may not recalculate due to rounding. AmericasProduct revenue in the Americas segment decreased by 2%. The product revenue decrease was driven by declines in the enterprise and commercial markets, partially offset by growth in the public sector and service provider markets. From a country perspective, product revenue decreased by 1% in the United States, 18% in Mexico, and 9% in Brazil, partially offset by a product revenue increase of 4% in Canada. EMEAThe increase in product revenue in the EMEA segment of 2% was driven by growth in the service provider and public sector markets, partially offset by declines in the commercial and enterprise markets. Product revenue from emerging countries within EMEA decreased by 7%, and product revenue for the remainder of the EMEA segment, which primarily consists of countries in Western Europe, increased by 4%. From a country perspective, product revenue increased by 4% in Germany, partially offset by declines in the United Kingdom and France by 1% and 2%, respectively.APJCProduct revenue in the APJC segment increased by 4%, driven by growth in the public sector, service provider and enterprise markets, partially offset by declines in the commercial market. From a country perspective, product revenue increased in Japan, Australia and India by 11%, 6% and 3%, respectively, partially offset by a decline of 4% in China.37Table of ContentsProduct Revenue by CategoryIn addition to the primary view on a geographic basis, we also prepare financial information related to product categories and customer markets for various purposes. We report our product revenue in the following categories: Infrastructure Platforms, Applications, Security, and Other Products.The following table presents product revenue by category (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentProduct revenue: Infrastructure Platforms$27,109 $27,219 $30,184 $(110)— %Applications5,504 5,568 5,803 (64)(1)%Security3,382 3,158 2,822 224 7 %Other Products19 33 196 (14)(43)%Total$36,014 $35,978 $39,005 $36 — %Amounts may not sum and percentages may not recalculate due to rounding. Prior period amounts have been reclassified to conform to the current period’s presentation. Infrastructure PlatformsThe Infrastructure Platforms product category represents our core networking offerings related to switching, routing, wireless, and the data center. Infrastructure Platforms revenue was flat compared to fiscal 2020, with growth in routing and wireless, offset by declines in switching and data center. This was the product area most impacted by the COVID-19 pandemic environment in the first half of fiscal 2021. Switching revenue declined in both campus switching and data center switching, although we had strong revenue growth in our Catalyst 9000 Series, Meraki switching offerings and Nexus 9000 Series. We experienced an increase in sales of routing products, with growth primarily in the service provider market. Wireless had strong growth driven by our Meraki and WiFi-6 products. Revenue from data center declined driven by continued market contraction impacting primarily our servers products.ApplicationsThe Applications product category includes our collaboration offerings (unified communications, Cisco TelePresence and conferencing) as well as IoT and AppDynamics analytics software offerings. Revenue in our Applications product category decreased by 1%, or $64 million, with a decline in Unified Communications and Cisco TelePresence partially offset by double digit growth in IoT software offerings and growth in Webex.SecurityRevenue in our Security product category increased 7%, or $224 million. Revenue from our cloud security portfolio reflected strong double-digit growth and continued momentum with our Duo and Umbrella offerings.38Table of ContentsService Revenue by SegmentThe following table presents the breakdown of service revenue by segment (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentService revenue: Americas$8,472 $8,285 $8,173 $187 2 %Percentage of service revenue61.4 %62.2 %63.4 %EMEA3,146 3,012 2,854 134 4 %Percentage of service revenue22.8 %22.6 %22.1 %APJC2,186 2,026 1,872 160 8 %Percentage of service revenue15.8 %15.2 %14.5 %Total$13,804 $13,323 $12,899 $481 4 %Amounts may not sum and percentages may not recalculate due to rounding. Service revenue increased 4%, driven by growth in our maintenance business and solution support offerings. Service revenue increased across all geographic segments. Service revenue benefited from the extra week in fiscal 2021.Gross MarginThe following table presents the gross margin for products and services (in millions, except percentages):AMOUNTPERCENTAGEYears EndedJuly 31, 2021July 25, 2020July 27, 2019July 31, 2021July 25, 2020July 27, 2019Gross margin:Product$22,714 $22,779 $24,142 63.1 %63.3 %61.9 %Service9,180 8,904 8,524 66.5 %66.8 %66.1 %Total$31,894 $31,683 $32,666 64.0 %64.3 %62.9 %Product Gross MarginThe following table summarizes the key factors that contributed to the change in product gross margin percentage from fiscal 2020 to fiscal 2021:Product Gross Margin PercentageFiscal 202063.3 %Productivity (1)0.8 %Product pricing(1.2)%Mix of products sold0.6 %Legal and indemnification charge(0.1)%Others(0.3)%Fiscal 202163.1 % (1) Productivity includes overall manufacturing-related costs, such as component costs, warranty expense, provision for inventory, freight, logistics, shipment volume, and other items not categorized elsewhere.Product gross margin decreased by 0.2 percentage points driven by pricing erosion, partially offset by favorable product mix and lower productivity benefits. The effect of pricing erosion was moderate driven by typical market factors and impacted each of our geographic segments. Productivity improvements were adversely impacted by ongoing costs related to supply chain constraints. The favorable mix was driven by changes in the proportion of products sold from each of our product categories. During fiscal 2021, we continued to manage through supply chain challenges seen industry wide due to component shortages, caused in part by the COVID-19 pandemic. These challenges resulted in increased costs (i.e. component costs, broker fees, 39Table of Contentsexpedited freight and overtime) which had a negative impact on product gross margin, and extended lead times to us and our customers. We have partnered with several of our key suppliers utilizing our volume purchasing and extending supply coverage, including revising supplier arrangements, to address supply chain challenges. We believe these actions will enable us to optimize our access to critical components, including semiconductors. We expect these supply chain challenges to continue through at least the first half of fiscal 2022 and potentially into the second half of fiscal 2022. Productivity improvements were driven by memory cost savings and other cost reductions including value engineering efforts (e.g. component redesign, board configuration, test processes and transformation processes) and continued operational efficiency in manufacturing operations.Service Gross MarginOur service gross margin percentage decreased by 0.3 percentage points primarily due to higher headcount-related and delivery costs, partially offset by higher sales volume and to a lesser extent, favorable mix of service offerings.Our service gross margin normally experiences some fluctuations due to various factors such as the timing of contract initiations in our renewals, our strategic investments in headcount, and the resources we deploy to support the overall service business. Other factors include the mix of service offerings, as the gross margin from our advanced services is typically lower than the gross margin from technical support services.Gross Margin by SegmentThe following table presents the total gross margin for each segment (in millions, except percentages):AMOUNTPERCENTAGEYears EndedJuly 31, 2021July 25, 2020July 27, 2019July 31, 2021July 25, 2020July 27, 2019Gross margin:Americas$19,499 $19,547 $20,338 66.9 %66.7 %65.8 %EMEA8,466 8,304 8,457 65.4 %65.6 %64.6 %APJC4,949 4,688 4,683 64.2 %63.8 %59.5 %Segment total32,914 32,538 33,479 66.1 %66.0 %64.5 %Unallocated corporate items (1)(1,020)(855)(813)Total$31,894 $31,683 $32,666 64.0 %64.3 %62.9 % (1) The unallocated corporate items include the effects of amortization and impairments of acquisition-related intangible assets, share-based compensation expense, significant litigation settlements and other contingencies, charges related to asset impairments and restructurings, and certain other charges. We do not allocate these items to the gross margin for each segment because management does not include such information in measuring the performance of the operating segments. Amounts may not sum and percentages may not recalculate due to rounding. We experienced a gross margin percentage increase in our Americas segment due to favorable product mix and productivity improvements, partially offset by pricing erosion. Gross margin in our EMEA segment decreased due to pricing erosion, partially offset by productivity improvements and, to a lesser extent, favorable product mix. Lower service gross margin also contributed to the decrease in the gross margin in this geographic segment.The APJC segment gross margin percentage increase was due to productivity improvements and favorable product mix, partially offset by pricing erosion.The gross margin percentage for a particular segment may fluctuate, and period-to-period changes in such percentages may or may not be indicative of a trend for that segment.40Table of ContentsResearch and Development (“R&D”), Sales and Marketing, and General and Administrative (“G&A”) ExpensesR&D, sales and marketing, and G&A expenses are summarized in the following table (in millions, except percentages):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsVariance in PercentResearch and development$6,549 $6,347 $6,577 $202 3 %Percentage of revenue13.1 %12.9 %12.7 %Sales and marketing9,259 9,169 9,571 90 1 %Percentage of revenue18.6 %18.6 %18.4 %General and administrative2,152 1,925 1,827 227 12 %Percentage of revenue4.3 %3.9 %3.5 %Total$17,960 $17,441 $17,975 $519 3 %Percentage of revenue36.1 %35.4 %34.6 %Fiscal 2021 had an extra week compared to fiscal 2020. The extra week in fiscal 2021 contributed to the increase in headcount-related expenses in our R&D, sales and marketing, and G&A expenses.R&D ExpensesR&D expenses increased due to higher headcount-related expenses, higher share-based compensation expense, higher acquisition-related costs and higher contracted services spending, partially offset by lower discretionary spending.We continue to invest in R&D in order to bring a broad range of products to market in a timely fashion. If we believe that we are unable to enter a particular market in a timely manner with internally developed products, we may purchase or license technology from other businesses, or we may partner with or acquire businesses as an alternative to internal R&D. Sales and Marketing ExpensesSales and marketing expenses increased primarily due to higher headcount-related expenses, higher contracted services spending and higher share-based compensation expense, partially offset by lower discretionary spending. G&A ExpensesG&A expenses increased due to the impact from the gain recognized on the sale of property in fiscal 2020 and higher headcount-related expenses.Effect of Foreign CurrencyIn fiscal 2021, foreign currency fluctuations, net of hedging, increased the combined R&D, sales and marketing, and G&A expenses by approximately $214 million, or 1.2%, compared with fiscal 2020. Amortization of Purchased Intangible AssetsThe following table presents the amortization of purchased intangible assets (in millions):Years EndedJuly 31, 2021July 25, 2020July 27, 2019Amortization of purchased intangible assets:Cost of sales$716 $659 $624 Operating expenses215 141 150 Total$931 $800 $774 The increase in amortization of purchased intangible assets was due largely to the amortization of purchased intangibles from our recent acquisitions.41Table of ContentsRestructuring and Other ChargesThe following table presents restructuring and other charges (in millions):Years EndedJuly 31, 2021July 25, 2020July 27, 2019Restructuring and other charges included in operating expenses$886 $481 $322 In the first quarter of fiscal 2021, we initiated a restructuring plan, which included a voluntary early retirement program, in order to realign the organization and enable further investment in key priority areas. The total pretax charges are estimated to be approximately $900 million. In connection with this restructuring plan, we incurred charges of $881 million during fiscal 2021. We substantially completed the Fiscal 2021 Plan in fiscal 2021 and do not expect any remaining charges related to this plan to be material. We estimate the Fiscal 2021 Plan will generate cost savings of approximately $1.0 billion on an annualized basis.We incurred total restructuring and other charges of $886 million in fiscal 2021. We incurred charges of $881 million related to the restructuring plan initiated during fiscal 2021 and the remainder of which was related to the restructuring plan announced during fiscal 2020.Operating IncomeThe following table presents our operating income and our operating income as a percentage of revenue (in millions, except percentages):Years EndedJuly 31, 2021July 25, 2020July 27, 2019Operating income$12,833 $13,620 $14,219 Operating income as a percentage of revenue25.8 %27.6 %27.4 %Operating income decreased by 6%, and as a percentage of revenue operating income decreased by 1.8 percentage points. These changes resulted primarily from: higher restructuring and other charges and a gross margin percentage decrease (driven by pricing erosion, partially offset by productivity improvements and product mix), partially offset by a revenue increase.Interest and Other Income (Loss), NetInterest Income (Expense), Net The following table summarizes interest income and interest expense (in millions):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsInterest income$618 $920 $1,308 $(302)Interest expense(434)(585)(859)151 Interest income (expense), net$184 $335 $449 $(151)Interest income decreased driven by lower interest rates and lower average balances of cash and available-for-sale debt investments. The decrease in interest expense was driven by a lower average debt balance and the impact of lower effective interest rates. 42Table of ContentsOther Income (Loss), Net The components of other income (loss), net, are summarized as follows (in millions):Years Ended2021 vs. 2020July 31, 2021July 25, 2020July 27, 2019Variance in DollarsGains (losses) on investments, net:Available-for-sale debt investments$53 $42 $(13)$11 Marketable equity investments6 (5)(3)11 Privately held investments266 95 6 171 Net gains (losses) on investments325 132 (10)193 Other gains (losses), net(80)(117)(87)37 Other income (loss), net$245 $15 $(97)$230 The change in net gains (losses) on available-for-sale debt investments was primarily attributable to higher realized gains as a result of market conditions, and the timing of sales of these investments. The change in net gains (losses) on marketable equity investments was attributable to market value fluctuations and the timing of recognition of gains and losses. The change in net gains (losses) on privately held investments was primarily due to higher net unrealized gains and lower impairment charges, partially offset by lower realized gains. The change in other gains (losses), net was primarily driven by lower donation expense and favorable impacts from our equity derivatives, partially offset by unfavorable impacts from foreign exchange.Provision for Income Taxes The provision for income taxes resulted in an effective tax rate of 20.1% for fiscal 2021, compared with 19.7% for fiscal 2020. The net 0.4 percentage points increase in the effective tax rate was primarily due to a decrease in the tax benefit from foreign income taxed at other than U.S. rates, offset by an increase in foreign-derived intangible income deduction and a decrease in state taxes.For a full reconciliation of our effective tax rate to the U.S. federal statutory rate of 21% and for further explanation of our provision for income taxes, see Note 18 to the Consolidated Financial Statements.43Table of ContentsLIQUIDITY AND CAPITAL RESOURCESThe following sections discuss the effects of changes in our balance sheet, our capital allocation strategy including stock repurchase program and dividends, our contractual obligations, and certain other commitments and activities on our liquidity and capital resources.Balance Sheet and Cash FlowsCash and Cash Equivalents and Investments The following table summarizes our cash and cash equivalents and investments (in millions): July 31, 2021July 25, 2020Increase (Decrease)Cash and cash equivalents$9,175 $11,809 $(2,634)Available-for-sale debt investments15,206 17,610 (2,404)Marketable equity securities137 — 137 Total$24,518 $29,419 $(4,901)The net decrease in cash and cash equivalents and investments from fiscal 2020 to fiscal 2021 was primarily driven by net cash paid for acquisitions and divestitures of $7.0 billion, cash returned to stockholders in the form of repurchases of common stock of $2.9 billion under the stock repurchase program and cash dividends of $6.2 billion, net decrease in debt of $3.0 billion, net increase in restricted cash of $0.8 billion, and capital expenditures of $0.7 billion. These uses of cash were partially offset by cash provided by operating activities of $15.5 billion.In addition to cash requirements in the normal course of business, we have approximately $0.7 billion of the U.S. transition tax on accumulated earnings for foreign subsidiaries and $2.5 billion of long-term debt outstanding at July 31, 2021 that will mature within the next 12 months from the balance sheet date. See further discussion of liquidity and future payments under “Contractual Obligations” and “Liquidity and Capital Resource Requirements” below.We maintain an investment portfolio of various holdings, types, and maturities. We classify our investments as short-term investments based on their nature and their availability for use in current operations. We believe the overall credit quality of our portfolio is strong, with our cash equivalents and our available-for-sale debt investment portfolio consisting primarily of high quality investment-grade securities. We believe that our strong cash and cash equivalents and investments position is critical at this time of uncertainty due to the COVID-19 pandemic and allows us to use our cash resources for strategic investments to gain access to new technologies, for acquisitions, for customer financing activities, for working capital needs, and for the repurchase of shares of common stock and payment of dividends as discussed below.Securities Lending We periodically engage in securities lending activities with certain of our available-for-sale debt investments. These transactions are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. We require collateral equal to at least 102% of the fair market value of the loaned security and that the collateral be in the form of cash or liquid, high-quality assets. We engage in these secured lending transactions only with highly creditworthy counterparties, and the associated portfolio custodian has agreed to indemnify us against collateral losses. We did not experience any losses in connection with the secured lending of securities during the periods presented.Free Cash Flow and Capital Allocation As part of our capital allocation strategy, we intend to return a minimum of 50% of our free cash flow annually to our stockholders through cash dividends and repurchases of common stock.We define free cash flow as net cash provided by operating activities less cash used to acquire property and equipment. The following table reconciles our net cash provided by operating activities to free cash flow (in millions):Years EndedJuly 31, 2021July 25, 2020July 27, 2019Net cash provided by operating activities$15,454 $15,426 $15,831 Acquisition of property and equipment(692)(770)(909)Free cash flow$14,762 $14,656 $14,922 We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, the rate at which products are shipped during the quarter (which we refer to as shipment linearity), the timing and collection of accounts receivable and financing receivables, inventory and supply chain management, deferred revenue and the timing and amount of tax and other payments. For additional discussion, see “Part I, Item 1A. Risk Factors” in this report.44Table of ContentsWe consider free cash flow to be a liquidity measure that provides useful information to management and investors because of our intent to return a stated percentage of free cash flow to stockholders in the form of dividends and stock repurchases. We further regard free cash flow as a useful measure because it reflects cash that can be used to, among other things, invest in our business, make strategic acquisitions, repurchase common stock, and pay dividends on our common stock, after deducting capital investments. A limitation of the utility of free cash flow as a measure of financial performance and liquidity is that the free cash flow does not represent the total increase or decrease in our cash balance for the period. In addition, we have other required uses of cash, including repaying the principal of our outstanding indebtedness. Free cash flow is not a measure calculated in accordance with U.S. generally accepted accounting principles and should not be regarded in isolation or as an alternative for net cash provided by operating activities or any other measure calculated in accordance with such principles, and other companies may calculate free cash flow in a different manner than we do. The following table summarizes the dividends paid and stock repurchases (in millions, except per-share amounts):DIVIDENDSSTOCK REPURCHASE PROGRAMTOTALYears EndedPer ShareAmountSharesWeighted-Average Price per ShareAmountAmountJuly 31, 2021$1.46 $6,163 64 $45.48 $2,902 $9,065 July 25, 2020$1.42 $6,016 59 $44.36 $2,619 $8,635 July 27, 2019$1.36 $5,979 418 $49.22 $20,577 $26,556 Any future dividends are subject to the approval of our Board of Directors. The remaining authorized amount for stock repurchases under this program is approximately $7.9 billion, with no termination date. Accounts Receivable, Net The following table summarizes our accounts receivable, net (in millions): July 31, 2021July 25, 2020Increase (Decrease)Accounts receivable, net$5,766 $5,472 $294 Our accounts receivable net, as of July 31, 2021 increased by approximately 5% compared with the end of fiscal 2020. Inventory Supply Chain The following table summarizes our inventories (in millions): July 31, 2021July 25, 2020Increase (Decrease)Inventories$1,559 $1,282 $277 Inventory as of July 31, 2021 increased by 22% from our inventory balance at the end of fiscal 2020. The increase in inventory was primarily due to an increase in raw materials, partially offset by a decrease in finished goods. We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements and our commitment to securing manufacturing capacity. Our purchase commitments are for short-term product manufacturing requirements as well as for commitments to suppliers to secure manufacturing capacity. Certain of our purchase commitments with contract manufacturers and suppliers relate to arrangements to secure long-term supply and pricing for certain product components for multi-year periods. A significant portion of our reported purchase commitments arising from these agreements are firm, noncancelable, and unconditional commitments. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. We believe our inventory and purchase commitments are in line with our current demand forecasts. 45Table of ContentsThe following table summarizes our purchase commitments with contract manufacturers and suppliers (in millions):Commitments by PeriodJuly 31, 2021July 25, 2020Less than 1 year$6,903 $3,994 1 to 3 years1,806 412 3 to 5 years1,545 — Total$10,254 $4,406 The increase in purchase commitments with contract manufacturers and suppliers compared with the end of fiscal 2020 was due to arrangements to secure long-term supply and pricing for certain product components for multi-year periods. We have partnered with several of our key suppliers utilizing our volume purchasing and extending supply coverage, including revising supplier arrangements, to address supply chain challenges.Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence because of rapidly changing technology and customer requirements. We believe the amount of our inventory and purchase commitments is appropriate for our revenue levels.Financing Receivables and Guarantees The following table summarizes our financing receivables (in millions): July 31, 2021July 25, 2020Increase (Decrease)Lease receivables, net$1,697 $2,088 $(391)Loan receivables, net5,117 5,856 (739)Financed service contracts, net2,450 2,821 (371)Total, net$9,264 $10,765 $(1,501)Financing Receivables Our financing arrangements include leases, loans, and financed service contracts. Lease receivables include sales-type leases. Arrangements related to leases are generally collateralized by a security interest in the underlying assets. Our loan receivables include customer financing for purchases of our hardware, software and services and also may include additional funds for other costs associated with network installation and integration of our products and services. We also provide financing to certain qualified customers for long-term service contracts, which primarily relate to technical support services. The majority of the revenue from these financed service contracts is deferred and is recognized ratably over the period during which the services are performed. Financing receivables decreased by 14%.Financing Guarantees In the normal course of business, third parties may provide financing arrangements to our customers and channel partners under financing programs. The financing arrangements to customers provided by third parties are related to leases and loans and typically have terms of up to three years. In some cases, we provide guarantees to third parties for these lease and loan arrangements. The financing arrangements to channel partners consist of revolving short-term financing provided by third parties, with payment terms generally ranging from 60 to 90 days. In certain instances, these financing arrangements result in a transfer of our receivables to the third party. The receivables are derecognized upon transfer, as these transfers qualify as true sales, and we receive payments for the receivables from the third party based on our standard payment terms. The volume of channel partner financing was $26.7 billion, $26.9 billion, and $29.6 billion in fiscal 2021, 2020, and 2019, respectively. These financing arrangements facilitate the working capital requirements of the channel partners, and in some cases, we guarantee a portion of these arrangements. The balance of the channel partner financing subject to guarantees was $1.3 billion and $1.1 billion as of July 31, 2021 and July 25, 2020, respectively. We could be called upon to make payments under these guarantees in the event of nonpayment by the channel partners or end-user customers. Historically, our payments under these arrangements have been immaterial. Where we provide a guarantee, we defer the revenue associated with the channel partner and end-user financing arrangement in accordance with revenue recognition policies, or we record a liability for the fair value of the guarantees. In either case, the deferred revenue is recognized as revenue when the guarantee is removed. As of July 31, 2021, the total maximum potential future payments related to these guarantees was approximately $160 million, of which approximately $21 million was recorded as deferred revenue.46Table of ContentsBorrowingsSenior Notes The following table summarizes the principal amount of our senior notes (in millions): Maturity DateJuly 31, 2021July 25, 2020Senior notes:Fixed-rate notes:2.20%February 28, 2021$— $2,500 2.90%March 4, 2021— 500 1.85%September 20, 20212,000 2,000 3.00%June 15, 2022500 500 2.60%February 28, 2023500 500 2.20%September 20, 2023750 750 3.625%March 4, 20241,000 1,000 3.50%June 15, 2025500 500 2.95%February 28, 2026750 750 2.50%September 20, 20261,500 1,500 5.90%February 15, 20392,000 2,000 5.50%January 15, 20402,000 2,000 Total$11,500 $14,500 Interest is payable semiannually on each class of the senior fixed-rate notes, each of which is redeemable by us at any time, subject to a make-whole premium. We were in compliance with all debt covenants as of July 31, 2021.Our $2.0 billion senior fixed-rate notes with a maturity date of September 20, 2021 were redeemed on August 20, 2021, pursuant to our par call redemption option. The redemption price was equal to 100% of the principal amount plus any accrued and unpaid interest to, but excluding, August 20, 2021.Commercial Paper We have a short-term debt financing program in which up to $10.0 billion is available through the issuance of commercial paper notes. We use the proceeds from the issuance of commercial paper notes for general corporate purposes. We had no commercial paper outstanding as of July 31, 2021 and July 25, 2020.Credit Facility On May 13, 2021, we entered into a 5-year credit agreement with certain institutional lenders that provides for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on May 13, 2026. The credit agreement is structured as an amendment and restatement of our 364-day credit agreement which would have terminated on May 14, 2021. As of July 31, 2021, we were in compliance with the required interest coverage ratio and the other covenants, and we had not borrowed any funds under the credit agreement. Any advances under the 5-year credit agreement will accrue interest at rates that are equal to, based on certain conditions, either (a) with respect to loans in U.S. dollars, (i) LIBOR or (ii) the Base Rate (to be defined as the highest of (x) the Bank of America prime rate, (y) the Federal Funds rate plus 0.50% and (z) a daily rate equal to one-month LIBOR plus 1.0%), (b) with respect to loans in Euros, EURIBOR, (c) with respect to loans in Yen, TIBOR and (d) with respect to loans in Pounds Sterling, SONIA plus a credit spread adjustment, plus a margin that is based on our senior debt credit ratings as published by Standard & Poor’s Financial Services, LLC and Moody’s Investors Service, Inc., provided that in no event will the interest rate be less than 0.0%. We will pay a quarterly commitment fee during the term of the 5-year credit agreement which may vary depending on our senior debt credit ratings. In addition, the 5-year credit agreement incorporates certain sustainability-linked metrics. Specifically, our applicable interest rate and commitment fee are subject to upward or downward adjustments if we achieve, or fail to achieve, certain specified targets based on two key performance indicator metrics: (i) social impact and (ii) foam reduction. We may also, upon the agreement of either the then-existing lenders or additional lenders not currently parties to the agreement, increase the commitments under the credit facility by up to an additional $2.0 billion and, at our option, extend the maturity of the facility for an additional year up to two times. The credit agreement requires that we comply with certain covenants, including that we maintain an interest coverage ratio as defined in the agreement.47Table of ContentsRemaining Performance Obligations The following table presents the breakdown of remaining performance obligations (in millions): July 31, 2021July 25, 2020Increase (Decrease)Product$13,270 $11,261 $2,009 Service17,623 17,093 530 Total$30,893 $28,354 $2,539 Total remaining performance obligations increased 9% in fiscal 2021. Remaining performance obligations for product and service increased 18% and 3%, respectively, compared to fiscal 2020.Deferred Revenue The following table presents the breakdown of deferred revenue (in millions): July 31, 2021July 25, 2020Increase (Decrease)Product$9,416 $7,895 $1,521 Service12,748 12,551 197 Total$22,164 $20,446 $1,718 Reported as:Current$12,148 $11,406 $742 Noncurrent10,016 9,040 976 Total$22,164 $20,446 $1,718 Total deferred revenue increased 8% in fiscal 2021. The increase in deferred product revenue of 19% was primarily due to increased deferrals related to our recurring software offerings. The increase in deferred service revenue was driven by the impact of contract renewals, partially offset by amortization of deferred service revenue.Contractual Obligations The impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with the factors that impact our cash flows from operations discussed previously. In addition, we plan for and measure our liquidity and capital resources through an annual budgeting process. The following table summarizes our contractual obligations at July 31, 2021 (in millions): PAYMENTS DUE BY PERIODJuly 31, 2021TotalLess than 1 Year1 to 3 Years3 to 5 YearsMore than 5 YearsOperating leases$1,245 $355 $474 $197 $219 Purchase commitments with contract manufacturers and suppliers10,254 6,903 1,806 1,545 — Other purchase obligations1,074 584 336 96 58 Senior notes11,500 2,500 2,250 1,250 5,500 Transition tax payable6,910 727 2,091 4,092 — Other long-term liabilities1,428 — 291 160 977 Total by period$32,411 $11,069 $7,248 $7,340 $6,754 Other long-term liabilities (uncertainty in the timing of future payments)2,490 Total$34,901 Operating Leases For more information on our operating leases, see Note 8 to the Consolidated Financial Statements.Purchase Commitments with Contract Manufacturers and Suppliers We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. Our purchase commitments are for short-term product manufacturing requirements as well as for commitments to suppliers to secure manufacturing capacity. Certain of our purchase commitments with contract manufacturers and suppliers relate to arrangements to secure long-term pricing for certain product components for multi-year periods. A significant portion of our reported estimated purchase 48Table of Contentscommitments arising from these agreements are firm, noncancelable, and unconditional commitments. We record a liability for firm, noncancelable, and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. See further discussion in “Inventory Supply Chain.” Other Purchase Obligations Other purchase obligations represent an estimate of all contractual obligations in the ordinary course of business, other than operating leases and commitments with contract manufacturers and suppliers, for which we have not received the goods or services. Purchase orders are not included in the preceding table as they typically represent our authorization to purchase rather than binding contractual purchase obligations. Long-Term Debt The amount of long-term debt in the preceding table represents the principal amount of the respective debt instruments. See Note 12 to the Consolidated Financial Statements.Transition Tax Payable Transition tax payable represents future cash tax payments associated with the one-time U.S. transition tax on accumulated earnings of foreign subsidiaries as a result of the Tax Cuts and Jobs Act (“the Tax Act”). See Note 18 to the Consolidated Financial Statements.Other Long-Term Liabilities Other long-term liabilities primarily include noncurrent income taxes payable, accrued liabilities for deferred compensation, deferred tax liabilities, and certain other long-term liabilities. Due to the uncertainty in the timing of future payments, our noncurrent income taxes payable of approximately $2.4 billion and deferred tax liabilities of $134 million were presented as one aggregated amount in the total column on a separate line in the preceding table. Noncurrent income taxes payable include uncertain tax positions. See Note 18 to the Consolidated Financial Statements.Other CommitmentsIn connection with our acquisitions, we have agreed to pay certain additional amounts contingent upon the achievement of certain agreed-upon technology, development, product, or other milestones or the continued employment with us of certain employees of the acquired entities. See Note 14 to the Consolidated Financial Statements.We also have certain funding commitments primarily related to our privately held investments, some of which may be based on the achievement of certain agreed-upon milestones, and some of which are required to be funded on demand. The funding commitments were $0.2 billion and $0.3 billion as of July 31, 2021 and July 25, 2020, respectively.Off-Balance Sheet ArrangementsWe consider our investments in unconsolidated variable interest entities to be off-balance sheet arrangements. In the ordinary course of business, we have privately held investments and provide financing to certain customers. Certain of these investments are considered to be variable interest entities. We evaluate on an ongoing basis our privately held investments and customer financings, and we have determined that as of July 31, 2021 there were no material unconsolidated variable interest entities.On an ongoing basis, we reassess our privately held investments and customer financings to determine if they are variable interest entities and if we would be regarded as the primary beneficiary pursuant to the applicable accounting guidance. As a result of this ongoing assessment, we may be required to make additional disclosures or consolidate these entities. Because we may not control these entities, we may not have the ability to influence these events.We provide financing guarantees, which are generally for various third-party financing arrangements extended to our channel partners and end-user customers. We could be called upon to make payments under these guarantees in the event of nonpayment by the channel partners or end-user customers. See the previous discussion of these financing guarantees under “Financing Receivables and Guarantees.”Liquidity and Capital Resource RequirementsWhile the COVID-19 pandemic has not materially impacted our liquidity and capital resources to date, it has led to increased disruption and volatility in capital markets and credit markets. The pandemic and resulting economic uncertainty could adversely affect our liquidity and capital resources in the future. Based on past performance and current expectations, we believe our cash and cash equivalents, investments, cash generated from operations, and ability to access capital markets and committed credit lines will satisfy, through at least the next 12 months, our liquidity requirements, both in total and domestically, including the following: working capital needs, capital expenditures, investment requirements, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on debt, pending acquisitions, future customer financings, and other liquidity requirements associated with our operations. There are no other transactions, arrangements, or relationships with unconsolidated entities or other persons that are reasonably likely to materially affect the liquidity and the availability of, as well as our requirements for, capital resources. 49Table of ContentsItem 7A.Quantitative and Qualitative Disclosures About Market RiskOur financial position is exposed to a variety of risks, including interest rate risk, equity price risk, and foreign currency exchange risk. We have seen an increase in these risks and related uncertainties with increased volatility in the financial markets in the current environment with the COVID-19 pandemic.Interest Rate RiskAvailable-for-Sale Debt Investments We maintain an investment portfolio of various holdings, types, and maturities. Our primary objective for holding available-for-sale debt investments is to achieve an appropriate investment return consistent with preserving principal and managing risk. At any time, a sharp rise in market interest rates could have a material adverse impact on the fair value of our available-for-sale debt investment portfolio. Conversely, declines in interest rates as has also happened recently, including the impact from lower credit spreads, could have a material adverse impact on interest income for our investment portfolio. We may utilize derivative instruments designated as hedging instruments to achieve our investment objectives. We had no outstanding hedging instruments for our available-for-sale debt investments as of July 31, 2021. Our available-for-sale debt investments are held for purposes other than trading. Our available-for-sale debt investments are not leveraged as of July 31, 2021. We monitor our interest rate and credit risks, including our credit exposures to specific rating categories and to individual issuers. We believe the overall credit quality of our portfolio is strong.The following tables present the hypothetical fair values of our available-for-sale debt investments, including the hedging effects when applicable, as a result of selected potential market decreases and increases in interest rates. The market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (BPS), plus 100 BPS, and plus 150 BPS. The hypothetical fair values as of July 31, 2021 and July 25, 2020 are as follows (in millions): VALUATION OF SECURITIESGIVEN AN INTEREST RATEDECREASE OF X BASIS POINTSFAIR VALUEAS OF JULY 31, 2021VALUATION OF SECURITIESGIVEN AN INTEREST RATEINCREASE OF X BASIS POINTS (150 BPS)(100 BPS)(50 BPS)50 BPS100 BPS150 BPSAvailable-for-sale debt investments$15,537$15,427$15,317$15,206$15,096$14,986$14,875 VALUATION OF SECURITIESGIVEN AN INTEREST RATEDECREASE OF X BASIS POINTSFAIR VALUEAS OF JULY 25, 2020VALUATION OF SECURITIESGIVEN AN INTEREST RATEINCREASE OF X BASIS POINTS (150 BPS)(100 BPS)(50 BPS)50 BPS100 BPS150 BPSAvailable-for-sale debt investments$17,877$17,788$17,699$17,610$17,522$17,433$17,344Financing Receivables As of July 31, 2021, our financing receivables had a carrying value of $9.3 billion, compared with $10.8 billion as of July 25, 2020. As of July 31, 2021, a hypothetical 50 BPS increase or decrease in market interest rates would change the fair value of our financing receivables by a decrease or increase of approximately $0.1 billion, respectively. Debt As of July 31, 2021, we had $11.5 billion in principal amount of senior fixed-rate notes outstanding. The carrying amount of the senior notes was $11.5 billion, and the related fair value based on market prices was $13.7 billion. As of July 31, 2021, a hypothetical 50 BPS increase or decrease in market interest rates would change the fair value of the fixed-rate debt, excluding the $2.0 billion of hedged debt, by a decrease or increase of approximately $0.4 billion, respectively. However, this hypothetical change in interest rates would not impact the interest expense on the fixed-rate debt that is not hedged.Equity Price RiskMarketable Equity Investments The fair value of our marketable equity investments is subject to market price volatility. We hold equity securities for strategic purposes or to diversify our overall investment portfolio. These equity securities are held for purposes other than trading. As of July 31, 2021, the total fair value of our investments in marketable equity securities was $137 million. We had no outstanding marketable equity securities as of July 25, 2020.Privately Held Investments These investments are recorded in other assets in our Consolidated Balance Sheets. As of July 31, 2021, the total carrying amount of our investments in privately held investments was $1.5 billion, compared with $1.3 billion at July 25, 2020. Some of these companies in which we invested are in the startup or development stages. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early stages and may never materialize. We could lose our entire investment in these companies. Our evaluation of privately held investments is based on the fundamentals of the businesses invested in, including, among other factors, the nature of their technologies and potential for financial return. 50Table of ContentsForeign Currency Exchange RiskOur foreign exchange forward contracts outstanding at fiscal year-end are summarized in U.S. dollar equivalents as follows (in millions): July 31, 2021July 25, 2020 Notional AmountFair ValueNotional AmountFair ValueForward contracts:Purchased$2,441 $(14)$2,441 $1 Sold$1,698 $12 $1,874 $4 At July 31, 2021 and July 25, 2020, we had no option contracts outstanding. We conduct business globally in numerous currencies. The direct effect of foreign currency fluctuations on revenue has not been material because our revenue is primarily denominated in U.S. dollars. However, if the U.S. dollar strengthens relative to other currencies, such strengthening could have an indirect effect on our revenue to the extent it raises the cost of our products to non-U.S. customers and thereby reduces demand. A weaker U.S. dollar could have the opposite effect. However, the precise indirect effect of currency fluctuations is difficult to measure or predict because our revenue is influenced by many factors in addition to the impact of such currency fluctuations.Approximately 70% of our operating expenses are U.S.-dollar denominated. In fiscal 2021, foreign currency fluctuations, net of hedging, increased our combined R&D, sales and marketing, and G&A expenses by approximately $214 million, or 1.2%, as compared with fiscal 2020. To reduce variability in operating expenses and service cost of sales caused by non-U.S.-dollar denominated operating expenses and costs, we may hedge certain forecasted foreign currency transactions with currency options and forward contracts. These hedging programs are not designed to provide foreign currency protection over long time horizons. In designing a specific hedging approach, we consider several factors, including offsetting exposures, significance of exposures, costs associated with entering into a particular hedge instrument, and potential effectiveness of the hedge. The gains and losses on foreign exchange contracts mitigate the effect of currency movements on our operating expenses and service cost of sales.We also enter into foreign exchange forward and option contracts to reduce the short-term effects of foreign currency fluctuations on receivables and payables that are denominated in currencies other than the functional currencies of the entities. The market risks associated with these foreign currency receivables and payables relate primarily to variances from our forecasted foreign currency transactions and balances. We do not enter into foreign exchange forward or option contracts for speculative purposes.51Table of Contents

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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSINTRODUCTIONManagement’s Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:•Executive Summary: Includes an overview of our business; current economic, competitive and regulatory trends relevant to our business; our current business strategy; and our primary sources of operating and non-operating revenues and expenses.•Critical Accounting Policies: Provides an explanation of accounting policies which may have a significant impact on our financial results and the estimates, assumptions and risks associated with those policies.•Recent Accounting Pronouncements: Includes an evaluation of recent accounting pronouncements and the potential impact of their future adoption on our financial results.•Results of Operations: Includes an analysis of our 2020 financial results and a discussion of any known events or trends which are likely to impact future results.•Liquidity and Capital Resources: Includes a discussion of our future cash requirements, capital resources, significant planned expenditures and financing arrangements.References in this discussion and analysis to “we” and “our” are to CME Group Inc. (CME Group) and its consolidated subsidiaries, collectively. References to “exchange” are to Chicago Mercantile Exchange Inc. (CME), the Board of Trade of the City of Chicago, Inc. (CBOT), New York Mercantile Exchange, Inc. (NYMEX) and Commodity Exchange, Inc. (COMEX), collectively, unless otherwise noted. EXECUTIVE SUMMARYBusiness OverviewCME Group, a Delaware stock corporation, is the holding company for CME, CBOT, NYMEX, COMEX, NEX and their respective subsidiaries. The holding company structure is designed to provide strategic and operational flexibility. CME Group's Class A common stock is listed on the Nasdaq Global Select Market (Nasdaq) under the ticker symbol "CME." Our exchange consists of designated contract markets for the trading of futures and options contracts. We also clear futures, options and swaps contracts through our clearing house. Futures contracts, options contracts and swaps contracts provide investors with vehicles for protecting against, and potentially profiting from, price changes in financial instruments and physical commodities. We are a global company with customer access available virtually all over the world. Our customers consist of professional traders, financial institutions, individual and institutional investors, major corporations, manufacturers, producers, governments and central banks. Customers include both members of the exchange and non-members. We offer our customers the opportunity to trade futures contracts and options contracts on a range of products including those based on interest rates, equity indexes, foreign exchange, agricultural commodities, energy and metals. Through our cash markets business, we offer fixed income trading through BrokerTec and foreign currency trading through EBS. Our products provide a means for hedging, speculating and allocating assets. We identify new products by monitoring economic trends and their impact on the risk management and speculative needs of our existing and prospective customers. Most of our products are available for trading through our electronic trading platforms. These execution facilities offer our customers immediate trade execution and price transparency. In addition, trades can be executed through privately negotiated transactions that are cleared and settled through our clearing house. We also provide optimization services that deliver transaction lifecycle management and information services to help our customers optimize their capital, mitigate their risk and reduce operational costs. Optimization services includes Traiana, TriOptima and Reset.Our clearing house clears, settles and guarantees futures and options contracts traded through our exchanges, in addition to cleared swaps products. Our clearing house's performance guarantee is an important function of our business. Because of this guarantee, our customers do not need to evaluate the credit of each potential counterparty or limit themselves to a selected set of counterparties. This flexibility increases the potential liquidity available for each trade. Additionally, the substitution of our clearing house as the counterparty to every transaction allows our customers to establish a position with one party and offset the position with another party. This contract offsetting process provides our customers with flexibility in establishing and adjusting positions and provides for collateral and margining efficiencies. Certain BrokerTec and EBS contracts are cleared at third-party clearing houses. 31Table of ContentsBusiness TrendsEconomic Environment. Our customers continue to use our markets as an effective and transparent means to manage risk and meet their investment needs. Trading activity in our centralized markets has fluctuated due to the ongoing uncertainty in the financial markets, fluctuations in the availability of credit, variations in the amount of assets under management as well as the Federal Reserve Bank’s interest rate policy and quantitative easing. We continue to maintain high quality and diverse products as well as various clearing and market data services which support our customers in any economic environment. Competitive Environment. Our industry is competitive and we continue to encounter competition in all aspects of our business. We expect competition to continue to intensify, especially in light of ongoing regulatory reform in the financial services industry. Competition is influenced by our brand and reputation; the efficiency and security of our settlement, clearing and support services; depth and liquidity of our markets; diversity of product offerings including frequency and quality of new product development and innovative services; our ability to position and expand upon existing products to address changing market needs; efficient and seamless customer experience; transparency, reliability, anonymity and security of transaction processing; the regulatory environment; connectivity, accessibility, flexibility in execution methods and distribution; technology capability and innovation, as well as overall transaction costs. We believe we are very well positioned with respect to these factors. Our asset classes contain products designed to address differing risk management needs, and customers are able to achieve operational and capital efficiencies by accessing our diverse products through our platforms and our clearing house. We face competition from other futures, securities and securities option exchanges; clearing organizations; swap execution facilities; alternative trade execution facilities; technology firms, including market data distributors and electronic trading system developers; and others. As markets continue to evolve, we will continue to adapt our trading technology and clearing services to meet the needs of our customers. The competitive environment to which we are subject is discussed in "Item 1. Business" on page 10.Regulatory Environment. Exchange-traded derivatives have historically been subject to extensive regulation. Developments in the regulatory environment have the potential to significantly impact our business. Compliance with regulations may require us and our customers to dedicate significant financial and operational resources which could adversely affect our profitability. The regulatory environment to which we are subject is discussed in "Item 1. Business" on page 11.Business StrategyOur strategy focuses on maximizing futures and options growth globally, diversifying our business and revenues, and delivering unparalleled customer efficiencies and operational excellence. This strategy allows us to continue to develop into a more broadly diversified financial exchange that provides trading and clearing solutions across a wide range of products and asset classes. Our strategic initiatives are discussed in "Item 1. Business" on page 7. RevenuesClearing and transaction fees. A majority of our revenue is derived from clearing and transaction fees, which include electronic trading fees, surcharges for privately negotiated transactions and other volume-related charges for exchange-traded and over-the-counter contracts. Because clearing and transaction fees are assessed on a per-contract or notional value basis, revenues and profitability fluctuate with changes in contract volume. In addition to the business trends noted earlier, our contract volume, and consequently our revenues, tend to increase during periods of economic and geopolitical uncertainty as our customers seek to manage their exposure to, or speculate on, the market volatility resulting from that uncertainty. While volume has the most significant impact on our clearing and transaction fees revenue, there are four other factors that also influence this source of revenue: •rate structure;•product mix;•venue; and•the percentage of trades executed by customers who are members compared with non-member customers.Rate structure. Customers benefit from volume discounts and limits on fees as part of our effort to increase liquidity in certain products. We offer various incentive programs to promote trading and clearing in various products and geographic locations. We may periodically change fees, volume discounts, fee limits and member discounts, perhaps significantly, based on our review of operations and the business environment. Product mix. We offer exchange-traded futures and options contracts as well as cleared-only interest rate swap contracts. Through our acquisition of NEX, we also offer foreign exchange spot and forward contracts and fixed income products. 