AVANOS MEDICAL, INC. (AVNS) FY 2022 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Avanos is a medical technology company focused on delivering clinically superior medical device solutions that will help patients get back to the things that matter. We are committed to addressing some of today’s most important healthcare needs, including providing a vital lifeline for nutrition to patients from hospital to home, and reducing the use of opioids while helping patients move from surgery to recovery. We develop, manufacture and market our recognized brands globally and hold leading market positions in multiple categories across our portfolio.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide investors with an understanding of our recent performance, financial condition and prospects and should be read in conjunction with the consolidated financial statements contained in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The following will be discussed and analyzed:

•Business Acquisition

•Subsequent Event

•Results of Operations and Related Information

•Liquidity and Capital Resources

•Critical Accounting Policies and Use of Estimates

•Legal Matters

Business Acquisition

On January 20, 2022, we acquired all of the equity voting interests and completed the acquisition of OrthogenRx, which is focused on the development and commercialization of treatments for knee pain caused by osteoarthritis. We expect the acquisition of OrthogenRx will enhance our chronic pain portfolio. The initial purchase price was $130.0 million at closing less working capital adjustments, with up to an additional $30.0 million payable in contingent cash consideration based on OrthogenRx’s growth in net sales during 2022 and 2023. The purchase price was funded by available cash on hand and the proceeds of borrowings, including from the incurrence of a new incremental tranche of term loans of $125.0 million under the Company’s prior senior secured revolving credit facility. The accompanying consolidated income statement for the year ended December 31, 2022 includes $76.2 million of net sales from OrthogenRx since the closing of the acquisition. In the year ended December 31, 2022, we incurred $2.0 million of costs in connection with the OrthogenRx acquisition, which are included in “Selling and general expenses.”

Subsequent Event

In January 2023, we initiated a three-year restructuring initiative pursuant to which we plan to: (i) combine our Chronic Care and Pain Management franchises into a single commercial organization focused on the Digestive Health and Orthopedic Pain & Recovery product categories; (ii) rationalize our product portfolio including certain low-margin, low-growth product categories, through targeted divestitures; (iii) undertake additional cost management activities to enhance the Company’s operating profitability; and (iv) pursue efficient capital allocation strategies, including through acquisitions that meet the Company’s strategic and financial criteria (the “Transformation Process”).

We expect to incur between $20.0 million and $25.0 million of cash expenses in connection with the Transformation Process, consisting of between $9.0 million and $12.0 million of program management consulting and employee retention expenses; between $8.0 million and $11.0 million of expenses associated with manufacturing and supply chain improvements and portfolio rationalization; and the remainder for expenses associated with organizational design and alignment and other related activities. These amounts include between $6.0 million and $8.0 million of employee severance and benefits costs.

We anticipate savings will total approximately $10.0 million in 2023. By 2025, we expect gross savings of between $45.0 million and $55.0 million, most of which will be achieved in 2024.

Results of Operations and Related Information

Use of Non-GAAP Measures

In this section, “Adjusted Operating Profit (Loss),” which is a profitability measure that is not calculated in accordance with accounting principles generally accepted in the United States (“GAAP”), is referred to as a non-GAAP financial measure. We provide this non-GAAP measure because we use it to measure our operational performance and provide greater insight into our ongoing business operations. This measure is not intended to be, and should not be, considered separately from, or an

Table of Contents

alternative to, the most directly comparable GAAP financial measures. A reconciliation of the non-GAAP measure to the most directly comparable GAAP financial measures is provided under “Adjusted Operating (Loss) Profit.”

Change in Accounting Principle

During the third quarter of 2022, we changed our method of accounting for certain inventory from the Last-In, First-Out (“LIFO”) method to the First-In, First-Out (“FIFO”) method. The FIFO method of accounting for inventory is preferable because it conforms our entire inventory to a single method of accounting and improves comparability with our peers. The effects of the change in accounting method from LIFO to FIFO have been retrospectively applied to all periods presented in all sections of this Form 10-K, including this MD&A. Refer to “Accounting Policies” in Note 1 to our consolidated financial statements in Item 8 of this Form 10-K for further information related to the change in accounting principle.

Net Sales

Our net sales are summarized in the following table for the years ended December 31, 2022, 2021 and 2020 (in millions):

______________________________

(a)Volume includes incremental sales from acquisitions.

(b)Other includes rounding.