32Table of ContentsRates are varied by product in order to optimize revenue on existing products and to encourage contract volume upon introduction of new products. Venue. Our exchange and platforms are an international marketplace that brings together buyers and sellers mainly through our electronic trading as well as through open outcry trading and privately negotiated transactions. Any customer who is guaranteed by a clearing firm and who agrees to be bound by our exchange rules is able to obtain direct access to our electronic platforms. Open outcry trading is conducted exclusively by our members, who may execute trades on behalf of customers or for themselves. Typically, customers submitting trades through our electronic platforms are charged fees for using the platforms in addition to the fees assessed on all transactions executed on our exchange. Customers entering into privately negotiated transactions also incur additional charges beyond the fees assessed on other transactions. Member/non-member mix. Generally, member customers are charged lower fees than our non-member customers. Holding all other factors constant, revenue decreases if the percentage of trades executed by members increases, and increases if the percentage of non-member trades increases. Clearing and transaction fees for cash markets business. Our cash markets business provides matching services whereby we match a buyer and seller of financial instruments to allow both parties to complete the trade bilaterally or through a third-party clearing house. We are not involved in the settlement of the contract but charge a transaction fee generally based on volume or notional value of the trade for providing the matching service. The cash markets business also includes BrokerTec Americas, which generates revenue from a matched principal business. This business serves as a fully matched counterparty to offsetting positions entered into by clients on its electronic trading platform to facilitate anonymity and access to clearing and settlement. Revenue is generated from this business generally on a transaction fee basis. Other sources. Revenue is also derived from other sources including market data and information services and other various services related to our exchange operations. Market data and information services. We receive market data and information services revenue from the dissemination of our market data to subscribers. Subscribers can obtain access to our market data services either directly or through third-party distributors. Our service offerings include access to real-time, delayed and end-of-day quotations, trade and summary market data for our products and other data sources. Users of our basic service receive real-time quotes and pay a flat monthly fee for each screen, or device, displaying our market data. Alternatively, customers can subscribe to market data provided on a limited group of products. The fee for this service is also a flat rate per month.Pricing for our market data services is based on the value of the service provided and the price of comparable services offered by our competitors. Increases or decreases in our market data and information services revenue are influenced by changes in our price structure and incentive programs for existing market data offerings, introduction of new market data services and changes in the number of devices in use. General economic factors that affect the financial services industry, which constitutes our primary customer base, also influence revenue from our market data services. Other revenues. Other revenue includes access and communication fees. Access and communication fees are connectivity fees charged to members and clearing firms that utilize our various telecommunications networks and communications services. Our communication services include our co-location program as well as the connectivity charges to customers of the CME Globex platform. Access fee revenue varies depending on the type of connection provided to customers. Other revenues include revenues from our optimization services, which include fees for risk management and information services for the over-the-counter markets, including portfolio reconciliation and post-trade processing. Revenue earned from these services is typically generated through subscriptions or transaction fees. Other revenues also include fees for post-trade services, fees for collateral management, equity subscription fees and fees for trade order routing through agreements from various strategic relationships as well as other services to members and clearing firms.ExpensesThe majority of our expenses do not vary directly with changes in our contract volume. However, licensing and other fee agreements can vary directly with certain equity, energy and swap volumes as well as the majority of our employee bonuses vary directly with overall contract volume. Compensation and benefits. Compensation and benefits expense is our most significant expense and includes employee wages, bonuses, stock-based compensation, benefits and employer taxes. Changes in this expense are driven by fluctuations in the number of employees, increases in wages as a result of inflation or labor market conditions, changes in rates for employer taxes and other cost increases affecting benefit plans. In addition, this expense is affected by the composition of our workforce. 33Table of ContentsThe expense associated with our bonus and stock-based compensation plans can also have a significant impact on this expense category. The bonus component of our compensation and benefits expense is based on our financial performance. Under the performance criteria of our annual incentive plans, the bonus funded under the plans is based on achieving certain financial performance targets established by the compensation committee of our board of directors. The compensation committee has discretion to make equitable adjustments to the cash earnings performance calculation to reflect effects of unplanned operating results or capital expenditures to meet intermediate- to long-term growth opportunities. In general, stock-based compensation is a non-cash expense related to restricted stock and performance share grants. Stock-based compensation varies depending on the quantity and fair value of awards granted. The fair value of restricted stock awards and other performance share grants is based on either the share price on the date of the grant or a model of expected future stock prices. Professional fees and outside services. This expense includes fees for consulting services received on strategic and technology initiatives; regulatory and other compliance matters; temporary labor as well as legal and accounting fees. This expense may fluctuate as a result of changes in services required to complete initiatives, handle legal proceedings and comply with regulatory and compliance requirements.Depreciation and amortization. Depreciation and amortization expense results from the depreciation of long-lived assets such as buildings, leasehold improvements, furniture, fixtures and equipment. This expense also includes the amortization of purchased and internally developed software. Amortization of purchased intangibles. Amortization of purchased intangibles includes amortization of intangible assets obtained in our acquisitions of CBOT Holdings, Inc., NYMEX Holdings, Inc. and NEX as well as other asset and business acquisitions. Intangible assets subject to amortization consist primarily of clearing firm, market data and other customer relationships. Other expenses. We incur additional ongoing expenses for communications, technology support services and various other activities necessary to support our operations. •Technology expense consists of costs related to maintenance of the hardware and software required to support our technology. It also includes costs for network connections for our electronic platforms and some market data customers; telecommunications costs of our exchange, and fees paid for access to external market data. This expense may be driven by system capacity, functionality and redundancy requirements. It also may be impacted by growth in electronic contract volume and changes in the number of telecommunications hubs and connections which allow customers outside the U.S. to access our electronic platforms directly. •Licensing and other fee agreements expense includes license fees paid as a result of contract volume in equity index products. This expense also includes royalty fees and broker rebates on energy and metals products as well as revenue sharing on cleared swaps contracts and some new product launches. This expense fluctuates with changes in contract volumes as well as changes in fee structures. •Other expenses include occupancy and building operations expenses including rent, maintenance, real estate taxes, utilities and other related costs related to leased property in Chicago, New York, the U.K., India as well as other smaller locations throughout the world. Other expenses also include marketing and travel-related expenses as well as general and administrative costs. Marketing, advertising and public relations expense includes media, print and other advertising costs, as well as costs associated with our product promotion. Other expenses also include litigation and customer settlements, impairment charges on operating assets, gains and losses on disposals of certain operating assets, and foreign currency transaction gains and losses resulting from changes in exchange rates on certain foreign monetary assets and liabilities.Non-Operating Income and ExpensesIncome and expenses incurred through activities outside of our core operations are considered non-operating. These activities include non-core investing and financing activities. •Investment income includes income from short-term investment of clearing firms' cash performance bonds and guaranty fund contributions as well as excess operating cash; interest income and realized gains and losses from our marketable securities; realized gains and losses as well as dividend income from our strategic equity investments, and gains and losses on trading securities in our non-qualified deferred compensation plans. Investment income is influenced by market interest rates, changes in the levels of cash performance bonds deposited by clearing firms, the amount of dividends distributed by our strategic investments and the availability of funds generated by operations. 34Table of Contents•Interest and other borrowing costs expense includes charges associated with various short-term and long-term funding facilities, including commitment fees on lines of credit agreements.•Equity in net earnings (losses) of unconsolidated subsidiaries includes income and losses from our investments in S&P/Dow Jones Indices LLC (S&P/DJI), Shanghai CFETS-NEX International Money Broking Co., Ltd. and Dubai Mercantile Exchange.•Other income (expense) includes expenses related to the distribution of a portion of interest earned on performance bond collateral reinvestment to the clearing firms, gains and losses on derivative contracts as well as other various income and expenses outside our core operations.CRITICAL ACCOUNTING POLICIESThe notes to our consolidated financial statements include disclosure of our significant accounting policies. In establishing these policies within the framework of accounting principles generally accepted in the U.S., management must make certain assessments, estimates and choices that will result in the application of these principles in a manner that appropriately reflects our financial condition and results of operations. Critical accounting policies are those policies that we believe present the most complex or subjective measurements and have the most potential to affect our financial position and operating results. While all decisions regarding accounting policies are important, there are certain accounting policies that we consider to be critical. These critical policies, which are presented in detail in the notes to our consolidated financial statements, relate to the valuation of financial instruments, goodwill and intangible assets, revenue recognition, income taxes and internal use software costs. Valuation of financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, or an exit price. We have categorized financial instruments measured at fair value into the following three-level fair value hierarchy based upon the level of judgment associated with the inputs used to measure the fair value: •Level 1 inputs, which are considered the most reliable evidence of fair value, consist of quoted prices (unadjusted) for identical assets or liabilities in active markets. •Level 2 inputs consist of observable market data, such as quoted prices for similar assets and liabilities in active markets, or inputs other than quoted prices that are directly observable. •Level 3 inputs consist of unobservable inputs, which are derived and cannot be corroborated by market data or other entity-specific inputs.For further discussion regarding the fair value of financial assets and liabilities, see note 2 of the notes to the consolidated financial statements. Goodwill and intangible assets. We review goodwill for impairment on a quarterly basis and whenever events or circumstances indicate that its carrying value may not be recoverable. Goodwill may be tested quantitatively for impairment by comparing the carrying value of a reporting unit to its estimated fair value. Estimating the fair value of a reporting unit involves the use of valuation techniques that rely on significant estimates and assumptions. These estimates and assumptions may include forecasted revenue growth rates; forecasted operating margins; risk-adjusted discount rates; forecasted economic and market conditions, and industry multiples. We base our fair value estimates on assumptions we believe to be reasonable given the information that is available to us at the time of our assessment; however, actual future results may differ significantly from those estimates. Under certain favorable circumstances, goodwill may be reviewed qualitatively for indications of impairment without utilizing valuation techniques to estimate fair value. The qualitative assessment of goodwill may rely on significant assumptions about forecasts of revenue growth, operating margins and economic conditions as well as overall market and industry-specific trends. In addition, the carrying value of goodwill, as denominated in foreign currencies, is adjusted each reporting period as a result of movements in foreign currency exchange rates relative to the U.S. dollar. Such foreign currency translation adjustments are recorded in accumulated other comprehensive income (loss) within shareholders' equity.We also review indefinite-lived intangible assets on a quarterly basis or more frequently when events and circumstances indicate that their carrying values may not be recoverable. Indefinite-lived intangible assets may be tested quantitatively for impairment by comparing their carrying values to their estimated fair values. Estimating the fair value of indefinite-lived intangible assets involves the use of valuation techniques that rely on significant estimates and assumptions. These estimates and assumptions may include forecasted revenue growth rates, forecasted allocations of expense and risk-adjusted discount rates. We base our fair value estimates on assumptions we believe to be reasonable given the information that is available to us at the time of our assessment; however, actual future results may differ significantly from those estimates. Similar to goodwill, under certain favorable circumstances, indefinite-lived intangible assets may be reviewed qualitatively for indications of impairment without utilizing valuation techniques to estimate fair value. The qualitative assessment of indefinite-lived intangible assets may rely on significant assumptions about forecasts of revenue growth, operating margins and economic conditions as well as overall market and industry-specific trends.35Table of ContentsIntangible assets subject to amortization are also assessed for impairment on a quarterly basis or more frequently when indicated by a change in economic or operational circumstances. The impairment assessment of these assets requires management to first compare the carrying value of the amortizing asset to its undiscounted net cash flows. If the carrying value exceeds the undiscounted net cash flows, management is then required to estimate the fair value of the assets and record an impairment loss for the excess of the carrying value over the fair value. In connection with this impairment assessment, management also challenges the useful lives of our definite-lived intangible assets on a periodic basis. Revenue recognition. A significant portion of our revenue is derived from the clearing and transaction fees we assess on each contract executed through our trading venues and cleared through our clearing house. Clearing and transaction fees are recognized as revenue when a buy and sell order are matched and when the trade is cleared. On occasion, the customer's exchange trading privileges may not be properly entered by the clearing firm and incorrect fees are charged for the transactions in the affected accounts. When this information is corrected within the time period allowed by the exchange, a fee adjustment is provided to the clearing firm. A reserve is established for estimated fee adjustments to reflect corrections to customer exchange trading privileges. This reserve has historically been immaterial. The reserve is based on the historical pattern of adjustments processed as well as management's estimate of future adjustment activity.Income taxes. Calculation of the income tax provision includes an estimate of the income taxes that will be paid for the current year as well as an estimate of income tax liabilities or benefits deferred into future years. Deferred tax assets are reviewed to determine if they will be realized in future periods. To the extent it is determined that some deferred tax assets may not be fully realized, the assets are reduced to their realizable value by a valuation allowance. The calculation of our tax provision involves uncertainty in the application of complex tax regulations and we occasionally may consult with relevant tax authorities or engage third party expertise where appropriate. We recognize potential liabilities for anticipated tax audit issues in the United States and other applicable foreign tax jurisdictions using a more-likely-than-not recognition threshold based on the technical merits of the tax position taken or expected to be taken. If the actual obligation of these amounts varies from our estimate, our income tax provision would be reduced or increased at the time that determination is made. This determination may not be known for several years. Past tax audits have not resulted in tax adjustments that resulted in a material change to the income tax provision in the year the audit was completed. The effective tax rate, defined as the income tax provision as a percentage of income before income taxes, will vary from year to year based on changes in tax jurisdictions, tax rates and regulations. In addition, the effective tax rate will vary with changes to income that are not subject to income tax and changes in expenses or losses that are not deductible, such as the utilization of foreign net operating losses. Internal use software costs. Certain internal and external costs that are incurred in connection with developing or obtaining software for internal use are capitalized. We also enter into software hosting arrangements for software projects maintained in the cloud. Software development costs incurred during the planning or maintenance stages of a software project are expensed as incurred, while costs incurred during the application development stage are capitalized and are amortized over the estimated useful life of the software, which is generally two to four years, but up to eight years for certain trading and clearing applications, depending upon expected useful lives. Amortization of capitalized costs begins only when the software becomes ready for its intended use. In addition, software assets are assessed for impairment when events or circumstances indicate that the carrying values may not be recoverable or that a reduction in the estimated useful lives is warranted.RECENT ACCOUNTING PRONOUNCEMENTSRefer to note 2 in our notes to the consolidated financial statements for information on newly adopted accounting pronouncements that are applicable to us.36Table of ContentsRESULTS OF OPERATIONSFinancial HighlightsThe following summarizes significant changes in our financial performance for the years presented. For a comparison of our results of operations for the fiscal years ended December 31, 2019, see "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed with the SEC on February 28, 2020. Year-over-Year Change(dollars in millions, except per share data)202020192020-2019Total revenues$4,883.6 $4,868.0 — %Total expenses2,246.2 2,280.2 (1)Operating margin54 %53 %Non-operating income (expense)$84.7 $101.8 (17)Effective tax expense rate22.6 %21.3 %Net income attributable to CME Group$2,105.2 $2,116.5 (1)Diluted earnings per common share attributable to CME Group5.87 5.91 (1)Cash flows from operating activities2,715.6 2,672.8 2 Revenues Year-over-Year Change(dollars in millions)202020192020-2019Clearing and transaction fees$3,897.4 $3,946.1 (1)%Market data and information services545.4 518.5 5 Other440.8 403.4 9 Total Revenues$4,883.6 $4,868.0 — Clearing and Transaction FeesFutures and Options The following table summarizes our total contract volume, revenue and average rate per contract for futures and options. Total contract volume includes contracts that are traded on our exchange and cleared through our clearing house and certain cleared-only contracts. Volume is measured in round turns, which is considered a completed transaction that involves a purchase and an offsetting sale of a contract. Average rate per contract is determined by dividing total clearing and transaction fees by total contract volume. Contract volume and average rate per contract disclosures below exclude trading volume for the cash markets business as well as interest rate swaps. Year-over-Year Change 202020192020-2019Total contract volume (in millions)4,820.6 4,830.0 — %Clearing and transaction fees (in millions)$3,384.6 $3,396.3 — Average rate per contract0.702 0.703 — We estimate the following decreases in clearing and transaction fees based on a change in total contract volume and a change in average rate per contract during 2020 compared with 2019. Year-over-Year Change(in millions)2020-2019Decrease due to change in total contract volume$(6.6)Decrease due to change in average rate per contract(5.1)Net decrease in clearing and transaction fees$(11.7)37Table of ContentsAverage rate per contract is impacted by our rate structure, including volume-based incentives, product mix, trading venue and the percentage of volume executed by customers who are members compared with non-member customers. Due to the relationship between average rate per contract and contract volume, the change in clearing and transaction fees attributable to changes in each is only an approximation.Contract VolumeThe following table summarizes average daily contract volume. Contract volume can be influenced by many factors, including political and economic factors, the regulatory environment and market competition. Year-over-Year Change(amounts in thousands)202020192020-2019Average Daily Volume by Product Line:Interest rates8,03210,349(22)%Equity indexes5,6503,45963 Foreign exchange862862— Agricultural commodities1,4171,454(3)Energy2,3942,3751 Metals6996685 Aggregate average daily volume19,05419,167(1)Average Daily Volume by Venue:CME Globex17,97717,1825 Open outcry4101,205(66)Privately negotiated 667780(15)Aggregate average daily volume19,05419,167(1)Electronic Volume as a Percentage of Total Volume94 %90 %In 2020 when compared with 2019, overall market volatility declined following a period of very high volatility in the first quarter of 2020. During the first quarter of 2020, the Federal Reserve made the unexpected decision to lower the federal funds rate due to economic concerns from the COVID-19 pandemic, which resulted in significant volatility within the financial and equity markets. However, interest rate volatility subsided following indication by the Federal Reserve that it did not intend to raise interest rates in the foreseeable future. Equity market volatility remained high throughout 2020 as a result of the governmental and business response to the COVID-19 pandemic, as well as political uncertainty surrounding the U.S. Presidential and Congressional elections in November. In addition, heightened producer price competition within the oil markets combined with lower energy demands during the COVID-19 pandemic resulted in significant market volatility within the energy market during the first quarter of 2020. However, this volatility subsided as oil prices stabilized and demand for crude oil remained low for the remainder of 2020. We believe these factors led to the changes in volume in 2020 when compared with 2019. 