Product Category Descriptions

Chronic care is a portfolio of products that include the following:

•Digestive health products such as our MIC-KEY enteral feeding tubes, Corpak patient feeding solutions and NeoMed neonatal and pediatric feeding solutions. In the year ended December 31, 2022, our legacy enteral feeding tubes, which includes our MIC-KEY enteral feeding tubes accounted for more than 10% of our consolidated net sales. In the years ended December 31, 2021 and 2020, our legacy enteral feeding tubes and our Corpak feeding solutions each accounted for more than 10% of our consolidated net sales.

•Respiratory health products such as our closed airway suction systems and other airway management devices under the Ballard, Microcuff and Endoclear brands. In the years ended December 31, 2022, 2021 and 2020, our closed airway suction systems accounted for more than 10% of our consolidated net sales.

Pain management is a portfolio of non-opioid pain solutions including:

•Acute pain products such as ON-Q and ambIT surgical pain pumps and Game Ready cold and compression therapy systems. In the year ended December 31, 2022, none of our acute pain products individually accounted for more than 10% of our consolidated net sales. In the years ended December 31, 2021 and 2020, our surgical pain products, which includes both On-Q and ambIT pumps, accounted for more than 10% of our consolidated net sales.

•Interventional pain solutions, which provide minimally invasive pain relief therapies, such as our COOLIEF pain therapy and OrthogenRx’s knee osteoarthritis pain relief injection products. In the years ended December 31, 2022, 2021 and 2020, products associated with our COOLIEF pain therapy accounted for more than 10% of our consolidated net sales.

Net Sales - 2022 Compared to 2021

Table of Contents

Net sales increased by 10.1% to $820.0 million for the year ended December 31, 2022, primarily due to incremental revenue from the OrthogenRx acquisition. Digestive health products experienced strong demand and volume, which was offset by decreased demand and volume in respiratory health products. In addition to volume, 0.7% of favorable pricing was offset by 1.9% of unfavorable foreign currency translation effects.

Net Sales - 2021 Compared to 2020

Net sales increased by 4.2% to $744.6 million for the year ended December 31, 2021. Volume was driven by our pain management franchise due to the recovery of elective surgical procedures and favorable comparison to last year’s net sales which were negatively impacted by the COVID-19 pandemic. In addition, volume benefited from continued robust demand for digestive health, which was partially offset by lower volume in respiratory health due to pandemic-fueled demand experienced last year as well as by pricing/mix.

Net Sales by Geographic Region

Net sales by region is presented in the table below (in millions):

Gross Profit (in millions)

Cost of products sold decreased from $378.8 million to $370.0 million during the year ended December 31, 2022, primarily driven by favorable product mix and slightly improved manufacturing efficiencies, partially offset by higher costs across our supply chain. In the year ended December 31, 2022, gross profit margin increased from 49.1% to 54.9%.

Cost of products sold increased from $343.9 million to $378.8 million during the year ended December 31, 2021, primarily driven by higher freight costs, including air freight, associated with shipping products from China to the United States and delays in returning our manufacturing operations to pre-pandemic efficiency levels. We recorded inventory allowances of $6.8 million, which includes $3.4 million for Halyard-branded products and $3.4 million for inventory associated with restructuring activities. Accordingly, in the year ended December 31, 2021, gross profit margin decreased from 51.9% to 49.1%.

Research and Development (in millions)

Research and development consists primarily of compensation for personnel and expenses for product trial costs, outside laboratory and license fees, the cost of laboratory equipment and facilities and asset write-offs for equipment associated with unsuccessful product launches. Research and development has historically been between 4% and 6% of net sales.

Selling and General Expenses (in millions)

Table of Contents

Selling and general expenses increased from $300.3 million in 2021 to $341.9 million in 2022, driven by higher selling costs, along with consulting costs associated with evaluating and planning for the Transformation Process, compliance costs associated with the EU MDR and higher acquisition-related costs.

In the year ended December 31, 2021, selling and general expenses decreased from $332.6 million in 2020 to $300.3 million in 2021. In 2021, savings were realized from the restructuring activities undertaken in 2020 and continued discipline over spending throughout 2021. The savings realized include lower compensation costs as we reduced the size of our senior leadership team and lower operating costs as we consolidated certain operations within the pain management franchise and reduced our office space footprint. Selling and general expenses included $2.4 million of restructuring expenses in 2021 compared to $4.9 million in 2020.

Other Expense, net (in millions)

Other expense, net decreased from $22.8 million in 2021 to $3.5 million in 2022 primarily due to lower legal costs and completion of the 2020 Restructuring and Post-Divestiture Restructuring plans.

Other expense, net decreased from $51.9 million in 2020 to $22.8 million in 2021 primarily due to lower restructuring costs. In 2020, other expense, net included $20.0 million of restructuring costs associated with our 2020 Restructuring. Other expense, net also includes litigation and legal costs of $15.0 million and $27.5 million in the years ended December 31, 2021 and 2020, respectively. Legal and litigation costs were incurred for matters described in “Commitments and Contingencies” in Note 13 to the consolidated financial statements in Item 8 of this Form 10-K.

Operating Profit (Loss) (in millions)

The items previously described drove operating profit to $74.0 million in the year ended December 31, 2022 compared to operating profit of $10.4 million and operating loss of $48.5 million, respectively, in the years ended December 31, 2021 and 2020.

Table of Contents

Adjusted Operating Profit (Loss)

A reconciliation of adjusted operating profit (loss), a non-GAAP measure, to operating profit (loss) is provided in the table below (in millions):

The items noted in the table above are described below:

On a GAAP basis, operating income increased compared to the prior year due to higher sales, lower legal costs and completion of restructuring activities, partially offset by higher selling costs.

Items impacting operating results include the following:

COVID-19 related expenses: As a result of the ongoing COVID-19 pandemic, we have incurred incremental expenses for additional personal protective equipment for our manufacturing employees, sanitation at our facilities and other costs. We incurred no COVID-19 related costs in the year ended December 31, 2022. We incurred $0.3 million and $7.9 million of COVID-19 related costs in the years ended December 31, 2021 and 2020, respectively.

2020 Restructuring charges: We incurred no 2020 Restructuring-related costs in the year ended December 31, 2022. We incurred $12.4 million and $27.6 million in the years ended December 31, 2021 and 2020, respectively, in connection with the 2020 Restructuring, which we initiated in the fourth quarter of 2020. As of December 31, 2021, restructuring activities associated with the 2020 Restructuring were substantially complete.

Post-Divestiture restructuring and transition charges: These charges were associated with the Post-Divestiture Restructuring Plan, a multi-phase restructuring plan intended to align our organizational structure, IT platform, supply chain and distribution channels to be more appropriate for our business following the Divestiture. We incurred no costs associated with the Post-Divestiture Restructuring Plan in the year ended December 31, 2022. We incurred $14.1 million and $17.1 million of costs in connection with the Post-Divestiture Restructuring Plan for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, these restructuring activities were substantially complete.

Acquisition and integration-related charges: We incurred $3.4 million, $1.6 million and $12.5 million of costs in connection with acquisition and integration activities for the years ended December 31, 2022, 2021 and 2020, respectively. Expenses incurred during 2022 were related to the acquisition of OrthogenRx. Expenses incurred in the prior periods were for integrations of earlier acquisitions. For the year ended December 31, 2020, acquisition and integration-related costs also includes $0.5 million of restructuring costs.

EU MDR Compliance: The EU MDR became effective in 2021 and brings significant new requirements for many of our medical devices. Incremental costs associated with EU MDR compliance are primarily related to re-certification of our products under the enhanced standards. We incurred $6.9 million and $4.0 million of costs related to EU MDR compliance in the years ended December 31, 2022 and 2021, respectively. We expect the activities resulting in incremental costs associated with our initial compliance with the EU MDR to continue through 2024.

Other items: In the year ended December 31, 2022, we incurred $3.8 million of expenses in connection with evaluating and planning for the Transformation Process. These costs consisted of $2.6 million of consulting costs associated with evaluation of overall scope and alternatives for transforming our business, and $1.2 million for the impairment of certain assets associated with research and development projects that were cancelled.

Litigation and legal: We incurred no costs for litigation matters in the year ended December 31, 2022. We incurred $15.0 million and $27.5 million of expenses for certain litigation matters in the years ended December 31, 2021 and 2020,

Table of Contents

respectively, which are included in “Other expense, net.” In 2021, costs include amounts associated with a $22.2 million payment related to a Deferred Prosecution Agreement (the “DPA”) with the United Sates Department of Justice (the “DOJ”), which is described in “Commitments and Contingencies” in Note 13 to the consolidated financial statements in Item 8 of this Form 10-K. In 2020, costs included incremental amounts associated with a $25.0 million payment to amicably resolve a dispute with Kimberly-Clark described in “Commitments and Contingencies” in Note 13 to the consolidated financial statements in Item 8 of this Form 10-K.