38Table of ContentsInterest Rate ProductsThe following table summarizes average daily contract volume for our key interest rate products. Eurodollar front 8 contracts include contracts expiring within two years. Eurodollar back 32 contracts include contracts expiring within three to ten years. Year-over-Year Change(amounts in thousands)202020192020-2019Eurodollar futures and options:Front 8 futures1,3111,997(34)%Back 32 futures633661(4)Options1,0581,685(37)U.S. Treasury futures and options:10-Year2,0262,324(13)5-Year1,0811,358(20)2-Year517749(31)Treasury bond4844673 Federal Funds futures and options207356(42)In 2020 when compared with 2019, overall interest rate contract volume decreased. We believe this was due to the Federal Reserve's decision to cut interest rates to near zero in early 2020 and its indication that it would not raise interest rates in the foreseeable future in response to the economic impact of the COVID-19 pandemic. Equity Index ProductsThe following table summarizes average daily contract volume for our key equity index products. Volume below for the year ended 2019 includes Micro-E-mini contract volumes for each index beginning on May 6, 2019, which was the date the contracts were launched. Year-over-Year Change(amounts in thousands)202020192020-2019E-mini S&P 500 futures and options3,5552,33852 %E-mini Nasdaq 100 futures and options1,302592120 E-mini Russell 2000 futures and options30216879 In 2020 when compared with 2019, equity index contract volume increased due to higher overall volatility in the equity market in 2020, particularly in the first and fourth quarters. We believe the increase in volatility was attributable to uncertainty surrounding the economic impact of governmental and business actions to combat the COVID-19 pandemic, as well as political uncertainty surrounding the U.S. presidential and congressional elections. Average daily contract volume in 2020 also included Micro-E-mini equity index contract volume of approximately 1.8 million per day compared to approximately 0.3 million per day in 2019. Micro-E-mini equity index contracts have a notional size of one-tenth of the traditional E-mini contracts. Foreign Exchange ProductsThe following table summarizes average daily contract volume for our key foreign exchange products. Year-over-Year Change(amounts in thousands)202020192020-2019Euro2372322 %Japanese yen123139(12)British pound116129(10)Australian dollar1071052 In 2020 when compared with 2019, overall foreign exchange contract volume was flat, which we believe resulted from lower overall volatility. In 2020, market volatility subsided in the second half of the year following very high foreign exchange volatility in the first quarter caused by significant uncertainty surrounding the economic impacts of governmental and business 39Table of Contentsactions to combat the COVID-19 pandemic. In addition, we believe foreign exchange trading declined slightly due to operational strains from stay at home orders and risk aversion by market participants during the COVID-19 pandemic. Agricultural Commodity ProductsThe following table summarizes average daily volume for our key agricultural commodity products. Year-over-Year Change(amounts in thousands)202020192020-2019Corn444525(15)%Soybean30726316 Wheat 2202152 Overall commodity contract volume was relatively flat in 2020 when compared with 2019. Corn contract volume decreased due to lower price volatility, which we believe was caused by large stock piles and lower demand. We believe the increase in soybean contract volume was due to an increase in demand for commodities from China.Energy ProductsThe following table summarizes average daily volume for our key energy products. Year-over-Year Change(amounts in thousands)202020192020-2019WTI crude oil1,2551,329(6)%Natural gas63952921 Refined products366381(4)Overall energy contract volume was relatively flat in 2020 when compared with 2019, which we believe was due to periods of high volatility in early 2020 followed by periods of low volatility as a result of governmental and business actions to combat the COVID-19 pandemic. The increase in natural gas volume is the result of significant price declines in early 2020 followed by price increases in the second half of 2020 as a result of higher demand during the winter months. This was partially offset by a decrease in crude oil volume due to a reduction in demand caused by the COVID-19 pandemic.Metal ProductsThe following table summarizes average daily volume for our key metal products.Year-over-Year Change(amounts in thousands)202020192020-2019Gold4564335 %Silver12310715 Copper9898— Overall metal contract volume increased in 2020 when compared with 2019 due to an increase in metals price volatility caused by investors using gold and other precious metals as safe-haven alternative investments due to significant uncertainty within other markets caused by the COVID-19 pandemic.Average Rate per ContractThe average rate per contract was substantially the same in 2020 when compared with 2019. There was an increase in the average rate per contract due to a change in product mix. Interest rate contract volume decreased by 12 percentage points as a percent of total volume, while all other products collectively increased by 12 percentage points. In general, interest rate products have a lower rate per contract compared with the remaining contracts. The increase in the average rate per contract was offset by the introduction of the micro-E-mini equity index contracts in mid-2019, which have a lower average rate per contract compared with a standard E-mini contract. Micro-E-mini equity index contracts have a notional size of one-tenth of the traditional E-mini contracts.40Table of ContentsCash Markets BusinessTotal clearing and transaction fees revenue in 2020 includes $447.4 million of transaction fees attributable to the cash markets business acquired from NEX compared with $483.0 million in 2019. This revenue primarily includes BrokerTecs's fixed income volume and EBS foreign exchange volume.Year-over-Year Change(amounts in millions)202020192020-2019BrokerTec fixed income transaction fees$173.2 $191.5 (10)%EBS foreign exchange transaction fees179.3 191.8 (7)%The related average daily notional value for the years ended 2020 and 2019 for key cash markets products were as follows:Year-over-Year Change(amounts in billions)202020192020-2019U.S. Treasury$125.9 $164.8 (24)%European Repo (in euros)264.4 269.6 (2)%Spot FX71.5 75.1 (5)%Overall average daily notional value for the cash markets business decreased in 2020 when compared with 2019 due to expectations of potentially low interest rates for an extended period of time and economic uncertainty surrounding the COVID-19 pandemic. Concentration of RevenueWe bill a significant portion of our clearing and transaction fees to our clearing firms. The majority of clearing and transaction fees received from clearing firms represent charges for trades executed and cleared on behalf of their customers. One clearing firm represented approximately 10% of our clearing and transaction fees in 2020. Should a clearing firm withdraw, we believe that the customer portion of the firm's trading activity would likely transfer to another clearing firm of the exchange. Therefore, we do not believe we are exposed to significant risk from an ongoing loss of revenue received from or through a particular clearing firm. Other Sources of RevenueMarket data and information services. In 2020 when compared with 2019, the increase in market data and information services revenue was largely attributable to an increase in certain device fees, an increase in subscriber device counts and higher demand for CME Group data.The two largest resellers of our market data represented, in aggregate, approximately 35% of our market data and information services revenue in 2020. Despite this concentration, we consider exposure to significant risk of revenue loss to be minimal. In the event that one of these vendors no longer subscribes to our market data, we believe the majority of that vendor's customers would likely subscribe to our market data through another reseller. Additionally, several of our largest institutional customers that utilize services from our two largest resellers report usage and remit payment of their fees directly to us.Other revenues. The increase in other revenues in 2020 when compared with 2019 is largely attributable to an increase in custody fees due to a new rate structure put in place in 2020.41Table of ContentsExpenses Year-over-Year Change(dollars in millions)202020192020-2019Compensation and benefits$856.5 $898.7 (5)%Technology198.5 201.5 (2)Professional fees and outside services191.3 174.1 10 Amortization of purchased intangibles311.2 314.7 (1)Depreciation and amortization153.2 158.6 (3)Licensing and other fee agreements244.9 172.2 42 Other290.6 360.4 (19)Total Expenses$2,246.2 $2,280.2 (1)2020 Compared With 2019Operating expenses decreased by $34.0 million in 2020 when compared with 2019. The following table shows the estimated impact of key factors resulting in the net decrease in operating expenses.(dollars in millions)Year-over-YearChangeChange as aPercentage of2019 ExpensesBonus expense$(54.3)(2)%Intangible and fixed asset impairments(49.8)(2)Travel and entertainment(25.0)(1)Marketing(20.9)(1)Stock-based compensation11.1 — Professional fees and outside services17.2 1 Licensing and other fee agreements72.7 3 Other expenses, net15.0 1 Total$(34.0)(1)%Overall operating expenses decreased in 2020 when compared with 2019 due to the following reasons:•Bonus expenses decreased in 2020 largely due to a reduction in headcount with legacy NEX businesses in conjunction with our planned integration, as well as performance relative to our 2020 cash earnings target when compared with 2019 performance relative to our 2019 cash earnings target.•During 2019, we recognized higher impairment charges on certain intangibles and fixed assets due to the disposal of various businesses.•Travel and entertainment expenses decreased as a result of the company's response to the COVID-19 pandemic, with the vast majority of staff working remotely during 2020.•Marketing expenses decreased compared with 2019 due to a reduction in planned advertising, media campaigns and special promotional events.Increases in operating expenses in 2020 when compared with 2019 were as follows:•Licensing and other fee agreements expenses increased during 2020 due to higher fees related to revenue sharing agreements for certain equity contracts, which resulted from an increase in volume and an increase in license rates for certain products.•Professional fees and outside services expenses increased due to higher legal fees compared to 2019, as well as professional and legal fees incurred in 2020 in connection with to our recently announced joint venture with IHS Markit.•Stock-based compensation expense increased due to acceleration of certain grants and the impact related to our September 2019 and 2020 grants.42Table of ContentsNon-Operating Income (Expense) Year-over-Year Change(dollars in millions)202020192020-2019Investment income$182.7 $637.9 (71)%Interest and other borrowing costs(166.2)(178.0)(7)Equity in net earnings (losses) of unconsolidated subsidiaries190.6 176.8 8 Other income (expense)(122.4)(534.9)(77)Total Non-Operating$84.7 $101.8 (17)Investment income. The decrease in investment income in 2020 when compared with 2019 was largely due to a decline in earnings from cash performance bond and guaranty fund contributions that are reinvested. The decrease in earnings resulted primarily from lower rates of interest earned in the cash account at the Federal Reserve Bank of Chicago following significant interest rate cuts in early 2020 despite an increase in our average reinvestment amount. Interest and other borrowing costs. Interest and other borrowing costs were lower in 2020 when compared with 2019, primarily due to lower borrowing costs on commercial paper issuances, as there were higher average balances of commercial paper outstanding during 2019 when compared with 2020. Interest and other borrowing costs were also lower during 2020 due to interest expense recognized on the €350.0 million fixed rate notes and the ¥19.1 billion term loan assumed as part of the NEX acquisition in 2018 and subsequently paid off during the first quarter of 2019.Equity in net earnings (losses) of unconsolidated subsidiaries. Higher income generated from our S&P/DJI business venture contributed to an increase in equity in net earnings (losses) of unconsolidated subsidiaries in 2020 when compared with 2019.Other income (expense). In 2020 when compared with 2019, we recognized lower expense related to a reduction in the distribution of interest earned on performance bond collateral reinvestments to the clearing firms due to lower interest income earned on our reinvestment. In addition, a gain of $1.5 million was recognized on derivative contracts in 2020 compared with a net loss of $17.7 million in 2019.Income Tax ProvisionThe following table summarizes the effective tax rate for the periods presented: 20202019Year-over-Year Change2020-2019Year ended December 3122.6 %21.3 %1.3 %In 2020 when compared with 2019, the effective tax rate was higher due to the recognition of additional benefits from the Internal Revenue Code Section 250 deduction in 2019. Proposed FDII Deduction regulations were released in 2019 and as a result, we revised our income tax calculations to reflect the proposed guidance. The benefit recognized in 2019 includes estimates for the deduction for 2018 and 2019, whereas the benefit recognized in 2020 only includes the deduction for 2020.LIQUIDITY AND CAPITAL RESOURCESCash RequirementsWe have historically met our funding requirements with cash generated by our ongoing operations. However, as part of the funding for the NEX acquisition, we utilized our commercial paper program in late 2018 and through the beginning of the second quarter of 2020 for short-term funding requirements. While our cost structure is generally fixed in the short term, our sources of operating cash are largely dependent on contract trading volume levels. In addition to using our existing cash, cash equivalents, marketable securities and cash generated from operations, we may continue to utilize our commercial paper program to meet our working capital needs, capital expenditures and other commitments. It is also possible that we may need to raise additional funds to finance our activities through future public debt offerings or by direct borrowings from financial institutions through our committed revolving credit facilities.Future capital expenditures for technology are anticipated as we continue to support our growth through increased system capacity, performance improvements, integration of acquired platforms as well as improvements to some of our office spaces. Each year, capital expenditures are incurred for improvements to and modification of our offices, remote data centers, telecommunications network and other operating equipment. In 2021, we expect capital expenditures to total approximately $180.0 million to $190.0 million, net of any leasehold improvement allowances and any one-time costs associated with the NEX integration. We continue to monitor our capital needs and may revise our forecasted expenditures as necessary in the future. 43Table of ContentsWe intend to continue to pay a regular quarterly dividend to our shareholders, with a target of between 50% to 60% of the prior year's cash earnings. The decision to pay a dividend and the amount of the dividend, however, remains within the discretion of our board of directors and may be affected by various factors, including our earnings, financial condition, capital requirements, levels of indebtedness and other considerations our board of directors deems relevant. We are also required to comply with restrictions contained in the general corporation laws of our state of incorporation, which could also limit our ability to declare and pay dividends. On February 3, 2021 the board of directors declared a regular quarterly dividend of $0.90 per share. The dividend will be payable on March 25, 2021 to shareholders of record on March 10, 2021. Assuming no changes in the number of shares outstanding, the first quarter dividend payment will total approximately $322.0 million. The board of directors also declared an additional, annual variable dividend of $2.50 per share on December 10, 2020 paid on January 13, 2021 to the shareholders of record on December 28, 2020. In general, the amount of the annual variable dividend will be determined by the end of each year, and the level will increase or decrease from year to year based on operating results, capital expenditures, potential merger and acquisition activity and other forms of capital return including regular dividends and share buybacks during the prior year. Sources and Uses of CashThe following is a summary of cash flows from operating, investing and financing activities. Year-over-Year Change(dollars in millions)202020192020-2019Net cash provided by operating activities$2,715.6 $2,672.8 2 %Net cash used in investing activities(175.5)(152.6)15 Net cash used in financing activities(2,458.2)(2,340.8)5 Operating activitiesNet cash provided by operating activities was relatively flat in 2020 compared with 2019.Investing activitiesThe increase in cash used in investing activities in 2020 compared with 2019 was largely due to a decrease in cash proceeds received on sales of certain privately-held investments.Financing activitiesCash used in financing activities was higher in 2020 when compared with 2019 due to an increase in the amount of cash dividends paid. The increase in cash used in financing activities was partially offset by a reduction in the amount of outstanding debt repayments in 2020 compared with 2019. Debt InstrumentsThe following table summarizes our debt outstanding as of December 31, 2020:(in millions)Par ValueFixed rate notes due September 2022, stated rate of 3.00% (1)$750.0 Fixed rate notes due May 2023, stated rate of 4.30%€15.0 Fixed rate notes due March 2025, stated rate of 3.00% (2)$750.0 Fixed rate notes due June 2028, stated rate of 3.75%$500.0 Fixed rate notes due September 2043, stated rate of 5.30% (3)$750.0 Fixed rate notes due June 2048, stated rate of 4.15%$700.0 _______________(1)We maintained a forward-starting interest rate swap agreement that modified the interest obligation associated with these notes so that the interest payable on the notes effectively became fixed at a rate of 3.32%.(2)We maintained a forward-starting interest rate swap agreement that modified the interest obligation associated with these notes so that the interest payable on the notes effectively became fixed at a rate of 3.11%.(3)We maintained a forward-starting interest rate swap agreement that modified the interest obligation associated with these notes so that the interest payable effectively became fixed at a rate of 4.73%.We maintain a $2.4 billion multi-currency revolving senior credit facility with various financial institutions, which matures in November 2022. The proceeds from this facility can be used for general corporate purposes, which includes providing liquidity for our clearing house in certain circumstances at our discretion and, if necessary, for maturities of commercial paper. As long 44Table of Contentsas we are not in default under this facility, we have the option to increase it up to $3.0 billion with the consent of the agent and lenders providing the additional funds. This facility is voluntarily pre-payable from time to time without premium or penalty. Under this facility, we are required to remain in compliance with a consolidated net worth test, which is defined as our consolidated shareholders' equity at September 30, 2017, giving effect to share repurchases made and special dividends paid during the term of the agreements (and in no event greater than $2.0 billion in aggregate), multiplied by 0.65. We currently do not have any borrowings outstanding under this facility, but the outstanding commercial paper balance is backstopped against this facility. We maintain a 364-day multi-currency revolving secured credit facility with a consortium of domestic and international banks to be used in certain situations by CME Clearing. The facility provides for borrowings of up to $7.0 billion. We may use the proceeds to provide temporary liquidity in the unlikely event a clearing firm fails to promptly discharge an obligation to CME Clearing, in the event of a liquidity constraint or default by a depository (custodian for our collateral), in the event of a temporary disruption with the domestic payments system that would delay payment of settlement variation between us and our clearing firms, or in other cases as provided by the CME rulebook. Clearing firm guaranty fund contributions received in the form of cash or U.S. Treasury securities as well as the performance bond assets (pursuant to the CME rulebook) can be used to collateralize the facility. At December 31, 2020, guaranty fund contributions available to collateralize the facility totaled $8.0 billion. We have the option to request an increase in the line from $7.0 billion to $10.0 billion. Our 364-day facility contains a requirement that CME remains in compliance with a consolidated tangible net worth test, defined as CME consolidated shareholder's equity less intangible assets (as defined in the agreement), of not less than $800.0 million. We currently do not have any borrowings outstanding under this facility. The indentures governing our fixed rate notes, our $2.4 billion multi-currency revolving senior credit facility and our 364-day multi-currency revolving secured credit facility for $7.0 billion do not contain specific covenants that restrict the ability to pay dividends. These documents, however, do contain other customary financial and operating covenants that place restrictions on the operations of the company that could indirectly affect the ability to pay dividends. At December 31, 2020, we have excess borrowing capacity for general corporate purposes of approximately $2.4 billion under our multi-currency revolving senior credit facility. At December 31, 2020, we were in compliance with the various covenant requirements of all our debt facilities. CME Group, as a holding company, has no operations of its own. Instead, it relies on dividends declared and paid to it by its subsidiaries in order to provide a portion of the funds which it uses to pay dividends to its shareholders. To satisfy our performance bond obligation with Singapore Exchange Limited, we may pledge CME-owned U.S. Treasury securities or U.S. dollars in lieu of, or in combination with, irrevocable letters of credit. At December 31, 2020, we had pledged letters of credit totaling $310.0 million. The following table summarizes our credit ratings as of December 31, 2020: Rating AgencyShort-TermDebt RatingLong-TermDebt RatingOutlookStandard & Poor’sA1+AA-StableMoody’s Investors ServiceP1Aa3StableGiven our cash flow generation, our ability to pay down debt levels and our ability to refinance existing debt facilities, if necessary, we expect to maintain an investment grade rating. If our ratings are downgraded below investment grade due to a change of control, we are required to make an offer to repurchase our fixed rate notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest.Liquidity and Cash ManagementCash and cash equivalents totaled $1.6 billion at December 31, 2020 and December 31, 2019. The balance retained in cash and cash equivalents is a function of anticipated or possible short-term cash needs, prevailing interest rates, our corporate investment policy and alternative investment choices. A majority of our cash and cash equivalents balance is invested in money market mutual funds that invest only in U.S. Treasury securities, U.S. government agency securities and U.S. Treasury security reverse repurchase agreements, and short-term bank deposits. Our exposure to credit and liquidity risk is minimal given the nature of the investments. Cash that is not available for general corporate purposes because of regulatory requirements or other restrictions is classified as restricted cash and is included in other current assets or other assets on the consolidated balance sheets.Our practice is to have our pension plan 100% funded at each year end on a projected benefit obligation basis, while also satisfying any minimum required contribution and obtaining the maximum tax deduction. Based on our actuarial projections, we estimate that an additional contribution may be necessary in 2021 to meet our funding goal. However, the amount of the 45Table of Contentsactual contribution is contingent on various factors, including the actual rate of return on our plan assets during 2021 and the December 31, 2021 discount rate. Regulatory Requirements CME is regulated by the CFTC as a U.S. Derivatives Clearing Organization (DCO). DCOs are required to maintain capital, as defined by the CFTC, in an amount at least equal to one year of projected operating expenses as well as cash, liquid securities, or a line of credit at least equal to six months of projected operating expenses. CME was designated by the Financial Stability Oversight Council as a systemically important financial market utility under Title VIII of Dodd-Frank. As a result, CME must comply with CFTC regulations applicable to a systemically important DCO for financial resources and liquidity resources. CME is in compliance with all DCO financial requirements.CME, CBOT, NYMEX and COMEX are regulated by the CFTC as Designated Contract Markets (DCM). DCMs are required to maintain capital, as defined by the CFTC, in an amount at least equal to one year of projected operating expenses as well as cash, liquid securities or a line of credit at least equal to six months of projected operating expenses. Our DCMs are in compliance with all DCM financial requirements. BrokerTec Americas LLC is required to maintain sufficient net capital under Securities Exchange Act of 1934, as amended (Exchange Act), Rule 15c3-1 (the Net Capital Rule). The Net Capital Rule focuses on liquidity and is designed to protect securities customers, counterparties, and creditors by requiring that broker-dealers have sufficient liquid resources on hand at all times to satisfy claims promptly. Rule 15c3-3, or the customer protection rule, which complements Rule 15c3-1, is designed to ensure that customer property (securities and funds) in the custody of broker-dealers is adequately safeguarded. By law, both of these rules apply to the activities of registered broker-dealers, but not to unregistered affiliates. The firm began operating as a (k)(2)(i) broker-dealer in November 2017 following notification to FINRA and the SEC. A company operating under the (k)(2)(i) exemption is not required to lock up customer funds as would otherwise be required under Rule 15c3-3 of the Exchange Act.