Intangibles amortization: Intangibles amortization is related primarily to the amortization of intangibles acquired in prior business acquisitions and was $25.7 million, $16.7 million and $19.4 million, respectively, in the years ended December 31, 2022, 2021 and 2020. The increase in amortization in the year ended December 31, 2022 is due to incremental amortization of intangibles acquired with OrthogenRx in early 2022.

Our non-GAAP measures excludes certain items, as applicable, for the relevant time periods as indicated in the “Operating Profit” table above. The excluded items include:

•Incremental expenses associated with altering operations in response to the COVID-19 pandemic.

•Expenses associated with restructuring activities, including IT-related charges.

•Expenses associated with post-Divestiture transition activities.

•Certain acquisition and integration charges related to the acquisitions of OrthogenRx, Game Ready, NeoMed, Summit and Endoclear.

•Expenses associated with EU MDR compliance.

•Expenses associated with other unusual items such as consulting costs associated with evaluating transformational restructuring or other strategies or asset impairment charges for cancelled research and development projects.

•Expenses associated with certain litigation matters.

•The amortization of intangible assets associated with prior business acquisitions.

Interest Expense

Interest expense was $10.0 million, $3.3 million and $15.6 million in the years ended December 31, 2022, 2021 and 2020, respectively. In the year ended December 31, 2022, interest expense includes an early extinguishment loss of $1.1 million incurred upon terminating our Prior Credit Agreement (as defined below) on June 24, 2022. In the year ended December 31, 2020, interest expense includes an early extinguishment loss of $1.3 million incurred upon redemption of our Senior Secured Notes on October 15, 2020. In each of the years ended December 31, 2022, 2021 and 2020, $0.1 million of interest was capitalized on long-term capital projects.

Interest expense consists of interest accrued and amortization of debt discount and issuance costs on our long-term debt. Accordingly, interest expense was higher in 2022 compared to 2021 due to establishment of our new Credit Agreement (as defined below). See “Debt” in Note 8 to the consolidated financial statements in Item 8 of this Form 10-K for further discussion of our indebtedness, our Prior Credit Agreement and our new Credit Agreement.

Provision for Income Taxes

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), enacted in March 2020, allows for the carryback of U.S. net operating losses, which were expected to be used in future years to prior years, resulting in a $3.8 million, $2.8 million and $25.1 million benefit in the years ended December 31, 2022, 2021 and 2020, respectively. As a result, as of December 31, 2022, we had $3.8 million of income tax receivables.

Our overall effective tax rate was 22.5% for the year ended December 31, 2022 compared to a rate of 13.7% in 2021 and 53.9% in 2020. The primary driver in the change in our effective tax rate was the CARES Act in 2020. See “Income Taxes” in Note 9 to the consolidated financial statements in Item 8 of this Form 10-K for further details regarding our income taxes.

Liquidity and Capital Resources

General

Our primary sources of liquidity are cash on hand provided by operating activities and amounts available with our revolving credit facility under our existing credit agreement. Our operating cash flow has historically been sufficient to meet our working capital requirements and fund capital expenditures. We expect our operating cash flow will be sufficient to meet our working capital requirements and fund capital expenditures in the next twelve months. In addition, with our borrowing capacity, we

Table of Contents

expect to have the ability to fund capital expenditures and other investments necessary to grow our business for the foreseeable future for both our domestic and international operations.

As of December 31, 2022, $54.7 million of our $127.7 million of cash and cash equivalents was held by foreign subsidiaries. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested and currently do not have plans to repatriate such earnings. See further discussion below in “Critical Accounting Policies and Use of Estimates” under “Income Taxes.” We do not expect restrictions on repatriation of cash held outside of the United States to have a material effect on our overall liquidity, financial condition or results of operations for the foreseeable future.