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are subject to various market risks, including those caused by changes in interest rates, credit and foreign currency exchange rates.Interest Rate Risk Debt outstanding at December 31, 2020 consisted of fixed-rate borrowings of $3.4 billion (in U.S. dollar equivalent). Changes in interest rates impact the fair values of fixed-rate debt, but do not impact earnings or cash flows. We did not have any variable-rate borrowings at December 31, 2020. Credit Risk CME Clearing HouseOur clearing house acts as the counterparty to all trades consummated on our exchanges as well as through third-party exchanges and swaps markets for which we provide clearing services. As a result, we are exposed to significant credit risk of third parties, including clearing firms. We are also exposed, indirectly, to the credit risk of customers of our clearing firms. These parties may default on their obligations due to bankruptcy, lack of liquidity, operational failure or other reasons. In order to ensure performance, we establish and monitor financial requirements for our clearing firms. We set minimum performance bond requirements for exchange-traded and interest rate swaps products. For clearing firms, we establish performance bond requirements to cover at least 99% of expected price changes for a given product within a given historical period with further quantitative and qualitative considerations based on market risk. We establish haircuts applied to collateral deposited to meet performance bond requirements to cover at least 99% of expected price changes and foreign currency changes for a given asset within a given historical period with further quantitative and qualitative considerations. Haircuts vary depending on the type of collateral and maturity. We mark-to-market open positions of clearing firms at least once a day (twice a day for futures and options contracts) and require payment from clearing firms whose positions have lost value and make payments to clearing firms whose positions have gained value. We have the capability to mark-to-market more frequently as market conditions warrant. These practices allow our clearing house to quickly identify any clearing firms that may not be able to satisfy the financial obligations resulting from changes in the prices of their open positions before those financial obligations become exceptionally large and jeopardize the ability of our clearing house to ensure performance of their open positions. Although we have policies and procedures to help ensure that our clearing firms can satisfy their obligations, these policies and procedures may not succeed in detecting problems or preventing defaults. We also have in place various measures intended to enable us to cover any default and maintain liquidity. Despite our safeguards, we cannot guarantee that these measures will be sufficient to protect us from a default or that we will not be materially and adversely affected in the event of a significant default.46Table of ContentsWe maintain two separate financial safeguard packages: •a financial safeguard package for all futures, options and over-the-counter swap contracts other than cleared interest rate swap contracts (base package); and•a financial safeguard package for cleared interest rate swap contracts.In the unlikely event of a payment default by a clearing firm, we would first apply assets of the defaulting clearing firm to satisfy its payment obligation. These assets include the defaulting firm's guaranty fund contributions, performance bonds and any other available assets, such as assets required for clearing membership and any associated trading rights. In addition, we would make a demand for payment pursuant to any applicable guarantee provided to us by the parent company of the clearing firm. Thereafter, if the payment default remains unsatisfied, we would use our corporate contributions designated for the respective financial safeguard package. We would then use guaranty fund contributions of other clearing firms within the respective financial safeguard package and funds collected through an assessment against solvent clearing firms within the respective financial safeguard package to satisfy the deficit.We maintain a $7.0 billion 364-day multi-currency line of credit with a consortium of domestic and international banks to be used in certain situations by our clearing house. We have the option to request an increase in the line from $7.0 billion to $10.0 billion. We may use the proceeds to provide temporary liquidity in the unlikely event of a clearing firm default, in the event of a liquidity constraint or default by a depositary (custodian of the collateral) or in the event of a temporary disruption with the payments systems that would delay payment of settlement variation between us and our clearing firms. The credit agreement requires us to pledge certain assets to the line of credit custodian prior to drawing on the line of credit. Pledged assets may include clearing firm guaranty fund deposits held by us in the form of cash or U.S. Treasury securities. Performance bond collateral of a defaulting clearing firm may also be used to secure a draw on the line. In addition to the 364-day multi-currency line of credit, we also have the option to use our $2.4 billion multi-currency revolving senior credit facility to provide liquidity for our clearing house in the unlikely event of default. At December 31, 2020, aggregate performance bond deposits for clearing firms for both financial safeguard packages was $211.9 billion including cash performance bond deposits, non-cash deposits, Interest Earnings Facility funds and letters of credit. A defaulting firm's performance bond deposits can be used in the event of default of that clearing firm. The following shows the available assets at December 31, 2020 in the event of a payment default by a clearing firm for the base financial safeguard package after first utilizing the defaulting firm's available assets: (in millions)Clearing HouseAvailable AssetsDesignated corporate contributions for futures and options(1)$100.0 Guaranty fund contributions(2)4,654.1 Assessment powers(3)12,798.9 _______________(1)Our clearing house designates $100.0 million of corporate contributions to satisfy a clearing firm default in the event that the defaulting clearing firm's guaranty contributions and performance bonds do not satisfy the deficit. (2)Guaranty fund contributions of clearing firms include guaranty fund contributions required of clearing firms, but do not include any excess deposits held by us at the direction of clearing firms. (3)In the event of a clearing firm default, if a loss continues to exist after the utilization of the assets of the defaulted firm, our corporate contribution and the non-defaulting clearing firms' guaranty fund contributions, we would assess all non-defaulting clearing members as provided in the rules governing the guaranty fund. We could assess non-defaulting clearing members 275% of their existing guaranty fund requirements up to a maximum of 550% of their existing guaranty fund requirements as provided in the rules. Assessment powers are calculated to reflect the potential obligation that each clearing member could be called for in the event clearing member defaults exhaust the guaranty fund; however, the total amount available would be reduced by the defaulted clearing members' assessment obligations since they would no longer be able to satisfy their obligations.47Table of ContentsThe following shows the available assets for the interest rate swap financial safeguard package at December 31, 2020 in the event of a payment default by a clearing firm that clears interest rate swap contracts, after first utilizing the defaulting firm's available assets: (in millions)Clearing HouseAvailable AssetsDesignated corporate contributions for interest rate swap contracts(1)$150.0 Guaranty fund contributions(2)3,392.1 Assessment powers(3)1,089.5 _______________(1)Our clearing house designates $150.0 million of corporate contributions to satisfy a clearing firm default in the event that the defaulting clearing firm's guaranty contributions and performance bonds do not satisfy the deficit. (2)Guaranty fund contributions of clearing firms for interest rate swap contracts include guaranty fund contributions required of those clearing firms. (3)In the event of a clearing firm default, if a loss continues to exist after the utilization of the assets of the defaulted firm, our corporate contribution and the non-defaulting firms' guaranty fund contributions, we would assess non-defaulting clearing members as provided in the rules governing the interest rate swap guaranty fund. Assessment powers are calculated to reflected the potential obligation that each clearing member could be called for based on potential failure of the third and fourth largest clearing.BrokerTec Americas Matched Principal BusinessBrokerTec Americas maintains a matched principal business, where it serves as a fully matched counterparty to offsetting positions entered into by clients on its electronic trading platform to facilitate anonymity and access to clearing and settlement. BrokerTec Americas uses Fixed Income Clearing Corporation (FICC), a third-party central clearing house as well as a third-party clearing bank for the settlement of transactions and is required to post short-term margin requirements twice a day that can vary based on the size of unsettled transactions and any adverse market changes. At December 31, 2020, the balance of the collateral at FICC was $100.1 million, which was included in other current assets on the consolidated balance sheet. Without sufficient funds to meet its obligations, BrokerTec Americas could be exposed to risk of breach of contract with the counterparties and the inability to continue as a member of the third-party central clearing house. Transactions with clearing house members are typically confirmed and novated shortly after execution, at which point the clearing house assumes the risk of settlement. For transactions with counterparties that are not members of the third-party clearing house, settlement typically occurs on the day following execution and, prior to settlement, BrokerTec Americas is exposed to the risk of loss in the event a counterparty fails to meet its obligations. If that were to occur, BrokerTec Americas would have the right to cover or liquidate the open position but could incur a loss as a result of market movements.Foreign Currency Exchange Rate RiskForeign Currency Transaction Risk We have foreign currency transaction risk related to changes in exchange rates on monetary assets, liabilities, revenues and expenses held at subsidiaries where those balances and activity are denominated in a currency other than the subsidiary's functional currency. Gains and losses on foreign currency transactions result primarily from cash, debt and other monetary assets, liabilities, revenues and expenses denominated in British pounds, euros and Japanese yen. Aggregate transaction losses for 2020, 2019 and 2018 were $9.3 million, $7.2 million and $73.6 million, respectively. We expect the foreign currency gain/loss to continue to fluctuate as long as we continue to hold monetary assets and liabilities at those subsidiaries. Brexit continues to generate economic and political uncertainty throughout the world, particularly throughout the U.K. and the E.U. This uncertainty could potentially lead to significant volatility with foreign currency exchange rates, which could result in additional foreign currency gain/loss. Foreign Currency Translation Risk We have foreign currency translation risk related to the translation of our foreign subsidiaries' assets, liabilities, revenues and expenses from their respective functional currencies to the U.S. dollar at each reporting date. Fluctuations in exchange rates may impact the amount of assets, liabilities, revenues and expenses we report on our consolidated balance sheets and consolidated statements of income. The financial statements of those foreign subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using a current exchange rate. Gains and losses resulting from this translation are recognized as a foreign currency translation adjustment within accumulated other comprehensive income, which is a component of shareholders' equity and comprehensive income. Aggregate translation gains (losses), net of tax, for 2020, 2019 and 2018 were $134.3 million, $(0.6) million and $(2.5) million, respectively. 48Table of ContentsForeign Currency Exchange Risk Related to Customer CollateralA portion of performance bond deposits is denominated in various foreign currencies. We mark-to-market all deposits daily and require payment from clearing firms whose collateral has lost value due to changes in foreign currency rates and price. Therefore, our exposure to foreign currency risk related to performance bond deposits is considered minimal and is not expected to be material to our financial condition or operating results.49Table of Contents

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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsCAUTION REGARDING FORWARD-LOOKING STATEMENTSThis Annual Report on Form 10-K for the fiscal year ended July 31, 2021, or this Form 10-K, including the information incorporated by reference herein, contains 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”), including forward-looking statements concerning the potential impact of the COVID-19 pandemic on our business, operations, and operating results. All statements other than statements of historical facts are statements that could be deemed forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-K involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. These forward-looking statements are made in reliance upon the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These factors include those listed in Part I, Item 1A under the caption entitled “Risk Factors” in this Form 10-K and those discussed elsewhere in this Form 10-K. Unless the context otherwise requires, references in this Form 10-K to “Copart,” the “Company,” “we,” “us,” or “our” refer to Copart, Inc. We encourage investors to review these factors carefully together with the other matters referred to herein, as well as in the other documents we file with the Securities and Exchange Commission (the “SEC”). We may from time to time make additional written and oral forward-looking statements, including statements contained in our filings with the SEC. We do not undertake to update any forward-looking statement that may be made from time to time by or on behalf of us.All references to numbered Notes are to specific Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K and which descriptions are incorporated into the applicable response by reference. Capitalized terms used, but not defined, in this Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) have the same meanings as in such Notes.OverviewWe are a leading provider of online auctions and vehicle remarketing services with operations in the United States (“U.S.”), Canada, the United Kingdom (“U.K.”), Brazil, the Republic of Ireland, Germany, Finland, the United Arab Emirates (“U.A.E.”), Oman, Bahrain, and Spain.Our goals are to generate sustainable profits for our stockholders, while also providing environmental and social benefits for the world around us. With respect to our environmental stewardship, we believe our business is a critical enabler for the global re-use and recycling of vehicles, parts, and raw materials. We are not responsible for the carbon emissions resulting from new vehicle manufacturing, governmental fuel emissions standards or vehicle use by consumers. Each vehicle that enters our business operations already exists, with whatever fuel technology and efficiency it was designed and built to have, and the substantial carbon emissions associated with the vehicle’s manufacture have already occurred. However, upon our receipt of an existing vehicle, we help decrease its total environmental impact by extending its useful life and thereby avoiding the carbon emissions associated with the alternative of new vehicle and auto parts manufacturing. For example, many of the cars we process and remarket are subsequently restored to driveable condition, reducing the new vehicle manufacturing burden the world would otherwise face. Many of our cars are purchased by dismantlers, who recycle and refurbish parts for vehicle repairs, again reducing new and aftermarket parts manufacturing. And finally, some of our vehicles are returned to their raw material inputs through scrapping, reducing the need for further new resource extraction. In each of these cases, our business reduces the carbon and other environmental footprint of the global transportation industry. Beyond our environmental stewardship, we also support the world’s communities in two important ways. First, we believe that we contribute to economic development and well-being by enabling more affordable access to mobility around the world. For example, many of the automobiles sold through our auction platform are purchased for use in developing countries where affordable transportation is a critical enabler of education, health care, and well-being more generally. Secondly, because of the special role we play in responding to catastrophic weather events, we believe we contribute to disaster recovery and resilience in the communities we serve. For example, we mobilized our people, entered into emergency leases, and engaged with a multitude of service providers to timely retrieve, store, and remarket tens of thousands of flood-damaged vehicles in the Houston, Texas metropolitan area in the wake of Hurricane Harvey in the summer of 2017.33Table of ContentsWe provide vehicle sellers with a full range of services to process and sell vehicles primarily over the internet through our Virtual Bidding Third Generation internet auction-style sales technology, which we refer to as VB3. Vehicle sellers consist primarily of insurance companies, but also include banks, finance companies, charities, fleet operators, dealers, vehicle rental companies, and individuals. We sell the vehicles principally to licensed vehicle dismantlers, rebuilders, repair licensees, used vehicle dealers, exporters, and to the general public. The majority of the vehicles sold on behalf of insurance companies are either damaged vehicles deemed a total loss; not economically repairable by the insurance companies; or are recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made. We offer vehicle sellers a full range of services that help expedite each stage of the vehicle sales process, minimize administrative and processing costs, and maximize the ultimate sales price through the online auction process.In the U.S., Canada, Brazil, the Republic of Ireland, Finland, the U.A.E., Oman, and Bahrain, we sell vehicles primarily as an agent and derive revenue primarily from auction and auction related sales transaction fees charged for vehicle remarketing services as well as fees for services subsequent to the auction, such as delivery and storage. In the U.K., Germany, and Spain we operate both as an agent and on a principal basis, in some cases purchasing salvage vehicles outright and reselling the vehicles for our own account. In Germany and Spain, we also derive revenue from listing vehicles on behalf of insurance companies and insurance experts to determine the vehicle’s residual value and/or to facilitate a sale for the insured.We monitor and analyze a number of key financial performance indicators in order to manage our business and evaluate our financial and operating performance. Such indicators include:Service and Vehicle Sales Revenue: Our service revenue consists of auction and auction related sales transaction fees charged for vehicle remarketing services. These auction and auction related services may include a combination of vehicle purchasing fees, vehicle listing fees, and vehicle selling fees that can be based on a predetermined percentage of the vehicle sales price, tiered vehicle sales price driven fees, or at a fixed fee based on the sale of each vehicle regardless of the selling price of the vehicle; transportation fees for the cost of transporting the vehicle to or from our facility; title processing and preparation fees; vehicle storage fees; bidding fees; and vehicle loading fees. These fees are recognized as net revenue (not gross vehicle selling price) at the time of auction in the amount of such fees charged. Purchased vehicle revenue includes the gross sales price of the vehicles which we have purchased or are otherwise considered to own. We have certain contracts with insurance companies, primarily in the U.K., in which we act as a principal, purchasing vehicles and reselling them for our own account. We also purchase vehicles in the open market, primarily from individuals, and resell them for our own account. Our revenue is impacted by several factors, including total loss frequency and the average vehicle auction selling price, as a significant amount of our service revenue is associated in some manner with the ultimate selling price of the vehicle. Vehicle auction selling prices are driven primarily by: (i) market demand for rebuildable, driveable vehicles; (ii) used car pricing, which we also believe has an impact on total loss frequency; (iii) end market demand for recycled and refurbished parts as reflected in demand from dismantlers; (iv) the mix of cars sold; (v) changes in the U.S. dollar exchange rate to foreign currencies, which we believe has an impact on auction participation by international buyers; and; (vi) changes in commodity prices, particularly the per ton price for crushed car bodies, as we believe this has an impact on the ultimate selling price of vehicles sold for scrap and vehicles sold for dismantling. We cannot specifically quantify the financial impact that commodity pricing, used car pricing, and product sales mix has on the selling price of vehicles, our service revenues, or financial results. Total loss frequency is the percentage of cars involved in accidents that insurance companies salvage rather than repair and is driven by the relationship between repair costs, used car values, and auction returns. Over the last several years, we believe there has been an increase in overall growth in the salvage market driven by an increase in total loss frequency. The increase in total loss frequency may have been driven by the change in used car values and repair costs, which we believe are generally trending upward. Changes in used car prices and repair costs, may impact total loss frequency and affect our growth rate. Used car values are determined by many factors, including used car supply, which is tied directly to new car sales, and the average age of cars on the road. The average age of cars on the road continued to increase, growing from 9.6 years in 2002 to 12.1 years in 2021. Repair costs are generally based on damage severity, vehicle complexity, repair parts availability, repair parts costs, labor costs, and repair shop lead times. The factors that can influence repair costs, used car pricing, and auction returns are many and varied and we cannot predict their movements. Accordingly, we cannot predict future trends in total loss frequency.Beginning in March 2020, our business and operations began to experience the impact of the worldwide COVID-19 pandemic. In materially all of our jurisdictions, we have been deemed by local authorities an essential business because our operations ensure the removal of vehicles from repair shops, impound yards, and streets and highways, enabling the critical function of road infrastructure. As a result, we have continued to operate our facilities as well as our online-only auctions, while following appropriate health and safety protocols to ensure safe working conditions for our employees as well as for our sellers, buyers, and other business partners with whom we come in contact.34Table of ContentsFrom a financial perspective, our operating results were adversely affected by lower processed vehicle volume, but these adverse effects were more than offset by corresponding increases in vehicle average sales prices. Although we initially saw substantial declines in vehicle assignments following the onset of the COVID-19 pandemic, which we attribute principally to reduced accident volume as miles driven dramatically declined in response to shelter-in-place orders across the globe, we have generally seen vehicle assignment volumes steadily recovering; however additional subsequent shelter-in-place orders have occasionally stalled or regressed the assignment volume commensurate with the severity and duration of such orders. We cannot predict how the pandemic will continue to develop, whether and to what extent new shelter-in-place orders will be issued, or to what extent the pandemic may have longer term unanticipated impacts on our markets, including, for example, the risk of long-term reductions in miles driven.Although we have been deemed an “essential business” in the jurisdictions in which we operate and have largely been able to continue our yard operations, we have been required to make adjustments in our business processes that may reduce efficiency or increase operating expenses, particularly if the pandemic continues over a long period of time. We adjusted, but did not make material modifications to, our operating expenses to be able to continue providing employment for our employees, service to our sellers, and process incoming vehicles for sale in future quarters. The pandemic may have an adverse effect on our future revenues, with the magnitude and timing of these effects dependent upon the extent and duration of suspended economic activity across our markets. We believe that the longer-term impact on our business will depend on potential adverse operational impacts from outbreaks of COVID-19 at any of our locations; additional outbreaks of COVID-19 in one or more of our geographic markets; a reduction in miles driven due to one or more factors relating to the COVID-19 pandemic; the relationship of supply and demand for newly manufactured vehicles, on the one hand, and used and salvage vehicles, on the other hand, due to reduced manufacturing capacity and broader supply chain disruptions during the COVID-19 pandemic and the effects of these supply and demand relationships on the average sale prices obtained at auction for the vehicles assigned to us for remarketing; further government actions in response to COVID-19 outbreaks that restrict business activity or travel; disruptions of governmental administrative operations due to COVID-19 outbreaks that adversely impact our core business activities, such as vehicle title processing; and deteriorating economic conditions generally, and the potential availability, among other things, of vaccines or treatments, none of which we can predict. For a further discussion of risks to our business and operating results arising from the pandemic, please see the section of this Annual Report on Form 10-K captioned “Risk Factors.”Operating Costs and Expenses: Yard operations expenses consist primarily of operating personnel (which includes yard management, clerical, and yard employees); rent; vehicle transportation; insurance; property related taxes; fuel; equipment maintenance and repair; marketing costs directly related to the auction process; and costs of vehicles sold under the purchase contracts. General and administrative expenses consist primarily of executive management; accounting; data processing; sales personnel; professional services; marketing expenses; and system maintenance and enhancements. Other (Expense) Income: Other (expense) income consists primarily of interest expense on long-term debt, see Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt; foreign exchange rate gains and losses; gains and losses from the disposal of assets, which will fluctuate based on the nature of these activities each period; and earnings from unconsolidated affiliates. Liquidity and Cash Flows: Our primary source of working capital is cash operating results and debt financing. The primary source of our liquidity is our cash and cash equivalents and Revolving Loan Facility. The primary factors affecting cash operating results are: (i) seasonality; (ii) market wins and losses; (iii) supplier mix; (iv) accident frequency; (v) total loss frequency; (vi) volume from our existing suppliers; (vii) commodity pricing; (viii) used car pricing; (ix) foreign currency exchange rates; (x) product mix; (xi) contract mix to the extent applicable; (xii) our capital expenditures; and (xiii) other macroeconomic factors such as COVID-19. These factors are further discussed in the Results of Operations and Risk Factors sections of this Annual Report on Form 10-K.Potential internal sources of additional working capital and liquidity are the sale of assets or the issuance of shares through option exercises and shares issued under our Employee Stock Purchase Plan. A potential external source of additional working capital and liquidity is the issuance of additional debt or equity. However, we cannot predict if these sources will be available in the future or on commercially acceptable terms.35Table of ContentsAcquisitions and New OperationsAs part of our overall expansion strategy of offering integrated services to vehicle sellers, we anticipate acquiring and developing facilities in new regions, as well as the regions currently served by our facilities. We believe that these acquisitions and openings will strengthen our coverage, as we have facilities located in the U.S., Canada, the U.K., Brazil, the Republic of Ireland, Germany, Finland, the U.A.E., Oman, Bahrain, and Spain with the intention of providing global coverage for our sellers. All of these acquisitions have been accounted for using the purchase method of accounting.The following tables set forth operational facilities that we have opened and are now operational from August 1, 2018 through July 31, 2021:United States LocationsDateSpartanburg, South CarolinaAugust 2018Madison, WisconsinSeptember 2018Harleyville, South CarolinaJanuary 2019Macon, GeorgiaJanuary 2019Mocksville, North CarolinaJanuary 2019Antelope, CaliforniaJanuary 2019Sacramento, CaliforniaMarch 2019Fredericksburg, VirginiaApril 2019West Mifflin, PennsylvaniaMay 2019Hartford, ConnecticutJuly 2019Buffalo, New YorkJuly 2019Fort Wayne, IndianaFebruary 2020Concord, North CarolinaMarch 2020Salt Lake City, UtahMay 2020Redding, CaliforniaAugust 2020Dothan, AlabamaAugust 2020Jacksonville, FloridaAugust 2020Milwaukee, WisconsinSeptember 2020Houston, TexasDecember 2020Knightdale, North CarolinaMarch 2021Gastonia, North CarolinaMay 2021Bismarck, North DakotaJune 2021Fairburn, GeorgiaJuly 2021Dyer, IndianaJuly 202136Table of ContentsInternational LocationsGeographic Service AreaDateCuritiba, ParanáBrazilSeptember 2018Mannheim, Rhineland-PalatinateGermanyOctober 2018Stuttgart, Baden-WürttembergGermanyNovember 2018Frankfurt, HessenGermanyNovember 2018Itzehoe, Schleswig-Holstein (Hamburg)GermanyNovember 2018Furth, Bavaria (Nuremberg)GermanyNovember 2018Massen, Brandenburg (Berlin)GermanyNovember 2018Friesack, Brandenburg (Berlin)GermanyDecember 2018Niederlehme, Brandenburg (Berlin)GermanyNovember 2019Pilsting, Bavaria (Munich)GermanyDecember 2019São Paulo, São PauloBrazilMay 2020Bruchmühlbach-Miesau, Rhineland-Palatinate (Mannheim)GermanyFebruary 2021Mallorca, Balearic IslandsSpainApril 2021The following table sets forth the operational facilities obtained through business acquisitions from August 1, 2018 through July 31, 2021:LocationsGeographic Service AreaDateGreenville, KentuckyUnited StatesMarch 2019Des Moines, IowaUnited StatesJuly 2021The period-to-period comparability of our consolidated operating results and financial position is affected by business acquisitions, new openings, weather, and product introductions during such periods. In addition to growth through business acquisitions, we seek to increase revenues and profitability by, among other things, (i) acquiring and developing additional vehicle storage facilities in key markets, including foreign markets; (ii) pursuing global, national, and regional vehicle seller agreements; (iii) increasing our service offerings; and (iv) expanding the application of VB3 into new markets. In addition, we implement our pricing structure and auction procedures, and attempt to introduce cost efficiencies at each of our acquired facilities by implementing our operational procedures, integrating our management information systems, and redeploying personnel, when necessary.37Table of ContentsResults of OperationsThe following table shows certain data from our consolidated statements of income expressed as a percentage of total service revenues and vehicle sales for fiscal 2021, 2020 and 2019:Year Ended July 31,(In percentages)202120202019Service revenues and vehicle sales: Service revenues85 %88 %86 %Vehicle sales15 %12 %14 %Total service revenues and vehicle sales100 %100 %100 %Operating expenses: Yard operations37 %44 %43 %Cost of vehicle sales13 %10 %13 %General and administrative8 %9 %9 %Total operating expenses58 %63 %65 %Operating income42 %37 %35 %Total other expense(1)%(1)%(1)%Income before income taxes41 %36 %34 %Income tax expense6 %4 %5 %Net income35 %32 %29 %Comparison of Fiscal Years ended July 31, 2021, 2020 and 2019 The following table presents a comparison of service revenues for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeService revenuesUnited States$2,017,504 $1,714,724 $1,537,431 $302,780 17.7 %$177,293 11.5 %International274,363 232,416 218,263 41,947 18.0 %14,153 6.5 %Total service revenues$2,291,867 $1,947,140 $1,755,694 $344,727 17.7 %$191,446 10.9 %Service Revenues. The increase in service revenues for fiscal 2021 of $344.7 million, or 17.7% as compared to fiscal 2020 came from (i) an increase in the U.S. of $302.8 million, and (ii) an increase in International of $41.9 million. The growth in the U.S. was driven primarily by an increase in revenue per car, partially offset by a decrease in volume. The decrease in volume in the U.S. was driven by the COVID-19 pandemic, which reduced accident volume as miles driven declined. Excluding the beneficial impact of $12.0 million due to changes in foreign currency exchange rates, primarily from the change in the British pound and Brazilian real to U.S. dollar exchange rates, the growth in International of $29.9 million was driven primarily by increased revenue per car, partially offset by decreased volume driven by the COVID-19 pandemic, which reduced accident volume as miles driven decreased.The following table presents a comparison of vehicle sales for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeVehicle salesUnited States$254,568 $145,962 $119,138 $108,606 74.4 %$26,824 22.5 %International146,076 112,481 167,125 33,595 29.9 %(54,644)(32.7)%Total vehicle sales$400,644 $258,443 $286,263 $142,201 55.0 %$(27,820)(9.7)%38Table of ContentsVehicle Sales. The increase in vehicle sales for fiscal 2021 of $142.2 million, or 55.0% as compared to fiscal 2020 came from (i) an increase in the U.S. of $108.6 million and (ii) an increase in International of $33.6 million. The growth in the U.S. was primarily the result of (i) increased volume and (ii) higher average auction selling prices, which we believe was due to a change in the mix of vehicles sold; increased demand; and reduced supply. Excluding a beneficial impact of $10.2 million due to changes in foreign currency exchange rates, primarily from the change in the British pound and European Union euro to U.S. dollar exchange rates, the increase in International of $23.4 million was primarily the result of higher average auction selling prices partially offset by decreased volume driven by contractual shifts from purchase contracts to fee based service contracts and COVID-19’s impact on volume, which reduced accident volume as miles driven declined. The following table presents a comparison of yard operations expense for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeYard operations expensesUnited States$849,037 $828,066 $751,653 $20,971 2.5 %$76,413 10.2 %International154,255 144,421 136,458 9,834 6.8 %7,963 5.8 %Total yard operations expenses$1,003,292 $972,487 $888,111 $30,805 3.2 %$84,376 9.5 %Yard operations expenses, excluding depreciation and amortizationUnited States$761,021 $760,043 $697,115 $978 0.1 %$62,928 9.0 %International141,354 135,445 127,829 5,909 4.4 %7,616 6.0 %Yard depreciation and amortizationUnited States$88,016 $68,023 $54,538 $19,993 29.4 %$13,485 24.7 %International12,901 8,976 8,629 3,925 43.7 %347 4.0 %Yard Operations Expenses. The increase in yard operations expenses for fiscal 2021 of $30.8 million, or 3.2% as compared to fiscal 2020 resulted from (i) an increase in the U.S. of $21.0 million, primarily from a $20.0 million increase in depreciation and an increase in the cost to process each car partially offset by a decline in volume driven by the COVID-19 pandemic, which reduced accident volume as miles driven declined; and (ii) an increase in International of $9.8 million related primarily from the detrimental impact of $7.6 million due to changes in foreign currency exchange rates, driven by changes in the British pound, Brazilian real, and European Union euro to U.S. dollar exchange rate; and an increase in the cost to process each car, partially offset by a decrease in volume driven by the COVID-19 pandemic. The increase in yard operations depreciation and amortization expenses resulted primarily from depreciating new and expanded facilities placed into service in the U.S. and International locations.The following table presents a comparison of cost of vehicle sales for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeCost of vehicle salesUnited States$227,365 $135,095 $112,268 $92,270 68.3 %$22,827 20.3 %International118,763 90,199 143,236 28,564 31.7 %(53,037)(37.0)%Total cost of vehicle sales$346,128 $225,294 $255,504 $120,834 53.6 %$(30,210)(11.8)%Cost of Vehicle Sales. The increase in cost of vehicle sales for fiscal 2021 of $120.8 million, or 53.6% as compared to fiscal 2020 was the result of (i) an increase in the U.S. of $92.3 million and (ii) an increase in International of $28.6 million. The increase in the U.S. was primarily the result of (i) increased volume and (ii) higher average purchase prices, which we believe was due to a change in the mix of vehicles sold; increased demand; and reduced supply. Excluding the detrimental impact of $8.3 million due to changes in foreign currency exchange rates, driven by changes in the British pound and European euro to U.S. dollar exchange rate, the increase in International of $20.3 million was primarily the result of higher average purchase prices partially offset by decreased volume driven by contractual shifts from purchase contracts to fee based service contracts and COVID-19’s impact on volume, which reduced accident volume as miles driven declined. 39Table of ContentsThe following table presents a comparison of general and administrative expenses for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeGeneral and administrative expensesUnited States$172,115 $154,346 $155,180 $17,769 11.5 %$(834)(0.5)%International34,550 37,357 26,687 (2,807)(7.5)%10,670 40.0 %Total general and administrative expenses$206,665 $191,703 $181,867 $14,962 7.8 %$9,836 5.4 %General and administrative expenses, excluding depreciation and amortizationUnited States$152,366 $131,551 $134,452 $20,815 15.8 %$(2,901)(2.2)%International33,245 35,761 25,687 (2,516)(7.0)%10,074 39.2 %General and administrative depreciation and amortizationUnited States$19,749 $22,795 $20,727 $(3,046)(13.4)%$2,068 10.0 %International1,305 1,596 1,001 (291)(18.2)%595 59.4 %General and Administrative Expenses. The increase in general and administrative expenses for fiscal 2021 of $15.0 million, or 7.8% as compared to fiscal 2020 came primarily from (i) an increase in the U.S. of $17.8 million, partially offset by (ii) a decrease in International of $2.8 million. Excluding depreciation and amortization, the decrease in International of $2.5 million resulted primarily from the detrimental impact of $1.4 million due to changes in foreign currency exchange rates, primarily from the change in the British pound, Brazilian real, and European Union euro to U.S. dollar exchange rate and lower current period costs including decreased travel costs and the nonrecurrence of certain legal costs incurred in fiscal 2020. Excluding depreciation and amortization, the increase in the U.S. of $20.8 million resulted primarily from increases in stock compensation and increased legal costs, partially offset by decreased payroll taxes from the exercise of employee stock options and travel costs. The decrease in depreciation and amortization expenses resulted primarily from fully depreciating certain intangible and technology assets in the U.S. and International locations. The following table summarizes total other expenses and income taxes for fiscal 2021, 2020 and 2019:Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeTotal other expenses(14,580)(15,260)(11,524)680 4.5 %(3,736)(32.4)%Income taxes185,351 100,932 113,258 84,419 83.6 %(12,326)(10.9)% Other Expenses. The decrease in total other expenses for fiscal 2021 of $0.7 million, or 4.5% as compared to fiscal 2020 was primarily due to a decrease in currency losses, primarily due to the change in the British pound and Brazilian real to U.S. dollar exchange rate, lower gains on the disposal of certain non-operating assets in the current year, and lower interest income earned in the current year, partially offset by higher earnings of unconsolidated affiliates. Income Taxes. Our effective income tax rates were 16.5% and 12.6%, for fiscal 2021 and 2020, respectively. The current and prior year’s effective tax rate was computed based on the U.S. federal statutory tax rate of 21.0%. The effective tax rate for fiscal year ending July 31, 2021 was favorably impacted by $19.8 million of discrete tax adjustments made in connection with finalizing our fiscal year 2020 tax return. The effective tax rate for fiscal year ending July 31, 2020 was negatively impacted by $1.7 million of discrete tax items related to amending previously filed income tax returns. The effective tax rates in the current and prior year were also impacted by the recognition of excess tax benefits from the exercise of employee stock options of $29.8 million and $92.5 million for fiscal years 2021 and 2020, respectively. Discussion of Fiscal Year ended July 31, 2020 compared to Fiscal Year ended July 31, 2019 For a discussion of fiscal 2020 as compared to fiscal 2019, please refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended July 31, 2020, filed with the SEC on September 28, 2020. 40Table of ContentsLiquidity and Capital ResourcesThe following table presents a comparison of key components of our liquidity and capital resources for fiscal 2021, 2020 and 2019, excluding additional funds available to us through our Revolving Loan Facility:July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeCash, cash equivalents, and restricted cash$1,048,260 $477,718 $186,319 $570,542 119.4 %$291,399 156.4 %Working capital1,281,580 607,715 405,163 673,865 110.9 %202,552 50.0 %Year Ended July 31,2021 vs. 20202020 vs. 2019(In thousands)202120202019Change% ChangeChange% ChangeOperating cash flows$990,891 $917,885 $646,646 $73,006 8.0 %$271,239 41.9 %Investing cash flows(465,466)(601,208)(356,267)135,742 22.6 %(244,941)(68.8)%Financing cash flows40,922 (27,414)(370,304)68,336 249.3 %342,890 92.6 %Capital expenditures, excluding acquisitions$(462,996)$(591,972)$(373,883)$128,976 21.8 %$(218,089)(58.3)%Acquisitions, net of cash acquired(5,000)(11,702)(745)6,702 57.3 %(10,957)(1,470.7)%Cash, cash equivalents, and restricted cash and working capital increased $570.5 million and $673.9 million at July 31, 2021, respectively, as compared to July 31, 2020. Cash, cash equivalents, and restricted cash increased primarily due to cash generated from operations and proceeds from stock option exercises, partially offset by capital expenditures and payments for employee stock-based tax withholdings. Working capital increased primarily from cash generated from operations and timing of cash receipts and payments, partially offset by capital expenditures and certain income tax benefits related to stock option exercises. Cash equivalents consisted of bank deposits, certificates of deposit, U.S. Treasury Bills, and funds invested in money market accounts, which bear interest at variable rates. Historically, we have financed our growth through cash generated from operations, public offerings of common stock, equity issued in conjunction with certain acquisitions, and debt financing. Our primary source of cash generated by operations is from the collection of service fees and reimbursable advances from the proceeds of vehicle sales. We expect to continue to use cash flows from operations to finance our working capital needs and to develop and grow our business. In addition to our stock repurchase program, we are considering a variety of alternative potential uses for our remaining cash balances and our cash flows from operations. These alternative potential uses include additional stock repurchases, repayments of long-term debt, the payment of dividends, and acquisitions. For further detail, see Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt and Note 11 — Stockholders’ Equity and under the subheadings “Credit Agreement” and “Note Purchase Agreement” below.Our business is seasonal as inclement weather during the winter months increases the frequency of accidents and consequently, the number of cars involved in accidents which the insurance companies salvage rather than repair. During the winter months, most of our facilities process 5% to 20% more vehicles than at other times of the year. Severe weather events, including but not limited to tornadoes, floods, hurricanes, and hailstorms, can also impact our volumes. These increased volumes require the increased use of our cash to pay out advances and handling costs of the additional business.The COVID-19 pandemic may also impact our liquidity, with the magnitude and timing of these effects dependent upon the extent and duration of suspended economic activity across our markets. The COVID-19 pandemic may impact our processed vehicle volume and corresponding vehicle average selling prices.41Table of ContentsWe believe that our currently available cash and cash equivalents and cash generated from operations will be sufficient to satisfy our operating and working capital requirements for the next 12 months and for the foreseeable future. We expect to acquire or develop additional locations and expand some of our current facilities in the foreseeable future. We may be required to raise additional cash through drawdowns on our Revolving Loan Facility or issuance of additional equity to fund this expansion. Although the timing and magnitude of growth through expansion and acquisitions are not predictable, the opening of new greenfield yards is contingent upon our ability to locate property that (i) is in an area in which we have a need for more capacity; (ii) has adequate size given the capacity needs; (iii) has the appropriate shape and topography for our operations; (iv) is reasonably close to a major road or highway; and (v) most importantly, has the appropriate zoning for our business. Costs to develop a new yard can range from $3.0 to $50.0 million, depending on size, location and developmental infrastructure requirements.As of July 31, 2021, $159.5 million of the $1.0 billion of cash, cash equivalents, and restricted cash was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., the repatriation of these funds could still be subject to the foreign withholding tax following the U.S. Tax Reform. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not require repatriation to fund our U.S. operations.Net cash provided by operating activities increased for fiscal 2021 as compared to fiscal 2020 due to improved cash operating results primarily from an increase in service and vehicle sales revenues, partially offset by an increase in yard operations and general and administrative expenses, and changes in operating assets and liabilities. The change in operating assets and liabilities was primarily the result of a decrease in funds received in accounts receivable of $143.5 million and a decrease in cash generated from the sale of inventory of $49.0 million, partially offset by net income taxes receivable of $12.9 million primarily related to excess tax benefits from stock option exercises, decreases in funds primarily used to pay land acquisition deposits of of $6.9 million, and decreases in funds used to pay accounts payable of $2.9 million.Net cash used in investing activities decreased for fiscal 2021 as compared to fiscal 2020 due primarily to decreases in capital expenditures and acquisitions and proceeds from the sale of assets. Our capital expenditures are primarily related to acquiring land, opening and improving facilities, capitalized software development costs for new software for internal use and major software enhancements, acquiring yard equipment, and lease buyouts of certain facilities. We continue to develop, expand, and invest in new and existing facilities and standardize the appearance of existing locations. As of July 31, 2021, we have no material non-cancelable commitments for future capital expenditures. Capitalized software development costs were $13.6 million, $13.2 million, and $8.4 million for fiscal 2021, 2020 and 2019, respectively. If, at any time it is determined that capitalized software provides a reduced economic benefit, the unamortized portion of the capitalized development costs will be impaired. See Notes to Consolidated Financial Statements, Capitalized Software Costs in Note 1 — Summary of Significant Accounting Policies.Net cash provided by (used in) financing activities changed from a use of cash to providing cash in fiscal 2021 as compared to fiscal 2020 due primarily to lower payments for employee stock-based tax withholdings as discussed in further detail under the subheading “Stock Repurchases”and the Notes to Consolidated Financial Statements, Note 11 — Stockholders’ Equity and lower debt issuance costs for the restructuring of our revolving loan facility as discussed in further detail in Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt, partially offset by a decrease in proceeds from the exercise of stock options.For a discussion of fiscal 2020 as compared to fiscal 2019, please refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended July 31, 2020, filed with the SEC on September 28, 2020. Stock RepurchasesOn September 22, 2011, our Board of Directors approved an 80 million share increase in the stock repurchase program, bringing the total current authorization to 196 million shares. The repurchases may be effected through solicited or unsolicited transactions in the open market or in privately negotiated transactions. No time limit has been placed on the duration of the stock repurchase program. Subject to applicable securities laws, such repurchases will be made at such times and in such amounts as we deem appropriate and may be discontinued at any time. For fiscal 2021 and 2020, we did not repurchase any shares of our common stock under the program. For fiscal 2019, we repurchased 7,635,596 shares of our common stock under the program at a weighted average price of $47.81 per share totaling $365.0 million. As of July 31, 2021, the total number of shares repurchased under the program was 114,549,198 and 81,450,802 shares were available for repurchase under our program.42Table of ContentsIn fiscal 2019, our former President exercised all of his vested stock options through a cashless exercise. In fiscal 2020, our Chief Executive Officer exercised all of his vested stock options through a cashless exercise. In fiscal 2021, certain employees exercised stock options through a cashless exercise. A portion of the options exercised were net settled in satisfaction of the exercise price. We remitted $3.8 million, $101.3 million, and $45.6 million during the years ended July 31, 2021, 2020 and 2019, respectively, to the proper taxing authorities in satisfaction of the employees’ statutory withholding requirements.The exercised stock options, utilizing a cashless exercise, are summarized in the following table:PeriodOptions ExercisedWeighted Average Exercise PriceShares Net Settled for ExerciseShares Withheld for Taxes (1)Net Shares to EmployeesWeighted Average Share Price for WithholdingEmployee Stock-Based Tax Withholding (in 000s)FY 2019—Q33,000,000 $17.81 945,162 806,039 1,248,799 $56.53 $45,565 FY 2020—Q14,000,000 17.81 865,719 1,231,595 1,902,686 82.29 101,348 FY 2021—Q490,000 17.73 12,366 29,349 48,285 129.01 3,786 (1)Shares withheld for taxes are treated as a repurchase of shares for accounting purposes but do not count against our stock repurchase program.Credit AgreementOn July 21, 2020, we entered into a First Amended and Restated Credit Agreement with Wells Fargo Bank, National Association, Truist Bank (as successor by merger to Suntrust Bank), BMO Harris Bank N.A., Santander Bank, N.A., and Bank of America, N.A., as administrative agent (as amended from time to time, the “Credit Amendment”), bringing the aggregate principal amount of the revolving credit commitments under the Credit Agreement ( the “Revolving Loan Facility”) to $1,050.0 million. The carrying amount of the Credit Agreement is comprised of borrowings under which interest accrues under a fluctuating interest rate structure. Accordingly, the carrying value approximated fair value at July 31, 2021, and was classified within Level II of the fair value hierarchy.The interest rate as of July 31, 2021 on our Revolving Loan Facility was the Eurodollar Rate of 0.75% plus an applicable margin of 1.50%. Amounts borrowed under the Revolving Loan Facility may be repaid and reborrowed until the maturity date of July 21, 2023. We had no outstanding borrowings under the Revolving Loan Facility as of July 31, 2021 or 2020. The Credit Agreement contains customary affirmative and negative covenants and we were in compliance with all covenants related to the Credit Agreement as of July 31, 2021.Note Purchase AgreementOn December 3, 2014, we entered into a Note Purchase Agreement and sold to certain purchasers (collectively, the “Purchasers”) $400.0 million in aggregate