Cash and equivalents increased by $9.2 million to $127.7 million as of December 31, 2022 compared to $118.5 million last year. The increase was driven by $90.9 million of cash provided by operating activities, $250.0 million of proceeds from our secured debt and $150.0 million of proceeds from our revolving credit facility partially offset by payments on our prior credit agreement including $126.6 million on our secured term loan and $170.0 million on our revolving credit facility, $116.1 million of cash used for the acquisition of OrthogenRx, $45.5 million used to repurchase shares of our common stock and $19.3 million of capital expenditures.

Cash and equivalents increased by $7.0 million to $118.5 million as of December 31, 2021 compared to $111.5 million as of December 31, 2020. The increase was driven by $87.3 million of cash provided by operating activities and $20.0 million of proceeds from our revolving credit facility partially offset by $70.0 million of repayments on our revolving credit facility, $21.0 million of capital expenditures and $11.5 million used to purchase treasury stock.

Long-Term Debt

On June 24, 2022, we entered into a credit agreement (the “Credit Agreement”) with certain lenders which established credit facilities in an aggregate principal amount of $500.0 million, consisting of a five-year senior secured term loan of $125.0 million (the “Term Loan Facility”) and a five-year senior secured revolving credit facility allowing borrowings of up to $375.0 million, with a letter of credit sub-facility in an amount of $75.0 million (the “Revolving Credit Facility”). All obligations under the Credit Agreement and certain hedging agreements and cash management arrangements thereunder are: (i) guaranteed by each of the Company’s direct and indirect, existing and future, material wholly owned domestic subsidiaries (“Guarantors”) and (ii) secured by a first priority lien on substantially all the assets of the Company and the Guarantors. The Credit Agreement contains an accordion feature that allows us to incur incremental term loans under the Term Loan Facility or under new term loan facilities or to increase the amount of the commitments under the Revolving Credit Facility, including through the establishment of one or more tranches under the Revolving Credit Facility. The Credit Agreement will mature on June 24, 2027.

Borrowings under the Term Loan Facility and Revolving Credit Facility bear interest at our option at either: (i) an adjusted term secured overnight financing rate (“SOFR”), plus a margin ranging between 1.50% to 2.00% per annum, depending on our consolidated total leverage ratio; (ii) an adjusted daily simple SOFR rate, plus a margin ranging between 1.50% to 2.00% per annum, depending on our consolidated total leverage ratio; or (iii) a base rate (calculated as the greatest of (a) the prime rate, (b) the NYFRB rate (being the greater of the federal funds effective rate or the overnight bank funding rate) plus 0.50%, and (c) the one month adjusted term SOFR rate plus 1.00%), plus a margin ranging between 0.50% to 1.00% per annum, depending on our consolidated total leverage ratio. The unused portion of the Revolving Credit Facility will be subject to a commitment fee ranging between 0.20% to 0.25% per annum, depending on our consolidated total leverage ratio. Unamortized debt discount and issuance costs are being amortized to interest expense over the life of the Term Loan Facility using the interest method, resulting in an effective interest rate of 6.5% as of December 31, 2022.

In connection with entering into the Credit Agreement, we terminated the Amended and Restated Credit Agreement dated as of October 30, 2018 by and among the Company, the lenders thereunder and Citibank N.A., as administrative agent (as amended and supplemented, the “Prior Credit Agreement”).

The Credit Agreement requires compliance with certain customary operational and financial covenants. As of December 31, 2022, we were in compliance with all of our debt covenants.

For further information regarding our debt arrangements, see “Debt” in Note 8 to the consolidated financial statements in Item 8 of this Form 10-K.

Share Repurchase Program

On December 15, 2021, we announced that our Board of Directors had approved a share repurchase program authorizing us to repurchase up to $30 million of our common stock. In the fourth quarter of 2021, we repurchased $10.7 million, and during the first quarter of 2022, we repurchased the remaining $19.3 million.

On May 16, 2022, the Board of Directors approved a new one-year program authorizing us to repurchase up to $25.0 million of our common stock. In connection with such repurchase program, we established a pre-arranged trading plan in accordance with

Table of Contents

Rule 10b5-1 which permitted common stock to be repurchased over a twelve-month period. Under this program, during the second quarter of 2022 we repurchased $14.1 million of our common stock, and during the third quarter of 2022 we repurchased the remaining $10.9 million.

For further information, see “Share Repurchase Program” in Note 16 to the consolidated financial statements in Item 8 of this Form 10-K.