principal amount of senior secured notes (the “Senior Notes”) consisting of (i) $100.0 million aggregate principal amount of 4.07% Senior Notes, Series A, due December 3, 2024; (ii) $100.0 million aggregate principal amount of 4.19% Senior Notes, Series B, due December 3, 2026; (iii) $100.0 million aggregate principal amount of 4.25% Senior Notes, Series C, due December 3, 2027; and (iv) $100.0 million aggregate principal amount of 4.35% Senior Notes, Series D, due December 3, 2029. Interest is due and payable quarterly, in arrears, on each of the Senior Notes. We may prepay the Senior Notes, in whole or in part, at any time, subject to certain conditions, including minimum amounts and payment of a make-whole amount equal to the discounted value of the remaining scheduled interest payments under the Senior Notes. The Note Purchase Agreement contains customary affirmative and negative covenants and we were in compliance with all covenants related to the Note Purchase Agreement as of July 31, 2021.For further detail on both the Credit Agreement and Note Purchase Agreement, see Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt .Off-Balance Sheet ArrangementsAs of July 31, 2021, we had no off-balance sheet arrangements pursuant to Item 303(a)(4) of Regulation S-K promulgated under the Securities Exchange Act of 1934, as amended.43Table of ContentsCritical Accounting Policies and EstimatesOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities as of the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. We consider the following policies to be the most critical to understanding the judgments that are involved and the uncertainties that could impact our results of operations, financial condition, and cash flows. For additional information, see Note 1 — Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements. The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related Notes in Part I., Item I., “Financial Statements.”Revenue RecognitionOur primary performance obligation is the auctioning of consigned vehicles through an online auction process. Service revenue and vehicle sales revenue are recognized at the date the vehicles are sold at auction, excluding annual registration fees. Costs to prepare the vehicles for auction, including inbound transportation costs and titling fees, are deferred and recognized at the time of revenue recognition at auction.Our disaggregation between service revenues and vehicle sales at the segment level reflects how the nature, timing, amount, and uncertainty of our revenues and cash flows are impacted by economic factors. We report sales taxes on relevant transactions on a net basis in our consolidated results of operations, and therefore do not include sales taxes in revenues or costs.Service revenuesOur service revenue consists of auction and auction related sales transaction fees charged for vehicle remarketing services. Within this revenue category, our primary performance obligation is the auctioning of consigned vehicles through an online auction process. These auction and auction related services may include a combination of vehicle purchasing fees, vehicle listing fees, and vehicle selling fees that can be based on a predetermined percentage of the vehicle sales price, tiered vehicle sales price driven fees, or at a fixed fee based on the sale of each vehicle regardless of the selling price of the vehicle; transportation fees for the cost of transporting the vehicle to or from our facility; title processing and preparation fees; vehicle storage fees; bidding fees; and vehicle loading fees. These services are not distinct within the context of the contract. Accordingly, revenue for these services is recognized when the single performance obligation is satisfied at the completion of the auction process. We do not take ownership of these consigned vehicles, which are stored at our facilities located throughout the U.S. and at its international locations. These fees are recognized as net revenue (not gross vehicle selling price) at the time of auction in the amount of such fees charged.We have a separate performance obligation related to providing access to our online auction platform. We charge members an annual registration fee for the right to participate in our online auctions and access our bidding platform. This fee is recognized ratably over the term of the arrangement, generally one year, as each day of access to the online auction platform represents the best depiction of the transfer of the service. No provision for returns has been established, as all sales are final with no right of return or warranty, although we provide for credit loss expense in the case of non-performance by our buyers or sellers.Year Ended July 31,(In thousands)202120202019Service revenuesUnited States$2,017,504 $1,714,724 $1,537,431 International274,363 232,416 218,263 Total service revenues$2,291,867 $1,947,140 $1,755,694 44Table of ContentsVehicle salesCertain vehicles are purchased and remarketed on our own behalf. We have a single performance obligation related to the sale of these vehicles, which is the completion of the online auction process. Vehicle sales revenue is recognized on the auction date. As we act as a principal in vehicle sales transactions, the gross sales price at auction is recorded as revenue.Year Ended July 31,(In thousands)202120202019Vehicle salesUnited States$254,568 $145,962 $119,138 International146,076 112,481 167,125 Total vehicle sales$400,644 $258,443 $286,263 Contract assetsWe capitalize certain contract assets related to obtaining a contract, where the amortization period for the related asset is greater than one year. These assets are amortized over the expected life of the customer relationship. Contract assets are classified as current or long-term other assets, based on the timing of when we expect to recognize the related revenues and are amortized as an offset to the associated revenues on a straight-line basis. We assess these costs for impairment at least quarterly and as “triggering” events occur that indicate it is more likely than not that an impairment exists. The contract asset costs where the amortization period for the related asset is one year or less are expensed as incurred and recorded within general and administrative expenses in the accompanying consolidated statements of income.Uncertain Tax PositionsIn determining net income for financial statement purposes, we must make certain estimates and judgments in the calculation of tax provisions and the resultant tax liabilities. In the ordinary course of global business, there may be transactions and calculations where the ultimate tax outcome is uncertain. In addition, our actual and forecasted earnings are subject to change due to economic, political and other conditions, such as new COVID-19 variants. Our effective tax rates could be affected by numerous factors such as changes in our business operations; acquisitions; investments; entry into new businesses and geographies; intercompany transactions; the relative amount of our foreign earnings, including earnings being lower than anticipated in jurisdictions where we have lower statutory rates and higher than anticipated in jurisdictions where we have higher statutory rates; losses incurred in jurisdictions for which we are not able to realize related tax benefits; the applicability of special tax regimes; changes in foreign currency exchange rates; changes in our stock price; changes to our forecasts of income and loss and the mix of jurisdictions to which they relate; changes in our deferred tax assets and liabilities and their valuation; changes in the laws, regulations, administrative practices, principles, and interpretations related to tax, including changes to the global tax framework; competition; and other laws and accounting rules in various jurisdictions. In addition, a number of countries have enacted or are actively pursuing changes to their tax laws applicable to corporate multinationals.The calculation of tax liabilities involves dealing with uncertainties in the interpretation and application of complex tax laws, and significant judgment is necessary to (i) determine whether, based on the technical merits, a tax position is more likely than not to be sustained and (ii) measure the amount of tax benefit that qualifies for recognition. Development in an audit, investigation, or other tax controversy could have a material effect on our operating results or cash flows in the period or periods for which that development occurs, as well as for prior and subsequent periods. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. Although we believe the estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different from what is reflected in the historical income tax provisions and accruals. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.Recently Issued Accounting StandardsFor a description of the new accounting standards that affect us, refer to the Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies.45Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskOur principal exposures to financial market risk are interest rate risk, foreign currency risk and translation risk. We do not hold or issue financial instruments for trading purposes.Interest Income RiskThe primary objective of our investment activities is to preserve principal while secondarily maximizing yields without significantly increasing risk. To achieve this objective in the current uncertain global financial markets, all cash and cash equivalents were held in bank deposits and money market funds as of July 31, 2021. As the interest rates on a material portion of our cash and cash equivalents are variable, a change in interest rates earned on our investment portfolio would impact interest income along with cash flows but would not materially impact the fair market value of the related underlying instruments. As of July 31, 2021, we held no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or mortgaged-backed securities. Based on the average cash balance held for fiscal 2021, a hypothetical 10% adverse change in our interest yield would not have materially affected our operating results.Interest Expense RiskOur total borrowings under the Revolving Loan Facility under the Credit Agreement were zero as of July 31, 2021. The Revolving Loan Facility under the Credit Agreement bears interest, at our election, at either (a) the Base Rate, which is defined as a fluctuating rate per annum equal to the greatest of (i) the Prime Rate in effect on such day; (ii) the Federal Funds Rate in effect on such date plus 0.50%; or (iii) the Eurodollar Rate plus 1.0%, subject to an interest rate floor of 0.75%, in each case plus an applicable margin ranging from 0.50% to 1.25% based on our consolidated total net leverage ratio during the preceding fiscal quarter; or (b) the Eurodollar Rate plus an applicable margin ranging from 1.50% to 2.25% depending on our consolidated total net leverage ratio during the preceding fiscal quarter. Interest is due and payable, in arrears, at the end of each calendar quarter for loans bearing interest at the Base Rate, and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of Eurodollar Rate Loans. If interest rates were to increase by 10% it would not materially affect our operating results.Foreign Currency and Translation ExposureFluctuations in foreign currencies create volatility in our reported results of operations because we are required to consolidate the results of operations of our foreign currency denominated subsidiaries. International net revenues are typically denominated in the local currency of each country and result from transactions by our operations in Canada, the U.K., Brazil, the Republic of Ireland, Germany, Finland, the U.A.E., Oman, Bahrain, and Spain. These operations also incur a majority of their expenses in the local currency, the British pound, Canadian dollar, Brazilian real, European Union euro, U.A.E. dirham, Omani rial, and Bahraini dinar. Our international operations are subject to risks associated with foreign exchange rate volatility, which could have a material and adverse impact on our future results. A hypothetical 10% adverse change in the value of the U.S. dollar relative to the British pound, Canadian dollar, Brazilian real, European Union euro, U.A.E. dirham, Omani rial, and Bahraini dinar would have resulted in a decrease in operating income of $11.0 million for fiscal 2021.On January 29, 2020, the European Parliament approved the U.K.’s withdrawal from the European Union, commonly referred to as “Brexit.” The U.K. officially left the European Union on January 31, 2020. Although we have not experienced any material disruptions in our business as a result of Brexit to date, the ultimate effects of Brexit on us are still difficult to predict, and adverse consequences concerning Brexit or the European Union could include deterioration in global economic conditions, instability in global financial markets, political uncertainty, volatility in currency exchange rates, or adverse changes in the cross-border agreements currently in place, any of which could have an adverse impact on our financial results in the future. Fluctuations in foreign currencies also create volatility in our consolidated financial position because we are required to remeasure substantially all assets and liabilities held by our foreign subsidiaries at the current exchange rate at the close of the accounting period. At July 31, 2021, the cumulative effect of foreign exchange rate fluctuations on our consolidated financial position was a net translation loss of $100.9 million. This loss was recognized as an adjustment to stockholders’ equity through accumulated other comprehensive income. A hypothetical 10% adverse change in the value of the U.S. dollar relative to the British pound, Canadian dollar, Brazilian real, European Union euro, U.A.E. dirham, Omani rial, and Bahraini dinar would not have materially affected our consolidated financial position. We do not hedge our exposure to translation risks arising from fluctuations in foreign currency exchange rates.46Table of Contents

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+Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThis discussion and analysis below for Darden Restaurants, Inc. (Darden, the Company, we, us or our) should be read in conjunction with our consolidated financial statements and related financial statement notes included in Part II of this report under the caption “Item 8 - Financial Statements and Supplementary Data.” We operate on a 52/53-week fiscal year, which ends on the last Sunday in May. Fiscal 2021, which ended May 30, 2021, consisted of 52 weeks and fiscal 2020, which ended May 31, 2020, consisted of 53 weeks. OVERVIEW OF OPERATIONS Our business operates in the full-service dining segment of the restaurant industry. At May 30, 2021, we operated 1,834 restaurants through subsidiaries in the United States and Canada under the Olive Garden®, LongHorn Steakhouse®, Cheddar’s Scratch Kitchen®, Yard House®, The Capital Grille®, Seasons 52®, Bahama Breeze® and Eddie V’s Prime Seafood® trademarks. We own and operate all of our restaurants in the United States and Canada, except for 2 joint venture restaurants managed by us and 33 franchised restaurants. We also have 24 franchised restaurants in operation located in Latin America. All intercompany balances and transactions have been eliminated in consolidation.COVID-19 PandemicFor much of fiscal 2021, the COVID-19 pandemic resulted in a significant reduction in guest traffic at our restaurants due to changes in consumer behavior as public health officials encouraged social distancing and required personal protective equipment and state and local governments mandated restrictions including suspension of dine-in operations, reduced restaurant seating capacity, table spacing requirements, bar closures and additional physical barriers. Beginning in late March 2020, we operated with all of our dining rooms closed and served our guests in a To Go only or To Go and delivery format. In late April 2020, state and local governments began to allow us to open dining rooms at limited capacities, along with other operating restrictions. As a result, we began fiscal 2021 with significant limitations on our operations, which over the course of the fiscal year varied widely from time to time, state to state and city to city. During November 2020, rising case rates resulted in certain jurisdictions implementing restrictions that again reduced dining room capacity or mandated the re-closure of dining rooms. Once COVID-19 vaccines were approved and moved into wider distribution in the United States in early 2021, public health conditions improved and almost all of the COVID-19 restrictions on businesses have eased. As of the date of this report, all of our restaurants were able to open their dining rooms to some extent and few capacity restrictions or other COVID-19 restrictions remained in place in the United States. However, it is possible additional outbreaks could require us to again reduce our capacity or limit or suspend our in-restaurant dining operations. As we navigated through the pandemic, we took significant steps to adapt our business model to allow us to continue to serve guests and support our team members, including investing in our team members through enhanced pay and benefits, streamlining our restaurant processes, simplifying our menus, and accelerating the rollout of technology to all of our brands to enhance the off-premise and in-restaurant guest experience. As our dining rooms have returned to full or close-to-full capacity, we are focused on continuing to provide a safe environment for our team members and guests, and maintaining many of the operating efficiencies established during fiscal 2021.Fiscal 2021 Financial HighlightsOur sales from continuing operations were $7.20 billion in fiscal 2021 compared to $7.81 billion in fiscal 2020. The 7.8 percent decrease in sales from continuing operations was primarily driven by negative combined Darden same-restaurant sales of 7.8 percent and one less week of operations in fiscal 2021, partially offset by revenue from the addition of 30 net new company-owned restaurants. The decrease in same-restaurant sales was driven by the impact of COVID-19.Net earnings from continuing operations for fiscal 2021 was $632.4 million ($4.80 per diluted share) compared with a net loss from continuing operations for fiscal 2020 of $49.2 million ($0.40 per diluted share). Our results from continuing operations for fiscal 2021 increased compared to fiscal 2020 primarily due to the economic impacts of COVID-19 which had a material adverse effect specifically on the fourth quarter of fiscal 2020, including $390.0 million of impairments. Our net loss from discontinued operations was $3.1 million ($0.03 per diluted share) for fiscal 2021, compared with a net loss from discontinued operations of $3.2 million ($0.03 per diluted share) for fiscal 2020. When combined with results from 27continuing operations, our diluted net earnings per share was $4.77 for fiscal 2021 and diluted net loss per share was $0.43 for fiscal 2020. OutlookWe expect fiscal 2022 sales from continuing operations to increase between 28 percent and 32 percent, driven by Darden same-restaurant sales growth of 25 percent to 29 percent and approximately 35-40 new restaurants. In fiscal 2022, we expect our annual effective tax rate to be between 13.0 percent and 14.0 percent and we expect capital expenditures incurred to build new restaurants, remodel and maintain existing restaurants and technology initiatives to be between $375.0 million and $425.0 million.RESULTS OF OPERATIONS FOR FISCAL 2021 AND 2020To facilitate review of our results of operations, the following table sets forth our financial results for the periods indicated. All information is derived from the consolidated statements of earnings for the fiscal years ended May 30, 2021 and May 31, 2020: Fiscal Year EndedPercent Change(in millions)May 30, 2021May 31, 20202021 vs 2020Sales$7,196.1 $7,806.9 (7.8)%Costs and expenses:Food and beverage2,072.1 2,240.8 (7.5)%Restaurant labor2,286.3 2,682.6 (14.8)%Restaurant expenses1,344.2 1,475.1 (8.9)%Marketing expenses91.1 238.0 (61.7)%General and administrative expenses396.2 376.4 5.3 %Depreciation and amortization350.9 355.9 (1.4)%Impairments and disposal of assets, net6.6 221.0 (97.0)%Goodwill impairment— 169.2 (100.0)%Total operating costs and expenses$6,547.4 $7,759.0 (15.6)%Operating income648.7 47.9 NMInterest, net63.5 57.3 10.8 %Other (income) expense, net8.7 151.6 (94.3)%Earnings (loss) before income taxes576.5 (161.0)NMIncome tax expense (benefit) (1)(55.9)(111.8)(50.0)%Earnings (loss) from continuing operations$632.4 $(49.2)NMLosses from discontinued operations, net of tax(3.1)(3.2)(3.1)%Net earnings (loss)$629.3 $(52.4)NM(1) Effective tax rate(9.7)%69.4 %NM- Percentage change not considered meaningful.28The following table details the number of company-owned restaurants currently reported in continuing operations, compared with the number open at the end of fiscal 2020:May 30, 2021May 31, 2020Olive Garden875 868 LongHorn Steakhouse533 522 Cheddar’s Scratch Kitchen170 165 Yard House81 81 The Capital Grille (1)63 60 Seasons 5244 44 Bahama Breeze42 41 Eddie V’s 26 23 Total1,834 1,804 (1)Includes three The Capital Burger restaurants in fiscal 2021 and two in fiscal 2020. SALES The following table presents our company-owned restaurant sales, U.S. same-restaurant sales (SRS) and average annual sales per restaurant by segment for the periods indicated:SalesAverage Annual Sales per Restaurant (2)Fiscal Year EndedPercent ChangeFiscal Year Ended(in millions)May 30, 2021May 31, 2020SRS (1)May 30, 2021May 31, 2020Olive Garden$3,593.4 $4,013.8 (10.5)%(9.9)%$4.1 $4.5 LongHorn Steakhouse$1,810.4 $1,701.1 6.4 %5.5 %$3.4 $3.2 Fine Dining$446.9 $541.1 (17.4)%(19.2)%$5.3 $6.5 Other Business$1,345.4 $1,550.9 (13.3)%(13.5)%$4.0 $4.5 $7,196.1 $7,806.9 (1)Same-restaurant sales is a year-over-year comparison of each period’s sales volumes for a 52-week year and is limited to restaurants open at least 16 months.(2)Average annual sales are calculated as sales divided by total restaurant operating weeks multiplied by 52 weeks; excludes franchise locations.Olive Garden’s sales decrease for fiscal 2021 was primarily driven by a U.S. same-restaurant sales decrease and one less week of operations, partially offset by revenue from new restaurants. The decrease in U.S. same-restaurant sales in fiscal 2021 was driven by the impact of COVID-19 and resulted from a 12.8 percent decrease in same-restaurant guest counts offset by a 2.9 percent increase in average check. LongHorn Steakhouse’s sales increase for fiscal 2021 was driven by a same-restaurant sales increase combined with revenue from new restaurants, partially offset by one less week of operations. The increase in same-restaurant sales in fiscal 2021 resulted from a 3.3 percent increase in same-restaurant guest counts combined with a 2.2 percent increase in average check. Fine Dining’s sales decrease for fiscal 2021 was driven by a same-restaurant sales decrease and one less week of operations, partially offset by revenue from new restaurants. The decrease in same-restaurant sales in fiscal 2021 was driven by the impact of COVID-19 and resulted from a 20.7 percent decrease in same-restaurant guest counts offset by a 1.5 percent increase in average check. Other Business’s sales decrease for fiscal 2021 was driven by a same-restaurant sales decrease and one less week of operations, partially offset by revenue from new restaurants. The decrease in same-restaurant sales in fiscal 2021 was driven by the impact of COVID-19 and resulted from a 15.5 percent decrease in same-restaurant guest counts offset by a 2.0 percent increase in average check. 29COSTS AND EXPENSES The following table sets forth selected operating data as a percent of sales from continuing operations for the periods indicated. This information is derived from the consolidated statements of earnings for the fiscal years ended May 30, 2021 and May 31, 2020.Fiscal Year EndedMay 30, 2021May 31, 2020Sales100.0 %100.0 %Costs and expenses:Food and beverage28.8 28.7 Restaurant labor31.8 34.4 Restaurant expenses18.7 18.9 Marketing expenses1.3 3.0 General and administrative expenses5.5 4.8 Depreciation and amortization4.9 4.6 Impairments and disposal of assets, net0.1 2.8 Goodwill impairment— 2.2 Total operating costs and expenses91.0 %99.4 %Operating income9.0 %0.6 %Interest, net0.9 0.7 Other (income) expense, net0.1 1.9 Earnings (loss) before income taxes8.0 %(2.1)%Income tax expense (benefit)(0.8)(1.4)Earnings (loss) from continuing operations8.8 %(0.6)%Total operating costs and expenses from continuing operations were $6.55 billion in fiscal 2021 and $7.76 billion in fiscal 2020. Fiscal 2021 Compared to Fiscal 2020: •Food and beverage costs increased as a percent of sales primarily due to a 0.7% impact from inflation and 0.4% impact from investments in food quality, partially offset by a 0.6% impact from pricing leverage and 0.4% impact from menu mix.•Restaurant labor costs decreased as a percent of sales primarily due to a 4.0% impact from productivity improvement driven by operational simplification and a 0.7% impact from pricing, partially offset by a 1.7% impact from sales deleverage and a 0.5% impact from inflation.•Restaurant expenses decreased as a percent of sales primarily due to a 1.4% impact from lower repairs and maintenance expenses, utility costs, and rent expense, and a 0.4% impact from pricing, partially offset by a 1.6% impact from sales deleverage.•Marketing expenses decreased as a percent of sales primarily due to a 2.0% impact from lower media spending at Olive Garden and LongHorn Steakhouse, partially offset by a 0.3% impact from sales deleverage.•General and administrative expenses increased as a percent of sales primarily due to a 0.6% impact related to our corporate restructuring actions during the first quarter of fiscal 2021, a 0.4% impact from the mark to market of our deferred compensation plans, and a 0.4% impact due to sales deleverage, partially offset by a 0.6% impact from cost savings initiatives and a 0.2% impact from a legal recovery.•Depreciation and amortization expenses increased as a percent of sales primarily due to sales deleverage.•Impairments and disposal of assets, net decreased as a percent of sales due to the economic impact of the COVID-19 pandemic on fiscal 2020. During the fourth quarter of fiscal 2020, we recorded non-cash impairment charges of $220.8 million related to a portion of our other indefinite-lived intangible assets, restaurant-level and other assets. •Goodwill impairment decreased as a percent of sales due to the economic impact of COVID-19 on fiscal 2020. During the fourth quarter of fiscal 2020, we recorded a non-cash impairment charge of $169.2 million related to a portion of our goodwill. 