Contractual Obligations

In the normal course of business, we enter into contracts and commitments that obligate us to make payments in the future. Information regarding our obligations under lease and debt arrangements and defined benefit plans are provided in Notes 6, 8, and 10, respectively, to the consolidated financial statements contained in Item 8 of this Form 10-K. For obligations under our purchase arrangements which consist mostly of open purchase orders and other commitments, as of December 31, 2022, we have amounts due in less than one year of $76.3 million, $14.3 million in one to three years, and zero thereafter.

Critical Accounting Policies and Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. The critical accounting policies we used in the preparation of the consolidated and financial statements are those that are important both to the presentation of our financial condition and results of operations and require significant judgments by management with regard to estimates used. The critical judgments by management relate to distributor rebate accruals, future cash flows associated with impairment testing for goodwill and long-lived assets, loss contingencies and deferred income taxes and potential tax assessments.

Use of Estimates

We prepare our consolidated financial statements in accordance with GAAP, which requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting periods. Estimates are used in accounting for, among other things, certain amounts included in discontinued operations, certain amounts included in assets and liabilities held for sale, distributor rebate accruals, future cash flows associated with impairment testing for goodwill and long-lived assets, loss contingencies, and deferred income taxes and potential income tax assessments. Our estimates are subject to uncertainties associated with the ongoing COVID-19 pandemic. Actual results could differ from these estimates, and the effect of the change could be material to our financial statements. Changes in these estimates are recorded when known.

Revenue Recognition

Sales revenue is recognized at the time of product shipment or delivery of our products to unaffiliated customers, depending on shipping terms. Accordingly, control of the products transfers to the customer in accordance with the transaction’s shipping terms. Sales revenue is recognized for the amount of considerations that we expect to be entitled to receive in exchange for our products. Sales are reported net of returns, rebates, incentives, each as described below, and freight allowed. Taxes imposed by governmental authorities on our revenue-producing activities with customers, such as sales taxes and value-added taxes, are excluded from net sales. Our contracts provide for forms of variable consideration including rebates, incentives and pricing tiers, each of which are described further in Note 1 “Accounting Policies” in Item 8 of this Form 10-K.

Loss Contingencies

The outcome of loss contingencies, legal proceedings, indemnification matters and claims brought against us is subject to uncertainty. An estimated loss contingency is accrued by a charge to earnings if it is probable that an asset has been impaired or a liability has been incurred and the amount can be reasonably estimated. Determination of whether to accrue a loss requires evaluation of the probability of an unfavorable outcome and the ability to make a reasonable estimate. Changes in these estimates could affect the timing and amount of accrual of loss contingencies.

Income Taxes

We recognize tax benefits in our financial statements when our uncertain tax positions are more likely than not to be sustained upon audit. The amount we recognize is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

We recognize deferred tax assets for deductible temporary differences, operating loss carry-forwards and tax credit carry-forwards. We record valuation allowances to reduce deferred tax assets to amounts that are more likely than not to be realized. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected

Table of Contents

future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. This assessment, which is completed on a taxing jurisdiction basis, takes into account a number of types of evidence, including the nature, frequency, and severity of current and cumulative financial reporting losses, sources of future taxable income, taxable income in prior carryback year(s) and tax planning strategies.

If it is determined that we would be able to realize deferred tax assets in the future in excess of our net recorded amount, an adjustment to the net deferred tax asset would increase income in the period that such determination was made. Likewise, should we determine that we would not be able to realize all or part of the net deferred tax assets in the future, an adjustment to the net deferred tax asset would decrease income in the period such determination was made. We regularly evaluate the need for valuation allowances against its deferred tax assets.

As of December 31, 2022, we have accumulated undistributed earnings generated by our foreign subsidiaries of approximately $34.5 million. Certain earnings were previously subject to tax due to the one-time transition tax of the Tax Cuts and Jobs Act of 2017. Any additional impacts due with respect to the previously-taxed earnings, if repatriated, would generally be limited to foreign withholding tax, U.S. state income tax and the tax effect of certain foreign exchange adjustments. We intend, however, to indefinitely reinvest these earnings and expect future U.S. cash generation to be sufficient to meet U.S. cash needs. At this time, the determination of deferred tax liabilities on the amount of financial reporting over tax basis is not practicable.

Legal Matters

A description of legal matters can be seen in “Commitments and Contingencies” in Note 13 to the consolidated financial statements in Item 8 of this Form 10-K.