30INCOME TAXES During fiscal 2021, we had an income tax benefit of $55.9 million ((9.7) percent effective tax rate) compared to an income tax benefit of $111.8 million (69.4 percent effective tax rate) in fiscal 2020. The significant change was driven primarily by the fact that we had $576.5 million in earnings before taxes in fiscal 2021, compared to a net loss before taxes $161.0 million in fiscal 2020. For fiscal 2021, our effective tax rate was also impacted by the generation of a net operating loss for tax purposes that will be carried back to the previous five tax years. We generated a net operating loss for tax purposes due to several factors, including the impact of COVID-19, accelerated tax depreciation, increased tax deductions for equity vestings and exercises, tax accounting method changes and various other tax planning initiatives. An income tax benefit is generated due to the difference in federal tax rates between fiscal year 2021 and the years to which the federal net operating loss will be carried back.NET EARNINGS AND NET EARNINGS PER SHARE FROM CONTINUING OPERATIONS Net earnings from continuing operations for fiscal 2021 were $632.4 million ($4.80 per diluted share) compared with net loss from continuing operations for fiscal 2020 of $49.2 million ($0.40 per diluted share). Our results from continuing operations for fiscal 2021 increased compared with fiscal 2020 primarily due to the economic impacts of COVID-19 which had a material adverse effect on the fourth quarter of fiscal 2020 including $390.0 million of asset impairments during the fourth quarter. In fiscal 2021, our diluted per share results from continuing operations were positively impacted by $0.76 due to a non-recurring income tax benefit, partially offset by $0.27 due to our corporate restructuring in the first quarter of fiscal 2021. In fiscal 2020, our diluted per share results from continuing operations were negatively impacted by approximately $2.19 due to non-cash goodwill and trademark impairments, approximately $0.29 due to non-cash restaurant-level impairments and approximately $0.18 due to inventory and note receivable write-downs. Additionally, our diluted per share results from continuing operations for fiscal 2020 were adversely impacted by approximately $0.89 due to a pension settlement charge and approximately $0.02 due to an international structure simplification from the second quarter of fiscal 2020.LOSS FROM DISCONTINUED OPERATIONS On an after-tax basis, results from discontinued operations for fiscal 2021 were a net loss of $3.1 million ($0.03 per diluted share) compared with a net loss for fiscal 2020 of $3.2 million ($0.03 per diluted share).SEGMENT RESULTSWe manage our restaurant brands, Olive Garden, LongHorn Steakhouse, Cheddar’s Scratch Kitchen, Yard House, The Capital Grille, Seasons 52, Bahama Breeze and Eddie V’s in the U.S. and Canada as operating segments. We aggregate our operating segments into reportable segments based on a combination of the size, economic characteristics and sub-segment of full-service dining within which each brand operates. Our four reportable segments are: (1) Olive Garden, (2) LongHorn Steakhouse, (3) Fine Dining and (4) Other Business. See Note 5 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report) for further details.Our management uses segment profit as the measure for assessing performance of our segments. The following table presents segment profit margin for the periods indicated:Fiscal Year EndedChangeSegmentMay 30, 2021May 31, 20202021 vs 2020Olive Garden23.2%18.3%490 BPLongHorn Steakhouse17.9%15.4%250 BPFine Dining17.7%16.3%140 BPOther Business14.4%8.9%550 BPThe increase in the Olive Garden segment profit margin for fiscal 2021 was driven primarily by lower restaurant labor as well as lower marketing expenses. The increase in the LongHorn Steakhouse segment profit margin for fiscal 2021 was driven by leveraging positive same-restaurant sales as well as lower marketing expenses. The increase in in the Fine Dining segment profit margin for 2021 was driven by lower marketing expenses and lower food and beverage costs. The increase in the Other Business segment profit margin for 2021 was driven by lower restaurant labor and lower marketing expenses.RESULTS OF OPERATIONS FOR FISCAL 2020 COMPARED TO 201931For a comparison of our results of operations for the fiscal years ended May 31, 2020 and May 26, 2019, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended May 31, 2020, filed with the SEC on July 24, 2020.SEASONALITY Our sales volumes have historically fluctuated seasonally. Typically, our average sales per restaurant are highest in the winter and spring, followed by the summer, and lowest in the fall. However, throughout fiscal 2021, a variety of factors, including the impacts of COVID-19 on our business, government actions taken to respond to COVID-19 and to stimulate the United States’ recovery from COVID-19, and changing consumer preferences caused fluctuations in our sales volumes that were different than our typical seasonality. Additionally, holidays, changes in the economy, severe weather and similar conditions may impact sales volumes seasonally in some operating regions. Because of the historical seasonality of our business and these other factors, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.IMPACT OF INFLATION We attempt to minimize the annual effects of inflation through appropriate planning, operating practices and menu price increases. We do not believe inflation had a significant overall effect on our annual results of operations during fiscal 2021 or 2020.CRITICAL ACCOUNTING ESTIMATESWe prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. Our significant accounting policies are more fully described in Note 1 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report). Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following estimates to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements. Leases We evaluate our leases at their inception to estimate their expected term, which commences on the date when we have the right to control the use of the leased property and includes the non-cancelable base term plus all option periods we are reasonably certain to exercise. Our judgment in determining the appropriate expected term and discount rate for each lease affects our evaluation of: •The classification and accounting for leases as operating versus finance; •The rent holidays and escalation in payments that are included in the calculation of the lease liability and related right-of-use asset; and•The term over which leasehold improvements for each restaurant facility are amortized. These judgments may produce materially different amounts of lease liabilities and right-of-use assets recognized on our consolidated balance sheets, as well as depreciation, amortization, interest and rent expense recognized in our consolidated statements of earnings if different discount rates and expected lease terms were used. Valuation of Long-Lived Assets Land, buildings and equipment, operating lease right-of-use assets and certain other assets, including definite-lived intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; changes in expected useful life; unanticipated competition; slower growth rates, ongoing maintenance and improvements of the assets, or changes in the usage or operating performance. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. Based on a review of operating results for each of our restaurants, the amount of net book value associated with lower performing restaurants that would be deemed at risk for impairment is not material to our consolidated financial statements.Valuation and Recoverability of Goodwill and Trademarks 32We have eight reporting units, six of which had goodwill and seven of which had trademarks. Goodwill and trademarks are not subject to amortization and goodwill has been assigned to reporting units for purposes of impairment testing. The reporting units are our restaurant brands. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. We review our goodwill and trademarks for impairment annually, as of the first day of our fourth fiscal quarter, or more frequently if indicators of impairment exist.During fiscal 2021, we elected to perform a qualitative assessment for our annual impairment review of goodwill and trademarks to determine whether or not indicators of impairment exist. In considering the qualitative approach related to goodwill, we evaluated factors including, but not limited to, COVID-19, macro-economic conditions, market and industry conditions, commodity cost fluctuations, competitive environment, share price performance, results of prior impairment tests, operational stability, the overall financial performance of the reporting units and the impacts of discount rates. As it relates to trademarks, we evaluate similar factors from the goodwill assessment, in addition to impacts of royalty rates. Based on the results of the qualitative assessment which considered the improvements of each of our brands’ financial performance, as well as the improved overall operating environment, no indicators of impairment were identified. Changes in circumstances existing at the measurement date or at other times in the future, or in the numerous estimates associated with management’s judgments and assumptions made in assessing the fair value of our goodwill and trademarks, could result in an impairment loss of a portion or all of our goodwill or trademarks.Impairment of our assets, including goodwill or trademarks, adversely affects our financial position and results of operations, and our leverage ratio for purposes of our revolving credit agreement (Revolving Credit Agreement) increases. A leverage ratio exceeding the maximum permitted under our Revolving Credit Agreement would be a default under our Revolving Credit Agreement. At May 30, 2021, additional write-downs of goodwill, other indefinite-lived intangible assets, or any other assets in excess of approximately $1.69 billion would have been required to cause our leverage ratio to exceed the permitted maximum. As our leverage ratio is determined on a quarterly basis, and due to the seasonal nature of our business, a lesser amount of impairment in future quarters could cause our leverage ratio to exceed the permitted maximum. Unearned Revenues Unearned revenues primarily represent our liability for gift cards that have been sold but not yet redeemed. The estimated value of gift cards expected to remain unused is recognized over the expected period of redemption as the remaining gift card values are redeemed, generally over a period of 12 years. Utilizing this method, we estimate both the amount of breakage and the time period of redemption. If actual redemption patterns vary from our estimates, actual gift card breakage income may differ from the amounts recorded. We update our estimates of our redemption period and our breakage rate periodically and apply that rate to gift card redemptions on a prospective basis. Changing our breakage-rate estimates by 50 basis points would have resulted in an adjustment in our breakage income of approximately $2.4 million for fiscal 2021.Income Taxes We estimate certain components of our provision for income taxes. These estimates include, among other items, depreciation and amortization expense allowable for tax purposes, allowable tax credits for items such as taxes paid on reported employee tip income, effective rates for state and local income taxes and the tax deductibility of certain other items. We adjust our annual effective income tax rate as additional information on outcomes or events becomes available. Assessment of uncertain tax positions requires judgments relating to the amounts, timing and likelihood of resolution. As described in Note 12 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report), the $51.8 million balance of unrecognized tax benefits at May 30, 2021, includes $35.9 million related to tax positions for which it is reasonably possible that the total amounts could change during the next 12 months based on the outcome of examinations. Of the $35.9 million, $18.0 million relates to items that would impact our effective income tax rate. LIQUIDITY AND CAPITAL RESOURCES Typically, cash flows generated from operating activities are our principal source of liquidity, which we use to finance capital expenditures for new restaurants and to remodel and maintain existing restaurants, to pay dividends to our shareholders and to repurchase shares of our common stock. Since substantially all of our sales are for cash and cash equivalents, and accounts payable are generally paid in 5 to 90 days, we are typically able to carry current liabilities in excess of current assets. As previously noted, during the fourth quarter of fiscal 2020, all of our restaurants began operating at reduced capacities due to COVID-19 and initially were not able to generate sufficient cash from operations to cover all of our projected expenditures while 33operating at those reduced capacities. Accordingly, we took significant steps to adapt our business, which allowed us to continue to serve guests, support our team members and secure our liquidity position to provide financial flexibility. As state and local governments allowed us to open dining rooms at limited capacities our cash flows improved, and during fiscal 2021 we generated positive operating cash flows and fully repaid our $270.0 million 364-day term loan prior to maturity. Additionally, our Board of Directors declared a cash dividend of $1.10 per share to be paid on August 2, 2021 to all shareholders of record as of the close of business on July 9, 2021.We currently manage our business and financial ratios to target an investment-grade bond rating, which has historically allowed flexible access to financing at reasonable costs. Our publicly issued long-term debt currently carries the following ratings:•Moody’s Investors Service “Baa3”; •Standard & Poor’s “BBB-”; and•Fitch “BBB-”. Our commercial paper has ratings of:•Moody’s Investors Service “P-3”; •Standard & Poor’s “A-3”; and •Fitch “F-3”.These ratings are as of the date of the filing of this report and have been obtained with the understanding that Moody’s Investors Service, Standard & Poor’s and Fitch will continue to monitor our credit and make future adjustments to these ratings to the extent warranted. The ratings are not a recommendation to buy, sell or hold our securities, may be changed, superseded or withdrawn at any time and should be evaluated independently of any other rating.We maintain a $750.0 million Revolving Credit Agreement with Bank of America, N.A. (BOA), as administrative agent, and the lenders and other agents party thereto. The Revolving Credit Agreement is a senior unsecured credit commitment to the Company and contains customary representations and affirmative and negative covenants (including limitations on liens and subsidiary debt and a maximum consolidated lease adjusted total debt to total capitalization ratio of 0.75 to 1.00) and events of default usual for credit facilities of this type. As of May 30, 2021, we were in compliance with all covenants under the Revolving Credit Agreement. The Revolving Credit Agreement matures on October 27, 2022, and the proceeds may be used for working capital and capital expenditures, the refinancing of certain indebtedness, certain acquisitions and general corporate purposes. Loans under the Revolving Credit Agreement bear interest at a rate of LIBOR plus a margin determined by reference to a ratings-based pricing grid (Applicable Margin), or the base rate (which is defined as the highest of the BOA prime rate plus 0.075 percent, the Federal Funds rate plus 0.500 percent, and the Eurocurrency Rate plus 1.075 percent) plus the Applicable Margin. Assuming a “BBB-” equivalent credit rating level, the Applicable Margin under the Revolving Credit Agreement will be 1.075 percent for LIBOR loans and 0.075 percent for base rate loans. As of May 30, 2021, we had no outstanding balances under the Revolving Credit Agreement. At May 30, 2021, our long-term debt consisted principally of: •$500.0 million of unsecured 3.850 percent senior notes due in May 2027;•$96.3 million of unsecured 6.000 percent senior notes due in August 2035;•$42.8 million of unsecured 6.800 percent senior notes due in October 2037; and•$300.0 million of unsecured 4.550 percent senior notes due in February 2048.The interest rate on our $42.8 million 6.800 percent senior notes due October 2037 is subject to adjustment from time to time if the debt rating assigned to such series of notes is downgraded below a certain rating level (or subsequently upgraded). The maximum adjustment is 2.000 percent above the initial interest rate and the interest rate cannot be reduced below the initial interest rate. As of May 30, 2021, no such adjustments are made to this rate. Through our shelf registration statement on file with the SEC, depending on conditions prevailing in the public capital markets, we may issue equity securities or unsecured debt securities from time to time in one or more series, which may consist of notes, debentures or other evidences of indebtedness in one or more offerings. From time to time, we may repurchase our outstanding debt in privately negotiated transactions. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements and other factors. From time to time, we enter into interest rate derivative instruments to manage interest rate risk inherent in our operations. See Note 7 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report). 34A summary of our contractual obligations and commercial commitments at May 30, 2021, is as follows: (in millions)Payments Due by PeriodContractual ObligationsTotalLess Than 1 Year1-3 Years3-5 YearsMore Than 5 YearsLong-term debt (1)$1,554.9 $41.6 $83.2 $83.2 $1,346.9 Leases (2)3,131.4 410.9 756.9 631.2 1,332.4 Purchase obligations (3)693.2 642.4 42.8 8.0 — Benefit obligations (4)357.7 29.4 63.1 68.4 196.8 Unrecognized income tax benefits (5)54.1 37.2 3.8 13.1 — Total contractual obligations$5,791.3 $1,161.5 $949.8 $803.9 $2,876.1 (in millions)Amount of Commitment Expiration per PeriodOther Commercial CommitmentsTotal Amounts CommittedLess Than 1 Year1-3 Years3-5 YearsMore Than 5 YearsStandby letters of credit (6)$99.4 $99.4 $— $— $— Guarantees (7)121.5 34.8 52.9 26.2 7.6 Total commercial commitments$220.9 $134.2 $52.9 $26.2 $7.6 (1)Includes interest payments associated with existing long-term debt. Excludes discount and issuance costs of $9.1 million. (2)Includes non-cancelable future operating lease and finance lease commitments. (3)Includes commitments for food and beverage items and supplies, capital projects, information technology and other miscellaneous commitments.(4)Includes expected contributions associated with our supplemental defined benefit pension plan and payments associated with our postretirement benefit plan and our non-qualified deferred compensation plan through fiscal 2031.(5)Includes interest on unrecognized income tax benefits of $2.3 million, $1.4 million of which relates to contingencies expected to be resolved within one year.(6)Includes letters of credit for $70.5 million of workers’ compensation and general liabilities accrued in our consolidated financial statements and letters of credit for $28.9 million of surety bonds related to other payments. (7)Consists solely of guarantees associated with leased properties that have been assigned to third parties and are primarily related to the disposition of Red Lobster.35Our adjusted debt to adjusted total capital ratio was 55 percent and 61 percent as of May 30, 2021 and May 31, 2020, respectively. Based on these ratios, we believe our financial condition is strong. We include the lease-debt equivalent and contractual lease guarantees in our adjusted debt to adjusted total capital ratio reported to shareholders, as we believe its inclusion better represents the optimal capital structure that we target from period to period and because it is consistent with the calculation of the covenant under our Revolving Credit Agreement. For fiscal 2021 and fiscal 2020, the lease-debt equivalent includes 6.00 times the total annual minimum rent for consolidated lease obligations of $385.7 million and $392.6 million, respectively. The composition of our capital structure is shown in the following table: (in millions, except ratios)May 30, 2021May 31, 2020CAPITAL STRUCTUREShort-term debt$— $270.0 Long-term debt, excluding unamortized discount and issuance costs938.9 939.1 Total debt$938.9 $1,209.1 Stockholders��� equity2,813.1 2,331.2 Total capital$3,752.0 $3,540.3 CALCULATION OF ADJUSTED CAPITALTotal debt$938.9 $1,209.1 Lease-debt equivalent2,314.2 2,355.4 Guarantees121.5 151.5 Adjusted debt$3,374.6 $3,716.0 Stockholders’ equity2,813.1 2,331.2 Adjusted total capital$6,187.7 $6,047.2 CAPITAL STRUCTURE RATIOSDebt to total capital ratio25 %34 %Adjusted debt to adjusted total capital ratio55 %61 %Net cash flows provided by operating activities from continuing operations were $1.19 billion and $717.4 million in fiscal 2021 and 2020, respectively. Net cash flows provided by operating activities include net earnings from continuing operations of $632.4 million in fiscal 2021 and net loss from continuing operations of $49.2 million in fiscal 2020. Net cash flows provided by operating activities from continuing operations increased in fiscal 2021 primarily due to higher net earnings from continuing operations.Net cash flows used in investing activities from continuing operations were $263.7 million in fiscal 2021 compared to net cash flows used in investing activities from continuing operations of $544.0 million in fiscal 2020. Capital expenditures incurred principally for building new restaurants, remodeling existing restaurants, replacing equipment, and technology initiatives were $254.9 million in fiscal 2021, compared to $459.9 million in fiscal 2020. The reduction in capital expenditures during fiscal 2021 was due to COVID-19. Net cash flows used in investing activities for fiscal 2020 also reflect net cash used of $55.8 million in the acquisition of Cheddar’s Scratch Kitchen restaurants from existing franchisees.Net cash flows used in financing activities from continuing operations were $478.9 million in fiscal 2021, compared to net cash flows provided by financing activities from continuing operations of $138.7 million in fiscal 2020. Net cash flows used in financing activities in fiscal 2021 included repayment of $270.0 million from a 364-day term loan, dividend payments of $202.6 million and share repurchases of $45.4 million, partially offset by proceeds from the exercise of employee stock options. Net cash flows providing by financing activities in fiscal 2020 included proceeds of $750.0 million from drawing on our Revolving Credit Agreement, net proceeds of $505.1 million from a follow-on common stock offering, proceeds of $270.0 million from a 364-day term loan and proceeds from the exercise of employee stock options, partially offset by repayment of the $750.0 million drawn from our Revolving Credit Agreement, dividend payments of $322.3 million and share repurchases of $330.3 million.Our defined benefit and other postretirement benefit costs and liabilities are determined using various actuarial assumptions and methodologies prescribed under Financial Accounting Standards Board Accounting Standards Codification Topic 715, Compensation - Retirement Benefits and Topic 712, Compensation - Nonretirement Postemployment Benefits. In April 2018, our Benefit Plans Committee approved the termination of our primary non-contributory defined benefit pension plan (the Retirement Income Plan for Darden Restaurants, Inc.). Plan participants who had not yet begun receiving their benefit payments were provided the opportunity to receive their full accrued benefits from plan assets by either (i) electing immediate lump sum 36distributions or annuities or (ii) deferring commencement of their benefits to a later date. During fiscal 2020, we made a funding contribution of approximately $12.7 million to fully fund the benefit obligation. As of May 31, 2020, all of the plan assets were either (i) distributed to settle the benefits for participants who selected the lump sum option or (ii) transferred to a third-party annuity provider for all other eligible participants. The settlement of the benefit obligation to plan participants in fiscal 2020 resulted in a pre-tax pension settlement charge of $145.5 million recorded in other (income) expense, net in our consolidated statement of earnings. We expect to contribute approximately $0.4 million to our supplemental defined benefit pension plan and approximately $2.0 million to our postretirement benefit plan during fiscal 2022. We are not aware of any trends or events that would materially affect our capital requirements or liquidity. We believe that our internal cash-generating capabilities, the potential issuance of equity or unsecured debt securities under our shelf registration statement and short-term commercial paper or drawings under our Revolving Credit Agreement should be sufficient to finance our capital expenditures, debt maturities and other operating activities through fiscal 2022. OFF-BALANCE SHEET ARRANGEMENTS We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, sales or expenses, results of operations, liquidity, capital expenditures or capital resources. FINANCIAL CONDITION Our total current assets were $1.87 billion at May 30, 2021, compared with $1.10 billion at May 31, 2020. The increase was primarily due to an increase in cash and cash equivalents driven by cash from operations as well as an increase in prepaid income taxes. Our total current liabilities were $1.85 billion at May 30, 2021, compared with $1.79 billion at May 31, 2020. The increase was primarily due to an increase in other current liabilities and accounts payable, partially offset by the repayment of our $270 million term loan in fiscal 2021. APPLICATION OF NEW ACCOUNTING STANDARDS See Note 1 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report) for a discussion of recently issued accounting standards.Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to a variety of market risks, including fluctuations in interest rates, foreign currency exchange rates, compensation and commodity prices. To manage this exposure, we periodically enter into interest rate and foreign currency exchange instruments, equity forward and commodity derivative instruments for other than trading purposes. See Notes 1 and 7 of the Notes to Consolidated Financial Statements (Part II, Item 8 of this report). We use the variance/covariance method to measure value at risk, over time horizons ranging from one week to one year, at the 95 percent confidence level. At May 30, 2021, our potential losses in future net earnings resulting from changes in equity forwards, commodity instruments and floating rate debt interest rate exposures were approximately $74.3 million over a period of one year. The value at risk from an increase in the fair value of all of our long-term fixed-rate debt, over a period of one year, was approximately $72.6 million. The fair value of our long-term fixed-rate debt outstanding as of May 30, 2021, averaged $1.01 billion, with a high of $1.06 billion and a low of $917.3 million during fiscal 2021. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows by targeting an appropriate mix of variable and fixed-rate debt. 37

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